Understanding Ownership and Business Entity Structures 1
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Who Owns the Business?
Many people think about starting a business the same way they would think about starting to paint the house, starting a new career, or starting any other big project: they think about doing something rather than owning something. Yet, when you start a business, in the eyes of the law you become a business owner and have to choose a form of business ownership. The form of ownership you choose has important legal, financial, tax, and marketing implications.
What forms of ownership are there?
There are four primary forms of business ownership:
- sole proprietorship (you are the only owner)
- partnership (two or more parties join together in the business, splitting up the work load, profits, and financing of the business however they wish)
- corporation (a legal entity, which under law has a "life" of its own separate from any individual who owns the corporation)
- Limited Liability Company, or LLC (a hybrid form of business combining the tax structure of partnerships with the liability protection of corporations)
What are the advantages of a sole proprietorship?
A sole proprietorship is the easiest form of business to set up and run. Here are a few of the reasons why:
- You make all the decisions. You alone can decide what to sell and how to sell it, when to expand the business and when to pull back, when to look for financing, when to buy new equipment, when and how long to work, and when to take the day off—without having to justify your decision to anyone.
- You can take money out of the business easily. Although it is not advisable, you don't even have to maintain a separate bank account for a sole proprietorship. As long as you keep accurate records of income and expenses, you could run it out of your personal checkbook.
- You can use losses to offset other income on your personal tax return.
- Start-up costs are relatively low. You generally have less paperwork and fewer regulations to comply with as a sole proprietor than you do with other forms of business.
Are there any disadvantages of operating as a sole proprietor?
Virtually every book and magazine article discussing what form of business a business owner should choose will tell you the biggest disadvantage of a sole proprietorship is that you have unlimited liability for the actions of your business. In other words, you are personally responsible for all business debts and actions and could lose your personal assets if the business goes bankrupt or gets sued.
But also remember that as the owner of any small business, you are likely to take the same risk no matter what form of business you start. Contrary to what you may read in books and how-to articles, incorporating a very small business does not automatically protect you from liability for the company's debts or actions.
Other disadvantages of a sole proprietorship include:
- There is no continuity of ownership. Usually when the owner of a sole proprietorship dies, the business comes to an end. While you could train someone to take over the business and make arrangements to pass on the business to a family member should you die, there may be no one in your family who has the interest or ability to carry on without you.
- Financing your business may be more difficult. Banks and other lenders may be reluctant to loan you unincorporated business money.
- Getting and keeping good employees may be difficult as the company grows.
How does a partnership work?
A partnership lets two or more people (or in some cases businesses) work together to achieve a common goal. There are different kinds of partnerships, but each partnership must have at least one general partner. (In most very small business partnerships, each partner is a general partner.) The partners share in the profits and the work according to an agreed arrangement. Each general partner can act on behalf of the partnership, doing anything necessary to run the business (hire employees, sign contracts, make purchases, etc.).
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