13. Business organizations
There are many types of business organizations in the business world. Choosing the form of business organization is a key factor to success of any business organization.
Anyone who wishes to start a business must take into consideration the objectives in setting up a business organization, the amount of capital needed to launch it and the level of control, the business and tax liability of different forms of ownership and expected profits or losses of the business.
There are essentially three basic ways to set up a privately owned enterprise: a sole proprietorship, a partnership, and a corporation. Each form of business organization has its advantages and disadvantages.
A sole proprietorship is an unincorporated business that is owned and operated by one person called a sole proprietor or sole trader. It's the most commonly used form for new small businesses.
Advantages of a Sole Proprietorship
A sole proprietorship is the least costly and easiest form of business organization to launch and operate.
A sole proprietorship is a business in which the owner is fully and personally responsible for all the obligations of the enterprise.
A sole proprietor is entitled to all the company’s profits and takes complete managerial control.
A sole proprietor is free to make any business decision – what kind of business activities to choose, who to hire or fire, when to take a vacation, when to liquidate his or her business and so on.
There is preferential tax treatment. It means that any profit earned from the business is considered a sole proprietor’s income. The owner pays only personal income taxes on the business’s profits, which are reported as personal income on the proprietor’s individual income tax return.
Disadvantages of a Sole Proprietorship
Unlimited liability being the major disadvantage of a sole proprietorship means that a sole proprietor assumes the burden of any losses or liabilities the enterprise faces. A business owner is personally responsible for the company’s debts. It means that personal assets such as money from his bank account and the proceeds from the sale of his house can be taken to pay liabilities of the business.
Limited resources refer to the owner’s personal financial resources and his or her ability to borrow.
A sole proprietorship ends with a sole proprietor’s death.
A partnership is an association of two or more persons, who act as co-owners of an unincorporated business and operate it for profit. The way a partnership is established, run and taxed often makes it the most attractive form of business. To start a partnership it’s necessary to draw up a partnership agreement stating the terms of the partnership, the rules of how to manage it, each partners’ personal rights and liabilities.
Advantages of a Partnership
A partnership is relatively easy and inexpensive to establish.
There are more possibilities in raising funds because the borrowing power of two or more partners is greater.
Each partner can benefit a partnership by his/her knowledge, skills or ideas and specializes in certain activities of the business.
Like a sole proprietorship partnerships are subject to special tax treatment. Any profit of a partnership passes on to its owners, who report their portion of earnings on their personal income tax returns.
Disadvantages of a Partnership:
A partnership has unlimited liability and if it is unable to meet its financial obligations, partners have to use their personal assets to pay off all the business’s debts.
Profit sharing can excite controversy when one or more partners aren’t putting great efforts into the management of the business.
Disagreements between the partners may cause management conflicts. Partners’ different ideas on how to run the company can lead to disagreements that are likely to harm its business activity.
The partnership is terminated because of the withdrawal or death of a partner. If the business is to continue, a new partnership agreement must be drawn up.
Unlike a sole proprietorship or a partnership, a corporation is a business that is authorized by law as a separate legal entity with its own powers, responsibilities, and obligations. The essential feature of a corporation is its legal independence from its owners. Ownership of a corporation is represented by shares of stock also called stock or shares. The corporate owners are known as shareholders or stockholders.
Advantages of a Corporation:
Limited liability is one of the major advantages of a corporation. Shareholders are not liable for the debts of a company they own shares in. If a business fails shareholders can lose no more than he or she has paid for the shares of stock but their personal assets – car, home, and personal bank accounts – are safe from the creditors of the business.
Being a separate legal entity, the corporation actually owns and operates the business for the benefit of the shareholders, but under their total control.
Shares of ownership are transferable. Stockholders can enter or leave a corporation at will simply by buying or selling shares of stock.
Corporation has unlimited life. The corporation’s power of succession enables it to have a continuous existence. Unlike a sole proprietorship, the death of the corporate stockholders will not terminate the corporation, since their shares are passed on to their heirs.
It is much easier for a corporation to increase capital to manage and expand its operations. To raise additional funds corporation attracts new stockholders by selling its new issues of shares to the public.
Disadvantages of a Corporation
A corporation is difficult and expensive to create and organize. This process requires higher start-up capital and the services of a lawyer to obtain a government charter.
Corporation is subject to double taxation. As a legal entity it pays a corporate income tax. Then, if the corporation distributes some of its net income to the stockholders as dividends, they are taxed again on the stockholders’ individual income tax returns.
The shareholders do not directly manage the corporation's daily operations. Instead, the shareholders meet at a corporation’s annual meeting to elect a board of directors whose job is to make general business decisions. Their decisions are then implemented by the corporation's officers, who are appointed by the directors.