Corporate Finance: Market Structures
Assignment:
For this Corporate Finance 301 assignment, you will submit a research paper that analyzes the types of organizational business structures. You will apply knowledge of business structure concepts as acquired in the course. The research paper should follow APA formatting style.
Sole proprietorship
A sole proprietorship is owned and run by an individual who is not distinguishable from the business. This means that the owner and their business are regarded as a single entity. This makes the owner liable for all liabilities the business will incur and entitled to all profits. Sole proprietorships are the most commonly used form of business structure because of their simplicity, and are popular among self-employed individuals and small businesses (AMERICA’S SBDC, 2021).
The primary advantage of a sole proprietorship is the ease with which it can be started. Only a few forms, if any, are required and there is little need for administration. But like all businesses, sole proprietorships also require legal permits and licenses for regulatory purposes. Still, they remain an inexpensive business structure in regard to their formation. Another advantage is that a sole trader has full control over business-related decisions. This autonomy also means they are not bothered as much by government regulations, including requirements like the reporting of financial information. Unlike businesses with multiple shareholders, sole proprietorships have a simplified method of tax reporting. They only need to file their personal income returns as opposed to filing disjointedly as a business (AMERICA’S SBDC, 2021).
The unlimited liability of a sole trader is a core disadvantage for this business structure. Without the legal distinction between the owner and the business, the former is burdened by unlimited personal liability for the business’s obligations and debts. This sometimes requires a sole trader to dig into their personal assets to offset debts. Raising business capital may be hard for a single owner as opposed to a business with shareholders. Lenders, especially banks, are reluctant to offer loans to sole proprietors because of the risk of business failure.
A corporate finance strategy aims to increase shareholder value mainly through revenue. It is focused on how companies raise, allocate, and manage finances (Vernimme, Quiry, Dallocchio, Fur, & Salvi, 2017). Sole proprietorships raise money through personal capital, loans, retained profits, and sale of assets among others (Mayer, Warner, Siedel, & Lieberman, 2012). How they allocate and manage these funds is at their discretion since business decisions are made by the sole owner. Therefore, revenue in sole proprietorships is dependent on the quality of financial decisions made by the owner.
Partnership
A partnership is formed when two or more people come together to form a business. The business partners share ownership of the business and act on behalf of one another as pertains to the business. Similar to a sole proprietorship, the co-owners of a partnership are not separate from the business. This means that they have personal liability towards the business. Like in sole proprietorship, profits and losses are distributed to the co-owners according to their shares as per their partnership agreement. There are several types of partnerships including a general partnership, limited partnership, and limited liability partnership (U.S. Small Business Administration, 2021). The differences between these partnerships revolve around liability. Partnerships are not taxed as a business, rather, individual owners remit personal tax from their share of income (O’Brien, 2020).
One of the advantages of a partnership is the ease with which it can be formed and dissolved. Just like a sole proprietorship, partnerships require little to no formality during formation and their startup costs are low. Partnerships also enjoy a range of expertise because they combine resources from more than one individual, including capital. Administration in partnerships is simple as profits and losses are shared among co-owners. These profits do not have to be disclosed publicly, just like in sole proprietorships. Some of the disadvantages of partnerships
are unlimited liability, potential disagreements, inequality in profit sharing, and slower decision making among others.
Business funding in partnerships comes from sources similar to those of sole proprietorships. They include bootstrapping, bank loans, crowd funding, grants, and venture capital funding in spite of its risks (Mayer, Warner, Siedel, & Lieberman, 2012). Financial strategies are devised by all co-owners of a partnership as they are all responsible for decision-making. Revenue from the business is distributed among co-owners and decisions to plough back into the business are made jointly.
Corporation
Unlike sole proprietorships and partnerships, corporations are a legal entity considered separate from its owners. The owners of a corporation usually have invested in the business and purchased its stock as proof of ownership. Their formation is also not simple like that of sole traders and partnerships, as it requires state recognition. Despite being separate from its owners, corporations have characteristics of individuals. For instance, it can enter into binding contracts and can sue or be sued. For purposes of taxation, corporations are split into either C or S corporations. C corporations are subject to both corporate income tax and personal income tax on the profits earned by shareholders (U.S. Small Business Administration, 2021). S corporations are not subjected to corporate income tax but losses and profits stream directly into shareholder’s income where they get taxed. As a result, the IRS has tightened regulations on qualifications required to qualify as an S corporation (O’Brien, 2020).
The biggest advantage of a corporation is that it exempts owners from personal liability. Transfer of ownership is not difficult except if the corporation is privately-held. Corporations enjoy the principle of perpetual life since ownership is transferrable even through generations. Another advantage is that raising capital may not be hard for corporations especially those that are publicly-held (U.S. Small Business Administration, 2021). This can be done through bonds and selling shares. One disadvantage of a corporation is double taxation, which can also result in excessive paperwork. Also, corporations may be expensive to start and require much regulation and oversight.
Some of the sources of funding from corporations include equity, retained earnings, debt capital, and venture capital among others (Mayer, Warner, Siedel, & Lieberman, 2012). Unlike sole proprietorships and partnerships, the owners of corporations may not be part of management. This implies that they may not be responsible for formulating financial strategies. Corporations are more likely to have a variety of investments that generate revenue for shareholders.
Limited liability company
A limited liability company (LLC) is formed under state law and its regulations vary among states. Ownership of an LLC is not restricted and anyone can be a member. Although its formation requires a lot of formality, an LLC is easier to establish than a corporation. This business structure combines various characteristics from other business structures, making it the most flexible in comparison to others. Like corporations, LLCs operate under limited liability for its owners. LLCs can operate either as a corporation or a one-person entity, which can be set up with minimal formality. In case an LLC decides to operate as a corporation, it will appoint individuals who will run the business. In this case it will also be taxed like a corporation but without double taxation. A single-member LLC would be taxed from their personal income like in a sole proprietorship or partnership. Unlike in corporations, and similar to sole proprietorships and partnerships, an LLC is dissolved upon the death of its owners or when a business files for bankruptcy.
The main advantage of an LLC is limited liability for its owners who are separate from the business (U.S. Small Business Administration, 2021). The owners of an LLC can choose how they want to be taxed. LLCs also have a flexible management structure. The disadvantages of an LLC include lack of recognition in most countries and the fact that members cannot reward themselves. Additionally, by operating under state law, LLCs become subject to increased scrutiny and regulation. LLCs also have a limited lifespan as movement outside a particular state, new membership, and death of a member necessitate dissolution of a business (U.S. Small Business Administration, 2021).
Sources of funding for LLCs are similar to those of a corporation and include equity and debt (Mayer, Warner, Siedel, & Lieberman, 2012). The allocation and management of these funds is at the discretion of management if an LLC opts to operate like a corporation, and to owners if it operates like a sole proprietorship. Nevertheless, the primary goal of a financial strategy is to ensure a business generates revenue to satisfy shareholders.
References
AMERICA’S SBDC. (2021). Sole Proprietorship—Is this Popular Business Structure Right for You? Retrieved from AMERICA’S SBDC: https://lavernesbdc.org/news/sole-proprietorship-is-this-popular-business-structure-right-for-you/
Mayer, D., Warner, D., Siedel, G. J., & Lieberman, J. K. (2012). Law for Entrepreneurs. Saylor Foundation.
O’Brien, M. (2020, March 26). 4 Types of Business Structures — and Their Tax Implications. Retrieved from ORACLE NETSUITE: https://www.netsuite.com/portal/resource/articles/business-strategy/business-structure.shtml
U.S. Small Business Administration. (2021). Choose a business structure. Retrieved from U.S. Small Business Administration: https://www.sba.gov/business-guide/launch-your-business/choose-business-structure
Vernimme, P., Quiry, ., Dallocchio, ., Fur, Y. L., & Salvi, A. (2017). Corporate Finance: Theory and Practice. John Wiley & Sons Ltd.