As a business owner, the business structure you choose influences everything about your business, from day-to-day operations to taxes, and how much of your personal assets are at risk. This is why it’s necessary for you to choose a business structure that gives you the right balance of legal protections and benefits and is sustainable for the business in the long run.
There are many ways a business can be structured legally; the three most common forms are sole proprietorship, partnership, limited liability, and corporation.
Although, small medium enterprises are mostly independently owned and funded by capital raised by family, friends and from personal savings, or oftentimes, partnership is also the second most preferred business ownership where partners can share equity.
Deciding the type of ownership is one of the most important business decisions. The ownership decisions have a long lasting impact on the future of the business and even the expansion plan. It is crucial that this decision is taken into consideration and well-analyzed. Before proceeding with ownership decisions, factors such as nature of the business, the vision and mission statement, the day-day operations should be taken into consideration.
Types of Business Ownership for Small Medium Enterprises (SMEs)
Sole Proprietorship
Most businesses start out independently. Sole proprietorship is the simplest business form under which one can operate a business. The sole proprietorship is not a legal entity. It simply refers to a person who owns the business and is personally responsible for its debts. it is however, the simplest form of business with nominal cost.
A business owner who wants to run a sole proprietorship business structure, only needs to identify and register the business under his/her real name, sign contracts and personally liable for business debts and lawsuits. This business structure is most straightforward, and is easy to implement. Though, the business decisions solely lie on one business owner, is the same way the existence of the business dies when the owner doesn’t wish to continue or dies.
Advantages of Sole proprietorship
- Sole proprietorship is an easy business structure to set up. It requires less paperwork and legal work. It does not require a lot of requirements and needs just a business license.
- A business owner who owns a business under the sole proprietorship is liable claim gains from business.
- Owners have direct control of the decision making and don’t share power.
- The business under a sole proprietorship is very flexible and regulation is minimal.
Disadvantages of Sole proprietorship
- There is no distinction between personal and business income. The owner has to only take part in business financial risks. Sometimes, because of the weight of the debts incurred, the owner’s personal assets can be confiscated.
- The business can end in the event of the death or departure of the owner. It lacks continuity.
- It will be difficult for the business to expand, since there are no partners or investors pooling funds and capital together for the growth of the business.
- Ownership is hard to transfer under a sole proprietorship.
Partnership
Partnership is the union of two or more people to claim ownership and fund a business. A partnership can be any endeavor undertaken jointly by multiple parties. The parties may be governments, nonprofits enterprises, businesses, or private individuals. The goals of a partnership vary widely and each partner has equal share in the net profits and losses of their business.
There are two forms of Partnership – General and Limited. In general partnership, the partners are equally responsible and liable for all the debts, even if they only contributed a small amount to fund the business. While in limited partnership, each partner is partly liable for the amount they contributed.
Advantages of Partnership
- It is easy to expand a business under a partnership business structure, since there is a pool of funds from more than one person. The capacity of the business is bigger.
- Each partner can get to share profits of the business equally among themselves. As well, as business risks.
- A partnership business structure allows for a pool of expertise, skills, experience from each partner, which potentially gives it a better chance of success than when done individually.
- In a partnership company, ownership and day to day management of the business is split between shareholders and directors, and ensures for a smooth running of the business.
Disadvantages of Partnership
- There are potential conflicts and differences especially related to the strategic direction of the company.
- The legacy of the business dies, when a partner decides to leave.
- The liability of debts incurred in the business is unlimited.
- Decision-making is slower in a partnership business structure; more time is spent for negotiating to reach an agreement.
Corporation
A corporation is a business structure that is separate and distinct from the owners. It is mostly for tax purposes, which means the profit generated from the business is taxed as personal income of the company. While other income distributed to the shareholders as dividends or profits is taxed as personal income of the owners.
Corporations can sue and be sued, own assets, remit federal and state taxes, and borrow money from financial institutions. A corporation is usually created for a common goal by a single shareholder or by multiple shareholders. A corporate can be formed as a for-profit or a not-for-profit entity.
Advantages of Corporation
- A corporation limits the liability of the owners to debts and losses.
- It is not difficult to transfer ownership of shares by shareholders.
- The existence of a corporation is perpetual.
- Owners have the right to retain their personal assets even if the business is in debt.
Disadvantages of Corporation
- Establishing a corporation is quite expensive.
- There is a lot of complexity around corporation
- Owners have to pay tax on income and also on the dividends received.
Limited Liability
A limited liability combines the traits of a sole proprietorship and corporation. It is a business structure that paying taxes is not required and neither are the owners limited to debts. The structure provides owners with limited liability while also providing them with some of the income advantages of a partnership.
Advantages of Limited Liability
- Owners are limited to liability of the company i.e debts or losses
- The profits of the LLC are shared by the owners without double-taxation.
Disadvantages of Limited Liability
- Establishing this business structure incurs cost.
- The business can be dissolved upon the death or bankruptcy of a member.