In Albuquerque recently, I presented this materials to owners of agribusinesses. In the next several blogs, I share that presentation.
In choosing an entity there are seven key factors to consider:
- Purpose. What is the purpose of the entity? The entity chosen should be "right" for the purpose. One entity does not fit all purposes. For example, a going concern will have operations and may have real estate. A S corporation may be right for the operations but wrong for the real estate (more on that in subsequent posts). The "right" entity for the real estate is likely to be a limited liability company (LLC).
- Liability. Limiting the owner's personal liability for the debts of the entity is an important factor in choosing an entity. Corporations and limited liability companies provide such protection to its owners. Sole proprietorships and partnerships do not with the exception of limited partnerships. In limited partnerships, the limited partner's contribution to the partnership is at risk but the limited partner is not personally liable. However, the general partner of a limited partnership is personally liable. Note that an owner can become personally liable by guaranteeing the debts of the entity. The owner may also be personally liable for their own actions. In this instance the personal liability arises out of those actions and not because of ownership of the entity.
- Cost. A factor to consider is the cost of forming the entity and the cost of maintaining the entity. Nothing comes free. There is a cost. More on this in subsequent posts.
- Size and complexity of the enterprise. The choice of the entity or entities will be driven in large part by the size of the operation and the complexity of the enterprise. A simple form of business is sole proprietorship but this does not allow for the addition of venture capital or partners. Nor does this simple form protect its owner from liability for its debts or claims. In a complex operation with risk of liability, it will be desirable to have an entity that provides limited liability.
- Regulatory requirements. The requirements on a particular operation may make one form of entity better than another form. In some personal services operations, the requirements and licensing is personal to the person delivering the services. This may make partnerships or limited liability partnerships more attractive than a corporation.
- Valuation. If transferring business interests to a younger generation of owners is important, valuation of that transfer will be important, too. The type of entity and the limitations on transfer will be factors in determining the value of the business interests.
- Taxation. How business entities are taxed is a significant factor in which entity is chosen. The purpose served by the entity is largely a tax driven decision. For example, C-corporations are taxed at the corporation level and dividends are taxed at the corporate and shareholder level (taxed twice). Partnerships, LLCs, and S-corporations are pass-through entities meaning that the shareholder pays the income tax of the portion of the entity allocated to that shareholder. Recognition of gain is treated differently among the entities. Usually there is a recognition of gain when an appreciating asset is distributed to shareholders of a corporation. Typically there is no recognition of that gain when the same appreciating asset is distributed to partners of a partnership or members of a limited liability company.
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