Entity Comparisons: a 101 Guide

By Joseph Pomerantz

As an entrepreneur, one of the most critical decisions is selecting the type of entity your business will be. While it may seem that these choices are primarily consequential in the tax realm, they have massive implications regarding the legal liability of the entity’s owner. When a business’ liabilities are not adequately limited from the owner’s assets, business creditors can seize an owner’s personal assets. Therefore, proper asset protection is paramount for a small business owner—or a business of any size.

This article will walk through the different options and consequences of choosing different types of entity structures.

In general, there are three categories of entities that can be chosen to structure an entity: (1) Partnership; (2) Corporations; and (3) Limited Liability Company (LLC).

Partnerships: 

The default structure for any business venture is a partnership, specifically, a General Partnership.1 In a General Partnership, at least two people come together for a joint business venture.2 These two partners, as a default, share equally in the profits and losses, are both personally liable for any liabilities that the Partnership may have, and equally control the day-to-day operations. (In the case of a single individual, there would be a Sole Proprietorship, and the sole owner would have the same liability as the General Partnership). Furthermore, for tax purposes, income generated by the partnership is “pass-through,” meaning the business’s total revenue is taxed as part of the owner’s personal income tax.

However, General Partnerships are not the begin-all and end-all of partnerships. Instead, there is a Limited Partnership (LP), Limited Liability Partnership (LLP), and Limited Liability Limited Partnership (LLLP). The idea with all the variations mentioned above on partnerships is to limit the liability of the partners.

In a Limited Partnership, one partner (called the limited partner) has no real control of the day-to-day operations. Most importantly, their liability is limited to the amount they invest in the company. (For example, if the limited partner owns thirty percent of a company, they would only be liable for thirty percent of any liability incurred by the company—while assets last). In contrast, the other partner (the general partner) assumes personal liability for the entity and manages the day-to-day operations.3 (To continue our example, if the company’s total liability is 110% of the company’s value, the general partner is personally on the hook for the additional ten percent.)

An LLP is similar to both a General Partnership and a Limited Partnership. It resembles a General Partnership in that all partners control the day-to-day operational control of the entity and resembles an LP in that there is no personal liability for any partners. Finally, an LLLP is similar to an LP in that not all partners can control the daily operations but differs in that the General Partner is also protected from personal liability in the LLLP.

While the idea of subjecting yourself to liability may seem off-putting, there are many benefits to doing so from a business perspective.

Corporations

The next option, and perhaps the most well-known, is the Corporation. This business entity also shields its owners from liability and offers certain tax benefits. The corporation’s owners are its shareholders, who elect a board of directors that delegate its responsibilities to CEOs, COOs, CFOs, etc. The Corporation, for tax purposes, is a standalone entity that subjects the corporation to double taxation (that being the first time on a corporate level and the second time at the owner’s level).

LLC

The last option is the limited liability company (LLC). LLCs are business entities that, like corporations, are standalone entities and therefore incur liabilities to which the entity may be subject. However, LLCs differ from limited forms of partnerships in that they offer the option to be treated as a corporation for tax purposes.4 Furthermore, the owners of an LLC are called members. LLCs can be either member-managed (one of the members oversees the LLC’s daily operations) or manager-managed (a third party is charged with running the day-to-day operations).

Governing Documents

Beyond the differences outlined above, the governing documents, owner’s powers, and compliance requirements vary tremendously. Therefore, owners must remain cautious of the nuances related to their structures and rules to avoid significant consequences.

In Partnerships, the governing document is called a “Partnership Agreement,” which lays out the general blueprint of the business and responsibilities of each partner. As the type of partnership gets more complex (i.e., LP, LLP, etc.), so will the Partnership Agreement.

In a Corporation, there are a few things to keep in mind regarding what governs. First, there are the Articles of the Corporation which are akin to the “Constitution” of the corporation. Second, there are the Bylaws, the laws governing the corporation. Bylaws lay out how many directors there are, how the corporation is to be dissolved, and virtually everything that pertains to how the corporation will be operated. Third, remember that shareholders—not the directors or CEOs, etc.— are the corporation’s owners. Therefore, the shareholders ultimately hold the power to make big decisions. Fourth, and related to the last point, is to understand that, although the corporate form offers protection, more consideration is required for each significant move the entity wants to make with each additional party brought into the corporation. Lastly, there are fiduciary duties owed to the corporation by the directors and officers that are non-existent in partnerships and LLCs.

Finally, in an LLC structure, the governing document is called an “Operating Agreement,” which is similar to the bylaws of a Corporation or a Partnership Agreement.

Summary

In summation, there is no “one size fits all” when choosing your entity structure and asset protection. Every entity has pros and cons, which vary based on your goals (such as whether the venture is long-term or short-term). Just as you and every entrepreneur are unique, every business and its goals are unique and need a custom structure and legal plan.

[1] See Martin v. Peyton, 246 N.Y. 213 (1927) (A contract which contemplates an association of two or more persons to carry on as co-owners of a business for profit is a partnership).

[2] N.Y. P’ship Law § 10 (McKinney).

[3] Id. §90.

[4] An LLC has the option to be treated as a C-Corp or an S-Corp for tax purposes. This should not be confused with what the entity is, regardless of how it’s treated for tax purposes it remains an LLC.

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