Question

Before deciding how to organize an operation, prospective entrepreneurs need to identify the legal structure that will best suit the demands of their business. This is important when considering tax and personal liability, and the availability of capital. Three primary legal forms of organizations are the sole proprietorship, the partnership, and the corporation. There are advantages and disadvantages to each type of business ownership. The entrepreneur’s specific situation, concerns, and desires will dictate the form of business ownership that is appropriate for the business. What are the different types of legal structures and some advantages and disadvantages of each? Discuss both reasons for and the risks of buying an existing business or franchise instead of starting a business from scratch.

Answer 1

The various legal forms of organizations are given below:

Sole Proprietorship

• You are the sole owner of the company
• The owner will be solely responsible for all the decisions of the company
• Getting initial capital for the company is the sole responsibility of the owner and can be a bit tricky
• In this type of business, regulatory burden is quite light
• All profits go to the owner directly
• Liability is however huge on the owner
• Debts can prove very heavy on the owner
• For legal entities, business and owner are one and the same
• All assets and liabilities belong to the owner

General Partnership

• This is the business between 2 or more people (partners)
• Each partner is jointly responsible for all decisions of the company
• The financial capital of all the partners in partnership ratio, forms the initial capital of business
• All partners get equal representation in every thing – profit, assets, debt, loss, etc.
• A disadvantage of this form of business is that partnership is quite prone to conflicts
• A partner can be held accountable to decision taken by another partner for the business
• For legal entities, business and the partners are considered one and the same
• Business income is taxed to all partners individually at individual tax rate

C Corporation

• Has unlimited number of shareholders who have their share as dividends
• Foreigners can also be shareholders
• Taxation is done on corporation’s profit as well as the individually on the shareholder’s liabilities
• This business is subjected to corporate income tax
• Tax is charged at corporate level
• Double taxation is levied on this company through the mode of dividends
• Tax is first levied on the corporation as a whole and then to individual shareholders

S Corporation

• Has a limit of 100 on the number of shareholders
• Does not have double taxation as S corporation is not held responsible for paying tax
• The income of shareholders is subjected to pass-through taxation where the income of business is passed through the owners

Limited Liability Company

• Constituted by one or more people through a special agreement in the form of writing
• The agreement specifies all the features of the business
• Banking and insurance cant be done by this form of business
• Owners are given liability protection
• Has pass through taxation
• No double taxation

Franchising is another option through which an entrepreneur can enter a new market. It is comparatively less risky than starting a new business from scratch.

Franchising: the company intends to conduct business of the parent company, called the franchisor, in the international market. An agreement binds the franchisee to the franchisor such that the franchisee needs to pay operational fee to the franchisor.

• Advantages of Franchising are:

• Franchisee has greater control over the business operation
• Easy mode of entry in international market
• Low cost, low risk entry mode
• Helps in generating economies of scale
• Capitalizes on local responsiveness as well

• Disadvantages of Franchising are:
  • Searching for a franchisee can be time consuming
  • Higher risk to the franchisor’s brand image and company reputation
  • Pressure of maintaining standards is quite high
• Example: McDonalds and Burger King had extended their operation in Indian market through the mode of franchising