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You Need to Know these 3 Things Before You Start a Business

January 22, 2018

One of the most important decisions in the planning process is choosing a form of business organization. There are three types of business organizations: sole proprietorships, partnerships, and corporations. These determine how the business can raise money, what risks the owners must bear, and how the business will be taxed. The following explains the basic pros and cons of each.

 

Sole Proprietorships

Sole proprietorships mean that there is one owner and they operate the business for their own profit. Common examples are are carinderias, sari-sari stores, bike shops, and small salons or barber shops.

This form of business is for those who want to run their business. It is the easiest form of business to set up as there are less requirements and legalities compared to partnerships and corporations.

A big drawback to this type of business is that the owner has unlimited liability, which means that lenders can make claims against the owner’s assets to recover debts owed by the business.

 

Partnerships

Partnerships are businesses owned by two or more people. This is formally established by the articles of partnership, a written contract containing the agreement of the partners.

Common examples are law firms, finance institutions, accounting offices, insurance agencies, and real estate firms. Their services usually cover a small town up to an entire city.

Due to the size and more number of owners, partnerships can raise more funds than sole proprietorships. They can also borrow more money from banks and other financial institutions compared to sole proprietorships.

However, like sole proprietorships, the partners of a business have unlimited liability and are expected to cover the debts of other partners if necessary. Partnerships must be registered in the Securities and Exchange Commission (SEC), and those with Foreign Equity must also accomplish Form F-105 and present Proof of Inward Remittance to the SEC.

 

Corporations

The owners of a corporation are called shareholders or stockholders. There are two types of corporations: stock and nonstock. Stock corporations are for profit entities while nonstock corporations are not for profit.

Unlike the two types previously discussed, the owners of a corporation have limited liability. This ensures that the maximum amount they can lose is only the amount that they have invested in the company. Other benefits include a long life, transferability of ownership, and an easier time of raising money due to their high level of access to banks, and financial markets, like the stock market.

As with all things, however, the corporation type of business also has its cons. As the largest business type, the government requires more from corporations. Regulations make corporations more expensive and difficult to set up. Taxes are also generally higher for corporations since both corporate income and dividends paid to shareholders are taxed. A publicly listed corporation’s finances may also have privacy issues since they are required to release financial statements to the public.

Like partnerships, corporations must be registered at the Securities and Exchange Commission. A corporation must consist of not less than five (5) and not more than fifteen (15) incorporators, each of which must hold at least one share to be considered a corporation. Corporations can only exist for a period lasting fifty (50) years, unless extended.

 

Which one of these three fits your business best?

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Source: Principles of Managerial Finance Gitman & Zutter, 13th Edition

 

Summary:

Business Type Pros Cons
Sole Proprietorship
  • Easiest to set up
  • Least capital needed
  • Best form for a small and/or fledgling businesses
  • Limited growth.
  • Owner has unlimited liability.
  • Borrowing power is dependent on the owner.
Partnership
  • Easier to set up than a corporation
  • Best form of business for people in the same line of business like accountants and lawyers
  • Generally has more borrowing power than sole proprietorships
  • Partners have unlimited liability and are expected to cover the debts of their partners if necessary.
Corporation
  • Have the greatest amount of borrowing power
  • Has other sources of income like issuing shares of the company
  • Owners have limited liability
  • In rare cases, corporations can be bailed out by governments in case of bankruptcy
  • Hardest to set up.
  • More requirements and regulations than the other two.
  • Are charged higher taxes than the other two.