Choosing a Form of Business Ownership

© 2013 South-Western, a part of Cengage Learning. All rights reserved. Chapter 4 | Slide 1

Choosing a Form of Business Ownership

Chapter

4


Sole Proprietorship

Partnership

Corporation• S Corporation• LLC (Limited Liability Corporation)

3 Main Forms of Ownership


To be “liable” for something means to be responsible for it.• In business, the owners of the business are

liable for the products (inventory), the buildings, the employees, the income, AND….

• The debt. Limited liability Unlimited liability

What is liability?


A business that is owned (and usually operated) by one person

The simplest form of business ownership and the easiest to start

The most popular form of business ownership

Sole Proprietorships


Relative Percentages of Sole Proprietorships, Partnerships, and Corporations in the U.S.

Source: U.S. Bureau of the Census, Statistical Abstract of the United States, Washington, D.C., 2010, Table 729 (www.census.gov).


Total Sales Receipts of American Businesses


Advantages and Disadvantages of Sole Proprietorships

ADVANTAGES• Ease of start-up

and closure• Pride of ownership• Retention of all profits• No special taxes• Flexibility of being your

own boss

DISADVANTAGES– Unlimited liability

• The business owner is personally responsible for all the debts of the business

– Lack of continuity– Lack of money to put into

the business– Limited management skills– Difficulty in hiring

employees


Partnerships

A voluntary association of two or more persons to act as co-owners of a business for profit

Less common form of ownership than sole proprietorship or corporation

No limit on the maximum number of partners; most have only two


Types of Partners

General partner• A person who assumes full or shared responsibility for operating a

business• General partnership: a business co-owned by two or more general

partners who are liable for everything the business does

Limited partner• A person who contributes capital to a business but has no

management responsibility or liability for losses beyond the amount he or she invested in the partnership

• Limited partnership: a business co-owned by one or more general partners who manage the business and limited partners who invest money in it


The Partnership Agreement

Articles of partnership• An agreement in writing explaining the terms of the

partnership• Agreement should state

– Who will make final decisions– What each partner’s duties will be– How much each partner will invest– How much profit or loss each partner receives

or is responsible for– How the partnership can be dissolved


Articles of Partnership


Articles of Partnership (cont.)


Advantages and Disadvantages of Partnerships

ADVANTAGES • Ease of start-up• Availability of capital

and credit• Personal interest• Combined business skills

and knowledge• Retention of profits • No special taxes

DISADVANTAGES• Unlimited liability

• Management disagreements

• Lack of continuity

• Frozen investment-easy to invest in, but sometimes hard to get your money back out if you need to.


Corporations

An artificial person created by law with most of the legal rights of a real person, including the rights to start and operate a business, to buy or sell property, to borrow money, to sue or be sued, and to enter into binding contracts.

Unlike a real person, however, a corporation exists only on paper.

They comprise about 19% of all businesses, but they account for 83% of sales revenues.


Stock Ownership in a Corporation

Important Terms:• Stock

– The shares of ownership of a corporation• Stockholder

– A person who owns a corporation’s stock• Closed corporation

– A corporation whose stock is owned by relatively few people and is not sold to the general public

• Open corporation (publicly traded)– A corporation whose stock is bought and sold on the

stock exchange and can be purchased by any individual


Forming a Corporation

Incorporation• The process of forming a corporation

Most experts recommend consulting a lawyer


Forming a Corporation (cont.)

Where to incorporate• Businesses can incorporate in any state they choose



The Corporate Charter (the articles of incorporation):• A contract between the corporation and the state in

which the state recognizes the formation of the artificial person that is the corporation and includes– firm’s name and address– incorporators’ names and addresses– purpose of the corporation– maximum amount of stock and types of stock

to be issued– rights and privileges of stockholders– length of time the corporation is to exist



Stockholders’ rights• Common stock

– Stock owned by individuals or firms who may vote on corporate matters but whose claims on profit and assets are subordinate to the claims of others

• Preferred stock– Stock owned by individuals or firms who usually do not have voting

rights but whose claims on dividends are paid before those of common stock owners

• Dividend– A distribution of earnings to the stockholders of a corporation

• Proxy– A legal form listing issues to be decided at a stockholders’ meeting

and enabling stockholders to transfer their voting rights to some other individual or individuals

– Board members are directly responsible to stockholders for how they operate the firm


Hierarchy of Corporate Structure

Stockholders exercise a great deal of influence through their right to elect the board of directors.


Corporate Structure

Board of directors• The top governing body of a corporation, the

members of which are elected by the stockholders• Responsible for setting corporate goals,

developing strategic plans to meet those goals, and the firm’s overall operation

• Outside directors: experienced managers or entrepreneurs from outside the corporation who have specific talents

• Inside directors: top managers from within the corporation


Corporate Structure (cont.)

Corporate officers• The chairman of the board, president, executive vice

presidents, corporate secretary, treasurer, and any other top executive appointed by the board

• Implement the chosen strategy and direct the work of the corporation, periodically reporting results to the board and stockholders


Before Enron, boards of directors used to basically “rubber stamp” what the Chief Executive Officers (like Ken Lay) wanted. After Enron and the passage of the Sarbanes-Oxley Act, which makes directors responsible for acting in accordance with sound financial practices, boards are no longer content to just rubber stamp CEOs’ decisions, especially where chief financial officers (like Andy Fastow) are concerned.

In 2010, as part of Wall Street reform, the Securities and Exchange Commission (SEC) made it easier for shareholders to have a bigger say on corporate leadership at publicly traded companies. Shareholders who own 3 percent or more of company stock for at least three years are now able to nominate candidates for directors on the annual proxy ballot. The intent is to help shareholders hold corporate boards more accountable for their decisions.

A Change Since Enron…


Advantages and Disadvantages of Corporations

ADVANTAGES • Limited liability

– Each owner’s financial liability is limited to the amount of money that he or she has paid for the corporation’s stock

• Ease of raising capital• Ease of transfer of

ownership• Perpetual life• Specialized management

DISADVANTAGES– Difficulty and expense

of formation– Government regulation

and increased paperwork– Conflict within the

corporation– Double taxation-

corporation itself is taxed and then stockholders are taxed also.

– Lack of secrecy


Advantages and Disadvantages of a Sole Proprietorship, Partnership, and Corporation


Class Exercise

You want to own and manage your own business. To help you evaluate your chances of success, answer these questions.

• Do you have any experience in a business like the one you want to start?

• Have you worked for someone else as a supervisor or manager?

• Have you saved any money? How much?

• Do you know how much money you will need to get your business started?

• Do you know how much credit you can get from your suppliers and bankers?

• Do you know the good and bad points about going it alone, having a partner, and incorporating your business?

• What do you know about your potential customer?


Special Types of Corporations

S-corporation• A corporation that is taxed as if it were a partnership

(income taxed as personal income of stockholders) but still offers limited liability

• Restricted to having only 100 or less stockholders Limited-liability company (LLC)

• Combines the benefits of a corporation and partnership but avoids some of the restrictions and disadvantages

• Not restricted to having only 100 stockholders


Advantages and Disadvantages of a Regular Corporation, S-Corporation, Limited-Liability Company


Special Types of Business Ownership (cont.)

Not-for-profit corporations• Corporations organized to provide social,

educational, religious, or other services, rather than to earn a profit

• Charities, museums, private schools, colleges, and charitable organizations are organized as not-for-profits primarily to ensure limited liability

• Must meet specific IRS guidelines to obtain tax-exempt status


Corporate Growth

Growth from within• Introducing new products• Entering new markets

Growth through mergers and acquisitions• Merger: the purchase of one corporation by another;

essentially the same as an acquisition• Hostile takeover: a situation in which the management and

board of directors of a firm targeted for acquisition disapprove of the merger

• Tender offer: an offer to purchase the stock of a firm targeted for acquisition at a price just high enough to tempt stockholders to sell their shares

• Proxy fight: a technique used to gather enough stockholder votes to control a targeted company


Corporate Growth (cont.)

Horizontal mergers• Mergers between firms that make and sell similar products• Subject to approval by federal agencies to protect

competition

• Example: If Dell and Apple were to merge

Vertical mergers• Mergers between firms that operate at different but related

levels of production and marketing of a product• Usually one firm is a supplier or customer of the other

• Example: If UniRoyal (makes tires) merged with a company that supplies rubber.

Conglomerate mergers• Mergers between firms in completely different industries


Chapter Quiz

1. In the United States, the form of business ownership that generates the largest amount of sales revenues is the

A. sole proprietorship. B. partnership.C. corporation.D. limited-liability company.E. S-corporation.


Chapter Quiz

2. Which of the following is a disadvantageof a sole proprietorship?

A. FlexibilityB. No special taxesC. Pride of ownershipD. Retention of all profitsE. Unlimited liability


Chapter Quiz

3. A business co-owned by one or more general partners who manage the business and limited partners who invest money into it is called a

A. not-for-profit organizations.B. limited partnership.C. general partnership.D. limited-liability company.E. S-partnership.


Chapter Quiz

4. A ____________ is a merger between firms that make and sell similar products or services in similar industries.

A. horizontal mergerB. vertical mergerC. conglomerate merger D. hostile takeoverE. tender offer

Choosing a Form of Business Ownership

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