Unit 1, Lesson 2 Legal Forms of Business Ownership AOF Applied Finance

Sole proprietorship: Going it alone Characteristics: Typical size: Very small A single individual owns and operates the business The “sole proprietor” is the owner of a sole proprietorship The sole proprietorship can hire employees, but the owner cannot be an employee Typical examples are small shopkeepers, artists, craftspeople, carpenters, consultants, and writers A potter is likely to be a sole proprietor.

Sole proprietorship advantages and disadvantages Advantages: Simple and inexpensive to create and operate Least regulated of all business forms All profits are reported on the owner’s personal income tax return Disadvantages: The owner is personally responsible for all actions of the business The owner is personally liable for all business debts

General partnership: Sharing the responsibility Characteristics: Typical size: From two individuals to a large firm with many partners The partners run the business but may not be employees of it There is slightly more regulation than for a sole proprietorship The owners sign a written partnership agreement about how to run the business What options might someone have if he no longer wanted to work with his partners?

General partnership advantages and disadvantages Would you become business partners with a friend? What qualities would you want your partner to have? Advantages: Simple and inexpensive to create and operate All profits are taxed as personal income to the partners Disadvantages: All partners are responsible for any actions taken in the name of the business by all other partners All business debts are the personal responsibility of the partners

Corporation: Putting up a wall Characteristics: Typical size: Ranges from one or two stockholders to millions of them The corporation can hire employees, which may include the owners In the eyes of the law, a corporation is treated like an individual: It can own property It can be sued It must file a tax return Forming a corporation is like putting up a wall between the business and its owners’ personal assets. Why would the law give corporations some of the same rights as individuals?

Corporation advantages and disadvantages Advantages: Corporation owners are not responsible for the actions taken by the business Debts are not the responsibility of the owners (limited liability) The business can sell shares (stock) in the business to the public in order to raise capital Disadvantages: Legally complex to start and operate One of the two most regulated business forms (the limited liability company is the other) Profits are taxed twice - once as corporation income, and again as investor income

Limited liability company (LLC): Bridging the gap Characteristics: Typical size: small to mid- sized businesses LLCs combine some aspects of a partnership and some aspects of a corporation Like a corporation, an LLC is treated as an individual for purposes of ownership and legal standing, but it is not taxed at the higher corporate rates

LLC advantages and disadvantages: Advantages: LLC partners have more flexibility to allocate profits and losses Debts are not the responsibility of the partners (limited liability) An LLC can choose to be taxed as the property of the owners (like a partnership) or an individual (like a corporation) Disadvantages: Like a corporation, an LLC is governed by complex laws The owners of an LLC normally can’t be employees When a partner dies, the LLC is dissolved

Responding to changing conditions What conditions might raise the risk of personal liability? Whichever legal form you choose at the start of your business, it doesn’t have to be permanent This possibility should be part of your long-range business planning and strategy