Legal Entity – Everything You Need to Know

In today’s dynamic business landscape, the concept of legal entity holds substantial significance, ensuring accountability, protection, and legality for employers. 

But what does the term legal entity mean, and how does it affect employers’ compliance, hiring process, and everyday operations? This article covers everything you need to know – from the different types of legal entities to prominent examples and other important tips for employers.

What is a legal entity

In simple terms, a legal entity is any business or organisation that has rights, responsibilities, and liabilities under a specific state or federal law. 

The purpose of legal entities is to provide certain protection which separates personal assets from business ones, mitigate risks, and safeguard shareholders. Each legal entity is unique and, therefore, has unique tax burdens and legal liabilities.

What is a legal entity identifier

A legal entity identifier (LEI) is a unique 20-digit alphanumerical code assigned to legal entities engaged in financial transactions. This code is obtained at a Local Operating Unit (LOU), which is an organisation authorised to issue them. LEI serves as a global reference for legal entities and has the following key functions:

• Providing identification – LEIs’ primary purpose is to provide unique and standardised identification to legal entities on global levels.
• Promoting transparency – LEIs’ standardised format provides easier monitoring of legal entities’ financial activities and, therefore, promotes transparency and access to vital information.
• Mitigating risk – LEIs provide links to comprehensive legal entity information, helping regulators and financial institutions manage risk associated with specific entities.
• Providing data accuracy – With legal entities’ obligation to update LEI information on a regular basis, LEIs promote accuracy and reliability in financial data reporting.

What are the different types of legal entities

There’s a wide variety of legal entity types, each coming with its own set of characteristics and purposes. The following are the different types of legal entities recognised globally:

• Sole proprietorships – Considered the simplest form of a legal entity, sole proprietorships are owned and operated by an individual. Sole proprietorships typically don’t provide legal separation between the owner’s and the business’s assets, and the owner is personally liable for the organisation’s debts. 
• Corporations – Corporations are owned by shareholders and represent a separate legal entity from their owners. Corporations provide the strongest level of personal liability protection, as shareholders are typically not personally liable for the organisation’s debt.
• Partnerships – Partnerships are the legal entity type where two or more people join forces to form and operate a business. Partnerships can be either general, where partners share liabilities for debt, and limited, where partners contribute capital but have limited liability.
• Limited liability companies – This type of legal entity is a combination of corporations and partnerships. Its structure allows limited liability to the owners while also allowing flexibility in management and taxation. 
• Joint ventures – Joint ventures are the type of legal entity where two and more companies join forces to collaborate. While each of the parties represents a separate legal entity, they share their resources, expenses, profits, and risks.

Legal entity examples

After gaining an understanding of what is a legal entity and the most common types, here are a few real-life examples for better clarification:

• Sole proprietorship – Sole proprietorships are typically small businesses, including examples such as local bakeries, plumbers, freelancers, photographers, and others.
• Corporations – Apple, one of the world’s largest technology companies, is a real-life example of a multinational corporation.  
• Partnerships – The law firm Smith & Johnson is an example of a partnership, where the two parties share resources, profits, and responsibilities to provide legal services. 
• Limited liability companies – Google, also one of the world’s largest technology companies, is recognised as an LLC. 
• Joint ventures – BMW Brilliance is a joint venture company between BMW and Brilliance Auto Group to produce and sell BMW cars on the Chinese market.

How do legal entities differ in other countries? 

The meaning of the term “legal entity” can vary, depending on the country’s jurisdiction. Below, we provide a brief overview of the most common types of legal entities in different countries:

• UK – The most favoured type of legal entity in the UK is the limited liability partnership (LLP). This entity combines the features of a partnership with limited liability companies, allowing flexibility in management while maintaining limited liability.
• Australia – Australia emphasises proprietary limited companies (Pty Ltd). This structure offers limited liability and is suitable for businesses of varying sizes and industries.
• Dubai – Dubai’s unique legal entities in its “free zones” offer tax incentives and full ownership for foreign investors. Free zones are specially designed areas with their own sets of regulations.
• South Africa – In South Africa, the legal entity structures called a private company (Pty Ltd) and a public company (Ltd) allow limited liability and favourable regulations.
• Netherlands – The most favoured legal entities in the Netherlands are sole proprietors, professional partnerships, and general partnerships.

When should you form a legal entity?

Deciding when to form a legal entity for your business is a critical step that requires assessing various factors. The timing of incorporation can significantly impact liability, taxation, and operational aspects of your business. Here are some of the most crucial considerations:

• The nature of your business – Considering the nature of your business and potential liabilities can help shield your personal assets from your business assets.
• Liability protection – Forming a legal entity limits your personal liability when facing disputes, debts, and legal judgements.
• Business development – Businesses who plan to seek investments and collaborate with partners can benefit from a legal entity in terms of risk mitigation.
• Taxation – Different types of legal entities are subject to different tax frameworks, which can be crucial in determining the type of legal entity.
• Business branding – Forming a legal entity allows you to establish a unique business name and identity, which is crucial for marketing, branding, and legal recognition.
• Law compliance – Certain business activities may require legal entities to comply with industry standards, licences, and permits.

The decision of when to form a legal entity should align with your business goals and long-term plans. Businesses are recommended to consult legal and financial professionals to decide about the right timing and structure for establishing a legal entity.

How to form a legal entity

Forming a legal entity involves a few steps and considerations to ensure compliance with legal regulations. The following is a general outline of how to form a legal entity:

• Choose the right entity type – Research and decide on the legal entity type that best suits your business needs, considering factors like liability protection, taxation, and management structure.
• Choose and register a business name – Select a unique and suitable name for your legal entity that adheres to the law regulations in your jurisdiction. 
• Draft governing documents – Prepare the necessary documents that outline the internal rules and structure of your legal entity.
• Obtain necessary licences and permits – Depending on your business activities, you might need to obtain permits, licences, and approvals to operate legally. 
• Obtain a tax identification number – A tax or employer identification number is necessary to open business bank accounts, hire employees, and make financial transactions.
• Open a business bank account – A business bank account is required, so employers can keep their business finances separate from personal finances.

Is the legal entity name important?

The legal entity name is one of the most important factors in the business incorporation process due to several reasons:

• Brand identity – Your legal entity name serves as your business’s first impression and how customers, clients, and partners perceive your business.
• Legal recognition – Legal entity names are officially recognised by government agencies, business partners, and customers. Therefore, choosing a legally compliant name is essential to avoid legal disputes and administrative issues.
• Differentiation and trademark– Selecting a unique business name helps to differentiate from competitors and reduces the risk of trademark conflicts.
• Online presence – The name of your business entity will influence all of your online interactions, including domain name and social media profiles.
• International expansion – Businesses that strive for global expansion should choose a legal entity name that is easy to understand and pronounce across different cultures and languages.

How does a legal entity affect taxes?

The choice of a legal entity can significantly impact how an organisation is taxed, as it’s one of the most important factors that determine the tax structure.

For instance, sole proprietorships businesses’ income and expenses are reported directly to the owner’s personal tax return, and there is no separation between personal and business income. Partnerships are not taxed on an entity level, but each partner is obligated to report their share of the income and pay tax individually. Corporations are subject to double taxation, while limited liability companies can be either taxed as sole proprietorships or corporations.

Instead of going through the administrative intricacies of opening a compliant legal entity, businesses can partner with a global expansion company such as Native Teams. With a presence in over +55 countries worldwide, businesses can hire and operate fully compliantly without establishing a legal entity. As your organisation’s Employer of record, Native Teams’ tax and legal professionals will take over your global payroll, taxation, HR paperwork and local law compliance so that you can stay fully focused on your business’s daily operations.

Summing up

To operate legally in a certain jurisdiction, businesses are required to establish a legal entity and obtain a legal entity identifier. There are a variety of types of legal entities – from sole proprietorships to limited liability companies and corporations, each of them with a unique set of legal liabilities and taxation requirements.

In order to form a legal entity, businesses must choose an appropriate business structure, pick a compliant legal entity name, and start the administrative process. On the other hand, international expansion companies like Native Teams can help businesses grow their business across borders by acting as an Employer of record and ensuring full legal compliance.