Question

Scenario 4:

You have just been appointed as a Client Service Officer in a business consulting firm. You are approached by Mr David Warner, a new start-up business client who cannot decide whether he should start the business as the sole owner, or in partnership with his friend, or he should set up a Proprietary Limited company.

From discussion with him you figured out that he prefers to have full control over his business, he does not want to take the risk of losing his personal assets if the business fails and he also likes to take advantage of any tax benefits that might come from the business.

Required:

1. Outline the advantages and disadvantages of various forms of business to Mr Warner.

2. Do you think he can have all his wish list fulfilled in any business structure?

Advise Mr Warner what type of ownership structure would best suit his preferences. Explain your reasoning fully to him.

Answer 1

Advantages and Disadvantages of starting the business as Sole Owner

Advantages

1. This is the simplest way of starting a business. Legal agreements and documentation is very less in these kinds of startups.

2. The Sole Owner has the complete control over all the operations, finance and investments of the business. Also, he isresponsible for making all decisions for the business.

3. The income tax of Sole proprietorship business are easy to file. Also, business losses can be used to offset personal income of the Sole Proprietor from other sources.



Disadvantages

1. There is no distinction between the personal finance of the sole Proprietor and the finance of the business. Sole owner is personally liable for any debts or obligations of the business.

2. A bankruptcy case involving a sole ownership will involve the business assets as well as the personal assets of the sole owner.

Advantages and Disadvantages of starting the business as Partnership

Advantages

1. The total cost of the startup will be shared by the total number of partners, so the burden will not be entirely on Mr. David.

2. The responsibilities and duties related to the business will also be shared by all the partners.

3. All the risks and expenses connected to the business will also be shared by all the partners.

4. 1+1= 11 can work in this type of startup. Each partner may have different skills and contacts, which will lead to the achievement of success of the business.

Disadvantages

1. In a general partnership, all the partners are jointly and individually liable for the business activities of the other, wholly and not just the part which they share.

2. The total profits of the business will be shared among all the partners.

3. Mr. David would not be having total control over the business. With profits, decisions will also be shared, which may lead to differences of opinion.

Advantages and Disadvantages of starting the business as Proprietary Limited Company

Advantages

1. A company is a seperate legal entity. Therefore, any claims made against the company will be paid by company’s cash reserves and assets only. Personal assets of shareholders or directors cannot br claimed.

2. This kind of business provides security to the investors, as it is having limited liabilty.

3. Customers also feel more confident when dealing with these kind of companies.

4. The tax rates applicable on a company are far lesser than individulas, sole traders and partnership.

5. Tax losses of the company can easily be carried forward to future profitable years. Also, tax losses from one business can be offset against profits made by another business.

7. Perpetual succession would not be harmed in these kinds of business startups.

Disadvantages

1. The director has to pay company debts personally and he will be criminally liable, if he breaches his duties.

2.  If a company makes a loss, this loss cannot be used to offset other personal income. This is possible in case of sole trader and partnership.

3. There is no tax-free threshold for companies, like in the cases of individuals or sole traders.

4.Formtion of a company is a costly affair. Also, it involves lot of legal documentation. It is a time consuming process.

If he prefers to have full control over his business, he shoul opt for either Sole trader or Proprietary Limited Comapny.

If he does not want to take the risk of losing his personal assets if the business fails, he should opt for Proprietary Limited Comapny.

If he wants to take advantages, then tax has to be planned efficiently. The tax rate applicable on a company is much lesser than sole trader and partnership. But it also to be noted that the very first penny earned by the company is chargeable to tax. Likewise, tax rates of Sole trader and partnership are more, but there is initial slab or threshold of income which is not chaergeable to tax.

If he is interested in starting partnership with his friend, then as per John D. Rockefeller, "A friendship founded on business is a good deal better than a business founded on friendship."

All his wish list can be fulfilled by Proprietary limited company.