A founder choosing between a sole proprietorship and a corporation is not picking a tax form. They are choosing who can sue them personally, how much capital they can raise, and whether the business survives their death.
Four primary forms exist. Compare these organizational forms across five dimensions: owner liability, taxation, control, capital access, and continuity of existence.
Sole proprietorship. One owner. The business is the owner; no separate legal entity exists. Profits are taxed once as the owner's personal income (pass-through). The owner has unlimited personal liability for business debts: creditors can seize personal assets. Capital is limited to the owner's resources plus what banks will lend personally. The business ends when the owner dies or quits.
General partnership. Two or more partners share ownership. No separate legal entity in the classic form. Profits flow through to partners' personal returns. Every general partner has unlimited joint and several liability: any partner's act binds the others, and a creditor can pursue any partner for the full debt. Control is shared by agreement.
Common mistakes
- Confusing general and limited partner liability. General partners have unlimited joint and several liability. Limited partners' liability is capped at their investment, but only if they do not participate in management. Trap: "Limited partner exercises management authority and retains limited liability." Wrong: management participation strips the shield.
- Saying corporations always pay double tax. Distributed corporate profits are taxed at the entity level and again at the shareholder dividend level. Retained earnings are taxed only once (at the entity level) until distributed. Trap: applying double tax to every dollar of corporate earnings.
- Treating "private" as "small." Private describes ownership and disclosure, not size. Some of the largest firms in the world are private. Trap: ranking corporate forms by size rather than by registration and disclosure status.
Bottom line
- Sole proprietorship and general partnership: unlimited personal liability plus pass-through taxation. Corporation: limited liability plus entity-level tax.
- Limited partnership has two classes: a GP with unlimited liability and control, and LPs with limited liability and no management role.
- Corporate features: separate legal entity, limited liability, transferable shares, perpetual life, and separation of ownership from control.
- Separation of ownership and control creates the principal-agent problem, where managers (agents) may pursue interests other than shareholders (principals).
Exam shortcut
For organizational form questions, anchor on liability plus tax first: unlimited plus pass-through (sole prop, GP), split (LP), limited plus double (corporation). For corporate features, remember the chain: separate legal entity creates limited liability, transferable shares, perpetual life, and ownership-control separation, which produces the principal-agent problem. For public versus private, the three differentiators are registration, continuous disclosure, and exchange trading.
The full lesson (about 2,535 words, 17 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- organizational forms and ownership
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