Alternative Forms of Business Organization (2)
Posted on November 22, 2008 - Filed Under Finance
A partnership is formed when two or more persons associate to conduct a non-incorporated business. Partnerships may operate under different degrees of formality, ranging from informal oral understandings to formal agreements filed with the state in which the partnership does business. Like a proprietorship, the major advantage of the partnership form of organization is its low cost and ease of formation. In addition, the tax treatment of a partnership is similar to that of a proprietorship: the partnership’s earnings are
allocated to the partners and taxed as personal income regardless of whether the earnings are actually paid out to the partners or retained in the business.1
Proprietorships and partnerships have several disadvantages, including the following:
- Selling their interest in the business is difficult for owners.
- The owners have unlimited personal liability for the debts of the business, which can result in losses greater than the amount invested in the business. In a proprietorship, unlimited liability means that the owner is personally responsible for the debts of the business. In a partnership, it means that if any partner is unable to meet his or her pro rata obligation in the event of bankruptcy, the remaining partners are responsible for the unsatisfied claims and must draw on their personal assets if necessary.
- The life of the business is limited to the life of the owners.
For these reasons, proprietorships and most partnerships are restricted to small businesses.
The three disadvantages listed above lead to the fourth, and perhaps the most important, disadvantage from a finance perspective: the difficulty that proprietorships and partnerships have in attracting substantial amounts of capital. This is no particular problem for a very small business or when the owners are very wealthy, but the difficulty of attracting capital becomes a real handicap if the business needs to grow substantially to take advantage of market opportunities. Thus, many companies start out as sole proprietorships or partnerships but then ultimately convert to the corporate form of organization.
Taken From : HEALTHCARE FINANCE
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