Introduction
Organizations review the market to identify various forms of business that they can adopt. The organizational form is directly related to various business-related functions and issues (Padgett & Powell, 2012). It should be noted that there are seven key categories of business characteristics. The key categories of characteristics include liability, income taxes, longevity or continuity of the organization, control, profit retention, location, and convenience or burden. In the US, businesses can be organized into the following legal forms including Sole proprietorship, General proprietorship, Limited Partnership, C-Corporation, S-Corporation, and Limited Liability Company (Padgett & Powell, 2012; Cakirer, 2007).
Discussion
Sole Proprietorship
A sole proprietorship does not require a business to be incorporated, and a single individual owns it. It is entirely up to the individual if he wants to run a business on his own or if he wants to run a business with the help of a team. He can hire a workforce that can work for him and operate a business. However, it should be noted that policies, decisions, and management of the company or organization are in the hands of a sole proprietor (Padgett & Powell, 2012). He performs major functions and monitors sales, operations, and finances of the organization. Furthermore, no legal work such as agreements or paperwork is required as the sole proprietor owns the business alone (Sitarz, 2011).
Sole proprietorship represents the easiest and simplest way of setting up a business. In the United States, there are as many as 17 million registered sole proprietorships. The figure represents almost 73% of the total businesses in the country. The number of sole proprietorships is increasing every year as this form is the easiest way to start a new business by individuals (Cakirer, 2007). According to a survey, more than 90% of sole proprietorships are single / one-individual-run businesses or operations. The remaining 10% of sole proprietorships operate with a small workforce. Sole proprietorships that have more than eight employees are less than 8% of the total (Sitarz, 2011).
Key Characteristics
The key characteristic of a sole proprietorship is that the business is relatively small, which is established by a single person’s capital investment. Another important characteristic is the unshared responsibility of the organization/business held by the sole owner as he is the only person looking after it (Cakirer, 2007; Sitarz, 2011).
Advantages
There are numerous advantages of a sole proprietorship. Simplicity is the most important and common advantage of a sole proprietorship (Padgett & Powell, 2012). It is very simple and easy to start a sole proprietorship as it requires limited legal work related to licensing, local permits, etc. Another key advantage of a sole proprietorship is its autonomy. It is the basis for this organizational form. Some other advantages include sole profit, single tax, shelter income, etc. (Sitarz, 2011).
Disadvantages
There are certain disadvantages of sole proprietorships. Firstly, a sole proprietor has limited resources as he is the only one to invest. Secondly, unlimited and unshared liability is a major drawback of this form. Thirdly, if the sole proprietor dies then, the business also ends with him (Sitarz, 2011).
Sole proprietorship limits the benefits of the organization or sole owner. For example, the sole owner has limited liability, and there is no longevity of the organization as it will finish as the person dies. Similarly, it is going to be difficult for a sole owner to expand the business in other locations as he is the only person who has control and power. However, there is no extra burden on the organization as there is a single income tax applied to this form of business (Sitarz, 2011).
General Partnership
Unlike a sole proprietorship, two or more two individuals combine their capital, resources, and capabilities to share profits from the business. There are certain laws such as the Uniform Partnership Act that define partnerships in the United States (Morse, 2010). At present, more than 1,350,000 partnerships are operating in the United States. The most common partnership is the commercial partnership. Other types of the partnership include professional partnerships that are implemented in the field of law and medicine (Morse, 2010).
Advantages
All partners of a business have equal authority over organizational affairs. Similarly, they share profit and loss from a business based on an agreed percentage. Furthermore, partnerships are not subjected to individual income tax laws (Morse, 2010).
Disadvantages
Unlimited personal liability is a key drawback as if one partner dies then, the entire debt or liability burden of the organization goes into the account of the other partner or partners (Morse, 2010).
All partners have protection from their liabilities as their assets and capital are limited and shared. Similarly, the business is exempted from individual income tax. The business has longevity as if one partner dies the other one can continue the business (Cakirer, 2007). All partners have control over the entity. The business can be easily expanded to other locations as partners can share business operations and activities. The workload is divided among all partners (Morse, 2010).
Limited Partnership
Limited Partnership is another type of partnership. According to the Uniform Limited Partnership Act, a Limited Partnership can be defined as, a partnership formed by two or more persons having as members one or more general partners and one or more limited partners. The limited partners as such shall not be bound by the [financial] obligations of the partnership beyond the extent of their investment’ (Padgett & Powell, 2012).
In a limited partnership, one partner (general partner) holds the responsibility of the business and the other (limited partner) only invests in the business. Furthermore, a limited partner is exempted from any financial obligations, and he is not legally liable for any other issue. His liability is directly proportional to the amount of capital that he invests (Padgett & Powell, 2012). Similarly, he does not have any rights related to the management of the organization or operations of the business. In other words, it could be said that a limited partner is just an investor in the business (Morse, 2010).
It should be noted that limited partners are considered more as investors than partners. According to many financial analysts, limited partners are investment vehicles. They just invest/put their money into a business or enterprise and do not have any responsibility regarding its day-to-day management or operations (Morse, 2010).
The overall purpose of limited partnership is to allow a person with financial resources to experience the business world through a partnership with others while not being liable to any of the responsibilities imposed on general partners. In such a case, even if the business fails then, a limited partner will lose only the amount he invested in the business (Cakirer, 2007).
Advantages
A limited partner only invests in the organization and is free from all the responsibilities and day-to-day management and operational activities of the business. The organization is not taxed as a corporation. The limited partners are free from any liabilities and if the business fails they will only lose the capital they invested and no more than that (Padgett & Powell, 2012).
Disadvantages
The limited partners do not have the right to participate in decision-making. They do not have any authority over the operations of the business. It could create fear among limited partners as decisions made by general partners could be wrong, and they could incur major losses (Morse, 2010).
In limited partnerships, both general and limited partners have equal liabilities of the business and no additional burden is placed on any partner. It suggests that a limited partner does face any compliance issues over the operations or day-to-day management of the organization. The decisions are made without his compliance. If the business is not considered a corporation then, it is free from income tax. Talking about profit retention, limited partnerships’ profit directly goes to the partners. However, the amount of share each partner receives depends upon the capital that was invested by the partner or it may also vary depending upon the clauses mentioned in the initial partnership agreement (Padgett & Powell, 2012).
It should be noted that in limited partnerships there is a longevity issue related to the continuity of businesses. If one partner dies then, it may hurt the business and can close it permanently (Cakirer, 2007). On the other hand, the factor of location remains crucial as different organizations and states have different reactions to such partnerships. In general, a limited partnership is considered as an organization and almost every state has the same law and principles regarding it. If partners plan to expand or move their business to some other state then, they do not have to redraft legal documents, etc. (Cakirer, 2007; Morse, 2010).
C-Corporation
A corporation is created under the law, and it is indiscernible and indefinable. The ‘for profit’ organizations that are named after the subsection ‘C ‘of the Internal Revenue Code are known as C-Corporations. According to the United States Federal Income Tax Law, C-Corporations are taxed disjointedly from their owners. It is the main difference between a C-corporation and an S-Corporation. Unlike publicly held corporations, C-Corporations are not listed on the stock exchange. Furthermore, owners closely hold C-Corporations. It is noted that the majority of small enterprises and organizations in the United States are considered as C-corporations for income tax (Mancuso, 2012).
Advantages
There are numerous advantages of C-Corporations. For example, C-corporations have limited liabilities for their workers, stakeholders, directors, etc. They have improved credibility between vendors and suppliers. Furthermore, owners enjoy certain tax advantages as tax rates applied to this form of organization are low as compared to other forms of business. Such a form of business provides great benefits to the owners. Moreover, it has high audit potential as compared to the pass-through entities (Padgett & Powell, 2012).
Disadvantages
Some of the significant disadvantages include double taxation of valuable assets upon sale or termination. Moreover, if the annual income of the corporation exceeds $75,000 then, high-income tax rates are applicable. Furthermore, tax traps are also present for collective profits and personal holding companies (Padgett & Powell, 2012).
C-Corporations have better longevity as compared to partnerships as they do not end if a partner dies. They can continue to operate forever. Thus, C-Corporations have comparatively longer lives unless the owners convert the business to S-Corporation. Similarly, the profit retention of such organizations is also high. It is because these organizations have fringe benefits and owners will only be taxed for the company’s income. Furthermore, in comparison to a sole proprietorship or partnership C-Corporations can easily sell their shares and can raise additional capital through equity markets. The liability of C-Corporation is not at stake as it is a for-profit organization.
The control of C-Corporations is in the hand of their owners, directors, or shareholders. They directly monitor and operate companies and take important decisions regarding the operations of their businesses. However, if one owner holds a majority of shares then, he has the maximum power to overrule any decision made by directors. C-Corporations continue to operate unless owners decide to close down their businesses or to convert them into S-corporations (Mancuso, 2012).
It should be noted that compliance in making decisions is acquired from all shareholders and key personnel of C-Corporations as they are important players of the organization. Their consent is of vital importance and decisions are made with their compliance only. Therefore, it could be stated that all owners share the responsibility of the business. Since laws about C-Corporations are similar in the United States, and everyone can open a C-Corporation therefore, it is not difficult to move or expand C-Corporations in other states. Therefore, it could be stated that C-Corporations can be located anywhere in the United States (Mancuso, 2012).
S-Corporation
S-Corporations are another type of for-profit organization that is quite similar to partnerships. For example, taxation issues of partnership and S-Corporations are similar (Mancuso, 2012).
Advantages
S-Corporations protect the assets of shareholders. Similarly, the pass-through taxation policy allows such organizations not to pay federal taxes as the characterization of income is tax favorable. The transference of ownership is simple and straightforward (Mancuso, 2012).
Disadvantages
It is difficult and expensive to establish S-Corporation as it is essential to file and incorporate the business through a strict legal framework. Furthermore, tax qualification compulsions may result in the dissolution of such corporations. S-Corporations are also limited to stock ownerships (Mancuso, 2012).
It has been discussed that the liabilities of such organizations are protected, and corporations do not pay federal taxes. Similarly, these organizations have a longer life span. The control of S-Corporations is in the hands of its shareholders. The profit is equally distributed between shareholders. Therefore, these organizations do not impose any threat on shareholders’ return on investment. To expand, S-Corporations can be moved or opened in any part of the country or state (Mancuso, 2012).
Limited Liability Company
Limited Liability Company (LLC) is an important type of organizational form. All states of the United States allow LLCs. In recent years, there has been rapid growth in this form of business setup. The LLC set up combines concepts of other forms of organizations such as C-Corporations, S-Corporations, etc. Unlike other organizations, owners of these companies are known as members (Mancuso, 2012).
Advantages
LLCs have more advantages as compared to other forms of organizations. They can be considered as corporations, sole proprietorships, or partnerships depending upon their registration terms, and they may be exempt from federal taxes. There are no wages paid to members. Furthermore, the allocation flexibility allows members to set profit-sharing levels in legal documents that are different from their initial investment documents (Padgett & Powell, 2012; Mancuso, 2012).
Disadvantages
The death of any member may cause the dissolution of the LLC. Moreover, self-employment tax applicable to this form of business is also considered a major disadvantage (Mancuso, 2012).
The liability of the company is limited as LLC members have limited ownership. However, it should be noted that the financial liability of the LLC member is limited. These companies are free from federal taxes, and they have a longer life than sole proprietorships. The control is divided equally between members. Shareholders can share profits on an equal basis. Therefore, profit distribution has no impact on the return on investments. Similarly, the liability burden is also divided among members of the LLC (Mancuso, 2012).
The factor of compliance is also very important for LLCs. As their control is divided equally among members, members take decisions after consent and approval are obtained from all members. It suggests that the important decisions of a limited liability company are made in compliance with the members of an organization. If a limited liability company wants to move or expand then, it can easily do so as various federal and state law setups support and guide members throughout the process. However, the closure of an LLC could be due to the death of one of the members (Mancuso, 2012).
Memorandum
To: Management of a manufacturing company
From: Business Consultant
Date: September 17, 2014
Subject: Recommendations for organizational setup
The sole proprietor currently deals in a variety of wood moldings, and his business is expected to generate yearly revenue of $600,000 before taxes. Keeping in view the company’s profitability and the possibility to expand in another U.S. state, the owner of the organization aims to change the organizational form of his business. The current owner of the business has the following objectives based on the identified risks and issues.
- The business requires additional capital for expansion.
- The business aims to limit its exposure to potential liabilities from its operations.
- The owner aims to have limited liability in the case of a business closure.
- The owner is concerned about the control of the business.
These objectives are addressed by considering different organizational forms and recommending the most appropriate form.
- A general partnership is not appropriate because it does not limit liability if one of the partners dies. The entire burden is transferred to the surviving partner.
- A limited partnership is not appropriate because the general partner holds the responsibility of the business obligations and the limited partner cannot participate in the decision-making process (Padgett & Powell, 2012). If one partner dies then, the business will have to close down. Also, the control of the business is not equally shared.
- C-Corporations have limited liabilities for workers and owners. Additional capital can be raised through the equity market, and the control of the business remains in the hands of its owners.
- S-Corporations offer similar advantages as C-Corporations, but they are expensive to register and require strict reporting standards.
- LLC has limited liabilities for owners but if one owner dies then, the company is dissolved.
It is recommended that the owner should consider C-Corporation as the organizational form. It will allow the owner to raise additional capital for a business expansion. Furthermore, it will restrict his liabilities that may arise from potential risks. The control of the business will remain with the owner of the business. There is no issue of longevity in this form of business, and the business allows higher profit retention.
References
Cakirer, K. (2007). An Equilibrium Theory of organizational forms: A complimentary Market Analysis. New York: ProQuest.
Mancuso, A. (2012). LLC or corporation?: How to choose the right firm for your business. Berkley: Nolo.
Morse, G. (2010). Partnership law. Oxford: Oxford University Press.
Padgett, J. F., & Powell, W. W. (2012). The emergence of organizations and markets. Princeton: Princeton University Press.
Sitarz, D. (2011). Sole proprietorship: Small Business Start-Up Kit. London: Nova Publishing Company.