Types of Ownership Structures

While business ownership may seem straightforward, businesses can be owned in a variety of ways. Some businesses have only a single owner who manages the day-to-day affairs of the business. Others are owned by a small handful of close friends. Large businesses are often owned by hundreds or thousands of people. Each type of ownership structure has different legal obligations associated with it.

Background

The first corporations were not created to make a profit. Instead, they were intended to manage the money of public institutions. In the seventeenth century, European business people established companies to manage colonial expeditions to North America. These companies were created specifically to earn their founders money and influence in the New World.

Once America became an independent nation, it followed the traditions of its British predecessors. American companies were contracted to carry out a specific task and were usually disbanded after that task was complete. This changed in 1886, when a US court ruling declared that corporations should have the same rights as people. This gave corporations the power to define their own goals, hold property, and separate shareholders from the legal entity itself.

Under this new ruling, corporations flourished. Massive railroad corporations gained unprecedented levels of power over the national economy. They used unscrupulous business practices to drive out all competition, forming trusts and monopolies for profit. Eventually, the government had to act. Congress passed antitrust and antimonopoly laws and raised corporate tax rates. This returned competition to the economy, driving down prices. While regulation on businesses and business ownership has waxed and waned over time, it has never again hit such historic levels of deregulation.

Overview

The smallest and simplest ownership option available to a business is the sole proprietorship. Most common in very small businesses and startups, a sole proprietorship is owned by just one person. That person's finances are inseparable from the business's finances. When the business makes money, the owner makes money. Sole proprietorships are not registered with the state or required to submit special paperwork to come into existence.

Sole proprietorship is useful for startups because of the minimal effort required to start the business. To qualify for a sole proprietorship, a startup simply needs to begin making transactions. However, this business option comes with increased liability. Because the owner's finances are completely merged with the business's finances, the owner must pay personal taxes on all of the business's earnings. Additionally, if the business is ever sued, fined, or required to borrow money, the owner is personally responsible for these debts.

In some cases, a sole proprietorship evolves into a partnership. A partnership is exactly the same as a sole proprietorship, except two individuals have an equal stake in the business. No paperwork is required to be filed with the state, and both partners are still personally responsible for potential debts and lawsuits. If this displeases either partner, they may enter into a limited partnership. In a limited partnership, one partner has much more power over the business itself. However, that partner is solely responsible for all debts incurred by the business. The weaker partner has a minimal say in all business decisions but still receives a predetermined cut of the profits.

As businesses grow, it is sometimes useful for them to become a corporation. Incorporation has several advantages over sole proprietorship, partnership, and limited partnership. Most importantly, an incorporated business becomes an independent, legal, taxable entity. The owners will only pay taxes on their declared salary and bonuses instead of on all the business's profits. Instead, the business will pay its own taxes out of its profits.

The most important aspect of the corporation is its ability to sell shares of the company. These shares, often called stock, represent a percentage of ownership in a business. Shares are sold to investors, and the money from those sales is put toward the growth of the business. In return, shareholders are often entitled to a percentage of the profits generated by the business or a say in major business decisions. They may also buy shares at a low price, usually when the business is just starting and needs investment money, and then sell them at a much higher price once the business is successful. Unincorporated businesses, including sole proprietorships and partnerships, may have trouble attracting investors because they cannot be publicly traded.

A limited liability company (LLC) is very similar to a corporation. The process of becoming a LLC turns the business into its own legally distinct entity. However, the owners still pay taxes on their share of the business's profits. Unlike corporations, LLCs do not publicly sell shares to investors. Instead, ownership of the company usually remains with its initial investors.

A business may also incorporate as a nonprofit. In this scenario, the business retains all the benefits of a corporation but is not usually taxed on its donations and earnings. Those earnings are expected to go to a specified charity. Ideally, overhead costs are kept to a minimum so that the maximum possible profit percentage goes toward the charity.

In rare cases, small groups may form a business as a cooperative. In a cooperative, the business is owned in equal shares by all its workers. All workers share in the business's profits, pay a share of its bills, and put in an equal amount of work. Many states require official paperwork to be submitted to be recognized as a cooperative. However, cooperatives are rare and do not usually function beyond the level of small, local businesses.

Bibliography

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