What is business entity concept and how does it differ from other types of legal entities?
The concept of the economic or business entity is important because it forms the basis for many accounting and tax rules. The definition of an economic or business entity is one that has separate existence, rights, duties, liabilities and ownership than those associated with its owners. In addition to providing guidance on what constitutes an economic or business entity, this concept also provides guidance on when such entities should be treated as separate from their owners for accounting purposes.
An economic or business entity exists if there are separately identifiable activities generating revenues and incurring expenses that are controlled by different individuals who have common interests in those profits. This can include any number of different structures including corporations (both C-corporations & S-corporations), limited liability companies (LLCs) partnerships, joint ventures etc.. In order to determine whether you have created an economically distinct legal structure
- 1 What is the Business Entity Concept?
- 2 Reasons for the Business Entity Concept
- 3 Importance/need of business entity concept:
- 4 Types of business entities
- 5 Advantages and disadvantages of different types of business entities
- 6 How to choose the right type for your needs
- 7 Steps in establishing a new entity
What is the Business Entity Concept?
In business, the term “business entity” may refer to a corporation or a company. In this context, it does not matter whether one is referring to a small or large formal enterprise or an informal enterprise such as a household. For all practical purposes, people engaged in business have their businesses registered so that they can officially do business under specific legal regulations and laws. This registration is usually associated with a particular location, which is where the owner of the business lives or has his residence.
Reasons for the Business Entity Concept
In a business entity, there are two most important reasons for going with the formalities of setting up a legal entity. Firstly, operating a business under a registered name affords better protection against liabilities and lawsuits. Secondly, it gives some sort of legal reliability to investors or lenders who want to put their money in such ventures.
Importance/need of business entity concept:
The legal entity concept is important for commercial or business transactions and activities and therefore it is essential in business. The need to establish a legal identity becomes all the more imperative if the business deals with other entities such as other people, companies, etc. Often businesses involve complex contractual arrangements among themselves or with customers that require clear identification of the appropriate parties before entering into such arrangements. Moreover, whenever there are disputes over specific transactions or agreements, proper identification of the concerned parties becomes even more crucial to resolve such disputes.
Types of business entities
There are four types of business entities:
1. Sole proprietorship: This is a business that is owned and operated by just one person. The sole owner conducts business on his own without the interference of any other individual or entity. No registration is required for those engaged in businesses as sole proprietorships
- 1. It is a business which is owned and run by only one individual, who has complete responsibility for making all the decisions regarding the organization’s management, financing, production planning etc., without any interference from outside sources.
- 2. There is no legal requirement that requires registration or incorporation of this type of business entity although in some areas it may be required to pay some taxes on its income.
- 3. No legal liability exists because there is no separation between personal property and business assets.
- 4. Unlimited liability means that both the owner’s personal assets and business debts are at risk in case the business fails financially due to inadequate capitalization or mismanagement in carrying out their operations which leads to
2.Partnership: which represents an association between two or more persons who agree to share the profits gained from running a specific enterprise agreed upon by all partners. In most cases, no legal documents are drawn up determining how profits be shared among the partners. Each partner is considered to be an owner of the business. In addition, no registration with any government agency is required for a partnership to begin doing business.
- A type of business entity that is owned and run by two or more individuals to share the responsibility of making decisions related to its management, financing, production planning etc.,
- There are no legal requirements for registration or incorporation even though some areas may require payment of taxes on income earned.
- No legal liability exists because there is no separation between personal property and business assets since there is only one set of legal documents which applies to both types.
- Unlimited liability means that both partners’ personal assets are at risk in case the business fails financially due to inadequate capitalization or mismanagement in carrying out their operations which leads to insolvency.
- Partnership needs no official since each partner has equal right over
3.Close corporation or family company: A close corporation or family company is a business that is owned by only a few people. It may also be referred to as a private firm and has relatively fewer subscribers than public corporations (closely held companies)
- It is a business that is owned by just a few individuals.
- Usually, the shareholders of this type of company are relatives or close associate’s who embark on business activity together. The rules governing its operation are also not very clear since the owner usually determine how to distribute profits among themselves without consulting anyone else.
- This type of business entity needs no registration due to the fact that it has few but highly loyal members.
- Unlimited liability means that both personal assets and business debts are at risk in case the enterprise fails financially due to inadequate capitalization or mismanagement in carrying out their operations which leads to insolvency.
- Close corporation or family company does not need any kind of official legal documents
4.Public corporation: This refers to companies whose shares are traded in the stock market, such as Apple Inc., Toyota Motor Corp., and General Motors Company (GM).
- It is a business entity that usually has many shareholders who are not involved in the day to day
- Ownership of stock gives investors voting rights and they have chances of deriving benefits from their shares. This implies that public corporations are managed by people other than those appointed by its owners.
- Public corporations are supposed to publicly disclose their finances, budgets, operations, etc..
- Corporation is liable for debts but this liability can be limited when they prepare articles of incorporation.
- Registration with any government agency is mandatory for them to begin doing business.
- Limited liability means that only the amount invested or contracted is at risk in case the corporation fails financially due to inadequate capitalization or
Advantages and disadvantages of different types of business entities
Informal business entities such as sole proprietorship and partnership do not have the legal status of a corporation. This means that there is no clear distinction between the owner and the business, which can be both a good thing and a bad thing. It is a good thing because it makes it easier for one to take control of his business. The flipside is that earning from this entity may not be taxed in the same way as when an individual earns interest on savings or takes home some amount after retirement . A corporate body has better tax benefits than other types of business entities since corporations are separate legal entities with their own financial statements, auditors, records , etc. A corporation may also offer additional protection to its owners by having limited liability provisions .
A sole proprietorship is an unincorporated business that is owned by one person. The owner functions as the business and receives all profits, reports them on his annual tax return, and pays taxes accordingly. A sole proprietor may even employ others to help him in running the business. This type of entity used to be preferred to other types since it was easy to establish without much paperwork or legal hassles. However, now there are requirements before one can start this type of enterprise . For instance, if one wants to obtain a business license for his unincorporated enterprise, he needs to meet certain administrative requirements based on where he lives .
The partnership is another informal type of business entity whose ownership rules are similar to those applicable in the case of a sole proprietorship. A partnership has its own set of financial and tax laws that apply in different countries and regions around the world .
A corporation is a business that is incorporated and whose ownership arrangement devolves on shareholders . A corporation has several advantages when compared to other types of business entities even though it may be subjected to heavier taxes since it is a separate legal entity. One such advantage is limited liability, which means that owners or shareholders can be held liable for their company’s losses only up to the amount they have invested in their company. This type of entity also offers entrepreneurs more protection from creditors who have lent money to the enterprise . Most types of businesses that are considered large enough often adopt this structure because it enhances a company’s credibility and creditworthiness.
The corporation is one of the most frequently used types of business entity for large, established companies . It allows owners to separate their personal assets from those of the business . Forming a corporation usually requires filing paperwork with the local state or federal government . A board of directors must approve articles of incorporation prior to submitting them to the state. The formation documents specify information such as the name of the company, its purpose, how many shares are authorized, where it will do business, etc. The articles also include provisions for establishing bylaws which outline operating procedures for shareholders. Bylaws typically require shareholder approval before they go into effect. Corporations often have their own set of internal policies guide employees’ behavior including but not limited to an employee handbook .
All of these types of entities offer business owners with a certain degree of protection and benefits afforded by the law. However, it is up to them as individuals to know what is legal and beneficial for their particular case . This means that different people may prefer different types of businesses depending on their own personal circumstances
How to choose the right type for your needs
Before choosing a business entity it is crucial to evaluate your business needs. The decision of choosing the right type of business organization will be determined by the nature, structure and size of your corporation. This means that if you are starting something on your own, you may opt for sole proprietorship since there are no other partners involved. But when there are many shareholders who want to share in management responsibilities or profits, then public corporation comes in handy. At the same time, if you do not want your personal assets to be at risk in case something goes wrong with your company, then private firm would be appropriate choice even though family company still has unlimited liability just like close corporation.
In addition, it is advisable for entrepreneurs to read more about different business organizations so as to avoid choosing the wrong type which might not yield positive results.
Steps in establishing a new entity
It is important for those who plan to set up a business entity to choose the type that best suits their needs. However, before doing so it is crucial that your business receives legal advice from a law professional. This will ensure that you are choosing the right type of business organization since not all types are adaptable with each other. The next step would entail registering your new corporation by complying with the local or state regulations regarding registration of business entities, which may require filing articles of incorporation, publishing notice in the newspaper and paying certain fees .
Next , entrepreneurs should appoint an attorney-in-fact, otherwise known as initial agent , who will be responsible for service of process , among other things . Then they must draft shareholder’s agreements to specify any agreement made between shareholders . It is also important for entrepreneurs to set up bylaws where they would outline the corporation’s policies. Meanwhile, it is equally important to create an employee handbook which will serve as a guide for employees’ rights and responsibilities regarding areas such as salaries, working hours, sick leaves etc. Thus , these are some of the steps that entrepreneurs should take when setting up their new business entity
All in all, individuals must conduct research on various types of business organizations in order to choose the right one which will best suit their needs. This means that before making any decision, individuals should know what is legal and beneficial in each case . For this reason it is advisable for them to read more about different business organizations before choosing one that will yield positive results.
The concept of the business entity is a legal and economic category that defines who may own property, sign contracts, be liable for debts or taxes. It’s important to understand this aspect of your company as it can affect how you operate in many ways. If we’ve answered any questions about the idea behind the business entity and what it means for your company, please let us know! We’re always happy to answer any questions on our blog posts – no matter how small they are.