When entrepreneurs establish a business, they must decide on the form of business ownership. There are three basic forms of business ownership: sole proprietorship, partnership, and corporation. The form that is chosen can affect the profitability, risk, and value of the firm. The business ownership decision determines how the earnings of a business are distributed among the owners of the business, the degree of liability of each owner, the degree of control that each owner has in running the business, the potential return of the business, and the risk of the business. These types of decisions are necessary for all business.
Sole Proprietorship
A business owned by a single owner is referred to as a sole proprietorship. The owner of a sole proprietorship is called a sole proprietor. A sole proprietor may obtain loans from creditors to help finance the firm’s operations, but these loans do not represent ownership. The sole proprietor is obligated to cover any payments resulting from the loans but does not need to share the business profits with creditors. Typical examples of sole proprietorships include a local restaurant, a local construction firm, a barber shop, a laundry service, and a local clothing store. About 70 percent of all firms in the United States are sole proprietorship. But because these firms are relatively small, they generate less than 10 percent of all business revenue. The earnings generated by a sole proprietorship are considered to be personal income received by the proprietor and are subject to personal income taxes collected by the Internal Revenue Service.
Characteristics of Sole Proprietors
Sole proprietors must be willing to accept full responsibility for the firm’s performance. The pressure of this responsibility can be must greater than any employee’s responsibility. Besides of this, Sole proprietors must also be willing to work flexible hours. They are on call at all times and may even have to substitute for a sick employee. Other than that, their responsibility for the success of the business encourages them to continually monitor business operations. They must exhibit strong leadership skills, be well organized, and communicate skill well with employees.
Many successful sole proprietors had precious work experience in the market in which they are competing, perhaps as an employee in a competitor’s firm. For example, restaurant managers commonly establish their own restaurant. Experience is critical to understanding the competition and the behavior of customers in a particular market.
Advantages of a Sole Proprietorship
- Easy Organization: Establishing a sole proprietorship is relatively easy. The legal requirements are minimal. A sole proprietorship need not establish a separate legal entity. The owner must register the firm with the state, which can normally be done by mail. The owner may also need to apply for an occupational license to conduct a particular type of business. The specific license requirements vary with the state and even the city where the business is located.
- Complete control: Having only one owner with complete control of the firm eliminates the chance of conflicts during the decision on the menu, the prices, and the salaries paid to employees.
- Lower Taxes: Because the earnings in a proprietorship are considered to be personal income, they may be subject to lower taxes than those imposed on some other forms of business ownership.
- Total Decision-Making Authority: Because the sole proprietor is in total control of the operations, he or she can respond quickly to changes, which is an asset in a rapidly shifting market. The freedom to set the company’s course of action is a major motivational force. For those who thrive on the enjoyment of seeking new proprietors thrive on the feeling of control they have over their personal financial futures and the recognition they earn as the owners of their business.
Disadvantages of a Sole Proprietorship
- The Sole Proprietor Incurs All Losses: Just as sole proprietors do not have to share the profits, they are unable to share any losses that the firm incurs. For example, assume you invest $10,000 of your funds in a lawn service and borrow an additional $8,000 that you invest in the business. Unfortunately, the revenue is barely sufficient to pay salaries to your employees, and you terminate the firm. You have not only lost all of your $10,000 investment in the firm but also are liable for $8,000 that you borrowed. Since you are the sole proprietor, no other owners are available to help cover the losses.
- Unlimited Liability: A sole proprietor is subject to unlimited liability, which means there is no limit on the debts for which the owner is liable. If a sole proprietors is sued, the sole proprietor is personally liable for an judgment against that firm.
- Limited Skills: A sole proprietor has limited skills and may be unable to control all parts of the business. For example, a sole proprietor may have difficulty running a large medical practice because different types of expertise may be needed.
- Limited Funds: A sole proprietor may have limited funds available to invest in the firm. Thus, sole proprietors have difficulty engaging in airplane manufacturing, shipbuilding, computer manufacturing, and other business that require substantial funds. Sole proprietors have limited funds to support the firm’s expansion or to absorb temporary losses. A poorly performing firm may improve if given sufficient time. But if this firm cannot obtain additional funds to make up for its losses, it may not be able to continue in business long enough to recover.
Partnership
A business that is co-owned by two people or more than two people is referred to as a partnership. The co-owners of the business are called partners. The co-owners must register the partnership with the state and may need to apply for an occupation license. About 10 percent of all firms are partnerships. Besides of this, in a general partnership, all partners have unlimited liability. That is, the partners are personally liable for all obligations of the firm. Conversely, in a limited partnership, the firm has some limited partners, or partners whose liability is limited to the cash or property they contributed to the partnerships. Limited partners are only investors in the partnership and do not participate in its management, but because they have invested in the business, they share its profits or losses. A limited partnership has one or more general partners, or partners who manage the business, receive a salary, share the profits or losses of the business, and have unlimited liability. The earnings distributed to each partners represent personal income and are subject to personal income taxes collect by the IRS.
Disadvantages of Partnerships
- Lack of Continuity: If one partner dies, complications arise. Partnership interest is often nontransferable through inheritance because the remaining partner may not want to be in a partnership with the person who inherits the deceased partner’s interest. Partners can make provisions in the partnership agreement to avoid dissolution due to death if all parties agree to accept as partners those who inherit the deceased’s interest.
- Control is shared: The decision making in a partnership must be shared. If the partners disagree about how the business should be run, business and personal relationships may be destroyed. Some owners of firms do not have the skills to manage a business.
- Unlimited Liability: General partners in a partnership are subject to unlimited liability, just like sole proprietors.
- Profits Are Shared: Any profits that the partnership generates must be shared among all partners. The more partners there are, the smaller the amount of a given level of profits that will be distributed to any individual partner.
Sole Proprietorship vs Partnership
Sole Proprietorship is better than Partnerships. Besides that, it is lower taxes because the earnings in a proprietorship are considered to be personal incomes, they may be subject to lower taxes than those imposed on some other forms of business ownership. Other than that, Sole Proprietors make us easy and quickly do decision and making authority. Because the sole proprietor is in total control of the operations, he or she can respond quickly to changes, which is an asset in a rapidly shifting market. The freedom to set the company’s course of action is a major motivational force. For those who thrive on the enjoyment of seeking new proprietors thrive on the feeling of control they have over their personal financial futures and the recognition they earn as the owners of their business. Other than that, Sole proprietors is much more better than Partnerships because of Partnerships much more disadvantages then Sole Proprietors. If one partner dies, complications arise. Partnership interest is often nontransferable through inheritance because the remaining partner may not want to be in a partnership with the person who inherits the deceased partner’s interest. Partners can make provisions in the partnership agreement to avoid dissolution due to death if all parties agree to accept as partners those who inherit the deceased’s interest.