exam 2 for business – Flashcards

SOLE PROPRIETORSHIPS. A sole proprietorship is a business that is owned (and usually operated) by one person. It is the simplest form of business ownership and the easiest to start. There are approximately 23 million nonfarm sole proprietorships in the United States. (See Figure 4-1.) They account for 72 percent of the country's business firms. As shown in Figure 4-2, sole proprietorships account for about $1.3 trillion, or about 4 percent of total annual sales. A. Advantages of Sole Proprietorships 1. Ease of Start-Up and Closure. Registering the name of the business and obtaining licenses and permits are the only legal requirements to start a business; this does not require an attorney. 2. Pride of Ownership. The amount of time and hard work that the owner invests in a sole proprietorship is substantial, and the owner deserves a great deal of credit for assuming the risks and solving the problems associated with operating sole proprietorships. 3. Retention of All Profits. All profits earned by a sole proprietorship become the personal earnings of its owner. Thus, the owner has a strong incentive to succeed. 4. No Special Taxes. The sole proprietorship's profits are taxed as personal income of the owner. Thus, sole proprietorships do not pay the special state and federal income taxes that corporations do. 5. Flexibility of Being Your Own Boss. The sole owner of a business is completely free to make decisions about the firm's operations. A sole proprietor can move a shop's location, open a new store, or close an old one. B. Disadvantages of Sole Proprietorships 1. Unlimited Liability. Unlimited liability is a legal concept that holds a business owner personally liable for all of a business's debts. If the business fails, the sole proprietor's personal property including savings and other assets can be seized to pay creditors. 2. Lack of Continuity. Legally, the sole proprietor is the business. If the owner retires, dies, or is declared legally incompetent, the business essentially ceases to exist. 3. Lack of Money. Banks, suppliers, and other lenders are often unwilling to lend large sums to sole proprietorships. The limited ability to borrow can prevent a sole proprietorship from growing. 4. Limited Management Skills. The sole proprietor often is the sole manager—in addition to being the sole salesperson, buyer, accountant, and, on occasion, janitor. The business can suffer in the areas in which the owner is less knowledgeable. 5. Difficulty in Hiring Employees. The sole proprietor may find it hard to attract and keep competent help. Potential employees may feel that there is no room for advancement in a firm whose owner assumes all managerial responsibilities. C. Beyond the Sole Proprietorship. The major disadvantage of a sole proprietorship is the limited amount that one person can do in a workday. One way to reduce the effect of this disadvantage is to have more than one owner.

II. PARTNERSHIPS. The U.S. Uniform Partnership Act defines a partnership as a voluntary association of two or more persons to act as co-owners of a business for profit. There are approximately 3 million partnerships in the United States, accounting for about $4.7 trillion in sales receipts each year. (See Figures 4-1 and 4-2.) However, partnerships represent only about 9 percent of all American businesses. A. Types of Partners 1. General Partners. A general partner is a person who assumes full or shared responsibility for operating a business. a) General partners are active in day-to-day business operations, and each partner can enter into contracts on behalf of all the others. He or she assumes unlimited liability for all debts, including debts incurred by any other general partner without his or her knowledge or consent. b) To avoid future liability, a general partner who withdraws from the partnership must give notice to creditors, customers, and suppliers. 2. Limited Partners. A limited partner is a person who contributes capital to a business but who has no management responsibility or liability for losses beyond his or her investment in the partnership. a) The general partner(s) collect fees and receive a percentage of the profits. Limited partners receive a portion of the profits and tax benefits. b) Special rules apply to limited partnerships intended to protect customers and creditors who deal with them. B. The Partnership Agreement. Articles of partnership are an agreement listing and explaining the terms of the partnership. (See Figure 4-3.) When entering into a partnership agreement, partners would be wise to let a neutral third party assist. LEFT INTENTIONALLY BLANK III. ADVANTAGES AND DISADVANTAGES OF PARTNERSHIPS A. Advantages of Partnerships 1. Ease of Start-Up. Partnerships are relatively easy to form. As with sole proprietorships, legal requirements are often limited to registering the name of the business and purchasing licenses or permits. 2. Availability of Capital and Credit. Because partners can pool their funds, a partnership usually has more capital available than does a sole proprietorship. This, coupled with the general partners' unlimited liability, can form the basis for a better credit rating. 3. Personal Interest. General partners are very concerned with the operation of the firm, perhaps even more so than sole proprietors; they are responsible for the actions of all other general partners, as well as for their own. 4. Combined Business Skills and Knowledge. Partners often have complementary skills. The weakness of one partner in a certain area may be offset by another partner's strength in that area. 5. Retention of Profits. As in a sole proprietorship, all profits belong to the owners of the partnership. 6. No Special Taxes. Like a sole proprietor, each partner is taxed only on his or her share of the profits. B. Disadvantages of Partnerships 1. Unlimited Liability. Each general partner is legally and personally responsible for the debts, taxes, and actions of any other partner, even if that partner did not incur those debts or do anything wrong. Limited partners, however, risk only their original investment. Today, many states allow partners to form a limited-liability partnership (LLP) in which a partner in the business may have limited-liability protection from legal action resulting from the malpractice or negligence of the other partners. 2. Management Disagreements. Most of the problems that develop in a partnership involve one partner doing something that disturbs the other partner(s). When partners disagree about decisions, policies, or ethics, distrust may build to the point where it is impossible to operate the business successfully. 3. Lack of Continuity. A partnership is terminated if any one of the general partners dies, withdraws, or is declared legally incompetent. 4. Frozen Investment. It is easy to invest money in a partnership, but it is sometimes quite difficult to get it out. The partnership agreement should outline the procedure for buying out a partner. C. Beyond the Partnership. The main advantages of a partnership over a sole proprietorship are the added capital and management expertise of the partners, but they share some disadvantages. A third form of business ownership, the corporation, overcomes many of the disadvantages.

CORPORATIONS. A corporation (or C-corporation) is an artificial person created by law, with most of the legal rights of a real person. There are approximately 6 million corporations in the United States. Corporations comprise about 19 percent of all businesses, but they account for 82 percent of all sales revenues. A. Corporate Ownership. The shares of ownership of a corporation are called stock, and those who own the shares are called stockholders. 1. A closed corporation is a corporation whose stock is owned by relatively few people and is not bought and sold on security exchanges. 2. An open corporation is a corporation whose stock is sold to the general public and can be purchased by any individual. B. Forming a Corporation. The process of forming a corporation is called incorporation. Most experts recommend that a lawyer should be consulted when beginning the incorporation process. (See Table 4-1 for some aspects that may require legal help.) 1. Where to Incorporate. A business is allowed to incorporate in any state it chooses. Most small and medium-sized businesses are incorporated in the state where they do the most business. Some states are more hospitable than others and offer fewer restrictions and other benefits to attract new firms. a) An incorporated business is called a domestic corporation in the state in which it is incorporated. b) In all other states where it does business, it is called a foreign corporation. c) A corporation chartered by another government and conducting business in the United States is an alien corporation. 2. The Corporate Charter. Once a home state has been chosen, the incorporators submit articles of incorporation to the secretary of state. A corporate charter is a contract between the corporation and the state in which the state recognizes the formation of the artificial person that is the corporation and usually includes the following: a) Firm's name and address b) Incorporators' names and addresses c) Purpose of the corporation d) Maximum amount and types of stock to be issued e) Rights and privileges of stockholders f) Length of time the corporation is to exist 3. Stockholders' Rights. There are two basic kinds of stock: common stock and preferred stock. Owners of common stock may vote on corporate matters; owners of preferred stock usually have no voting rights, but their claims on dividends are paid before those of common-stock owners. a) Owners of both common and preferred stock share in the profits earned by the corporation through the payment of dividends. A dividend is a distribution of earnings to the stockholders of a corporation. b) Other rights include receiving information about the corporation, voting on changes to the corporate charter, and attending the corporation's annual stockholders' meeting. c) Because common stockholders usually live all over the nation, very few actually attend the annual meeting. Instead, they vote by proxy. A proxy is a legal form listing issues to be decided and enabling stockholders to transfer their voting rights to some other individual or individuals. 4. Organizational Meeting. As the last step in forming a corporation, the incorporators and the original stockholders meet to elect their first board of directors. The board members are directly responsible to the stockholders for the way they operate the firm. C. Corporate Structure 1. Board of Directors. The board of directors is the top governing body of a corporation. Directors are elected by the stockholders and can be chosen either from within or outside the corporation. The major responsibilities of the board of directors are to set company goals and to develop general plans for meeting those goals. Corporate Officers. Corporate officers (the chairman of the board, president, executive vice presidents, corporate secretary, treasurer, and any other top executives) are appointed by the board of directors. (See Figure 4-4.) These officers help the board make plans, carry out strategies established by the board, hire employees, and manage day-to-day business activities. V. ADVANTAGES AND DISADVANTAGES OF CORPORATIONS A. Advantages of Corporations 1. Limited Liability. One of the most attractive features of corporate ownership is limited liability. If a corporation fails, creditors have a claim only on the assets of the corporation. 2. Ease of Raising Capital. The corporation is an effective form of business ownership for raising capital. 3. Ease of Transfer of Ownership. Ownership is transferred when shares of stock are sold, and practically no restrictions apply to the sale and purchase of stock issued by an open corporation. 4. Perpetual Life. Because a corporation is essentially a legal "person," it exists independently of its owners and survives them. 5. Specialized Management. Typically, corporations are able to recruit more skilled, knowledgeable, and talented managers than sole proprietorships and partnerships. B. Disadvantages of Corporations. See Table 4-2 for a comparison of some of the advantages and disadvantages of a sole proprietorship, partnership, and corporation. 1. Difficulty and Expense of Formation. Forming a corporation can be a relatively complex and costly process. 2. Government Regulation and Increased Paperwork. Most government regulation of business is directed at corporations, which must file many reports on their business operations and finances with local, state, and federal governments and make periodic reports to stockholders. 3. Conflict Within the Corporation. The pressure to increase sales revenue, reduce expenses, and increase profits often leads to stress and tension for both managers and employees. 4. Double Taxation. Unlike sole proprietorships and partnerships, corporations must pay a tax on their profits. Then stockholders must pay a personal income tax on profits received as dividends. 5. Lack of Secrecy. Because open corporations are required to submit detailed reports to government agencies and to stockholders, they cannot keep all of their operations confidential.

SPECIAL TYPES OF BUSINESS OWNERSHIP. Some entrepreneurs choose other forms of organization to meet their special needs. Among these are S corporations, limited-liability companies, and not-for-profit corporations. A. S-Corporations. If a corporation meets certain requirements, its directors may apply to the Internal Revenue Service for status as an S-corporation. An S-corporation is a corporation that is taxed as though it were a partnership. To qualify for this special status, the firm must meet the following criteria: 1. No more than 100 stockholders are allowed. 2. Stockholders must be individuals, estates, or certain trusts. 3. There can only be one class of outstanding stock. 4. The firm must be a domestic corporation eligible to file for S corporation status. 5. There can be no partnerships, corporations, or nonresident-alien stockholders. 6. All stockholders must agree to the decision to form an S corporation. B. Limited-Liability Companies. A limited-liability company (LLC) is a form of business ownership that combines the benefits of a corporation and a partnership while avoiding some of the restrictions and disadvantages of those forms of ownership. Chief advantages of an LLC include the following: 1. LLCs with at least two members are taxed like a partnership and thus avoid the double taxation imposed on most corporations. LLCs with one member are taxed like a sole proprietorship. 2. Like a corporation, an LLC provides limited-liability protection for acts and debts of the LLC. 3. The LLC provides more management flexibility and fewer restrictions when compared with corporations. An LLC is generally run by the owners or managers who make all the management decisions. (See Table 4-3 for help in understanding the differences between regular corporations, S-corporations, and limited-liability companies.) C. Not-for-Profit Corporations. A not-for-profit corporation (or non-profit) is a corporation organized to provide a social, educational, religious, or other service rather than to earn a profit. Various charities, museums, private schools, and colleges are organized in this way, primarily to ensure limited liability. Once approved by state authorities, not-for-profit corporations must meet specific Internal Revenue Service guidelines in order to obtain tax-exempt status.

JOINT VENTURES AND SYNDICATES A. Joint Ventures. A joint venture is an agreement between two or more groups to form a business entity to achieve a specific goal or to operate for a specific period of time. Once the goal is reached or the time period passes, the joint venture is dissolved. B. Syndicates. A syndicate is a temporary association of individuals or firms organized to perform a specific task that requires a large amount of capital and is dissolved as soon as its purpose has been accomplished. Syndicates are most commonly used to underwrite large insurance policies, loans, and investments.

CORPORATE GROWTH. Growth is a basic characteristic of business. Larger firms generally have greater sales revenue and thus greater profit to facilitate growth. If a business does not grow, it is actually shrinking relative to the economy. Growth is also a means by which some executives boost their power, prestige, and reputation. A. Growth from Within. Most corporations grow by expanding their present operations. Growth from within can have relatively little adverse effect on the firm. Because this type of growth is anticipated, it can be gradual, and the firm can usually adapt to it easily. B. Growth Through Mergers and Acquisitions. Another way for a firm to grow is by purchasing another company. The purchase of one corporation by another is called a merger. An "acquisition" is essentially the same thing as a merger, but the term is usually used in reference to a large corporation's purchase of another corporation. A hostile takeover is a situation in which the management and board of directors of the firm targeted for acquisition disapprove of the merger. When a merger or an acquisition becomes hostile, a corporate raider—another company or a wealthy investor—may make a tender offer or start a proxy fight to gain control of the target company. A tender offer is 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. In a proxy fight, the raiders attempt to gather enough stockholder votes to control the targeted company. Faced with the prospects of takeover, existing management may try several techniques (sometimes referred to as "poison pills," "shark repellents," or "porcupine provisions") to maintain control of the firm and avoid the hostile takeover. Mergers can be horizontal, vertical, or conglomerate. (See Figure 4-5.) 1. Horizontal Mergers. A horizontal merger is a merger between firms that make and sell similar products or services in similar markets. 2. Vertical Mergers. A vertical merger is a merger between firms that operate at different but related levels in the production and marketing of a product. 3. Conglomerate Mergers. A conglomerate merger is a merger between firms in completely different industries. C. Merger and Acquisition Trends for the Future 1. Economists, financial analysts, corporate managers, and stockholders still hotly debate whether takeovers are good for the economy—or for individual companies—in the long run. 2. Takeover advocates argue that firms that are taken over are more profitable and productive. 3. Most experts now predict that mergers and acquisitions after the economic crisis will be the result of cash-rich companies looking to acquire businesses that will enhance their position in the marketplace and involve companies or investors from other countries. Future mergers and acquisitions will be driven by solid business logic and the desire to compete in the international marketplace.