Lesson 19 - Intermediate Accounting Course 

19. Understanding Different Business Entities: Sole Proprietorships, Partnerships, Corporations

When starting a business, choosing the right type of business entity is crucial. The structure you select affects your taxes, legal liability, decision-making authority, and ability to raise capital. The three main types of business entities are sole proprietorships, partnerships, and corporations.

Each structure has its advantages and disadvantages, depending on the size, goals, and risk tolerance of the business owner.

1️⃣ Sole Proprietorship

A sole proprietorship is the simplest business structure, where one individual owns and operates the business.

Key Features:

✔ Owned and run by one person
✔ The owner has full control over business decisions
✔ No legal separation between the owner and the business
✔ Profits and losses are reported on the owner’s personal tax return

Advantages:

✅ Easy and inexpensive to set up – No complex legal paperwork
✅ Complete control – The owner makes all decisions
✅ Simple taxation – Business income is taxed as personal income

Disadvantages:

❌ Unlimited liability – The owner is personally responsible for all debts
❌ Difficult to raise capital – No option to sell shares or attract investors
❌ Limited business lifespan – If the owner retires or dies, the business ends

📌 Example: A freelance graphic designer working under their name is a sole proprietor. If a client sues them, their personal assets (like their house and savings) are at risk.

2️⃣ Partnership

A partnership is a business owned by two or more people who share profits, losses, and responsibilities. There are two main types:

🔹 General Partnership (GP):

• All partners share equal responsibility for debts and management.
  
  

• Each partner has unlimited liability (like a sole proprietorship).
  
  

🔹 Limited Partnership (LP):

• Includes general partners (who manage the business) and limited partners (who only invest money).
  
  

• Limited partners have liability protection but no decision-making power.
  
  

Key Features:

✔ Owned by two or more individuals
✔ Partners share profits and responsibilities
✔ Can be informal or require a legal agreement

Advantages:

✅ Easier to raise capital – More people can contribute funds
✅ Shared responsibility – Work and risks are divided
✅ Pass-through taxation – Profits are taxed on partners' personal tax returns

Disadvantages:

❌ Unlimited liability for general partners – They are personally responsible for business debts
❌ Potential conflicts – Disagreements can harm the business
❌ Shared profits – Earnings are split among partners

📌 Example: A law firm where two lawyers operate as partners. If the firm is sued, both are personally liable for damages.

3️⃣ Corporation

A corporation is a separate legal entity from its owners, meaning it can own property, enter contracts, sue, and be sued independently. The two main types are:

🔹 C Corporation (C Corp):

• Owned by shareholders who elect a board of directors.
  
  

• Profits are taxed twice (corporate tax + personal tax on dividends).
  
  

🔹 S Corporation (S Corp):

• Allows profits to "pass through" to shareholders, avoiding double taxation.
  
  

• Limited to 100 shareholders and must be U.S. citizens.
  
  

Key Features:

✔ Separate legal identity from its owners
✔ Owners (shareholders) have limited liability
✔ Can raise capital by selling stock

Advantages:

✅ Limited liability – Owners are not personally responsible for debts
✅ Easier to raise capital – Can issue shares to investors
✅ Business continuity – The company can exist indefinitely, regardless of owner changes

Disadvantages:

❌ Expensive and complex to set up – Requires legal documentation and fees
❌ Heavier regulations and reporting – Must follow corporate governance rules
❌ Double taxation (C Corp) – Profits are taxed twice

📌 Example: Apple Inc. is a corporation. If the company goes bankrupt, shareholders only lose the value of their stock—not their personal assets.

4️⃣ Comparing Business Entities 

5️⃣ Choosing the Right Business Structure

• Freelancer or small business owner? → Sole proprietorship (simple and low-cost)
  
  

• Starting a business with partners? → Partnership (shared responsibilities, but be cautious of liability)
  
  

• Want liability protection and growth potential? → Corporation (best for long-term expansion)
  
  

📌 Key Tip: Many small businesses start as sole proprietorships or partnerships and later transition into corporations as they grow.

6️⃣ Key Takeaways

🔹 Sole proprietorships are simple but expose owners to unlimited liability.
🔹 Partnerships allow shared ownership but require trust and clear agreements.
🔹 Corporations offer liability protection and growth potential, but with more regulations.
🔹 The right choice depends on tax considerations, liability concerns, and long-term goals.

Understanding business entities helps entrepreneurs and investors make informed decisions about starting and managing companies.