Partnership FirmSole Proprietorship

Unlimited Liability: Why Sole Proprietorships and Partnerships Must be Careful

Unlike other business entities like private limited companies, sole proprietorship and partnership companies render unlimited liabilities to the members. It may therefore be chosen only for selected businesses and are not appropriate for businesses that seek to expand and grow quickly.

To succeed, a business should be surrounded by assets, not liabilities. Before kick-starting a Sole Proprietorships business, the prospective business owner must weigh the pros and cons of selecting a particular business structure. Amongst the several factors to be considered, the type of business entity is one of the chief factors to be reflected upon before diving into the other aspects of the business. 

There are quite a number of business entities as guaranteed by the Companies Act, 2013: https://www.mca.gov.in/Ministry/pdf/CompaniesAct2013.pdf, the most common ones being a public limited company, private limited company, partnership, limited liability partnership, sole proprietorship, One Person Company, etc. Each of these business entities bestows certain opportunities and obstacles on the owner. Keeping the business’s goals in mind, the business owner should choose the right type of business entity.

For instance, if the nature of the business does not mandate borrowing loans, or does not involve transactions that might result in huge liabilities, then the business owner might very opt for individual ownership or sole proprietorship. A partnership firm would also very well suit such businesses. 

Under such circumstances, a sole proprietorship or partnership would function more reasonably well than a private limited company or a limited liability partnership firm. Furthermore, the mentioned corporate entities are quite expensive to establish and have an endless list of compliances to be adhered to.

However, when the risks involved are unfathomable, a sole proprietorship or partnership firm may not be the best structure for the respective business for the following reasons:

Personal Liability:

One of the most disappointing aspects vested with sole proprietorship firms and partnership firms is the unlimited liability it shoves on their members. Unlimited liability here means that if the company is unable to meet its debts, the creditors can go after the business owners to recover the same. It is evident that, under such circumstances, the proprietor or the partners must settle the debts, even if that means preceding their personal assets and possessions. 

Therefore, choosing these business entities for establishments that involve vast amounts of money would amount to digging one’s own grave. Therefore, a sole proprietorship or general partnership is suitable only for small-scale businesses. Most individuals who run their businesses from home opt for a sole proprietorship or general partnership. Businesses that are complex, or involve risks and liabilities, cannot be incorporated into sole proprietorship or general partnership.

The Business Owner and the Company are not Separate Entities:

The most significant advantage a private limited company and Limited Liability Partnership (LLP) companies boast is their ability to stay as separate entities legally. In other words, they have a legal existence of their own. On the other hand, it is this quality that a sole proprietorship and a general partnership company lack. 

For this reason, Sole Proprietorships and partnerships usually cease to exist if the promoters leave, as they don’t have a separate legal entity. In a nutshell, a sole-proprietorship company and its proprietor and a general partnership along with its partners are the same, and so are their debts and liabilities.

Challenges Posed by Sole Proprietorships:

There are a few conflicts of interest a sole proprietorships forces on the proprietor:

  • The owner’s responsibility is one of the main limitations of a sole proprietorship. If the business fails, it can cause a dent in the owner’s wealth and might make the prospects a tough attempt
  • The other concern is that sole owners have limited capital access. The money from their savings may not be sufficient to expand the business. Also, the majority of banks and financial institutions are often hesitant to lend loans to sole proprietors
  • A sole proprietorship’s life cycle is uncertain and dependent on its holders. An incapacitated owner can adversely affect the company, and can even result in the company being closed down. Without its master, a sole proprietorship cannot proceed
  • The management power is entirely restricted in the case of a sole proprietorship. The sole proprietor cannot act as a jack of all trades. A sole proprietorship has minimal resources, so there aren’t many competent resources to propel the company forward. This can lead to mismanagement and sometimes result in poor organizational decisions. One of the many solutions to overcome this issue is to convert a sole proprietorship to a private limited company in India.

Challenges Exhibited by Partnership Firms:

Unlike LLPs, general partnership firms pose a few challenges, as illustrated below.

  • Complications occur when one partner passes away. A partnership interest is often non-transferable through inheritance as the remaining partner may not wish to be in partnership with the person inheriting the interest of the deceased partner. Partners may make provisions in the partnership agreement to avoid separation due to death if both parties agree to recognise those who inherit the interest of the deceased as partners
  • It is necessary to share decisions in a partnership. If the partners have a conflict over the ways of business operations, their business and personal relationships may face issues
  • Any benefits generated by the partnership must be shared between all partners. The more partners, the fewer profits would be assigned to a single partner.

Thus, a business owner should make an informed decision when choosing a suitable corporate entity to house the business. There are no right or wrong choices, only those suitable or unsuitable when deciding upon the business entity. Selecting a qualified entity would undoubtedly take the business to places.

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