Each traditional business form, sole proprietorships, corporations, and partnerships, all have their own advantages and disadvantages. Before you enter any of these types of business forms, you should always weigh out the advantages and disadvantages of what you are getting yourself into to see if it is worth it. A sole proprietorship is the simplest form of business organization where the owner is the business. There are many advantages to a sole proprietorship. One major advantage is that the proprietor owns the entire business and receives all of the profits.
A sole proprietorship is less of a hassle to start as well because few legal formalities are required. The sole proprietor is free to make any decision they want to such as who to hire, when to take a vacation, and what kind of business to pursue. You save money in a sole proprietorship because it is relatively cheap to start up and you don’t have to pay a lot of taxes. You only pay income taxes on the business’s profits and you are also allowed to establish certain tax-exempt retirement accounts. As good as all of that sounds, there are some bad things that go along with sole proprietorships as well.
A major disadvantage of a sole proprietorship is that as sole owner, the proprietor alone bears the burden of any losses or liabilities incurred. If your business or employees get sued, there is unlimited personal liability for the owner of a sole proprietorship. Creditors can go after the owner’s personal assets to satisfy any business debts. As a sole proprietor it isn’t easy to raise money(capital) for your business because you are limited to your personal funds and any personal loans that you can obtain.
A partnership is one of the most common forms of business organization. A partnership is an agreement, express or implied, between two or more persons to carry on a business for a profit. In a partnership it is easier to secure financing than if you were in a sole proprietorship. Since you have other equal partners, you don’t have to put as much money into the business. You can easily fund your business venture with investors that invest money only but do not actively participate in the business(limited partnerships). Much like sole proprietorships, partnerships are relatively inexpensive to get going, because of their relative ease of formation.
There are some disadvantages to partnerships though. It is more than likely that you and your partner(s) will be almost completely personally responsible for covering the costs of starting your business. You may each have enough money to invest to start the business, or you may need to secure business loans from a lender. When filing taxes, partners report their share of profits and losses and their personal tax return, regardless of whether or not the profits are distributed to partners or kept in the business. While general partnerships do not have to pay state or federal income taxes, they must file an annual informational tax return with the Internal Revenue Service and State Franchise Tax Board.
This return indicates how much the partnership earned or lost and how much each partner earned or lost. The general partnership must also file annual tax forms for each partner indicating the income each partner has earned, if any. Each partner also adds their earnings (or subtracts their losses) from their personal tax returns.
A corporation is a legal entity or structure created under the authority of a state’s laws, consisting of a person or group of persons who become shareholders. The entity’s existence is considered separate and distinct from that of its members. Like a real person, a corporation can enter into contracts, sue and be sued, pay taxes separately from its owners, and do the other things necessary to conduct business. One of the key reasons for forming a corporation is the limited liability protection provided to its owners. Because a corporation is considered a separate legal entity, the shareholders have limited liability for the corporation’s debts.
The personal assets of shareholders are not at risk for satisfying corporate debts or liabilities. Owners of a corporation only pay taxes on corporate profits paid to them in the form of salaries, bonuses, and dividends. The corporation pays taxes, at the corporate rate, on any profits. Another advantage of a corporation is the built-in stock structure which makes it attractive to investors.
Corporations have a ton of disadvantages that make it difficult to start a corporation. As opposed to other business forms, such as partnerships or LLCs, corporations are the more expensive and complicated both to initially setup and to maintain. This is because state corporate laws have many rules and formalities which corporations must follow, including requirements that corporations makes various filings and fee payments.
The corporate form also provides you with less flexibility in how you can distribute your company’s profits and losses (as opposed to LLCs, which generally allow you to distribute however you would like). Another costly disadvantage to corporations (which LLCs share as well) is that many states require your business to get a license, even if the corporation is actually located in another state, if you are going to do business in that state. Obviously, this can become very costly for corporations intending to do broad, nationwide business. This same requirement does not generally apply to sole proprietorships or partnerships