Business Organization Forms, Their Pros and Cons

Introduction

A business is an organization that is formed with a view of selling products and services to customers. Business organizations are formed to generate profits to increase the owners’ wealth. The operators and owners of businesses take the risk of starting the business because they expect a financial return from their investment. The various forms of businesses that exist are sole proprietorship, which is owned by one person, a partnership, which is an association of two or more people to make a profit, corporation, and Limited Liability Company (LLC). When starting a new venture, the key issue that needs to be resolved is the legal aspect concerning an organization.

The factors that should be considered in arriving at that decision include; the expense and complexity associated with operating and organizing a business, personal liability extent, profits and losses distribution, tax implications, and considerations, among others. Anyone who wishes to start up a business must carry out extensive research on the various forms of business organization. It will enable one to decide on the ideal type, depending on the size of capital required manpower, etc., (Rohrlich, 1967).

The objective of this paper is to analyze the various sources of business organizations and try to investigate the best of them all based on advantages and disadvantages. The paper also looks at the differences between the forms of business organizations and specifically the differences between a sole proprietorship and general partnership, a general partnership and a limited partnership, C and S corporations and their characteristics, and the characteristics of a limited liability company.

Sole Proprietorship

It is a business organization whose ownership and operations have one person called the sole trader. The sole proprietorship has the simplest structure and the mode of operation and initiation. The owner of this form of the business organization, usually, represents his or her own business and, therefore, anyone who conducts his or her business without forming a separate business entity creates a sole proprietorship. A sole proprietor manages all the activities of the business irrespective of their nature. A sole proprietorship has the following benefits;

A major benefit associated with a sole proprietorship is the fact that the proprietor acquires the right to enjoy all the profits from the business alone because he assumes all the risks by himself. It is also less costly and easier to start than any form of business because there are few formalities required, for instance, there is no need of filing any legal document with the government to start the business. The only document that is usually required to operate a sole proprietorship is the business license (Gitman, 2007).

A sole proprietorship also entails a flexibility in that the sole proprietor is in a position to make decisions alone without consulting with anyone. Some of the decisions that the sole proprietor could make include the decision on whom to hire, the kind of business activity to venture into, the right time to take a vacation, among others. The proprietor does not need the approval of anyone to sell or transfer the business to another. Decision making in a sole proprietorship is faster as compared to corporations or partnerships.

Insole proprietorship form of business, it is easy to maintain and keep secrecy because the sole proprietor can keep the business secrets by himself and, the possibility of secret leakages is minimal (Hamilton, 1996).

A sole trader is in a position to create a personal touch with his or her customers. It is because the trade is mainly located in the streets and villages and so he or she has locals as customers. As such, a sole proprietor can develop friendship, family relationships, and intimacy with the customers.

However, the sole proprietorship form of business has the following limitations as compared to another form of business activities such as partnership and Limited liability companies;

There may be limited resources in sole proprietorship as the business is owned by one person and, so the accumulated resources are scarce and limited as compared to company or partnership whereby capital is, usually, contributed by many individuals (Coman, 1949).

In a sole proprietorship, there is limited managerial efficiency as the proprietor being alone cannot be the head of all the business branches. He, therefore, cannot be an expert in sales, purchase, production, accounts, and marketing. As such, he suffers from the managerial efficiency enjoyed by other forms of business organizations.

A sole proprietorship is also associated with temporary existence because it revolves around an individual and so, that in case of death and illness, the entire business is adversely affected. A sole proprietorship does not have perpetual succession and can be terminated by the death of the trader. It also does not have a legal personality and does not exist as a legal entity.

A sole proprietor undertakes all business responsibilities. He is also liable personally for all the liabilities and financial obligations. The sole proprietor has personal liability in the business and is responsible to pay the financial obligations of the business and settle its debts.

Despite the existence of modern large-sized corporations, a sole proprietorship is still flourishing due to its simplicity, quick decision, easy formation, and personal touch with the customers and also the business. It is the most ideal type of business organization where the business size is small, the amount of capital required is small, there is less business risk, decisions are taken immediately, and secrecy is maintained (Hamilton, 1996).

With regards to taxation, the benefit arises in that the pass-through system is used in sole proprietorship whereby the business is not required to file returns, but rather the income is, usually, accounted for the tax return of the owner. The disadvantage, however, is that the taxation usually depends on the income of the proprietor and, so the proprietor ends up paying a higher tax rate as compared to small corporations.

Partnership

A partnership refers to a form of business that is, usually, co-owned by more than two people who are referred to as partners. Partnership business can either be general or limited wherein the former the members have all personal liabilities to the debts of the company while in the latter the partnership caters to its debts.

In a general partnership, the partners usually have unlimited liabilities and, therefore, they pay the financial obligations of the company where the business is not able to honor them. The advantages that are associated with this form of partnership include;

In a general partnership, there is additional funding as compared to the sole proprietorship and, therefore, there is the availability of more money to finance the operations of the business. This business type usually has the potential for growth as a result of access to substantial funds. The collective ability and wisdom of the partners in this form of business is an advantage as compared to a sole proprietorship. The sole proprietor has to rely on his or her ability and resources.

Another advantage associated with the general partnership form of business is that losses are shared among partners. It implies that any losses that the business incurs are, usually, spread across the partners. Each partner will thus absorb only a certain fraction of loss (Hamilton, 1996).

In a general partnership, a partnership statement is filled with the state, and there are no fees that are required, and hence it’s less costly to form. Such information as the purpose of forming the partnership, location, and name, the partner’s addresses are usually filed in the partnership statement with the state.

A general partnership also does not have perpetual existence and, so the partnership ceases to exist upon such occurrences as retirement, death, expulsion, withdrawal, expiration of the agreed date, or dissolution by a court order.

Concerning taxation, the partners in a general partnership are not, usually, subject to federal tax upon their incomes. The partnership books are closed at the end of the tax period and all the expenses are divided, among the general partners depending on the percentage of ownership.

Also, with a general partnership, there tends to be more specialization and so the partners are deemed to focus on the areas that they are best suited. In the case of an accounting firm, one accountant could be in charge of individual taxes while the other specializes in taxes for businesses.

However, in the case of a limited partnership, the partners usually have limited liability and, so their personal property cannot be sold in case the business fails to meet its obligations. However, the extent of a person’s limited liability is largely dependent on the state’s Limited partnership Legislation. Many states usually protect against those claims but allow the partners to suffer the consequences of their incompetence, and in case they act negligently.

An important note to consider is that the limited partnership business is controlled by the general partners and, therefore, selling the limited partnership’s interests requires the approval of the general partners.

The retirement, death, bankruptcy, or withdrawal of a limited partner usually does not render the cessation of a limited partnership form of business, which is contrary in the case of a general partnership.

The partnership has many advantages and disadvantages as well, which determines its ranking among other forms of businesses. The general partners that exist in a general partnership have unlimited liabilities and, so, in case the business fails to meet its due obligations, their personal property can be sold to recover the amounts owed by the business.

In a general partnership, the decision-making aspect is shared and, if there results in disagreements among partners, then the personal, as well as business relationships may be ruined. Also, some of the partners lack managerial skills and so they can expose the business to huge amounts of losses. Partnership business is also associated with disagreements between partners. People usually have different opinions and ideas concerning the proper running of a business (Rohrlich, 1967).

Also, in a general partnership, the profits of the business are shared among partners in a general partnership, which implies that the higher the number of partners there are, the smaller the profits amounts will be for any individual partner.

The main benefit of forming a limited partnership is to enable investors to have limited liability in their investment. It gives the partnership the capacity to own properties, as in the case of corporations that exist as a legal entity. It is a separate legal entity that is legally recognized as an artificial person. The partners pay income taxes from the income they earn from the partnership. A limited partnership has limitations that include the need for advanced accounting procedures; the fact that limited partnership lives only for a stipulated period and also the limited partners do not have a voice as far as managing the business entity is concerned once the business investment is in partnership.

The profits in a limited partnership are shared among the limited partners just like in the case of a general partnership.

There are inflexible and strict rules that must be adhered to in the formation of a limited partnership. A certificate requires to be filed with the county’s clerk in the area where the partnership is deemed to operate to provide a record that proves the existence of the partnership and this makes the maintenance as well as formation costs of a limited partnership to be higher as compared to those of general partnership.

C-corporation

A C-corporation has a legal personality, and it is responsible for its obligations, which give it an advantage over other companies with no legal personality. The shareholders are not responsible for the debts incurred by or on behalf of the company because the corporation caters to its debts.

The C Corporation is controlled by three groups of people i.e. the shareholders, board of directors, and the corporate officers. The shareholders usually own the corporation, and they elect the directors who have the responsibility of managing the activities of a C corporation. The corporation officers, however, have the responsibility of carrying out the daily operations of a corporation, and they report directly to the Board of directors

The general laws that govern a corporation need to be followed strictly in forming a C corporation and includes the filing of reports by state, the board of directors to hold organizational meetings, preparation and filing of the corporate charter, preparation of the by-laws, and establishing the location of the business.

Employees working in a C Company own the business and thus rendering them to enjoy fringe benefits. A C-corporation is mandated to have a nonrestricted number of shareholders and should also maintain legal documents like the certificate of incorporation for it to continue operating. They are required by the law to pay any fees that are attached to the legal requirements so that they can have the freedom to operate.

Tax payment is done as per the C tax code, which also plays part in protecting liability. There exist different stock classes in C Corporation. The business interests may well be held by shareholders who might be unlimited in number and individuals, whether foreign or domestic. The existence of this form of business organization is indefinitely (Coman, 1949).

Most corporations with over 75 shareholders prefer C Corporation to other businesses because they are likely to get accumulated dividends to them. The mere existence of such shareholders poses a disadvantage for C Corporation, especially during taxation. It is because it amounts to double taxation (Schlesinger, 2000).

One of the advantages of C Corporation is the availability of fringe benefits that are available to the employees and the shareholders. Such fringe benefits may include a contribution to pension funds, etc.

A C-corporation is also not restricted by the rules relating to the issuance of shares as compared to an S corporation. The shares that are normally issued in C Corporation can be of different classes (Brigham &Houston, 2009).

Compared to a sole proprietorship, a C corporation is more advantageous in that it can accumulate large capital amounts easily.

C corporation issues double taxation, and that is one of its disadvantages. The corporate-level tax is charged on the proceeds obtained from the disposal of assets. Also, a C corporation cannot allocate the profits and losses easily, unlike a limited liability company. In an LCC, the shareholders earn dividends from the profits earned by the company. In the event the company is liquidated or sold, they also earn a share of the assets.

S-Corporations

An S-Corporation or small business corporation refers to a hybrid entity that allows smaller corporations to avoid double taxation resulting from corporate profits. The shareholders thus report a profit distribution on their tax returns. The S-Corporations usually have the organizations as the directors, stockholders, and officers just like corporations. They are also required to meet certain ownership and size requirements. The maximum number of qualifying shareholders is 100. They are, however, taxed the same manner a partnership form of business is taxed. The losses and incomes are taxed as though they are personal incomes (Schlesinger, 2000).

An S corporation requires Articles of Incorporation before its formation, which is maintained by the relevant authority. There are also state filing fees that need to be paid on its formation and document filing.

Tax benefits and limited liability are the main advantages of an S Corporation. The Owners of the S-corporations do not have personal liability for the debts of the company. In the case of an S Corporation, are the issue of double taxation may arise but are dealt with accordingly. The shareholders may be liable to par Corporate, and they can, in turn, claim a deduction from the incomes they have.S corporation continues to exist indefinitely. Raising capital for starting an S corporation is easier than the case of a sole proprietorship (Schlesinger, 2000).

One of the limitations of S Corporations is that even the shareholders are usually limited in the deductibles. It is due to the amount due to the business losses that may arise. It depicts that there is a lack of flexibility in profit allocation, which should depend on the interest of the shareholders in the businesses. It is in contrast with limited liability companies where there is much flexibility in profit allocation (Schlesinger, 2000).

Limited liability company (LLC)

This refers to a type of business organization with both the characteristics of a corporation and a partnership business, that is, it shares in their elements. An LCC as a business entity is formed under state law. A limited liability company provides the members with an option to fully partake the entity management. They thus exhibit the very corporate characteristics of limited liability. LLCs have the following advantages; they provide its members with such rights as unique voting rights necessarily, having to create another class of stock. The rights also can be modified by amending the operating agreement of the LCC’s (Brigham &Houston, 2009).

The formation of an LLC requires an Articles of Organization, which should be duly prepared, and any fee attached to it should be settled in full. The operating agreement that defines the company’s ownership, profit sharing, ownership charges, and responsibilities are advisable.

The profit made by the organization may either be retained for business expansion or may be given out to the shareholders in form of dividends. These decisions are made by the management of the organization for there is no law that directs the distribution or retention of the profit. The management may decide to retain a proportion of all of the organization’s profits or distribute it to the shareholders in form of dividends.

The shareholders receive dividends in form of stock or cash at any agreed moment or declared at the AGM. Compared to C corporations, LLCs are subject to only one tax that is borne by members’ corporations and, so C corporations end up paying taxes twice in form of state income tax and also entity-level federal(Owens,1946).

LLCs does not operate under various restrictions that are found under S corporations such as; the number of members whereby in the case of S corporations the maximum number is 75 whereas there is no highest number of persons who are required to form LCC.S corporations have only one class of the stock whereas LCCs enjoys the existence of several stock classes with outstanding, and infinite interests. LCCs can have alien shareholders, which is contrary to an S corporation. Also, an LCC usually apportions the profits and losses more flexibly as compared to S corporation i.e. S corporations are required to receive loss benefits or pay taxes in proportion to stock ownership (Gitman, 2007).

They are also favored often over partnerships as they provide tax benefits and limited liability to members at the same time.

The disadvantages of an LLC include an LLC ceases to exist at the end of the duration specified in the agreement or upon the death of a member. Transferability of interest is restricted by the statute law. Members of LLC pay self-employment tax, which is counted on the income that they earn from the company. One can, however, save on the self-employment taxes when he or she decides to join a C corporation or an S corporation (Gitman, 2007).

If an LCC member dies, becomes incapacitated, or becomes bankrupt, the limited liability company is dissolved automatically unless the members had included the provisions for business continuation in the operating agreement.

Conclusion

The most ideal form of business organization that should be implied in this situation is an S corporation. It is because of the advantages such as the advantages associated with taxation i.e. there is the absence of corporate tax as business income passes through to personal income tax of the owners and thus getting rid of the aspect of double taxation. Once the business is being sold, one can use it as a retirement strategy as taxable gains could have gone down. The losses and expenses that one incurs while starting up a business could offset against ones’ income. An S corporation also protects against losses and liabilities concerning the business.

Memorandum

  • MEMORANDUM
  • To: The Manufacturer
  • From: ABC
  • Subject: An investigation of the most ideal form of business to venture into
  • Date: November 3, 2010

In response to the given situation, the manufacturer should convert the sole proprietorship business into an S-Corporation. It is because the S-Corporation form of business offers more benefits for his situation. Since one of the worries of the sole proprietor is the risk and potential liability that will accompany the business organization that he is going to form, S-corporation offers a solution. It is because the member will not have personal liabilities to the debts and risks incurred in the course of running the business on its behalf. The business caters to its obligations and debts. The corporation also pays health insurance for the members and, therefore, in case of injuries while at work, the insurance caters to the expenses.

The sole proprietor also wishes to raise capital to expand the business, and S corporation gives him the chance to do so. He can raise capital from the sale of shares to a maximum of 100 shareholders. He will have control of the business since he can be able to restrict the number of shareholders he wishes to have. He will, therefore, be able to raise capital to purchase capital assets and expand the geographical area of the business.

Concerning the control and the continuation of the business in the case of death of the owner of the company is also ensured in the case of C Corporation. The business has indefinite existence and has directors that are elected by the shareholders and who are responsible for running the affairs of the business.

The issue of taxation that was also a concern of the sole trader is dealt with in the case of S corporation. The problem of double taxation is eliminated in the case of S corporation because there is no tax paid at the corporate level. The salaries are subject to self-employment tax, but distributions to the shareholders are exempted from such tax. The sharing of profit made by the business depends on the interest of the shareholders in the business. S corporation is, therefore, the most appropriate form of business that the manufactures should engage in.

Employment and Labor laws

Labor laws refer to a set of regulations that are aimed at addressing the obligations and rights of both the employers and the employees. Labor laws address such issues as working conditions, health, and safety, unfair treatment and discrimination, minimum pay, unfair dismissal, working hours, child labor, right to organize, among others(Bridegam,2009).

In the United States, labor laws are a collection of federal as well as state laws. Federal laws are those laws that set the rules and regulations that govern the rights of the workers. There is no application of Federal laws to local government and state employees and other employees. Federal laws thus protect the employee s in the private sector. Employees who are in the public sector are usually protected by state laws.

The employment standards contained in the Employment Act in the U.S serve to protect the rights of the employees against privacy rights violations, sexual harassment, working hazards, sexual discrimination, age discrimination, discrimination as a result of discrimination, among others. Certain Acts have been enacted, such as the Family and Medical Leave Act, Age, and Discrimination in Employment Act, Americans with Disabilities Act, among others, to cater to the employee’s welfare (Bridegam, 2009).

Employees are the main driving force behind organizational success, and so employees ought to be treated right to contribute to growth. It is important to consider that as social beings, employees have sentiments and emotions and so they should be accorded the right treatment if organizations are set to achieve their goals of wealth maximization, profit maximization, among others. Well motivated employees perform their duties enthusiastically. The International Labor Organization commonly termed ILO works to improve the working conditions as well as protect basic human rights, and also promoting social justice globally (Bridegam, 2009).

The Family and Medical Leave Act of 1993, abbreviated as (FMLA) requires employers of companies to provide workers job-protected leave dues that are unpaid. In the cases where the employees may fall sick, taking care of a sick member of the family or newborn babies, the Act protects them from such.

The laws thus give direction concerning balancing work and family. It also protects the workers in their working conditions. The FMLA allows a three-month leave from a job that is protected but unpaid. The employees are deemed to be restored to the initial position that they were serving once they return from leave. They are also entitled to the return of all benefits due to them before they leave time (United States.Dept.labor, 1995 page 36)

The provisions of the FMLA Act in the case of employee A applies in that being a bona fide employee of the company for two years he was reinstated to the same position he was before with the previous pay. The reason why the employee requested the leave was also by the FMLA Act i.e., taking care of the spouse who has given birth. The organization has more than 75 employees who meet the FMLA eligibility for leave threshold, which requires that a business should not have less than 50 employees for FMLA to apply. The maximum period that the FMLA mandates is three months a year, and therefore the manager did not violate the Act by denying the employee from requesting the withheld salary of 11 weeks (the United States. Dept. labor, 1995, page 36)

The Age Discrimination in Employment Act of 1967, commonly termed ADEA provides laws that prohibit discrimination resulting from age. The ADEA applies to those employers present in interstate commerce. The Act, however, does not encourage the mere favoring of either the old people over those who are young and vice versa. The specific bans include issues related to employees’ wage discrimination, hiring, among others. The ADEA is usually enforced by EEOC, which makes it function properly and effectively. According to The Act, a private person or the EEOC can sue for the damage to the extent of the loss or damage suffered. The remedies for ADEA are the reinstatement and damages in the absence of reinstatement (Mathews et.al., 1996, 23).

In the case of employee B, who is 68 years, the ADEA Act was violated by not giving the employee a promotion as a result of age despite performing outstandingly well. The law forbids employers from firing employees because they consider them to be too old or decline to hire employees who are beyond forty years of age. Provided that employee A is capable of performing duties as per the organizational requirements, the promotion denial should not have taken place. The employee, therefore, should proceed and sue the organization for violating the Act (Mathews, et.al., 1996).

The Americans With Disabilities Act of 1990, commonly termed as ADEA was enacted in 1990 and amended later in 2009. The ADEA represents a wide range of laws that discourages discrimination as a result of a disability. An organization, therefore, is not allowed to discriminate against an individual who has a disability in such aspects as job and hiring procedures, discharge and advancements, job training, workers’ compensation, and the privileges that are associated with employment (Fielder, 2004, 34).

Discrimination may entail denying qualified people an employment opportunity, failure to make the necessary accommodations to mentally or physically handicapped people, the decision not to advance employees who are disabled in the organization, and also the failure to provide them with the required training ( Fielder, 2004, 16).

The ADEA Act was not violated in this case because the sole purpose of any business organization is to make profits that are necessitated by cutting down expenses and costs. In this case, however, the company will incur extra costs and maybe not be able to meet its objective, particularly if the organization is striving to compete with others in the area. The applicant should instead seek a position that doesn’t require many movements as this implies that the organization will have to restructure its facilities to cater to the applicant. The company, however, should set up reasonable accommodations to cater to the applicant in case he wishes to seek another post.

It doesn’t mean that people with disabilities should be denied some vacancies that arise in organizations. The position that the applicant has applied for is, however, not conducive for the organization, and the shareholders may not be justified that the company incurred losses as they tried to adjust facilities to cater to the disabled employee.

The employee should thus be made to understand the truth of the matter, and the company should commit to putting in place reasonable facilities for the disabled people in the future.

Reference List

Brigham, E., & Houston, J. (2009). Fundamentals of Financial Management. The Wall Street: Cengage Learning Press.

Coman, E, (1949). Sources of business information. New York: Prentice Hall.

Gitman, L. (2007). Principles of Managerial Finance. San Diego. Pearson Education.

Hamilton, R. (1996). Business Organizations: Unincorporated businesses and closely held corporations. New York: Aspen Law & Business.

Owens, R. (1946). Business organization and combination. New York: Prentice Hall, Inc.

Rohrlich, C. (1967). Organizing corporate and other business enterprises. New York State: M.Bender publishers.

Schlesinger, M. (2000). S corporations: tax practice and analysis. Washington Dc: CCH.

Bridegam, M. (2009). Unions and Labor Laws. New York: InfoBase Publishing.

Fielder, T. (2004). Mental Disabilities and the Americans with Disabilities Act: Westport: CT.Quorum Books, page 57.

Mathews, et.al. (1996). The Sourcebook for Older Americans. US: Berkley Nolo Press United States.

Dept.labor. (1995). Family and medical leave Act: final regulations: Washington DC: Commerce Clearing House. pg. 36.