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Before your startup can get down to business, you have to choose which type of business entity it will be. — Getty Images/.shock

There are many steps to starting a business, but one of the most important ones is choosing a business entity. The type of business you select determines the legal and tax consequences for your company. Various entities also offer different liability protections, or protections for an owner's personal assets from their business assets. Here are some of the most common business entities that entrepreneurs choose to use when launching a new venture.

[Read more: How to Choose a Legal Entity for Your Startup]

Sole proprietorship

A sole proprietorship is a business run by one individual. Sole proprietorships are easy to set up because there is virtually no paperwork needed to get started. The business is simply started in your name, and all company payables come from your personal accounts. This option also carries the most risk, however. A sole proprietorship means the business owner is personally responsible for financial issues related to your business.

DBA

DBA stands for “doing business as.” It’s actually not a business entity, per se, but a registration that gives your business its own alias. While you file for a DBA as a sole proprietor, for instance, you can create a separate name for your business and stop using your personal name. This lends more credibility to your company and affords you some degree of privacy. A DBA is not a legal standing, however. Your business entity does not change as a result of your DBA.

[Read more: How to Register Your New Startup]

Partnership or limited partnership

General partnerships and limited partnerships are the next level up from sole proprietorships. In a general partnership, you, the business founder, would bring on a partner to share the responsibility for the business’s debts. A limited partnership structure limits the personal liability of each limited partner according to the amount they have invested in the firm. The business’s tax return is kept separate from the partners’ personal tax returns, and regular reporting of profits and losses must be filed.

“These types of structures are moderately priced to set up and also allow any business losses to be applied to the partner’s tax bill,” wrote ZenBusiness. “The biggest problem with most partnerships is the partners. Since you are both responsible for the company, if your partner bankrupts the firm, you will be left holding the bill.”

A sole proprietorship means the business owner is personally responsible for financial issues related to your business.

LLC

An LLC, or limited liability company, is a structure that allows partners or owners to limit their personal liability while maintaining the tax flexibility of a partnership. An LLC must be registered with the state (meaning there will be a filing fee). There’s a bigger tax burden associated with running an LLC, since this entity is responsible for federal, state, and local taxes. But LLCs protect the owners from personal liability.

“An LLC makes sense if your company is only at the stage in your development process where you will have the ability to attract angel investors, but not VCs (i.e., you are expecting that your business will generate losses),” wrote Early Growth Financial Services. “Angels will be motivated by the potential tax losses; VCs will not. VCs still prefer purchasing stock in a corporation over purchasing membership interests.”

Corporation

Finally, some entrepreneurs choose to start a corporation, such as a C corporation, an S corporation, or a nonprofit corporation, from day one. This type of business entity is completely separate from its owners and has its own legal rights — meaning a corporation can sue, own and sell property, and sell ownership in the form of equities.

Of course, the major benefit here is that owners and shareholders have no legal or financial liability for running the business. Corporations file taxes separately. There are many rules governing compliance at a corporation, so this structure is best suited for larger startups that have the capacity to hire an accountant. Bottom line: these entities are more complex than a sole proprietorship or partnership, and therefore more expensive.

CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation.

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Published May 25, 2022