There are various characteristics that distinguish the various business entities, including: formation, maintenance, ownership, control, personal liability protection of owners, compensation of owners, and taxation of owners. Given the option to design a new legal entity, it would be nice to be able to choose all of the most favorable provisions of each business entity and combine them into one entity. Of course, not all businesses have the same needs for its business entity. As such, this new business entity would need to provide options to the organizer regarding the most desirable characteristics. Below we discuss the most desirable characteristics of each business entity.
The easiest business entity to form is a general partnership. It arises simply by partners carrying on a commercial activity and sharing the profits or losses. The parties do not even have to realize that they have created a partnership. All other types of business entity must be filed with the state government where the business is organized and/or doing business. Allowing for the creation of a business entity without filing documents with the state government would be quite advantageous.
Every state requires business entities make annual filings with the appropriate state office. This generally entails updating any changes in company structure and paying a filing fee. Some states require additional filings, such as company financial statements. Other companies charge franchise taxes or other sorts of fees. Exempting a new entity from the annual reporting requirements would be a positive attribute for company owners.
Ownership & Control
A unique characteristic of certain business entities (LLCs and Corporations) allows a distinct separation from ownership and control. They also allow for the creation of varying classes of ownership interest. The different classes allow the company to provide specific benefits to different owners. This is especially beneficial when the company goes through multiple rounds of equity investment. Developing an easy method of authorizing multiple classes of ownership without revising or restating the organizing documents would be very beneficial. It would certainly make the equity funding process easier.
Allowing predefined control structure would ease the burdens of organizing company management. Corporations have a very defined corporate control structure. Limited liability companies, on the other hand, do not. Allowing for flexibility but uniformity in the design of company structures would easy the organizational burdens on founds.
Limited Personal Liability
Some entities exist independently of the owners. This allows the entity to shield the owner from personal liability for company debts. So, if the company becomes subject to a large debt and cannot pay, the creditors cannot reach the personal assets of the owners. The creditor is limited to collecting against the assets of the company.
Currently, some business entities allow for company profits or losses to flow through to the owners. The owners report these profits or losses on their personal income tax returns. Other business entities, specifically C-corporations, are required to pay taxes at the entity level. Most businesses that qualify for pass-through tax status choose that option. Unfortunately, those options become unavailable when the company fails to meets certain ownership requirements. In developing a new entity, it would greatly benefit owners to establish a pass-through tax structure.
In some types of entities, the owners cannot receive a salary for services to the company. Rather, the owner must receive compensation in the form of a share of profits or available capital (generally referred to as a “draw”). Allowing owners to receive a salary for their services to the company independent of their share of company profits would be very advantageous.
Designing a hypothetical business entity is a fun exercise. In reality, most of the desired attributes can be achieved with appropriate legal and tax planning. The legal professionals at LawTrades are experts in matters of business organization and structuring. They can provide all of the guidance and services necessary to design your company structure to meet your business needs.