A business entity is an organization that is initiated and managed according to the corporate law to execute business activities, do charity work, or engage in any activity allowed by statute (Lam, Man, and Jay, 234). In most cases, businesses are formed to sell goods and provide services. There are various forms of businesses defined and established by law. These include sole proprietorship, partnership, corporations, cooperatives, and limited liability companies. According to Matheson (7), entrepreneurs targeting to participate in business need to carefully consider the kind of business entity to venture into since each of the forms presented above are subject to different laws from their formation to management. This paper explores the different types of business entities, their features, their advantages, and disadvantage. The ultimate aim is to identify which business format is best suited for different situations.
Matheson (7) defines a sole proprietorship as a business entity that is established directly by a single individual. From this definition, it can be inferred that sole proprietorships are mostly small business establishments that are not subject to the complex corporate laws that govern larger entities that are owned and run by many different parties. In concurrence with this inference, Matheson (7) points out that there are no specialized statutes that govern the creation and running of sole proprietorships. In the specific context of California Galak, Kostiantyn, and Olga (255) point out that one is only required to have a local business permit or license depending on the kind of business carried out by the sole proprietorship. Registration with the state is therefore not necessary. Generally, sole proprietorships are governed by the substantive law of agency, tort, and contracts and the owner reserves the right to transfer the business to any other party just like any other personal property (Matheson, 8).
Advantages and Disadvantages of Sole Proprietorship
From the definition of a sole proprietorship presented above, it is evident that it is very easy to establish a business under this format. This simplicity results from the fact that only one individual is involved hence the decision making process is not complex. In addition, establishing a business under this format, according to Matheson (8), is relatively easy owing to the fact that it avoids complex state registration requirements. Due to the small scale, this business format requires relatively little capital to start and operate and the entrepreneur enjoys all the profit realized
Despite the fact that a sole proprietorship has numerous significant advantages, Matheson (8) reveals that it has a number of shortcomings. Legally, the entrepreneur has unlimited liability meaning that personal property can be acquired by creditors in the event the business cannot pay its debts. The proprietor also bears all losses incurred by the business. In addition to the unlimited liability, since only one individual is involved in this kind of business, the acquisition of a significant amount of money in the form of loans can be difficult. This limits the ability of the business to grow as fast as businesses operated in other formats.
Sole Proprietorship Best Fit
A good situation to adopt this entity is where an individual has plans to start a barbershop. He/she should go for a sole proprietorship since it is easy to start as it does not require much capital. Moreover, there are few legal formalities necessary to start and operate it. The trader can also seek help from the family to help in running the business. Despite the possibility of including family members, the owner has absolute control of all the profit realized by such a business. Therefore, sole proprietorship entity is best fit for the business.
A partnership is similar to a sole proprietorship in many aspects. However, the main difference is that a partnership is formed and owned by two or more people (Boyd, Brewster, et al., 58). There are two types of partnerships: General partnership and limited liability partnership. A general partnership is a business entity in which the partners take active roles in the management of the business, and they have an equal share of losses and profits. Like sole proprietorship, a general partnership does not require to be registered with the state. In the formation of a partnership according to Matheson (8), a written partnership agreement is not necessary due to the fact that most states have a partnership act that sets out the relationship between the partners and between the partners and the business entity.
Advantages and Disadvantages of General Partnership
Similar to a sole proprietorship, a general partnership is easy to start since there is no need to register the company with the state. The firm also does not require any corporate formalities or paperwork to begin its operations. Furthermore, the business is easy to start and operate since relatively little capital is needed during its initiation. In contrast to a sole proprietorship, losses are not borne by a single individual as all partners share liability equally (Cole, 3).
One of the most profound shortcomings of a general partnership specifically in California is the fact that each partner is held liable for any negligent action done by one partner. This means that if one member engages in unlawful activity in the name of the business, then all other partners will be charged in a court of law. Also, similar to a sole proprietorship it is difficult for a partnership to get business loans to fund its operations thus limiting its ability to grow at the same rate as other business formats (Matheson, 8).
A limited partnership is different from a general partnership in that it requires registration as a business during formation. Two types of partners exist in limited partnership: those who own, operate, and bear the liabilities of the business; and those who act only as investors in the company (Bradley, Christopher, 38). Limited partners do not have active roles in the company, and their liability is limited to only the amount of capital they contributed to start the business.
Advantages and Disadvantages of a Limited Partnership
Compared to a general partnership, business entities falling under this category have access to more partners hence can raise significantly higher amounts of funds to run the firm. For a limited partner, this form of business is advantageous since it allows them to exit the business at any time and their exit does not affect the operation of the company. However, general partners are held responsible for the business’s debts and liabilities meaning that their personal property can be used to meet the liabilities incurred by the business.
Best Fit Example
People who wish to set up a grocery will be concerned about sharing responsibility in operating the business. Therefore the best business entity for them is a limited partnership since, it would allow the founders to access enough funds from both limited and general partners while at the same time enabling them to avoid the legal technicalities that are faced by more complex business entities such as corporations and limited liability companies.
Corporations are businesses that exist as separate entities from the owners. It, therefore, means that a corporation is a person created through a legal process. As ordinary people, the business can be sued or sue a person or other company in its name (Forsythe, Lynn M., et al., 311). Before forming corporations, the company is expected to comply with various formalities, including tax regulations. In California, the company is required to pay incorporation fees before the business can be allowed to begin operations.
Advantages and Disadvantages of Corporations
Due to the fact that corporations are viewed as autonomous entities by the law, personal property cannot be used to settle the debts of the company. In addition, shareholders do not directly participate in governance and management of the business and so these kinds of businesses consume very little of their time. Finally, they have a better access to capital due to the fact that a large number of shareholders make monetary contributions and receive equity in return. In addition, their access to loans is relatively easy.
One of the most profound shortcomings of this business format is that it exposes shareholders to double taxation. In addition, there are numerous legal obligations that corporations must meet from their formation their operation. The decision making process in such organizations is therefore much more complex compared to the business formats discussed in previous sections.
Best fit Example
Large enterprises like supermarkets are best run as corporations. This is because large investments are required from the shareholders and so elaborate legal protection of assets is required. Compliance with stringent corporate law thus offers this protection to the funds contributed by shareholders if such a business is established as a corporation. In addition, it is important to note that due to the massive investments required to start and run entities such as supermarkets, liabilities in terms of debts are expected to be high. In that regard, protection for the personal property of shareholders is required. Corporate law offers this protection by treating corporations as entities that are separate from shareholders. For that reason, the personal property of shareholders will not be taken to service debts accumulated by an unprofitable supermarket chain.
Limited Liability Company
Like corporations, limited liability companies are businesses that exist as separate legal entities from their owners. The firm is an artificial person created through a legal process. The liability of the shareholders is limited to only the amount of capital they contributed to start the company (Forsythe, Lynn, Lizhu and John, 123).
Advantages and Disadvantages of Limited Liability Companies
Similar to corporations, shareholders are not obligated to pay the business debts using their personal property. However, in the specific context of California, the law allows members to choose whether they want their business to be taxed as a corporation or partnership. In addition, such firms are able to raise a lot of capital since they are publicly listed entities that sell shares to ordinary people. Their formation is, however, very expensive and legally complex compared to partnerships.
A good example of a business that can be run as a limited liability company is a manufacturing company. Despite the fact that such a business does not involve very large investments like in the case of corporations, the amount of investment is relatively high due to the capital intensive nature of the business. A manufacturing company therefore has the capacity to accumulate massive liabilities that would lead to massive financial implications for entrepreneurs in general partnerships or sole proprietorship formats. The limited liability company format protects the personal property of the shareholders and would thus be the best option for a manufacturing company.
From the evaluation of different business entities above, it has emerged that each has numerous distinct advantages and disadvantages. For someone with low capital and seeking to run their business autonomously, the sole proprietorship format would be the most appropriate. However, in many cases, groups of people with a common vision come together and pool funds to start a business. For such individuals, a general partnership and limited liability partnership stand out as the two most plausible business formats. Between the two, a limited liability partnership would be the most appropriate especially if relatively huge sums of money involved. Such a format is essential since the personal assets would be legally protected from being acquired in meeting the liabilities incurred by the business. In cases of highly complex organization involving very high amounts of capital from many people, corporation format would be most appropriate since, despite the fact that the shareholders will be exposed to double taxation, none will be expected to directly manage the business entity and none will be liable of any debts accrued by the organization.
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