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What Should You Consider When Deciding Which Type of Business Entity Is Best for You?

On Behalf of | Aug 25, 2019 | Business And Corporate Law

If you are planning on starting a business, one of the first legal steps you will need to take is to form a business entity. Taking care of this step now will save you steps later on. And depending on the type of entity you choose, it could also provide you with critical liability protection in the event that something goes wrong in the early stages of your business’s operations.

When choosing which type of business entity to form, there are several different factors to consider. This includes legal considerations (such as the liability protection referenced above), as well as financial and practical considerations such as minimizing your overall tax liability and making your business structure attractive to outside investors. In this article, we will cover some of the key considerations for choosing the best type of entity for your business endeavor as well some additional considerations related to where and how to set up your new company.

4 Key Considerations for Choosing a Business Entity

While each state has its own laws governing the establishment of different types of business entities (more on this below), there are several “standard” business entity forms. For example, in Tennessee, the options are:

  • Limited liability company (LLC)
  • For-profit corporation (C-corporation or S-corporation)
  • Not-for-profit corporation
  • General partnership
  • Limited partnership
  • Limited liability partnership (LLP)

So, which option should you choose? Here are some of the key factors to consider:

1. What Type of Business Will You Be Operating?

The first factor to consider is the type of business you will be operating. Certain types of businesses tend to lend themselves more to one structure than another; although, with the flexibility of LLCs and LLPs, this is less of a factor than it once was. Of course, if you will be operating a for-profit business, then a not-for-profit corporation will be off of the table. Likewise, since a partnership involves two or more owners by definition, if you are going solo then you will need to choose from the other options that are available.

2. Will You Have Co-Owners? If So, How Many?

The more co-owners your business will have, the more structure you may want to have around to control rights and transfers of ownership shares. Generally speaking, LLCs and corporations provide for the greatest amount of flexibility in these areas, although there can be benefits to the partnership structure here as well. With regard to corporations, the S-corporation is limited to one class of stock and 100 shareholders, while C-corporations can have unlimited shareholders and multiple classes of shares.

3. Will You Be Seeking Outside Investment?

If you will be seeking to attract outside investors, the type of entity you choose (and how you structure it) can significantly impact the attractiveness of your investment opportunity to outside investors. A general partnership will be off of the table (because all partners in a general partnership are exposed to personal liability). And while a limited partnership may be a possibility, an LLC or corporation will most likely be your best option.

4. How Do You Want to Be Taxed?

Business entities can either be subject to corporate-style “double taxation” or partnership-style “pass-through taxation.” LLCs, LLPs, limited partnerships and general partnerships are subject to pass-through taxation by default, while double taxation (which can actually result in tax savings in some circumstances) is the standard for corporate entities. However, LLCs and partnerships can elect to be taxed as corporations, and electing S-corporation status will result in pass-through taxation for corporate shareholders.

Additional Legal Considerations for Starting a Business in Tennessee

Once you choose the type of entity that makes the most sense for your business venture, then you need to move forward with actually forming your new business. Typically, this involves filing a form and paying a fee to the state corporations department (in Tennessee, this is the Secretary of State). Are you done now? Not so fast. Before you open for business, there are several other legal considerations you may need to address as well. For example:

  • Should you form your business entity in Tennessee or somewhere else? The fact that you are starting your business in Tennessee does not necessarily mean that you should form your business entity in Tennessee. Other states, such as Wyoming, offer unique benefits that will be attractive to many new business owners.
  • Should you buy insurance (or, more appropriately, how much insurance should you buy)? Even if you form a limited liability entity, you will still likely want to have plenty of insurance to protect your business and personal assets. Individual needs vary, but common business policies include auto, errors and omissions, and general liability.
  • What legal documents do you need to prepare? The form you file with the state is not the only piece of paperwork you need to start a business. You will also need a shareholder, member, or partnership agreement to govern your entity. And depending on your entity structure and ownership, you may need meeting minutes, board resolutions, subscription agreements, and various other documents as well.
  • Do you need to make any additional business filings? In addition to these types of internal governing documents, you may also need to make some additional business filings. For example, all businesses need a federal tax identification number, and you may need various licenses, permits, and other government approvals in order to legally operate within your chosen industry or from your chosen location.
  • Will you be hiring independent contractors or employees? If you will be hiring independent contractors, you will need a solid independent contractor agreement. If you will be hiring employees, you will need policies, agreements, manuals, and various other forms of documentation.

Discuss Your Needs with a Business Lawyer in Clarksville or Springfield, TN

If you are thinking about starting a new business in Tennessee, we encourage you to contact us to discuss your legal needs. To speak with one of our experienced business law attorneys in confidence, please call 931-650-5484 (Clarksville) or 615-656-7021 (Springfield) or inquire online today.