Ownership Structures: Choose Your Best Business Entity Type

Starting your own company is easy. However, making the correct choice for your business entity type is challenging. Determining which business entity is right for your business is essential to take full advantage of your chosen model’s benefits. Let’s look at common business ownership structures and their characteristics in North Carolina. Then, you can see which entity type is best for your start-up!

Learn About Entity Structures in North Carolina

There are many different business ownership structures to choose from in NC. Factors that may affect your choice include:

Your business model
Number of owners
Amount of equity or ability to raise capital

Before you and your possible business partner determine which entity is correct for you, ensure everyone involved is on the same page. Defining your business and determining the amount of capital you have is also crucial when starting a business.

Create a Business Plan to Iron Out Details

The best way to outline your business model is with a business plan. A business plan may consist of many features, including:

Documented projection of future revenue inflows
A balance sheet
The product or service you plan to provide

A business plan helps bring the necessary people together to iron out the details of your business. Everyone, from your accountants to your shareholders, must understand the company’s structure. Being on the same page allows your business to move forward.

Having a business attorney review your plan is also of utmost importance. Your business attorney can ensure your business’s process or ideology works with your state’s laws. They can also inform you about other possible business structures to consider.

Five Business Ownership Structures in North Carolina

There are five different business ownership structures in North Carolina:

Sole Proprietorship: Sole proprietorships are the most self-explanatory of the ownership structures. This entity consists of one owner responsible for and held liable for any debts the business will incur with no limitation.
General Partnership (GP): Partnerships are two or more parties with a private business that share profits and losses.
Limited Partnership (LP): Limited Partnerships are the same as LLCs except that it consists of partners exclusively and not individuals like with an LLC.
Corporation: Corporations consist of board members and shareholders that invest in the company. The public may trade in these shares once the corporation goes public.
Limited Liability Company (LLC): Privately owned company with limited liability, so they do not face personal responsibility for the business’s debts.

Let’s look at these business ownership structures in depth so that you better understand how they work.

Sole Proprietorship

Sole proprietorships are the most basic type of business entity and consist of one owner who makes all decisions. One of the downsides is that the owner is personally liable for all debts in the company’s name.

For example, Tom opens a car wash business. He saves up $50,000 of his own money and creates his business plan. An attorney helps him structure his car wash business as a sole proprietorship.

Then, Tom accidentally crashes and totals a car worth $100,000. Insurance doesn’t cover the damage. The crash happened under the business’s name, but Tom had no liability protection. Tom must come up with $100,000 to cover the damages. Will he sell his car wash and his personal home to cover his debt?

Tom wanted the benefits of being a sole proprietor. As a sole proprietor, he could hold all his earnings. However, the downfall of his business was that he also had to pay for his debts and losses.

General Partnerships (GP)

General Partnerships are almost like sole proprietorships except that there is more than one person, and both must agree on how to run their business together. A GP can consist of two or more persons. “Persons” can be an individual, another partnership, or even a corporation.

You don’t need to file paperwork to start a GP, but creating an agreement with each partner is prudent to alleviate any hiccups that may occur within the business. Partners may decide not to draw up the paperwork, but the partnership will still fall under the rules of the North Carolina Uniform Partnership Act (NCUPA) from a legal standpoint.

Like a sole proprietorship, all partners are held liable for their actions and for the other partners’ actions.

For example, Tom decides to bring his brother, Bill, into his car wash business. Tom and Bill each put $25,000 into their general partnership.

One day, Bill crashes a car worth $100,000 when moving cars around to wash and causes $50,000 in damages. The crash happens while the business is in operation, but insurance does not cover the damages.

So both Bill and Tom face personal liability for the collision damages. Their company is worth $50,000, but they are not ready to sell—instead, Tom and Bill each come up with $25,000 to pay for the damages and keep their business.

One benefit of a general partnership is that other partners can help create the company and share responsibility. On the other hand, the downside is that one partner’s actions can affect every other partner financially.

With a GP, one partner also has the power to make decisions for all the other partners without their consent. If partners are like-minded about the company’s interests, the ability of each partner to make decisions on the spot without permission from the other partner can be a good thing.

You can dissolve a GP for any reason, such as

The death of a partner
Retirement
A partner leaving

Each partner files their income tax return individually with their losses and gains.

Limited Partnerships

If you have two or more persons involved in a partnership and want a more formal structure, you may create an LP. There are a few subtle differences between a general and a limited partnership. With an LP, one or more persons is a general partner, and the other one or more is a limited partner.

The general partner(s) ultimately holds all liability, but the limited partner(s) only faces liability to the extent of their capital contribution. Unlike a General Partnership, an LP must file a certificate of the Limited Partnership with the North Carolina Secretary of State.

For example, Tom and Bill start a car wash business, each contributing $25,000. However, Tom is a general partner, and Bill is a limited partner. One day Tom is moving the cars around, and he crashes a $100,000 vehicle and totals it beyond repair. Car insurance does not cover the damage.

Since the company is worth $50,000 and Bill is a limited partner, his debt is $25,000. He is only responsible for the amount he contributed to the business. However, Tom is the general partner, so he must come up with the other $75,000 to cover the debt for their business.

Limited partnerships mainly benefit the limited partners. A limited partner can be part of all business decisions but not worry about the unlimited liability the general partner will have.

Income taxes work the same way for an LP as for a GP.

Corporations

The most commonly known business entity is a corporation. State laws govern a corporation and require meticulous record filing and rules following. Corporations must document and follow specific procedures for:

Preparing agreements
Holding meetings with recorded minutes
Issuing stock
Establishing bookkeeping practices

Corporate officers or shareholders only face liability up to their capital contribution. However, corporate owners who fail to recognize their legal duties can lose liability protection (called “piercing the veil”). The corporate veil no longer protects one or more owners if they break laws.

Tom and Bill decide to include three family members in their car wash business and make their company go public by issuing stock. Each family member puts up $10,000 to invest and start the business. Since they are a corporation now, they have monthly meetings set up with recorded times of their meetings to go over the business operations.

However, the corporation’s owners don’t understand about keeping separate bank accounts as a corporation. Instead, the family shareholders use the company accounts for most of their household bills, groceries, and other personal expenses.

Someone harmed by the company files a lawsuit against the corporation for damages, claiming damages that would normally only have to be paid by the corporation. If a court agrees, the shareholders will pay damages beyond the amount of their capital contribution (because they pierced the corporate veil protecting their assets).

Corporate Structure and Tax Treatment

A corporate structure includes a board of directors that oversees the whole company. The shareholders of the company elect the board of directors. The board then delegates and elects officers to manage everything from finances to operations.

Both the board of directors and the chief officers elected have fiduciary duties to act in the best interest of the company and the shareholders.

Exclusive rights entice others to invest more into a corporation. Significant shareholders of the corporation often receive exclusive rights, such as:

Voting rights
Preferred stock
Stock options

From a tax perspective, corporations can file as a “C-Corporation,” in which individuals face double taxation: once at the corporate level and then again at the shareholder level.

Or, they can file as an “S-Corporation,” where shareholders only face taxes once, with the benefits and taxes both passing through the S-corporation to the members.

Limited Liability Companies

A limited liability company is the best business entity to protect your company’s partners or members from debt. There is no personal liability for business debts for any members, but you can lose what you put in (your capital contribution). While “piercing the veil” is still a concern, LLCs have fewer formalities to adhere to, which often makes this a better tool for liability protection.

To create an LLC, organizers file articles of organization with the North Carolina Secretary of State. These include information such as:

Name of the company
Address of the company
Even the termination date of the LLC, if so desired

An LLC can have any number of members when created. It can even have just one member, like a sole proprietorship. However, unlike a sole proprietorship, the LLC is protected from liabilities.

An LLC is similar to an LP in some ways. An operating agreement is not required but is highly encouraged to avoid possible future disagreements. If you don’t create an operating agreement, default rules govern.

Our last example of Tom and his car wash has Tom and his family members contribute $10,000 each to the car wash. They have decided to form an LLC so they have personal protection from anything that might happen during business operations.

One day, one of the family members crashes and totals a $100,000 vehicle while moving the lot around for the car wash. Insurance won’t cover the damages.

Since the company is an LLC, individuals only face liability up to their interest in the business. Members don’t need to worry about their home or other personal assets paying off business debt.

Limited Liability Companies can be either manager-managed or member-managed. The members of the LLC can manage the company or bring in an outside individual with no ties to the company to keep track of and manage the operations.

Taxes on LLCs are the same as partnerships from federal and state viewpoints. Single-member LLCs are by default disregarded entities, and multi-member LLCs are treated as partnerships. LLCs can choose to be taxed as either a C-Corp or an S-Corp, which might prove advantageous, particularly if you want the tax treatment of an S-Corp but fewer corporate formalities to obtain liability protection.

We Can Help

At Hopler, Wilms, and Hanna, we are ready to help you choose the best business entity type for your start-up. Our Business Law team is ready to assist you in creating or running any kind of business. And, we’re always available for questions about costs, tax implications, solid financial strategies, or next steps!

Focusing on what legal entity would work well with our client’s goals is just one way we provide strategic advice. We’re with you from your beginning phases to your successfully running venture and beyond!