Introduction
Irrespective of the entity desired to carry on business activities, the purpose of every business organization is primarily to make returns on investment, i.e., profit while taking on their business. However, as an entrepreneur, one of the first hurdles you will encounter is deciding on the most suitable business entity to choose for your start-up.
While trying to decide, every entrepreneur should understand that there are no right or wrong answers. Fortunately, one of the hacks to selecting the most appropriate business entity is to consider the business’s goal and weigh each business entity’s advantages and disadvantages before finally deciding on which to register.
Factors that Determine Your Choice of Entity
As an intending start-up owner, here are some of the factors you put into consideration when faced with the problem of picking a suitable entity for your start-up;
Liability:
You need to consider the extent to which you want to be immune to legal liability. For instance, a sole proprietor is personally liable for the debt and expenses incurred while running the business. Partners share liabilities in a partnership business.
Companies offer the best protection in the case of harm due to the separate legal personality between the owners and the business entity. Ask yourself if you can afford to be personally liable or if you would want to share your liabilities or even separate your personality from that of the business. Answering this would guide you to your best option when choosing a business entity.
Tax implication:
As a start-up owner trying to maximize profit, you should aim to utilize every opportunity you have to optimize taxation. You would want to avoid double taxation, common to incorporated companies, i.e., personal income and corporate tax that the owner would pay.
On the other hand, sole proprietors, partnerships, and LLCs all pay tax on personal income, which is how profits are managed.
Control
As an entrepreneur, you must decide whether you want to maintain primary control over your business. For example, a sole proprietorship or an LLC is best suited for owners wishing to control the start-up and its activities.
However, this is not the same for corporations. A corporation is still subject to the rules applied to larger organizations, even as a small entity.
The Cost of Formation and Administrative Fee
A sole proprietorship is the most popular form of business entity because registration is fast, easy, and cheaper than other business entities. Additionally, start-up owners would most likely prefer sole proprietorship or even a partnership when considering the cost of record-keeping and paperwork and the costs associated with incorporation.
Usually, taking care of administrative requirements sometimes consumes the owner’s time, especially in the early stages of the business.
Flexibility
Unlike other business entities, a sole proprietorship is more flexible because decision-making is vested in the sole proprietor. Generally, individual needs are a critical consideration.
No two business situations will be the same, particularly when multiple owners have different ideologies. Hence, it is crucial to consider this factor when picking a business entity.
Fundraising
Decide whether or not there is a likelihood of fundraising. The business entity you settle for can ruin your chances of raising funds in specific ways. For example, sole proprietorships generally cannot offer stocks. That right is reserved primarily for corporations.
As a result, most investors would not want to invest in a business entity set up as a sole proprietorship.
Types of Business Entities or Organizations
Sole Proprietorship
This is the oldest and most straightforward type of business entity. In an exclusive proprietorship business model, the responsibility of running and managing the company’s daily affairs rests with the sole proprietor. Aside from the fact that it is the most common business entity, the entity is also fast and cheap to register.
Furthermore, the sole proprietor has complete decision-making power and control over the business. A start-up using the exclusive proprietorship business model is exempted from corporate tax payments.
However, a significant disadvantage of a sole proprietorship is that the sole proprietor is personally liable for the debts and expenses of the business. Examples Some famous companies that started as sole proprietorships and eventually grew into multimillion-dollar companies include Walmart, Marriot Hotels, and eBay.
Partnership
This is a form of business entity owned by two (2) or more persons not exceeding twenty (20). This structure is generally good for people keen on going into business with family members, friends, and close associates. Partners in partnership business entities share profits and losses and make decisions within the business structure. A partnership business entity is divided into two;
“General Partnership” (GP)
The responsibilities and rewards are shared equally here. A GP is similar to a sole proprietorship business model, except that there are now two or more owners who make decisions and control the start-up.
This business entity is advantageous because it allows start-ups to delegate business responsibilities to partners according to skill sets and strengths. Additionally, a general partnership is exempt from corporate tax.
Limited Liability Partnership (LLP)
In this form of business entity, one or more of the partners, usually founders, retain complete control over the start-up while others, usually the investors, have little or no power but assume some responsibilities and receive an agreed measure of the total profit.
The investors purchase a limited partnership interest, which gives them individual security. Investors prefer limited liability partnerships to general partnerships because of this particular security. Partners may still delegate roles and responsibilities within the start-up according to skill sets and investment.
Also, this kind of entity is exempt from corporate tax. However, entrepreneurs dislike this entity because they have little or no built-in protection.
Irrespective of the type of partnership, partners should ensure they execute a partnership agreement. Google is an example of a famous company that started as a partnership business between Larry Page and Sergey Brin and eventually grew into a leading global search engine. Other successful partnerships include Microsoft, Warner Bros., and Apple.
Company
A company is a business entity with a separate legal entity from its owner. This business structure separates your assets from your company’s debts. In Nigeria, a company may take any of these forms;
- A company limited by shares: A company limited by shares is one where members have their liability limited to unpaid claims. Hence, members of a limited liability company are not personally liable and shielded from any debts, lawsuits, or other financial liabilities of the business. Examples of well-known LLCs are Pepsi-Cola, Sony, and Nike.
- Company limited by guarantee: Here, the liability of members-only arises at the point of winding up and the company not being able to pay its debts.
- Unlimited company: A total liability company is a company that does not have any of the liabilities of its members. This type of company is rare but possible. If the company cannot offset its indebtedness, the creditors can go after the personal liability of the subscribers.
In conclusion, startup founders can choose any entity if it aligns with their business goals and circumstances.