Difference Between Sole Proprietorship and Partnership
Selecting the ideal organizational entity will help to protect your personal assets from any risks and liability that you may incur as your business develops.7 min read
What is the difference between sole proprietorship and partnership? Selecting the ideal organizational entity will help to protect your personal assets from any risks and liability that you may incur as your business develops.
What Is Sole Proprietorship?
As one of the oldest forms of businesses, sole proprietorship is an easy one to create, and it's widely prevalent. One owner operates a sole proprietorship. This single owner is in sole charge of making business decisions. The person who owns and runs the business is known as the sole trader or sole proprietor.
Sole tradership is another name for this type of business. The proprietor uses his or her own finances, experience, skills, expertise, and knowledge to operate the business on his or her own. The sole proprietor is in full control of all business activities. Legally, the owner and the company are inseparable.
What Makes a Partnership?
When two or more individuals share responsibility for running a business, this is known as a partnership. A partnership is a business organization owned by two or more individuals.
Partners include all individuals who run the business. These individuals have an agreement to share the company's profits and losses. Collectively, a partnership is called a firm. The ratio in which profits and losses are shared is decided by an agreement between the partners. A partnership is a legally binding relationship between partners. This is an unseen relationship.
The firm name is the business name the company operates under. The physical form of the partnership is the firm. Each partner operates as the other partner's principal and agent, and the mutual agency is considered the essence of the partnership. A partnership can't exist if this clause isn't in place.
Types of partnerships include:
- Limited Liability Partnership
The different types of partners that can be part of a partnership include:
Anyone who's considered a partner is an agent of the partnership and is therefore allowed to manage the firm.
What Is the Use of a Partnership Agreement?
It is not uncommon for a business partnership to experience disputes between the owners. Although a partnership agreement should assist in resolving and deterring disagreements, sometimes it does not. For example, if a partner causes irreparable damage or doesn't perform his or her responsibilities and duties, a partnership agreement may not reconcile the differences.
What Is the Scope for Raising Capital in a Sole Proprietorship or Partnership?
In a sole proprietorship, the scope for raising money or capital is limited. If the owner doesn't have a substantial amount of collateral, then a bank will most likely not grant a loan.
In a partnership, the scope for raising money or capital is relatively high. It's significantly easier for a partnership to raise capital because the more individuals associated with a business, the more potential collateral they may offer to the banks. Also, a partnership may attract outside investors by offering them an opportunity to invest in the growing business.
What is the Difference Between Proprietor and a Partner?
In a sole proprietorship, the owner or proprietor is liable for all losses, and in turn, receives all of the profits. On the other hand, in a partnership, the partners must share in the profit and losses as agreed to in the partnership agreement.
Similarities Between a Sole Proprietorship and Partnership
Both of these types of businesses are considered relatively easy to form. You don't need formation paperwork to start operation of either of these types of companies. In both partnerships and sole proprietorships, these businesses do not exist as entities separate from the business owners.
Sole proprietorships and partnerships are sometimes designated as pass-through entities. Pass-through entities are structured entities that offer business owners a more favorable tax rate while still protecting the owner or members from personal liability. For federal income tax purposes, types of pass-through entities include sole proprietorships, partnerships, LLCs, and S corporations.
Pass-through entities do not pay income taxes on a corporate or business level to the Internal Revenue Service. Therefore, they can provide an alternative to the double taxation that occurs in a corporate business structure. With a pass-through entity, the owners share the income and their income levels determine the amount of tax they owe.
Pass-through entities, or flow-through entities, make up over 60 percent of all business entities in the United States. Small business owners prefer structuring their business as either a sole proprietorship or partnership because this requires filing far less documentation with regulators. Therefore, there are much fewer formalities to follow in comparison to an LLC or corporation.
For example, partnerships and sole proprietorships are not required to have company meetings. Therefore, they're not required to track meeting minutes. Also, they're not forced to file annual reports or submit financial statements to governmental regulators.
What is the Difference Between a Sole Proprietorship and Partnership?
The main difference between a sole proprietorship and partnership is the number of people who own and operate the business. In a sole proprietorship, if the owner dies or the business is sold, the company is automatically dissolved. In a partnership, if an owner dies or withdraws from the business, the company may automatically be dissolved. In many cases, a partnership will continue to carry on after an owner withdraws or dies. Remember, the partnership agreement needs to address these types of issues so that the business isn't forced to dissolve.
The partnership agreement should outline the steps that the business owners should take when another partner:
- Withdraws from the business
Any time two or more parties decide to form a business, a partnership is automatically created. Any time an individual decides to start a business, a sole proprietorship is created. There is no need to file documents or paperwork with a governmental agency when a partnership or a sole proprietorship is created.
In other words, there is no need to register a sole proprietorship with local, state, or federal agencies. On the other hand, partners may decide, based on their own discretion, whether they'd like to register their business. Remember, a partnership may be created orally or in writing.
Only one owner is allowed in a sole proprietorship. On the contrary, a partnership is allowed a minimum number of two partners and a maximum number of 100 partners.
One of the main advantages of running a sole proprietorship is that the sole business owner is not forced to share confidential information or business plans with anyone. On the other hand, partners must share their business plans with the other owners.
Drafting and Signing a Partnership Agreement
It is not required by law to create a partnership agreement for establishing a partnership, but it provides a significant benefit in ensuring that all parties agree to the terms. A well-written partnership agreement should assist in advising how to handle disputes and other difficult situations. A partnership agreement should cover the following topics:
- Dispute resolution.
- Each partner's capital contributions.
- Voting rules.
- Allocation of losses, draws, and profits.
- Steps to admit or withdrawal partners.
Honest and well-intentioned partners may find themselves in the heat of a legal battle if a written partnership agreement is not created. Should conditions or circumstances change a partnership agreement, it can always be changed or amended at a later date.
What Is a Partnership Agreement?
A partnership agreement may also be known as:
- Business partnership agreement
- General partnership agreement
- Articles of partnership
- Partnership contract
A partnership agreement is made between two or more business partners and addresses the responsibilities, profit and loss allocations, withdrawals, capital contributions, financial reporting, and other rules or guidelines of the business. A partnership agreement will display unmistakable intentions by all partners to form a partnership. The importance of a partnership agreement is illustrated in the dispute resolution process.
Disadvantages of Sole Proprietorship and Partnership
Sole proprietorships are only owned by one person and therefore do not allow outside parties to invest in the business. Therefore, raising capital in a sole proprietorship is much more difficult as business owners must rely on personal savings, loans from friends and family, or business loans from banks. Remember, banks will only make loans to a sole proprietorship based on the owner's creditworthiness.
Details on Decision-Making
A sole proprietor acts as the single decision-maker of the business. This includes maintaining complete control over the finances and operations of the company. A sole proprietor doesn't have to consult with another person when he or she makes decisions related to the business.
Because there's a single owner in a sole proprietorship, decisions can be made quickly. This differs from a partnership, where partners will have to consult with one another before making decisions related to the business.
Each partner in a partnership has input on all important business decisions, including how to use company resources.
In partnerships, each partner can contribute his or her unique viewpoint when making business decisions. Having input from more than one person may result in advantageous business decisions.
About Liability Differences
Whether it's a sole proprietor or individual partners in a partnership, both have unlimited liability for:
- Lawsuits affecting the business
- Business obligations
- Company liabilities
If a company's assets are not sufficient to cover the business's debts, sole proprietors, as well as partners, can lose personal assets, including their homes and cars.
A partner can be held liable for the negligent behavior of another partner. If business assets are deemed insufficient to meet existing obligations of the partnership, any of the partners could lose personal assets. Creditors can sue a proprietor who owes debts.
How Each Deals with Conflicts
Because a sole proprietor makes decisions for the business alone, he or she doesn't have business conflicts when it's time to make company decisions.
Having a partnership agreement can help the partners run the business without unnecessary conflicts and disputes. Because each partner may have differing ideas on business decisions, even with a partnership agreement in place, disputes may arise. When partners don't feel that other partners are doing their share of the company's work or if there's a lot of disagreement between partners, the company may suffer. It's not considered good practice to operate a partnership without having a detailed agreement in place.
If you need help with creating a sole proprietorship or partnership, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.