Types of Business Ownership

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The first step of business ownership is registering the business. It involves understanding the business’s and its owners’ legal and financial rights and responsibilities. It is crucial to understand the different types of business ownership and determine the one that will best serve your interest.

When looking at the different types of business ownership, it’s vital to think long-term. You should consider where you want your business to head and other factors, such as access to credit facilities. That’s why you should look into each type of legal entity, their merits and demerits and choose the one that would best serve your interests.

Different Types of Business Ownership

The possession shape of your business is one of the essential decisions you will make for your business. The type of legal structure you choose will significantly affect your legal and monetary responsibility and how you manage and operate your business. You should take a deep dive into the legal structures of different types of business ownership and choose the one that could best serve your business.

Sole proprietorship

This is the simplest legal structure for any business with the least amount of paperwork. Most people tend to lean towards this option because of the fewer bureaucracies and easy registration process.

To establish a sole proprietorship, you need good and actionable ideas, plenty of determination, and endless passion and hard work for what lies ahead.

The only paperwork you will need is what is required for filing a fictitious name if you choose not to use your own. You will also need the pre-requisite licenses to begin your operations. These vary depending on the nature of your business.

Under sole proprietorship, you’re not required to perform any formal action. Hiring a professional to file the required government documents to get started is unnecessary. You can do everything yourself.

With nearly three-quarters of all businesses operating as sole proprietorships, this business structure is the most popular of all. It serves as a great starting point for many businesses that eventually become partnerships and corporations.

As a sole proprietorship, one person owns and operates the business. You don’t have any partners to confer with or boards to answer to. The law recognises you and the business as one and the same.

Benefits of sole proprietorship

  • Easy to form – A sole proprietorship is the easiest business structure to set up. It requires minimal amounts of paperwork and red tape, which is why it is one of the preferred options.
  • Least expensive to set up – This legal entity targets new businesses started with minimal financial input. The cost of registering a sole proprietorship is minimal but depends on your locality. Typically, you need to pay a nominal business license fee and maybe business tax.
  • Easy dissolution – As easy as it is to get up, a sole proprietorship is just as easy to take down. You can dissolve the business anytime without the lengthy processes that other businesses endure. Also, there is no legal waiting period or formal paperwork involved.
  • Sole recipient of profits – As the business’s sole owner, you receive all the profits from the business. The profits and losses can be reported directly on your individual income tax return. If you suffer business losses, you can deduct them against any other income you may have to reduce your overall tax burden.
  • Maximum authority – With a sole proprietorship, no organisational manoeuvring is involved. You are alone, and you make all the business decisions.
  • Taxfree asset withdrawal – You can shift funds in and out of your business accounts or withdraw assets from the business with few legal or tax consequences.

Disadvantages  

  • Unlimited personal liability – The greatest demerit of a sole proprietorship is that you absorb all the debt incurred by the business. The law recognises you and the business as one, and therefore, your personal assets can be confiscated to satisfy your business obligations.
  • Limited ability to raise capital – You may find it difficult to get business loans until the business grows and has gained a good credit rating. Going solo prolongs the time it takes to raise capital for your business.
  • Limited tax savings for fringe benefits – You are not qualified to receive the same tax benefits corporations get for offering certain fringe benefits, such as group-term life insurance benefits.

Partnership

Partnerships refer to a business structure involving several parties that share ownership and management responsibilities. There are two distinct types of partnerships;

  1. General partnerships

In many ways, the general partnership structure is similar to a sole proprietorship. There is unlimited liability for the partners and a limited business life. The only difference is that you can share the work and financial pressures of running the entity. You can also share decision-making responsibilities and everything else that goes along with the business with your trusted colleague or colleagues. If you’ve selected your partners well, you should find that the partnership works smoothly.

Under a general partnership, the partners share the management of the financing and liability of the company. The partnership doesn’t have to be divided equally. It all depends on your agreement and the level of investment.

It’s perfectly legal for one partner to have majority ownership of the entity. Here are some advantages of general partnerships;

Advantages of general partnership

  • Easy to establish – Like sole proprietorship, a general partnership has no formal paperwork or waiting period. You must fill in the necessary paperwork if you operate under a pseudonym. It’s recommended that you draw up an agreement called the partnership agreement at an additional cost. Depending on your area of expertise, you will also need to secure a business license.
  • Synergistic – Partnerships draw from the strength of more than one person, increasing the chances of the business surviving drastically when you recruit the right partners. In the perfect scenario, good partners complement each other’s skills.
  • Stronger growth potential – With a partnership, you have better chances of acquiring a loan. Bankers look at partnerships more favourably than sole proprietorships. Besides having more than a single credit rating, there is a recourse if something happens to one owner. The others can step in and take over the mantle. You are also able to take advantage of the additional talent and expertise needed to grow your business.
  • Direct rewards – Partners reap the benefits of their efforts by directly sharing the profits
  • Freedom from government control and special taxation – Partnerships generally don’t pay income tax. Instead, the partners report their share of income or loss on their own individual tax returns.

Disadvantages of general partnership

  • Unlimited personal liability for the business’s debts – All partners have personal liability for the debts, taxes and other claims against the partnership.
  • Business terminates upon the death of a partner – The business might terminate if the partner dies or terminates their partnership unless the partnership agreement indicates otherwise.
  • Any partner can commit the business to obligations. Any partner is considered an agent for the partnership and can make decisions that might commit the partnership to various unrealistic expectations.

Limited partnership

The other alternative for a partnership is the limited partner, where certain partners have limited personal liability. A limited partnership is more regulated than a general partnership. It allows investors who will not be actively involved in the business’s operations and will not be exposed to unlimited liabilities of the business’s debts should it go out of business.

A limited partner only risks his or her investment. In exchange, they must allow one or more general partners to exercise control over the business. In many cases, if a limited partner becomes involved in the partnership’s operations, they may lose their protected status as a limited partner, making them liable for the partnership’s debts.

Partnership agreement

A partnership agreement is a vital document in every partnership. However, it is not legally required. It is also known as the Articles of Partnership and outlines the contribution of each of the partners to the business.

The agreement also determines the roles of the partners in the business relationship, be they financial, material, or managerial. Some of the nugget features in a standard partnership agreement include;

Capitalisation

This aspect of the agreement turns a moral obligation into a legal one. A business cannot promote its ideas without adequate funding. Because businesses cannot predict their future financial needs, this is a one-shot provision that caters to the initial capitalisation of the business.

Authority/dispute resolution

This addresses how disputes among partners should be resolved. Arbitration is a much simpler and less expensive method of settling disputes among parties without involving outside litigation. The participants in the case should decide whether certain or all disputes concerning the business must be arbitrated.

Management

The partnership agreement should also highlight the business’s management method. It may limit or enhance the normal powers of managing partners. It may also provide non-competition between owners and the business and provide methods of computing salaries and bonuses. Also included here is a provision for continuing the business should one of the owners become disabled or unable to help manage the business.

Sale of partnership interest

This is one of the most important clauses in a partnership agreement. It restricts the participant’s right to sell their interests to third parties. The partners chose each other because of their personal qualities. Therefore, permitting one to sell his or her share to a third party would defeat the partnership. The agreement should also provide for a method by which a dissatisfied partner can dispose of their interest in the business without forcing the other partner to take in a stranger.

The most commonly suggested solution is for the business or other partner to buy the interest before it is offered to outside. The provision must also cover determining the price and payment terms for the dissatisfied owner’s interest.

Death of a partner

What happens when one of the partners dies or becomes permanently disabled? This provides for a mandatory buy-out of the dead partner’s interest in the business. If these contingencies are not available, it could lead to tremendous difficulties for the business. In the absence of such an agreement, the death of a partner automatically dissolves the partnership.

Corporation

This type of business structure is considered the most formalised and complex form of business organisation. It is costlier, more difficult, requires more paperwork, and often requires professional assistance.

A corporation is a separate legal entity organised in accordance with the law. Ownership is divided into shares of stock. The business activities are dictated by a charter stating the powers and limitations of the business. Corporations that do business in more than one state must comply with the necessary laws.

Corporations come in various configurations to suit various requirements and laws. However, registering your business ownership as a corporation usually has similar main advantages.

Advantage of corporations

  • Liability is limited to the amount owners have paid for their share of stock. Generally, stockholders in a corporation are not personally liable for claims against the corporation and are only liable for their personal investment.
  • The business’s life is unaffected by one of its owners’ death or transfer of shares. The business continues to operate indefinitely as a corporation. This continuity makes corporations more appealing to customers and suppliers.
  • It is easier to raise capital in larger amounts and from many investors.
  • Owners can delegate authority to hired managers, therefore securing centralised control.
  • You can draw upon all the owners’ financial and managerial expertise with a corporation.

Disadvantages

  • Corporations are more expensive to form. There are many forms to file corporations, including articles of incorporation, and the legal fees to file the necessary documentation can be substantial.
  • Once established, the charter indicates all decisions and other activities of the business.
  • Because of the various forms involved with a corporation and continuous filing schedules with government offices, ongoing record-keeping is necessary.
  • Minority stakeholders can sometimes be exploited
  • Taxes are imposed on the business, and dividends are paid to the owners.

Types of Corporations

Here are some primary types of corporations in the UK;

C-corporations

This is a regular corporation, but its entity is kept separate from its owners. This means it offers the most protection in terms of personal liability.

C-corporations are taxed in two categories: as a separate element independent from the owners when they generate income and at the shareholder stage when it’s allocated as dividends. C-corporations can elect their board of directors and carry out annual meetings with stakeholders.

S-corporations

S corporations handle their taxes only at the stockholders’ stage. It simply means that they notify stockholders of their monetary records containing information like earnings, losses, loans and charges for tax processing before disbursing remuneration to them free of tax.

In terms of government regulation, S-corporations are comparable to C-corporations. The policies relevant to them depend on location.

Choosing the Best Type of Business Ownership Structure

The type of business ownership you settle for will have far-reaching repercussions for the business. It could even determine the success of the business. Some of the factors to consider when choosing the best type of business ownership structure include;

Ownership structure

One of the factors to consider when considering the type of business ownership to go for is how many owners the business will have and how each of the owners will be in the day-to-day management of the company.

If you’re the only owner, you can operate a sole proprietorship, a single-member LLC or a corporation. If you have multiple business partners, you can explore a partnership, an LLC or a corporation. If you have more owners, the decision-making process becomes more difficult, which makes an LLC or a corporation the better choice over a partnership.’

For many partners, an LLC offers the most flexibility regarding ownership and management structure. All owners of an LLC can be involved in day-to-day operations, or you can designate one or more owners to run the business while the others are passive investors.

Investment and financing needs

Determining the type of ownership structure speaks to more than just ensuring the partners feel represented. It also affects access to investment and financing options. If you plan on taking a bank loan to start your business, you will find that banks are more likely to loan to an LLC or a corporation than a partnership or a sole proprietorship.

A corporation is likely your best bet if you’re hoping to work with investors. Unlike other types of business ownership, a corporate structure allows a business to sell ownership and shares in the company through its stock offerings. This makes it easier to attract investment capital and hire and retain key employees by issuing stock options.

If your business doesn’t need to issue stock options and will never go public, forming a corporation isn’t worth the added expense. An LLC can provide the same protection as a corporation if you want limited liability. Additionally, the flexibility and simplicity of an LLC offer a clear advantage over corporations.

Formalities and Expenses

Sole proprietorships and partnerships are easy to set up. You don’t have to file any special forms or pay any fees to start your business, and neither do you have to set up or follow any special operating rules.

LLCs and corporations, on the other hand, are almost always more expensive to create and more difficult to maintain. With an LLC, you have to file paperwork, which comes at a fee. You are also required to elect officers to run the company and keep records of important business decisions that must be followed, among other vital formalities.

Taking the simplest and most affordable form of ownership, like a partnership or proprietorship, makes sense if you’re starting the business on a tight budget. Unless the business is particularly risky, the limited personal liability provided by an LLC or corporation may not be worth the cost and paperwork required to create and run one.

Risk and Liabilities

The best ownership structure for your business depends on the type of services or products you intend to provide. If such services are risky, like roof repairs and trading stocks, you should opt for a type of ownership that provides personal liability protection (limited liability). It protects your personal assets from business debts and claims.

When choosing a type of ownership, you should carefully assess your risks and liabilities to ensure you pick an option that provides ample personal liability protection. Where risks and liabilities are unavoidable, a corporation or LLC is your best choice.

Income taxes

Another crucial factor to consider when determining the right type of business ownership is the income tax, which can be vastly different for each type of ownership.

Sole proprietorships, LLCs and partnerships pay all taxes on business profits similarly. These are called “pass-through” tax entities, which means that all the profits and losses pass through the business to the owners, who report their share of the profits or deduct their share of the losses on their personal income returns.

Therefore, sole proprietors LLC and partners can count on about the same amount of tax complexities, costs and paperwork. Owners of these non-corporation-type businesses must pay income tax on all net profits regardless of how much they actually take out of the business each year.

Even if all the profits are kept in the business checking account to meet upcoming business expenses, the owners must report their share of these profits as income on their tax returns.

Owners of a corporation do not report their shares of corporate profits on their personal tax returns. The owners pay taxes only on the profits they receive through salaries, dividends and bonuses.

The corporation pays taxes on any profits left in the company from year to year. This separate level of taxation adds a layer of complexity to filing and paying taxes. But it can be a benefit to some businesses. Owners of a corporation don’t have to pay personal income taxes on profits they don’t receive.

What if you change your mind?

Let’s face it: your business needs might change over time, and your choice of business structure is not set in stone. You can start as a sole proprietorship, but as your business needs evolve, your business grows, or the risk of personal liability increases, you may need to change the ownership structure. Luckily, this is possible. Although complex, it is possible to change your business’s ownership type from one to the next, but the options work differently for different companies.

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