Business Entities: classify, understand, choose, and manage.

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Business
Entities
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Sole Proprietorship Partnership Limited Liability Company Corporation

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Business
EntitiesBusiness entities are essential for starting, managing, and growing your
business. This guides to business entities covers every major type, core
concepts, criteria for choosing an entity, and legal entity
management.
855.517.2193 North America
+1.503.517.4293 Global
Berkman Solutions

Copyright 2018 Berkman LLC
Berkman Solutions
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Types of
Business Entities

Deﬁnition
A limited liability company (LLC) is a unique form of
business entity. LLC owners are called members. The
people who run an LLC are called managers.
However, the organizational documents can change
this terminology. There are, generally, no restrictions
on the number or type of owners of an LLC.
LIMITED
LIABILITY
COMPANY

Flexible
It is easy to create LLCs which have the formality of
a corporation with ofﬁcers and directors, or
informal management like a partnership.
Pass through tax status
LLCs typically provide pass through tax treatment.
Pass through tax status, like partnerships, means that
the business does not pay income taxes on its
income. Instead, income is allocated to the
members who then pay taxes on their share.
LIMITED
LIABILITY
COMPANY

Member-Managed
A member-managed LLC resembles a partnership.
Each member can enter contracts for the LLC.
They are simple and the founding members are the
same people operating the business.
Manager-Managed
Manager-managed LLCs separate the ownership
and management functions. Manager-managed
LLCs more closely resemble corporations in this way.
In fact, manager-managed LLCs often adopt the
terminology of corporations.
LIMITED
LIABILITY
COMPANY

Definition
Corporations are owned by shareholders, who can
be individuals or other entities. Shareholders are
issued stock (or shares) in exchange for investment
of money or something of value, like intellectual
property or an employment agreement.
Shareholders vote for a board of directors, who in
turn select officers to manage the company. Officers
run the day-to-day business, while the directors
oversee the managers. The board of directors is also
responsible for certain types of decisions such as
mergers and acquisitions, sales of major assets, and
bankruptcy.
CORPORATION

Predictable for Investors
Corporations are the preferred legal entity for
businesses that are or plan to be publicly traded.
Accessing public markets for investment capital is not
the only reason to choose a corporation.
Corporations are also ﬂexible. The law of
corporations is well established and predictable.
CORPORATION

C Corp
A C Corporation is the most common business entity
for large companies and those which are publicly
traded. While there are many reasons businesses
choose the C Corporation form of legal entity, the
primary driver is corporate ﬁnance law.
S Corp
S Corporations are, roughly speaking, an earlier form
of a limited liability company in that they combine
the tax beneﬁts of a partnership with the liability
protections of a corporation. There are ownership
restrictions for S Corps that do not apply to LLCs.
CORPORATION

Deﬁnition
Partnerships are informal business entities. They
one of the oldest forms of business entities.
There are number of risks to a partnership that
warrant careful attention. The most important is that
any partner in the partnership can bind all the other
partners so that each partner is individually liable
for each obligation of the entire partnership.
There are certainly ways around this problem and a
number of statutory alternatives have emerged, but
founders should be thoughtful about partnership
formation.
PARTNERSHIP

General Partnership
A general partnership is disregarded for tax
purposes. Partners are strictly liable.
Limited Partnership
Limited partnerships have a general partner and at
least one limited partner (LP). A limited partner has
no management authority.
Limited Liability Partnership
Each partner has limited liability. The scope of limited
liability varies widely from state to state.
PARTNERSHIP

Tax Status
Partnerships can be informal business entities,
which means there are no ﬁling requirements and
few, if any, maintenance requirements. Partnerships
are not generally recognized as business entities
for tax purposes, which means proﬁts and losses are
allocated to the partners individually as a pass-
through.
PARTNERSHIP

Deﬁnition and Issues
A sole proprietorship is a one person business entity.
A sole proprietorship is not incorporated, avoids
double taxation, and does not provide any
liability protection. The assets of the owner are
fully exposed.
Notwithstanding this risk, sole proprietorships are
quite common, because individuals want to avoid the
cost and hassle of setting up and managing a separate
legal entity.
SOLE
PROPRIETOR-
SHIP

Key Concepts
Big Idea, LLC
Person
Ownership
Management
Tax status
Compliance
Jurisdiction

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Natural Person
Natural persons can own property individually or
with others. They can enter contracts, pay taxes,
and engage in political activity. Natural persons
might have restraints on their legal capacity.
Legal Person
When a government recognizes a legal entity, it
confers rights and responsibilities. Entities can: can
own property, enter contracts, and pay taxes.
Legal entities may or may not have the right to
engage in political activity in their own name. Rights
and responsibilities vary by jurisdiction.
PERSON

Economic Owners
An economic interest means that the owner has a
claim on the financial value of the legal entity. This
does not mean that the entity has obligation to
distribute profits to the owners in the form of
dividends or distributions.
Management Owners
An owner who can make decisions on behalf of the
legal entity has management rights. A management
owner might exert that authority somewhat
indirectly by participating on the Board of Directors,
or by working as an officer in the company.
OWNERSHIP
Big Idea, LLC

Directors
Directors provide oversight for the business entity
and appoint officers. Owners appoint directors to
represent them on the Board of Directors. In small
and medium businesses, owners will usually just
appoint themselves.
Officers
In a corporation, managers are typically called
officers. LLCs call them managers, but often change
the title to officer in the organizational documents.
Officers have authority to direct the daily business
MANAGE-
MENT

Pass Through
When an entity is disregarded for tax purposes, we
say that it beneﬁts from pass through tax status. Pass
through entities do not pay taxes on their business
income. Instead, the owners pay income taxes on
their share of the income from the business.
Entity Level
Corporations in the US are subject to double
taxation. Double taxation means that the entity pays
taxes and then the owner pays taxes on dividends or
distributions.
TAX STATUS

Filing Obligations
When you incorporate, you must maintain the legal
entity to preserve the benefits. Each jurisdiction is
different, but the all share some periodic filing and
the payment of a fee of some kind. Miss the filing or
fail to make the payment, you risk the legal shield of
the entity, not just for yourself, but for every owner
and officer in your organization.
COMPLIANCE

Place of Incorporation
Most businesses will incorporate in the state where
they will do business and where the owners live, but
that does not have to be the case. The state where a
business incorporates is called the place of
incorporation.
Principal Place of Business
The principal place of business is the jurisdiction
where the business has its headquarters. A
business can incorporate in Delaware and have its
principal place of business in Texas, even the owners
live in California.
JURISDICTION

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Choosing a
Business Entity

The Choice
Best choice of available options under prevailing circumstances

Cost of incorporation
Ease of incorporation
Management requirements
Tax and ﬁnancial objectives
CRITERIA

Types of Taxes
Personal income
Business income
Franchise taxes
Property taxes
Consumption taxes
Capital gains
TAX
Considerations

Territorial system
The territorial system only taxes income earned
within the country.
Residential system
The residence system taxes income earned
globally for every company residing in the territory.
INTER-
NATIONAL
TAXES
Get professional advice

Maintain
Business Entities

Maintain Business Entities
Forming a business is a one time event that creates a long string of
maintenance tasks for as long as the entity is a going concern. Limiting
liability and asset protection are primary objectives for forming a
business entity. Maintenance preserves those beneﬁts. Without
careful maintenance of the legal entity, it might not provide protection
when it is needed most. Over time things change for every business
entity. Those changes are easily ﬁled and forgotten.

Legal name
Legal address
Jurisdiction
Place of incorporation and principal place of business
Form of organization
LLC, Corporation, Partnership, etc.
Registered agent
Incorporation date
SUMMARY
Keep basic data about a
business entity in one
place

Organization documents
Filings and registrations
Agreements
Meeting minutes
Risk management & insurance
Other
DOCUMENTS
Company records and
documents are critical for
preserving the corporate
veil, the legal term for the
limited liability provided
by the form of legal entity.

Organizational documents
Organizational documents include all the filings and paperwork that
created the legal entity in the first place. The title of those documents
varies by state and by legal entity type. Common organizational
documents include: Articles of Incorporation, By-Laws, Operating
Agreements, and Stock Certificates (or other evidence of equity
ownership).

Filings and registrations
Filings and registrations refer to documents created annually (or as
necessary). Most states, for example, require that businesses ﬁle an
Annual Statement or Annual Report. For businesses that operate in more
than one state, the business likely needs to ﬁle a "Foreign Authorization"
to do business outside the jurisdiction of incorporation.

Agreements
Most entities have a some form of Ownership Agreement and
Management Agreement.
If the owners are contributing some form of property (such as
intellectual property, real estate, or equipment), then there will be
documents related to that property.

Meeting minutes
The meeting minutes created during shareholder meetings, board of
directors meetings, or committee meetings should also be part of the
legal entity record.

Risk management &
insurance
Insurance policies that pertain the business could also be stored with the
corporate records. In particular, Directors and Ofﬁcers policies (D&O
insurance) and Errors and Omissions policies (E&O insurance) might be
ﬁled in the risk management folder.

Legal and Compliance
Obligations
Requirements are business entity obligations. For
example, a business entity must file an Annual
Statement each year. The business might operate in
a regulated industry where it must file for a permit or
license every year.
Other examples of requirements include DBA filings
(Doing Business As, or trade name filings). States
require companies conducting business in the state
but not incorporated there to file for a Foreign
Authorization.
REQUIRE-
MENTS

Directors
Appointed by owners. Directors might have a term of
service. They also might serve on committees for
larger boards. Officers or managers have job titles
and terms of service as well.
Officers
Appointed by directors. Officers or managers have
job titles and terms of service as well.
PEOPLE
These terms usually apply
to corporations, but the
concept is important for
most business entities.

Parents
A parent is an immediate, direct owner of some or
all of the equity of a particular entity. If three
founders form an LLC called NewCo LLC and they
each have one-third of the membership interests,
then all three are parents of NewCo LLC.
Subsidiaries
A subsidiary is a business entity owned wholly or in
part by another business entity. For example, if
NewCo LLC owns EastShop, Inc. and WestShop, Inc.,
then EastShop and WestShop are subsidiaries of
NewCo LLC.
OWNERS &
INVESTORS
Keeping track of the
ownership interests in any
business entity is critical.

Related and
unrelated owners
A corporate registry lists all the entities under management control.
However, if the founders decide to let an outside investor, named OVest
Group, LLP, invest in SouthShop, OVest would not appear in the
corporate registry because the founders and NewCo management have
no responsibility for OVest as a legal entity. They certainly want OVest to
appear as an owner, but OVest is an unrelated owner.
Read more: Related and Unrelated Legal Entities in Org Charts

Complex relationships
Some org charts are simple, but many are not. Org
charts need to handle generation skipping, where an
owner owns a company both directly and indirectly. It
also needs to show related and unrelated entities.
As ownership details change the org chart needs to
reﬂect those changes automatically, which is one of
the reasons hand drawn org charts are dangerous.
They capture a point in time at best.
ORG CHART
A visual representation of
the ownership structure.

Business Entities: classify, understand, choose, and manage.

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