Around 90 percent of businesses nationwide deal with at least one lawsuit in their lifetimes. This must be one of the reasons enterprises are usually set up as separate legal entities (SLEs) today. The term, SLE, is also frequently heard during discussions among business people, including students of business-related courses like entrepreneurship and accounting.
The fact that SLEs are a widely covered subject is proof of their significance. When people go into business, so much is at stake. Capital includes money, time, labor, and other valuable resources. With more knowledge of SLEs, this capital can be better protected.
Setting up an enterprise as an SLE safeguards shareholders’ personal assets when necessary, such as when their company faces a lawsuit. With our free market system leading to an ever-volatile national economy, it pays to be ready.
Understanding SLEs
An SLE is an independent business accountable for itself. The law considers it an autonomous being, detached from the shareholders behind it. As such, it has rights as if it were a human person. For example, it can enter into contracts, purchase or sell assets, sue and countersue, and so on.
Depending on how a business is structured, it may or may not be an SLE. Below are the different types of enterprises recognized as separate entities by the law:
- C Corporations. A C corporation is one of the most common types of corporations today. Shareholders pay their personal taxes separately from the business’s corporate income taxes.
- S Corporations. These corporations pass through their corporate income tax, losses, deductions, and credits to their stakeholders.
- Limited liability companies. LLCs enjoy the liability protection of a corporation while benefiting from a partnership’s versatility and pass-through tax feature.
- Limited partnerships. In a limited partnership, tax liabilities are limited to certain partners as opposed to a general partnership, in which shareholders have equal liabilities.
SLEs vs. Separate Entities (SEs)
As previously defined, an SLE is a business regarded by the law as separate from its shareholders. In contrast, a separate entity (SE) is a business whose finances are managed independently from its shareholders.
An SE, therefore, is not legally acknowledged as a separate entity. However, its financial affairs are treated separately from those of its shareholders. It will have its own bank, credit card accounts, and tax identification number (TIN).
Note that SEs are not automatically SLEs. That indicates the personal assets of an SE’s shareholders are not legally safe should the business face a lawsuit. Below are the types of enterprises that are SEs but not SLEs:
- Sole proprietorships. As the term indicates, only one person owns a sole proprietorship business and has total authority over all its aspects. As it is considered an extension of the owner, this type of business is not an SLE.
- Partnerships. There are several types of partnerships, and each impacts shareholder liability differently.
- General partnership. Shareholders are equally liable for all obligations of the business.
- Limited liability partnership. Only the shareholder party to the lawsuit has liability.
- Limited partnership. This type of business combines the features of the first two types of partnerships. A shareholder’s liability is contingent on their investment in an organization. The same is true for “silent members,” or stakeholders not involved in the daily operations of the enterprise.
- LLC partnerships. As multimember enterprises, LLC partnerships are treated as LLCs by the law.
Note that no federal law impacts the separation of partnership businesses from their shareholders. Hence, parties planning to establish partnerships should check their state laws to clarify issues regarding liabilities.
Significance of SLEs in Business
The significance of SLEs goes beyond identifying the different types they come in or how they compare to SEs. More importantly, this business setup is well-known for its benefits to businesses and shareholders.
While situations can vary for different enterprises, they all enjoy the overarching SLE advantage of personal asset protection. Specifically, these assets will be safe against any unpaid debts of the business, along with any stakeholder’s personal bankruptcy and liabilities.
Consider a restaurant that shuts down with unpaid loans from prior kitchen equipment purchases. If the business has only one owner, it is a sole proprietorship. Hence, the owner will pay for the entire debt using personal money.
Suppose the restaurant is a limited partnership, with one partner holding a 40 percent share and the other owning the remaining 60 percent. In this situation, each partner will pay only a portion of the debt equivalent to their investment using their own money.
If the business is an S corporation, none of the stakeholders will use personal resources to pay the debt. Instead, as an SLE, the restaurant will cover the payments by disposing of its assets to raise the required amount.
Protect Your Personal Assets as an SLE
When a business has its own legally recognized personality, shareholders are more at peace in facing financial challenges. The business can act on its own as an SLE, taking responsibility for its liabilities using its funds as an SLE. No owner will have to use their personal resources to pay for such liabilities.
Moreover, setting up a business as an SLE can help protect shareholders’ personal assets. Even if the company is under government investigation, the owners of the enterprise have protection for their personal finances.
However, only specific business structures can function as SLEs. These include S corporations, C corporations, LLCs, and limited partnerships. Sole proprietorships and partnerships cannot act as SLEs but can adopt the structure of SEs.
The US economy expanded by 2.6 percent in the third quarter of 2022, but it’s hardly in the pink of health. When starting a business at this time, safeguards are necessary to protect all shareholders in any eventuality. A simple way of doing this is to structure the enterprise as a separate legal entity.
