UU-MAN-4008-MW - ENTREPRENEURSHIP

Week 4 – Topic Overview

Forms of business ownership

Learning Objectives
1. To know and understand the different legal forms of businesses
2. To identify the advantages and disadvantages of these different forms of business

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Table of Contents

1. Introduction ............................................................................................................................................... 3
2. Sole proprietorship .................................................................................................................................... 3
2.1 Pros and cons of proprietorship ........................................................................................................... 3
2.1.1 Pros ............................................................................................................................................... 3
2.2 Cons ..................................................................................................................................................... 4
3. Partnership................................................................................................................................................. 4
3.1 Types of partners ................................................................................................................................. 5
3.1.2 General Partners ............................................................................................................................ 5
3.1.3 Limited Partners ............................................................................................................................ 5
3.1.4 Limited liability partnerships (LLP) ............................................................................................. 5
3.2 The partnership agreement .................................................................................................................. 5
3.3 Advantages and disadvantages of partnerships ................................................................................... 6
3.4 Disadvantages ...................................................................................................................................... 6
4. Corporations .............................................................................................................................................. 7
4.1 Corporate ownership ........................................................................................................................... 7
4.2 Types of corporations .......................................................................................................................... 7
4.2.1 A closed corporation ..................................................................................................................... 7
4.2.2 An open corporation ..................................................................................................................... 7
4.2.3 S-Corporations .............................................................................................................................. 8
4.3 Corporation basics ............................................................................................................................... 8
4.4 Benefits and drawbacks of incorporation ............................................................................................ 8
4.4.1 Benefits ............................................................................................................................................. 9
4.4.2 Drawbacks ........................................................................................................................................ 9
5. Cooperatives ............................................................................................................................................ 10
6. Other forms of business ownership/Special types of business ownership .............................................. 10
6.1 Limited-Liability companies (LLC) .................................................................................................. 10
6.2 Not-for-Profit Corporations ............................................................................................................... 11
6.3 Joint Ventures .................................................................................................................................... 11
6.4 Syndicates .......................................................................................................................................... 11
6.5 Virtual corporations ........................................................................................................................... 12
References ................................................................................................................................................... 13

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1. Introduction
An entrepreneur has to be familiar with the different legal types of business ownership. There are three
main legal forms of business: (a) sole proprietorship; (b) partnership; and (c) corporation. These will be
discussed in detail.

2. Sole proprietorship
A sole proprietorship is a business that is owned (and usually operated) by one person as the owner controls
all business aspects (Prescott et al., 2010; Greene, 2011; Scarborough & Cornwall, 2019), thus the
proprietor qualifies to get all profits earned by the business (Burrow et al., 2008). Sole proprietorship
businesses may be very small with few employees or maybe large with many employees (Greene, 2011).
Not all sole proprietorship businesses are run full-time as many entrepreneurs run part-time businesses out
of an office or their home (Burrow et al., 2008).

2.1 Pros and cons of proprietorship

There are many pros and cons facing the sole proprietor.

2.1.1 Pros
Ease of Start-Up and Closure: Often, a start-up requires no contracts, agreements, or other legal documents.
The legal requirements are usually limited to registering the name of the business and obtaining any
necessary licenses or permits. If the business fails, it can be closed easily as there is no need for for any
legal procedures (Prescott et al., 2010; Scarborough & Cornwall, 2019).
Retention of All Profits: as all profits come to the personal earnings of the owner. This is the reason why
most entrepreneurs are attracted to the sole proprietorship form of business. This prompts the owner to
work for long hours and to think consistantly about how the business can operate more efficiently (Burrow
et al., 2008).
The flexibility of Being Your Own Boss: A sole proprietor is completely free to make decisions about the
firm’s operations. A sole proprietor has the liberty to switch from retailing to wholesaling, change location,
open a new store or close an old one without asking or waiting for approval from anyone. Thus, decisions
are made quickly in a sole proprietorship (Burrow et al., 2008; Scarborough & Cornwall, 2019).
Owner Personally Knows Employees and Customers: As many proprietorships are small, the owner and
the employees get to know each other personally. Such an association can lead to reciprocal appreciation
and a notion of “family” as the founder and employees work side by side during their daily business
activities. Sole proprietors often advance close relationships with their customers as well (Burrow et al.,
2008).

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Owner Is Free from Red Tape: Few legal documents are required when starting sole proprietorships while
government bureaucracy may be minimised. It is possible to get license before operations begin for some
businesses such as restaurants (Burrow et al., 2008; Scarborough & Cornwall, 2019).

2.2 Cons
Unlimited Personal Liability: The proprietor is individually accountable for all the debts of the firm as there
is lawfully no distinction between the debts of the firm and the owner (Burrow et al., 2008; Prescott et al.,
2010; Greene, 2011; Skripak, 2016; Scarborough & Cornwall, 2019). This is the major reason why aspiring
entrepreneurs with considerable personal riches are discouraged from using the sole proprietor form of
business organization.
Lack of Continuity: Legally, the sole proprietor is the business. If the owner retires, dies, or is declared
legally incompetent, the firm basically closes (Burrow et al., 2008; Skripak, 2016; Scarborough &
Cornwall, 2019). However, in most cases, if the business is profitable, the owner’s heirs take it over and
either sell it or continue to operate it.
Lack of Money: as banks, suppliers, and other lenders are usually reluctant to lend large sums of money to
sole proprietorships as the assets of most sole proprietors are limited. Other reasons are that these limited
assets may have been used already as the basis for personal borrowing (i.e., home mortgage or car loan)
(Burrow et al., 2008; Greene, 2011).
Proprietor may lack the necessary skills and abilities: Not even very experienced proprietors can have
expertise in all areas. Except if the proprietor gets the required expertise by hiring employees, the firm can
suffer in the areas that the owner is less knowledgeable (Burrow et al., 2008; Scarborough & Cornwall,
2019).
Difficulty in Hiring Employees: The owner may find it difficult to appeal to and retain qualified staff as
they may have a feeling that there is no space for advancement in a business whose owner assumes all
managerial duties. And if those who are employed are willing to take on extra duties, they may find that
the only way to do so is to resign from the sole proprietorship and go to work for a larger firm or start up
their own businesses.
However, it is argued that most sole proprietorship businesses that are at risk for failure are those started
by individuals with few management skills and little money.

3. Partnership
A partnership is a voluntary association of two or more persons coming together as co-owners of a business
For a profit (Skripak, 2016; Scarborough & Cornwall, 2019). There is no legal maximum number of
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partners in a partnership, but most have two. Large accounting firms, law, and advertising partnerships
usually have multiple partners. A major component in the success of a partnership is that partners must
clearly agree upon each person’s responsibilities

3.1 Types of partners

The following are the most common types of partners:

3.1.2 General Partners

A general partnership is a business co-owned by two or more general partners who are liable for everything
the business does (Burrow et al., 2008; Prescott et al., 2010; Skripak, 2016). To avoid future liability, a
general partner who withdraws from the partnership must give notice to creditors, customers, and suppliers.
No formal filings or documents are required to form a general partnership, but it may be formed by an oral
or written agreement. The partnership agreement should normally be in writing (Prescott et al., 2010).

3.1.3 Limited Partners

A limited partner is a person who invests money in a business but who has no management responsibility
or liability for losses beyond his or her investment in the partnership (Burrow et al., 2008; Prescott et al.,
2010; Skripak, 2016). Limited partnerships may be formed to finance real estate, oil and gas, motion picture,
and other business ventures. Mostly, the general partner or partners collect management fees and receive a
percentage of profits. Limited partners receive a portion of profits and tax benefits. The primary advantage
of the limited partnership is that the limited partners' liability for the partnership's debts is limited to the
capital they contributed (Prescott et al., 2010).

3.1.4 Limited liability partnerships (LLP)

LLP is usually limited to certain kinds of professions such as attorneys. With an LLP, partners are allowed
limited liability protection even if they take an active role in the business of the partnership. All partners
enjoy limited liability exposure. To enjoy this limited liability, the partnership is usually obligated to
maintain general liability insurance to cover possible injured parties (Prescott et al., 2010).

3.2 The partnership agreement

When two or more entrepreneurs decide to go into business together, they usually sign a partnership
agreement, which sets down in writing the rights and responsibilities of each owner. It identifies various
aspects such as: (1) the business or partnership name as well as the partners’ names; (2) the value and type
of value of the investment that was contributed by each partner; (3) the dutues and managerial rights of
each partner; (4) accounting methods to be used; (5) how profits and losses will be divided among the
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partners; (6) the partners withdraw the salaries; (7) partnership duration; (8) conditions under which the
partnership can be dissolved; (9) distribution of assets upon dissolution of the partnership; (10) procedure
for dealing with the death of a partner (Greene, 2011; Skripak, 2016).
Despite the fact that people taking part in a partnership can draft their own agreement, it is recommended
to consult a neutral third party such as an attorney, a consultant, or an accountant as they may assist with
any disputes that might arise.

3.3 Advantages and disadvantages of partnerships

Partnerships have many advantages and disadvantages. The most important ones are discussed below:
Ease of start-up: Just like a sole proprietorship, the legal requirements are restricted to registering the name
of the firm and obtaining any necessary licenses or permits. It may not be necessary to prepare a partnership
agreement although doing so is generally a good idea (Scarborough & Cornwall, 2019).
Availability of capital and credit: Since partners can bring their funds together, a partnership usually has
more capital available. This additional capital, coupled with the general partners’ unlimited liability, can
form the basis for a better credit rating and banks and suppliers may be more willing to borrow them larger
loans (Burrow et al., 2008; Greene, 2011; Skripak, 2016).
Combined Business Skills and Knowledge: Partners often have complementary skills. The weakness of one
partner may be offset by another partner’s strength in that area (Scarborough & Cornwall, 2019).
Retention of Profits: The partners get all the profits. The partners divide the financial rewards among
themselves and this motivates them to work harder to succeed. Nevertheless, the partnership agreement
must be clear on how the profits will be shared among the partners.
Contribution of goodwill: Each partner has the probability of having many followers. This will make a
number of people to be willing to do business with the newly formed partnership since they know the
owners (i.e., goodwill) (Burrow et al., 2008).
Reduction in competition: The formation of a partnership by two or more proprietors in the same line of
business may decrease or eliminate competition (Burrow et al., 2008).

3.4 Disadvantages
Unlimited Liability: Each partner is legally and personally answerable for the debts, taxes, and actions of
any other partner running a partnership business, even if that partner did not acquire those debts. Thus,
partners may end up using their personal; assets to pay creditors. However, as discussed, limited partners
risk only their original investment (Burrow et al., 2008; Greene, 2011; Skripak, 2016; Scarborough &
Cornwall, 2019).

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Management Disagreements: As humans, business partners with egos, ambitions, and money on the line
are susceptible to friction. When disagreements start about decisions, policies, or ethics, distrust may build
to the point where it is difficult to run the business successfully (Burrow et al., 2008; Greene, 2011; Skripak,
2016; Scarborough & Cornwall, 2019).
Frozen Investment: Although it is easy to invest money in a partnership, sometimes it is difficult to get it
out. For example, when remaining partners are not willing to buy shares that belong to a retiring partner or
one who wants to move to another town. To take care of such scenarios, the partnership agreement must
include some procedure for buying out a partner (Burrow et al., 2008).

4. Corporations
A corporation is a legal entity that is entirely separate from the parties who own it. It can enter into binding
contracts, buy and sell property, sue and be sued, be held responsible for its actions, and be taxed (Burrow
et al., 2008; Greene, 2011; Skripak, 2016). Once businesses reach any substantial size, it is advantageous
to organise as a Corporation so that its owners can limit their liability. Thus, corporations tend to be far
larger than businesses using other forms of ownership (Skripak, 2016). However, there are some small
corporations that exist (Burrow et al., 2008).

4.1 Corporate ownership

The shares of ownership of a corporation are called stock. A corporation stock is owned by people known
as shareholders or stockholders and these also own part of the corporation. A corporation may sell its stock
to individuals or some other companies once it is formed. It also may issue stock as a reward to key
employees in return for certain services or as a return to investors in place of cash payments (Greene, 2011).

4.2 Types of corporations

4.2.1 A closed corporation

Has its stock owned by few people and cannot be sold to the general public. It is also known as a closely
held corporation (Burrow et al., 2008). For example, DeWitt and Lila Wallace owned virtually all the stock
of Reader’s Digest Association for a long time (from 1921 to 1990), making it one of the largest
corporations of this kind. A person who wishes to sell the stock of a closed corporation generally arranges
to sell it privately to another stockholder or a close acquaintance.

4.2.2 An open corporation

Whose stock can be bought and sold by any individual. Examples of open corporations include General

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Electric, Microsoft, and Johnson & Johnson. It is also known as a publicly owned corporation. They have
many stockholders, which can be hundreds of thousands or more, and many of these stockholders in large
corporations own few shares. If the corporation performs well, stockholders get a return on their investment
through getting dividends and by selling their stock for more than what they paid for it. If the corporation
does not perform well, stockholders will not receive any dividends and may opt to sell their stock for less
than what they paid for it. If the corporation goes out of business, stockholders may lose their entire
investment (Burrow et al., 2008).

4.2.3 S-Corporations
An S-corporation is taxed as though it were a partnership (Greene, 2011). Only, the individual shareholders
are taxed on the profits (dividends) they earn. S corporations should adhere to the same formalities and
record-keeping procedures as regular corporations. They are run by a board of directors and officers
(Greene, 2011). Corporate profits or losses “pass-through” the business and are reported on the owners’
personal income tax returns. To be regarded as an S-corporation, a firm must meet the following criteria:
(1) should not have more than 100 stockholders; (2) individuals, estates, or certain trusts must be
stockholders; (3) there can be only one class of outstanding stock; (4) in order to be eligible to file for S-
corporation, the firm must be a domestic one; (5) there can be no partnerships, corporations, or nonresident-
alien stockholders; (6) there should be an agreement by all stockholders to form an S-corporation.
Becoming an S-corporation can be an essential way to avoid double taxation while retaining the
corporation’s legal benefit of limited liability.

4.3 Corporation basics

Refers to ownership of a corporation in the form of shares of stock. A unit of ownership in a corporation is
called a share of stock. As stated earlier, shareholders or stockholders own stock in the corporation. Board
of directors who meet several times a year to make critical decisions about the company are found in every
corporation. The duties of the board of directors include electing the corporation’s senior officers,
determining their salaries, setting the corporation’s rules for conducting business, and deciding how much
the corporation should pay in dividends. The company’s officers, not the board of directors, are responsible
for the day-to-day management of the corporation (Greene, 2011; Skripak, 2016).

4.4 Benefits and drawbacks of incorporation

Just like other forms of business ownership, corporations have their benefits as well as drawbacks.

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4.4.1 Benefits
Limited liability: Since shareholders are not responsible for the obligations of the corporation, and they can
lose no more than the amount that they personally invested in the company, the failure of the corporation
to pay debts will not make the shareholders eligible to pay anything as they would have lost all the money
that they invested in the business (Burrow et al., 2008; Greene, 2011; Skripak, 2016).
Ease of raising capital: Corporations can raise funds by selling stock. Depending on its size and financial
strength, the corporation also has an advantage in getting bank loans (Burrow et al., 2008; Skripak, 2016).
Specialized management: Due to their size and ability to pay high sales commissions and benefits,
corporations are generally able to attract more skilled, knowledgeable, and talented employees (Skripak,
2016).
Continuity and transferability: Because the corporation has a legal life separate from the lives of its owners,
it can exist forever as the withdrawal, death, or incompetence of a key owner does not cause the corporation
to be terminated. Transferring ownership of a corporation is easy as shareholders simply sell their stock to
others (Burrow et al., 2008; Skripak, 2016).

4.4.2 Drawbacks
Conflict of interest between management and shareholders: Managers are often interested in career
advancements than the overall profitability of the company while stockholders are concerned with profits
without regard to the well-being of employees (Skripak, 2016).
Double taxation: Corporations are taxed twice as they pay taxes from their income while shareholders pay
taxes on the dividends they receive from the corporation. This means that the corporation’s profits are taxed
as corporate income and again as individual income (Burrow et al., 2008; Greene, 2011).
Difficulty and Expenses of formation: Forming a corporation can be a relatively complex and costly process
due to application fees, attorney’s fees, registration costs associated with selling stock, and other
organizational costs that can amount to thousands of dollars for even a medium-sized corporation. These
costs of incorporating, in terms of both time and money, discourage many entrepreneurs from forming
corporations (Burrow et al., 2008).
Conflict Within the Corporation: As large corporations may employ thousands, conflict is inevitable. For
example, the pressure to increase sales revenue, reduce expenses and increase profits often leads to
increased stress and tension for both managers and employees. This is mostly applicable to corporations
operating in a competitive industry, attempting to develop and market new products, or downsizing the
workforce to reduce employee salary expenses during an economic crisis.

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Lack of secrecy: Especially for open corporations that are required to submit detailed reports to government
agencies and to stockholders. They cannot keep their operations confidential, and competitors can study
these corporate reports and use the information to compete more effectively.

5. Cooperatives
A cooperative (also known as a co-op) is a business that is owned and controlled by those who use its
services. It is an association of individuals or firms whose motive is to perform some business function for
its members. Individuals and firms who belong to the cooperative join together to market products, purchase
supplies, and provide services for its members. The company shares its financial success each year with its
members, who get a refund each year based on their eligible purchases. They are most prevalent in
agriculture although they are found in all segments of the economy (Skripak, 2016). The members of a
cooperative are much like stockholders in a corporation with the protection of limited liability. They usually
join a cooperative by buying shares of stock and electing a board of directors, which appoints officers to
run the cooperative. Just like a corporation, a cooperative must also obtain a charter in which it is organized
in order to operate (Burrow et al., 2008).
The purpose of cooperatives is to provide members with cost and profit advantages. For example, a group
of blueberry growers makes more profit by forming a cooperative for the purpose of selling their berries.
Once the business is organized and operating, the members (owners) sell their berries through the
cooperative. The cooperative markets the berries. In turn, the growers earn more than if they tried to market
the berries on their own. In addition, as owners, they share in the profits of the business (Burrow et al.,
2008).

6. Other forms of business ownership/Special types of business ownership

In addition to the three commonly adopted forms of business organization, some entrepreneurs select other
forms of organization to meet their particular needs which are explained below.

6.1 Limited-Liability companies (LLC)

This is generally considered a hybrid between a corporation and partnership as it normally passes through
an entity for income tax purposes similar to the partnership and affords its owners the limited liability
protection associated with the corporate form. Its formation is generally more complex and formal than the
general partnership. The owners are referred to as members and they may participate in management
without risking personal liability for the entity’s debts. LLCs combine the advantages of the corporate form

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(the limited liability of the entity's owners, the ease of raising capital, and the fact that owners can be
involved in the management of the entity's operations) while avoiding the double taxation feature of the
basic corporate form. Furthermore, unlike the sub-S structure, there are no limitations on the number and
types of parties that can bemembers of an LLC (Prescott et al., 2010).

6.2 Not-for-Profit Corporations

A not-for-profit corporation (sometimes called a non-profit) is an organization formed to serve some public
purpose rather than for financial gain. As long as the organization’s activity is for charitable, religious,
educational, scientific, social, or literary purposes, it can be exempt from paying income taxes and its
shareholders do not get any dividends. Additionally, individuals and other organizations that contribute to
the not-for-profit corporation can take a tax deduction for those contributions. The types of groups that
normally apply for non-profit status vary widely and include churches, synagogues, mosques, and other
places of worship; museums; universities; and conservation groups (Burrow et al., 2008; Skripak, 2016).
Although many non-profit corporations dependent on volunteers to perform services, larger organisations
have paid employees. Examples include the Bill and Melinda Gates Foundation, United Way, Goodwill
Industries, Habitat for Humanity, the Rotary Club, the Girl Scouts, and the Red Cross.

6.3 Joint Ventures

A joint venture is an agreement between two or more businesses to work together in order to achieve a
specific goal or to operate for a specific period of time. Both the scope of the joint venture and the liabilities
of the people or businesses involved usually are limited to one project. Once the goal is reached, the period
of time elapses, or the project is completed, the joint venture is dissolved. Individuals and corporations can
enter into joint ventures. Each partner in the joint venture is expected to bring management expertise and/or
money to the venture. An example is Walmart which joined forces with India’s Bharti Enterprises to
establish wholesale cash-and-carry stores that sell directly to local retailers in different cities and towns in
India (Burrow et al., 2008).

6.4 Syndicates
A syndicate is a temporary association of individuals or firms organized to perform a specific task that
requires a large amount of capital. The syndicate is formed because no one person or firm is willing to put
up the entire amount required for the undertaking. It is dissolved as soon as its purpose has been
accomplished. For example, three Wall Street firms (i.e., Bank of America, JPMorgan Chase & Co.,
Goldman Sachs) formed a syndicate to sell shares of stock in Symetra a Washington-based insurance

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company. With the help of the syndicate, Symetra was able to raise $365 million in 2010.13.

6.5 Virtual corporations

The virtual corporation is a network of companies that form alliances among themselves as needed to take
advantage of fast-changing market conditions. It is considered a more fluid form of a joint venture. Nike is
a virtual corporation. And it manufactures and markets its products worldwide. A large network of Asian
companies purchases materials and manufactures shoes and other apparel products in countries such as
China, Taiwan, Indonesia, and Korea. Then separate companies on all continents sell the shoes. Thus, all
in all, more than 500 companies worldwide participate in making and selling Nike products. Virtual
corporations tend to be more temporary relationships than joint ventures. Several companies within the
network may team up to take advantage of a market opportunity. These same companies may also work
with a different combination of partners within the network, depending on the expertise needed to take
advantage of a particular market opportunity at that time (Burrow et al., 2008).

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 References

Burrow, J. L., Kleindl, B., & Everard, K. (2008). Business Principles and Management (12th Ed).

Thompson South-Western.

Greene, C. L. 2011. 21th Century Business Entrepreneurship (2nd Ed). South-Western Cengage Learning

Prescott, G. L., Madden, K. E., &Foster, R. M. (2010). Forms of Business Ownership: A Primer for

Commercial Lenders. Commercial Lending Review: 27-32.

Scarborough, N. M., & Cornwall, J. R. (2019). Essentials of Entrepreneurship and Small Business

Management (9th Ed). Pearson.

Skripak, J. S. (2016). Fundamentals of Business. Virginia Tech.

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