Three friends Josh, Zandra and Malik are having a discussion about the types of business structures and the liability aspect of each type.
a. Zandra sees many advantages in forming a sole proprietorship. She thinks that the business is separate from the owner and therefore any debts belong solely to the business. Explain to Zandra the concept of unlimited liability and if she is correct that any debts that a sole proprietor accrues belong only to the business. (2 marks)
b. Josh thinks that being in a general partnership is better for him as he sees more advantages in having another person in the business. His understanding is that any profits of the partnership are always split evenly, explain if this is always the case. Also if a 3rd party sues the partnership, he thinks that the liability of each partner will be spilt evenly and each partner will be liable only for their own share, explain if this is accurate.( 2 marks)
c. Malik thinks that a limited partnership is the best type, as the partnership can have access to the funds invested by the limited partners. He thinks that every partner, whether a general or a limited partner, shares equally in the liability of all debts. Again explain if this is an accurate understanding. ( 2 marks)
d. Josh, Zandra and Malik are also wondering about forming a corporation. They are aware that there are more formalities and regulations involved but they would like to know what is the main advantage of forming a corporation, explain this to them. (1 mark)
Solutions
- A sole proprietorship is the simplest form of business organization which is considered the same entity as the owner. According to Jentz & Miller (Pp. 586), a sole proprietor can own and manage any business type whether formal or informal, and of any size. In connection to a sole proprietorship, unlimited liability refers to the owner’s responsibility for all business debts which are payable by personal assets. Ashcroft et., al. (Pp. 569) argue that a sole proprietor is liable for any debts incurred by the business, and the creditors are allowed to seize personal assets if the debts are not payable with the business’s capital. Therefore, Zandra’s argument is incorrect because a sole proprietor has unlimited liability, and any debts accrued by the business belong to the owner.
- There are two types of partnership namely; General partnership and limited partnership. In a general partnership, all partners take part in the management. On the other hand, in a limited partnership, only the general partners take part in the management while the limited partners are considered investors. Josh would benefit from a general partnership by having someone to help in the management. However, as Whittington & Delaney (Pp. 1044) argues, “profits and losses are shared equally among the partners unless otherwise specified by the agreement”. Josh’s argument is incorrect because equal sharing of profits and losses is only available among the general partners if there is no such provision in the partnership agreement. If a third party sue the partnership, each partner has unlimited liability for the debts unless otherwise stated in the agreement. Therefore, the partner’s liability specifically in a general partnership is unlimited and not per an individual’s contribution.
- A limited partnership is a form of business whereby one or more partners are not involved in the management. The limited partner serves as an investor in the business, getting profits that match a share of their contributions. This means that the partnership has access to funds invested by the limited partners and is usually used to determine the share of profits that the partnership owes each individual.
- A corporation is required by the law to be a unique entity that is legally separate from its owners (Press Pp. 28). This form of business is considered a viable option for individuals who want to be shielded from business liability. Zandra, Josh, and Malik can benefit from a corporation in several ways. One benefit of a corporation is that the three would be considered shareholders and legally spate from the business entity. This means their asset cannot be used to pay for business debts, and hence a limited liability. Secondly, the corporation can raise funds by selling stock, and when some specific requirements are met, it is easier to convert the corporation to S corporation that offers more benefits and protection to the owners (Press, Pp. 29).
