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The advantages and disadvantages of choosing proprietorship, partnership, or incorporation

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First-time entrepreneurs have several factors to consider, from marketing to startup capital. However, before business owners can get their companies off the ground, people have to register their enterprises. Prior to the certification process, businesses have to choose the type of endeavor they will run. There are three options for entrepreneurs – sole proprietorship, partnership or corporation. Let’s take a closer look at what each of these choices entails, and the advantages and disadvantages they offer:

Sole proprietorship

This option is perhaps the most common among companies in the U.S rather than Canada. A sole proprietorship allows an individual to own and manage the business and its transactions. The company does not have to pay any specific enterprise taxes because entrepreneurs will pay taxes on their income from the business as part of their personal taxes. The business owner of a sole proprietorship is responsible for debts and liabilities and can sell the enterprise – or pass it on to family members – whenever he or she feels inclined. This option is a smart choice for entrepreneurs looking to start a business fast, as sole proprietorship is often less costly and includes less paperwork and formalities than corporations or partnerships. Owning a sole proprietorship can be seen as risky, so it may be difficult for business owners to find investors.

Entrepreneurs will have to abide by the regulations of the city or municipality where the company is located to register the business or obtain a license. Sole proprietorships don’t require any formal or legal steps at the federal, state or local level, as long as there is only one owner. Companies will have to register their name, however, if the enterprise is known by anything other than the entrepreneur’s name.

Partnership

This option is a little more tricky as there are two types of partnerships: general and limited. A general partnership is created whenever two or more people agree to operate as co-owners. Entrepreneurs in this kind of an agreement share responsibility of profits and losses, have joint ownership of the company and have an equal right to management. General partnerships are more common than limited partnerships and don’t require any formal or legal paperwork. General partnerships must meet local registration obligations, however; most often, these businesses will pay a minimum tax to the city where they operate.

Limited partnerships include one general partner and one or more limited partnerships. The limited partners have no management role in the business and only contribute assets, while the general partner assumes all management responsibility. Only the general partner will be held personally liable for business debts and obligations, whereas the limited partners can lose no more than their stake in the partnership. Limited partnerships must file with the state before beginning to operate, which may include registration fees.

The advantages and disadvantages of a general partnership include:

  • Increased knowledge and contacts among multiple partners.
  • No business tax. Partners file profits and losses on personal income tax reports.
  • Improved management with more than one owner.
  • Easy to establish.

The disadvantages of a general partnership include:

  • Partners cannot transfer interest of the business without approval of other partners.
  • Joint liability for debts and obligations.
  • Potential for instability if one partner decides to withdraw or dies.

The advantages and disadvantages of a limited partnership include:

  • Attractive to investors since they can come on as limited partners.
  • Partners are taxed on personal income tax returns.
  • Limited partners get to share in the profits without having to manage the business.
  • General partner is fully liable for company debts.
  • No filing for general partnership; required filing for limited partnerships.

Corporations

This option is a separate legal entity, independent from the people who own, control and manage the business. The corporation itself can enter into contracts, incur debts and pay taxes apart from its owners. These types of businesses must pay corporate income taxes on their profits, after paying salaries, bonuses and factoring in deductible expenses. Corporations offer limited personal liability, meaning the owners’ personal assets are protected from creditors of the company.

These businesses must file “articles of incorporation,” usually with their state department and pay a filing fee. For smaller corporations, this process tends to be simple, as the government provides a form to fill out. Corporations should also create bylaws, which determine the rules for governing business formalities and decisions.

The advantages of a corporation include no personal liability on the part of the stakeholder, as well as ability to raise funds by selling shares of the company and deduct the cost of employee benefits. Corporations also have disadvantages, such as extra time and money to form the enterprise, government monitoring resulting in additional paperwork and potential higher taxes.

Entrepreneurs must decide what type of business they wish to form and follow the necessary formal and legal requirements to register the company, if necessary. Sole proprietorships, partnerships and corporations each have their own advantages and disadvantages business owners should strongly consider before jumping into anything too quickly.

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