There are many forms of business organizations. These include Sole proprietorship, partnerships, and corporations. Entrepreneurs are therefore faced with the challenge of determining what form of business organization best suits them. In making the decision on what form of business to start various factors have to be taken into consideration. The entrepreneur looks into the legal requirement to be conformed to, the resource requirements, the managerial skills needed, the objectives, and the lifespan of the targeted business. Tax issues are also necessary for the making of the decision. The basic factors that determine the operation and structure of the business are creation, ownership, management, liability, profit, taxation, continuity, and termination.
This is an unincorporated business organization that is started and run mostly by one person with the objective of making a profit. By unincorporated, we mean that the business and the owner are considered as one entity. It, therefore, means that the property of the owner and that of the business are inseparable during insolvency. This is the most common of the business organizations and research reveals that there are 17 million in the US, which is 73% of all business. This form of organization has the characteristics that it requires small resources and not many legal requirements are required in the formation. The distinguishing characteristic of this organization lies with the unlimited liability of the owner and the unshared responsibility. The size does not necessarily distinguish it from other forms.
A sole proprietorship has the advantages of simple information as not much legal requirement is needed. Secondly, this kind of organization is flexible. Flexibility means that the owner has the freedom to change from one line of activity to the other which is considered profitable. There is also the advantage of faster decision-making as the owner makes the sole decisions; no obligation to seek others’ opinions. The owner as well enjoys all the gain of the business as profits are not shared. Moreover, the business only pays one type of tax i.e. only the legal permit is paid for, and the local taxes. Other advantages include retention of control by the owner and the low cost of operation. These operating costs have tax benefits.
According to Oxley (1997), this form of organization has various disadvantages. First, there is the limitation that the owner has unlimited liability in cases where the business faces risk and losses. He incurs all the losses and where there is an insolvency petition against the business the owner is solely responsible. There is also the disadvantage of limited resources. In cases where the owner lacks resources, it becomes difficult to obtain the resources as financial institutions require collateral; which in most cases is lacking. Again it is impossible to ask for contribution as in a partnership. Finally, this form of the business suffers from managerial skills in cases where there is a need for technical knowledge.
It is important to notice that despite the disadvantages and constraints that face-sole proprietors; it remains the most common form of business.
The owner has unlimited liability on the business debt. The owner’s property is also the property of the business and therefore all his property can be used to discharge tax
The business pays taxes to the local income taxes and licenses necessary to begin the business. The profits of the business are taxed together with other incomes of the business.
The business has no permanent lifespan. The dissolution of the business terminates the business. Again the death of the owner leads to the termination of the life of the business.
In the management of the business, the owner is the sole decision-maker. He makes all the major decisions that pertain to the management of the business. In as much as the owner may consult others on the best decision to make, he has the right to make the ultimate decision.
The owner of the organization makes a decision on what portion of earnings he can retain for reinvestments. He may decide to retain the total amount or withdraw the whole amount for personal consumption. The owner enjoys all the gain and shoulders the total loss.
The owner may decide to expand the business to other locations by the creation of other branches. This decision will depend upon the viability of the expansion. Where the business has to open branches to new states, the owner must ensure compliance with the regulation of the jurisdiction for example compliance to the new tax rates of the region.
The decision to expand will mean much control burden on the owner and increased decision. This may force the owner to engage others to help in the day-to-day running of the business.
A partnership is defined as a form of unincorporated organization where two or more competent parties come together by contributing resources, skills, and knowledge and start a business with the aim of making profits and sharing the profits or losses in a defined proportion. The aim of making a profit is fundamental in the determination of a partnership. Most partnerships are for commercial purposes. However, there is also professional partnership i.e. for accountants or lawyers. Oxley “This is the form of partnership where all partners are active and acts as agents of the partnership” (22).
A general partnership has the advantage that there is the pooling of capital, sharing of profits and losses, retention of control i.e. partners participate in the management and that the partnership’s income is the only one to be taxed. “the shared ideas creates better management and ensures sharing of the responsibility burden. The legal requirement for the formation of a partnership is also not long as compared to those of a company
Dignam, A. & Lowry, J. (2006) argue that “Generally partnership, a partner cannot transfer a share of his own without the consent of all partners”. This sort of joint venture suffers the weakness that the death or withdrawal of a partner automatically terminates the affiliation,” (Dignam, A. & Lowry, J. 2006). He also adds that “Partners also have unlimited liability in the debts of the business”. Lastly, the decision-making process may be difficult as all partners must be consulted.
All partners have unlimited liability to the business debts and take part in the sharing of the profits of the organization. The personal property of the partners may thus be taken in settlement of the debt of the partnership.
In this form of organization, the taxes are paid on the income of the partners only as the income of the business is also the income of the partners, not a separate entity. Licenses for the various businesses must also be paid to the local authorities.
This form of organization has no permanent life and comes into termination upon the death of a partner or withdrawal of a partner. It may also be terminated upon the attainment of the objective.
In this kind of partnership, general control is exercised by the partners through agreement. Each partner acts as an agent to the business and his action binds the business.
The profits of the business can be retained upon the agreement by the partners. The partners may also decide to share all the gains among themselves.
The partnership business may be expanded to realize more return. This decision will mean compliance with legal requirements and new tax policies where branches are opened in different states.
The burden of expansion means more burden on the side of the partners in terms of management and costs. The returns filed will also be increased.
Oxley (1997) defines it as: “Form of partnership in which there is at least one general partner and one limited partner”. Oxley further adds that the general partner has unlimited liability on the debts and operation of the partnership while the limited partner is liable to the extent of his investments in the partnership (1997). A limited partner takes no part in the management of the business and is therefore like an investor. The limited partner has a claim on the property o the business before the general partners and upon his death, the property passes to his personal representative.
Pfeffer (1997) suggests that a limited partnership will be taxed as a corporation where it has two or more of the following characteristics: there is free transferability, limited partner’s participation in the management, limited liability of the limited partner to the debts of the business and continuing life.
A limited partner will be liable to the extent of his venture to the partnership. His personal property will not be taken to discharge the debtv of the organization. This form of organization also shares the advantage of shared management pooled capital and few legal formalities as enjoyed by the general partnership.
The general partners have unlimited liability to the partnership debts. The limited partner is as well unable to participate in the management of the business. The disadvantage of profit-sharing, as opposed to sole proprietorship, also features.
A limited partnership has similar features to those of a general partnership.
A corporation is an incorporated organization that is created by law where the business entity and the owners are taken as two different persons. A corporation has a permanent life and it’s intangible since it’s invisible and there is a separate entity of the business and the owners. Profits corporations are classified as c-corporations and S- corporations.
C – Corporation
C corporation derives their names from subsection c of the internal revenue code. C-corporation income is double taxed as opposed to those of S-corporation. Those that are listed in the stock market are referred to as publicly held corporations why those whose shares are not traded in the stock market are called closed corporations.
Advantages of C-Corporations
Limited liability as owners are not liable to the debts of the business, ease of raising additional capital by raising new shares, ownership can also be easily changed by selling shares in the secondary market. Other advantages include unlimited lifespan, tax allowance expenses, and an unlimited number of owners.
The corporation suffers the drawback of double taxation and the ease of changing ownership may lead to the exploitation of minority shareholders. A large number of shareholders may result in difficulty in decision-making.
This kind of corporation has similar features with c-corporation with the exception that they don’t pay tax on the business income but on the dividend. The other difference is the limitation on maximum shares requirement by this organization.
The advantages and disadvantages are shared by the two forms of the corporation except for the double taxation.
Features of corporation
“There is easy transfer of ownership i.e. through the sale of shares in the stock market,” as per (Powell W.W. and Brantley, P. 1992). “The characteristic of unlimited liability also limits the liability of owners to the extent of venture in the business,” Dignam, A. & Lowry, J. (2006). Tax liability of the corporation is subjected to the income and they are therefore exempted from taxation in a situation where they incur losses. On the other hand, it is easier for corporations to raise capital for their business as they can sell shares to interested parties. Perpetual life as the business doesn’t terminate with the death of or exit of a shareholder. The profit to be retained may depend on the retention policy of the business. The control is on the management team but shareholders also contribute during the general election and on appointments to the board of directors. Expansion on activities will require a change in the article of operation and where the business expands to new state compliance to new tax policies is mandatory. This expansion adds no burden on the owners as the business is a different entity.
The advantages of Limited Liability Corporation are similar to those of C- corporations.
Corporations pay double taxations on their income as their income and dividends are both taxed. They, therefore, have a heavy tax burden. The ease of transfer of shares may also become a disadvantage to the minority shareholders in respect of their interest (Powell W.W. and Brantley, P. 1992).
From the above analysis of the advantages and limitations of each business organization, I can advise the sole proprietor to change and form a corporation. Given the size of the entity and the high risk that face the business, it is only through incorporating the entity into a corporation that can relieve the proprietor from the cost of compensation in case of risk occurrence or in from payment of high premiums to cover the risk.
Likewise, the several activities that are undertaken may require additional capital that may not be easy to obtain from personal savings or by the retention of the earnings. The expansion of the activities will also demand better management and much attention. This will prove much difficult for the sole proprietor to provide on his own therefore making it necessary for the conversion of the business.
In conclusion, it requires a detailed analysis of what form of business an entrepreneur should venture into in order to realize gains. Each organization should be thoroughly vetted and comparison and contrast made between the various organizations for better decision making. The fact that all forms of organizations suffer from various drawbacks implies that a trade-off exists in the final decision made.
Dignam, A. & Lowry, J. (2006). Company Law, London: Oxford University Press
Pfeffer, J. (1997). New Directions for Organization Theory: Problems and Prospects. London: Oxford University Press.
Powell W.W. and Brantley, P. (1992) ‘Competitive Cooperation in Biotechnology: Learning through Networks?’ in N. Nohria and R. Eccles (eds) Networks and Organizations, pp. 366-94. Boston, MA: Harvard Business School Press.
Oxley, J. E. (1997) ‘Appropriability Hazards and Governance in Strategic Alliances: A Transaction Cost Approach’, Journal of Law, Economics and Organization, 13 (2): 387-409.