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Why use a business entity in the first place?

 

Historically, small businesses were typically sole proprietorships or general partnerships. These are the terms given to an individual or group of people that go into business without forming any separate business entity such as a limited liability company, s-corporation, or limited partnership, etc. In consulting with business owners now I still run into the odd sole proprietorship or general partnership. These businesses often arose spontaneously, buying a mower for your kid to mow lawns for spending money evolved into a lawn care business or the little app you made in your spare time is suddenly getting thousands of downloads a week on the app store. While it is entirely possible to operate a business as a sole proprietor or general partnership, doing so leaves a lot of benefits on the table and leaves the owner(s) personally open to liability for the debts of the business and lawsuits from disgruntled customers.

Instead, it is far wiser to operate a business under a separate legal business entity such as a limited liability company or s-corporation. In the eyes of the law, a business entity is separate and distinct from the owner(s) of that entity. In terms of liability protection, it means that the assets of the business are not the assets of the owner(s). (See our article on piercing the corporate veil for discussion on when that’s not always the case). From the perspective of the owner, that means that if the business goes under or is sued, creditors and disgruntled plaintiffs can only access the businesses’ assets, not the owner(s) assets. This is the “limited liability” that a business entity provides. Thus, the owner(s) home, car, bank accounts, etc. are safe when the business is run through a separate properly organized and operated business entity.

Business entities come in several different flavors and there is no one-size-fits-all solution, so if you’re starting a new business or looking to transition your business from a sole proprietorship or general partnership to something that gives some liability protection, consult an attorney and do your homework to ensure the business entity you create is the right one for you.

Craig WinderBasics