When getting your new business started, one of the most important decisions will be the choice of a legal structure that best suits your needs and the needs of your particular business. In today’s article we will explain what a sole proprietorship means and how it may best suit your business structure, as well as finding out if a partnership may be right for you.
Sole Proprietorship: A sole proprietorship is owned and operated by one person. This is the simplest and least expensive business structure to form. Many start-up companies choose this form until it becomes practical to enter into a partnership or to incorporate. One of the advantages of the sole proprietorship is the ease of formation. There are fewer legal restrictions and it is the least expensive to form. The costs vary according to the city in which the business is formed, but usually include a license fee and may include a business tax. As the sole owner, all profits go to you, as do the losses! You will be taxed as an individual. Your business profit and loss is recorded on Federal Tax Form 1040, Schedule C, and the bottom line amount is transferred to your personal tax form. You will also file Schedule SE, which is your contribution to Social Security. The control and decision making are vested in you as the owner.
One of the major disadvantages of the sole proprietorship is unlimited personal liability. You will be responsible for the full amount of business debt, which may exceed your investment. This liability may extend to personal assets such as home and vehicles. Since financing comes from the proprietor and loans are based on the financial strength of the individual, obtaining long-term business financing may be difficult. The future of the company is dependent upon the owner’s capabilities in terms of knowledge, drive and financial potential, which may limit growth potential. As the only person responsible for the business, the sole proprietor assumes heavy responsibility.
Partnership: A partnership is a legal business relationship in which two or more people agree to share ownership and management of a business. Often partners are chosen who possess skills or expertise that are complementary. Sharing ownership of a business may be a way of raising additional capital. Care should be taken when choosing a partner: you will be bound by each other’s decisions. Choose carefully based on compatibility of work styles, business practices, character, financial situations, skills and expertise.
The advantages of a partnership include the ease of formation, the sharing of responsibility and the increased growth potential. By sharing in the profits, the partners are motivated to succeed. This form allows for the distribution of the work load and allows for a sharing of ideas, skills and responsibilities. A partnership makes it possible to obtain more capital and to tap into more skills, giving the business increased potential.
One of the disadvantages of a partnership is the unlimited personal liability as partners personally are responsible for business debt. While the opportunity for getting long-term financing is greater in a partnership, it is still dependent upon review of the individual partners’ assets.
Do not underestimate the need for a partnership agreement. Many friendships and good working relationships have ended over business disputes. Like a sole proprietorship, a partnership terminates as a legal entity upon the death or withdrawal of a general partner unless the partnership agreement provides otherwise.
The buying out of a partnership or sale to another party must be spelled out in the agreement. This is also where the terms of profit distribution are stated. Take time and carefully prepare a partnership agreement and have it notarized. It will serve as a guideline for your working relationship with your partners. It will outline the financial, managerial and material contributions by the partners in the business and delineate the roles of the partners in the business relationship.