FORMS OF BUSINESSES

 Business owners are faced with a number of choices when selecting the form of
enterprise. They may elect to operate unincorporated, as a sole proprietorship, a
partnership, or a limited-liability company (LLC); or they may incorporate as a
regular corporation. The choice of ownership form is not irrevocable, and owners
of existing businesses often decide to change the form as circumstances dictate.
 The choice of a form of ownership is a complex decision facing all business
owners because it will have a significant impact on the initial start-up cost, the
control and flexibility in management, the taxation of the business and individual
owners, the ability of the firm to raise capital, and the business risks absorbed by
the individual owners
 Business owners normally taken into account the following issues when selecting
the form of ownership under which the business will operate:
 Start-up costs and formalities of operation
 Control of the business and management
 Flexibility in business operations
 Ability of the business to raise funds
 Limiting the liability of owners from business operations
 Overall tax burden
 Business continuity and termination
 Compensation and fringe benefits

Therefore, the structure and operations of any form of business are defined by the
following eight primary factors;
1. Creation—how the business is started
2. Management—how it is managed and operates on a daily basis
3. Ownership—who owns the business’s property and assets
4. Profit—how the business’s profits and losses are distributed
5. Liability—who is accountable for the business’s legal responsibilities
6. Taxation—how the business is taxed
7. Continuity—the length of the business’s life
8. Termination—how the business can be terminated/dissolved

Consequently, a business may be organized by an individual as a sole proprietorship or

by associations of persons by mutual agreement as a partnership or by an association of
persons who form a cooperative society or by a number of persons as a joint stock
company.

SOLE PROPRIETORSHIP

 By definition, a sole proprietorship is an unincorporated business owned by one

person. Or

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  It’s a form of business org. in which an individual raises his own capital, uses his
own skills & knowledge in the management of the its affairs and is solely
responsible for the results of its operations.

A sole proprietor may run the business directly or may hire others to run it, but ultimately
it is the sole proprietor’s decisions that determine the firm’s destiny. Typically, a sole
proprietor performs most of the major functions such as overall manager, sales manager
and finance manager. Since the proprietor is the sole owner of the business, there is
generally no need for any agreements or formalities

Characteristics

 Compared to other structures it is the simplest to start- do not require government

approval (legal)
 The business has no existence apart from the owner, and owner is his or her own
boss (single ownership & one person control)
 The owner owns the business assets and is personally responsible for all debts of
the business (no separate entity from the firm)
 All liabilities of the business and actions undertaken in the name of the business
are the owner’s personal liability (unlimited liability and undivided risk)
 Sole proprietorship does not pay corporate income tax - income and expense are
reported on the owner’s personal tax return
 The owner reaps the benefits of his/her success
 The business ceases upon the death of the owner
 Since the finances of the business and owner are one in the same, significant
attention must be devoted to financial planning

The real distinguishing feature of a sole proprietorship is not size; it is the unlimited
and unshared responsibility of the sole owner.

Advantages
 Simplicity—starting a sole proprietorship is relatively simple. The only legal
formalities are applying for appropriate state or local permits and licenses and
filing a special certificate if the sole proprietor intends to operate the business
under a name other than his or her own. Similarly, no legal action is required to
terminate a sole proprietorship.
 Autonomy—enjoys freedom of action. no boss to criticize a sole proprietor’s
work or a partner who must be consulted on decisions or no board of directors
 Sole Gain—Related to this aspect of the proprietorship is the fact that all profits
belong to the sole owner i.e. no partners to share the proceeds or no stockholders
to claim dividends.
 Single Tax—The sole proprietor and the sole proprietor’s business are taxed as a
single unit
 Shelter Income—Along with other forms of business, the sole proprietor enjoys
the tax advantage of reducing taxable income by charging off costs of doing
business as “expenses.”

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Disadvantages
 Limited Resources—one disadvantage is that of limited resources.
 The sole proprietorship form also is limited in terms of business talent and ability.
 Unlimited and Unshared Liability-There is no distinction between the sole
proprietor’s business assets and liabilities and his or her personal assets and
liabilities.
 Business Dies with the Sole Proprietor—No disadvantage of a sole proprietorship
could be more significant to a financial advisor than the fact that—without
planning—the business dies when the sole proprietor dies.

PARTNERSHIP

When two or more people agree to combine their resources and skills for mutual profit,
they have formed a partnership.
 A partnership is defined as “an association of two or more persons to carry on as
co-owners of a business or any other undertaking for profit.” Or
 A partnership is a voluntary association of two or more persons, each contributing
money, property, skills, labor, or goodwill as the capital of the new firm.

Characteristics
 There must be at least 2 or more persons coming together for purposes of
business, and by law numbers are limited i.e. a minimum of 2 and maximum of 20
for general or 10 for banking.
 There is contractual relationship – business set up by an agreement between
persons, called partners. It can be oral, written or implied.
 Profit motivated and there must be agree on a division of ownership and profits
based on the relative value of each partner’s contributions.
 A partnership is an entity distinct from its partners
 More legal formality than with a sole proprietorship but less than with a
corporation or limited liability company
 Principal-agent relationship i.e. business must be carried on by all or one or more
of them, acting on behalf of all partners.
 Property acquired by a partnership is property of the partnership and not the
partners individually

Partnership formation
A partnership rests on a contact among persons, anytime two or more persons agree carry
on as co-owners a business for profit, and its formation does not involve any special legal
problems-law does not compel partners to register but registration is necessary.

Ways of formation.
1. By word of mouth – partners agree by spoken words that they have formed a
partnership and respect it. Need no to record anything.
2. In writing- partners agree and put their agreement in writing, in document
referred to as a ‘Partnership Deed’ or ‘Articles of Partnership’.

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 3. Implied partnership – born out of the course of dealings where there is no
explicit agreement either orally or written but partnership r/ship is implied from
the behaviour or actions of the people involved e.g agents or brokers.

The partnership deed

This is an agreement which spells out the rights and obligations of the partners. In
absence of a partnership deed, the Partnership Act can operate.
Contents
I. Names and addresses of partners,
II. Name and location of the partnership
III. Purpose of the partnership/nature of business to be conducted
IV. Capital or amount of money, property or services each partner will contribute
V. Compensation to be paid to partners or rates of interest to be allowed on capital
Duration of the partnership and the procedure for dissolution of partnership
VI. Ratio/plan for distribution of profits and losses
Amounts, if any, partners may draw in advance before ascertainment of profits.
VII. Partners’ salaries, if any
VIII. Preparation and auditing of accounts
IX. Voting rights of the partners and provision for settling differences
X. Admission of new partners

Relationship of Partners
 Each partner is an agent of the partnership for the purpose of its business
 Acts of an individual partner in carrying on partnership business binds the
partnership, unless the partner did not have authority to act for the partnership
 Partners are jointly liable for debts of the partnership
 Partners are jointly liable for civil liability judgments against the partnership
 Generally criminal liability of one partner will not be imputed to other partner(s)

The partnership agreement does not have to be filed with any state or local authority/
agency, but each partner should sign and retain a copy. In fact, when launching a
partnership, all that is required is that you purchase a business license in the partnerships
name, just as you would buy a license for a sole proprietorship or any other form of
business.

Property interest of General Partnership.

 Each partner has a right to share in the profits and receives pro rata share of
profits and any sale of assets upon dissolution of the partnership. Interest in
partnership may be transferred, such as in case of the death of a partner. His
INTEREST in the partnership goes to his or her heirs.
 Property brought into the partnership or acquired on account thereof is partnership
property. Property acquired by partnership funds is partnership property.
 Partner's use of partnership property is limited. There is no right to possess
business property for non-business purpose without consent. Partnership property
(not interest) is not assignable, subject to attachment or subject to marital rights.

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Financial rights & obligations of Partners.
 Each partner has equitable rights to profits unless there is a formal partnership
agreement stating otherwise.
 Liability for losses is shared equally – in the absence of an agreement. There is
right to require contribution from co-partners.
 There is the right to reimbursement for reasonable expenses paid out within
course of business or preservation of partnership, right to indemnification for
liabilities incurred while acting on behalf of partnership, the right to interest on
loans and advances made to partnership.
 However, there is NO right to compensation for working for the business unless
stated in the agreement.
 Surviving partner entitled to reasonable compensation for winding up dissolved
partnership.
Management rights of Partnership
 As stated above, there is equal right in management and conduct of partnership -
unless contrary to agreement.
 Management rights are NOT transferable with interest of partnership.
 Ordinary business disputes are decided by majority of partners, not based on
contributions and/or right to profits.
 Agreements contrary to the partnership agreement are valid only if ALL of the
partners agree.
 New Partners may be admitted with unanimous consent of the partners.

Rights and liabilities of the Partners.

 Each partner has equal right to use or possess partnership property for partnership
purposes.
 They each have equal access to financial books and records of partnership.
 The books are best kept at the ordinary place of business of the partnership -
unless contrary to agreement.
 Each partner is an agent of the partnership with fiduciary duties to the partnership.
 Partner may not bring suit in an action at law against another partner or the
partnership based on business operation. Personal actions between partners
unrelated to business may be maintained at law.
Obligations and liabilities to third parties
 Each partner has personal liability for all debt of partnership.
 They have joint and several liability for torts, and joint liability for debts and
obligations under contracts.
 However, Incoming partners are not automatically liable for pre-existing debt but
do have personal liability for debts incurred after admission as partner.
 Partner remains liable after withdrawing from partnership and a Partner's estate
remains liable for debts incurred before his death.

 The general rule is that all personal assets are on the line for business debts
incurred by you OR YOUR PARTNER.

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  This may include your home, in which case the personal liability is the same as a
sole proprietorship, unless your wife is your partner
 A Partnership Agreement does not bind third parties who are not aware of it.

Dissolution of Partnership.
There are a number of ways a partnership can come to an end.
(i) If the partnership has accomplished the purpose for which the partnership was
formed, it can be wound up (This is termed Dissolution by natural expiration).
(ii) A partnership is dissolved by the withdrawal of any partner, or
(iii) A partnership is dissolved by the mutual consent of all the partners.

 The effects of Dissolution for any reason essentially means the termination of
authority of partners to act for partnership except in cases involving the
Completion of pending transactions, acts necessary for winding up and good faith
advances by third parties.
 Dissolution does not discharge liabilities of any partner existing at the time of
dissolution.
What we have discussed in this section concerns GENERAL PARTNERSHIPS.
Partnership Types
There are 2 basic types i.e. General partnership and Limited partnership– Principal
distinction between a general and limited partnership is the extent of liability of a general
partner versus a limited partner
1. General Partnership-All partners share in the duties, profits and liabilities and
income of partnership is income of the individual partners.
2. Limited Partnership-The liability of a limited partner is limited to the amount of
capital contribution to the partnership. Basically, a limited partner may not
contribute services nor perform any management or control over operation of the
partnership
Others are;
Family Limited Partnership
A version of the limited partnership, the family limited partnership (FLP) is sometimes
used in estate planning, especially when there is a family business interest. In a family
limited partnership, a property-owning family member transfer’s property such as real
estate and stocks to the partnership, receiving partnership units in exchange. Younger
generations receive limited partnership units while the senior, member(s) receive general
partnership units, maintaining control of the assets.

Professional Partnerships
Another way of differentiating partnerships is to divide them into commercial (business)
partnerships and professional (personal service) partnerships. Typical professional or
personal service partnerships are legal, medical, engineering, architectural, accounting,
dental, advertising, consulting firms, realtors, and brokers.

Types of partners

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  Classified according to the age i.e. Minor or Major partners. Major- 18 yrs &
above, who are liable to all actions of the partnership, and minor ones – below 18
yrs, who are not accountable of any actions.
 Classified according to roles i.e. Active or Dormant partners. Active partners on
top of contributing & sharing on profits or losses, takes active participation in
running the business, while dormant partner don’t take part in the day-to- day
running of the business
 Classified according to capital contribution i.e. Real or Quasi partners. Real
partners contribute capital and shares in profits and losses, and may or not run the
business. On the other hand, quasi partners don’t contribute and are not involved
in running of the business but only allows his/her name to be used.

Advantages and disadvantages of Partnership

Advantages
 Ease of formation;
 Relatively low start-up costs;
 Additional sources of investment
capital;
 Possible tax advantages;
 Limited regulation;
 Broader management base.
 Free to undertake any business
 Specialization is possible
Disadvantages
 Unlimited liability;
 Lack of continuity;
 Divided authority;
 Difficulty raising additional capital;
 Hard to find suitable partners;
 Possible development of conflict
between partners.
 Less freedom of action compared to sole
proprietorship.

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