Sole proprietorship vs partnership firm

There are several forms of organisation that are available to businesses in which they can house their operations. Determining the correct form of organisation is one of the first steps that need to be undertaken when setting up a business.

This article looks at meaning of and differences between two forms of organisation – sole proprietorship and partnership firm.

Definitions and meanings

Sole proprietorship:

Sole proprietorship is a form of business organisation which is owned and run by a single individual. A sole proprietorship form of business organisation does not have a separate legal entity and its legal form is the same as its owner.

A sole proprietorship may hire multiple people to manage and operate the business, but the legal and economic ownership lies solely with the individual owner i.e.: with the sole proprietor. The sole proprietor is entitled to solely receive all profits of the business and also has unlimited liability towards all dues of the business. In fact in a sole proprietorship, the sole proprietor may become personally liable for dues of the business if the business assets are not sufficient.

Sole proprietorship form of business is suitable for small scale often family run businesses where the scale of operations is limited.

 Partnership firm:

A partnership firm is a form of business organisation in which two or more individuals/entities (partners) enter into an agreement to operate a business with the intention to earn profits.

The terms of a partnership firm are governed by an agreement termed as a partnership deed. The partnership deed specifies amongst other aspects – the capital contribution of all partners, the profit sharing ratio amongst partners, the responsibilities of all the partners, the remuneration payable to partners etc.

Whether a partnership firm is a separate legal entity than the individuals/entities that are its partners depends on the type of partnership. A partnership can primarily be of two types – unlimited partnership and limited liability partnership.

In an unlimited partnership, the partners’ liability is unlimited and they can even be personally liable for the debts and obligations of the business. Thus there is no real distinction between the legal identity of the partnership and its partners.  In limited liability partnerships, the liability of the partners is limited, generally to their respective capital contributions in the firm. In this case the legal entity of the partnership is different from that of its partners.

Key differences between sole proprietorship and partnership firm:

The difference between sole proprietorship and partnership firm has been detailed below:

1. Meaning

A sole proprietorship is a form of business organisation which is owned by a single person and in which there is no distinction between the owner of the business and the business itself.

A partnership firm is a form of business organisation in which two or more entities agree to work together to operate a business with earning profit as its core objective.

2. Number and nature of owners/partners

A sole proprietorship has a single individual owner, namely the sole proprietor.

A partnership firm has multiple partners (2 or more). The partners can be individuals, partnership firms or companies.

3. Separate entity

There is so separate legal entity of the business in the case of a sole proprietorship.

In the case of a partnership firm, the separate legal entity of the business depends on the type of partnership. An unlimited partnership does not have a distinct and separate legal entity whereas a limited liability partnership has a distinct and separate legal entity than that of its partners.

4. Liability

The liability of a sole proprietor is unlimited i.e., he/she can be held personally liable for the debts and obligations of the business.

The liability of partners depends on whether it is an unlimited partnership or a limited liability partnership. The liability of partners amongst each other is also determined by the terms of the partnership deed.

5. Profits of the business earned by

In a sole proprietorship, the profits of the business are earned solely by the sole proprietor.

In a partnership firm, the profits are shared amongst the partners in the profit sharing ratio decided by mutual agreement and specified in the partnership deed.

6. Decision making

In a sole proprietorship, decision making is the sole prerogative of the owner of the business. A sole proprietor is not obligated to consult any other individual while making any business decisions.

In a partnership firm, decision making is a consultative process involving the several partners of the firm. The individual authority and power of each of the partners of the firm is generally determined in the partnership deed.

7. Governed by

The sole proprietorship is not governed by any specific and dedicated statute.

Most countries have a specific statute that governs the operation of partnership firms. For example in the USA, every state has its own state level partnership law.

8. Continuity and stability

A sole proprietorship is solely dependent on its owner and thus comes to an end with the death or incapacitation of the sole proprietor.

In case of a partnership firm with more than two partners, death of any partner may not necessarily affect the continuity of the partnership firm. The surviving partners may continue the business of the partnership subject to the terms of the partnership deed.

9. Suitable for

A sole proprietorship is suitable for small scale businesses wherein limited funds and management is needed.

Partnership firms are more suited for mid-sized businesses which require more funds which can be brought in by multiple partners. They are also more suitable for businesses that require different skills and expertise as available with different partners.

Conclusion – sole proprietorship vs partnership firm

Both sole proprietorship and partnership firm are unincorporated entities and each has its own set of advantages and disadvantages. The appropriate business form has to be chosen considering the type of business, scale of business, risk taking ability of the founders etc. Sole proprietorship is opted for when businesses start small and they do not want to undertake complicated compliance formalities. Partnership firms are opted for when there is apparent advantage in the coming together of multiple entities especially those with varied skill sets to collectively run a business.

 

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