Difference Between Sole Proprietorship and Corporation

Edited by Diffzy | Updated on: September 21, 2022

       

Difference Between Sole Proprietorship and Corporation Difference Between Sole Proprietorship and Corporation

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Introduction

If one is planning to start a business or is interested in expanding an existing one, an important decision relates to the choice of the form of the organization. Forms of business organizations refer to the type of organizations that differ in terms of ownership and management. The major forms of an organization include sole proprietorship, joint Hindu family business, cooperative society, and corporation or company.

The most appropriate form of organization is determined by weighing the advantages and disadvantages of each type of organization against one's requirements. Two of the most popular, yet starkly different forms of organizations are sole proprietorship and corporation.

Sole Proprietorship vs Corporation

The main difference between a sole proprietorship and a corporation is that a sole proprietorship has one single owner who controls and manages the business while a corporation (also referred to as ‘company’ subsequently) is owned jointly by several individuals called shareholders and is operated and controlled by a Board of directors.

Difference Between Sole Proprietorship and Corporation in Tabular Form

Table: Sole Proprietorship vs Corporation
Parameters of Comparison
Sole Proprietorship
Corporation
Definition
Sole proprietorship refers to the form of business organization that is owned, operated, and controlled by an individual who is the recipient of all profits and bearer of all risks.
A corporation is an association of persons formed for carrying out business activities and has a legal status independent of its members.
Formation
The formation of a sole proprietorship involves minimal legal formalities. Registration is not compulsory. Thus, the process of formation is very easy.
The formation of a corporation involves lengthy and expensive procedures, as registration is compulsory. Thus, formation is complex
Members
As the name goes, a sole proprietorship has only a single owner.
A corporation may be of two types- a public corporation and a private corporation. In the case of a public corporation, the minimum number of members required for incorporation is 7 while there is no maximum limit. In the case of a private corporation, the minimum number of members for incorporation is 2 while the maximum is 200 members.
Capital contribution
A limited amount of finance is required to form and operate a sole proprietorship.
Large financial resources are required to form, operate, and expand a corporation.
Liability
The sole proprietor has unlimited liability. This implies that the owner is personally responsible for the repayment of debts in case the assets of the business are insufficient to meet all the debts.
The liability of members is limited to the extent of capital contributed by them to the corporation. The creditors of the corporation can use only the assets of the company to retrieve their debts.
Control and Management
The owner takes all the decisions, major or minor, in the case of a sole proprietorship. Thus, quick decision-making is achieved.
In the case of a corporation, there exists a separation between ownership and management. Shareholders are the owners while the board of directors constitutes the management. Communication and approval of various proposals are slow as they must pass through various channels. This leads to delays in decision-making.
Continuity
The sole proprietor ceases to exist when the owner dies, becomes mentally unstable, or retires from the firm as the business and the owner are regarded as the same. This leads to instability.
A corporation is a stable form of business organization, as it is not affected by the entry and exit of its members. "Members may come, and members may go, but the company continues to exist.”
Risk Bearing
The sole proprietor bears all the risks and losses of the business. He is solely responsible for the same.
The risk of losses in a company is borne by all the shareholders. In the face of a financial crisis, all shareholders must contribute to the extent of their shares in the company’s capital. The risk of loss thus gets spread over many people.

What is a Sole Proprietorship?

The sole proprietorship is a popular form of business organization and is the most suitable form for small businesses, especially in their initial years of operation. Sole proprietorship refers to a form of a business organization that is owned, managed, and controlled by an individual who is the recipient of all profits and bearer of all losses and risks. This is evident from the term itself-'sole' implies single and 'proprietor' refers to owner.

Features

  1. Formation and closure-There is an ease in the formation and closure of a sole proprietorship is very few legal requirements are present. Further, there is no separate law that governs sole proprietorship.
  2. Control-The right to run the business and take decisions lies in the hands of the sole proprietor and he/she can carry out their plans without any interference from others.
  3. No separate entity-According to the law, no distinction is made between the sole trader and the business, as the business lacks an identity that is separate from that of its owner. Thus, the owner is responsible for all business activities.
  4. Sole risk bearer and profit recipient-The risk of failure of the business is borne by the sole proprietor alone. However, if the business is successful, he/she enjoys all the profits of the business, which becomes a direct reward for his or her risk-taking.

Merits

  1. Confidentiality of information-Sole decision-making enables the proprietor to keep all business information confidential and maintain secrecy. A sole trader is also not bound by the law to publish the firm's accounts.
  2. Sense of accomplishment-There is a personal satisfaction involved in working for oneself. The knowledge that one is responsible for the success of the business contributes to self-satisfaction and confidence in one's abilities.
  3. Quick Decision making-A sole proprietor enjoys considerable freedom in making business 3. decisions. Decision-making is prompt as there is no need to consult others. This leads to timely capitalization of market opportunities.

Limitations

  1. Lack of resources: Resources of a sole proprietor are limited to his/ her savings and borrowings. Banks and other lending institutions may be reluctant to grant loans due to limited security.
  2. Limited managerial ability: The owner must assume responsibility for all the tasks of the business, and it is rare to find an individual who excels in all areas. Thus, decision-making may not be balanced. Also, due to a lack of resources, the owner may not be able to appoint and retain talented and ambitious employees.
  3. The limited life of business concern: This type of business is owned, controlled, and operated by one person. Hence, death, lunacy, insolvency, or bankruptcy of the sole proprietor can lead to its closure.

Suitability

  1. Businesses requiring less capital and managerial abilities like a retail store.
  2. The business where personalized services are required like professions.
  3. Business catering to demands of local markets like laundry and grocery stores.

What is a Corporation?

A corporation is an association of persons formed for carrying out business activities and has a legal status independent of its members. It can be described as an artificial person having a separate legal entity, perpetual succession, and a common seal. The company form of organization is governed by The Companies Act, 2013. As per section 2(20) of Act 2013, a company means a company incorporated under this Act or any other previous company law. The owners of the corporation are called shareholders, and the capital of the company is divided into smaller parts called 'shares' which can be transferred freely from one shareholder to another person.

Features

  1. Separate legal entity: From the day of its incorporation, a company acquires an identity, distinct from its members. Its assets and liabilities are separate from those of its owners. The law does not recognize the business and owners to be the same.
  2. Perpetual succession: A company being a creation of the law, can be brought to an end only by the law. It will only cease to exist when a specific procedure for its closure, called winding up, is completed.
  3. Control: The management and control of the affairs of the company are undertaken by the Board of Directors, which appoints the top management officials for running the business. The shareholders do not have the right to be involved in the day-to-day business of the company.
  4. Common seal: The company being an artificial person cannot sign its name by itself. Therefore, every company is required to have its seal which acts as the official signature of the company. Any document which does not carry the common seal of the company is not binding on the company.

Merits

  1. Scope for expansion: As compared to the sole proprietorship and partnership forms of organization, a company has large financial resources. Further, capital can be attracted from the public as well as through loans from banks and financial institutions. Thus there is greater scope for expansion.
  2. Limited liability: The shareholders are liable to the extent of the amount unpaid on the shares held by them. Also, only the assets of the company can be used to settle the debts, leaving the owner's personal property free from any charge. This reduces the degree of risk borne by an investor.
  3. Professional management: A company can afford to pay higher salaries to specialists and professionals. It can, therefore, employ people who are experts in their area of specialization. The creation of the different departments for various activities in a company results in balanced decision-making.

Limitations

  1. Complexity in formation: The formation of a company requires greater time, effort, and extensive knowledge of legal requirements and the procedures involved
  2. Lack of secrecy: The Companies Act requires each public company to provide from time to time a lot of information to the office of the registrar of companies. Such information is also available to the public. It is, therefore, difficult to maintain complete secrecy about the operations of the company.
  3. Impersonal work environment: Separation of ownership and management leads to situations in which there is a lack of effort as well as personal involvement on the part of the officers of a company. The large size of a company further makes it difficult for the owners and top management to maintain personal contact with the employees, customers, and creditors.

Types

Companies can be of two types-private and public.

  1. A private company restricts the transfer of shares and does not invite the public to subscribe to its securities.
  2. A public company is allowed to raise its funds by inviting the public to subscribe to its securities. Furthermore, there is a free transferability of securities in the case of a public company.

Main Differences Between Sole proprietorship and Corporation in Points

  1. The sole proprietorship is owned by a single individual while a corporation is owned by several individuals jointly.
  2. Sole proprietorships report their business profits and losses directly through the proprietor's income tax return, while corporations must pay tax on the company's actual profit/loss.
  3. There is a lot of paperwork involved in both setting up a corporation and running it, as compared to setting up and running a sole proprietorship.
  4. A sole proprietor has complete control over the business, whereas, in corporations, important decisions are made by exercising voting rights.
  5. There is no separate act that governs sole proprietorship, while corporations are governed by the Companies Act 2013.
  6. Expansion of the business is more difficult in a sole proprietorship as compared to a corporation due to the lack of resources and managerial capabilities in a sole proprietorship.

Conclusion

Sole proprietorship and corporation are two different forms of business organizations. They are different from one another based on capital contribution, ownership, risk-taking, ease of expansion, etc. A sole proprietorship is easy to form, operate and close, while corporations require extensive paperwork for the same. However, corporations have ease in expansion due to the availability of financial and non-financial resources as well as managerial talent.

The selection of an appropriate form of organization can be made after considering various factors. Initial costs, liability, continuity, capital considerations, managerial ability, degree of control, and nature of business are the key factors that need to be considered while deciding about the suitable form of organization for one's business.

References

  • Class 11 NCERT Business studies textbook.

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"Difference Between Sole Proprietorship and Corporation." Diffzy.com, 2022. Sun. 25 Sep. 2022. <https://www.diffzy.com/article/difference-between-sole-proprietorship-and-corporation-542>.



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