Each year, entrepreneurs turn business ideas into reality, but many are unsure where to begin or which business structure best suits their needs, particularly first-time business owners. Understanding the different types of legal for-profit business entities can help aspiring business owners make informed decisions about how to structure their businesses.
This overview examines four types of business entities:
- Limited Liability Companies
- Corporations
- General Partnerships
- Limited Partnerships
Limited Liability Companies (LLCs)
Limited Liability Companies (LLCs) are one of the most common entities due to their ease of administration. LLCs are owned by “members,” who may choose to manage the company themselves or appoint one or more managers to handle day-to-day operations. An LLC can have just one owner (a single-member LLC) or multiple members, which makes it a flexible choice even for a first-time owner going into business alone.
To form a limited liability company in Ohio, you must file Articles of Organization with the Ohio Secretary of State and appoint a statutory agent with an Ohio address who can accept legal documents on the company’s behalf. Managerial rights are often laid out in the LLC’s operating agreement, which is an internal governance document that Ohio does not legally require, but is strongly recommended. If an LLC does not have an operating agreement, then it is subject to Ohio’s default rules that may not align with how you truly want your LLC to operate.
The biggest benefit to forming an LLC is that the LLC is treated as an entity distinct from its members, meaning that members are generally not personally liable for the debts and obligations of the LLC. This large shield from personal liability creates a great incentive for individuals to choose an LLC as their business structure because their personal assets will be protected in the event the company is sued.
However, it is worth noting that the LLC structure does not create an impenetrable shield from personal liability. Members can still be subject to personal liability for violating fiduciary duties owed to other members or if the LLC is not treated as separate from its members. The latter example is called “veil piercing,” and it typically happens when members commingle their personal funds with the funds of the LLC.
An important factor in forming an LLC is having a well-written operating agreement. This is crucial to the proper functioning of a multi-member LLC and can be more costly than forming a general or limited partnership (discussed below). However, the LLC is a great option for a small to mid-size business, whether you are going into business on your own or with one or more partners.
Corporations
In Ohio, a corporation is formed by filing Articles of Incorporation with the Ohio Secretary of State. Corporations are managed by a board of directors and owned by shareholders. A corporation’s day-to-day governance is set out in an internal document called a Code of Regulations, which is Ohio’s version of corporate bylaws. Like LLCs, corporations are considered distinct from their shareholders and directors, meaning that both shareholders and directors are generally not personally liable for acts and obligations of the corporation.
There are two main types of corporations: C-corporations and S-corporations. Once formed, a corporation is considered a C-corporation by default. An S-corporation is not a separate kind of corporation you form under Ohio law; it is a federal tax status that a qualifying corporation elects with the IRS. C-corporations are often larger companies, while the S-corporation election is commonly used by smaller, closely held businesses that meet the IRS’s eligibility requirements. The biggest difference between the two is taxation.
C-Corporations
C-corporations pay tax on their income before distributing profits to shareholders. Shareholders must then pay income tax on the profits they receive. This is often referred to as “double taxation.”
S-Corporations
S-corporations are treated as pass-through tax entities, meaning the income and losses of an S-corporation are passed through the business to the shareholders, who then report the losses and profits on their tax returns.
General partnerships, limited partnerships, and LLCs are also generally treated as pass-through tax entities by default, although an LLC may elect to be taxed differently.
Along with limited liability, the biggest benefit of forming a corporation is that the structure generally provides for an unlimited number of shareholders, which encourages more investment and rapid business growth. That is why this model is typically best for bigger companies. However, this benefit is also a major drawback because shareholders who own a majority of the corporation’s stock could gain control over management decisions.
The double-taxation requirement for C-corporations can also be burdensome for business owners, and although S-corporations allow for pass-through taxation, there is typically a cap on the number of shareholders and a requirement to meet other stringent IRS requirements.
General Partnerships
General partnerships are the default classification for co-owners of a business. A general partnership is formed when two or more people, intentionally or unintentionally, join forces to carry on as co-owners of a business for profit. The owners of the business personally share the profits and losses and are equally responsible for the debts and liabilities of the company. Each partner is jointly and severally responsible for the acts of the other partners and the business as a whole, which means a creditor can pursue any single partner for the full amount owed, not just that partner’s share.
A formal agreement or a filing with the Ohio Secretary of State is not necessary to form a general partnership. However, partners who operate under a name other than their own surnames should register that trade or fictitious “doing business as” name with the Ohio Secretary of State, and a partnership that sells taxable goods will also need an Ohio vendor’s license.
The biggest drawback is that each partner faces unlimited, personal, and joint-and-several liability, meaning your personal assets can be reached to satisfy the partnership’s debts.
If you currently operate as a general partnership, please reach out to discuss alternative entities that could provide stronger protection and long-term advantages.
Limited Partnerships
Unlike general partnerships, limited partnerships must be registered with the Ohio Secretary of State and are often formed to raise capital for the business. Limited partnerships require limited partners to cede control of one or more general partners, who are solely responsible for managing the company. The general partners have unlimited liability, as in a general partnership, while the limited partners generally risk only the money they have invested in the business, so long as they do not take part in managing the company.
If you want to bring outside investors into your business while keeping day-to-day management in the hands of a general partner, a limited partnership may be a good fit. Keep in mind, however, that whoever serves as the general partner remains personally responsible for the business’s debts, while the limited partners keep their liability shield only so long as they stay out of managing the company.
Choosing the right business structure is a decision that should not be taken lightly. This is a consequential decision and is best approached with experienced legal and tax guidance. For those starting a business and unsure which entity best fits their needs, consulting with qualified corporate and tax counsel can help clarify the trade-offs and inform decisions about entity selection and other business formation matters. The next steps include preparing and filing formation documents, opening business bank accounts, registering for applicable taxes, and establishing day-to-day operations.
For more information or to seek counsel from our Business & Corporate or Taxation practice groups, please reach out to request a consultation or call us at 216-696-1422. McCarthy Lebit would like to thank law clerk Logan B. Kijewski for his work in assisting with the preparation of this legal blog post for The More Report.
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This information is provided for general informational purposes only and should not be construed as legal advice. Readers should consult with qualified legal counsel regarding their specific circumstances before taking any action based on the information presented.
