Chapter 5

Copyright 2008 Prentice Hall Publishing 1Chapter 5: Forms of Ownership

Forms of Business OwnershipChapter 5

Copyright 2008 Prentice Hall Publishing 2

Choosing a Form of OwnershipChoosing a Form of Ownership

There is no one “best” form of ownership.There is no one “best” form of ownership. The best form of ownership depends on an The best form of ownership depends on an

entrepreneur’s particular situation.entrepreneur’s particular situation. Key: Understanding the characteristics of Key: Understanding the characteristics of

each form of ownership and how well they each form of ownership and how well they match an entrepreneur’s business and match an entrepreneur’s business and personal circumstances. personal circumstances.


Factors Affecting the ChoiceFactors Affecting the Choice

Tax considerationsTax considerations Liability exposureLiability exposure Start-up and future capital Start-up and future capital

requirementsrequirements ControlControl Managerial abilityManagerial ability Business goalsBusiness goals Management succession plansManagement succession plans Cost of formationCost of formation


Major Forms of OwnershipMajor Forms of Ownership

Sole ProprietorshipSole Proprietorship PartnershipPartnership CorporationCorporation S CorporationS Corporation Limited Liability CompanyLimited Liability Company Joint VentureJoint Venture

Source: BizStats.com/businesses.htm

Forms of Business OwnershipPercentage of Businesses

Sole proprietorships71.6%

Partnerships5.4%

Corporations20.2%

Limited Liability Companies

2.9%

Forms of OwnershipPercentage of Business Sales

Sole proprietorships4.9%

Corporations84.7%

Partnerships8.8%

Limited Liability Companies

1.7%

Source: BizStats.com/businesses.htm


Advantages of the Sole Advantages of the Sole ProprietorshipProprietorship

Simple to createSimple to create Least costly form to beginLeast costly form to begin Profit incentiveProfit incentive Total decision-making authorityTotal decision-making authority No special legal restrictionsNo special legal restrictions Easy to discontinueEasy to discontinue


Disadvantages of the Sole Disadvantages of the Sole ProprietorshipProprietorship

Unlimited personal liabilityUnlimited personal liability Limited skills and capabilitiesLimited skills and capabilities Feelings of isolationFeelings of isolation Limited access to capitalLimited access to capital Lack of continuityLack of continuity


Liability Features of the Basic Forms of Liability Features of the Basic Forms of OwnershipOwnership

Sole Proprietorship

Claims of Sole Proprietor’s Creditors

Sole Proprietor’s Personal Assets


PartnershipPartnership

An association of two or more people who An association of two or more people who co-own a business for the purpose of co-own a business for the purpose of making a profit.making a profit.

AlwaysAlways wise to create a partnership wise to create a partnership agreement.agreement.

Best partnerships are built on trust and Best partnerships are built on trust and respect. respect.


Advantages of the PartnershipAdvantages of the Partnership

Easy to establishEasy to establish Complementary skills of partnersComplementary skills of partners Division of profitsDivision of profits Larger pool of capitalLarger pool of capital Ability to attract limited partnersAbility to attract limited partners


Types of PartnersTypes of Partners

General partnersGeneral partners Take an active role in managing a business.Take an active role in managing a business. Have unlimited liability for the partnership’s Have unlimited liability for the partnership’s

debts.debts. Every partnership must have at least one Every partnership must have at least one

general partner.general partner. Limited partnersLimited partners

Cannot participate in the day-to-day Cannot participate in the day-to-day management of a company. management of a company.

Have limited liability for the partnership’s debts. Have limited liability for the partnership’s debts.


Advantages of the PartnershipAdvantages of the Partnership

Easy to establishEasy to establish Complementary skills of partnersComplementary skills of partners Division of profitsDivision of profits Larger pool of capitalLarger pool of capital Ability to attract limited partnersAbility to attract limited partners Little government regulationLittle government regulation FlexibilityFlexibility TaxationTaxation


Disadvantages of the PartnershipDisadvantages of the Partnership

Unlimited liability of at least one partnerUnlimited liability of at least one partner Capital accumulationCapital accumulation Difficulty in disposing of partnership Difficulty in disposing of partnership

interestinterest Lack of continuityLack of continuity Potential for personality and authority Potential for personality and authority

conflictsconflicts Partners bound by law of agencyPartners bound by law of agency


Liability Features of the Basic Forms of OwnershipLiability Features of the Basic Forms of Ownership

Partnership

Claims of Partnership’s Creditors

Partnership’s AssetsGeneralPartner’sPersonalAssets

GeneralPartner’sPersonalAssets


Limited PartnershipLimited Partnership

A partnership composed of at least one A partnership composed of at least one general partner and one or more limited general partner and one or more limited partners.partners.

General partner in this partnership is treated General partner in this partnership is treated exactly as in a general partnership.exactly as in a general partnership.

Limited partner has limited liability and is Limited partner has limited liability and is treated as an investor in the business. treated as an investor in the business.


CorporationCorporation

A separate legal entity from its owners.A separate legal entity from its owners. Types of corporations:Types of corporations:

DomesticDomestic – a corporation doing business in the – a corporation doing business in the state in which it is incorporated.state in which it is incorporated.

ForeignForeign – a corporation doing business in a – a corporation doing business in a state other than the state in which it is state other than the state in which it is incorporated. incorporated.

AlienAlien – a corporation formed in another country – a corporation formed in another country but doing business in the United States. but doing business in the United States.


CorporationCorporation

Types of corporations:Types of corporations: Publicly heldPublicly held – a corporation that has a large – a corporation that has a large

number of shareholders and whose stock number of shareholders and whose stock usually is traded on one of the large stock usually is traded on one of the large stock exchanges.exchanges.

Closely heldClosely held – a corporation in which shares – a corporation in which shares are controlled by a relatively small number are controlled by a relatively small number of people, often family members, relatives, of people, often family members, relatives, or friends. or friends.


Advantages of the Advantages of the CorporationCorporation

Limited liability of stockholdersLimited liability of stockholders Ability to attract capitalAbility to attract capital Ability to continue indefinitelyAbility to continue indefinitely Transferable ownershipTransferable ownership



Corporation

Claims of Corporation’s Creditors

Corporation’s Assets

Shareholder’sPersonal Assets


BarrierBarrier


Disadvantages of the Disadvantages of the CorporationCorporation

Cost and time of incorporatingCost and time of incorporating Double taxationDouble taxation Potential for diminished managerial Potential for diminished managerial

incentivesincentives Legal requirements and regulatory “red Legal requirements and regulatory “red

tape”tape” Potential loss of control by founder(s)Potential loss of control by founder(s)


S CorporationS Corporation

No different from any other corporation from a No different from any other corporation from a legal perspective.legal perspective.

For tax purposes, however, an S corporation is For tax purposes, however, an S corporation is taxed like a partnership, passing all of its profits taxed like a partnership, passing all of its profits (or losses) through to individual shareholders.(or losses) through to individual shareholders.

To elect “S” status, all shareholders must consent, To elect “S” status, all shareholders must consent, and the corporation must file with the IRS within and the corporation must file with the IRS within the first 75 days of its tax year.the first 75 days of its tax year.



S-Corporation

Claims of S-Corporation’s Creditors

S-Corporation’s Assets



BarrierBarrier


Limited Liability Company (LLC)Limited Liability Company (LLC)

Resembles an S corporation but is Resembles an S corporation but is notnot subject to the same restrictions.subject to the same restrictions.

Two documents required: Two documents required: Articles of organizationArticles of organization Operating agreementOperating agreement


Limited Liability Company (LLC)Limited Liability Company (LLC)

An LLC cannot have more than An LLC cannot have more than twotwo of of these four corporate characteristics:these four corporate characteristics: Limited liabilityLimited liability Continuity of lifeContinuity of life Free transferability of interestFree transferability of interest Centralized managementCentralized management



Limited Liability Company (LLC)

Claims of LLC’s Creditors

LLC’s Assets

Member’sPersonal Assets

Member’sPersonal Assets

BarrierBarrier

Chapter 5

Business

Transcript of Chapter 5