Module-5: Forms of Business Ownership

There are three basic forms of business ownership, namely the Sole proprietorship, the
Partnership and the Corporation.
4.1 Sole Proprietorship
The definition of a Sole Proprietorship is: A business enterprise exclusively owned, managed
and controlled by a single person with all authority, responsibility and risk.
A sole proprietorship requires almost no legal formalities. It can start the day you want it to
start. One may even open a bank account on the name of your sole proprietorship concern.
In case you wish to have a trade mark, design and use it as your trade mark. One may even
register a Trade Mark with the proper authorities. The only thing you must take care of is
that you have the required licenses specific to your line of business. For Example: If you
are a doctor you need a license to practice etc.
A sole proprietorship is the most common type of business. There are sole proprietorships
everywhere. Small grocery stores, STD booths are mostly proprietorship businesses. A “Sole
Proprietorship” business means that there is only ONE owner. There may be employees or
helpers hired under the owner, but there are only one “head” who administors and runs
the show.The basic advantage of a sole proprietorship is that since you are the only owner,
you are free to run the business just the way you want to run it. Also, in a sole proprietorship
you get to keep all the profits. The biggest disadvantage is that there is “unlimited liability”
on the “Sole Owner”.
A sole proprietorship is the oldest and the most common form of business. It is a one-man
organisation where a single individual owns, manages and controls the business. Its main
features are:
1. Ease of formation is its most important feature because it is not required to go through
elaborate legal formalities. No agreement is to be made and registration of the firm is also
not essential. However, the owner may be required to obtain a license specific to the line of
business from the local administration.
2. The capital required by the organisation is supplied wholly by the owner himself and he
depends largely on his own savings and profits of his business.
3. Owner has a complete control over all the aspects of his business and it is he who takes
all the decisions though he may engage the services of a few others to carry out the day-to-
day activities.
4. Owner alone enjoys the benefits or profits of the business and he alone bears the losses.
5. The firm has no legal existence separate from its owner.
6. The liability of the proprietor is unlimited i.e. it extends beyond the capital invested in the
firm.
7. Lack of continuity i.e. the existence of a sole proprietorship business is dependent on the
life of the proprietor and illness; death etc. of the owner brings an end to the business. The
continuity of business operation is therefore uncertain.
Basic Advantages
1. Ease of formation
2. Maximum incentive for work
3. Secrecy of business
4. Quick decisions and flexibility of operations
Basic Disadvantages
1. Limited capital
2. Limited managerial ability
3. Limited life
4. Unlimited liability
Hence, this form of organisation is suitable for the businesses which involve moderate risk,
small financial resources, capital requirement is small and risk involvement is not heavy like
automobile repair shops, small bakery shops, tailoring, etc. It accounts for the largest
number of business concerns in India.
4.2 Partnership
Definition: A legal form of business operation between two or more individuals who share
management and profits. The federal government recognizes several types of partnerships.
The two most common are general and limited partnerships.
If your business will be owned and operated by several individuals, you'll want to take a look
at structuring your business as a partnership. Partnerships come in two varieties: general
partnerships and limited partnerships. In a general partnership, the partners manage the
company and assume responsibility for the partnership's debts and other obligations. A
limited partnership has both general and limited partners. The general partners own and
operate the business and assume liability for the partnership, while the limited partners
serve as investors only; they have no control over the company and are not subject to the
same liabilities as the general partners.
Unless you expect to have many passive investors, limited partnerships are generally not the
best choice for a new business because of all the required filings and administrative
complexities. If you have two or more partners who want to be actively involved, a general
partnership would be much easier to form.
One of the major advantages of a partnership is the tax treatment it enjoys. A partnership
doesn't pay tax on its income but "passes through" any profits or losses to the individual
partners. At tax time, the partnership must file a tax return (Form 1065) that reports its
income and loss to the IRS. In addition, each partner reports his or her share of income and
loss on Schedule K-1 of Form 1065.
Personal liability is a major concern if you use a general partnership to structure your
business. Like sole proprietors, general partners are personally liable for the partnership's
obligations and debts. Each general partner can act on behalf of the partnership, take out
loans and make decisions that will affect and be binding on all the partners (if the
partnership agreement permits). Keep in mind that partnerships are also more expensive to
establish than sole proprietorships because they require more legal and accounting
services.
 If you decide to organize your business as a partnership, be sure you draft a partnership
agreement that details how business decisions are made, how disputes are resolved and
how to handle a buyout. You'll be glad you have this agreement if for some reason you run
into difficulties with one of the partners or if someone wants out of the arrangement.
The agreement should address the purpose of the business and the authority and
responsibility of each partner. It's a good idea to consult an attorney experienced with small
businesses for help in drafting the agreement. Here are some other issues you'll want the
agreement to address:
 How will the ownership interest be shared? It's not necessary, for example, for two owners
to equally share ownership and authority. However, if you decide to do it, make sure the
proportion is stated clearly in the agreement.
 How will decisions be made? It's a good idea to establish voting rights in case a major
disagreement arises. When just two partners own the business 50-50, there's the possibility
of a deadlock. To avoid this, some businesses provide in advance for a third partner, a
trusted associate who may own only 1 percent of the business but whose vote can break a
tie.
 When one partner withdraws, how will the purchase price be determined? One possibility
is to agree on a neutral third party, such as your banker or accountant, to find an appraiser
to determine the price of the partnership interest.
 If a partner withdraws from the partnership, when will the money be paid? Depending on
the partnership agreement, you can agree that the money be paid over three, five or 10
years, with interest. You don't want to be hit with a cash-flow crisis if the entire price has to
be paid on the spot on one lump sum.
4.2.1 Different form of Partnership
General Partnership
A General Partnership is composed of 2 or more persons (usually not a married couple) who
agree to contribute money, labor, or skill to a business. Each partner shares the profits,
losses, and management of the business and each partner is personally and equally liable
for debts of the partnership. Formal terms of the partnership are usually contained in a
written partnership agreement.
Limited Partnership
A Limited Partnership is composed of one or more general partners and one or more limited
partners. The general partners manage the business and share fully in its profits and losses.
Limited partners share in the profits of the business, but their losses are limited to the
extent of their investment. Limited partners are usually not involved in the day-to-day
operations of the business.
Limited Liability Partnership (LLP)
A Limited Liability Partnership (LLP) is similar to a General Partnership except that normally
a partner doesn’t have personal liability for the negligence of another partner. This business
structure is used most by professionals, such as accountants and lawyers.
Limited Liability Limited Partnership (LLLP)
A Limited Liability Limited Partnership is a Limited Partnership that chooses to become an
LLLP by including a statement to that effect in its certificate of limited partnership. This type
of business structure may shield general partners from liability for obligations of the LLLP.
4.3 Corporation
Corporation: The owners of a corporation have limited liability and the business has a
separate legal personality from its owners. Corporations can be either government-
owned or privately-owned. They can organize either for profit or as not-for-
profit organizations. A privately-owned, for-profit corporation is owned by its shareholders,
who elect a board of directors to direct the corporation and hire its managerial staff. A
privately-owned, for-profit corporation can be either privately held by a small group of
individuals, or publicly held, with publicly traded shares listed on a stock exchange.
The corporate structure is more complex and expensive than most other business
structures. A corporation is an independent legal entity, separate from its owners, and as
such, it requires complying with more regulations and tax requirements.
The biggest benefit for a business owner who decides to incorporate is the liability
protection he or she receives. A corporation's debt is not considered that of its owners, so
if you organize your business as a corporation, you are not putting your personal assets at
risk. A corporation also can retain some of its profits without the owner paying tax on
them.
Another plus is the ability of a corporation to raise money. A corporation can sell stock,
either common or preferred, to raise funds. Corporations also continue indefinitely, even if
one of the shareholders dies, sells the shares or becomes disabled. The corporate structure,
however, comes with a number of downsides. A major one is higher costs. Corporations are
formed under the laws of each state with its own set of regulations. You will probably
need the assistance of an attorney to guide you. In addition, because a corporation must
follow more complex rules and regulations than a partnership or sole proprietorship, it
requires more accounting and tax preparation services.
Another drawback to forming a corporation: Owners of the corporation pay a double tax
on the business's earnings. Not only are corporations subject to corporate income tax at
both the federal and state levels, but any earnings distributed to shareholders in the form of
dividends are taxed at individual tax rates on their personal income tax returns.
One strategy to help soften the blow of double taxation is to pay some money out as salary
to you and any other corporate shareholders who work for the company. A corporation is
not required to pay tax on earnings paid as reasonable compensation, and it can deduct
the payments as a business expense. However, the IRS has limits on what it believes to be
reasonable compensation.
A Corporation is a more complex business structure. A corporation has certain rights,
privileges, and liabilities beyond those of an individual. Doing business as a corporation may
yield tax or financial benefits, but these can be offset by other considerations, such as
increased licensing fees or decreased personal control. Corporations may be formed for
profit or non-profit purposes. A corporation is considered a separate, juridical entity distinct
from its owners, stockholders, employees and board of directors. It is the most complex
form of business ownership. However, due to the many advantages of a corporation over a
sole proprietorship and a partnership, many entrepreneurs incorporate. While it is
possible for any form of business organization to succeed, some lenders and investors
prefer to put their money into corporations, avoiding partnerships and sole
proprietorships for investments of any significant size. Because of this practical reason, a
corporation may offer greater potential for growth compared to the first two forms of
business ownership, as, practically, it can finance its operation through various strategies
including issuing shares.
4.4 Other forms of Ownership
4.4.1 Trust
A Trust is a legal relationship in which one person, called the trustee, holds property for the
benefit of another person, called the beneficiary.
4.4.2 Joint Venture
A Joint Venture is formed for a limited length of time to carry out a business transaction or
operation.

4.4.3 Cooperative

Often referred to as a "co-op", a cooperative is a limited liability business that can organize
for-profit or not-for-profit. A cooperative differs from a corporation in that it has members,
not shareholders, and they share decision-making authority. Cooperatives are typically
classified as either consumer cooperatives or worker cooperatives. Cooperatives are
fundamental to the ideology of economic democracy.
4.4.4 Non-profit Corporations
A non profit / not for profit corporation is a corporation formed to carry out a charitable,
educational, religious, literary, or scientific purpose. A non-profit can raise much-needed
funds by soliciting public and private grant money and donations from individuals and
companies. The federal and state governments do not generally tax non-profit corporations
on money they take in that is related to their non-profit purpose, because of the benefits
they contribute to society.

4.5 Conclusion

Before you can decide how you want to structure your business, you'll need to know what
your options are. Here's a brief rundown on the most common ways to organize a business:
 Sole Proprietorship
 Partnership
 Limited Partnership
 Limited Liability Company (LLC)
 Corporation (for-profit)
 Non-profit corporation (not-for-profit), and
 Cooperative.