There are three different forms of business ownership, the Sole Proprietorship, the Partnership, and the Corporation. Each of these businesses have major advantages and disadvantages.
The sole proprietorship is a business which is owned and managed by one individual. Some of its advantages are, the ease of formation, its management control, and its distribution of profits. Some of the disadvantages are, its unlimited liability, the lack of continuity, the capital requirements.
Let’s begin with the advantages. A sole proprietorship is very easy to create. Anyone who wants their own business simply needs to get the necessary licenses from, for example, the state, the county, and/or their local government. After he or she obtain these licenses, he/she can begin operating their business.
In a sole proprietorship, the sole proprietor has full control over his/her operations. Because he/she has this control, they can respond quickly to the changes that may occur in the market. This is a great motivator for a sole proprietor because he/she can keep up with the trends.
The sole proprietor also owns all the profits that his/her business takes in. They themselves own the business and therefore do not have to distribute the profits with anyone else. The only thing that he/she needs to do with the profits is pay the company expenses and the rest is theirs to do with as they please. This tends to be a great incentive for a sole proprietor.
Next, we have the disadvantages. The sole proprietorship has unlimited personal liability. The sole proprietor is personally liable for all of the businesses debts. He/she is the sole owner, which means there is no one else responsible to contributing to the payment of debts. This is one of the biggest disadvantages of a sole proprietorship.
There is also a lack of continuity in a proprietorship. If for some reason the sole proprietor dies, retires, or becomes incapacitated, the business could end. When this happens, if a member of the family, or an employee, does not take over the business, the business could be in big trouble.
A proprietorship is usually a small business, and to find good employees that are dedicated to staying with the business could be hard. The reason for this is that most people look for security, and advancement in their employment, this usually does not exist in businesses which are small. If no one takes over the business, and the business had debts, creditors can go to the courts for a petition to sell off the assets so that they can pay back these debts, therefore the business has discontinued.
It is also very hard in a sole proprietorship to obtain capital. Most banks and other lending institutions have certain formulas/requirements for determining how eligible a borrower may be. Many proprietorships do not meet these formulas/requirements and are therefore limited to whatever capital the owner has to contribute, and whatever money he/she can borrow. This can be a major set back in a proprietorship depending on the amount of capital the owner has to invest.
The next form of business ownership is the partnership. A partnership is an association of two or more people who co own a business for the purpose of making a profit. Some of its advantages are its ease of formation, its distribution of profits, its capital requirements, and its taxation. Some of its disadvantages are, its unlimited liability, its lack of continuity, and it management control.
Once again, let’s start with the advantages. The partnership, like the sole proprietorship, is also easy to establish. All the owners have to do is obtain the necessary business licenses, and submit a few required forms. If the business is run under a trade name, the partners will have to file for a certificate to conduct their business. When the accomplish all of the above, they can start operating their business.
In a partnership, an agreement is usually made up outlining the share of profits each partner should receive. It is necessary for the partners to abide by this agreement when it comes to distributing the profits to ensure that each partner receives the right amount. Besides for this technique, there are no restrictions as to how the partners distribute the company’s profits, they just need to stay consistent with the agreement.
A partnership also has a broader pool of capital than the sole proprietorship. In comparison to the sole proprietorship, the partnership has several owners instead of one. This means that each partner’s personal assets will support a larger borrowing capacity from lending institutions.
When you are a part of a partnership, the business is not subject to federal taxation. A partnerships net income/losses are passed along to the partners as personal income, in which the partners have to pay income tax on. This way, the partnership avoids “double taxation”.
Next, we have the disadvantages of the partnership. One of its main disadvantages is its unlimited liability. One partner is given the title of the general partner. This means that if there are any problems (for example with debts), that partner assumes full responsibility. This is also why the general partner is usually the partner with the least personal resources.
A partnership, once again like the Sole Proprietorship, has a lack of continuity. Complications begin to arise if one of the partners die. A partnerships interest inheritance is often non-transferrable because the remaining partner may not agree on working with the person which inherited that portion of the partnership. This would cause great implications in the partnership because one person is no longer there, which means the work that person was responsible for now has to be distributed among the rest. There is a way of avoiding this problem though, the partners can agree on who will obtain the partnership interest in the event of them dying.
Lastly, there is great potential for conflicts in a partnership. There is no longer one owner which means control is distributed among several people. With several people in control, there is no way to completely avoid conflicts. However, the partners will have to learn to work through their problems by communicating with each other. If they do not do this, their conflicts will remain unresolved which could end up being the cause of their partnership, and business, failing. Communication is essential in a partnership, as it is in any form of business.
Finally, there is the corporation. A corporation is a separate legal entity apart from its owners, in which receives the right to exist from the state in which it is incorporated. It is the most complex of the three major forms of business ownership.
Some of the advantages are, its limited liability, its capital requirements, and its continuity. Its disadvantages are, the cost and time in the incorporation process, the double taxation, and the loss of management control.
A corporation lets its investors limit their liability to the corporation by letting them decide the total amount of investment in the business. This is allowed because it is a separate legal entity, whereas a Sole Proprietorship and a Partnership are not. This also gives the corporation stockholders legal protection towards their personal assets outside the business.
A corporation has great ability when it comes to attracting capital. The only limitation they have, is the number of shares authorized in its charter, this too can be changed. The corporation can raise money by simply selling shares of some of its stock to investors. This way they gain money to begin business and expand.
A corporations future does not lie in the hands of one individual person. It has shares worldwide, and will continue to live as long as people invest in it. The only way a corporation can discontinue, is if it fails to pay its taxes or is limited to a specific length of life by the charter.
Next, there are the disadvantages. To start a corporation it can be costly and time consuming. The actual creating of the corporation can cost between $500 and $2,500. There are also fees involved in establishing a corporation which does not exist with a sole proprietorship, or a partnership. In some states you need the assistance of an attorney to establish the corporation, whereas in others you can do it all on your own.
A corporation also has the disadvantage of double taxation. This means that it must pay taxes on its net income at the federal level, in most states, and to some local governments as well. The corporation pays taxes on dividends at the corporate tax rate, then stockholders must pay taxes on the dividends they receive from the same profits at the individual tax rate. As you can see it is being taxed twice.
There’s also a potential loss of control by the founder(s) of the corporation. When shares are sold in the company, you are really selling shares of ownership, which gives some control to the person who bought the share. The more shares the founder sells to gain capital, the more control he/she is losing. This could be a big problem and amount to a great loss of control for the founder if he/she needs a large capital infusion.
Lastly, the profits of the corporation are widely distributed. People all over the world can obtain shares on the corporation, and therefore receive dividends from the corporation. Therefore the profits are widely distributed among all the shareholders.
As you can see from the information I have given, there are three major types of business ownership. All of these types have their advantages and disadvantages, so it depends on what you decide is better for you in starting a business.