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Forms of Businesses: Sole Proprietorship
Forms of Businesses: Sole Proprietorship
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
SOLE PROPRIETORSHIP
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
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.”
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’.
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.
The general rule is that all personal assets are on the line for business debts
incurred by you OR YOUR PARTNER.
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
Advantages Disadvantages
Ease of formation; Unlimited liability;
Relatively low start-up costs; Lack of continuity;
Additional sources of investment Divided authority;
capital; Difficulty raising additional capital;
Possible tax advantages; Hard to find suitable partners;
Limited regulation; Possible development of conflict
Broader management base. between partners.
Free to undertake any business Less freedom of action compared to sole
Specialization is possible proprietorship.