Business Entities #1

Running a business involves many stages of making game-changing decisions. One such decision is deciding what type of business framework you choose to adopt. So let’s explore three of six business frameworks that an entrepreneur can chose from.

The Corporation

A corporation is a business entity that is treated as a “legal person” separate from its owners. The major advantage of this framework is that the personal assets of investors, owners and shareholders are separate from the business’s assets and liabilities. This means that they can take part in the company’s profits through dividends and stock appreciation while not being personally liable to the company’s debts. So investors are responsible only for the amount they invest.

According to entrepreneur.com, a corporation is defined as a form of business operation that declares the business as a separate, legal entity guided by a group of officers known as the board of directors. Stockholders, shareholders, or members are the owners of a corporation, and it is managed by a board of directors. 

Incorporation is the legal process of the creation of a corporation. To set up a corporation, legal documents containing the primary purpose of the business, name, location, number of shares and types of stock issued, etc are drafted. A corporate can be formed as a for-profit or a not-for-profit entity. One of the defining features of corporations is their ability to raise capital by issuing shares of stock.

Microsoft Corporation, the Coca-Cola Company, Toyota Motor Corporation, etc are all well-known businesses that are corporations. There are three main types of corporations:

• C-Corps
• S-Corps
• Non-Profit Corporation

We’ll discuss these different types of corporations in a future article.

Downsides of running a Corporation include costly and time consuming registration process as compared to forming a sole proprietorship or partnership. Double taxation is also incurred for shareholders both at corporate and personal level. From inc.com, the corporation must pay income tax at the corporate rate before any profits can be paid to shareholders. Then any profits that are distributed to shareholders through dividends are subject to income tax again at the recipient’s individual rate. Another significant trade-off is heavy documentation required. Aside from incorporation documents, companies must file annual reports and tax returns, as well as maintain accounting records, licenses, and other important documents.

The Sole Proprietor

A Sole Proprietorship is the most simple form of business entities. It follows a single ownership framework, where one person owns the business. Unlike LLCs, they are not a separate legal entity but one and the same with the owner. This implies that the assets and liabilities of the business are not different from assets and liabilities of the owner and vice versa.

This framework is good for low-risk business owners who want to test out their idea before turning it into a full fledged business. Moreover, its simplicity, ease of setup, and nominal cost make it both time and cost effective. Also, sole proprietorship is subjected to fewer government regulations and documentations as compared to other entities. Unlike the shareholders of other business forms like corporations, the owner of a sole proprietorship needs to pay tax only once. The sole proprietor pays only the personal income tax on the profits earned by the entity. The entity itself does not have to pay income tax.

Coca-Cola, Apple, Hewlett-Packards, Amazon, Google, Mattel and Walt Disney all started as Sole Proprietorship. As the company starts to grow bigger and more complex, the owner can decide to change the business from sole proprietorship to maybe a better suited framework like a corporation.

The main trade-off of this business form is that business owner is legally liable for everything that happens with his business. Complete financial responsibility falls in the shoulders of the sole proprietor, which can put his personal assets at risk. So, if a sole proprietor business runs into financial trouble, creditors can bring lawsuits against the business owner. Another downside is that the business can’t have additional owners, the proprietor can’t bring on investors or partners by selling shares of stock. Furthermore, the ability of the business to take a loan from the bank depends on the owner’s credit history.

Partnership

Businesses owned by two or more people or parties is known as a partnership. You’ll often find this business framework compared to marriages, and with good reason. When agreeing to form a partnership with other individuals or groups or individuals you essentially agree to mingle your finances, manage the business and share its profits and losses.

One of the many advantages of a partnership firm include having lesser legal obligations such as easier accounting process, fewer records to maintain, easy registration process. Moreover, entrepreneurs can share the burden companionship and mutual support. Additionally, having more than one partner can potentially give the business a better chance of success since each partner will bring their own knowledge, skills, experience and contacts to the business.

Unlike a Corporation, a business partnership is not a legal entity separate from its owners. This is where you’re gonna have to be careful because the partners are personally liable for debts and losses incurred. If the business is sued because of something your business partner does, you both have to answer. And if you’re not careful, creditors and courts can lay claim to your personal assets to settle the score. Compared to running a business as a sole trader, decision-making process can be tedious since can be slower as you’ll need to discuss with your partners. When partners disagree, time will be spent negotiating to build a consensus. 

Types of partnership firms include:

1. General Partnership
2. Limited Partnership
3. Limited Liability Partnership

References:

1. myonlineca.in- “Names of sole proprietorship companies in India”
2. entrepreneur.com- “Sole Proprietorship”
3. corporatefinanceinstitute.com- “Sole Proprietorship”
4. informdirect.co.uk- “Advantages and Disadvantages of a Partnership business”
5. inc.com- “Double Taxation”