When starting a business in Tennessee, it’s important to consider the various types of business entities available and choose what’s right for you. Each type comes with its own set of legal, financial, and operational implications. Understanding the differences between them will help you make an informed choice that aligns with your business goals and objectives.
Here is an overview of the types of business entities available under Tennessee law to consider. We will highlight some of the key characteristics of each and discuss some situations where such business entity may be desirable.
Sole Proprietorship
A sole proprietorship is the simplest type of business entity. In a sole proprietorship, an individual operates their business as the only owner, often with a doing-business-as (DBA) designation. While it’s easy to set up, the owner assumes full personal liability for business debts and obligations.
This may be appropriate for business owners who are in industries with minimal liability exposure. For example, financial coaching does not involve making fiduciary decisions on a client’s behalf and is not a regulated occupation.
But if your business will involve more serious and complex interactions with customers, especially if there are fiduciary duties, another type of business entity is likely preferable.
General Partnership
Unlike other types of business entities, general partnerships can happen “accidentally.” Under Tennessee law, the association of two or more persons to carry on as co-owners of a business for profit forms a partnership, whether or not they intended to do so. Accidental partnership is rare, though.
Partners share profits, losses, and management responsibilities. Like a sole proprietorship, partners are personally liable for the business’s obligations, including personal injury and other tort claims.
General partnerships do not require a written partnership agreement, though they are a good idea to set clear expectations for all parties involved.
When there are multiple owners, it is important to diligently track each partner’s capital contributions to the business. The profits and losses flow through to each partner’s tax returns. Working with a CPA to track the partnership’s financials is highly advisable.
Limited Liability Partnership
The limited liability partnership (LLP) provides partners with limited personal liability for the actions of other partners. This shields individual partners from the responsibility arising from the negligence or misconduct of other partners. This separation encourages the creation of new businesses without undue risk to one’s personal assets based on other partners’ actions.
The LLP provides a liability shield that general partnerships do not. General partners may be liable for the actions of other partners. But partners in an LLP are generally only personally liable for their own actions.
LLPs must file formation documents with the Secretary of State, unlike general partnerships. The filing must include information such as the principal office, mailing address, registered agent, and a statement of the LLP’s business.
This type of business entity may be desirable for professional occupations like law, CPA, and architecture firms.
S-Corporation
An S-Corporation is a type of business entity the Internal Revenue Code authorizes. The owners of a corporation are the shareholders. A board of directors makes high-level business decisions, and corporate officers carry out those decisions. The S-corporation is a tax designation that provides the corporation with two main benefits.
The first benefit is limited liability protection for shareholders. The second is that profits and losses to pass through to shareholders’ personal tax returns, avoiding double taxation. Profit and losses flow through regardless of whether the S-corporation makes distributions.
An S-corporation is “closely-held.” Shares of this type of business entity are not for sale on the open market. Federal law does not permit more than 100 shareholders in an S-corporation. S-corporations also cannot have more than one class of stock, meaning all shareholders have the same type of voting rights.
An S-corporation may be a good type of business entity for those who are looking for private investors. Additionally, for business owners that desire to carry out business according to their personal values, the Supreme Court has held that closely-held businesses may be exempted from certain regulations that violate the owners’ religious beliefs.
C-Corporation
The C-corporation is also a type of business entity that provides limited liability to shareholders. They have complex governance structures and are subject to corporate taxation, which can result in double taxation.
Companies that issue publicly-traded stock are C-corporations. Household names like Home Depot, Apple, Google (Alphabet), etc. are all C-corporations. C-corporations can have different classes of stock, unlike S-corporations. This means some shareholders may have rights that others do not.
Like S-corporations, C-corporations generally have a board of directors, corporate officers, shareholders, and employees. The board of directors votes on major decisions and corporate officers carry out those decisions.
If you plan on selling stock on the open market, such as the Nasdaq, a C-corporation may be the right choice for your business. But there are significant record-keeping requirements with this type of business entity. The board of directors must make decisions carefully to protect investors’ economic interests.
Limited Liability Company
A limited liability company (LLC) is one of the most flexible of all types of business entities. It combines fundamental elements of corporations and partnerships to get the best of both worlds. The LLC offers the protection of the corporate veil to shield its members (owners), as well as pass-through taxation and reduced record-keeping requirements.
The LLC is a disregarded entity for tax purposes by default. The IRS treats single member LLCs as sole proprietorships, and multi-member LLCs as partnerships. But an LLC may elect S-corporation tax status by timely filing the Form 2553 with the IRS.
Tennessee has two sets of LLC law. The “old act” is the Tennessee Limited Liability Company Act, and the “new act” is the Tennessee Revised Limited Liability Company Act. Both are in effect without a sunset provision. For purposes of this article, we will address the new act’s provisions for LLCs formed after January 1, 2006.
There are three types of LLCs in Tennessee: member-managed, manager-managed, and director-managed.
In a member-managed LLC, all members participate in management decisions. This is optimal for businesses where the members actively participate in the business (think owner-operators).
In a manager-managed LLC, members appoint a manager or a group of managers to handle the day-to-day operations. This structure can be optimal when some members are passive investors.
A director-managed LLC is a Tennessee-unique structure. A board of directors manages the LLC, akin to a corporation. This allows for a clear separation between ownership and management. This type of business entity looks more like a corporation than an LLC.
Professional businesses can also operate as LLCs. Many law firms use the PLLC (Professional Limited Liability Company) structure. All members must generally be qualified to practice the profession in order to qualify for the PLLC.
Tennessee LLCs may have a written operating agreement, but the law does not require this. For multi-member LLCs, this is highly advisable to set clear expectations among all members and to have a record of initial capital contributions.
The LLC is one of the most common types of entities that new businesses use. Its highly flexible approach and liability protection offer the best of both sole proprietorships/partnerships and corporations.
Which Type of Business Entity Should I Choose?
Selecting the right type of business entity involves many factors. Important considerations include liability protection, tax implications, management preferences, and future growth prospects.
It’s highly advisable to consult both legal and financial professionals to ensure you’re making the best decision for your specific business situation and plans.
Connell Law, PLLC can assist with business formation and navigating Tennessee business law. Our team is here to provide you with a free consultation to ensure you’re setting your business up for success from the very beginning.
Contact us today to schedule your consultation and take the first step towards a prosperous business journey.
