Page 123 - Introduction to Business

CHAPTER 3 Business Governance, Ethics, and Social Responsibility 97

Business Governance Structures

LEARNING OBJECTIVE 1
Describe the differences among sole proprietorships, partnerships, and corporations.

Sole Proprietorships
You don’t need to form a large corporation like Citigroup in order to go into business.
The vast majority of businesses operating in the United States operate as sole pro- sole proprietorships Individually
prietorships. Indeed, roughly 18 million Americans do business as unincorporated operated unincorporated businesses
sole proprietors, who are solely responsible for running the business. These individ-
uals report the revenues, expenses, and profits or losses of their business on their
personal tax return, assuming that all business is transacted “on the books.” 4
There are a number of advantages to operating a sole proprietorship. For one,
you can do business in your own personal name and pay taxes on earnings only
once at your personal income tax rate (doing business under an “assumed name” is
only slightly more complicated).
There are, however, some important disadvantages. The most important is prob-
ably liability; that is, as a sole proprietor you are personally liable for any claims
against your business. Various forms of insurance can provide considerable liability
protection, but it is very difficult to completely insure against all forms of liability.
Another potential disadvantage is in raising capital for your business. You may be
relying on your own personal financial statement as the basis on which to raise cap-
ital, and investors may be skeptical about putting money into a “one person show.”
In sum, sole proprietorships are the simplest way to operate a business, but may
not be the best governance structure in terms of potential liability and the need to
raise capital. Exhibit 3.1 gives an overview of different forms of business governance.

EXHIBIT 3.1
Characteristics of Different Business Structures

Formation Funding Taxation Liability
Sole proprietorship Very easy to form May be difficult to Earnings taxed on personal Personal liability for
raise capital income tax form, no double business, can insure
taxation against some
liabilities
Partnership Need partnership Capital contributions Income and losses Complicated liabil-
agreement, from different reported on personal ity issues: general
somewhat harder partners; outside tax form, no double liability for actions
to form than sole funding possibly taxation of other partners
proprietorship easier to obtain than and for business,
with sole but some partners
proprietorship are liable just to
extent of capital
contributions
Traditional Generally more Capital formation Separate tax entity; No personal
corporation difficult to form generally easier separate individual liability for share-
than sole than with sole taxation of dividends holders except
proprietorships proprietorship or paid to shareholders in very rare
and partnerships partnership; able to although at special cases of fraud,
float public shares low tax rates etc.

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