Anyone who wants to start a company ought to consider the various forms companies can take. The form a company takes will impact management, profit sharing, and liability. There are, of course, other factors to consider, but this article will use liability, profits, and management as the key factors in distinguishing company forms.
The three major company forms we will consider are: sole proprietorships, partnerships, and corporations.
1. Sole proprietorship: proprietorships are run by a single person whose company is not legally distinct from that person. This means that should the company fail, the individual is totally responsible for the debt of that company. However, this also means that a proprietor has sole control of company assets and profits.
An important side note: proprietors may apply for and obtain a trade name, which distinguishes them from the company. Trade names do NOT change the proprietor's liability status.
2. Partnership: in contrast to a proprietorship, where an individual has sole responsibility for the management of their company, a partnership is formed of two or more individuals who agree to advance their common interests. This agreement can be formalized through Articles of Partnership--a contract between the partners that defines expectations for each other. All partnerships, Articles of Partnership or not, share the rights of management, liability for debt, and profits. Specific percentages of profit depend on what the partners agree to.
Partnerships, unlike proprietorships, come in various forms. We will consider three:
First, a general partnership is one where all partners share management, liability and profits. Should the company fail, they all will be held liable for debt.
Second, a limited partnership is one with at least one general partner, and at least one limited partner. A limited partner is someone who invests in the company and can expect a return on that investment. Also, a limited partner is limited in the sense that that, should the company fail, they are not held legally responsible for the debt of the company. Finally, a limited partner does not have management rights in the company.
Finally, A limited liability partnership is one where, like a general partnership, all members retain management rights and share profits. However, unlike a general partnership, all members retain a limited liability status where, should the company fail, an individual partner would not be held responsible for the negligence of another. Think of this type of partnership as a blend of a general partnership's sharing of management/profits with the same limited liability status enjoyed by limited partners.
3. A corporation: corporations are distinct from other company forms in that they are considered a legal person -- in other words, they are a distinct legal entity that can, for example, sue and be sued, claim human rights violations and be cited for the same, etc. Because corporations are a distinct legal entity, should the company fail, individual stockholders and employees will, generally, not be held liable for the debt. They will likely lose their investments or jobs, but like a limited partner, they enjoy limited liability status.
Corporations also differ from proprietorships and partnerships in terms of management. Management of a corporation is determined by a board of directors. Those who sit on the board are usually determined by vote of the stockholders.
Profit in a corporation is determined primarily by the value of its stock. If the value of the stock increases, then shareholders, directors and employees will benefit. Should the stock value decrease, shareholders lose money on their investment, and directors/employees can also lose money if the stake value does not recuperate.