Forms of Business Organization | Main 4
Forms of Business Organization are the legally recognized structures of companies.
Business structures are essential in determining how the profits will be shared and distributed, taxes to be paid, who holds liabilities, and the different responsibilities placed on different shareholders.
4 Forms of Business Organization
- Sole proprietorship,
- Corporations and
- Limited Liability Companies (LLCs).
1. Sole Proprietorship
As the simplest among the 4 forms of business organization, a sole proprietorship business is a business that is owned and run by a single person. It is the most common and the easiest kind of business anyone would decide to venture into. This is because it does not require a lot of resources to start and because most startups begin as a sole proprietorship.
There is no difference between the business and the owner in the sole proprietorship as they are one. The business owner can hire other people, but only he is responsible for making decisions for the business.
How it works
A sole proprietorship is formed and owned by a single person; therefore, most of the time, you will find that sole proprietorships are small businesses. The owner has complete control over the decisions made within the business regardless of any other employee working there.
In addition, all profits made by the business are enjoyed by only the owner. The owner will also be liable for any losses suffered by the business.
Since there is no distinction between the owner and the business, the business has unlimited liability. It means that if the business faces a lawsuit, the owner will be the one facing the lawsuit; if the owner dies, the huge chances are that the business will die.
Funding the sole proprietor business can prove quite challenging. It is because sole proprietors have minimal options for raising money. Some of the sources of finance for sole proprietors include; personal savings, raising money from friends and family, existing profits, loans, and the sale of assets.
A partnership is a type of business owned by two or more people. It shares significant similarities with the sole proprietors. However, all the partners share responsibilities for running and managing the company. As with the sole proprietorships business, there is no distinction between the owners and the business; therefore, liability is unlimited and rests on the partners.
How it works
According to its definition, a partnership comprises two or more owners who come together and combine their resources to create a business. As with any other business, the goal is to make and maximize profit.
Unlike sole proprietors, these partners agree to share the profits, losses, and risks of forming a business, where all profits, losses, and risks are placed on a single person.
Taxation of Partnerships
Income received from the business is passed onto the partners, who must file their taxes separately as personal income taxes. They must also pay the self-employment tax, determined by the share of business profits.
Partnership business has unlimited liability. The partners are entirely liable for any financial obligations the business faces. They are also liable for any lawsuits made on the business, which means they are at a disadvantage in getting their assets seized if any obligations are not met.
A corporation is a legal entity created by a group of shareholders. It exists separately from its owners as it is a legal entity with the same rights and responsibilities as an individual. It can enter contracts, sue and be sued, own assets, and even get loans from banks.
How it works
A corporation is created when shareholders decide to incorporate it and own a share each. During the corporation’s creation, an annual general meeting is held where members of the board of directors are voted in. Each shareholders holds one vote per share, so the more shares one holds, the more the votes.
The board of directors is tasked with decision-making on issues affecting the company. A corporation has a limited liability, which means that the company’s owner is not liable for any debts, losses, or lawsuits. However, they can fully enjoy profits generated depending on each shareholder’s shares.
Regarding the lifespan of the company, in case one of the owners dies or is unable to run the company, another person will be elected and chosen to replace him. It means that the corporation’s lifespan is long and can only end when it is dissolved or bankrupt.
In such circumstance, it will start by selling assets to pay debts. Whatever remains after debts have been paid will be given to the shareholder.
Taxation of Corporations
Unlike the other forms of business organization, corporations have the disadvantage of double taxation. They will have to pay taxes on the profits earned and taxes on dividends distributed to investors. This discourages some investors because they pay too much taxes for income earned. It is, however, subject to other reasons from one investor to another.
They, however, have a considerable advantage when it comes to raising money to fund the company. It is because they have many channels of acquiring capital which include; loans, issuing of stock to the public, and profits retained, among others.
4. Limited Liability Companies (LLCs)
Limited liability companies work a lot, similar to corporations. They are a hybrid business that combines both partnerships and corporations. This is because it has similar characteristics to both partnerships and corporations. Like its name, it has limited liability, meaning the owners are fully guarded against any debts, lawsuits, and losses the company faces.
These Limited Liability Companies exists as a separate artificial person. Owners of such companies are not personally liable for eventualities the LLCs could face. It is preferred to those who want a blend of partnerships and corporations.
How it works
Unlike corporations, limited liability companies have no limit on the shareholders needed to be in the company. When forming a limited liability company, the shareholder has to file the articles of association to the secretary of state.
The elements contained in the articles of association include; rights, powers, duties, liabilities, and any obligations of the members involved. Limited liability companies have the disadvantage of being dissolved if and when a member dies or it goes bankrupt. Therefore, unlike corporations, a Limited Liability Company has a limited lifespan.
The main difference between limited liability companies and partnerships is that an LLC can own assets and protect its owners from liabilities. In contrast, a partnership has unlimited liability, and the business cannot own assets.
If these assets are collateral, the most the owners can lose is the extent they have contributed to purchasing such assets. It is a safe business structure where one does not want to be personally liable for the management and debt obligations, as is for sole proprietors and general partners.
Taxation of Limited Liability Companies (LLCs)
Unlike corporations where double taxation exists, Limited Liability Company has single taxation. Once profits are shared among the shareholders, the taxation does not apply to the shareholders’ income. Thus, they enjoy the tax advantage of partnerships and even sole proprietorship.