Business Structures
Does being an entrepreneur interest you? Do you think the incentives outweigh the challenges you might face? If so, you might be wondering how exactly someone becomes an entrepreneur. There are many ways to accomplish this: you can go into business on your own, start a business with a partner, or maybe even start your own corporation. In the United States, there are five main business structures that entrepreneurs can use: sole proprietorships, partnerships, corporations, franchises, and cooperatives. In this lesson, we'll define each of these business structures and give a brief overview of the advantages and disadvantages they offer to their owners.
Sole Proprietorship
Definition: A sole proprietorship is a business with one owner. Most businesses in America are sole proprietorships.
P R O S
Sole proprietorships are generally easy and inexpensive to start, and their owners don't have to pay any extra business taxes. The business's income will be taxed as personal income.
The owners of sole proprietorships have total control over their business; they get to make all the important decisions themselves, without having to get approval from anyone else.
The owners of sole proprietorships keep all of the profits for themselves.
C O N S
The owners of sole proprietorships usually have limited financial resources because they have to finance everything on their own.
The owners of sole proprietorships have total responsibility for the business. If they don't have skills in a lot of areas, they may find it difficult to take care of everything their business needs.
Because owners of sole proprietorships have total responsibility for their business, they also have unlimited personal liability for the losses or debts incurred by that business. This means that if a business fails, the owner might have to pay off the business's debt with personal assets. For example, you could be forced to sell your house to pay off debt incurred by your business.
Partnership
Definition: A partnership is a business with two or more owners.
P R O S
Like sole proprietorships, partnerships are generally easy and cheap to start. An important additional step, however, is drafting a partnership agreement that outlines each partner's privileges and responsibilities. This can be crucial to resolving disputes that may arise between the company's partners.
Like sole proprietorships, owners of partnerships don't have to pay any special business taxes. They only pay personal income taxes on the profits they earn.
The owners of partnerships can share responsibilities based on the different skills and talents they have. For example, one partner might be better with numbers and thus more suited to handling the company's accounting, while another partner may be more creative and better able to run the advertising.
C O N S
Although partners can pool their financial resources, they will still usually have limited funds.
The stress of running a business can create conflict between partners, which will put a strain on the business and make it harder for the company to succeed.
Like sole proprietorships, owners of partnerships have unlimited personal liability for the losses and debts incurred by the business.
Corporation
Definition: A corporation is a business that operates as a separate legal entity from its owners. This means that the corporation is seen by the law as a separate entity (or a separate "person")—it can make contracts, be sued, and buy and sell property. The "owners" of a corporation are the individuals who own shares of the company's stock, known as shareholders. Each of these shareholders owns a percentage of the company based on how many shares he or she owns. For example, Apple is a corporation owned by its shareholders. If Apple had 100 total shares of stock, and you owned 20 of those shares, that means you would own 20% of the company. (Note that, as of 2022, there are actually about 16 billion shares of Apple stock!) The managers of the corporation, including the chief executive officer (CEO), work on behalf of the shareholders to generate profits for them. In the United States, corporations are the business structure that generates the most income.
P R O S
By selling stock to new shareholders, corporations can access an enormous amount of money, which they can invest in capital and human resources—much more money than sole proprietorships or partnerships could ever access.
Because corporations are considered a separate entity from the shareholders that own them, those owners only have limited liability. They don't have unlimited personal liability like the owners of sole proprietorships and partnerships.
C O N S
Because corporations have to pay a corporate income tax on all of their profits, the owners of corporations are subjected to double taxation. First, the corporation pays corporate income tax (currently 21% in the United States). Then, when the corporation passes on its profits to its shareholders, those shareholders must pay personal income tax on the money they receive.
Corporations are more complicated and more expensive to establish than other business structures. They are also subject to much more regulation from the government. This is why most small companies do not become corporations.
Cooperative
Definition: A cooperative is a business that's owned and controlled by the members who use its products. In other words, the members of a cooperative are both the owners of that business and the consumers of the products that the business creates. We've already learned about one type of cooperative in this course: credit unions. The people with bank accounts at the credit union are also, collectively, the owners of that credit union.
p r o s
Members of a cooperative often get discounts on the goods and services produced by the cooperative and might receive refunds at the end of the year.
Members of a cooperative do not have personal liability for the business.
Members of a cooperative have a say in how the business is run and usually have similar interests to the other members.
C o n s
The cooperative's business decisions might not benefit every member.
The decision-making process of a cooperative also tends to be slower and more complex than in a typical business. This means cooperatives are less able to react to changes in the marketplace.
Franchise
Definition: A franchise is a business owned by an entrepreneur that is licensed to sell products under the name of a larger corporation. In a franchise agreement, the franchisor sells a license to the franchisee that allows the franchisee to do business under the name of the franchisor. For example, many restaurants are franchises. There are thousands of McDonald's restaurants around the world, but most of them aren't operated by the McDonald's corporation. Instead, those restaurants are franchises. McDonald's is the franchisor, and it sells licenses to individual franchisees. Those franchisees can then open up a restaurant that uses the McDonald's name and sells McDonald's food.
p r o s
A major advantage of owning a franchise is that owners get access to the franchisor's brand name. For example, it will be easier to attract customers to McDonald's than to Jimmy Jack's Burger Shack.
A franchise also receives training and product knowledge from the franchisor, and it benefits from the franchisor's advertising.
c o n s
Franchisees usually have to pay an expensive franchise fee for their license to operate.
Franchisees have limited control over their business because they have to offer the products that the franchisor tells them to, and they must follow the operational standards set by the franchisor.
Review of Key Terms
sole proprietorship: a business with one owner
partnership: a business with two or more owners
partnership agreement: an agreement between business partners that outlines each partner's privileges and responsibilities
corporation: a business that operates as a separate legal entity from its owners
shareholder: an individual who owns stock in a corporation
cooperative: a business that's owned and controlled by the members who use its products
franchise: a business owned by an entrepreneur that is licensed to sell products under the name of a larger corporation
There are many different ways to start a business, each with its own advantages and disadvantages. Entrepreneurs must decide which structure works best for them based on what they value the most.