Proprietorship, Partnership, Corporation: Choosing your BusinessType

Proprietorship, Partnership, Corporation:
Choosing your Business Type

by Michael G. Oleyar

The day has finally arrived when you are 100 percent committed to fulfilling a long sought after dream - starting your own small business. But, before you take the great leap of faith, serious thought must be given to the type of business entity that will best serve your needs. There are three basic business structures that are appropriate for a small business.

A sole proprietorship is essentially a one-person business. This individual must perform the duties of owner, manager and employee. The advantages in choosing a sole proprietorship are: the absence of formalities with one person making the decisions, the lack of regulatory or reporting requirements, and no double taxation. Although the advantages are appealing, the disadvantages must be considered.

A significant deterrent to a sole proprietorship is that the owner is subject to unlimited personal liability for the endeavors of the business. This liability cannot be limited to a predetermined portion of assets. Several other unfavorable attributes are: the business is subject to termination upon the death or incapacity of the owner, all profits of the business are taxed as income to the proprietor, and the capital of the business is limited to the assets of the owner.

The second business form is a partnership. The idea of a partnership dates back to Roman Law. A partnership is simply an association of two or more individuals carrying on as co-owners of a business for profit. The concept, as was in the time of Caesar, has remained basically the same in today’s complex society.

There are two types of partnerships recognized in the United States. The first, a general partnership, is a situation where partners share equally in liability. However, in the second, a limited partnership, the "limited" partner’s liability is restricted to a predetermined amount.

One of the most appealing characteristics of a partnership is flexibility. Partners can define their relationship in almost any way they desire. Other benefits of a partnership include: a greater likelihood to raise more capital, the ability to spread taxable income through many partners, and preclusion of any person from becoming a partner without consent of all partners.

The most significant drawback of a partnership is the unlimited personal liability for each partner, including liability for actions by other partners. Another disadvantage is the uncertain duration. A partnership is technically dissolved when any general partner ceases for any reason to be a partner.

The final business form is a corporation. A Corporation is defined as an association of persons created by statute as a separate legal entity. The concept of a corporation comes from the English monarchy’s awarding of charters to favored individuals. Today, in the twentieth century, the industrialization and enormous size of businesses has enabled the characteristics of a corporation, such as: centralized direction, limited financial commitment, and limitless number of passive investors, to be a favored form of a business. There are various types of corporations. Their distinctions are usually defined by how they are treated by the IRS.

The S Corporation, a popular type chosen by many small businesses derives its name from chapter S of the Internal Revenue Code. The major significance in S corporate status is that it usually avoids the corporate income tax or double taxation and corporate losses, which can be claimed by the shareholders. Excluding the tax implications, under state law the S Corporation is generally allotted the same legal characteristics as other corporations.

One distinct quality to a corporation is the limited liability of the shareholders for the debts of the business. The shareholder is only exposed to the extent of the value of his or her stock. Other admirable traits of a corporation include: the free transferability of ownership, duration of a corporation is perpetual, and the ability to sue. Yes, you guessed it, if a corporation can sue, it can also be sued - unfortunately, a minor drawback. There are other disadvantages such as: formalities of reporting and regulations, management and control is separate from ownership, and minority shareholders are subject to the whims of the majority shareholders. Although the disadvantages of a corporation are significant, the ability to save on taxes and retain a larger percentage of the profits is enough to make a corporation the favored choice of small entrepreneurs.

In choosing a particular business form you must keep in mind several important factors: legal restrictions, liability, tax treatment and flexibility. Regardless of whether you choose a sole proprietorship, partnership or corporation be sure that the decision you make is well informed and thoroughly.