When starting a business an important question that must be answered is, “What legal form will the business take?” Depending on the business, and what the owners are looking to accomplish that question can be answered in many ways.
The business owner will want to determine what best aligns with their goals for the business when it comes to start-up costs, control of the business, overall tax burden, continuity and termination of the business, the ability to raise funds, flexibility of operations, and the liability of the owners.
To assist in deciding which business form is right for you and we will discuss sole proprietorship, partnership, C corporation, S corporation, and limited liability corporations . To begin with, we will explore a sole proprietorship and then move on to the other forms in the next posts. For speed and simplicity, there is an easy to read chart that directly compares each form at the end of this series.
A sole proprietorship is an unincorporated business that is owned by one person. Sole proprietorships are the easiest business form to set up and are the most abundant business form. Most sole proprietorships are single-person operations, but they can have employees other than the owner working for them.
Sole proprietorships that have more than eight employees account for less than 8% of total sole proprietorships. What sets the sole proprietorship apart from other business forms is the unlimited and unshared liability of the owner.
Ease and Simplicity– Starting a sole proprietorship is comparatively easy. Legally all that is required is apply for state or local permits. If the business wishes to function under a name other than the sole proprietor’s then a special certificate is required.
Solitary Gain– The profits, and benefits that are made by the business operations belong to the owner. There are no stockholders, dividends or partners that have a claim to the profits or benefits in this business.
Single Tax– the owner and the business are taxed as one, this is called pass through taxation. Profits made by the business are personal income to the owner, even when the profits are not withdrawn from the business.
Income Shelter– The owner of a sole proprietorship is able to reduce taxable income by writing off the costs of doing business as expenses. This is useful for things like gas used to get to the work location, or depreciation.
Independence– The sole proprietorship exemplifies one of the biggest reasons people start a business. As a sole proprietor, you are the boss and have the freedom to make any business decision independently of any partner, corporate bylaws, or other entity.
Unrestricted and Unshared Liability– There exists no difference between the sole proprietors assets and liabilities and those of the business. If the business fails, or the business is sued, creditors and lawyers are able to go after the business’s assets as well as the sole proprietors.
There is no legal protection for the owner against claims of creditors to the business. Generally, the only exception to this is life insurance. Cash values of the policies and the death benefits are typically untouchable by the business’s creditors.
Finite Resources– The capital for the sole proprietorships is typically limited by the personal financial resources available to the owner and their ability to borrow money. A company would not be a sole proprietorship if it raised money from outside investors, making this business form a poor choice for a business venture that requires large capital contributions.
The talent, time, and resourcefulness of the owner also limit this business form. The business will suffer when the sole proprietor is sick or disabled, or when a project arises that requires skills the sole proprietor does not have.
Longevity– After the sole proprietor has passed, or decides pass the business along to another, the business usually declines. Sole proprietorships are rarely able to replace the experience and expertise of the owner, which causes the overall business to suffer.
The next business form we will explore is the Partnership.
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