Deciding to launch a business, you’ll have yet another tough decision to make. That is choosing a proper business form for your future venture. Initiating a smaller enterprise, many entrepreneurs choose between a sole proprietorship and a partnership. If you want to get all the profit and are confident enough to run the firm and carry all related responsibilities on your own, a sole proprietorship might be a good starter option. Yet, if you’d rather share liabilities with someone else and are ready to share profits as well, you’d better find business partners and consider establishing a partnership. Do you want to learn more about sole proprietorship and partnership and see how they relate to each other? Then keep reading our article.
Understanding a Sole Proprietorship and a Partnership
Sell handmade toys online? Deliver cleaning or babysitter services to your neighbors and friends? Write articles from home? If so, you are a sole proprietor. It’s an unregistered business form that occurs as soon as you start receiving money for some products or services. As the name suggests, this entity is established and operated by a single individual. You don’t have to contact state authorities and file any registration documents for that. Once you start some sort of activity and get paid for that, a sole proprietorship exists automatically. The good thing about this business form is the no-hassle formation and easy operation without many formalities and boring paperwork. And you don’t have to run your business solo, you can hire employers. However, as an owner, you are the only one who stays responsible for all company issues. On the other hand, no one but you will get all the profit.
Technically, a partnership is very similar to a sole proprietorship. No state filing is needed, and there are no complex formalities to follow. The difference is that you launch a venture with one or more fellow-thinkers sharing your entrepreneurial ideas and purposes. They will become your partners and share your business responsibilities too. Setting up a partnership is as simple as coming to an agreement and shaking hands to confirm it. Hence, it’s yet another informal business structure. However, to bring your relations to a legal field and avoid any internal conflicts that might arise, as well as to verify each partner’s financial contribution to the company equity, you can sign a partnership agreement.
Both being unregistered entities, sole proprietorships and partnerships are the simplest business forms much favored by smaller entrepreneurs and startuppers, especially those with limited budgets. Both are affordable, extremely easy to set up, and easy to run. On the flip side, though, both bring unlimited personal liabilities to their owners for anything that happens within their business. So, at some point, these structures might fail to match a growing business scenario.
In the meantime, let’s take a closer look at how these entities compare in key business aspects any businessman should consider.
Sole Proprietorship vs Partnership: Where Are They Similar
As stated above, quick and simple formation is what makes these two business forms attractive for newbies and beginner businessmen who have no experience of opening a commercial enterprise. With sole proprietorships and partnerships, you’ll have no problems at all. None of these forms requires state filing and entangles many routines. The only formalities you’ll have to match relate to licensing and naming. Thus, many cities, counties, and states call for getting special licenses and permits for certain types of activities or professions. So, depending on the industry you operate in or the products and services you provide, you might have to register one or more licenses. Likewise, if you plan to use a company name different from your personal name or that of your partners, you’ll have to file an application for DBA (doing business as) registration in the state you operate in.
One more thing these entrepreneurial structures have in common is taxation. Both entities benefit from pass-through taxation, which means they don’t pay income taxes at federal and state levels. In a sole proprietorship, all company profits and losses are reported under the personal tax return of its owner. The same is true for partnerships. Yet, here profits and losses are first distributed to the co-owners pro-rata to the equity interest, and then each of them pays income taxes under their personal tax rates. Both sole proprietors and partners are considered self-employed and are exposed to self-employment taxes accordingly. On the other hand, both of these structures are entitled to get a 20% tax deduction on the qualified business income to cut down a total taxable amount.
Unlimited personal liability is yet another aspect shared by sole proprietors and partners. Enterprise owners are held personally liable for all company debts, legal problems, and any lawsuits involving the company. More than that, the owners are liable for those issues with their own assets. In other words, their property and individual funds can be used for settling the company debts and penalties.
Sole Proprietorships vs Partnerships: What Are the Differences Between Them
Though pretty much similar in some core characteristics, sole proprietorships and partnerships have many nuances and details they are different in.
It’s an obvious aspect that sets two entities apart. While a sole proprietorship is owned by one individual, partnerships are established by a number of partners. Notably, you could start a business with a single associate and then engage more partners in the course of running your venture.
Though it might seem not a big deal at a glance, digging deeper, you’ll see that this difference largely impacts the way the business is conducted and controlled.
Working solo, you are the one to make all decisions and obtain all profits, as well as you are the one in charge of your business. Collaborating with partners, you share everything with them including both responsibilities and business management. All key decisions are to be made and approved by all partners. On one hand, it’s nice to have different points of view and approaches to consider to find the most efficient and reasonable solution. On the other hand, though, it might often cause internal conflicts and disagreements. A good balancing tool, in this case, is a partnership agreement that will clearly outline each partner’s authorities and duties and set up decision-making procedures.
Since a sole proprietorship is associated with its owner, an owner acts as a business manager by default. While regulating day-to-day operations without the need to agree on it with anyone else, a sole proprietor might fail to efficiently manage ongoing activities due to a simple lack of knowledge, training, or professional skills. Besides, as the venture grows, a sole proprietor will be unable to duly embrace all management aspects.
In a partnership, partners can use their experience and skills to jointly operate the business. They can appoint a general managing partner or even hire a third-party manager to distribute the company management authorities properly and efficiently. The downside of this, though, is that internal disputes between partners about the company management strategy often slow down overall business development and can even put the whole company’s existence at stake.
Despite the fact that personal owner’s liability is pertinent to both of these business forms, partnerships bring more financial risks. Within this type of collaboration, you’ll be responsible not only for your own actions and their consequences but also for those of other partners. Thus, if one of the associates makes any mistake or misbehaves, the rest of the partners are accountable for it as well.
The biggest minus of a sole proprietorship is the lack of fundraising opportunities. To infuse the operating capital with some funds, a sole proprietor could only take a loan or credit that will become their personal liability in the end.
For the partnership, getting some added money is easy. Owners could find more partners that will financially support their business by equity contributions. And when engaging finances via bank loans, partners will share that financial burden as well.
A sole proprietorship is existent as long as the business owner is alive. If a sole proprietor dies or decides to sell the business, a sole proprietorship is automatically dissolved. Under the same circumstances, partnerships can be dissolved as well. Yet, if you have a partnership agreement in place specifying the business duration issue, a partnership can continue to function even if one of its owners passes away, retires, or withdraws.