Many small business owners face a tough decision when starting a business. Will they start the business all on their own, or will they seek others to help in their venture? This ultimately comes down to whether they want to pursue a sole proprietorship or a partnership. In this article, we are going to dive into each of these classifications and discuss the good and the bad aspects of both.
What is a Sole Proprietorship?
A sole proprietorship means that you are formally running your own business. Sole proprietorships are some of the most common forms of small businesses, mainly due to the numerous benefits they provide.
Firstly, it is by far the easiest type of business to start, since most states do not require sole proprietors to register their business with their Secretary of State. There are also fewer regulations about having a board of directors (since it will just be you) and recorded meetings. Another obvious bonus is that you have no one to answer to but yourself, having the ability to set your own work schedule and routine. You also don’t have to share your profits with anyone (unless you hire employees, of course). This sounds like a pretty sweet deal, but there are some downsides to a sole proprietorship.
The biggest problem with sole proprietorships is that the business owner’s personal financials are tied directly to the business. This means that if the business goes bankrupt, so does the business owner. This makes a sole proprietorship a bit riskier. Along the same lines, any lawsuit brought against your business is also brought to you personally (meaning you are responsible for all the fees and costs associated with litigation). Sole proprietorships are also responsible for paying both income taxes and a self-employment tax (for Social Security and Medicare) on all profits of the business. This means that as the business becomes more profitable, you will end up owing even more in taxes.
What is a Partnership?
Partnerships are when multiple people start a business together. This means that two or more people will run the business as co-owners. There are a couple of different ways in which partnerships can form. General partners have an equal share in running the company and both have input in how the business will be run. Limited partners invest in the company, but are not involved in managing the actual day to day operations. Sometimes partnerships can be larger and more complex, with certain people having a bigger share of the company than others. If you are a small business owner, the most likely partnership you will form is with two or three general partners running a business with you, or with an investor who helps kick-start the business. But don’t forget that are many types of structures under the umbrella of partnerships. Learn here all the types of legal structures for a business.
There are a lot of positives in most partnerships. While partnerships do have to pay taxes on any profits earned, the owners are not separately taxed for being self-employed. Partnerships can also be very fruitful due to the added knowledge, skills, and experience each partner can provide. Lastly, although they are harder to setup than sole proprietorships, partnerships are usually very easy to begin.
The downsides of a partnership should still be considered, however. One of the worst parts of a partnership is that you can possibly be held liable for something someone else has done. If someone sues a partner individually the other partner may not be brought in on the lawsuit, but if the sued partner cannot pay the full amount owed, the courts can take assets of the partner not involved in the lawsuit. There can also be some incredibly tricky situations that arise when one partner wants to dissolve the business and the others don’t. While you may not pay as many taxes in a partnership, you are still legally and somewhat financially tied to your partner(s).
Remember that you can always start with a sole proprietorship and as your business grows, turn it into a partnership. Learn here if it’s the time to convert your sole proprietorship to a partnership.
Below is a breakdown of the pros and cons of each type of legal structure:
Full profits for owner
|No Self-Employment Taxes|
Financial dependence on partners
We hope that this article has given you a better idea of whether a sole proprietorship or partnership is right for your business. Be sure to visit the rest of our website for more guidance on Marketing, Management, and Financials. We wish you the best of luck in whichever business venture you decide to pursue!