Legal forms of Business ownership

If a person is considering starting a small business, he may be trying to sort out the different

types of businesses and wondering which type is best for him/ her. Each type is best for a

specific purpose or situation, relating to taxes, liability, and the ability to control the profits

and losses of the business.

The various forms of business ownership are sole proprietorship, partnership and corporation.

Sole Proprietorship

This is a business owned by one person. It needs no charter, has few costs, and that person

gets to keep all the money to his/her self. The problem is, of course, that a one-person

business can’t make as much money as a large business, the owner will have to work very

hard, and if the business loses money, the loss translates directly to the owner A sole

proprietorship is generally the simplest way to set up a business. A sole proprietor is full

responsible for all debts and obligations related to his or her business. Creditor with a claim

against a sole proprietor would normally have a right against all of his or her assets, whether

business or personal. This is known as unlimited liability.

Advantages

• Ease of formation

• Low start-up costs

• Less administrative paperwork than some other organizational structures (such as

incorporation)

• Owner in direct control of decision making

• Minimal working capital required

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• Tax advantages to the owner (Tax is at graduated rates)

• All profits to owner

Disadvantages

• Unlimited liability

• Difficulty raising capital

• Lack of continuity in business organization in the absence of the owner

• All losses to owner

Partnership

A partnership is a relationship that exists between two or more persons carrying on a business

in common with a view to making profit. It is an agreement in which two or more persons

combine their resources in a business with a view to making a profit. In order to establish the

terms of the business and to protect partners in the event of disagreement or dissolution of the

business, a partnership agreement should be drawn up, usually with the assistance of a

lawyer. Partners share in the profits according to the terms of the agreement. Where two or

more persons wish to form a partnership, then it is recommended that they agree on the terms

upon which the partnership will be run and the relationship between each other. This is done

in writing and signed off as agreed by all the partners and therefore it becomes a partnership

deed or agreement.

Contents of partnership agreement

• Name(s) and address(s) of both the firm and the partners

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• Capital to be contributed by each partner

• The profit sharing ratios that may be expressed as a fraction or as a percentage.

• Salaries to be paid to any partners who will be involved in the active management of the

business

• Any interest to be charged on drawings made by the partners

• Interests to be given to the partners on their capital balances

• Procedures to be taken on the retirement or admission of a partner

Advantages

• Ease of formation

• Low start-up costs

• Additional sources of investment

• Broader management base

Disadvantages

• Unlimited liability (for general partners)

• Lack of continuity

• Decision making authority diluted

• Hard to find suitable partners

• Possible development of conflict between partners

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 Corporation

A corporation is a legal entity that is separate from its owners, the shareholders. No

shareholder of a corporation is personally liable for the debts, obligations or acts of the

corporation. Directors, officers and insiders can bear some liability for their involvement with

the corporation. A corporation is identified by the terms "Limited", "Ltd.", "Incorporated",

"Inc.", "Corporation", or "Corp.". Whatever the term, it must appear with the corporate name

on all documents, stationery, and so on, as it appears on the incorporation document. A

corporation has legal rights and obligations of its own which are distinct from those of the

individuals who either constitute its membership or management. This attribute of legal

personality has received considerable judicial exposition in relation to registered companies

and the overall practical effects may be summarized as follows:

(i) Limited Liability

The debts of the corporation are its own and a member or manager of the corporation

cannot be sued in order to recover the debts. If a corporation such as a registered

company is unable to pay its debts it may be wound-up and during the winding-up its

members will be asked to 'contribute' what is required to pay the debts but a member

cannot be asked to pay more than the amount, if any, that is unpaid on the shares held by

him (or the amount he guaranteed if it is a company limited by guarantee).

(ii) Perpetual Succession

The death of a member or members of the corporation does not result in the death

of the corporation. Members come and go and are merely succeeded by other

persons who become new members. The corporation 'dies' only when its legal life

is brought to an end by a legal process known as liquidation.

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 (iii) Owning of Property

The property of a body corporate such as a registered cooperative society or a

registered company does not belong to its members. Consequently, a member

cannot insure the property since he does not have insurable interest therein. A

person cannot, generally speaking, have insurable interest in the property of

another person. The law regards a corporation and its member as separate persons

for this purpose.

(iv) Suing or being sued

Because of the legal separation between a corporation and its members, it follows

that a wrong to, or by, the corporation is not a wrong to, or by, its members.

Formation of Corporations

A corporation may be brought into existence by

(a) Registration

(b) Statute

This is created by an Act of Parliament and comes into existence from the date of

commencement of the Act. An example of a statutory corporation is the Agricultural Finance

Corporation". Section 3(1) of the Act states that "there is hereby established a corporation to

be known as the Agricultural Finance Corporation". Section 3(3) of the Act states that "the

corporation shall be a body corporate with perpetual succession and a common seal"

(c) Charter

A chartered corporation may be created under Section 14 of the Universities Act, 195. Sec 12

of the Act empowers the President of Kenya to grant a charter to any private university

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intended to be set up in Kenya if, in his opinion, the grant of the charter to the institution

concerned may be of benefit to the future development of university education in Kenya.

Advantages

• Limited liability

• Specialized management

• Ownership is transferable

• Continuous existence

• Separate legal entity

• Possible tax advantage (if you qualify for small business tax rate)

• Easier to raise capital

Disadvantages

• Closely regulated

• Most expensive form to organize

• Charter restrictions

• Extensive record keeping necessary

• Double taxation of dividends