What Is a Business Entity?
A business entity in accounting is the designation for a company or corporation with its separate existence.
A business entity account shows all types of transactions affecting this independent legal identity, whether profits and losses from operations, dividends received, capital investments made by owners, etc.
Types of Business Entities
There are several types of business entities. The common ones are:
In a sole proprietorship, the owner of the company takes all the risks and enjoys full benefits from the operation.
This type of entity is very simple to set up and easy to liquidate.
However, this structure lacks business continuity in case the owner dies or decides to retire from business. This means that there is no separation between the assets of a sole proprietor and their personal assets.
It is an association of two or more persons who run a business together.
This type of entity has similar features to a sole proprietorship in terms of low cost, ease of creation, and simple operation.
General Partnership does not have legal existence apart from the partners who are personally liable for any debts incurred by the partnership business.
Partnerships are easy to create and dissolve, but it lacks business continuity. Upon the death of a partner, its assets become part of his estate or pass to heirs as per law.
This is a business with two types of partners, general and limited.
The general partner manages the company’s affairs, while the limited partner is only liable for his investment in the partnership business.
Limited Partnership has similar merits to General Partnership.
It offers more protection from debts incurred by the company because they are divided between general and limited liability partners according to their contribution.
C Corp is a business entity with legal existence apart from its owners.
C Corp offers more flexibility in terms of operation, management, and financial arrangements for investment purposes because it separates the personal assets of shareholders or investors from their investments.
For example, if one shareholder invests $20,000 into a corporation, he is personally not responsible for the corporation’s debt that exceeds $20,000.
In C Corporation, shareholders are liable only for the amount they invest and no more than this.
S Corp is a business entity that combines features of C Corporation and Limited Partnership.
It has a similar advantage to C Corp in terms of liability, where shareholders are not liable for the company’s debt up to their contribution.
Still, it also allows more types of financial arrangements like limited partners in the case of Limited Partnership.
This type of business entity has a pass-through taxation feature where the company’s profits are passed directly to shareholders, who then declare it as part of their gross income.
They also have to pay personal income tax for that amount.
Limited Liability Company
LLC is a business entity with tax and liability features of Limited Partnership and C Corporation.
LLC has a legal existence like C Corp, but it also allows flexibility in operation, management, types of investors, or owners.
It also protects its members from personal liabilities for company debts up to their contribution, unlike Limited Partnership, where partners are liable for all types of debts incurred by the business.
You can choose how you want to structure your LLC legally. You have two options, either as a C corporation or pass-through entity on taxes.
The types of business entities mentioned above are just a few examples available to entrepreneurs who wish to start their businesses.
Still, before making any decision, entrepreneurs should consult with an attorney or tax adviser specializing in this area to avoid making any mistakes in the early stages of business operation.
The Importance of Choosing the Business Entity Type
There are various types of business entities out there, and each one is suitable for certain types of businesses.
It is important to choose the right type of business entity because it will serve as the basis for the operation of your company in terms of management, financial arrangements, taxation issues, and protection from liabilities.
In other words, failure to understand the types of business entities available and the rules that apply to them will place your business at risk.
Before making any decision on what type of entity you wish to choose for your company, it is highly recommended to consult with a professional tax adviser or an attorney.
Types of business entities are divided according to the laws in certain states, and each state has its own types, so it is crucial for entrepreneurs not to make mistakes at the early stages.
How to Set Up a Business Entity?
Below are the steps you need to take to set up a business entity:
1) Make sure you understand the types of business entities available.
This is important because if you fail to choose the right type, your business may face serious problems in terms of taxation and management, which can lead it to failure even before its launch.
You should also consult with a professional tax adviser or attorney to avoid making mistakes at this initial stage.
2) Determine which business entity is right for your company.
It is important to determine which type your company will fall under because this decision will serve as the basis for the operation of your company in terms of taxation issues, management types, etc.
3) Check the requirements for types of business entities in your state.
It is essential to check what types of business entities are available and which ones you will be able to choose from.
Types of business entities vary between states, so make sure you understand all legal requirements before making any final decision on this matter.
4) Choose the name of your business entity.
After types of business entities are chosen, you will need to choose a name that goes with it so as not to have any problems with legality and other issues related to company identity in the future.
When Should You Change Your Business Entity Type?
In case it turns out that the types of business entity chosen were not suitable after a period of time, entrepreneurs should consider changing them to avoid any serious problems that may arise from this situation.
This means that types of business entities should be changed if they are no longer suitable, and the main criteria are to choose types that will always fit your company regardless of the situation.
Nowadays, the types of business entities mentioned above are widely used, but only every type fits certain types of businesses, so it is important to make the right choice for a business to achieve success.
About the Author
True Tamplin, BSc, CEPF®
True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.
True is a Certified Educator in Personal Finance (CEPF®), a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.