Foundation - Legal Bodies

Once an entrepreneur makes the decision to launch a business, she/he has to decide on the form of ownership. Each country knows slightly different forms and liabilities, several similar forms are however highly common in many countries: sole proprietorship, general partnership, limited partnership, limited liability company, joint-stock company and association. These should be described in short here.

Choosing a form of ownership is important as it has got far reaching effects for both the entrepreneur and the business: invest sufficient time and thought! The different forms distinguish themselves with different features, advantages and disadvantages.

There is not one “best” form of ownership; one form for one entrepreneur may not be suitable for another one. When evaluating the forms, you should consider some of the following most important issues (ZIMMERER et al. 2011):

• Tax considerations
• Liability exposure
• Start-up and future capital requirements
• Control by the entrepreneur
• Managerial ability
• Business goals
• Management succession plans
• Cost of formation

It is the simplest and most popular ownership, a business owned and managed by one individual. In a proprietorship, the owner is the business.

Advantages of Proprietorship

• Simple to create. If an entrepreneur wants to operate a business under his own name, she/he simply obtains the necessary licences.
• Least costly form of ownership to begin
• Profit incentive: Once owners pay all their companies’ expenses they can keep the remaining profits (less tax)
• No minimum capital required
• Total decision-making authority
• No special legal restrictions
• Easy to discontinue

Disadvantages of Proprietorship

• Unlimited personal liability of the owner, which means that the sole proprietor is personally liable for the business’s debts.
• Limited skills and capabilities: Many business failures occur because owners lack the skills, knowledge, and experience in areas that are vital to business success.
• Feelings of isolation: There is no one else to turn to for help when solving problems or getting feedback on a new idea.
• Limited access to capital while maintaining sole proprietorship
• Lack of continuity of the business if the proprietor dies, retires or becomes incapacitated, the business automatically terminates.

(Adapted from: KMUPORTAL (2014))

The general partnership is suited for smaller companies that operate in a highly partner-related environment.

The general partnership is particularly suitable for the joint exercise of self-employment as a commercial enterprise and smaller businesses. Typically the partners are connected closely with each other. Social enterprises and other non-profit making organisations should not use this business structure (BGATEWAY 2014).

Advantages of General Partnership

• No minimum capital required
• Foundation relatively easy and straightforward
• Organisational structure of the General Partnership is quite simple

Disadvantages of General Partnership

• You need at least two people to form a General Partnership
• Unlimited personal liability and joint guarantee of the partners, which means that the partners are each liable with their personal assets for the business’s debts.
• There is a mutual dependence of the partners.
• The participation of all can complicate the entrepreneurial flexibility.
• The professional flexibility is limited, for example by a non-competition clause.
• Disputes between partners can cause difficulties, and the partnership may have to be dissolved if one of its members resigns or dies. It's possible to resolve these issues in advance by drawing up a deed of partnership (STERLING FINANCE (UK) LIMITES 2011)

(Adapted from SPADACCINI (2014) and ENTREPRENEUR (2014))

The Limited Partnership is a partnership owned by two classes of partners: general partners manage the enterprise and are personally liable for its debts; limited partners contribute capital and share in the profits but normally do not participate in the management of the enterprise. Another notable distinction between the two classes of partners is that limited partners incur no liability for partnership debts beyond their capital contributions. Limited partners enjoy liability protection much like the shareholders of a corporation.

Advantages of a Limited Partnership

• Owners can start partnerships relatively easily and inexpensively.
• Partnerships do not require annual meetings and require few ongoing formalities.
• General partner can be either an individual or a corporation.
• Capital contribution as a limited partner is easy, and they incur no liability for partnership debts beyond their capital contributions.
• Partnerships offer favourable taxation to most smaller businesses.
• Partnerships often do not have to pay minimum taxes that are required of LLCs and corporations.

Disadvantages of a Limited Partnership

• General partners are personally liable for losses incurred.
• The written partnership agreements are not necessarily easy to draft
• Poorly organized partnerships and oral partnerships can lead to disputes among owners.
• Individual partners bear responsibility for the actions of other partners.

An LLC requires an entrepreneur to create two documents: the articles of organisation, and the operating agreement. The LLC’s article of organisation orarticle of association actually creates the LLC by establishing its name and address, its method of management (board managed or member management), and the names and addresses of each organiser.

The operating agreement outlines the provisions governing the way the LLC will conduct business, such as members’ capital contributions to the LLC, the admission or withdrawal of members, distributions from the business, and how the LLC will be managed.

Advantages of Limited Liability Company (LLC)

• Limited liability for shareholders
• Relatively small initial capital needed
• Fancy names are possible, no family name required

Disadvantages of Limited Liability Company (LLC)

• Registry not simple, always change needed if proprietors change
• Minimal capital for foundation is CHF 20‘000 in Switzerland, € 25‘000 in Germany.
• Ownership is public
• Annual meeting of all proprietors mandatory

The joint-stock company (or corporation in the US) is the most complex form of business ownership. It is a separate entity apart from its owners, and may engage in business, make contracts, sue and be sued, own property, and pay taxes. Because the life of the corporation is independent of its owners, the shareholders can sell their interests in the business without affecting its continuation.

Advantages of the joint-stock company

• Limited liability of stockholders: A joint-stock company allows investors to limit their liability to the total amount of their investment in the business.
• Ability to attract capital: joint-stock companies have proved to be the most effective form of ownership for accumulating large amounts of capital.
• Transferable ownership

Disadvantages of the joint-stock company

• Cost and time involved in the incorporation process
• Potential for diminished managerial incentives
• Legal requirements and regulatory red tape: joint-stock companies are subject to more legal, reporting, and financial requirements than other forms of ownership
• High initial capital
• Potential loss of control by the founder(s): Entrepreneurs may have to give up significant amounts of control, even to the extent that the founder becomes a minority shareholder.

An association qualifies as a group of natural persons and/or legal entities constituted and organised on the basis of a written agreement with the pursuit of a non-economic purpose. Associations running a commercial enterprise to promote their noneconomic aim are required by law to register in the competent commercial register. For other associations, registration in the commercial register is optional. Non-profit associations may, for the better attainment of their goals, carry on an industrial or commercial activity. Such additional activity, however, must be of a subsidiary character and may not form the principal objective of the association (KAMMERER & SPRECHER 2011).

Advantages of an Association

• Easy foundation
• Easy organisation
• Limited liability: For its contractual obligations, only the association may be held liable.

Disadvantages of an Association

• Verification of non-profit character needed
• Registration if commercial activities
• Only partly possible to do business
• Profits cannot be distributed among members, and income generated from association capital cannot be distributed to its members.

In Further Readings, you can find links to specific requirements and conditions of forms of business ownerships in Peru, Uganda, Vietnam and India.