Business Formation and Sole Proprietorship - Essay Example

? Business formation affiliation Business formation When creating a business its form depends on the size of the company,the financial resources that are available, objectives of the company and availability of mergers, partners or shareholders. According to Ray (2001) business forms are also based on the motives of the owners. He further points out that government regulations are the most significant factors that should be considered when creating business entities. Additionally, alternative business forms have increased making it easier for the business environment to incorporate many companies thus promoting the economy (Besley & Brigham, 2008). Sole proprietorship This form of business organization is one that is organized under the management of an individual. The organization only depends on the contribution of the individual. The setting of this particular organization is based on contribution and profit sharing by an individual. However, this form of business setting can have support from family members or sponsors which do not reflect on the formal participation in the creation of the business entity. According to Ray (2001) sole proprietorship is a creation of a decision making process by one person. He further points out that, this form of business organization survival does not depend on contributions from donors or business partners. Additionally, a sole proprietor may use a business name apart from his legal name to represent his business entity. Ray (2001) points out that the sole proprietor owns all the assets in the business. In describing the formation and operation of a sole proprietorship, Pettet (2005) says that it is only more that buying and selling of services and goods. He further points out that the description of the activities in the business is automatically shaped by the owner’s activities. In this business form, taxation is only done on the business as the source of income for the owner. The owner is not further taxed as an individual. Additionally, the location of a sole proprietor business is decided by the owner and it is not dictated by any law. Advantages (Besley & Brigham, 2008) There are few legal formalities that are involved in its creation There is no profit sharing as the entire profit generated is taken by the proprietor The business entity can benefit from contributions by family members and relatives The capital required for the creation of a sole proprietorship is minimum compared to the amount required for the creation of other business entities. Operating challenges are minimized since no complex record keeping systems are required The unlimited liability status of the owner attracts creditors Disadvantages (Besley & Brigham, 2008) The proprietor incurs all the loss that may be generated by the organization The exposure of this form of business to sponsors is minimized The proprietor is the sole contributor of the capital required The continuity of this form of business entity is made unpredictable. For instance, if the proprietor dies the business may be dissolved There is a minimized exposure to talent and expertise General partnerships This form of business is based on skill and resources contribution by two or more people (Pettet, 2005). Partnerships are legally registered as business creation by two or more people. The contribution by each partner should be voluntary and the contribution by each partner is legally recorded. Such business entities are legally bound by rules and regulation created by governments. The contribution of resources and capital may vary in terms of quantity but must be on agreeable terms and compensation conditions. The contribution by a partner dictates the sharing profit ratio: the highest contributor of capital and resources get a greater share of the profit. Name of partners, loss and profit sharing ratio, name of partnership, capital of the business of the entity and the provisions in settling differences are the constitution of the legal provisions of general partnerships (Besley & Brigham, 2008). In case of debts to creditors, personal assets can be subject to liquidation and attachment. In a partnership, a partner can be held liable for any dealings with a third party. Additionally, all partners are held liable for the business actions of one partner (Ray, 2001). This is because all partners in a partnership are agents of the general partnership. Apart from these general characteristics, different countries have different provisions on formation and operating partnerships. Taxation in a general partnership is based on the profit sharing ratio. The general partner with the highest profit ratio is taxed more. Additionally, business assets are also taxed. However, the general partners can choose the taxation stipulation of their choice. Additionally, this business has unlimited liability where the personally assets of one general partner can repay their debt in the organization. The business assets can also pay debt in cases of debt or major losses. There is no individual ownership of business assets. All general partners in the business entity have the right to control and take part in every decision making. Location is also determined by an open forum by all partners. Advantages (Pettet, 2005) The loss incurred in the organization is shared among the partners Raising the capital is shared among the partners as well as sharing of the risk in the business entity General partnerships are free from federal income tax Disadvantages (Pettet, 2005) The death of one partner may end the creation of the partnership The assets in the business can repay debts or losses Such business creation are prone to disagreements and complex legal creations are required There is no individual ownership of business assets Limited partnerships Limited partnerships are business creations by two or more persons. The partners are such that there are general and limited partners. Limited partners are not bound by financial obligation to the business but bound to contribute to the investment and creation of the business entity. According to Besley & Brigham (2008) the limited partners are like investor: the only connection is based on only their investment in the business entity. On the other hand, general partners conduct the daily operations. In this business formation, the limited partner is not exposed to the unlimited liabilities exposed to the general partner. General partners act as agents of the limited partnerships (Ray, 2001). The limited partners do not have partnership agent rights. Profit sharing in limited partnerships is defined by the contribution of both the limited and general partners. According to Pettet (2005) the continuity of limited partnership is dictated only by the general partners who have the right to dissolve the partnership. General partners in limited partnership may cause dissolution of the entity in case of death, retirement or dissolution of their ownership rights. Taxation is made on general partners and limited partners according to their income. Additionally, the business entity is also taxed depending on its general income and value. Ray (2001) points out that general partnerships are much convenient than limited partnerships since profit sharing is centralized is less paper work is needed. General partners in limited partnerships also dictate on the location of the entity. In words by Besley & Brigham (2008) limited partnerships engage in investment ventures. They further point out that this feature allows for the involvement of limited partners who act as investors. Apart from the normal professional partnerships, limited partnerships can be in form family partnerships where ownership is hereditary from parents to their children (Besley & Brigham, 2008). Like general partnerships, the income tax basis of the organization is based on the size of the organization in terms of profit returns. Profit sharing and retention are usually documented and bounded legally. Ray (2011) argues regardless of the form of partner, profit sharing is done depending on the contribution of the partner. The amount of profit given up by any partner goes to the business which increases the capital in the organization. All partners in the organization take part in the control of the business. However, general partners make all the decisions in the organization and control all operations. The continuity of the business is determined by the decision of the general partners. Termination of investment by a limited partner cannot lead to dissolution of the business. Regulatory requirements provide that all agreements in limited partnership are legally bounded as proof in case of misunderstanding and increase convenience. Legal provisions on limited partnerships (Ray, 2001) The limited partner cannot be active in the management of the firm The limited partner receives a specified amount of the profit Partnerships interests can be negotiated by the creditors Upon death the representative of the limited partner is entitled to the portion owned by the partner Advantages (Ray, 2001) Risks and losses are shared among members Capital contribution is also shared among the partners Investment by limited partners promote the continuity of the limited partnerships Disadvantages (Ray, 2001) Physical participation of limited members in limited partnership organizations may create inequality in specialization and division of labor Unlike sole proprietorships, individual property cannot be used as an asset in a limited partnership company Limited partners’ creditors may influence decision making processes C-corporation A C-corporation is a corporation that is separately taxed from its owners. These provisions are provided by the United States federal income tax law. Under this law, a corporation is determined on its form: C-Corporation or S-Corporation. However, the creation of a C corporation is the same as any creation of any other corporation. It depends on the provisions of the law in a specific location of the corporation (Besley & Brigham, 2008). A corporation is a business entity created by law and composed by individuals but under a common title or name. The setting of a corporation is in a way such that the corporation is not affected by the exit or demise of one individual. C corporations are traded in the stock market. Those that are not traded are referred to as closely held corporations (Ray, 2001). In C Corporation there is limited liability. The operations of the corporation are mostly controlled by stock holders who also elect board members. Taxation on C Corporations is only done under the company name excluding the owners. Additionally, stockholders are also taxed as partial owners of the business. However, this can be avoided if the shareholders leave the profit generated in the business. The decision of taxation in a C Corporation is done depending on the size of the corporation in terms of the returns profit the organization gets. The owners of the business entity control the organization, however, stockholders dictate most crucial decisions as they take part in open forums on decisions making. Board members make the final decision is C Corporations. The chairman of the board of members has the ultimate final decision making. However, stockholders have the most significance influence in the organization. Location in this form of business is done by the owners. The board members are elected by the stockholders: this displays the significance of the stockholders in the control of C Corporations. Another characteristic of C Corporations is that the organization is allowed to raise money by offering stock to new investors. Dissolution of a C Corporation can be made by either by a court decision, bankruptcy or owners and stockholders decide to sell the business entity. However, majority stockholders can stop the sale of the company and claim ownership of the company. The expansion of a C Corporation requires knowledge of the new location in terms of operating laws. Each location or state has specific requirements that an C Corporation must adhere to regardless of its registration state or location. Advantages (Besley & Brigham, 2008) The formation of the business entity is governed by law which makes its formation easier Personal assets are nor exposed to risks Capital and resource contribution are made by all the contributors Such business entities are exposed to investments more than partnerships and sole proprietorships Such an organization cannot be dissolved after the death Owners of the corporation are not taxed as part of revenue from the organization Disadvantages (Besley & Brigham, 2008) Formation and decision making are made complex by the legal requirements and the magnitude of contributors Profit generated is also invested in the business which stretches the profit sharing ratio Stocks can be easily transferred from one stakeholder to another which puts the continuity of a corporation at risk. S-Corporation This form of business is categorized in way such that the owners of the corporation are taxed. In this form of business, the owners of the corporation are taxed depending on their earning from the number of shares they own. For instance, a person owning 60% of the total shares will be taxed more than any other shareholder in the business entity. Additionally, the revenue generated by the entity is not taxed. Apart from the difference in taxation, S Corporations have the same characteristics as other corporations. According to Pettet (2005) owners of S Corporations are responsible for the revenues needed for the corporation to operate. All the expenses and losses are passed to the shareholders. Legally, the maximum number of shareholders is specified to 100 members only. Like any other corporation, S Corporations are controlled by the stockholders. Additionally, S Corporation owners have limited liability whereby their personal assets are not subject of compensation to creditors in an event of debt. Income generated in this business fm is shared among the shareholders. According to Pettet (2005) profit allocation to shareholders is determined by their contribution in the corporation. A shareholder has the right to transfer their shares. Additionally, in case a shareholder dies their spouse are entitled to ownership of their share. Owners of the S Corporation control most activities in the entity. However, shareholders have the right to take part in decision making processes involved in the business. The owners of the business need not to give other persons in the organization the power to control. Owners also dictate the location of the S Corporation. In generalizing on taxation of S Corporations, owners and shareholders are subject to taxation leaving out company and personal assets of the owners. In case of debts to creditors, personal assets can be subject to liquidation and attachment. In a partnership, a partner can be held liable for any dealings with a third party. Name of owners, loss and profit sharing ratio, name of business, capital of the business of the entity and the provisions in settling differences are the constitution of the legal provisions of S Corporations (Besley & Brigham, 2008) Like C Corporations, S Corporations also have different responsibilities in case of shift in location. The law in each state must be adhered to regardless of the state the business was registered in. however, the business does not need ne documents in order to operate in a new location. In S Corporations the convenience is based on the requirement by the organization to bind legally all agreements done in the company. This requirement is also a regulatory requirement. Advantages (Pettet, 2005) Expenses and losses are effectively shared thus minimizing the persona contribution of each owner The magnitude of financial risks the business entity is exposed to is greatly minimized There is a limited number of shareholders which minimizes unreasonable share transfer among shareholders Disadvantages (Pettet, 2005) The death of one partner may end the creation of the partnership The assets in the business can repay debts or losses Such business creation are prone to disagreements and complex legal creations are required There is no individual ownership of business assets Limited liability Company Limited liability companies have personal liability protection and tax benefits same as corporation. LLCs are owned by members. The owner limit is reduced to 100 (Ray, 2001). Unlike S-Corporations, LLCs does have limited ownership of shares. However, a member cannot transfer ownership without the consent of other members. Loss and profit sharing is not fixed as each member is obligated depending on their contribution in LLC. Owners of LLC can actively be part of the management. Taxation of LLCs is similar to that of corporations, partnerships and sole proprietorship (Ray, 2001). Continuity of LLCs can be through death of an owner, recognition or retirement. However, different countries have specific provisions on creation, running and maintain LLCs. A LLC Company should have a name which is registered under. In an argument by Ray (2001) an owner of a LLC can choose to be taxed either as a partnership, sole proprietorship, C Corporation or S Corporation as long as the LLC qualifies for such treatment. In some states, the creation of an LLC can be done by the involvement of only one person. Taxation is LLCs are determined by members who may chose to be taxed personally by their income based on their income or through taxation of their company. Additionally, personal taxation is done by income level and ratio of each member. The profit sharing ration depends on the contribution of each member. Members with larger investment receive greater portions of the profit generated. Members also deliberate on the location of the company. Advantages (Besley & Brigham, 2008) There is limited liability on personal assets LLCs are legally bound which minimizes the risk of unreasonable sharing and transfer of shares Members pay tax according to their share holding capacity. There is a limited number of shareholders which minimizes unreasonable share transfer among shareholders They is high attraction to investors and donors Disadvantages (Besley & Brigham, 2008) Complex legal formalities required for creating an LLC Such business creation are prone to disagreements and complex legal creations are required There is no individual ownership of business assets Company assets can pay debts in case of bankruptcy Memorandum The most effective business form that should apply in this particular case is the Limited Liability Company. A shift from a sole proprietorship to a LLC is not made complex since the owner may not need partners or co-owners. Applying a LLC formation may not require the involvement of other partners. This means that there will be no profit sharing. Additionally, the owner of this particular venture may choose the preferable taxation stipulation. Another reason for choosing an LLC is the fact that its expansion is not limited which may suit this particular venture whereby the owner has an objective of expanding the entity. The owner will also have limited liability which means that his personal assets will be protected from compensating debtors (Ray, 2001). Unlike partnerships, upon the death of the owner the existence of the business is not affected. After creating an LLC from this sole proprietorship, the owner may attract creditors and investors in this particular business venture which may be crucial in financing his expansion projects and providing insurance covers for his employees. This will address the owners concern about employees being exposed to risks while working. Additionally, in case of any exposure to risk an employee cannot be compensated by the owners’ assets. Additionally, the owner will have less record keeping and administrative paper work to work on. A shift from a sole proprietorship to LLC the business entity will be treated separately from members and the owner. In this particular LLC, the owner will be the only owners thus no much paper work is need in terms of creation on profit and loss sharing ratios. After the transformation, the owner should consider opting taxation as sole proprietor. This means that his personal assets will be excluded from taxation. However, the owner can also opt to be taxed as a corporation which may leave out taxation of company assets. The owner will also have the advantage of controlling the entire business entity. The creation of an LLC as the only member means that he will be the sole owners and controller of the business entity. References Besley, S. & Brigham, E. (2008). Principles of Finance. New York: Cengage Learning. Pettet, B. (2005). Company Law. London: Pearson Education. Ray, J. (2001). The Most Valuable Business Forms You'll Ever Need. New York: Sphinx Publishing. Read More