In starting a small business, one of the most important decisions you will make is choosing a business ownership model. While there are several types of small business ownership models to consider, each has its advantages and disadvantages.
Here are three small business ownership models from which you can make an informed decision that is right for you.
1. Sole Proprietorship
This is the simplest and most common form of small business ownership. The business is owned and operated by one person who is personally responsible for all aspects of the business, including its debts and liabilities.
The advantages of a sole proprietorship include:
- Easy To Start: One advantage of the sole proprietorship ownership model is the ease of establishing it. Unlike other ownership models, like corporations or partnerships, you do not require any formal registration or paperwork to start a sole proprietorship. You can open shop by simply starting the business and operating it as an individual. This ease can be especially beneficial for entrepreneurs who are starting out without a lot of resources or time to invest in formalising their businesses. You can quickly and easily start earning income from their business without worrying about legal or administrative procedures. Furthermore, because the business is operated by an individual, you don’t need to consult with or gain approval of other owners or partners.
- Complete Control: As a sole proprietor, you have complete control over your business. You can decide how to manage your business operations and finances without consulting any partners or board members. This is an attraction for individuals who want to run their business on their own terms and do not want to share decision making or profits with others.
On the other hand, a sole proprietorship comes with some disadvantages. These include the following:
- Unlimited Liability: As the sole owner, you are personally liable for the debts and legal issues that may arise in the business. This puts your personal assets at risk when the business faces financial or legal trouble. This is because the business is not considered a separate legal entity from the owner.
- Limited Access To Capital: A key disadvantage of the sole proprietorship ownership model is the difficulty in raising capital. It is not easy to convince lenders or investors to provide funding for the business because the owner is singularly responsible for the financial obligations of the business. If you plan on raising capital or want to have a larger business structure with multiple employees, a sole proprietorship might not be your best option.
- Slow Growth Potential: The business is owned and operated by a single individual. This limits the amount of work the business can do and the number of customers it can serve. This makes it difficult for the business to grow and expand beyond a certain point, especially if the owner does not have the expertise or resources needed to take the business to the next level. The business may also lack the marketing expertise or financial resources to invest in new products, hire more staff, or enter new markets.
Overall, if you want a simple and low-cost way to start a small business and you are willing to bear the risks associated with personal liability, consider setting up a sole proprietorship.
2. Partnership
This is a business owned by two or more people who share the responsibilities, profits and liabilities of the business. This can be a general partnership or a limited partnership. The partners in a general partnership are responsible for the management and financial obligations of the business. In limited partnerships, one or more partners have limited liability and are not involved in the daily operations of the business.
The advantages of a partnership include:
- Sharing Of Resources: The partnership ownership model enables the sharing of management and financial resources. Because the business is owned and operated by two or more individuals, the partners pool resources and contribute unique skills and experiences to the business. This can be especially beneficial for businesses that require different skills or expertise to operate successfully. For example, one partner may have strong marketing skills while another may be excellent at managing the finances of the business. By working together, the partners are able to make better decisions and achieve more as a team than they could individually. Furthermore, more capital will be available to invest in the business since each partner makes a financial contribution to its funding.
- Simple Filing Of Taxes: Unlike entities that require complex tax filings, partnerships are not subject to corporate income tax. The partners report their shares of the profits and losses of the business on their individual tax returns. This simplifies their tax filings since partners do not have to file a separate tax return for the business. Partners are also able to take advantage of tax deductions for business expenses or employee benefits.
While partnerships offer several benefits, this ownership model also has its drawbacks. These include:
- Unlimited Personal Liability For General Partners: Each general partner is individually liable for the debts and obligations of the business. When the partnership is sued or is in debt, the personal assets of the partners, like homes, cars and savings, may be at risk. This is a significant risk for general partners because the mistake or negligence of one partner will make all partners liable for any resulting damages. However, partners in a limited partnership are only liable for the amount of money or assets invested in the business.
- Disagreements Among Partners: Partners often have different ideas about how to allocate resources or run the business. These disagreements can cause tensions and disputes, which can damage the relationship between partners, undermine the success of the business or result in the dissolution of the partnership and closure of the business.
By communicating openly and setting clear goals, sharing decision-making, working together to build a success business, backed by a solid partnership agreement, partnerships can be a powerful model for owning a small business that benefits everyone involved.
3. Limited Liability Company
This business structure combines the liability protection of a corporation with the tax benefits of a partnership. A limited liability company is owned by one or more members who do not bear personal liability for the debts and obligations of the business. This model, often used in businesses where large amounts of capital are needed, allows investors to participate in the enterprise without taking personal risks.
The advantages of a Limited Liability Company include:
- Limited Liability Protection: This is crucial for protecting your personal assets in the event of a lawsuit or legal dispute. If the business is sued or falls into debt, the personal assets of the members are generally protected. However, members may be held personally liable if they engage in fraudulent or illegal activities, fail to maintain proper separation between their personal and business affairs or give personal guarantees for business loans.
- Management Structure: The management structure of a Limited Liability Company makes it easier to manage and grow your business.
While there are many benefits to structuring your small business as a Limited Liability Company, there is a drawback to be aware of:
- High Setup Costs: It can be more expensive to set up a Limited Liability Company. You will need to incorporate the Corporate Affairs Commission, which comes with the associated costs of preparing the articles of association and paying filing fees. While the exact costs of forming a Limited Liability Company will vary depending on the size of the business, it can be a more significant expense compared with other business structures.
In conclusion, it is important to choose the right business ownership model that will produce the results you envision as you embark on your journey to business success.
If you need help structuring your business ownership, contact us today.
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