So you are thinking about starting a business – what are your options? In this article we will discuss the five main types available to individuals and groups:
|Partnership||Limited Liability (LLC/LLP)|
So let’s begin by first covering some basic terminology from the leading MBA textbook used at universities Fundamentals of Financial Managment (Amazon Best Seller)
- Finance addresses how resources are gathered, allocated, and managed by individuals, organizations, and governments.
- Corporations are entities that are legally separate from mangers and in almost all cases are authorized by the state or government to conduct business.
- A treasurer is responsible for managing an organizations cash, investments, funds, and risks.
- In a limited liability organization, an investor is personal responsibility for liabilities can never be less than zero. Additionally, it can never be more than the amount invested in the common share (if applicable).
- In a limited partner organization, the individual who is a member has the right of not having personal assets at risk in the event of failure or issues with the other partners.
- Maximizing Shareholder Wealth – this is typically a goal of management and is measured by the effect of a decision, project, or action on the price of the firm’s common stock. If the company is private, there are no shareholders.
- Value in finance regardless of whether it is a corporation or partnership, represents the current worth of the future cash flows generated by the company. It is then discounted at a rate appropriate for the potential risk of said assets.
A proprietorships is most notably unincorporated and owned by one individual. This is the easy form of business to go into, they are inexpensive to form, subject to few government regulations and have lower income taxes (as compared to corporations). That being said, three disadvantages still exist and most notably is unlimited personal liability. In short, you can lose more than the amount of money you invested in the company
For example, you can invest $10K in your business but can also be sued for $1M in the case something happens!
Secondly, your business is limited to the life of who starts it and you are required to change the structure of the company every time you bring in new equity. Lastly, it is extremely difficult for these businesses to raise large sums of capital. Given these well-known disadvantages, industry experts typically recommend proprietorships be used primarily for small businesses.
A partnership is a legal arrangement between two or more people who want to do business together. They are very similar to proprietorships in that they are easy and inexpensive. Additionally, the income of your business is on a pro-rata basis aka partners are ONLY taxed as individuals allowing you to avoid corporate income tax. That being said, all the partners are often subject to unlimited liability.
Say for example the firm goes bankrupt, and one partner is not able to pay their share of the debt. The other partners will then be responsible for making good on any unsatisfied debt.
So make sure you trust who you go into business with!
As mentioned above in our terminology, corporations are legal entities registered with a state and separate from owners and managers. This has an advantage say in the event a corporation loses all its money. The owners can lose only the funds they invested in the company. Additionally, corporations have unlimited lives, have ease of transferring shares of stock and also have a much easier time to raise capital for operating the business.
While everything sounds good so far, there are disadvantages. Most notably, taxes. Corporations are subject to double taxation of both the money they earn and any earnings paid out as dividends. Stockholders are then taxed as personal income. But, the government in it’s in “pro business” agenda created what is called an S Corporation to help. In these cases, the business is taxed as if it is a proprietorship or partnership. The requirement to filling as an S Corporation is you must have no more than 100 stockholders so these are typically small, privately owned firms.
Limited Liability Company & Partnership (LLC/LLP)
In LLCs, an organization is a hybrid between a partnership and a corporation. LLPs are similar in nature but are mainly professional firms such as law, accounting, and real estate. Both organizations are taxed as partnerships but unlike a general partner (who has full control in a partnership) an investor in LLCs/LLPs have power in proportion to their ownership. These types of entities are very popular in the modern day but still suffer from the disadvantage of raising capital to support growth. Also, they are often structured with heavy legal jargon and their protections vary by state.
So as you begin your journey into your business, or want to walk away with additional information, we highly recommend you check out the preferred text for business schools. We have also provided you with a summary chart below. Enjoy!
|Proprietorship Partnership/LLC/LLP||*Ease of formation|
*Subject to few regulations
*No corporate income taxes
|*Difficult to raise capital|
*Easy transfer of ownership
*Ease of raising capital
*Cost of setup and report filing