What kind of business formation is right for You?
Selecting the best entity for a given venture involves a number of considerations including (1) taxation, (2) owner liability, (3) governance, (4) capital structure, and (5) potential exit strategies, to name a few.
Below is a primer on some of the various entities that are available for Washington businesses. We have highlighted some of the main features of each of the primary entity options.
The Sole Proprietor
A sole proprietorship is a business that is owned and controlled by a single individual or a married couple. A sole proprietorship is simple to form and operate, but the business owner(s) is personally liable for all of the business’ debts and any claims brought against the business. Sole proprietorships are flow-through entities—i.e. the owner must report any business income and expenses, along with other items, on their individual tax returns.
The General Partnership
A general partnership is an association of two or more individuals that intend to carry on as co-owners of a business for a profit. No formal paperwork is required to form a general partnership. In fact, general partnerships are sometimes can be formed accidentally or without the intent of the general partners. Each partner is an agent of the business, and acts of each partner while carrying on the business will generally bind the partnership, including the individual partners. Additionally, each general partner is jointly and severally liable for all debts and obligations of the partnership. Each partner has a right to share the profits and losses, and a right to participate in the management of the business. The formal terms of the partnership are usually contained in a written partnership agreement.
The Limited Partnership
A limited partnership has both general and limited partners. The general partners participate in management and share the profits and losses. General partners are jointly and severally liable for all debts and obligations of the partnership. One of the key differences between this form of entity and a general partnership is that the limited partners generally do not participate in management and are only liable to the extent of their investment (or contribution) in the partnership. Unlike a general partnership, the creation of a limited partnership requires the execution and filing of a certificate of limited partnership with the Secretary of State.
The Limited Liability Partnership
A limited liability partnership is similar to a general partnership except that each partner is generally not personally liable for the negligence of another partner. This business structure is used most commonly by professional service companies such as accountants and lawyers.
The Limited Liability Company
A limited liability company (most commonly referred to as an LLC) is an entity in which one or more individuals called “members” have limited liability for the enterprise’s debts and obligations. This is true even if the member participates in management of the LLC. Members of an LLC have increased flexibility in structuring the management of their venture through the LLC’s governing document, known as an “operating agreement.”
A corporation is a legal entity formed under state law. Corporations split up management and ownership of the company—shareholders own the corporation, but senior management controls the day to day operations. Generally, neither managers nor shareholders are personally liable for the debts of a corporation. Corporations come with burdensome administrative hassles, and are usually taxed quite differently (and sometimes more extensively) than partnerships. However, the corporate structure is often ideal for raising capital, and the corporate form has long been the most commonly used legal form for operating publicly-held businesses. Variations of corporations include S-corporations, non-profit corporations, and just recently Washington passed legislation to allow a new form of corporation in Washington, the Social Purpose Corporation. S-corporations are subject to a number of restrictions, but enjoy pass-through taxation, similar to partnerships. A non-profit corporation is a legal entity that is carried on to benefit some public interest, rather than a profits-based motive.