Business Entities: Types, Pros + Cons
By Jordan Vital Ash, Esq. (Founder & Attorney )
October 15, 2025
Choosing the Right Foundation for Your Business
When approached by a client who is looking to start a new business, often the first thing we discuss is the form of entity that business takes. There is a lot of misinformation on business entities, and selecting the right business entity is one of the most critical early decisions an entrepreneur can make. The structure you choose affects how your business is taxed, how profits are distributed, how ownership is transferred, and—perhaps most importantly—how personal liability is handled.
California offers several options for structuring a business, each with unique benefits and limitations. The following is a general overview of the primary entity types recognized under California and federal law, along with their key advantages, disadvantages, and some practical considerations.
1. Sole Proprietorship (SP)
Definition:
A sole proprietorship is the simplest and most common business structure. It refers to an individual who owns and operates a business without forming a separate legal entity.
Pros:
Minimal setup cost and paperwork – practically automatic.
Consists of one individual so complete control over decision-making.
Pass-through taxation (profits taxed only once on personal returns – simplest tax reporting).
Cons:
No liability protection—personal and business assets are legally the same – if you’re held liable, your personal assets could be at risk.
Not structured for partners or investors, no personal liability protection results typically in limited financing and investment opportunities.
Ends upon the owner’s death or incapacity.
Note: Even without formal registration, a sole proprietor may need to file a fictitious business name (DBA) with the county and obtain necessary licenses or permits.
2. General Partnership (GP)
Definition:
A general partnership is formed when two or more people agree—formally or informally—to operate a business for profit. This is essentially a sole proprietorship with two or more people.
Pros:
Simple to establish.
Shared management and pooled resources.
Pass-through taxation.
Cons:
Each partner is personally liable for business debts and the actions of other partners.
Potential for management conflicts (partner chemistry/alignment is crucial!)
Dissolution can be complicated if a partner leaves.
Note: Although there is typically no legal requirement for one, a written Partnership Agreement is usually strongly recommended to outline roles, contributions, profit sharing, and dispute resolution mechanisms.
3. Limited Liability Company (LLC)
Definition:
An LLC is a flexible hybrid entity offering the liability protection of a corporation with the tax benefits and operational simplicity of a partnership.
Pros:
Limited personal liability for members – if your business is found liable for any wrongdoing, your personal assets may be shielded.
Flexible management structure (member- or manager-managed).
Pass-through taxation by default, with the option to elect corporate taxation.
Fewer formalities than corporations.
Cons:
Subject to California’s annual $800 franchise tax (and possible additional fees) – this is paid annually regardless of whether you did business or not.
Certain formalities are required to maintain liability protection – may need to file with the Secretary of State, CDTFA, FTB, and others.
Self-employment taxes may apply.
Note: Although not legally required, a written Operating Agreement is essential to the sustainability and smooth running of your business. This is especially for multi-member LLCs, to establish ownership percentages, profit allocations, voting rights, and exit provisions. It’s never as simple as just “50/50”!
4. Corporation
Definition:
A corporation is a separate legal entity formed by filing Articles of Incorporation with the Secretary of State. It’s advantage is in strong liability protection and more attractive to investors, but requires strict compliance with corporate legal formalities.
Pros:
Personal liability protection for shareholders (*in many circumstances but not all).
Easier access to capital and investors.
Perpetual existence (survives ownership changes).
Ability to elect S-Corporation status for pass-through taxation (*only certain businesses are eligible and this is usually elected for tax-saving purposes – will be written about more in a future article).
Cons:
Requires strict compliance with corporate formalities such as annual meetings, bylaws, and minutes.
C-Corporations face “double taxation” (meaning corporate income taxed first, then shareholder income after that is taxed again – always consult with an accountant regarding these complex tax matters).
Higher setup and maintenance costs.
Note: Proper separation of personal and business finances is critical maintaining the “corporate veil” of liability protection and avoiding personal exposure (“piercing the corporate veil” to be addressed in a future article) .
5. Limited Partnership (LP) and Limited Liability Partnership (LLP)
Limited Partnership (LP):
An LP has at least one general partner who manages the business and bears personal liability, and one or more limited partners whose liability is limited to their investment.
Limited Liability Partnership (LLP):
Common among licensed professionals such as lawyers, accountants, and architects. All partners receive limited liability protection for partnership debts.
Pros:
Flexibility in management and investment.
Liability protection for limited partners (LP) and all partners (LLP).
Cons:
LPs expose general partners to personal liability.
Annual registration and compliance costs.
Note: LLPs must register with the California Secretary of State and comply with profession-specific regulatory boards.
6. Nonprofit Corporation
Definition:
A nonprofit corporation is formed for charitable, educational, religious, or community purposes rather than profit. It may qualify for tax-exempt status under the Internal Revenue Code. Most people are familiar with the term “501(c)(3)” which is the IRS designation for charitable or education-based nonprofits, but there are many others including “501(c)(6)” which applies to nonprofit business associations.
Pros:
Exemption from state and federal income taxes (upon 501(c) approval)(*probably the biggest reason nonprofits are chosen).
Eligibility for public and private grants.
Limited liability for directors and officers.
Cons:
Strict governance, reporting, and recordkeeping requirements.
Profits cannot be distributed to members or directors.
Subject to oversight by the California Attorney General.
Note: Obtaining 501(c)(3) or other tax-exempt status requires a separate IRS application beyond state incorporation, usually via Form 1023 or 1023-EZ.
Summary Comparison
| Entity Type | Liability Protection | Taxation | Ease of Formation | Best For |
|---|---|---|---|---|
| Sole Proprietorship | None | Pass-through | Very Easy | Freelancers, solo entrepreneurs |
| General Partnership | None (shared) | Pass-through | Easy | Small co-owned businesses |
| LLC | Yes | Pass-through or Corporate | Moderate | Small to mid-sized companies |
| Corporation | Yes | C: Double / S: Pass-through | Complex | Growth-oriented or investor-backed ventures |
| LP / LLP | Partial or Full | Pass-through | Moderate | Professional or investment entities |
| Nonprofit | Yes | Tax-exempt | Moderate | Charitable, advocacy, or educational organizations |
Choosing the Right Structure
The “right” entity depends on several factors and is different for every situation. These factors include:
The number of owners or investors.
The level of personal risk tolerance.
Preferred tax treatment.
Desired flexibility in management and governance.
Long-term growth and investment plans.
Selecting an entity without understanding these implications can lead to costly restructuring, partnership disputes, tax inefficiencies, or liability exposure.
Conclusion
Choosing the right business structure is more than a paperwork exercise — it’s a strategic decision that provides the framework and parameters for how your enterprise will grow, operate, and protect its owners.
About ASH LEGAL
ASH LEGAL provides tailored legal counsel for California businesses, entrepreneurs, owners, employers and startups navigating state and local employment compliance.
For guidance or policy review, contact us at (818) 856-6617, jordan@ashlegal.pro or reach out directly through our Contact Page.
Disclaimer: The information in this article is provided for general informational purposes only and does not constitute legal advice. Reading this post does not create an attorney-client relationship with ASH LEGAL. For advice specific to your situation, please contact us directly at ashlegal.pro.