FORMS OF BUSINESS: SOLE PROPRIETORSHIP,

PARTNERSHIP, CORPORATION

After deciding to start a business (and the particular business to pursue), one of the important
issues is the form of business entity that will serve as the vehicle in pursuing the business. You
may say that the next important issue is the source of funding, which is correct, but that issue will
be discussed much later. Right now, let’s focus on the forms of business.

The choice of the form of business or business organization depends on various factors. In
certain business, like banks, the law requires that the business entity must be a corporation. A
small business, like your friendly sari-sari store, is better off as a sole proprietorship, although it
could also be converted to another form of business if the circumstances require that shift.
Sole proprietorship
Also referred to as “single proprietorship,” a sole proprietorship is the most simple form of
business and the easiest to register, through the Bureau of Trade Regulation and Consumer
Protection (BTRCP) of the Department of Trade and Industry (DTI). It is owned by an individual
who has full control/authority of its own and owns all the assets, as well as personally answers all
liabilities or losses. The fact that it is run by the individual means that it is highly flexible and the
owner retains absolute control over it.

The problem, however, is that a sole proprietor has unlimited liability. Creditors may proceed not
only against the assets and property of the business, but also after the personal properties of the
owner. In other words, the law basically treats the business and the owner as one and the same.
This uniform treatment also has important tax implications. Partnerships and corporations may
lessen their tax liability through a myriad of business expenses and other tax avoidance
techniques. These tax deductions may not be applicable to a sole proprietorship. Also, the
potential growth and reach of a sole proprietorship pale in comparison with that of a corporation.
Partnership
A partnership consists of two or more persons who bind themselves to contribute money or
industry to a common fund, with the intention of dividing the profits among themselves. The most
common example of partnerships are professional partnerships, like in the case of law firms and
accounting firms. Just like a corporation, it is registered with the Securities and Exchange
Commission (SEC).

A partnership, just like a corporation, is a juridical entity, which means that it has a personality
distinct and separate from that of its members. A partnership may be general or limited. In a
general partnership, the partners have unlimited liability for the debts and obligation of the
partnership, pretty much like a sole proprietorship. In a limited partnership, one or more general
partners have unlimited liability and the limited partners have liability only up to the amount of
their capital contributions. Unlike a corporation, which survives even when a member/stockholder
dies or gets out, a partnership is dissolved upon the death of a partner or whenever a partner
bolts out.
Corporation
A corporation is a juridical entity established under the Corporation Code and registered with the
SEC. It must be created by or composed of at least 5 natural persons (up to a maximum of 15),
technically called “incorporators.” Juridical persons, like other corporations or partnerships,
cannot be incorporators, although they may subsequenly purchase shares and become
corporate shareholders/stockholders.

The liability of the shareholders of a corporation is limited to the amount of their capital
contribution. In other words, personal assets of stockholders cannot generally be attached to
satisfy the corporation’s liabilities, although the responsible members may be held personally
liable in certain cases. For instance, the incorporators may be held liable when the doctrine of
piercing the corporate veil is applied. The responsible officers may also be held soliarily liable
with the corporation in certain labor cases, particularly in cases of illegal dismissal.
The biggest businesses take the form of corporations, a testament to the effectiveness of this
business organization. A corporation, however, is relatively more difficult to create, organize and
manage. There are more reportorial requirements with the SEC. Unless you own sufficient
number of shares to control the corporation, you’ll most likely be left with no participation in the
management. The impact of these concerns, however, is minimized by the army of lawyers,
accountants and consultants that assist the corporation’s management.
Differences between Sole Proprietorship, Partnership and
Corporation
A sole proprietorship is a business that has a single owner who is responsible for making decisions for
the company. A partnership consists of two or more individuals who share the responsibility of running
the company. A corporation is one of the most recognizable business structures and has a separate
identity from the owners of the company. One or more owners may participate as shareholders of a
corporation.

Formation
A partnership business automatically begins when two or more people decide to go into business. Sole
proprietorships begin automatically when a single business owner decides to open a business. There are no
documents to file to begin a sole proprietorship or a partnership. However, businesses are required to file articles
of incorporation, also known as a certificate of formation, to legally form a corporation in any state. Each state
charges a fee, which varies from state to state, to file articles of incorporation. In addition, corporations are
required to register with each state where the company intends to make business transactions. This requirement
is not imposed on sole proprietorships or partnerships.

Liability
Sole proprietors and partners in a partnership business have unlimited liability for all debts and liabilities that
occur while operating the business. This means partners and sole proprietors may lose their homes, cars and
other personal assets, if the company's assets are insufficient to cover the company's debts. Corporations provide
owners of the company with limited liability protection against business losses and obligations. This means
owners of a corporation will not lose their home, if the company goes bankrupt. Owners of a corporation are
liable for company debts and obligations up to the extent of their investment in the company.

Taxation
Partnerships and sole proprietorships are referred to as pass-through entities. This is because sole proprietors
and partners in a partnership report their share of company profits and losses directly on their personal income
tax return. Sole proprietorships and partnerships are not required to file business taxes with the Internal Revenue
Service. Corporations are subject to double taxation. This occurs when the corporation pays taxes on the
company's profits at the business level, and shareholders pay taxes on income received from the corporation on
their personal tax return.

Structure
Corporations have a structure consisting of shareholders, directors, officers and employees. Every corporation
must select at least one person to serve on its board of directors. The board of directors is responsible for
allocating the company's resources and increasing the shareholders' profits. Officers are required to manage the
day-to-day activities of the company and implement the decisions made by the company's shareholders and
directors. Sole proprietorships and partnerships have a more informal structure that does not require the
selection of officers and directors. Sole proprietors have full control over every aspect of their business, whereas
partnerships and corporations have to vote on important company issues.

Formalities
Partnerships and sole proprietorships have far less paperwork and fewer ongoing formalities to adhere to in
comparison to a corporation. Corporations are required to hold at least one annual meeting, while sole
proprietorships and partnerships do not have to hold company meetings. A corporation must keep strict financial
records and keep a ledger detailing how the company reached certain decisions. Unlike a corporation, sole
proprietorships and partnerships are not required to file annual reports with the state or create financial
statements.
Be a Sole Proprietorship, Partnership or Corporation?
For most entrepreneurs, one of the most important decisions is whether to be a sole proprietorship, a
partnership or a corporation. A mistake in form of organization can bring long-term damage to a
business. Despite the risks, most people make this decision without a good idea of the type that is really
best for their company.
 
Usually, we rely on our accountant or some other person who we believe is knowledgeable in making this
decision. While most of the time their advice may have been correct, it would be better if you yourself
understand what is best for the company you are planning to put up. Below are tips on the advantages
and disadvantages of each type of organization:
 
Sole Proprietorship
 
This is when only one person owns and controls the business. It is the most simple and inexpensive
alternative. If you have very limited capital, then this may be your only option. It is also very fast to put
up. The large majority of businesses in the Philippines are sole proprietorships. The main problem here is
that you and the business are legally the same, and this means that your company’s liabilities are also
your personal obligations, exposing you to great risks.
 
There are many cases where a business is formed as a sole proprietorship even though it is not really so.
The most common example is the case of married couples. When a husband and wife form a company, it
should, at least, be a partnership since there are two of them. A partnership allows two or more persons.
Many couples think having the business in the name of only one of them does not matter if everything is
conjugal property anyway. To be on the safe side, consult an expert on all the possible consequences of
this arrangement.
 
Partnership
 
Midway between the sole proprietorship and corporation is the partnership form of business.
Partnerships are registered in the Securities and Exchange Commission. Some types of business must be
partnerships. Some types of professional practices, like law and accounting, can only be organized as
partnerships.
 
A partnership’s income is equally divided among the partners, unless there is a written provision that
dictates otherwise. Frequently, there are quarrels because there are partners that think their partner is
not putting in the same amount of effort or investment and still get the same profit. Decide on a fair
arrangement beforehand.
 
If you are the main investor, and the one personally liable, this position is called the general partner. The
others are called limited partners because they have only limited liability, as if they were shareholders in
a corporation.
 
Corporation
 
A corporation is considered a separate entity; an artificial person created by law and, like partnerships, is
registered in the Securities and Exchange Commission. It takes at least five persons to form a corporation
in the Philippines. There are many advantages if you are a corporation, and thus almost all large
companies are corporations because of these. Also, there are some businesses that by law must be
organized as a corporation, like a lending company for example.
 
The main deterrent in choosing a corporation is the much larger amount of expenses and effort required
in setting up and maintaining this type of legal entity. If the expense is not a problem, a corporation is
quite probably the best option.
 
The most often cited advantage of corporations is limited liability. That is, in normal circumstances, you
will not be liable beyond your investment in the corporation. This is quite understandable since operating
a business always has some risks and you would want your personal assets to be free from creditors in
case your business goes bankrupt. However, this is not entirely accurate. If you have unpaid subscribed
shares, then you are still liable for the unpaid balance of the stock. You can have fully paid shares so that
you will not be surprised by this. There are also some other situations where you may be personally
liable.
 
One of the greatest advantages of a corporation is that it is relatively easier to get additional capital for it.
Note, however, that in applying for a loan for your business, there is often fine print that makes you
personally liable for unpaid obligations. Try to avoid this provision, if possible, as it nullifies the legal
protection of your personal assets if your company is a corporation.
 
Perhaps the most serious disadvantage of corporations is that there is double taxation. The company’s
income is first taxed, and then cash dividends to stockholders are once again taxed. However, in practice
there are also tax advantages in being a corporation.
 
Choosing the appropriate legal structure for your company has a profound impact on its eventual
success, so do not take this decision lightly. The good news about this is that, should you find the status
quo not ideal, it is possible to change to a different form of business structure. But you can only make a
wise judgment on this crucial matter if you have a basic understanding of the advantages and
disadvantages of the options.