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Correct Business Entity Based on Your Circumstances

In the Chapter 31 section, “Choosing a Business Association,” the author lays out a set of business entities and discusses the variables that set these entities apart.  Based on these variables, a potential business owner or a group of potential business partners can decide which entity is the most appropriate choice for their unique circumstances and goals.  The first variable to consider is the ease with which the business can be formed.  Per the textbook, “some (business associations) can be created with no formality, while others require the filing of documents with the state.”  Taxation on owners and shareholders varies between the types of entities, as does the transferability of financial interest.  Liability differs between the various types of businesses, so partners, general partners, limited partners, members and shareholders have different liability concerns and considerations.  The continuity of the business types varies if bankruptcy is sought or if a principal in the business dies or withdraws his interest.  Finally, the control of the business varies according to the type of entity.

All of these factors are worthy of strong consideration and deliberation when an owner or a group of owners is deciding which type of business entity to form.  However other

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variables, based on the owner’s unique circumstances, desires and visions for the company can also greatly affect the choice of an appropriate entity.  A small, start-up business is going to have very different characteristics than a large corporation.  Per the article, 72% of business entities are sole proprietorships, so this form is a good choice for many smaller, start-up companies where the owner has full control over management and operations.  This choice makes the business more nimble, flexible and able to adapt to change.  Conversely, most medium and large companies tend to be corporations.  Per the article, 85% of total business revenue is generated by corporations even though this type of business entity accounts for only 20% of businesses.

Large corporations are much less nimble and flexible than small sole proprietorships, and inefficient bureaucracies are more likely to infest and take root in larger corporations.  The small proprietorship can pivot and adapt to changing market conditions quickly and effectively while the more unwieldy corporation has momentum and mass that is more averse to change.  However, one significant advantage that corporations possess is the ability to grow the business quickly by diluting ownership and issuing more stock.  Thirdly, risk tolerance is an essential consideration for any business owner or group of business owners.  Within that realm, liability, continuity, control and transferability are all included.  The more risk averse, the more an owner or owners will probably lean toward becoming a corporation because shareholders enjoy limited liability, firm continuity, control from the board of directors, and free transferability.

All these business entity types have distinct qualities, advantages and caveats.  For one seeking to start a business, a sole proprietorship is an excellent choice.  It is easy and quick, so scarce funds can be plowed directly into the business rather than used merely to form the business.  This simple entity can be grasped by a novice without the legal considerations and obligations that some of the more complicated business entities entail.  The owner has complete control over the financing, management and operation of the business, so this entity’s autonomy is unmatched.  The sole owner is free to reap the profits if the business is successful, and guilt and hardship are not relayed to other owners if the business fails.  Almost three quarters of businesses are sole proprietorships, so the new, small start-up business owner can feel confident and comfortable with the choice of this entity.

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