Startups / Entrepreneurs- Types of Ownership and Equity Explained
Businesses can be classified in different ways, depending on the type of ownership and equity a person has over an organization. A lot of times, the various classifications can seem difficult for a startup entrepreneur who’s just entering the corporate landscape.
Typically, anyone can set up a corporate entity, provided that they meet the requirements set forth by their state or locality. The way their businesses are classified would depend upon a variety of factors and the classifications also come into play when determining how a business is recognized and taxed under the law.
Here are the main ways a business owner can hold equity or ownership in their business to help startup entrepreneurs further understand the corporate landscape:
A sole proprietorship is a business entity that’s owned by one person. He or she has full, 100% ownership and control over the company and receives its profit entirely (after tax). There is no legal distinction made between the owner of a sole proprietorship and the business, which means that the solo entrepreneur will be responsible for all the debts and liabilities the company incurs.
A partnership is a business formed by a number of people for a common business purpose. They form a partnership agreement in writing and legally register the business by fulfilling the requirements set forth in their state. The partnership agreement is a governing document that outlines:
- How the company is run
- How the company is managed
- How the company is owned
Typically, the ownership in a partnership is set up by interest — i.e. one can be a 50% partner, a 90% partner, etc. In most cases, this interest percentage also determines the profit that each partner gets.
In a general partnership, the owners of the business can be personally liable in case the company is sued. Third parties can sue the partners directly and go after their personal assets. Hence, it’s more ideal to create a limited liability corporation (LLC) or limited partnership.
Limited Liability Corporation (LLC)
A limited liability corporation (LLC) or limited partnership refers to a private company whose owners do not have personal liability in case the company is sued. These types of businesses are also taxed differently. To form an LLC, filings must be made in each State and submitted to the Secretary of State.
An LLC refers to the owners as members whose ownership and equity are also determined by interests. Similar to a general partnership, there can be 1% members or 50% members, etc. in this type of business.
There’s also an option to issue units or a distinct form of ownership that could represent a percentage. For example, there are a hundred units, 10 of which could be issued to an individual who will then have a 10% ownership interest.
A corporation is the only form of business that has shares of stock. This can be in the form of common stock, founder stock, or preferred stock, among others. The ownership of a corporation is divided according to their shares.
For example, if there are a hundred shares available and an individual gets 10 shares of common stock, they can be classified as a 10% owner of the corporation. All this depends on how many shares are available and how many are issued.
These are the primary ways that a business owner can hold equity or ownership in a business, either as a sole proprietor, partnership, LLC, or corporation.