Unit 1, Lesson 2

Legal Forms of Business Ownership

AOFApplied Finance

Sole proprietorship: Going it alone

Characteristics:•Typical size: Very small•A single individual owns and operates the business•The “sole proprietor” is the owner of a sole proprietorship •The sole proprietorship can hire employees, but the owner cannot be an employee•Typical examples are small shopkeepers, artists, craftspeople, carpenters, consultants, and writers

A potter is likely to be a sole proprietor.

Sole proprietorship advantages and disadvantages

Advantages:• Simple and inexpensive

to create and operate• Least regulated of all

business forms• All profits are reported

on the owner’s personal income tax return

Disadvantages:• The owner is personally

responsible for all actions of the business

• The owner is personally liable for all business debts

General partnership: Sharing the responsibility

Characteristics:• Typical size: From two

individuals to a large firm with many partners

• The partners run the business but may not be employees of it

• There is slightly more regulation than for a sole proprietorship

• The owners sign a written partnership agreement about how to run the business

What options might someone have if he no longer wanted to work with his partners?

General partnership advantages and disadvantages

Would you become business partners with a friend? What qualities would you want your partner to have?

Advantages:• Simple and

inexpensive to create and operate

• All profits are taxed as personal income to the partners

Disadvantages:• All partners are

responsible for any actions taken in the name of the business by all other partners

• All business debts are the personal responsibility of the partners

Corporation: Putting up a wall

Characteristics:• Typical size: Ranges from

one or two stockholders to millions of them

• The corporation can hire employees, which may include the owners

• In the eyes of the law, a corporation is treated like an individual:

• It can own property• It can be sued• It must file a tax return

Forming a corporation is like putting up a wall between the business and its owners’ personal assets.

Why would the law give corporations some of the same rights as individuals?

Corporation advantages and disadvantages

Advantages:• Corporation owners are

not responsible for the actions taken by the business

• Debts are not the responsibility of the owners (limited liability)

• The business can sell shares (stock) in the business to the public in order to raise capital

Disadvantages:• Legally complex to start and

operate• One of the two most

regulated business forms (the limited liability company is the other)

• Profits are taxed twice - once as corporation income, and again as investor income

Limited liability company (LLC): Bridging the gap

Characteristics:• Typical size: small to mid-

sized businesses• LLCs combine some

aspects of a partnership and some aspects of a corporation

• Like a corporation, an LLC is treated as an individual for purposes of ownership and legal standing, but it is not taxed at the higher corporate rates

LLC advantages and disadvantages:

Advantages:• LLC partners have more

flexibility to allocate profits and losses

• Debts are not the responsibility of the partners (limited liability)

• An LLC can choose to be taxed as the property of the owners (like a partnership) or an individual (like a corporation)

Disadvantages:• Like a corporation, an LLC is

governed by complex laws• The owners of an LLC

normally can’t be employees

• When a partner dies, the LLC is dissolved

Responding to changing conditions

What conditions might raise the risk of personal liability?

• Whichever legal form you choose at the start of your business, it doesn’t have to be permanent

• This possibility should be part of your long-range business planning and strategy