The scenario in question gives us the portfolio of a person that likes to do things around the home and has come up with an idea that might benefit his/her home and perhaps other homes globally. Another version of this idea already exists on the market but the person believes his invention might further simplify and make the “appliance” more user friendly and safer. This person does not have available funds for the project and would therefore have to look to an outsider to complete the task at hand.
The inventor has researched the market of the other “appliance” and found that it has an annual growth of 2%. He believes this invention could increase that growth because he thinks this invention might be used in many other “appliances” making the product quite versatile and therefore appealing to a wide range of markets. For the person to be able to make a wise decision about how to make his project a reality we look at three types of business, the sole proprietorship, general partnership and corporation, while considering the advantages and disadvantages.
After looking thoroughly at these types of businesses, we try to make an informed decision in which type to recommend for the project, keeping in mind all the aspects of the persons “limitations”. These three types of businesses all have their advantages and disadvantages and based on those we determine that general partnership would be the smartest way to proceed, as the persons “limitations” minimize the chances of the two other options succeeding.
Let us start by looking at closely at the three business types in question regarding the scenario.
Sole proprietorship, a business owned and operated by one person.
He would be in full control, and accountable to no one but himself. In the case listed this could be good because he could manage his time between his business and the home equally, on the other hand it might also bring difficulties both to the home and business as one might suffer from the other. Managing a business by oneself must be a difficult task.
It is easily achievable. The startup of a sole proprietorship would be easy, but does success come from ease? There must be some risks and difficulties involved.
Less money to be raised for starting up the business. As written in the scenario, the subject does not have access to large funds, therefore this could be a less financially upsetting way to start.
He would be liable for all the debts of the business personally, there is no limit to his liability. Putting his family’s financial security at risk might not seem a good idea and hardly appealing to his spouse, but taking a considerable amount of risk would be necessary.
He might find it difficult to attain funding. Being an individual with low “net worth” banks and other loan facilities might not want to take the chance of lending the money for the project.
General partnership, two or more persons whom share monetary responsibilities.
Growth possibilities. As described in the scenario the idea could be usable with several “appliances” making the project likely to have considerable growth potential in time.
Easier to attain funding. If two or more individuals take up partnership it is more likely to be appealing to monetary facilities to fund the project because two individuals are worth more than just one.
Both partners are taxed as individuals. Only one level of taxation. Partners are taxed according to their partnership agreement and have full control over how their income is allocated in accordance to their interests as long as there is economic reason.
One person may be liable for all debts. If for example a person would only be letting someone use their name in the partnership agreement, that same person, even if he or she could prove never to have had anything to do with the business itself, could be liable. It is therefore extremely important to have a good, detailed partnership agreement that covers all aspects of the partnership.
Conveyance of ownership can be arduous. If for example one of the partners died, the partnership would go to his next of kin or whomever is his or her heir. This could be a problem if that person is not interested in the partnership or for any other reason is unable to uphold the partnership agreement.
Corporation, a business where owners have separate status from the business itself and are only financially liable at part.
The owners are only liable for the funds they bring into the business. There is an exception from this rule, if the incorporation of the company was not “up to par”, an owner can be held liable.
The business is not reliant on the owners to continue. The board members can easily agree on “pushing” an owner out of the corporation, which can be become a reality in this particular scenario if the inventor or initial owner of the corporation does not have a “bulletproof” agreement and/or patent of the product of the corporation. If an owner dies or by any other means cannot uphold his status in the corporation it does not affect the corporation itself.
Costly startup. As written before, the subject is not a person of great means. Starting a corporation could be extremely difficult for this person.
Rules and regulations. There are different rules and regulations in accordance with where the corporation is incorporated, for the subject it might be a wise decision to incorporate in another state than where he lives, which in turn could make the spouse unhappy for it would obviously make the home life difficult and/or resolve in them having to move the whole family to a new place.
The owner as well as the business are taxed separately, making the income double taxed. “First, a corporation pays income taxes on company profits. Then stockholders pay taxes on their income (in form of dividends) returned by their investments.”( Ebert, R. J., & Griffin,R. W. (2011), page 48)
To make an informed decision regarding the type of business that best fits the person’s interests, abilities and the product, the first step for the person could be to have the idea assessed. There are several businesses that offer that kind of services and for this particular scenario it might be the best thing to do. From reading the scenario it is apparent that the persons spouse is insecure about the whole affair and by having the idea or invention assessed the inventor could get an experienced professional in this field to assess the product regarding manufacturing possibilities, consumer needs, legal aspects and distribution, before he jumps in “at the deep end” and puts his family’s financial security at risk.
Having done that, based on the assessment, he could make an informed decision regarding the business type best suitable. After reading the scenario and studying the business types it would be likely that the best type in this case would be General partnership. That recommendation is based on the fact that the person is low on funding options and taking in consideration the families security, sole proprietorship seems too risky because the person would have to create large debts in the beginning to just produce the product, that is, if any type of monetary company would want to risk lending to the person in the first place.
Also by opting for sole proprietorship, all obligations of the business would fall on the person, making the venture potentially minimize family time. Even though sole proprietorship could result in great personal success and money if all went as planned, the initial risk would be too great, especially when taken into consideration the fact that the person has little or no managerial skills. By choosing general partnership, the person could, after having the invention assessed, and perhaps patented the “appliance”, make detailed business plan that could be presented to one or more potential business partners with access to large funds and /or good credit, being careful in choosing someone who can bring to the table something that compensates his shortcomings, like his lack of managerial skills.
General partnership also divides the risk, making the project more appealing to the persons spouse. By creating a “bulletproof” detailed partnership agreement it minimizes the risk of all factors of the disadvantages in general partnership. Choosing the corporation type at this time would not be wise because it requires large funds and could prove too large an undertaking for the person at this point. That however does not mean things cannot change in time.
Courtney from Study Moose
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