What Legal Entities Do You Need to Set Up Your Business? A Beginner’s Guide to Business Structures
When you start a business you have a myriad of things to consider – from branding to sourcing to marketing to accounting – but what many new business owners often don’t get is that choosing from all the legal entities is crucial in how the day-to-day operations of the business might look like.
While for many business owners a legal structure is an afterthought, we want to caution you against it. The business structure you choose can affect your business in heavily consequential ways. It determines how the government sees you, and how well (or badly) you’re protected.
We want to demystify this process so that you can be one step closer to setting up your business up for success.
Disclaimer: This is not legal advice and it is not to be taken as such. This article is for educational purposes only. Laws vary by state and country, and your situation may require professional guidance. Always consult with a licensed attorney or accountant before making legal or tax decisions.
Why do legal entities matter so much?
Think of your business structure, or legal entity, like the foundation of a house. It determines how stable your business will be, how you’re taxed, how you can raise money, and even whether your personal assets are at risk if something goes wrong.
Some structures are very simple—perfect for freelancers or hobby businesses. Others are more formal, offering protection but requiring more paperwork.
The Most Common Types of Legal Entities
1. Sole Proprietorship (the simplest option of all legal entities)
A sole proprietorship is the most basic way to operate a business. You don’t need to file paperwork to create one, it automatically exists when you start doing business under your own name.
This means that you and your business are legally the same: Income and expenses are reported on your personal tax return.
This might be useful for freelancers, consultants, or very small businesses just starting out and has no extra setup costs.
Drawbacks: No liability protection – this means that if your business gets sued, or goes into debt, your personal assets (like your house or savings) are at risk.
So, while this structure might sound like a no-brainer, it might be useful to consider which other structures might offer you more protection in case anything goes wrong.
Most entrepreneurs eventually move away from sole-proprietorships to gain liability protection, which means it might be worth the hassle to set up a different structure at the beginning, depending on your goals.
2. Limited Liability Company (LLC)
An LLC is one of the most popular legal entities choice for small business owners. It creates a separate entity that can own assets, sign contracts, and protect your personal property.
An LLC separates your business finances from your personal finances. If your business faces a lawsuit, your personal assets are usually protected. However, this is not always the case.
If you’re a one-person LLC, this LLCs is often treated as a sole-proprietorship, meaning that all protections go out the window, and you might find yourself back to square one.
However, multi-member LLCs may offer liability protection with simpler paperwork than a corporation, as well as flexible taxation options. You can often choose how your LLC is taxed by the government: as sole-proprietorship, partnership, or corporation – meaning that you may be able to reap the same tax benefits and legal protections as other entities without the added paperwork.
Drawbacks: Costs money to set up and maintain, but we’ve found that this amount is often not unattainable (although it varies by state). It also requires annual reports and fees in some states.
3. Partnership (General Partnership or Limited Partnership)
A partnership is when two or more people agree to run a business together. In this legal entity, profits and losses pass through to each partner’s personal tax return, and it’s easy to set up if you’re starting a business with a friend, co-founder, or family member.
Drawbacks: In a general partnership, each partner is personally liable for debts and lawsuits. A limited partnership gives liability protection to limited partners but not general partners.
4. Corporation (C-Corp and S-Corp)
A corporation is a separate legal entity that exists independently of its owners (shareholders), it offers strong liability protection, easier access to outside investors, and potential tax advantages.
Types:
A C-Corp is a standard corporation that is taxed separately from owners. It can issue multiple types of stock.
An S-Corp is a special tax designation available to qualifying corporations and LLCs, allowing profits to “pass through” to owners’ personal tax returns (avoiding double taxation).
If you want to raise money from investors, issue stock, or eventually sell your company, corporations are the way to go.
Drawbacks: Complex paperwork, strict regulations, and higher costs.
5. Nonprofit Corporation
A nonprofit corporation allows you to operate an organization for charitable, educational, or religious purposes. It allows you to apply for tax-exempt status with the IRS in the U.S., donations to your organization may be tax-deductible for donors, and it protects directors and officers from personal liability while giving the organization credibility.
Drawbacks: Strict compliance rules and reporting requirements, and you cannot distribute profits to owners or shareholders.
6. DBA (Doing Business As)
A DBA is not a separate legal entity, but a way to register a business name different from your personal name.
With a DBA, you operate as “Sunshine Consulting” (i.e. your business name) instead of “John Smith” (i.e. your personal name) – in short, it gives your business a professional name without forming an LLC or corporation.
Drawbacks: Offers no liability protection. It’s only a registration of your name.
Which Legal Entities Are Essential and Which Ones Are Optional?
If you’re an entrepreneur starting a small business, you might want to opt for an LLC.
If you want to go even simpler than that, you might do a sole-proprietorship, or a DBA. But these have significant drawbacks, although they may allow you to start quick.
What we highly recommend for most businesses, again, is the LLC, which offers the best balance of protection, cost and simplicity.
(Depending on what level of protection you’re seeking, make sure to ask your lawyer or accountant whether an LLC is the right choice, as they sometimes don’t provide full protection).
You may want to consider a partnership or corporation (if you plan to scale big from the get-go, and you have the means to maintain it), or a non-profit.
In general, LLCs are essential (Of course this always depends on your goals. Please, consult a lawyer or accountant to save yourself years of headaches!)
Where to Get Reliable Legal Entities Guidance
Since every state (and country) has different rules, it’s important to double-check before registering your business. Here are some trusted places to look for guidance:
Your Secretary of State website – Where you officially register LLCs, corporations, and DBAs (varies by state).
Local Small Business Development Centers (SBDCs) – Free or low-cost business counseling.
And again, for personal advice, always consult a licensed attorney or accountant who understands your industry and location.
Final Thoughts
If you’re just starting out and testing your idea, a sole proprietorship or DBA is fine.
If you’re serious about growing and protecting your assets, an LLC is the most common and flexible choice.
If you’re building a large company with investors, a corporation may be required.
If your mission is charitable, a nonprofit is the way to go.
Remember: this decision has both legal and financial consequences, so don’t rush it. Take the time to understand your options, write down your business goals, and get professional advice.
Have questions? Leave us a comment below and we’d be happy to help you!
– Business Mentor Studio Team
P.S. For more resources like this, don’t forget to check out our blog!
