What is the meaning of a legal entity? Key questions answered
A specific suite of terminology exists in the world of business – and understanding it all can be a minefield, especially if you’re just beginning your business journey.
It can be hugely challenging, even if you’ve been operating for many years, to interpret all of the jargon. Yet a failure to do so could mean that you’re caught out come reporting time.
One of the most frequently used terms in the world of compliance and governance is that of the legal entity. This term feels like the embodiment of legalese; both vague and specific, with multiple meanings and no meanings at all. Yet it’s the glue that holds entity management together. Simply put, without a legal entity, there is no entity to manage.
But what is the meaning of a legal entity, why is it so important to compliance and legal operations teams and how can entity management software help to manage them?
What Is a Legal Entity?
A legal entity is any company or organization that has legal rights and responsibilities, including tax filings. It is a business that can enter into contracts either as a vendor or a supplier and can sue or be sued in a court of law.
Legal entities are structured in a way that allows for a greater degree of protection for strictly personal assets from lawsuits and regulatory penalties. Each type of entity provides a different set of protections and tax burdens.
A legal entity can enter into contracts and assume the obligations of those contracts, can borrow and pay debts, can file suits and be named by other parties in suits, and can be held to account for the results of those lawsuits.
Every legal entity is issued a Legal Entity Identifier (LEI) – a 20-character code that serves as a reference to connect a company with financial information. LEIs are still not fully standardized, despite the globalized economic world in which we live, due to the laws and regulations that govern legal entities fluctuating drastically across jurisdictions.
What Are the Different Types of Legal Entities?
Legal entities are the various structures under which you may create a corporation: from S corporations and C corporations to limited liability companies, sole proprietorships, trusts, nonprofits and so on.
There are around 15 types of business legal entities in the U.S. that require different variations of legal entity documents. However, the most common legal structures to choose from are:
- Sole proprietorship – someone who owns an unincorporated business by himself or herself, making all of the decisions but taking all of the risks
- Partnership – an easy way for business owners to share the responsibilities and profits of a company; typically strengthened by a partnership agreement, making clear the working relationship between the partners from the outset
- C corporation – the most common type of U.S. corporation, establishing a C corporation offers liability protection meaning the business owners’ assets are not at risk. Yet the downsides include heightened regulatory complexity and increased tax rates
- Limited liability company (LLC) – somewhat of a hybrid between a general partnership and a corporation, LLCs offer the limited liability assurances that corporations offer without the penalty of double taxation
That’s the U.S. scene in a nutshell, yet it’s not fully indicative of business practice in other parts of the world. Let’s take a look at the meaning of legal entities in other jurisdictions.
How Do Legal Entities Differ in Other Countries?
The question “What is the meaning of a legal entity?” varies widely depending on your location. While a legal entity will always be defined the same way – that is, as a company or organization that has legal rights and responsibilities – its ultimate form can differ.
Here’s a whistle-stop global tour of legal entities, beyond the U.S. view:
- In the UK, to be an incorporated entity, you can choose a limited company (limited by guarantee or shares), a limited liability partnership (LLP), a community interest company (CIC), a charitable incorporated organization (CIO), an industrial and provident society, or a financial mutual, among others.
- In Australia, the four most common types of business structures are a sole trader (unincorporated), a company, a partnership, and a trust.
- In Dubai, which can differ from the other Emirates, companies are registered by category – company, partnership, branch office or free zone company – and are then incorporated as a limited liability company, a civil company, a joint-venture company, a private shareholding company, or a public shareholding company, though this is an extreme simplification of the process there.
- In South Africa, the principal methods of doing business are through a public (Ltd), or private (Pty Ltd) company; a personal liability company (Inc); a partnership, business trust, sole proprietorship, or an external company (a branch of a foreign company).
- Over in The Netherlands, business is done by a general, limited or professional partnership, a private company with limited liability or as a sole trader.
As you can see, while the meaning of a legal entity doesn’t technically change across different jurisdictions, the legal entity form and types of legal entity can look different and have varying compliance and governance implications.
How Does a Legal Entity Affect Personal Liability?
In the UK or Australia, you could be a sole trader, or in the U.S. a sole proprietorship, and still be able to do business without forming a legal entity. The important distinction is around liability.
Without a legal entity, there is no line between your business finances and liabilities and your personal ones. That means if your company is sued or goes into debt, you could be held personally liable for this; your personal assets could be seized to pay the debt, or you could be sued personally and face the consequences.
It all comes down to what kind of business you’re running. If you’re selling your homemade crafts on Etsy, then you probably don’t need to know the answer to the question, “What is the meaning of a legal entity?”. However, if you’re a start-up that’s ready to evolve into your next phase, it’s a good idea to consider which type of business structure best suits your company.
What Should I Choose as My Legal Entity Name?
A business entity’s name is highly valuable – it’s what you’re known for in the marketplace, what your reputation is built around, and what you trade from. Yet that doesn’t make it a trademark.
Selecting a name is a hugely important decision, and with this comes responsibility. Legal advice should be sought to ensure that the name is compliant with laws restricting business entity names, and that all steps needed to protect the client’s rights to its name are completed.
An original legal name must be selected before a business entity can be formed. This legal name can be changed in the future, but a business entity can have only one legal name at any given time. Getting it right from the outset can save significant resources and headaches later on.
How Can Technology Help Manage a Legal Entity?
Legal entities don’t manage themselves. Whether you are managing multiple entities or just have one to consider, entity management and entity governance are of utmost importance to your compliance status.
While responsibilities and requirements differ depending on the part of the world in which the legal entity is incorporated, you can guarantee each legal entity will need to submit some form of report to regulators, industry bodies, or government departments on a semi-regular basis – be that annual financial statements, monthly tax filings or confirmation of director information.
Keeping on top of all of your legal entity’s regulatory responsibilities can be both time-consuming and complex, especially once you add into the mix multiple entities within one corporate structure.
Compliance and legal operations teams need to approach managing these entities from an entity governance point of view. This means keeping a strategic eye on all entity requirements and being able to forecast any downstream impact of changes to regulation or responsibilities.
The best way to work with an entity governance approach is through harnessing technology for your entity-based operations. Diligent’s entity management software helps to digitize your entity management practice by centralizing information, ensuring your organization’s compliance with all local, state, and global regulations. Cybersecurity, ESG, and most compliance measurement rolls up to single source of truth for all entity-related information, from contracts and other documents to director information and compliance calendars. Plus, it helps you automate process chains, find information instantly, manage corporate data, and appoint a signing authority.
Schedule a demo to discover how Diligent’s entity and board management software can help keep your legal entities on a sound compliance path.
