Partnerships v Corporations

A brief comparison of partnerships and corporations

The question of whether to start your business as a partnership or corporation never gets old. With the advent of the One Person Corporation, this question once again popped up in the minds of aspiring business owners and entrepreneurs alike.

For individuals planning to start their business alone, sole proprietorships and OPC are an option. However for two or more individuals planning to start a business together, you have partnerships or corporations to choose from. But how would you know which to choose? Below, we discuss briefly the differences between a partnership and corporation and what it entails to be established as one.

What are they?

Partnership, in a nutshell, is when two or more people agree to contribute their cash, assets, and/or services. They pool their contributions in one entity (the partnership) in the hope of utilizing them collectively to gain some profit which will be distributed among them. Formally, they are registered with the Securities and Exchange Commission (SEC) upon which they obtain their own juridical personality and are governed by specific articles contained in our Civil Code.

Corporations, like partnerships, are artificial beings as well. They gain powers, attributes, and the rights of a corporation as expressed in the corporation code upon being successfully registered with SEC. With the passing of the revised corporation code, as low as one person to a maximum of 15 can incorporate. After incorporation, the number of shareholders are limitless depending on how the company would want to structure its capital stock.

It has now been established that both types of business obtain a juridical entity separate from their respective partners and shareholders. What greatly differs them from one another is how they are being managed. For the management structure of a partnership is much more simple. Basically the management is up to the general partners. They generally have equal say and decisions will be based on the majority. Corporations on the other hand have a board of directors and a set of company officers. Shareholders who are not officers nor part of the board are mere passive investors with little to no involvement in the management of the company.

The questions that you would like to ask will revolve around how you and your business partners will want to act. Are you more of an active business owner who wishes to manage his/her own business or a passive investor who wish to just reap the claims when they become available? Do you prefer a more bureaucratic way of leading or are you fine with others having an equal say as you?

What is its purpose?

One determining factor of which business type you would choose is the purpose of your business. For practices of profession such as law, accounting, and architecture, these require you to be organized as a partnership. This is the case as professionals are often regulated by their own governing bodies and adhere to their rules and regulations.

When it comes to corporations, it is particularly useful when the purpose of your business, or should we say organization, is for charitable, religious, educational, civic and other purposes with social impact. These are called non-stock corporations and no income shall accrue to its members, trustees, or officers. Depending on your purpose or what you plan to do, the law limits you in which vehicle you can use to carry out them.

How much does it cost?

As mentioned earlier, partnerships and corporations alike are registered with the SEC. For the registration costs, it will be relatively the same for both entities. In terms of ongoing costs to maintain your business structure, it is also relatively the same. So fees aside, you also have to consider the time and effort you’ll put in as there is a lot of bureaucracy to go through not only in SEC but also in local government units.

How much will I owe?

One defining characteristic of a partnership is that in general, all partners have unlimited liability. In other words, if the partnership is unable to meet its obligations, its creditors can go after the personal assets of the company. However, you can avoid this from happening by becoming a limited partner, a partner who has limited liability. You become as such at the price of some rights and generally you are not able to manage the partnership. General partners on the other hand enjoy multiple rights and the right to manage the partnership affairs but have unlimited liability. The principle “to whom much is given much is expected” applies in this case.

On the contrary, shareholders of a corporation enjoy limited liability. Only the amount put in by the shareholder can be sought out by its creditors. That sounds appealing but that isn’t always the case. Loan contracts from creditors may include clauses where they can apply payments of their loans through personal assets of shareholders. In addition to that, the courts can also make shareholders liable when it has been established that a corporation has been used for fraudulent and illegal acts. The corporate veil can be pierced when a corporation is used as a mere alter ego of a person or corporation to evade its obligations . So watch out for conditions that may make the limited liability characteristic of a shareholder invalid.

To summarize the nature of the liability for both business structures, refer to the table below:

How do I get my income?

Notwithstanding non-profit organizations, partnerships and corporations ordinarily exist to earn income. What you do (or can do) with that income largely varies depending on what business type you will register as.

For partnerships, partners agree upon inception on an income distribution plan. They can agree on how much a partner gets on net profits, and how much a partner absorbs on net losses. This is particularly useful when you want to hold yourself and your partners accountable for their participation in the partnership. Income will be proportionately reflected in their capital balance which makes it easier to keep track of how much the partnership owes a partner.

In corporations, shareholders only earn their due through dividends or selling of shares (if there is any share appreciation.) All income accumulated throughout the years are kept in a retained earnings account and for that to be distributed as dividends, there are certain limitations that the corporation must abide. One limitation is that not all retained earnings can be given out as dividends as only unrestricted retained earnings can be distributed. Unrestricted retained earnings arise from deducting all restrictions placed on a corporation’s earnings because of funds set aside for future projects or legal requirements such as those to assure creditors are paid. Conversely, you also have to take note to declare dividends to avoid being assessed of improperly accumulated retained earnings tax. The computation for dividends is also complex if you take into account different classes of shareholders and the different terms of paying dividends. Ultimately it is also up to the board of directors to make a resolution to declare dividends just.

How do I pay taxes?

In general, partnerships are taxed just like corporations. They are subject to the same rules when it comes to determining taxes. Only general professional partnerships (GPP) are different as the partners are taxed based on their individual capacities. Meaning, the share of the partner in the GPP net income is taxed under their own name. On the other hand, share of the profit of a partner in a regular partnership is subject to final withholding tax just like dividends paid to individual shareholders.

In Summation

There is no clear cut winner on what business type is better. It’s a combination of your purpose, appetite for risk, plans for harvesting your investment, tax implications as an individual, and desired management style. It is also a question of your plans in the future. Ask yourself how big do you see your business growing and ask if a certain type of business will help you achieve your vision now and still be appropriate in the future.

When you’re ready to launch your startup, getting it ready for prime time is more than just simply incorporating the business. Establishing a new company is easy, but making sure it’s well established is not.

With our experienced team of associates and regulatory consultants, we at UpSmart Strategy Consulting Inc. make sure that you get the right advice at the very start through our Business Registration Advisory Services, Business Registration Services, and Resident Agent Services. Drop us a message at consulting@upsmartph.com for your registration needs!

About UpSmart

UpSmart is the premier financial consultancy firm in the startup, SME, and social enterprise industry. UpSmart specializes in strategic finance (e.g., structuring and restructuring of legal entities, valuing and modelling companies, serving as chief financial officer of companies) and operational finance (e.g., optimizing business processes and controls, accounting and bookkeeping support, financial reporting and analysis).

About Luke

Luke is an associate in UpSmart’s consulting practice. He is a certified public accountant and was previously was the Editor-in-Chief of UP Guilder Institute, the premier business publication of UP College of Business Administration.