Questions

1. Explain the advantages and disadvantages of sole proprietorships and partnerships?

2. Describe the similarities and differences between C corporations and S corporations
3. Understand the characteristics of a limited liability company.
4. Explain the process of creating a legal entity for a business

Answers
1. Advantages and disadvantages of sole proprietorships and partnerships
Advantages of Sole Proprietorships
SIMPLE TO CREATE One of the most attractive features of a proprietorship is how fast and
simple it is to begin. If an entrepreneur wants to operate a business under his or her own name.

LEAST COSTLY FORM OF OWNERSHIP TO BEGIN In addition to being easy to begin, a

proprietorship is generally the least expensive form of ownership to establish. There is no need to
create and file legal documents that are recommended for partnerships and required for
corporations.

PROFIT INCENTIVE One major advantage of proprietorships is that once owners pay all of
their companies’ expenses, they can keep the remaining profits (less taxes, of course). The profit
incentive is a powerful one, and profits represent an excellent way of “keeping score” in the
game of business. Sole proprietors report the net income of their businesses within their personal
tax form on Schedule C of IRS Form 1040, and the amount is taxed at the entrepreneur’s
personal tax rate.

TOTAL DECISION-MAKING AUTHORITY Because the sole proprietor is in total control

of
operations, he or she can respond quickly to changes, which is an asset in a rapidly shifting
market. The freedom to set the company’s course of action is a major motivational force.

For those who thrive on the challenge of seeking new opportunities in business, the freedom of
fast, flexible decision making is vital.
NO SPECIAL LEGAL RESTRICTIONS The proprietorship is the least-regulated form of
business ownership. In a time when government regulation seems never-ending, this feature has
much merit.

EASY TO DISCONTINUE If an entrepreneur decides to discontinue operations, he or she can

terminate the business quickly even though he or she will still be personally liable for any
outstanding debts and obligations the business cannot pay.

Disadvantages of Sole Proprietorships

UNLIMITED PERSONAL LIABILITY Probably the greatest disadvantage of a sole
proprietorship is the unlimited personal liability of the owner, meaning that the sole proprietor is
personally liable for all of the business’s debts.

LIMITED SKILLS AND CAPABILITIES A sole proprietor has total decision-making

authority, but that does not mean that he or she has the range of skills that running a successful
business requires. Each of us has areas in which our education, training, and work experiences
have taught us a great deal, yet there are other areas in which our decision-making ability is weak

FEELINGS OF ISOLATION Running a business alone allows an entrepreneur maximum

flexibility, but it also creates feelings of isolation; there is no one else to turn to for help when
solving problems or getting feedback on a new idea. Most sole proprietors admit that there are
times when they feel the pressure of being alone and completely responsible for every major
business decision.

LIMITED ACCESS TO CAPITAL If a business is to grow and expand, a sole proprietor often
needs additional financial resources. However, many proprietors have already put all of the
resources they have into their businesses and have used their personal assets as collateral to
acquire loans, making it difficult to borrow additional funds. A sole proprietorship is limited to
whatever capital the owner can contribute and whatever money he or she can borrow. In short,
proprietors find it difficult to raise additional money and maintain sole ownership.

LACK OF CONTINUITY OF THE BUSINESS Lack of continuity is inherent in a sole

proprietorship. If the proprietor dies, retires, or becomes incapacitated, the business
automatically terminates. Unless a family member or an employee can take over (which means
that person is now a sole proprietor), the business will disappear
A partnership is an association of two or more people who co-own a business for the purpose
of making a profit. In a partnership, the co-owners (partners) share the business’s assets,
liabilities, and profits according to the terms of a previously established partnership agreement.

Advantages of Partnerships
EASY TO ESTABLISH Like a proprietorship, a partnership is easy and inexpensive to
establish. The owners must obtain the necessary business licenses and submit a minimal number
of forms. In most states, partners must file a certificate for conducting business as partners if the
business is run under a trade name.

COMPLEMENTARY SKILLS In a sole proprietorship, the owner must wear lots of different
hats, and not all of them will fit well. In successful partnerships, the parties’ skills and abilities
usually complement one another, strengthening the company’s managerial foundation. A
common need for many entrepreneurs today is the need for partners with technical skills. Many
new businesses have strong Web-based components or are app-based business models.

DIVISION OF PROFITS There are no restrictions on how partners distribute the company’s
profits, as long as they are consistent with the partnership agreement and do not violate the rights
of any partner. The partnership agreement should articulate each partner’s contribution to the
business and his or her share of the profits. If the partners fail to create an agreement, the RUPA
says the partners share equally in the partnership’s profits, even if their original capital
contributions were unequal.

LARGER POOL OF CAPITAL The partnership form of ownership can significantly broaden
the pool of capital available to a business. Each partner’s asset base enhances the business’s pool
of capital and improves its ability to borrow needed funds; together, partners’ personal assets
provide a larger capital base and support greater borrowing capacity.

ABILITY TO ATTRACT LIMITED PARTNERS When partners share in owning, operating,

and managing a business, they are general partners. General partners have unlimited liability for
the partnership’s debts and usually take an active role in managing the business. Every
partnership must have at least one general partner, although there is no limit on the number of
general partners a business can have.
Disadvantages of Partnerships
UNLIMITED LIABILITY OF AT LEAST ONE PARTNER At least one member of every
partnership must be a general partner. The general partner has unlimited personal liability for any
debts that remain after the partnership’s assets are exhausted.

CAPITAL ACCUMULATION Although the partnership form of ownership is superior to the

proprietorship in its ability to attract capital, it is generally not as effective as the corporate form
of ownership, which can raise capital by selling shares of ownership to outside investors.

DIFFICULTY IN DISPOSING OF PARTNERSHIP INTEREST Most partnership

agreements restrict how partners can dispose of their shares of the business. Usually, an
agreement requires a partner to sell his or her interest to the remaining partner(s).

POTENTIAL FOR PERSONALITY AND AUTHORITY CONFLICTS Being in a

partnership is much like being in a marriage. making sure that partners’ work habits, goals,
ethics, and general business philosophy are compatible is an important step in avoiding a nasty
business divorce.

PARTNERS ARE BOUND BY THE LAW OF AGENCY Each partner is an agent for the
business and can legally bind the partnership and, hence, the other partners, to contracts—even
without the remaining partners’ knowledge or consent. Because of this agency power, all
partners must exercise good faith and reasonable care when performing their responsibilities.

2. the similarities and differences between C corporations and S corporations

C corporations are the traditional form of incorporation. All large publicly traded
companies and some small businesses are C corporations. C corporations are separate
legal entities and therefore must pay taxes on their net income at the federal level, in most
states, and to some local governments as well. Before stockholders receive a penny of its
net income as dividends, a C corporation must pay taxes at the corporate tax rate, a
graduated tax on corporate profits. Then, stockholders must pay taxes on the dividends
they receive from these same profits at their individual tax rates. Thus, a corporation’s
profits are taxed twice. This double taxation is a distinct disadvantage of the C
corporation form of ownership.
 S Corporations
In 1954, the IRS Code created the Subchapter S corporation, more commonly known as S
corporation or S Corp. Unlike C corporations, S corporations do not pay taxes on
corporate income. Income earned by S corporations is passed through to the owners, just
as it is in a sole proprietorship or a partnership. The S corporation was established
specifically for small, closely held businesses to free the owners from the double taxation
that occurs with a C corporation. Table 6.2 shows a comparison of the tax bill for a small
company organized as a C corporation and the tax liability of the same company
organized as an S corporation (or a limited liability company, which shares the same tax
treatment as an S corporation).
3. Characteristics of limited liability company include separate legal existence, limited
liability, flexibility in taxation, and simplicity in operation.
4. the process of creating a legal entity for a business
a. Select a Name.
b. Pick a Legal Structure.
c. Select a Location.
d. File Necessary Paperwork.
e. Set Up Financing and Taxes.
f. Hire Employees.