Choosing the Right Business Entity as a Franchise
One of the most important decisions for a franchise – whether as a franchisor or franchisee – is choosing a business entity type. Your business entity selection will depend on several personal, financial and business-related factors specific to your franchise.
Here, you’ll learn what is necessary to know when finding your right business entity as a franchise, including the different business entities, their character traits and how those traits might counter or work towards the needs of a franchise.
What Are the Different Types of Business Entities?
You can largely classify business entities based on one trait – their liability protection. Some entity choices, like partnerships and sole proprietorships, do not offer liability protection because the law does not separate the entity from the people who control it.
For that reason, the choice of business entity usually comes down to two options, a corporation or limited liability company (LLC). Each one offers liability protection through the separation of the entity and its owners.
A corporation is a business entity whose owner(s) are shareholders. Stock certificates reflect their ownership interest. Corporations are managed by a board of directors and officers (e.g., president, CEO, CFO, etc.)
In addition to limited liability, the defining feature of a corporation is that it is taxed separately from the shareholders. In other words, the corporation pays income tax on its profit in a given tax year and the shareholders also pay tax on any distributions they receive.
Corporations can come in two forms, either C-corps or S-corps. The difference is that S-corps can avoid taxation at the corporate level but must meet other formalities such as limits on the number of shareholders.
Limited Liability Companies
An LLC is like an S-corp because taxation passes through to the owner (i.e., member). However, no limits exist on the number of members an LLC can have. LLCs can be managed by their members or an elected manager.
What Is the Right Entity Choice for a Franchise?
The right entity choice for your franchise depends on the ownership structure, financial needs and other business goals. Working with your team of lawyers, accountants and other business professionals can better assist you in making the right decision about the entity type. However, some general themes often arise when choosing between a corporation or LLC:
- The number of owners (the more owners, the more favorable a corporation may become)
- The need for larger sums of capital from multiple investors (again, corporations might make more sense with the larger this number becomes)
- Added costs (LLCs might be cheaper administratively because of fewer tax returns and other filing requirements)
Sometimes, the right business entity for your franchise will change over time. When this happens, procedures for converting your entity likely exist in your registered state. However, working closely with legal counsel can be helpful to avoid compliance problems or other corporate governance issues.
Legal Help Establishing the Chosen and Right Business Entity as a Franchise
Planning for the needs of your franchise will help narrow down the right business entity choice. However, the answer often comes down to the tax and corporate governance trade-offs between a corporation and an LLC.
The attorneys at Franchise & Business Law Group regularly advise clients on matters involving entity selection. Please contact us if you have any questions about establishing an LLC or corporation for your franchise.
Contact Franchise & Business Law Group today to schedule a consultation about entity selection for your franchise.