Business Organizations: Sole Proprietorship, Partnership and the Corporation
A common issue that all organizations will go through is how to effectively structure their business. Where, the various benefits as well as drawbacks of sole proprietorships, partnerships and corporations can be confusing. In business the way that an entity is organized will speak volumes about a business’ structure, duties and liabilities. This is important because for many, the various distinctions can offer a number unique benefits. Where, the structure will depend upon the financial situation of the owners and their overall views (to determine when as well in what form an entity will evolve). This is significant because, the way a business is structured will have a dramatic impact on the owners’ lives and the business itself. However, to fully experience the different benefits requires that you compare the three most common ways that a business entity is organized. Then, you must examine the overall drawbacks of each type of organizational structure. This will provide the greatest insights as to the overall strengths and drawbacks of each.
Sole Proprietorship
The sole proprietorship is when a business or organization is controlled and owned by one person. This is one of the simplest forms of entities to form, where there is little paper work or upfront fees. However, the most important characteristic is: the legal view that the business and the owner are the same person. In general, these kinds of business structures are ideal for those who are seeking to keep their organization small and are not looking to take on lots of liabilities (debts). (“Sole Proprietorship”)
Advantages
The sole proprietorship has a number of distinct benefits the most notable would include: they are easy to establish, the tax structure is fairly straightforward and it is easy to manage. The way that this kind of entity is easy to establish is within the various state laws, where there are no formal requirements that must be met (such as: submitting a number of different legal documents to establish the entity). A sole proprietorship does not file any federal or state income taxes. Instead, all profits from the business are taxed as a part of the owner’s individual income. This type of business structure, offers the owner direct control to manage the entity as they see fit. (“Sole Proprietorship”)
Drawbacks
There are a number of drawbacks with sole proprietorships the most notable would include: financing can be difficult to obtain, the owner is responsible for all liabilities and the entity ceases upon the death or retirement of the owner. A sole proprietorship is based off of the creditworthiness of the owner. This means that if they want to be to obtain any kinds of financing it is limited to mainly personal / business loans through small banks. The owner can not go to outside financial markets or use other financing options. This makes the responsibility for all liabilities that a business may accumulate with creditors, distributors or various utilities a direct obligation of the owner. When the owner is disabled, passes away or retires the entity will cease existence. This means that it can not be passed on to other generations or continue operation without the direct involvement of the owner. (“Sole Proprietorship”)
The overall benefits and drawbacks of a sole proprietorship will depend upon the overall financial and personal objectives of the person starting the business. In general, this type of entity would be ideal for someone who is looking to start a small business that is: owner operated and managed. Because of this direct control and the simplicity of starting such entities is why this would be ideal for a small business that plan on remaining a particular size. However, the overall drawbacks indicate that if the business grows and there is a change in the responsibilities / duties the overall risks could increase. Where, the owner is personally liable for all debts that the business will incur.
Partnerships
A partnership is when two or more owners agree to form a for profit entity (a business). Under the law, such an entity would exist when this arrangement between the two parties is covered under a written agreement. (“General Partnership”)
Advantages
There are a number of different advantages to establishing a partnership the most notable would include: there are few legal requirements, partners can be able to combine their resource / skills (for the benefit of the organization), the partnership does not have to pay taxes, and there is flexibility in determining profits / losses. To form any kind of partnership all that is required is written agreement (the partnership agreement). This can be submitted to the Secretary of State or the owners can keep the agreement among themselves. (“General Partnership”)
Once a partnership has been established the different partners can be able to pool their different skills and resources together. This is important because there could be lower start up costs and the different weaknesses of a particular partner can be balanced out by another partner’s strength. (“General Partnership”)
A partnership does not have to pay taxes; instead, the profits that are received from the business are reported on the each partner’s individual tax return. The way that various profits and losses are reported can vary, where the partners have the ability to adjust the total amount of profits that they are reporting on their taxes. What happens is this organizational structure gives the owners the flexibility to write the different profits off against the losses. This can be used to reduce the overall amounts of that owners would have to show on their individual tax returns. (“General Partnership”)
Drawbacks
There are number of different drawbacks with a partnership the most notable would include: assets of the partners can be used to cover business liabilities and the partners share in the overall liabilities / debts of the business. In a partnership the assets of the business can be seized by creditors to satisfy the various debt obligations the business made. The overall percentage that would be equally divided among the different partners, based upon their percentage of ownership in the partnership agreement. (“General Partnership”)
A partnership is ideal for those people who are starting a business that would like to pool their different talents and resources together, to share in the overall profits. Like with a sole proprietorship these business entities are fairly easy to establish. Where, a partnership agreement is required to set up an organization. However, the overall assets of the different partners can become a part of the business and any they are responsible for any liabilities that the partnership will incur. (“General Partnership”)
Corporations
A corporation is considered to be a separate legal entity, where it can open bank accounts, buy / sell real estate and conduct business. It is owned by the stockholders. These are people who own a percentage of the outstanding stock of the company. This is significant; because the shareholders elect the board of directors (their job is to manage the company). To achieve this objective, the board will appoint various managers and officers. At which point, the board will meet periodically to monitor the business, management and the various officers’ will report directly to the board about what is occurring. (“Definition of a Corporation”)
Advantages
There are a number of distinct advantages that corporations offer the most notable would include: shareholders are not liable for company debts, there are tax savings, the entity can outlive shareholders and it makes raising investment capital easier. Because a corporation is considered to be a separate legal entity means that the shareholders, officers or the board of directors are not responsible for the debts that may be accumulated. This means that no matter what liabilities the corporation generates, the personal assets of any of the individuals can not be used to satisfy corporate obligations to creditors. (“Definition of a Corporation”)
When looking that the second advantage of a corporation, there are tax savings, the for corporations is lower and there are lots of write offs. The marginal income tax rate is lower for corporations than individuals. This is important because setting up this type of business structure will allow individuals to pass on the overall profits to the business. Where, it can pay less in taxes than an individual. Then, when you combine this with the different write offs that can be obtained, means that the overall amount that is being paid in taxes can be reduced even further. As these various write offs can be used to bring down the overall rate that the company is paying in taxes. (“Definition of a Corporation”)
A third advantage of corporation is that it can outlive shareholders. This is significant, because control of a company can be passed from one generation to the next very easily. As this is taking place, it means that the overall amounts of wealth can increase over the long-term by having an entity that can remain in business for an unlimited amount of time. (“Definition of a Corporation”)
A fourth advantage of a corporation is that it is easy to raise various forms of financing. The structure of corporation allows it to be owned by large numbers of individual (shareholders). This is significant, because it means that a corporation can use the public markets to be able to . As a result, some corporations have the potential to raise billions of dollars through the public markets using such financing methods. (“Definition of a Corporation”)
Drawbacks
There are number of different drawbacks of corporations the most notable would include: there are more costs for establishing such entities, there are formalities and there is unemployment insurance. In general, the costs for establishing a corporation can range from a few hundred dollars to thousands of dollars in legal fees. As there will be time spent filing all of the appropriate paperwork with the courts and the state. This is significant because some business owners may not have the time or money to establish such an entity. (“Definition of a Corporation”)
A second drawback of corporations is there are no formalities. This is important because once a corporation has been established, you must ensure that a number of different activities are undertaken to include: filing corporate minutes, having the board of directors / shareholders meetings and ensuring that the company is in compliance with all laws. These are important because without anyone of the above mentioned activities not covered, means that the business could lose its recognition as a separate legal entity. Where, the shareholders would be responsible for all liabilities that the company has. (“Definition of a Corporation”)
A third drawback of corporation is that unemployment taxes must be paid on any salaries that are received. In many cases, the shareholder of a corporation will be a manager or work at the company. The reason why this is important is because on any kind of salary that is received, means that unemployment taxes must be paid. This can cause the overall amounts of profits to decline, by having to pay taxes that would not apply to the other types of business entities. (“Definition of a Corporation”)
Clearly, all three business organizations have a number of different benefits and drawbacks. For the sole proprietorship, the most notable benefits would include: they are easy to establish, the tax structure is fairly straightforward and it is easy to manage. While the different drawbacks would include: financing can be difficult to obtain, the owner is responsible for all liabilities and the entity ceases upon the death or retirement of the owner. The benefits for a partnership would include: there are few legal requirements, partners can be able to combine their resource / skills (for the benefit of the organization), the partnership does not have to pay taxes, and there is flexibility in determining profits / losses. The drawbacks would include: assets of the partners can be used to cover business liabilities and the partners share in the overall liabilities / debts of the business. For the corporation, the different advantages would include: shareholders are not liable for company debts, there are tax savings, it can outlive shareholders and it makes raising investment capital easier. While, the different drawbacks of such an entity would include: there are more costs for establishing such entities, there are formalities and there is unemployment insurance. What this shows is that each entity has number of different strengths and weaknesses. Depending upon the objectives of the organization, the financial situation of the owners and their overall levels of comfort will determine which kind of entity is established. This is important because it underscores how a careful examination of each must be undertaken to determine which one would work best for the various businesses.
Bibliography
“Definition of a Corporation.” Legal Zoom. 2010. Web. 26 Apr. 2010.
“General Partnership.” Iowa Secretary of State. 2010. Web. 26 Apr. 2010.
“Incorporation.” Legal Zoom. 2010. Web. 26 Apr. 2010.
“Sole Proprietorship.” Iowa Secretary of State. 2010. Web. 26 Apr. 2010
