One of the important step to take when thinking of How to start a small business is to pick the form of business organisation you want. Different forms of business confer different legal securities to the owner when it comes to liabilities of the debts from the business. Other differences lies in their method of paying tax.
Therefore it is prudent to make the right choice of form of business organization that will fit with the type of business you will want to start.
Two forms of business organization exist, namely;
- Limited liability Entities
- Unlimited Liability Entities
Liability simply refers to an obligation arising from a past business event. In other words, it means an obligation a business owes another business in the course of a previous business transaction.
Examples of a liability
- A service not rendered
- An obligation to supply goods.
- Debt to a company or an individual
- wages payable
- Loan from bank
- Mortgages e.t.c.
Therefore, the major difference between different forms of business organization lies in the responsibility of the owners to settle the above mentioned debts if anything should happen to the business.
Unlimited Liability Entities
Unlimited Liability entities are business forms that have no legal protection on the personal properties of the owner if anything should go wrong with the business (including personal cars or houses). Therefore, the owner or owners of the business will be held accountable for the debts owed by the company.
2 business types are under this category;
This is a type of business entity owned by an individual. Sole proprietorship is a business legally treated as the same with the owner. There is no distinction between the business and its owner. Both operate same account, same assets and Liabilities.
According to Chron, Sole proprietorship makes up about 73 percent of all small businesses because it requires a small capital and it is easy to start.1 Also,the profit and management of the business solely depends on the owner.
However, the limitation of this type of business are;
- As a sole proprietor you must report all business income or losses on your personal income tax return; the business and the owner share the same taxation.2
2. There is no legal form of protection to the personal assets of the business owner. This means that the owner can loose personal belongings as an obligation to the business.
3. It is a risky form of business and losses are borne alone.
4. It cannot be incorporated and therefore getting a business name is difficult. However, you can get a legal business name by filing a “Doing Business As” (DBA). This can allow you open a business account with your business name.
Another form of business under this category is General partnership; It is a similar form of business with sole proprietorship. The difference is that its members is from minimum of 2 up to 50 members.
In General partnership, Partners often enter into a partnership agreement to share in assets, profits and legal liabilities of its business. In other words, any of the partners can be liable for the debt of the company with his/her personal assets.
The advantage of this form of business is that the partnership is not always that complex. It is also cheaper and easier to establish when compared to Limited Liability companies. However, the disadvantage is that the Partnership can be dissolved by death or break-apart of a partner unless stated otherwise in the partnership law.
Limited Liability Companies
Most times people often confuse LLC with a Corporation. LLC is a hybrid of sole proprietorship or partnership and a corporation. Both LLC and Corporation however, protect their owners from liability for business obligations. The liability here is Limited in the sense that any legal action will only affect your input to the business and not your personal assets. But they are different in their management, ownership and method of taxation.
Differences between a limited Liability Company and a Corporation
- Corporation issue shares of stock to individuals known as shareholders while LLC shares its stocks between owners known as members.
- Transfer of shares is easier with corporation unlike the Limited Liability Company where a member cannot transfer the shares to another.
- The management of of a corporation is more rigid than that of a limited Liability company. The Management of corporations is by “Board of directors” while in LLC, members contribute to its management.
- Corporations can pay tax as a C corporation or S corporation. The C corporation type of taxation is the “double taxation”. In Double taxation, the Shareholder pays tax both at Corporate level and also from dividends received from the business. The S Corporation type of taxation is for smaller corporations, they pay tax based on the share of the profits from the company. However, In LLCs, They pay their tax as personal tax returns.
Since we have known the difference between a Limited liability Company and Corporations, lets talk about the different types of Limited Liability Companies. They are as follows;
1. Limited Liability Partnership (LLP)
This is another form of partnership that is different from the general partnership. In general partnership, the partners are individually accountable for the misconduct or Negligence of the Company. This is different from Limited Liability partnership where all the partners are liable for the action of the business.
The LLP is a form of business usually popular among a group of professionals in agreement for the services they render. Examples includes; lawyers, accountants, and architects.
2. Private Limited Company (PVT.LTD)
It is a type of company limited by shares. The shares of a private limited company are distributed to a group of people such as a family but not the general public. Therefore, the laws governing the Private Limited liability companies is not as stringent as that of the Public limited liability company.
The Private limited liability company has only one business leader always referred to as Boss.
One advantage of a PVT.LTD over LTD is that the former cannot disclose its financial operations to the public whereas LTD provides its financial information to the public.
3. Public Limited Liability (LTD)
Public limited company is owned publicly by a large number of investors. Unlike the Private Limited liability company, their stocks are traded in open markets among investors. They can easily raise capitals through the sale of securities.
This types of business has higher tendency of continuation than other forms of business because their shares are open to the public.
The limitation of this type of business is its complexity and the start-up capital is huge in relation to other forms of business.
When choosing the structure and form of business to go into, It is important to bear the following at the back of your mind.
- The level of legal protection you can get from the business on your personal assets.
- How the business pays their tax.
- Flexibility of the management system.
- Continuity of the business.