The sole proprietorship is the oldest form of business organization. As the title suggests, a single person owns the business, holds title to all its assets, and is personally responsible for all of its debts. A proprietorship pays no separate income taxes. The owner merely adds any profits or subtracts any losses from the business when determining personal taxable income. This business form is widely used in service industries. Because of its simplicity, a sole proprietorship can be established with few complications and the little expense. Simplicity is its greatest virtue.
Its principal shortcoming is that the owner is personally liable for all business obligations. If the organization is sued, the proprietor as an individual is sued and has unlimited liability, which means that much of his or her personal property, as well as the assets of the business, may be seized to settle claims. Another problem with a sole proprietorship is the difficulty in raising capital. Because the life and success of the business is so dependent on a single individual, a sole proprietorship may not be as attractive to lenders as another form of organization.
Moreover, the proprietorship has certain disadvantages. Fringe benefits, such as medical coverage and group insurance, are not regarded by the Internal Revenue Service as expenses of the firm and there of are not fully deductible for tax purposes. A corporation often deducts these benefits, but the proprietor must pay for a major portion of them from income left over after paying taxes. In addition to these drawbacks, the proprietorship form makes the transfer of ownership more difficult than does the corporate form. In estate planning, no portion of the enterprise can be transferred to members of the family during the proprietorâ€™s lifetime. For these reasons, this form of organization does not afford the flexibility that other forms do.
A partnership is similar to a proprietorship, except there is more than one owner. A partnership, like a proprietorship, pays no income taxes. Instead, individual partners include their share of profits or losses from the business as part of their personal taxable income. One potential advantage of this business form is that, relative to a proprietorship, a greater amount of capital can often be raised. More than one owner may now be providing personal capital, and lenders may be more agreeable to providing funds given a larger owner investment base.
In a general partnership all partners have unlimited liability; they are jointly liable for the obligation of the partnership. Because each partner can bind the partnership with obligations, general partners should be selected with care. In most cases a formal arrangement, or partnership agreement, sets forth the powers of each partner, the distribution of profits, the amounts of capital to be invested by the partners, procedures for admitting new partners, and procedures for reconstituting the partnership in the case of the death or withdrawal of a partner. Legally, the partnership is dissolved if one of the partners dies or withdraws. In such cases, settlements are invariably â€œsticky,â€ and reconstitution of the partnership can be a difficult matter.
In limited partnerships, limited partners contribute capital and have liability confined to that amount of capital; they cannot lose more than they put in. There must, however, be at least one general partner in the partnership, whose liability is unlimited. Limited partners do not participate in the operation of the business; this is left to the general partner(s). The limited partners are strictly investors, and they share in the profits or losses of the partnership according to the terms of the partnership agreement. The type of arrangement is frequently used in financing real estate ventures.