Business Structure and the Choice of Legal Form
When a person starts a business, the first and foremost question that comes to mind is what kind of business he wants to set up. The type of business has a direct relation to the taxes to be paid and, later on, has a great impact on the expansion and growth of a business.
There are different types of business entities in terms of ownership, liability, and type of business, including sole proprietorships, partnerships, registered companies, limited liability companies, business corporations, and public limited companies (GASME, n.d.).
Sole Proprietorship, Control, and Unlimited Liability
The simplest form of business is the sole proprietorship. One person is the owner and controller of the business. He is solely responsible for all the debts and liabilities and the profit and loss of the business. A sole proprietor has to comply with the state licensing requirements and the local regulations.
One of the advantages of the sole proprietor is the authority to retain the business for as long as possible, to sell it to anyone, or transfer it to his heirs. The sale or transfer of the business is at the sole discretion of the proprietor. It is easy to start a sole proprietor business as it requires less paperwork and fewer formalities. It also requires a lesser amount of money to start a business as compared to partnerships and registered companies because of the lower legal costs and fewer formalities. It gives higher control to the owner in terms of making decisions. There are also tax benefits, as a company doesn’t have to pay taxes because all the profits belong to a person, so the proprietor has to pay taxes in terms of his personal tax payment.
The sole proprietorship has some disadvantages as well. The sole proprietor is responsible for all the debts and liabilities of the business. He is also responsible for the debts and liabilities that occur due to the acts of some of his employees (NY Times, 2007). Moreover, it implies unlimited liability for the person, which makes his personal belongings liable for the obligations of the business, and this is the biggest disadvantage of sole proprietorship. Also, it is difficult for sole proprietors to take loans from financial institutions as they are reluctant to lend money to sole proprietors (Juliane Russ, n.d.).
Partnership Agreements, Shared Ownership, and Legal Responsibility
A partnership is a legal entity that is formed by the association of two or more persons to act as co-owners of a company. The partnership agreement is the foundation of the partnership. It provides the basis for the share of investment, the share of profit, liabilities, dispute resolution, the inclusion of new partners, the exit of existing partners, and the dissolution of the entire entity.
Like a sole proprietorship, partnerships are easy to start as compared to registered companies and require lower start-up costs. There are fewer legal formalities, which include gaining a license and registering a business. Another advantage of the partnership over sole proprietorship is access to capital, as the sole proprietor only has his own money as capital. In a partnership, partners accumulate their money to form capital for the business. Each partner can get a loan from the bank in his personal capacity, extending capital to the company. The other advantage of the partnership is that partners can personally retain profit, just like a sole proprietorship. The preference for partnership over sole proprietorship is that persons can also pool their personal knowledge and skills for the growth of the business, so the weakness of one partner can be overcome through the strength of another partner. It also helps in effective decision-making and growth of the business. It also has a tax advantage, just like a sole proprietorship, as the company is not taxed, and the partners are taxed on the basis of their personal income.
All the partners are liable for all the liabilities of the company, just like in a sole proprietorship. If a partnership goes through a critical situation, the partners’ personal belongings can also be used to pay the debts. So the liability is unlimited to their personal assets as well. Another disadvantage of the partnership over sole proprietorship is disagreement or difference of opinion between the partners, which may affect the smooth running of the business or can even cause dissolution of the partnership. If one partner signs a contract, all the partners become obligated to it. Moreover, the unequal contribution of skills, efforts, and resources may tend to increase disputes. A partner cannot transfer an interest in the business without the consent of other partners.
Continuity, Exit, and the Institutional Weaknesses of Partnerships
Another disadvantage of the partnership over registered companies is the problem of continuity of the partnership in case of the exit or death of a partner. However, this can be managed by entering adequate clauses in the partnership agreement (Rowena Martinez, 2016).
Companies that are registered with the SEC after submitting specific documents are categorized as registered companies. There are two types of registered companies.
- Limited liability companies
- Business corporations.
A Limited Liability Company is also known as a Private Ltd. Company. It has characteristics of both a corporation and a sole proprietorship/partnership.
Registered Companies and the Protection of Limited Liability
The main advantage is its limited liability, as only the company is responsible for debts and obligations, and the personal assets of a shareholder are not liable for the debts, unlike in a sole proprietorship and partnership. Another advantage is that the amount of money invested does not entitle a person to be the owner of that proportion of a company, as ownership is decided through an agreement. It has the same taxation benefits if it elects to be taxed as a sole proprietorship or partnership. Taxes are passed to the persons. It has no limitation on the number of members. A limited company can contain as many members as possible. Another advantage is that not only can an individual be a member of a limited company, but a sole proprietorship or partnership company can also be its member, making fundraising easy for the limited company. Another important advantage from the perspective of the growth of a company is that management can be hired by the members, as compared to the sole proprietorship and partnership in which the owner is solely responsible for decision-making.
Limited companies require more setup formalities as compared to sole proprietorships and partnerships. Registration fees are higher for limited liability companies as compared to sole proprietorships and partnerships. Even some states charge annual renewal fees. Financial institutions and medical companies cannot be limited liability companies (Rowena Martinez, 2016).
Public limited companies are companies that issue shares, which help in raising capital. The most important advantage is that the company can raise as much capital as possible through floating shares, which cannot be done in a sole proprietorship or partnership. By spreading the shares, the company also spreads its ownership among a larger number of people, thus minimizing the risk of loss among them. It makes it easy for the public limited company to obtain funds from financial institutions by maintaining a stock exchange listing, thus increasing creditworthiness. Because of this, the corporation will have more chances of growth as compared to the other two forms of business. Shares can be easily transferred in a public limited company. It is also easy for the founders to exit the business because of the easy transfer of shares and the reputation maintained by the company, which helps owners get an appropriate bidding rate.
More rules and regulations have to be complied with. More formalities are involved in the formation, with a greater cost of formation. There is no privacy in public limited companies as they have to make more details available to the public. Their accounts are scrutinized by analysts. Also, the company can be vulnerable if the majority of the shareholders decide to bid (Johnathan Korchak, 2016). So these different kinds of companies have different advantages and disadvantages. The person who wants to start a business should take a closer look at these to decide which type of company to open.
References
Johnathan Korchak. (2016, 25 November). Advantages and disadvantages of a public limited company. Retrieved from https://www.informdirect.co.uk: https://www.informdirect.co.uk/company-formation/public-limited-company-advantages-disadvantages/
Juliane Russ. (n.d.). Sole Proprietorship & Incorporated. Retrieved from https://smallbusiness.chron.com: https://smallbusiness.chron.com/advantages-disadvantages-between-being-sole-proprietorship-incorporated-17803.html
NY Times. (2007, June 5). Advantages and Disadvantages of Sole Proprietorships. Retrieved from https://www.nytimes.com: https://www.nytimes.com/allbusiness/AB4113314_primary.html
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