How a company finances itself, from operations to growth, differs depending upon the corporate structure a company has chosen. Capital is money, and how a company handles its money is its capital structure (Kennon, 2017). This structure is determined by how a company is incorporated, or if is isn’t incorporated, and both debt capital and equity capital are derived from and distributed in specific manners for all company types, incorporated or not. Specifically, capital structures of sole proprietorships, who are not incorporated, and corporations, who are incorporated, vary significantly.
One of the first major differences between sole proprietorships and corporations pertaining to their capital structure is the responsibility of debt (not debt equity) of the company. In a sole proprietorship, debt is the responsibility of the owner of the proprietorship where in a corporation, this is not the case (“Comparing,” 2017). This gives the owners of a corporation protection from creditors should the business incur debts beyond its ability to pay them. There are a few exceptions to this rule, though, and if corporation rules and regulations are not followed and recorded appropriately, personal funds of the shareholders could be liable for corporate debt. This is true in cases here corporations have not paid appropriate taxes, where corporations have mixed personal money with corporate money, or if there are not regular shareholder meetings. This is the exception rather than the rule, however.
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Another difference between sole proprietorships and corporations in regard to their capital structures comes with forms of equity. A corporation’s equity capital comes in the form or stock, both common and preferred (“Definition,” 2017). Shareholders in a corporation are the ones who provide the cash and assets, or equity financing, for a corporation. In a sole proprietorship, just one person is responsible for providing funds for the business, transferring them from personal funds, personal assets, other businesses, and other sources.
Corporate debt equity and sole proprietorship debt equity are also different. Bonds, loans, and securities are forms of corporate debt that do not appear in companies with a sole proprietorship status. “Debt financing is provided by banks or bondholders who, respectively, receive loan contracts and publicly traded bonds in return for their money” (“Definition,” 2017). Because sole proprietorships are owned by a single, unincorporated individual, the responsibility of all debt rests on this individual owner. Debt incurred must be paid by the owner.
Profitability is another area of difference between the two structures. In the case of sole proprietors, all profits are available to the owner (Beesley, 2013). In a corporation, there is a tertiary division of profits if profits are realized. First, there is the tax burden of the corporation that must be satisfied. Then, capital investing is undertaken, and finally, dividends are paid to shareholders. Shareholders are then taxes on their portion of the profits as recorded on an IRS Schedule K at the end of each year. In the case that the corporate structure is that of an S corporation, however, the S corporation does not pay taxes itself, but passes along the entire corporation tax responsibility to the shareholders. The profit distribution of a corporation is much more complex than that of a sole proprietorship. A sole proprietorship owner simply takes a distribution from the profits of the business and pays taxes on that distribution. The caveat for the sole proprietorship owner is that taking distributions decreases the capital equity of the company.
Finally, the similarities between a sole proprietorship and a corporation are that both must report and pay taxes on business profits, both must follow the IRS tax code, both must keep records of all capital, debt, and profit, and both can change capital structure if needed; a sole proprietor can become a corporation and vice versa, although the latter is much more complex and takes a great deal of time and paperwork to complete.
- Beesley, C. (2013, Feb. 27). Sole proprietorship-Is this popular business structure right for you? Starting a Business: U.S. Small Business Association. Retrieved from https://www.sba.gov/blogs/sole-proprietorship-popular-business-structure-right-you
- Comparing corporations to sole proprietorships and partnerships. (2017). Legal Zoom. Retrieved from https://www.legalzoom.com/knowledge/corporation/topic/sole-proprietor-corporation-partnership-comparison
- Definition of corporate capital structure. (2017). Financial Times Lexicon. Retrieved from http://lexicon.ft.com/Term?term=corporate-capital-structure
- Kennon, J. (2017, Feb. 27). An introduction to capital structure. The Balance. Retrieved from https://www.thebalance.com/an-introduction-to-capital-structure-357496
