Before any entrepreneur should decide
on the ownership structure for his or her business, learning at
least a little bit about how each structure works is important.
This is a brief rundown of the most common forms of doing business.
The three most common forms of business
ownership in the United States are the sole proprietorship,
the partnership, and the corporation.
Sole Proprietorships
A sole proprietorship is a business that is owned (and usually operated)
by one person. It is the simplest form of business ownership, and
it is the easiest to start. There are more than 15.8 million sole
proprietorships in the United States. They account for almost three-fourths
of the country's business firms. Legally, a sole proprietorship
is inseparable from its owner -- the business and the owner are
one and the same. This means the owner of the business reports business
income and losses on her personal tax return and is personally liable
for any business-related obligations, such as debts or court judgments.
Advantages of Sole Proprietorships
Ease of Start-Up. No contracts, agreements, or other legal documents
are required to start a sole proprietorship, and there are no minimum
capital requirements.
Retention of All Profits. All profits earned by a sole proprietorship
become the personal earnings of its owner. Thus the owner has a
strong incentive to succeed. Flexibility. The sole owner of a business
is completely free to make decisions about the firm's operations.
A sole proprietor can switch from retailing to wholesaling, move
a shop's location, open a new store, or close an old one.
Possible Tax Advantages. The sole proprietorship's profits are taxed
as personal income of the owner. Thus a sole proprietorship does
not pay the special state and federal income taxes that corporations
pay.
Secrecy. Sole proprietors are not required by federal or state governments
to publicly reveal their business plans, profits, or other vital
facts, so competitors cannot get their hands on this information.
Disadvantages of Sole Proprietorships
Unlimited Liability. A sole proprietor is personally liable for
all the debts of his or her business. Lack of Continuity. Legally,
the sole proprietor is the business. If the owner dies or is declared
legally incompetent, the business essentially ceases to exist.
Lack of Money. Banks, suppliers, and other lenders are usually unwilling
to lend large sums to sole proprietorships. The limited ability
to borrow can prevent a sole proprietorship from growing.
Limited Management Skills. The sole proprietor often is the sole
manager'in addition to being the sole salesperson, buyer, accountant,
and, on occasion, janitor.
Difficulty in Hiring Employees. The sole proprietor may find it
hard to attract and keep competent help. Potential employees may
feel that there is no room for advancement in a firm whose owner
assumes all managerial responsibilities.
PARTNERSHIPS
A partnership is a voluntary association of two or more persons
who act as co-owners of a business for profit. There are approximately
1.5 million partnerships in the United States, accounting for about
$627 billion in receipts. However, partnerships represent only about
7 percent of all American businesses. Just like sole proprietorships,
a partnership is simply a business owned by two or more people that
hasn't filed papers to become a corporation or a limited liability
company (LLC). No paperwork needs to be filed to form a partnership
-- the arrangement begins as soon as you start a business with another
person. As in a sole proprietorship, the partnership's owners pay
taxes on their shares of the business income on their personal tax
returns and they are each personally liable for the entire amount
of any business debts and claims.
Types of Partners
General Partners. A general partner is one who assumes full or shared
responsibility for operating a business. General partners are active
in day-to-day business operations, and each partner can enter into
contracts on behalf of all the others. Each partner is taxed on
his or her share of the profit. To avoid future liability, a general
partner who withdraws from the partnership must give notice to creditors,
customers, and suppliers.
Limited Partners. A limited partner is a person who contributes
capital to a business but is not active in managing it; his or her
liability is limited to the amount he or she has invested. A limited
partnership is a business co-owned by one or more general partners
who manage the business and limited partners who invest money in
it. A master limited partnership is a business partnership that
is owned and managed like a corporation but taxed like a partnership.
The Partnership Agreement. Articles of partnership are a written
agreement listing and explaining the terms of the partnership.
Advantages of Partnerships
Ease of Start-Up. Like sole proprietorships, partnerships are relatively
easy to form. Prospective partners do not need to consult an attorney;
however, an attorney's advice and assistance may be helpful.
Availability of Capital and Credit. Partners can pool their funds
so that their business has more capital than would be available
to a sole proprietorship.
Retention of Profits. As in a sole proprietorship, all profits belong
to the owners of the partnership.
Personal Interest. General partners are very concerned with the
operation of the firm'perhaps even more so than sole proprietors'because
they are responsible for the actions of all other general partners,
as well as for their own.
Combined Business Skills and Knowledge. Partners often have complementary
skills. The weakness of one partner in a certain area may be offset
by another partner's strength in that area.
Possible Tax Advantages. Like sole proprietors, partners are taxed
only on their individual income from the business.
Disadvantages of Partnerships
Unlimited Liability. Each general partner is personally responsible
for all debts of the business, regardless of whether a particular
partner incurred those debts.
Lack of Continuity. A partnership is terminated if any one of the
general partners dies, withdraws, or is declared legally incompetent.
Effects of Management Disagreements. The division of responsibilities
among several partners means that partners must work together as
a team. If they begin to disagree about decisions, policies, or
ethics, distrust may build and worsen over time.
Frozen Investment. It is easy to invest money in a partnership,
but it is sometimes quite difficult to get it out.
Beyond the Partnership. A partnership has several advantages over
a sole proprietorship, but it shares the disadvantage of unlimited
liability. A third form of business ownership, the corporation,
overcomes this disadvantage.
Corporations
A corporation "is an artificial being, invisible, intangible,
and existing only in contemplation of the law." Hence a corporation
is an artificial person created by law, with most of the legal rights
of a real person.
There are more than four million corporations in the United States.
Corporations constitute only about one-fifth of all businesses,
but they account for almost 90 percent of all sales revenues and
more than three-quarters of all business profits.
Corporate Ownership. The shares of ownership of a corporation are
called its stock, and those who own the shares are called stockholders,
or sometimes shareholders.
A close corporation is a corporation whose stock is owned by relatively
few people and is not traded openly.
An open corporation is a corporation whose stock is traded openly
in stock markets and can be purchased by any individual.
Forming a Corporation. The process of forming a corporation is called
incorporation.
Where to Incorporate. In the US, a business is allowed to incorporate
in any state it chooses. An incorporated business is called a domestic
corporation in the state in which it is incorporated. In all other
states where it does business, it is called a foreign corporation.
A corporation chartered by another government and conducting business
in the United States is an alien corporation.
The Corporate Charter. Once a "home state" has been chosen,
the incorporators submit articles of incorporation to its secretary
of state. A corporate charter is a contract between the corporation
and the state, in which the state recognizes the formation of the
artificial person that is the corporation.
Stockholders' Rights. There are two basic kinds of stock: common
stock and preferred stock. Each type entitles the owner to a different
set of rights and privileges. The common stockholders may vote on
corporate matters; preferred stockholders usually have no voting
rights.
Perhaps the most important right of owners of both common and preferred
stock is the right to share in the profit earned by the corporation
through the payment of dividends. A dividend is a distribution of
earnings to the stockholders of a corporation.
Other rights include being offered additional stock in advance of
a public offering (pre-emptive rights), examining corporate records,
voting on the corporate charter, and attending the corporation's
annual stockholders' meeting.
Other business ownership structures
Various types of businesses are organized for special purposes.
Among these are S-corporations, limited liability companies, government-owned
corporations, not-for-profit corporations, cooperatives, joint ventures,
and syndicates.
S-Corporations. If a corporation meets certain requirements, its
directors may apply to the Internal Revenue Service for status as
an S-corporation. An S-corporation is a corporation that is taxed
as though it were a partnership. To qualify for this special status,
the firm must meet certain criteria. Limited Liability Companies.
A limited liability company (LLC) is a form of business ownership
that combines the benefits of a corporation and a partnership while
avoiding some of the restrictions and disadvantages of those forms
of ownership. Chief advantages of an LLC are:
It is taxed like a partnership and thus avoids the double taxation
imposed on most corporations.
Like a corporation, it provides limited liability protection.
Government-Owned Corporations. A government-owned corporation is
owned and operated by a local, state, or federal government. It
usually provides a service the business sector is reluctant or unable
to offer. A quasi-government corporation is a business owned partly
by the government and partly by private citizens or firms.
Not-for-Profit Corporations. A not-for-profit corporation is a corporation
organized to provide a social, educational, religious, or other
service rather than to earn a profit. Various charities, museums,
private schools, and colleges are organized in this way, primarily
to ensure limited liability. A nonprofit can raise much-needed funds
by receiving public and private grant money and donations from individuals
and companies. The federal and state governments do not generally
tax nonprofit corporations on money they make that is related to
their nonprofit purpose, because of the benefits they contribute
to society.
Cooperatives. A cooperative is an association of individuals or
firms whose purpose is to perform some business function for all
its members. Cooperatives are found in all segments of our economy,
but they are most prevalent in agriculture.
Joint Ventures. A joint venture is an agreement between two or more
groups to form a business entity to achieve a specific goal or to
operate for a specific period of time. Once the goal is reached
or the period of time has elapsed, the joint venture is dissolved.
Syndicates. A syndicate is a temporary association of individuals
or firms organized to perform a specific task that requires a large
amount of capital. Syndicates are most commonly used to underwrite
large insurance policies, loans, and investments.
