As a business owner, one of the first decisions you have to make is about the legal structure of your enterprise. The decision has to be made on the basis of the level of ownership, amount of control, taxes, vulnerability to legal issues and last but not the least, the expected profits. There is no scope of being indecisive as it concerns long-term implications. So, it’s vital to be clear about the legal forms of business and its pros and cons. These are as follows:
Legal Forms Of Business
A sole proprietorship is the simplest legal forms of business ownership. The sole proprietor or entrepreneur is a person who operates the business exclusively by and for himself/herself. He/She is the sole contributor to all the capital, skills, results, etcetera of the enterprise. The sole proprietor is the mastermind of all matters concerning his/her business and it is subject only to the general laws of the country he/she resides in.
There is no separation of ownership and management whatsoever. The existence of the business is solely dependent on the owner and his/her decisions. So, when the owner is dead, the business is as well. Usually, small businesses start as sole proprietorships. Sole proprietors can be independent contractors, freelancers, home-based businesses, etc.
Some advantages of being a sole proprietor are
- The proprietor is the sole owner of all profits
- Proprietorships are subject to some legal formalities
- Owners have total flexibility and control in running the business
- Profits are taxed just once
- An easy and inexpensive form of business ownership
- The secrecy of business strategies can be maintained.
There are some disadvantages too. These are:
- The entrepreneur is solely liable for business debts.
- Personal assets might be in danger due to debts
- Transfer of ownership is difficult.
- The owner might have to gain consumer loans due to the enterprise’s limitation in raising funds
The convenience of a sole proprietorship is in the following cases.
- Businesses where the initial investment is relatively small
- Businesses where risk is limited
- When you need to take rapid decisions
- Businesses where the impact of the external environment has to be considered
- Businesses where skilled management isn’t required at all
In partnerships, the enterprise’s ownership share between two or more people. Like proprietorships, the partners are the brains behind all matters concerning their business and it is subject only to the general laws of the country they reside in.
There must be a legal agreement clearly stating how profits will be shared, how decisions will be made, how conflicts will be solved, how future partners can be subjected to the partnership, how partners can be bought out or what steps can be taken for dissolution of the partnership when required.
The agreement may be oral or in writing. But it’s best to keep all the terms and conditions written, signed by the partners and stamped to avoid any misunderstanding. The agreement can alter on the mutual consent of the partners.
Partnerships are of two types: General and limited. In general partnerships, both owners invest their blood and sweat to the business and both have unlimited liability. Even if one partner invests much less than the other, both are equally responsible for any debt. General partnerships don’t necessarily have to be written formally. It can be verbal or implied between the two business owners.
On the other hand, limited partnerships require a formal agreement between the partners. That is, there has to be a partnership deed. Limited partnerships allow partners to limit their own liability for debts according to the magnitude of ownership or investment.
Some advantages of doing partnerships are:
- Easy and inexpensive to establish, whether general or limited
- Shared resources provide more funds for the business
- Profits are shared between each partner
- Separate legal status gives liability protection
- Profits are taxed just once
- Complementary skills of partners will prove to be beneficial for the enterprise
- Employees can be lured to become fellow partners if given the incentive
There are also some disadvantages including:
- Selling the business is tough since it requires finding a new partner
- A partnership ends on any one of the partner’s deaths or willful withdrawal
- Partners are responsible for each other’s actions
- There might be a misunderstanding if there is no detailed partnership deed
- Since the process involves decision making of two or more people, conflicts might arise
- Partners might end up feuding over the sharing of profits
Corporations are independent entities by law. Its legal status is different from that of those who own the company. A corporation can enter contractual agreements, can be taxed and sued as an individual entity. A corporation has its own life and change of ownership won’t lead to dissolution. A corporation’s profits are taxed as its individual income. Profits or dividends distributed among the shareholders are also taxed as their personal incomes.
Corporations are of two types: S and C corporations. A C-corporation is taxed separately from its owners, giving the owners limited liability. This leads to further risk-takings and investments. An S-corporation, on the other hand, offers the owners limited liability. These corporations don’t pay income taxes and treat profits as distributions of dividends, which shareholders have to report as their earnings on individual income tax returns.
Advantages of a corporation are:
- The owner is subjected to limited liability over debts and losses, even if the corporation is sued for billions
- Profits and losses are subject to the corporation
- A corporation has unlimited commercial life and transfer of ownership is comparatively easy
- Personal assets of owners can’t be used to clear the corporation’s debts
- Through the sale of stock, the corporation can raise additional funds
The disadvantages are:
- Corporations are subject to close monitoring by governments.
- Complying with national rules might prove costly
- Establishing a corporation and operating it, both can be expensive
- Corporations have more administrative responsibilities and require complex paperwork
- Corporations may be subject to double taxation as a result of incorporating
In conclusion, based on these forms of businesses, it’s up to you decide how you want your business to be structured for further flourishing.