Business Formation—Understanding Legal Structures (Part 1)

By Hampton & Pigott
Posted on 4-8-2021

Starting a business can be a fantastic way to take control of your future. Long before you open your doors or serve your first client, though, you'll have to decide what kind of legal form your business will take. Business owners typically choose to establish their businesses as separate legal entities, generally as a method of helping to ensure that there is a financial and legal separation between the individual running the company and the company itself. Doing so not only allows for a degree of formal separation but also allows the business to undertake several actions that might be unique to specific formats. As such, it's always wise to consult with an attorney to determine which of the popular legal forms might be right for your business.

Types of Business Entities

As a new business owner, you might wonder exactly what type of form your business should take. Though the differences between each form can be difficult to explain without a thorough understanding of business law, there are a few things that are essential for business owners to understand about the three major types of business entities.

Going It Alone: The Sole Proprietorship

The most common type of business format in The United States is the sole proprietorship. Technically speaking, this doesn't even count as a type of separate legal entity because there is no formal separation between the proprietor and the business. When you choose this form, you're going to have to balance the relative ease of doing business this way with the fact that you'll hold personal liability for everything that happens to the business.

It is also important to remember that this type of formation leaves no room for others at the top. If you are a sole proprietor, you can't give up part of your business to an investor or bring in a partner. As such, this type of business formation is best used by true solo entrepreneurs.

Working With a Partner: General Partnerships

General partnerships are businesses that are run together by two or more people. They are formed either purposefully with a partnership agreement or in the course of business when partners work together, but they always function as an entity separate from the individual partners. In fact, it might be best to see this kind of arrangement as one that is separate from the sum of its component parts.

General partnerships are simple business arrangements, and with that simplicity often comes liability. Each partner in a general partnership is liable,not only for their own actions but also for the actions of their partner. When losses occur or suits are brought against the partnership, each partner is liable for all of the potential downsides – not just what he or she brings to the table.

Different Roles: Limited Partnerships

Not every partnership is right for the general partnership formation. In some cases, businesses are run by a combination of people who actually run the business and take on liability as well as those who have limited liability but no contributions beyond capital. This tends to be a popular form of partnership for companies that want to bring on investors but who don't necessarily want the investors to be involved in daily operations as well as for investors who want to help build a business but who want to limit their own personal liability.

In the upcoming continuation of this series, we will consider more business entities including LLC, C Corporations, S Corporations, and how you can choose the right structure for your business. If you would like assistance now please feel free to reach out to our skilled attorneys at Hampton & Pigott.