For starting a franchise business, one needs to own a business entity. A Business entity is an organization that is formed to perform all business activities. A business entity is entitled to all the rights that an individual possesses. This includes owning real estate, bearing liabilities, and paying taxes under the federal code. Each kind of business entity has its own purpose and hence is suitable for a particular kind of business. To comprehend more on what kind of business entity fits best for franchise owners, we have made a comparison of business entities for franchise owners.
The business factors that need to be considered are- the tax code the business entity is entitled to, the amount of exposure to liability that particular entity compels, and the ease of application, registration, and management
Off all types, three types of business entities are best suited for franchise owners-
- Limited liability company
A sole proprietorship is a type of business form that one person owns and manages. Here, the business and the owner are not legally separate. It is the simplest form of business entity or structure.
The business owner, also known as a proprietor or a trader, conducts business using their legal name or by using an alternative trade name that can be achieved post-registration of the business.
Of its simplistic idea and less expenditure in setting up a sole proprietorship, it is one of the most sought business entities and is common among small businesses, freelancers, and other self-employed individuals.
However, the overtly simple features and minimal setup costs do not compensate for the liability exposure of the owner. The proprietor may be the sole manager of the business yet it is not considered as a legal entity. The structure does not allow any personal protection- also in terms of assets, on the lines of all financial and legal failures or issues.
Corporations are business entities that are separate from their owners. Corporations, under the law, can enter contract loans and borrow money, sue or be sued, hire employees, own assets, and pay taxes. They possess rights as an individual. Corporations are flexible and popular. With regards to taxation, corporations can be sub-categorized majorly into C Corporations, S Corporations, Professional Corporations, and Non-Profit Corporation.
Of the above, C corporation is the most preferred in the US. With a C Corporation, one can grow business through the sale of stock and there is no limit to the number of stockholders. The C corporation provides protection to the owners as well as the stakeholders by limiting their liability. A fact to know here is that, even if the owner decides to disperse, the company doesn’t dissolve. Although tax deduction is offered, the amount of tax is doubled at the business’s revenue level and stakeholder dividend level. A C Corporation is the only entity that can support financing through Rollover for Business Startups.
Creating a C Corporation involves a ton of paper works and relatively larger operating fees.
S Corporation is quite similar to the C Corporation concept in regard to the liability and security of the owners and the stakeholders. However, major differences are seen in the terms of tax implications.
One significant difference is that this entity is accessible to only US citizens and permanent residents. An S Corporation can limit its stakeholders to 100 only and also, and the growth potential from the sale of stock is also limited. S Corporation stockholders need to be individuals and not entities. In the context of being debt-free, S Corporation doesn’t allow any other methods but having a huge sum of liquid cash.
Limited Liability Company
An LLC or Limited Liability Company is a kind of business entity that offers its owners a certain degree of protection from liabilities. An LLC presents the best of both- Partnership and Corporation. Limited Liability to all of its owners like a corporation, without the complexities of the setup and maintenance of the business as well as the flexibility of allocating profits like a partnership.
Hence, this business entity offers a lot of flexibility in operations.
LLCs can take different forms under the federal tax code. If your LLC has one member only, the business will be referred to as Sole Proprietorship, while with more than two owners, the business is bound to be called a partnership. When it comes to tax code, LLC is referred to as an S Corporation, and a single ownership LLC is required to fill the form as a sole proprietorship.
The protection of limited liability is a big one, as we’ve mentioned because it protects you and your team from the debts and obligations of the business when things go wrong. The profit and loss of this entity is reported on personal taxes, so no need for a corporate tax return. Forming this entity requires no citizenship. Unlike the S corp, you do not need to be a U.S. citizen or permanent resident to start an LLC. An LLC can be owned by a C-corp, which means people who already have a business but want to use ROBS to inject capital to fuel their growth are able to do so.
Being the most secure form of business entity, LLCs too has a downside. You cannot attract investors via the sale of stock. Which, potentially, can stunt the growth of your company. LLC revenue may be subjected to self-employment tax. You don’t know what you’re going to get from any given state, since LLCs can be treated differently depending on which state you’re in. And there is a chance of getting charged an extra load for conversion of the business from LLC to C Corporation or S Corporation.
Now that you know all about the major business entities that you can pay heed to, it’s easier to settle on a particular business entity that would be the most favorable for you and your franchise business.
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