Business Ownership – Types, Advantages and Disadvantages

Published by: Madhubala Minda

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What is Business Ownership?

Business Ownership refers to the control that a business owner has over his organization. It includes the power to make decisions and dictate functions and day-to-day operations.

To define the term business ownership, one has to understand the numerous types of business ownership structures that are in existence.

The business owner can either start a new business where the control rests fully with him like in sole proprietorships or partially like in partnerships with them, franchise an existing business structure and obtain the rights to market the products of an already established and successful business entity or buy an already operating business structure that has an established client base as well as suppliers. The business owner can also take the help of financial advisors and financial accountants to ask related questions

Different Types of Business Ownership for Small Business Owners

Types of Business Ownership

Ownership structure, business type or business entity are synonyms of each other with the same meaning. It indicates the business structure, who the business owner is, how the business shall be taxed and who is responsible for the business liability, and whether personal liability will be on line for the business debts that the business incurs

The different types of business ownership for small businesses are as follows

1. Sole Proprietorship

What is a Sole Proprietorship?

One of the most simple, common and popular types of business ownership for small businesses is the sole proprietorship business structure. It is a business owned by a single person who is referred to as the sole proprietor. The business does not have a separate legal entity from the business owner who is personally responsible for day-to-day operations and all business debts.

In the sole proprietorships, it is the sole proprietor who has complete control over the business and receives the business profit

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Advantages of a Sole Proprietorship

1. Inexpensive

Sole proprietors do not have to pay legal fees to start a sole proprietorship business

2. Simplicity

A sole proprietorship has a simple legal structure where the sole proprietor is not required for filing paperwork of the new business

3. Complete Control

Sole proprietors have complete control over day-to-day operations

4. Pass-Through Taxation

In sole proprietorships, the business owner does not have to file an extra tax form as it is not taxed separately. Business losses can be deducted from the personal tax returns and business profits from the sole proprietorship pass through to the personal income of the business owner. As a pass-through taxation entity, the sole proprietorships are eligible for a 20% QBI deduction

Disadvantages of a Sole Proprietorship

1. Unlimited Personal Liability

In the sole proprietorship business the monetary obligations of the business or the business debts are the owners personal liability. Unlimited liability also includes personal assets of the owner

2. Legal Liability

The owner of a sole proprietorship has legal liability for business debt which are considered as his personal liability

3. Access to Funding

It is harder for sole proprietorships to raise money and gain access to loans and investments

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2. General Partnerships

What is a General Partnership?

A General Partnership has a similar type of business ownership legal structure to the sole proprietorship except it has more than one business owner and multiple employees. If a person is committed to a business venture without creating a legal entity his structure becomes a partnership by default. A formal partnership agreement is necessary for partnership business structures as it outlines the ownership obligations, rights and shares of each partner

Advantages of General Partnerships

1. Easy to Start

A partnership agreement can start even verbally with a handshake although it is recommended to create a formal partnership agreement to avoid any future disputes

2. Pass-Through-Taxation

The tax situation is similar to that of the sole proprietorship as the income is passed based on their share of ownership or as decided through the partnership agreement. The partners can deduct their business losses from their personal tax return

3. Investments

Investors are interested in investing money in a partnership firm

4. Liability Protection

There is a separate legal status to provide liability protection

Disadvantages of a General Partnership

1. Liability Risk

A general partnership works similar to a sole proprietorship where business partners are both jointly and personally liable for the actions of each partner and all the business debt. Personal assets of the partners are also included in the liability risk

2. Lack of Control

As there is more than one partner it becomes difficult to have full control over the business decisions. The decision-making is mostly dependent upon the partnership agreement which explains how and by whom every aspect of the new business is to be handled

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3. Limited Partnerships

What are Limited Partnerships?

Limited Partnerships are business ownership structures with at least one silent partner who is not involved in the daily operations of the business. The silent partner can invest money but is not eligible for making business decisions of the legal entity.

Advantages of Limited Partnership

1. Limited Liability

The silent partner in limited partnerships has limited liability as he cannot be held personally liable for any amount that is greater than his investment in the company

2. Durable Partnership Structure

It is easy for the silent partner to leave the firm without harming the entire limited partnerships structure

3. Tax Options

Limited Partnerships are considered pass-through-taxation entities although their tax treatment varies by state

Disadvantages of Limited Partnership

1. Expensive

Limited Partnerships are expensive as the owners have to file paperwork with the state and pay associated legal fees

2. Uneven Distribution of Liability

In limited partnerships, the risks liability and responsibility are not distributed evenly

4. C-corporation

What is a C-corporation?

A C-corporation is one of the business ownership structures that is legally separate from the owner. The business can borrow money, enter a contract, own property and even start a lawsuit. A corporation is owned by the shareholders and is formed by filing articles of incorporation with the state.

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Business income and profits belong to the corporation and are subject to corporate income tax. The profits can be distributed to the shareholders through dividends.

Corporations by default are C-corporations and they are called so because they are taxed under Subchapter C of the IRC. These are not pass-through entities like the sole proprietorships, partnerships, and LLCs.

Advantages of C-corporations

1. Limited Liability

C-corporations unlike partnerships and sole proprietorships have legal separation from the owners and are thus legally responsible for themselves. In case the corporation faces a legal lawsuit the owners are not personally liable for the financial settlement

2. Self-employment Taxes

Shareholders who work in the business are taxed as employees, exempting them from self-employment tax

3. Tax advantages

C-corporation is eligible for more tax deductions than other business structures

4. Access to Capital

It is easy for a corporation to access capital as they can make unlimited stock offers to investors, businesses or individuals

Disadvantages of C-corporations

1. Corporate Taxation

The corporate profits are subject to corporate taxation

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2. Double Taxation

Corporate profits of corporations can be taxed twice (double taxation) as the first tax is on profits and the next on dividends

3. Less Control

The business owner is spread among the shareholders and the governing authority is held by the board of directors hence there is less individual control of the business

4. Complex and Expensive

Corporations are more complex and expensive to form than the sole proprietorships, general partnerships and limited partnerships

5. Regulatory Oversight

Corporations have to face greater scrutiny than Limited Liability Company (LLC) as they have to disclose information like legal documents and earnings annually to shareholders and sometimes to the public

5. S-corporation

What is S-corporation?

An S-corporation is a business ownership legal structure with not more than 100 shareholders or limited partners and with permission of issuing only one class of stock. Only trusts, certain estates, individuals and specific tax-exempt organizations can own shares in the S-corporations.

S-corporations does not have to pay federal income tax as both profits and earnings are treated as distributions. The shareholders have to report their business income on personal income tax returns. The S-corporations are created to enjoy the benefits of pass-through taxation and avoid the issue of double taxation.

Advantages of S-corporations

1. Limited Liability

Owners personal liability for business debts and legal obligations is limited hence he is not personally liable for business obligations

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2. Access to Funding

It is easy for S-corporations to attract funding from investors

3. Pass-Through Taxation

S-corporations are eligible for a pass-through tax process that can minimize the tax burden of both the business and shareholders. Business profit and some losses can pass directly through personal income without paying corporate tax

Disadvantages of S-corporation

1. More Paperwork

Starting an S-corporation requires filling out extra paperwork for S-corp status

2. Expensive

The paperwork requires extra resources and time and thus proves expensive

3. Complex

Corporations have to report earnings and other information to the shareholders

4. Limited Ownership

This type of entity can be owned only by U.S. citizens

5. Limited Eligibility

An S-corporation will have to meet the set requirements to qualify for the S-corp status

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6. Restrictions on Selling Stock

S-corps have limits on issuing stocks hence it is better to check the Federal and State laws before opting for an S-corporation business ownership legal structure

6. Limited Liability Company LLC

What is a Limited Liability Company (LLC)?

LLC is a legal entity that can be formed by filing articles of organization with the secretary of state and creating an LLC operating agreement. It is one of the popular business ownership structures for small businesses as it retains several benefits of sole proprietorship while limiting legal and financial liability. The owner is not personally liable for the business.

Advantages of Limited Liability Companies

1. Limited Personal Liability Risk

The owner of an LLC is not personally responsible for business liabilities as it draws a line between business and personal assets. The personal bank accounts and personal property of the owner are not at risk

2. Active Ownership

LLCs can be owned by two or more members with as much control and involvement as they like

3. Tax Options

An LLC is a pass-through entity that is eligible for a 20% QBI deduction. It also has additional flexibility of allowing the members to pay corporate tax

Disadvantages of Limited Liability Companies

1. Complexity

LLC owners have to file the articles of formation with the state. The owner has to attend to the ongoing regulatory paperwork and hire a registered agent to file periodic reports with the state

2. Administrative Costs

State filings cost money and the owner has to dish out extra money for financial and legal guidance

7. Nonprofit Corporation

What is Nonprofit Corporation?

Nonprofit organizations are formed as corporations and have to file the articles of incorporation with the secretary of the state. This type of ownership structure applies to tax-exempt status specified under Section 501(c) of the Internal Revenue Code (IRC). Non-profit organizations can generate profits but the business income has to be reinvested in the charity operations

Advantages of Nonprofit Corporations

1. Liability Protection

Nonprofit corporations protect owners from personal liability just like other corporations

2. Tax Exemption

Nonprofit corporations are eligible for tax-exempt status from local, state and federal taxes.

Disadvantages of Nonprofit Corporations

1. Limited Activities

Activities of Nonprofit corporations are limited to charitable purposes

2. Limited Access to Funding

Nonprofit corporations are dependent upon donations and grants to fund their charitable operations

3. Increased Regulatory Oversight

Nonprofit corporations have to undergo set registration and reporting of legal documents at both state and federal government

8. Benefit Corporation

What is Benefit Corporation?

Benefit Corporations are business structures formed as corporations to earn profits as well as serve a public benefit.

Advantages of Benefit Corporations

1. Limited Liability

A benefit corporation will limit the liability of a shareholder for financial and legal obligations

2. Access to Funding

This type of business ownership benefits from investor capital to accomplish their social causes

3. Profit Distribution

A Benefit Corporation can distribute profits as dividends to their shareholders

Disadvantages of Benefit Corporations

1. Corporate Taxes

These structures are subject to federal corporate income tax

2. Increased Regulatory Oversight

Business owners will have to report the financial and social impact to the shareholders annually

3. Varying Regulations

Benefit Corporations are available in 35 states in the U.S. with varying regulations

How To Choose the Best Business Structure for Small Business

Best Business Structure

It is a bit difficult to select the best business structure without gathering information about all the other business structures in existence. Important questions at this point are will the business liability have an impact on personal liability, how much money will the business owner save after paying taxes and how to conduct daily operations

Before choosing the business ownership structure for their businesses the would-be owners should ask themselves questions related to the following headings

1. Ownership Control

Ownership control is one of the important aspects of a business and it is prudent to decide beforehand how much control an owner wants. Does he want to take all the decisions by himself then the sole proprietorship structure is best for him or does he want to co-own a business like a partnership and share control like in an LLC or opt for stock corporations

2. Business Taxes

Taxes are an integral part of every business and the owner needs to deliberate about the structure and identify the tax bracket he will have to face later on. Also, look at the corporate and personal tax return rates and how the options impact the bottom line.

Some business ownership like sole proprietorship and partnership are designed as pass-through entities that allow the owner to claim business profits and losses on personal tax returns whereas some structures are taxed separately and some are eligible for double taxation. LLCs are a great option for owners who are looking for limited liability protection.

3. Personal Liability and Risk

Before starting a business ask yourself whether you are ready to put your personal assets and property on the line. Sole proprietorship and partnership structures make the owner personally responsible for financial losses suffered by the business whereas a corporation and LLC have a limited liability risk

4. Investment of Time and Money

Business ownership like a sole proprietorship is easy to start and maintain whereas there are others like corporations and LLCs that demand a lot of time and effort. Be sure how much time and money you are ready to invest as an owner

5. Length of the Business Structure

What about the future of the business is an important question that needs to be addressed by the owner. Do you want it to be a separate entity from yourself, are you forming it intending to sell it or do you want to preserve it for the next generation?

After addressing the above-mentioned questions, it becomes easier to find the right fit in terms of business ownership and decide whether it is sole proprietorship, partnership, corporation, limited liability company or any other type of business ownership structure that is meant for you

Conclusion

Business ownership is all about finding the best possible option and forming a company that will help you to make your dreams come true. It is a personal choice of the owner no doubt but must also be practical so that there is the least number of hassles in the future.

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Madhubala Minda

Madhubala Minda is a content writer for Digiaide. She writes unique and research-driven content on various Brands, Competitors, Management topics and wellness. With years of content writing under her belt, Madhu Bala is one of the strengthening pillars of Digiaide content team.