Introduction to Business Entities

In this two part post, I’m going to look at the six major business entities authorized in Illinois.  The legal structure a business takes is of utmost importance when starting a business.  While entrepreneurs need to focus on sales and marketing efforts to bring  their venture to life, they also have to consider their company’s legal structure, as the form the entity takes determines many things, including how it will be taxed, where liability within the entity falls, and who may act on behalf of the entity.  When starting a business, it is important for entrepreneurs to understand the differences between each business structure in order to properly determine which type of entity best suits their needs.  This outline will discuss the sole proprietorship, general partnership, and limited partnership.  Part two will discuss the Limited Liability Company and two types of corporations.

Sole Proprietorship

A sole proprietorship is the simplest, quickest and cheapest way to establish a business.  No forms need be filed with the state and no fees need be paid.  A business license or permit may, however, be required.  Additionally, the business must file a d/b/a (“doing business as”) form with the state if the owner wishes to operate under a name different than his/her exact legal name.  A sole proprietorship is an individually owned and operated business where the proprietor is the one and only owner and decision maker for the business. From a legal standpoint, the entity is not separate from the owner and, as a result, profits and losses from the sole proprietorship are reported and taxed on the owner’s personal tax return.

The simplicity of setting up a sole proprietorship must be weighed against the pitfalls it subjects the owner to, primarily unlimited personal liability, meaning the business owner is responsible for all debts and lawsuits filed against the business.  While insurance may reduce some of the risk inherent in a sole proprietorship, it is generally insufficient to cover all the potential liabilities that may arise.

General Partnership

This is the same as a sole proprietorship, but it involves two people rather than one.  By default, the partners share management and operational control of the entity and also share equally in the profits/losses of the company.  A partnership agreement may, however, establish different amounts of control and/or payments among the partners.  While a General Partnership may be established without any formal filing, it is highly recommended that the partners have an agreement in place which details their rights and duties to each other.

Similar to a sole proprietorship, taxation occurs at the personal level. Each partner is taxed on their income tax return, based on his/her ownership percentage and the amount of income they receive.  While not directly taxed, partnerships are required to file tax returns for informational purposes.  Also like a sole proprietorship, partners in a General Partnership are subject to unlimited personal liability. Each partner is responsible in full for the business’s debts, any lawsuits filed against the business, and torts committed by themselves, their co-partners, and their employees.  Again, insurance can reduce some, but not all of the risk involved here.  Additionally, partners are jointly and severally liable for the company’s debts, meaning that a creditor may go after one partner for the full debt of the company.  There is no requirement for a creditor to obtain equal judgments against all partners.

Limited Partnership

A limited partnership is a partnership in which there are one or more “general partners” as well as one or more “limited partners.”  Under this structure, the limited partners have limited liability (they may lose their investment in the venture, but are not liable for debts of the company).  In return for this limited liability, limited partners can have no management authority.  In effect, a limited partner is simply an investor in the business and if a limited partner does assert any management control, he will lose his limited liability status and revert to a general partner. The managers of this type of entity are the general partners, whose rights and duties are the same as those described in the general partnership section above.  Limited partnerships are required to file documentation with the Secretary of State to establish the entity and the company is taxed as a partnership.

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