What is an entity in business? As a business person, what comes to mind when you hear the word “entity”? Do you know what entity is in business and its different types?
If you don’t, do not worry; this article will enlighten you about an entity in business.
Understanding the different types of entities in business will help you run your business better and know the best entity to create when starting a new business.
Keep reading to find out more.
What Is Entity? – What Is an Entity in Business
An entity or business entity is any organization established by one or more persons to operate a given business or engage in trades or related activities.
One can also call it a business structure.
An entity is registered and created by filling out documents at state agencies.
So, you should follow the state laws and regulations required to establish a business entity in your state.
Also, you have to pay the obligatory fees needed to set up your business legally.
The business entity you decide to establish determines your organizational structure and the documents you are to file.
It will also determine liability, taxes, and how to pay them.
The right entity to set up also depends on the number of business owners and the type of business you’re intending to operate.
Purposes for Forming Business Entities – What Is Entity in Business
Generally, people establish business entities for four purposes which are:
Business Owners Protection
Some types of business entities, when properly created and operated, provide distinction for their owners.
In other words, it legally separates the business entity from the business owners.
As a result, when a business faces legitimate issues and actions, the owners are not liable.
However, this doesn’t protect the owners from legal responsibility that comes about due to personal actions they take or personal benefits.
Structured Operations of Business – What Is Entity in Business
Some business entities need to have clear dictation of how the organization will be run.
This dictation or provision can be documented or verbally stated.
However, it helps to determine the business’s internal governance, provide structure, and avert disputes or conflicts between owners.
The image of a business is essential to its success.
Forming a proper business entity gives your business a good and professional image.
This will boost customer confidence in your business and its products and services.
Saving Taxes – What Is Entity in Business
Depending on a business’s size, expenses, and profitability, owners can save more of their taxes when choosing an appropriate entity for their business.
You should seek tax professionals’ advice before setting up your business.
Types of Business Entities – What Is Entity in Business
There are mainly four types of business entities, and they include:
A sole proprietorship is a business owned and controlled by an individual.
It is the easiest business to establish.
One reason is that you can choose not to register with your state.
However, depending on the industry you are venturing into, you may need to apply for a business license or permit from the local government.
An example of a sole proprietorship business is a consultant or freelancing business.
Features of Sole Proprietorship – What Is Entity in Business
The following are some features of sole proprietorships:
A core feature of sole proprietorships is that it has only one owner.
Although you might have a couple of employees, you are still the owner.
You have total authority over the business’s governance, operations, and management.
This helps to prevent disputes that often arise in business entities with two or more owners.
Simplicity – What Is Entity in Business
A sole proprietorship business is the simplest of all the different business entities.
As a result, it is the commonest type of business entity in various locations.
It has a simple setup, management, operation, and also dissolution.
Additionally, sole proprietorship taxation is simple.
Sole proprietorships don’t provide a legal separation identity for their owners.
As a result, sole proprietors don’t need to file business tax returns.
Instead, the business income tax is the same as the owner’s income tax.
As a sole proprietor, all your profit goes to your account, and you don’t need to share with any partner.
Of course, a sole proprietor will pay their employees’ wages and benefits.
However, they don’t share the profit the business produces.
So, sole proprietors can decide to invest their profits back into the business or increase their salary.
Unlimited Liability – What Is Entity in Business
Another top feature of sole proprietorships is that they have unlimited liability.
Unlimited liability connotes that owners are personally responsible for all the liabilities and debts of the business.
Furthermore, the business doesn’t have a separate legal identity from its owner.
In other words, the business and its owner are the same.
Consequently, anything that happens to the owner happens to the business and vice versa.
For example, if the owner dies or goes bankrupt, the business will cease to exist.
Also, if the business is in debt and unable to repay it, the owner’s assets will be at risk as they might need to sell some of them off to cover the debt.
Sole proprietorships are familiar for their minimal formality.
Unlike other business entities, sole proprietorships don’t require several documents and reports to register.
In most cases, a business license or permit from local agencies is what you need for your business.
Pros of Sole Proprietorships – What Is Entity in Business
When you opt for a sole proprietorship, here are some of the amazing advantages you will enjoy:
Easy to Establish/ Wind Up
Due to its minimal formality and simplicity, you can easily establish sole proprietorship businesses.
With a business license or permit from local agencies, you are ready to kick-start your business.
Also, you can set your sole proprietorship running in no time with a small capital.
Just as it is easy to establish, it is also easy to close down because you have all the authority to do so.
Quick Decision and Action – What Is Entity in Business
In a sole proprietorship, you can make decisions and implement rules or tasks faster.
For other business entities, you might need other owners’ agreements before deciding on something and taking action.
But as a sole proprietor, you don’t need any other person’s consent before making decisions.
As a sole proprietor, you earn all the profits as you bear all the risk.
Therefore, your effort shares a direct connection with your reward.
In other words, your hard work, efficiency, and productivity determine how high or low your profit will be.
This helps to motivate you to do well, especially as you know you will be getting all the rewards.
Cons of Sole Proprietorships – What Is Entity in Business
The best things have their drawbacks.
This applies to sole proprietorships too.
So, when checking out the advantages, also consider the disadvantages to see if it is best for you.
The following are some of the cons of sole proprietorships:
The great downside to sole proprietorships is the unlimited liability that comes with it.
When the business faces debts, you will have to take the fall by using your assets to sort out those debts.
Since you are in charge of paying your business debts and obligations, this can make you too cautious and less interested in taking on risks that could help grow your business.
Limited Capital – What Is Entity in Business
Most sole proprietorships start their business through bootstrapping.
The owner generates all the capital without getting investments.
It can be difficult for one person to gather substantial capital.
Limited capital can make business owners struggle to make needed improvements or expansions.
Sole proprietorships have no separate identity from their owners.
In the case of death, insolvency, or bankruptcy of the owner can lead to the end of the business.
Therefore, sole proprietorships have no continuity.
Partnership – What Is Entity in Business
Partnerships are business entities established by two or more persons.
The people who form a partnership are partners in business.
They agree on how to manage the business and how they share the losses and profits among themselves.
The agreement can either be in a file or oral.
Partnerships are unincorporated businesses.
In other words, they don’t possess separate legal identities from their owners.
In addition, the owners bear full responsibility for the business action or inaction.
So, the owners can sue or be sued for their businesses’ inactivity or activity.
Partnerships have two categories: general partnership and limited partnership.
General Partnerships (GPs) – What Is Entity in Business
General partnerships closely resemble sole proprietorships.
This is because, just like sole proprietorships, owners are not to register general partnerships with the state.
Also, depending on the industry chosen, owners might have to get business permits and licenses to operate.
Despite these similarities, the number of owners differentiates sole proprietorships from general partnerships.
Where sole proprietorships have one owner, general partnerships have two or more owners.
In several states, general partnerships are formed when all the members sign a partnership agreement.
Pros of general partnerships:
- They are easy to establish and dissolve due to the lack of state registration
- Business losses can be deducted from the owners’ tax returns
- All partners shared every loss and profit of the business
- No corporate paperwork and formalities are necessary for setting up
- Less stress for one person as several partners will be working together to establish and grow the business
Cons of general partnership:
- Every member is liable for business liabilities and debts.
- It is challenging to build business credit or get loans as an unregistered entity.
- All owners are jointly and severally liable.
- Disputes between the owners can disrupt the business.
- There is no continuity, as partnerships dissolve automatically should one partner die.
- Each owner has independent authority over the business contracts and loans.
Limited Partnerships (LPs) – What Is Entity in Business
A limited partnership is a form of partnership with a general partner who oversees and manages the business operations and limited partners who don’t.
The general partner of this form of partnership is liable for the business’s debts and liabilities.
Meanwhile, the limited partners merely invest in the business and have little authority over the business’s operational process.
Also, they have limited liability up to their investment amount.
In other words, limited partners only share in the business profits, not its liability or losses.
Further, LPs are required to file returns reporting the business’s gains, losses, income, and deductions.
However, they don’t file income taxes.
Pros of LPs:
- First, raising money for the business is easier as shareholders can become partners without becoming liable for business losses.
- The general partner controls the business operations even after a limited partner funds it.
- The partnership can still exist and operate even if limited partners withdraw.
Cons of LPs:
- A general partner solely bears all the business liabilities and debts.
- Limited partnerships set up are more expensive than general partnerships as LP businesses are required to state fillings.
- Limited partners of LPs who actively play a role in the business face the risks of personal liability.
Individuals establish this business entity to generate profit from business operations.
Corporations can be sued, sue others, make contracts, own assets, loan funds from institutions, and remit state and federal taxes.
To create a corporation, you will undergo the legal process referred to as incorporation.
During this process, you will fill out drafted legal documents entailing your business’s primary purpose, location, name, the figure of your business shares, and the kind of stock you issue.
This incorporation process gives corporations a distinctive feature that legally protects their owners from business lawsuits or debts.
Types of Corporations – What Is Entity in Business
Corporations are categorized into the following :
This is an incorporated business that is most known.
C Corporation contains most of a corporation’s attributes, unlike the other corporation.
The owners gain profits and are only taxed as individuals.
Meanwhile, the business gets taxed separately.
Pros of C Corporation:
- The owners enjoy limited liability.
- It is easier to get capital.
- You can quickly transfer ownership.
- Some business expenses are deductible from its tax.
- C Corporation can continue existing after the owners’ death.
Cons of C Corporation:
- It has several federal and state regulations to follow.
- C corporation is expensive to form.
- The profits of corporations are double taxed.
S Corporation – What Is Entity in Business
S Corporation is also created like C Corporation.
However, the difference can come from its tax purposes and owner limitations.
S Corporations can have as many as 100 shareholders.
Also, they are not taxed separately, as the shareholders shoulder the profits and losses with their income tax returns.
Pros of S Corporation:
- Firstly, you can avoid double taxation.
- Owners are not liable for business debts or liabilities.
- Also, you can quickly transfer your shares.
- S Corps can continue exiting after the death of their owners.
- Lastly, owners enjoy tax-free benefits.
Cons of S Corporation:
- There is a limited maximum of 100 shareholders in an S corps.
- The shareholder types are limited.
Limited Liability Companies (LLC) – What Is Entity in Business
An (LLC) limited liability company is a business entity that protects its owners from being legally responsible for the business’s debts and liabilities.
This entity is considered a hybrid because it combines the features of a sole partnership or partnership with those of a corporation.
LLCs are businesses that are legally separated from their owners.
An individual or several people can own an LLC.
An LLC is referred to as a multi-member LLC.
Every LLC should have an operating LLC agreement that stipulates the working relationships between their owners, managers and financial details.
Additionally, an LLC needs to have a business plan.
Some examples of LLCs are Blackberry, Pepsi-Cola, and Nike.
Advantages of LLC – What Is Entity in Business
The following are some of the benefits of LLC:
- First, the owners of LLCs are not personally liable for their business’ debts and liabilities.
- Secondly, the option allows you to choose for your LLC to be taxed and assessed as a partnership or corporation to avoid being taxed twice.
- Also, LLCs have few corporate formalities.
- Lastly, there is no restriction on the number of owners.
Disadvantages of LLC – What Is Entity in Business
Here are some of the disadvantages of LLC, which you can weigh with the advantages to decide if you should opt for this entity.
- Owners of LLCs pay more taxes when their profits are subjected to social security and Medicare taxes.
- LLCs are expensive to create due to state registration requirements.
Conclusion on What Is Entity in Business
A business entity is any organization established by one or more persons to operate a given business or engage in trades or related activities.
Forming entities in business include providing protection for business owners and improving your professional image.
It also helps to save taxes and ensure a structured business operation.
There are four main business entities: sole proprietorship, partnership, corporation, and Limited Liability Company.
When opting for any of these entities, you need to know their features and weigh their pros and cons to know the one that is best for you.
In this discussion, we have covered everything you need to know about an entity in business.
So, ensure that you use the information you get from it.