An important decision in starting a business is the choice of legal entity. This case provides a realistic, yet stylized, setting to facilitate a discussion of factors to consider in the entity choice decision, emphasizing legal and tax issues. Two MBA graduates have raised $5.2 million in equity from a small group of investors to buy a company. Upon deciding to buy assets from another company to start their business venture, they must determine the legal entity that best meets the needs of management and the investors. There are three alternative versions of this case, with the only difference being the allocation of profits to the investors. In this B case, the allocations of profits are not allowed for an S corporation given the restriction limiting the entity to one class of stock. This B case provides for a non-pro rata allocation of profits, which equates to management receiving a 20% profit (i.e., carried) interest.

An important decision in starting a business is the choice of legal entity. This case provides a realistic, yet stylized, setting to facilitate a discussion of factors to consider in the entity choice decision, emphasizing legal and tax issues. Two MBA graduates have raised $5.2 million in equity from a small group of investors to buy a company. Upon deciding to buy assets from another company to start their business venture, they must determine the legal entity that best meets the needs of management and the investors. There are three alternative versions of this case, with the only difference being the allocation of profits to the investors. In this C case, the allocations of profits are not allowed for an S corporation given the restriction limiting the entity to one class of stock. This C case provides for a 10% guaranteed return (i.e., hurdle rate) before the non-pro rata allocation of profits interests.

This technical note focuses on common business entities: sole proprietorships, general partnerships (GPs), limited partnerships (LPs), limited liability partnerships (LLPs), limited liability companies (LLCs), S corporations, and C corporations and offers insights into the basic factors to consider when choosing one of these entities. The Appendix provides an overview of other important entities in the federal tax code: real-estate investment trusts (REITs), regulated investment companies (e.g., mutual funds), and publicly traded partnerships (PTPs).

Appropriate for students interested in purchasing a company. Follows two MBA graduates with $5.2 million in equity to invest as they start the process of choosing an entity structure for their new venture.