Should A Small Business or Start Up Be Formed As A Sole Proprietorship, Partnership, LLC, or Corporation?


Business Going Up - Should a Small Business be a LLC, Partnership, or CorporationThis article focuses on the four major business entities that function within the United States and the world: A Sole Proprietorship, Partnership, LLC, and Corporation, and the advantages and disadvantages entrepreneurs should consider when deciding what type of entity their business should function as. The different types of businesses will be defined and evaluated in order from the simplest business formations, to the most complex.

 Sole Proprietorship: A business entity that is owned by a single person, there is no legal distinction between the owner and the business itself.

Advantages:

  • A sole proprietor has complete control and decision-making power over the business affairs.
  • A sole proprietor has the ability to sell the company at his or her discretion.
  • No corporate tax payments are levied against the sole proprietor.
  • There are only minimal requirements and legal costs involved in forming a sole proprietorship.

Disadvantages:

  • The sole proprietor is held liable for all the debts, risks, and obligations of the business.
  • The Sole Proprietor responsible for any liabilities incurred as a result of acts committed by employees of the company.
  • All responsibilities and business decisions are that of the sole proprietor (also considered as an advantage)
  • Investors, for the most part, do not invest in sole proprietorships making it harder to raise capital.

Partnerships: A partnership is an agreement between two or more people to cooperate in order to finance and operate a business

Advantages:

  •  Partnerships are normally easy to establish.
  • In general, the more people that are involved with the partnership the easier it will be for the business to raise funds. This happens because the partners themselves can “pool” their money together, and are often allowed to borrow more money than if the business was a sole proprietorship.
  • The skill sets of the partners may complement each other very well, giving the partners an advantage over competitors. This can also be very cost effective if each partner takes charge of running a different aspect of the business.

Disadvantages:

  • All partners are mutually and individually reliable for the actions of the other partners.
  • All profits must be shared. It is up to the partners to agree on how much profit is split between the partners depending on time and investment put into the company.
  • Disagreements can occur in the partnership due to the sharing of decision-making responsibilities. This can often times be detrimental, leading to a withdrawal of partners or a split in the company.
  • Partnerships often face situations in which they are limited in transforming into a very large company.
  • The biggest disadvantage of a Partnership is unlimited liability. This means that partners are liable without limit for all of the debts and errors made by the company. For example: If one partner 5% of a company and another owns 95% and the business fails, then the partners have to pay back the 5% and the 95% of the respective debt they own. But if the partner owning 95% cannot pay what he owes then legally the 5% owner must pay all the debt that the 95% owner fails to meet.

 Limited Liability Company (LLC): Considered by most people to be a sort of hybrid enterprise, an LLC combines features of a partnership or sole proprietorship with that of a corporate structure.

 Advantages:

  • An LLC can choose to be taxed as a sole proprietorship, partnership, S Corporation or C corporation giving multiple options and flexibility with regards to tax policies.
  • Members within the LLC are protected from some or all of the liability for acts and debts of the LLC depending on the laws of the state or country in which the LLC resides.
  • Less busy work (paperwork, file keeping, etc…) than a corporation.
  • No double taxation, also known as Pass-through Taxation.
  • In most countries and States LLCs are viewed as a separate entity from its members.
  • In Most countries and states a single person can set up an LLC.
  • An LLC provides more protection from a forced buyout or being acquired from a competitor or “hungry” investor.

 Disadvantages:

  • It is often more difficult for an LLC to raise financial capital because investors generally are more comfortable with giving money to a better understood corporation with a goal of an eventual Initial public offer (IPO).
  • Many States impose a franchise or capital tax on an LLC in which the LLC has to pay taxes to the state for the right to exist as an LLC. Even so, this tax is usually a lot less punitive compared to taxes imposed on a corporation.
  • Renewal fees can be very high depending on the country or state.
  • Management structure is not defined.  This can lead to problems in regards to who exactly has the power within an LLC to agree to contracts with outside businesses.
  • Taxing jurisdictions Outside of a country in which an LLC is located often tax an LLC as if it were a corporation.

Corporation Advantages: (This is a general summation of the advantages and disadvantages corporations face, there are several different types of corporations).

Advantages

  • There is limited liability on the part of the owners. Creditors of a corporation cannot go after the money of a stockholder. Because a corporation is a distinct legal entity, creditors can only try to seize the assets of the corporation itself.
  • Selling or transferring ones right to ownership of the company (stock) is extremely easy. Any person looking to sell their ownership can do so quickly and easily through a stockbroker.
  • A corporation can continue on through power of succession. For example: if in a sole proprietorship the owner of the company dies without distinctly defining what would happen to the company after their death, the company could legally be dissolved.
  • Corporations have an easier time raising capital because investors are more likely to invest in corporations rather than a sole proprietorship, LLC., or a partnership.

Disadvantages

  • Organizing and understanding the types of regulation in which a corporation is subjected to is very complex. Applications must be filed and approved by the Securities and Exchange Commission (SEC). Once approved the corporation is closely monitored and must comply with all the rules set by the SEC.
  • There is a possibility of double taxation that could occur when a corporation pays out dividends to it’s stockholders. This happens when a corporation is first taxed on the income it makes, and then the stockholders are personally taxed when receiving dividends dispersed by the corporation.
  • Corporations have a centralized management that restricts participation in decision making from stockholders that do not have a large amount of stock ownership.

 Links and References

 www.sec.gov

 Admin. “What Are the Advantages and Disadvantages of Forming a Corporation?”BusinessAccent.com: Man, Mind, Marketing, Money and Manners. 7 Feb. 2009.

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