Be A Sole Proprietorship, Partnership Or Corporation?

For most entrepreneurs, one of the most important decisions is whether to be a sole proprietorship, a partnership or a corporation. A mistake in form of organization can bring long-term damage to a business. Despite the risks, most people make this decision without a good idea of the type that is really best for their company.

Usually, we rely on our accountant or some other person who we believe is knowledgeable in making this decision. While most of the time their advice may have been correct, it would be better if you yourself understand what is best for the company you are planning to put up. Below are tips on the advantages and disadvantages of each type of organization:

Sole Proprietorship

This is when only one person owns and controls the business. It is the most simple and inexpensive alternative. If you have very limited capital, then this may be your only option. It is also very fast to put up. The large majority of businesses in the Philippines are sole proprietorships. The main problem here is that you and the business are legally the same, and this means that your company’s liabilities are also your personal obligations, exposing you to great risks.

There are many cases where a business is formed as a sole proprietorship even though it is not really so. The most common example is the case of married couples. When a husband and wife form a company, it should, at least, be a partnership since there are two of them. A partnership allows two or more persons. Many couples think having the business in the name of only one of them does not matter if everything is conjugal property anyway. To be on the safe side, consult an expert on all the possible consequences of this arrangement.

Partnership

Midway between the sole proprietorship and corporation is the partnership form of business. Partnerships are registered in the Securities and Exchange Commission. Some types of business must be partnerships. Some types of professional practices, like law and accounting, can only be organized as partnerships.

A partnership’s income is equally divided among the partners, unless there is a written provision that dictates otherwise. Frequently, there are quarrels because there are partners that think their partner is not putting in the same amount of effort or investment and still get the same profit. Decide on a fair arrangement beforehand.

If you are the main investor, and the one personally liable, this position is called the general partner. The others are called limited partners because they have only limited liability, as if they were shareholders in a corporation.

Corporation

A corporation is considered a separate entity; an artificial person created by law and, like partnerships, is registered in the Securities and Exchange Commission. It takes at least five persons to form a corporation in the Philippines. There are many advantages if you are a corporation, and thus almost all large companies are corporations because of these. Also, there are some businesses that by law must be organized as a corporation, like a lending company for example.

The main deterrent in choosing a corporation is the much larger amount of expenses and effort required in setting up and maintaining this type of legal entity. If the expense is not a problem, a corporation is quite probably the best option.

The most often cited advantage of corporations is limited liability. That is, in normal circumstances, you will not be liable beyond your investment in the corporation. This is quite understandable since operating a business always has some risks and you would want your personal assets to be free from creditors in case your business goes bankrupt. However, this is not entirely accurate. If you have unpaid subscribed shares, then you are still liable for the unpaid balance of the stock. You can have fully paid shares so that you will not be surprised by this. There are also some other situations where you may be personally liable.

One of the greatest advantages of a corporation is that it is relatively easier to get additional capital for it. Note, however, that in applying for a loan for your business, there is often fine print that makes you personally liable for unpaid obligations. Try to avoid this provision, if possible, as it nullifies the legal protection of your personal assets if your company is a corporation.

Perhaps the most serious disadvantage of corporations is that there is double taxation. The company’s income is first taxed, and then cash dividends to stockholders are once again taxed. However, in practice there are also tax advantages in being a corporation.

Choosing the appropriate legal structure for your company has a profound impact on its eventual success, so do not take this decision lightly. The good news about this is that, should you find the status quo not ideal, it is possible to change to a different form of business structure. But you can only make a wise judgement on this crucial matter if you have a basic understanding of the advantages and disadvantages of the options.

*Originally published by the Manila Bulletin. D-4, Sunday, July 7, 2013. Written by Ruben Anlacan, Jr. (President, BusinessCoach, Inc.) All rights reserved. May not be reproduced or copied without express written permission of the copyright holders.