The selection of a business entity is the first and foremost step to your dream of establishing a successful business. But as we say, often the first step is the most difficult step. Individuals get very confused in selecting the right entity for their proposed or an existing business. Selection of an appropriate entity is very important to build a smooth road ahead for your business. Generally a person depends on five criteria’s for selecting the most appropriate form of business entity for his business. The five criteria are defined below-:
i. Formation Process
ii. Liability of the Business Owner
iii. Taxation of the Entity
iv. Statutory Compliance of the Entity
v. Mechanism to infuse funds into the Business Entity
The above five criteria’s are considered as the most important factor for deciding the most appropriate business entity. The US allows the business owners to form different types of entities for starting their own business depending upon state to state. The most commonly form of entities which is recognised in the US is as follows-:
i. Sole Proprietorship
ii. Partnership
iii. Limited Liability Company (LLC)
iv. Corporation
Sole Proprietorship is the simplest form of organisation where an individual can start his business without any form of registration. Partnerships are used when two or more individuals want to start a business with the motive of earning profit which is to be decided on a mutual basis. LLC combines the attributes of both Partnership and Corporation where the liability of the members are unlimited but the formation process and compliance part is more or less similar to that of Corporation. Corporation on the other hand offers the benefit of unlimited liability and is commonly used to raise funds from different sources.
Based on the above five criteria, the segregation of the entity has been done where Sl No. 1 implies the most preferable entity for a particular criteria and Sl No.4 denotes the least preferable entity for the selected criteria.
| Sl No. | Formation Process | Liability of the Business Owner | Taxation | Statutory Compliance | Raise Funds |
| 1 | Sole Proprietor-ship- No Registration required to start the business | Corporation – Liability is unlimited | Sole Proprietor-ship- Only personal Tax | Sole Proprietor-ship- Very less regulatory compliance | Corporation- Can raise funds from various sources |
| 2 | Partnership- Agreement of Partnership is sufficient to start the business | LLC- Liability is unlimited although flexibility is less than Corporation. | LLC- Option to choose between personal and corporate tax | Partnership- Simple compliance but more than sole proprietorship | LLC- Funds can be raised from members only*** |
| 3 | LLC- Articles of Organisation and Operating Sheet, in case of some states, is required to start the business | Partnership- Liability is unlimited in general partnerships and in other forms it may be limited* | Partnership- Personal Tax | LLC- Compliance has to be done on various aspects | Partnership- Funds can be raised only from partners*** |
| 4 | Corporation- Require Compulsory registration and various documents before starting the business | Sole Proprietor-ship- Liability is unlimited of the individual | Corporation- Corporate Tax. And individual liable to pay tax in their own hands too except in case of S-Corp** | Corporation- Compliance burden is heavy as many statutory documents need to be maintained. | Sole Proprietor-ship– Only own capital can be infused |
* Partnerships are also divided between three categories. This are as following
i. General Partnerships– Liability of all members are unlimited
ii. Limited Partnership– Liability of certain members are limited and certain members are unlimited.
iii. Limited Liability Partnership (LLP) – Liability of all members are unlimited. The difference between LLP and LLC is that LLP’s are easy to form as compare to LLC. Also compliance requirements are less in LLP. On contrary LLC has an option to choose between its taxation system i.e whether it want to opt for personal taxation or corporate tax. Also LLC can be formed even with 1 member whereas LLC couldn’t. Also choosing between LLP and LLC depends upon the state also where you want to start your business.
** Corporations are generally formed as C-Corp where corporate tax is to be paid by C-Corp and profit has to be distributed to shareholders in the form of dividends, where again dividend will be taxed in the hands of the shareholders. However there is also an option to follow S-Corp rule where the organisation needs to be eligible to become a S-Corp. If an organisation becomes eligible to become S-Corp, then it can follw pass through taxation where tax has to be paid by only members and corporation won’t be require to pay any taxes.
*** Entities have been segregated on the criteria of raising of funds assuming that the funds is to be raised by only the owners of the organisation. The raising of funds through borrowings can be done in every form of entities depending upon the relevant statue guiding such entity.
Thus each entity has its own pros and cons. Selection of the entity depends on the case of the individual. However if you are still confused on choosing the right form of entity, then below is a brief case study on the same.
| Case | Best Form of Entity |
| If you are an individual who is starting his first business or don’t have any experience in the business line | Go for sole proprietorship. After you have gain enough experience and ready to expand your business, then form a LLC. |
| If two or more than two individual have started to form business, with minimum or no experience | Go for General Partnership, if you don’t want any statutory compliance for the time being. However if you are ready to handle few statutory compliances, then go for Limited Liability Partnership. In future if you want to expand and raise funds from various sources then go for Corporation |
| If you have a good start up or a business idea and for that you would require funds from various sources | Go for Corporation. S-Corp allows maximum of 100 shareholders and only US residents are eligible to become a shareholder of S-Corporation. If you can fit in this criterion, then S-Corp would be best suited for you. Otherwise forma C-Corp. |
Thus it can be seen that selection of a business entity is very important otherwise you may get struck in statutory compliances or miss on a big opportunity in spite of having a very good idea. Hence it is important to follow due diligence before selecting the right form of entity for your business organisation.
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