As stated by BusinessDictionary.com, a separate legal entity is a business that is given its own individual legal status. This is usually done by forming a limited liability company or a corporation so that the company's actions may be legally declared as separate from those of an individual person, the company's shareholders or another company.
One reason why businesses create separate legal entities is so that the debts of those separate entities are not shared by the shareholders. As the Houston Chronicle explains, if a separate legal entity owes money to creditors, the creditors can not take that money from the shareholders' personal wealth.
Another reason for creating a separate legal entity, according to the Houston Chronicle, is that such entities have "perpetual existence." In other words, if any person tied to the entity dies or leaves the company, the entity continues on without that person. This also allows shareholders or investors to sell their interest in the company and allow the company to continue on without them.
The history of the separate legal entity is a long one, going at least as far back as mercantile trading companies in the 1600's such as the British East India Company and the Hudson Bay Company, as explained by the University of Tennessee.