This is the simplest form of a business structure where an individual owns the business. The business is not a legal entity and the owner is personally responsible for all the legal suits and debts of the business. The process of setting up a sole proprietorship is fairly easy and simple. A sole proprietorship can operate under the real name of the owner or under a fictitious name (DBA) such as ‘Drew’s Barbecue.’ A sole proprietor only needs to get local licenses to start operating. Many businesses start as a sole proprietorship and graduate to other complex business structures as they expand.
Advantages of Sole Proprietorship
• Ease of setup
• Owners can freely mix personal and business assets
• Sole proprietorship carries little or no formalities
• Easy decision making
Disadvantages of Sole Proprietorship
• A sole proprietor cannot sell interests in his business to raise money
• The business owner is solely responsible for the legal suits and debts of the business
• Sole proprietorship rarely survives after incapacitation or death of the owner
Partnerships operate in more or less the same way as sole proprietorship only that in partnerships, more than one person is involved. A partnership is usually an agreement between two or more people to work together in a business, sharing profits and losses. Like sole proprietorship, partnerships are relatively easy to form. As much as this is an advantage, don’t get into a partnership without a formal written agreement or an operating agreement to be more specific. Because of its ease of formation and informality involved in its setup, partnerships are more likely to end in disputes and lawsuits between partners. Find an attorney to draft the partnership agreement to avoid future squabbles within the business.
Advantages of Partnership
• Easy to setup and few ongoing formalities
• Partnerships are pass-through tax entities
• Partnerships don’t require annual meetings
Disadvantages of Partnership
• Individual partners are responsible for the actions of other partners
• Oral and informal partnerships can lead to disputes and lawsuits among partners
• All partners are subject to unlimited personal liability for losses, debts, and liabilities of the business, except in cases of limited liability partnerships and limited partnerships
Limited Liability Company (LLC)
LLCs are a comparatively recent phenomenon, with the first of such companies hitting the market in the 1980’s and 90’s. LLCs are normally referred to as hybrid businesses as they combine the elements of a partnership or sole proprietorship with those of a corporation. Like sole proprietorships and partnerships, LLCs are easy to set up and allow for quick operation. On the other hand, just like corporations, LLC owners are not personally responsible for losses, debts, and other business liabilities. LLCs can be managed as corporations (manager-managed LLC) or as partnerships (member-managed LLC). LLCs can also choose to have a president, board of directors and officers just like corporations or they can choose to ignore such formalities altogether. LLCs however are not alternatives to corporations, but as businesses grow they can be converted to corporations. This is usually a complex matter that requires sophisticated legal and tax analysis and should not be attempted without the help of a qualified accountant and attorney.
Advantages of the LLC
• Few formalities involved and there is no need for annual meetings
• Owners are protected from the business liabilities and debts
• Like partnerships, they are quite simple and allow for quick operation
Disadvantages of the LLC
• They are more expensive to set up compared to partnerships
• They are subject to annual fees and periodic filings with the state
• Unanticipated problems in their operation may occur as they do not have a reliable legal precedent to guide managers and owners. The LLC law is, however, becoming more streamlined as time passes by
• LLCs are not the appropriate vehicles for businesses that seek to raise money in the capital markets or those that seek to go public
• Certain states do not allow the setup of LLCs for certain professional vocations
The term corporation has its roots in Latin word ‘Corpus,’ which means body. A corporation is, therefore, a legal body in the eyes of the law. A corporation is owned by shareholders, operated by officers, and managed by the board of directors. The shareholders determine who runs the corporation and how it conducts business. The shareholders receive profits based on the shares of stock they own. A corporation has perpetual life. When shareholders leave or pass on, they can transfer their shares to other individuals who continue to run the corporation. Corporations can raise funds more easily than sole proprietorships and partnerships. To raise investment capital a corporation only needs to sell its shares of stock. Corporations can further be divided into two: C Corporation or S Corporation.
Advantages of Corporations
• Owners are protected from personal liability of the corporation’s liabilities and losses
• Corporations are the appropriate vehicle for businesses that want to go public
• Corporation owners and managers are guided by a reliable body of legal precedent
• Corporations can easily transfer ownership through the transfer of securities
• Corporations can easily sell securities to raise capital
• Corporations can enjoy tax benefits under certain circumstances.
• Corporations can have unlimited life.
Disadvantages of Corporations
• Corporations are double taxed. First, the corporation pays a tax on its gains and then the shareholders pay a tax on the dividend or distribution they receive
• Corporations require input from many people, so they are slow to act
• Corporations must adhere to certain organizational guidelines such as annual general shareholders meetings
• More expensive to set up compared to sole proprietorships and partnerships