Question

List the advantages and disadvantages of a sole proprietorship, partnership and corporation.

Answer 1

(Q) List the advantages and disadvantages of a sole proprietorship, partnership and corporation.

(Ans) A sole proprietorship is the simplest business structure in which one person is the owner and operator of the business. This sole proprietor is responsible for all aspects of the business and reaps all profits of the business.

Advantages of Sole Proprietorship:

• Easy to Form: Proprietary concerns can be formed easily and quickly. Very few legal formalities need to be fulfilled. There is no need to go for any registration or enter into an agreement with someone. One can form it and dissolve it quickly.
• Full Control : The owner has full control over everything. He is answer­able to no one else. He decides everything in the best interests of the business. Right or wrong, he takes charge of the situation.
• Low Start-up Costs : Sole proprietorship ranges from having no employees and up to a number of employees which is easier to deal with in terms of expenses, taxes and compensation. Costs of opening a business with this structure do not require costly legal expenses as well as corporate taxes.
• Profit : One of the perks of sole proprietorship is that the owner can keep all the profits to himself unlike if he is on a partnership with another individual or if he has a corporation with investors where profits will be divided among themselves.
• Economical and Efficient Operations: The owner can put resources to best use. He can take steps to eliminate wastages of all kinds. He can control the cost of running the show.

Disadvantages of Sole Proprietorship:

• Personal and Business Assets : One of the drawbacks of sole proprietorship is that the owner’s money is tied to his business in the sense that finances of the owner and the business are one and the same and that there is no legal separation between the two. If the owner’s business encounters a problem or incurs debt and other obligations, he can risk losing his personal money to settle these issues.
• Lacks Professional Skills and Talent: The proprietor lacks professional skills, talent and expertise. He has limited knowledge and does not have the ability to gauze competition, changes in fashions and customer tastes and preferences, trends in economy etc.
• Small Size: By its very nature, proprietary concerns cannot grow big. They have limited means. They cannot expand operations in a big way. As a result, they do not enjoy the economies of scale.
• Growth Prospects: Business cannot go beyond a point for a variety of reasons—limited capital, owner lacks needed skills and competencies required to run the show on a large scale, unlimited liability compels many owners to remain small etc.

Partnership is a form of business which involves sharing of the rights to own, manage and control business among two or more persons. The term partnership literally means, ‘an association of two or more people as partners’.

The advantages of partnership form of organisation are discussed below:

• Easy Formation : Registration is not compulsory in the case of Partnership firm. It can be formed without any legal formality and expenses. Thus they are simple and economical to form and operate.
• Flexibility in operation : Due to the limited number of partners there is flexibility in the operations of business as the partners can amend any objectives or change any operations any time by mutual consent.
• Sharing of Risk : In partnership every partner bears the risks individually as it is easier compared to sole proprietorship.
• Financial Resources: Partners can pool their resources and expand the financial base of a firm. Creditors would be more willing to extend credit facility to a firm based on the reputation of partners and the soundness of business carried out by the partners.
• Talent can be Pooled: Partners can divide work among themselves, depending on their individual skills, and talents. This helps the firm to grow quickly.

Disadvantages of partnership Firm:

• Unlimited Liability : Liability of every partner in a partnership firm is unlimited as any of the partners may be called upon to pay all the debts even from its personal properties. A single wrong decision by one partner can lead other partners in heavy losses and liabilities.
• Lack of Harmony : According partnership agreement every partner has equal rights. Some situations might occur in which one or the other partner will not agree on the same thing which will cause difference of opinion resulting mistrust and disharmony among the partners.
• Limited Resources: The firm can have limited doses of capital infused by partners. It is clearly unsuitable for businesses that demand heavy investments. Beyond a point, a firm cannot expand its business.
• Transferability of Interest: It is difficult to transfer the interest of one partner to an outsider unless all other existing partners unanimously agree. An investment in a partnership business, therefore, becomes an illiquid asset.
• No legal status : A partnership firm does not have a legal status like a Joint Stock Company.

A Corporation is a legal entity, organized under state laws, whose investors purchase shares of stock as evidence of ownership in it. A corporation is a business organization that is distinct from its owners. Shareholders are the owners of a corporation.

Advantages of Corporations :

• Easier to raise capital: It is easier to attract capital with the sale of stocks and bonds. A corporation can have an unlimited number of investors. A publicly-held corporation in particular can raise substantial amounts by selling shares or issuing bonds.
• Limited liability: The shareholders are not generally liable for the debts and liabilities of the corporation beyond their contributions to capital. However, lenders will usually require personal guarantees by the shareholders on loans to the corporation.
• Stability of Existence : The organisation of a company as a separate legal entity gives it a character of permanence or continuity. As an incorporated body, a company enjoys perpetual existence.
• Economies of Scale : Since the company operates on a large scale, it would result in the realisation of economies in purchases, management, distribution or selling. These economies would provide goods to the consumer at a cheaper price.
• Scope for Expansion : As there is no restriction to the maximum number of members in a public company, expansion of business is easy by issuing new shares and debentures.
• Tax Benefits : Company pays lower tax on a higher income. This is because of the reason that the company pays tax on the flat rates. Similarly, company gets some tax concessions if it establishes itself in a backward area.

Disadvantages of Corporations :

• Difficulty in formation : The legal formalities and procedures required in the formation of a company are many. It has to approach large number of people for its capital and it cannot commence business, unless it has obtained a certificate of incorporation and a certificate to commence business.
• Delay in Decision Making : In company form of organisation, all important decisions are taken by the board of directors and shareholders in general meeting. Hence, decision making process is time consuming. Board of directors itself has often to be at the mercy of bureaucracy.
• Lack of Secrecy : Every issue is discussed in the meeting of the board of directors. The minutes of meeting and accounts of the firm’s profit and loss etc., have to be published. In this situation maintenance of secrecy is difficult.
• Excessive tax filings : Depending on the kind of corporation, the various types of income and other taxes that must be paid can require a substantial amount of paperwork.
• Lack of Personal Interest : In company form of organisation, the day-to-day management is vested with the salaried persons or executives who do not have any personal interest in the company. This may lead to reduced employee motivation and result in inefficiency.
• More Government Restrictions : The internal working of the company is subject to statutory restrictions regarding meeting, voting, audit, etc. The establishment and running of a company, therefore, would prove to be troublesome and burdensome because of complicated legal regulations.