Download SOLE PROPRIETORSHIP The sole proprietorship is

SOLE PROPRIETORSHIP
The sole proprietorship is the most common business form; “there are over 17 million sole
proprietorships in this country, representing over 73 percent of all businesses” (Stevick, p. 1.7).
Sole proprietorships are basically what they sound like – there is a sole proprietor, a sole owner
with all control, all profits, all resources, and liability.
Advantages
 Control
o Unlimited control, or “autonomy,” is, perhaps, the most attractive reason for an
individual to start their own business, and is a major advantage of the sole
proprietorship; the sole proprietor has complete control over their business. There
is no boss to answer to, no partner to run ideas by, and no board or shareholders to
seek approval from. The sole proprietor can decide on changes at any time to
their company in almost any way, so long as they are capable of producing the
changes.
 Profit Sharing
o Similar to unlimited control, and just as attractive, is the advantage that the sole
proprietorship has where the sole proprietor is the only benefactor of profits and
gains. Just as there is no partner to share control with, there is no partner to split
profits with.
 Convenience
o Convenience and simplicity is another major advantage of the sole proprietorship,
putting it within reach of most individuals. According to Stevick, “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” (p. 1.9). Furthermore, terminating the
business is just as easy – easier, in fact. The proprietor simply concludes all
business agreements and outstanding commitments, and ceases to do business.
 Taxation
o Pass-through taxation is a great advantage of the sole proprietorship. With this
form of taxation, the proprietorship, the company, is not subject to income tax,
but rather this is passed-through to the owner, who then pays any of the taxes with
their personal income taxes. This is a great advantage, because it means that the
profits are taxed once through the owner, rather than being taxed twice – once
through the company and again through the owner. Furthermore, the proprietor
may charge costs of doing business and depreciation as “expenses” to the
company, and because this is a pass-through taxation entity, the proprietor may
therefore reduce the taxable income.
Disadvantages
 Liability
o The owner is solely responsible for the liability of his/her company, thus
“unlimited liability.” This is considered to be a disadvantage, as this puts a huge
burden on the one individual. This is a two-edged sword for the owner, because
they have unlimited control as listed above, but they also have the unlimited
liability. Firstly, the burden of liability belongs solely to the proprietor; there is
no sharing of liability between multiple parties. Secondly, and possibly more
crucial, is the fact that unlimited liability has no distinction between business

assets/liabilities and personal assets/liabilities. In other words, any debts owed by
the company must be paid not only by the company’s assets and profits, but also
by the owner’s private assets and profits, if the company’s assets cannot cover the
debts. So, a company in debt could completely wipe out personal assets such as
private vehicles, personal profits, and even the proprietor’s home.
Longevity
o The life-span, or longevity, of a sole proprietorship is widely-viewed as the most
significant disadvantage to this form of business. The life-span of the sole
proprietorship lasts only as long as the sole proprietor is alive, or
mentally/physically able to run the business. Upon death, the company is
dissolved unless extensive measures are taken in the owner’s Last Will and
Testament, specifying that the business should continue. However, even with this
provision, most individuals do not have adequate planning and resources to
continue the business after his/her death. The largest reason this is a disadvantage
is because it leaves the owner’s family with no source of income, and the assets
are generally distributed “under the supervision of the appropriate courts”
(Stevick, p. 1.11). Because most individuals start sole proprietorships in order to
have autonomy, independence, and self-reliance, leaving the family with no
income or company assets is a considerable disadvantage.
o In addition to the legal guidelines that determine the longevity of a sole
proprietorship, another aspect of longevity is the fact that the resources, funds,
and other capital come from the sole owner – there is no pooling of resources
between multiple individuals. Because of this, sole proprietors may find that their
business fails before it has a chance to succeed because they run out of funds and
cannot get lines of credit on their own merit.
GENERAL PARTNERSHIP
General partnerships are formed when 2 or more individuals join efforts, resources, and capital to
form a business. General partnerships are fairly similar to sole proprietorships in terms of
liability and taxation, but differ from sole proprietorships in that control and profits are shared
between the partners. A main reason individuals join together in a partnership is the pooling of
resources and capital that results.
Advantages
 Profit Sharing
o Profit sharing is often tied to that of control. Where control is divided amongst
individuals, profits generally are, also. As with the control in general
partnerships, the partners also share the profits, either equally, or at a mutually
agreeable proportion. While this could be a disadvantage in and of itself, it is offset by the advantage that partnerships offer more resources and capital in order to
increase profitability.
 Convenience
o General partnerships are fairly simple to create – a distinct advantage; in addition
to the business license required, all that is needed is a contract. While oral
contracts are acceptable and have been upheld in court, best practice calls for
written contracts. The creation of a partnership may become a little more
complicated than a sole proprietorship if the articles of partnership within the
contract are fully covered, as this takes some discussion and negotiation. These
items, discussed by Stevick, are such things as:
 “Names of the partners
 Name of the partnership
 Nature of the business to be conducted
 Capital and property of the firm
 Capital contribution of each partner
 Share of each partner in the profits and losses
 Provisions for settling differences
 Drawing account arrangements (technically, partners do not receive a
salary)” (p. 1.14)
 Taxation
o Like sole proprietorships, pass-through taxation is a great advantage of
partnerships. With this form of taxation, the company is not subject to income
tax, but rather this is passed-through to the partners, who then pay any of the taxes
with their personal income taxes.
Disadvantages
 Control
o In a general partnership, control is divided equally between the partners.
Furthermore, mutual consent is needed by all members in order to allow another
individual to become a member of the partnership. Control, however, could be
seen as a disadvantage for general partnerships, because each partner is an acting
agent for the company, and may conduct business and enter agreements for the
company – even if the others in the partnership are not aware at the time of the
transaction.
 Liability
o Liability with general partnerships is almost identical to that in sole
proprietorships. Every partner is personally and individually liable for debts
incurred by the company – again, “unlimited liability.” While the burden of
liability lies solely on the owner in a proprietorship, it is shared to some extent in
a general partnership, but this can be more of a risk than the sole burden of a
proprietorship, because each partner is liable for every other partner. Because
unlimited liability extends not just to business liabilities, but personal liabilities as
well, “the personal insolvency of any partner can jeopardize the entire partnership
business…[as] the personal creditors can force a liquidation of the partnership
interest in order to satisfy their claims” (Stevick, pp. 1.17-18).
 Longevity
o For general partnerships, a buy-sell agreement (also known as an ownership
transfer plan) must be executed if the partners desire the partnership to continue
after the death of a partner. If there is no buy-sell agreement, the partnership
legally must be terminated. If, however, there is an agreement in place, this
allows the heirs of the deceased partner to sell their interest to the remaining
partner(s) to continue the business.
LIMITED PARTNERSHIP
With almost the same characteristics of general partnerships, limited partnerships include at least
one general partner and at least one limited partner. The general partner retains almost the same
characteristics as they would have under a general partnership, but the limited partner is where
the main differences are. The limited partner is essentially an investor, providing capital for the
company and sharing the profits, without the liability or control of a general partner.
Advantages
 Control
o The control in a limited partnership is kept strictly to the general partners.
Limited partners do not have control in the company, do not make decisions, and
have no voice in day-to-day management of the company. Remember that limited
partners are essentially investors, so they do not act in the regular business
activities.
 Profit Sharing
o As with a general partnership, the profits in a limited partnership are shared
among the partners. As more resources are pooled, this means that there is greater
potential for higher profits to divide.
 Convenience
o Limited partnerships are simple to create, just like general partnerships. A
contract with articles of partnership outlining the same items as listed under
“general partnerships,” along with the business license, are what is needed to
create the limited partnership.
 Taxation
o Like sole proprietorships, pass-through taxation is a great advantage of
partnerships. With this form of taxation, the company is not subject to income
tax, but rather this is passed-through to the partners, who then pay any of the taxes
with their personal income taxes.
Disadvantages
 Liability
o Liability with limited partnerships is a mixture of unlimited liability and limited
liability. As limited partnerships have at least one member who is a general
partner, liability for that individual is unlimited, in the same way as sole
proprietorships and general partnerships. As for the limited partners, this is an
advantage to them, because they have limited liability. They “shall not be bound
by the [financial] obligations of the partnership beyond the extent of their
investment” (Stevick, p. 1.20). This allows general members to get the
investment and capital they may need, because it is lower-risk to the limited
member than if they joined as a general member.
 Longevity
o Unlike a general partnership, the death of a limited partner does not terminate the
business. This holds true only for the limited partner(s), however, as death of a
general partner follows the same stipulations as those for a general partnerships.
While death of the limited partner does not terminate the company, the personal
representative of the limited partner will receive the portion of assets and profits
owed to the limited partner, so they can distribute these and settle the affairs. So,
limited partnerships are a mixed-bag of advantages and disadvantages with regard
to longevity, because on the one hand the business stays intact at the death of the
limited partner, but on the other hand it is still susceptible to the disadvantages of
the general partnership.
C-CORPORATION
Corporations differ from proprietorships and partnerships largely in that they are themselves
their own entity, independent and separate from the owners. Corporations have longevity in
mind, and they do not cease to exist at the death of an owner, but have boards of directors and
shareholders that continue the existence of the entity. Additionally, a corporation is created by
law with a charter granted and approved by the proper official, and “as an entity, it is viewed as
an artificial person and is subject to many of the privileges and restrictions of a natural person”
(Stevick, p. 1.24). C corporations, specifically, potentially differ very little from proprietorships,
except with key characteristics such as limited liability and increased tax benefits. Furthermore,
the owners/shareholders in C corporations are also employees who receive salaries.
Advantages
 Taxation
o Unlike S corporations, C corporations are taxable as an entity, so the net income
of the business is taxed before it is passed to the individual owners for further
taxation. The net income is after all deductions, such as salaries and fringe
benefits. Any profit distributed from net income is considered dividends, which
are further taxable and are not deductible, and because of this, C corporations
attempt to reduce or avoid dividends. It should be noted, however, that the IRS
has strict rules in place that must be followed in regards to dividends.
 Liability
o Similar to the limited liability of a limited partner, stockholders are held liable
only in as far as they have investment, but their personal assets cannot be held for
company liabilities. The corporation itself is held liable for its employees and
debts.
 Longevity
o Corporations are terminated either as a result of a “vote of stockholders,
bankruptcy, [or] violation of certification incorporation (by court)” (p. 1.47).
With good management, policies, and ethics, these can generally be avoided.
And, unlike the previous forms of organization discussed, the death of a
stockholder does not affect the continuation of the business. This is a huge
advantage, and is a main determinant in why companies choose to incorporate.
Disadvantages
 Control
o Control is greatly diffused and distributed in many corporations. Unlike the
previous forms of organization where control and management is directly in the
owners’ hands, corporations have officers that manage the company, make
decisions, and handle the majority of the control. These officers are selected by
the board of directors. The board of directors, in turn, is composed of individuals
elected by the shareholders. It should be noted that it is possible for the
shareholder to also be the acting officer, and in this case the control would be
identical to that of sole proprietorships.
 Profit Sharing

o Corporations have a board of directors responsible for the profit sharing. After all
salaries have been paid and deductions have taken place, the board decides how
the remaining profit, the dividends, will be paid or kept.
Convenience
o C corporations are very likely the most burdensome of all forms of business to
create. Not only must the company obtain a standard business license in order to
operate, but in order to be an incorporated entity, a certificate of incorporation
must be filed with the state. At that point, filing doesn’t guarantee incorporation –
the proper official (generally Secretary of State) must approve the charter.
Furthermore, any violations of the certificate of incorporation will terminate the
company’s incorporation status.
S-CORPORATION
With the same characteristics as general corporations, S corporations are further distinguished
with features that are similar to partnerships. For instance, both forms for business are passthrough taxation, so the tax is paid on earnings by the owners rather than by the company itself.
As taxation is a major attribute of S corporations, “the popularity of S corporations fluctuates
with changes in income tax law and the tax status of individuals and their businesses…decisions
to incorporate as a C or S corporation will often vary based on the relative income tax brackets of
the individual owner(s) and the corporation” (Stevick, pp. 1.35-36).
Advantages
 Taxation
o S corporations are similar to sole proprietorships and partnerships, in that S
corporations are a pass-through entity. With this form of taxation, the company is
not subject to income tax, but rather this is passed-through to the individuals, who
then pay any of the taxes with their personal income taxes. This is a nice
advantage as the profits are not taxed twice.
 Liability
o The liability for S corporations is the same as C corporations – namely, the
corporation is held liable, but the stockholders are only liable as far as they have
investments.
 Longevity
o Corporations are terminated either as a result of a “vote of stockholders,
bankruptcy, [or] violation of certification incorporation (by court)” (p. 1.47).
With good management, policies, and ethics, these can generally be avoided.
And, unlike the previous forms of organization discussed, the death of a
stockholder does not affect the continuation of the business. This is a huge
advantage, and is a main determinant in why companies choose to incorporate.
Disadvantages
 Control
o Control is handled the same way C corporations handle it. Through officers,
appointed by the directors, who were elected by the shareholders.
 Profit Sharing
o Corporations have a board of directors responsible for the profit sharing. After all
salaries have been paid and deductions have taken place, the board decides how
the remaining profit, the dividends, will be paid or kept.

Convenience
o S corporations, like C corporations, are required to file a certificate of
incorporation with the state, and must have the same approval by the appropriate
official. They do not, however, need to file a business license like C corporations
must.
LIMITED LIABILITY COMPANY
Limited Liability Companies (LLC) are somewhat of a conglomeration of all business types, and
are rapidly growing as they seem to combine many advantages of different business forms
without all of the disadvantages. LLCs combine aspects of the simplicity, control, and tax
benefits of partnerships/proprietorships with the limited liability and potential longevity of
corporations.
Advantages
 Control
o Control has similar advantages as that of sole proprietorships and partnerships.
There are no stockholders and board of directors with which to share management
and control, and therefore the members have a more hands-on, direct approach
with the company. Frequently, the members actively manage the company on a
day-to-day basis.
 Profit Sharing
o Profit sharing is similar to that in partnerships. While corporations must share the
profits with the stockholders, profits in LLCs are divided among the members,
proportionate to the amount of their interest.
 Convenience
o According to Stevick, LLCs are established by filing articles of organization with
the state (p. 1.46).
 Taxation
o Taxation for LLCs is determined by specific characteristics to see if it falls in line
more with a sole proprietorship, a partnership, or a C corporation. For example,
“a business with only one owner can elect to be taxed as a sole proprietorship or
as a corporation. Businesses with two or more owners can elect a partnership or
corporate tax status” (Stevick, p. 1.41).
 Liability
o Similar to corporations, LLCs have limited liability (hence, the name). Whereas
partnership members are liable for the negligence of other members, LLC
members are liable only for their own actions and their own contribution to the
LLC. Furthermore, unlike limited partners in a limited partnership, members of
an LLC are permitted to actively manage and control the company.
Disadvantages
 Longevity
o Similar to proprietorships and partnerships, death can dissolve the company, in
most states. However, most states also permit the surviving LLC members to
vote on the LLC’s continuance – either a unanimous decision must be reached, or
a certain percent of members must be in agreement (depending on the operating
agreement or state law).
Memorandum
To:
Manufacturing Business Owner
From: Katie Gardner
Date: 2/11/2012
Re:
Recommended business organization
From what you have told me, your main concerns with your business organization are:
1. Liability – you want to protect your personal assets from the liability of anything that
happens to the company.
2. Profitability – you wish to increase your capital and grow your company.
3. Profit-sharing – you want to maximize the profit that you personally can keep.
4. Income Tax – you want to maximize your income tax benefits.
5. Longevity – you want the business to continue in the event of your death, and want your
family to continue to have a source of income.
Sole Proprietorship
You are already operating as a sole proprietorship, which does not offer you the protection and
longevity you are looking for. It does offer the tax benefits and maximized profit as you are the
sole beneficiary of the income, however, so we want to maintain those items as best we can.
General Partnership
A general partnership would increase your capital, but still leaves you vulnerable to the
unlimited liability you are currently subject to. In a business working with power tools, forklifts
and other vehicles, and handling installations in homes, I believe that getting your company in a
position where you are not personally held liable is of upmost importance.
Limited Partnership
If you were simply looking for more capital, I would recommend this form of business, because
you would retain much of the profits and control of the company. However, this form still leaves
you open to the unlimited liability that we are hoping to steer away from.
C-Corporation
A C-corporation is definitely something to consider as you could greatly increase your capital,
increase your borrowing power, increase your profitability, and maintain the longevity of your
company. It does not provide the pass-through taxation you currently have, however, and could
potentially water-down your share of the profit as you would need to share the profits with
shareholders, and answer to the board of directors. You have thought of having family members
as acting officers, and that theoretically could work, but you do need to keep in mind that as you
expand shareholders to increase capital, the likelihood of becoming a minority shareholder
and/or losing shares if your family chooses to sell could end up shifting your family out of the
business.
S-Corporation
If you do choose to incorporate, I would strongly urge you to consider an S-corporation over a Ccorporation. An S-corporation would still give you the benefits of being incorporated, namely
longevity, increased capital and potential profits, etc. However, an S-corporation would give
you the pass-through taxation that you are already enjoying, so your income and profits would be
taxed once, rather than twice.
Limited Liability Company
Based on all of your concerns, I would recommend that you turn your business into a Limited
Liability Company, because it combines the best of the forms for a small business such as yours.
In terms of liability, LLCs protect you as well as a corporation, because the business is liable,
and your personal interests and assets are maintained separately and kept protected. You still
have the option to increase capital and profitability, depending on the members you have and the
kinds of loans you will be eligible for as an LLC. Your profit-sharing will still be fairly strong –
you may have to divide it between one or more members, but unlike the corporations, you would
have no stockholders that take a piece of the pie, so to speak, leaving you with less. You also
have the flexibility with income tax to act as a partnership or proprietorship, or as a corporation –
this is a great advantage of LLCs. Lastly, although you do not have a guaranteed longevity with
an LLC like you do if you are incorporated, if you have family members involved that you would
like to protect in the event of your death, it can be arranged to give them the responsibility to
decide whether or not the business should continue. Therefore, if it is necessary for their welfare
that the business continues in your absence, they will be able to do so. To conclude this
recommendation, “LLCs are attractive to family businesses that want to keep control in the
family. How is this accomplished? Generally, ownership interests cannot be transferred without
the consent of other members” (Stevick, p. 1.40).
References
Stevick, G.E. (2003). Essentials of Business Insurance: Financial advisor series: Product
essentials. Bryn Maw, PA: The American College. Retrieved February 11, 2012 from
http://www.theamericancollege.edu/pdf/fa251-class1.pdf.