Chapter 4: Choosing a Form of Business Ownership

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Sole Proprietorship
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Sole Proprietorship = is a business that is owned (and usually operated) by one person – most are small – is the simplest form of business ownership and the easiest to start – Walmart, JCPenney, H.J. Heinz Company, and Procter and Gamble Company, started out as tiny, and in many cases, struggling sole proprietorships – 23 million nonfarm sole proprietorships in the US (account for 72% of the country’s business firms) – most popular form of ownership when compared with partnerships and corporations, yet rank last in total sales revenue (corporations rank first in that category) – most common in retailing, service, and agriculture (clothing boutique, corner grocery, television-repair shop down the street, and small, independent farmers) ADVANTAGES OF SOLE PROPRIETORSHIPS – Simplicity and Universal Control (Two Main Characteristics) – simplest and cheapest way to start a business – start-up requires no contracts, agreements, or other legal documents – established without the services of an attorney – legal requirements often limited to registering the name of the business and obtaining any necessary licenses or permits a) Pride of Ownership b) Retention of All Profits c) No Special Taxes (does not pay the special state and federal income taxes that corporations pay) d) Flexibility of Being Your Own Boss (can switch from retailing to wholesaling, move a shop’s location, open a new store, or close an old one easily) DISADVANTAGES OF SOLE PROPRIETORSHIPS a) *UNLIMITED LIABILITY (a legal concept that holds a business owner personally responsible for all the debts of the business) b) Lack of Continuity – if the own retires, dies, or is declared legally incompetent, the business essentially ceases to exist – an illness can be devastating if the sole proprietor’s personal skills are what determine if the business is a success or a failure c) Lack of Money – banks, suppliers, and other lenders usually are unwilling to lend large sums of money to sole proprietorships – many lenders are concerned about the large number of sole proprietorships that fail d) Limited Management Skills – in addition to being the only salesperson, buyer, accountant, and, on occasion, janitor – necessary expertise by hiring employees, assistant or consultants, the business can suffer in the areas in which the own is less knowledgeable e) Difficulty in Hiring Employees – hard to attract and keep competent help – may find that the only way to do so is to quit the sole proprietorship and go to work for a larger firm or start up their own business
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Sole Proprietorship
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a business that is owned (and usually operated) by one person
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Partnerships
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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 – hire a diverse staff of employees and provides cultural diversity training for Fortune 1000 firms, large not-for-profit organizations, and government agencies – there are approximately 3 million partnerships in the US, and this type of ownership accounts for about $5 trillion in sales receipts each year – this form of ownership is much less common than the sole proprietorship or the corporation (9% of all American businesses) TYPE OF PARTNERS 1) General Partners = a person who assumes full or shared responsibility for operating a business – he/she assumes unlimited liability for all debts – a business co-owned by two or more general partners who are liable for everything the business does – at least one general partner is responsible for the debts of the limited partnership – manages the business 2) Limited Partners = a person who invests money in a business but who has no management responsibility or liability for losses beyond his or her investment in the partnership – a business co-owned by one or more general partners who manage the business and limited partners who invest money in it – receive a portion of profits and tax benefits – rules are intended to protect customers and creditors who deal with limited partnerships due to potential liability problems – provides investment capital 3) A Master Limited Partnership (MLP) or Publicly Traded Partnership (PTP) = a limited partnership that has units of ownership that can be traded on security exchanges much like shares of ownership in a corporation – Two Major Advantages a) units of ownership in MLPs can be sold to investors to raise capital/profit b) income from MLPs is generally reported as the personal income of the owners (thus they avoid the double taxation paid on corporate income) – MLPs typically are in natural resources, energy, or real estate-related businesses THE PARTNERSHIP AGREEMENT Should State: – who will make the final decisions – what each partner’s duties will be – the investment each partner will make – how much profit or loss each partner receives or is responsible for – what happens if a partner wants to dissolve the partnership or dies
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Unlimited Liability
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a legal concept that holds a business owner personally responsible for all the debts of the business
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Partnership
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a voluntary association of two or more persons to act as co-owners of a business for profit
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General Partner
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a person who assumes full or shared responsibility for operating a business
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Limited Partners
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a person who invests money in a business but has no management responsibility or liability for losses beyond the amount he or she invested in the partnership
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Master Limited Partnership (MLP)
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a limited partnership that has units of ownership that can be traded on security exchanges much like shares of ownership in a corporation
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Advantages and Disadvantages of Partnerships
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Advantages of Partnerships a) Ease of Start-Up (legal requirements often are limited to registering the name of the business and obtaining any necessary licenses or permits) b) Availability of Capital and Credit – partners can pool their funds, a partnership usually has more capital available than a sole proprietorship does – may encourage banks and suppliers to extend more credit or approve larger loans to a partnership than to a sole proprietor c) Personal Interest – responsible for the actions of all other general partners, as well as for their own – a strong motivating force and often makes all the people involved in the partnership work harder to become more successful d) Combined Business Skills and Knowledge – partners often have complementary skills – one’s weakness may be the partners strength – relieves some pressure when having to make decisions e) Retention of Profits – all profits belong to the owners of the partnership – highly motivated to do their best to make the firm succeed f) No Special Taxes – although a partnership pays no income tax, the Internal Revenue requires partnerships to file an annual information return that states the name and addresses of all partners involved in the business – each partner is required to report his or her share of profit (or loss) from the partnership on his or her individual tax return – each partner’s share of the partnership profit is taxed in the same way a sole proprietor is taxed DISADVANTAGES OF PARTNERSHIPS a) Unlimited Liability – each partner is legally and personally responsible for the debts, taxes, and actions of any other partner conducting partnership business, even if that partner did not incur those debts or do anything wrong – Limited-Liability Partnership (LLP) = a partner may have limited-liability protection from legal action resulting from the malpractice or negligence of the other partners (all partners may have limited liability) b) Management Disagreements – involves one partner doing something that disturbs the other partner(s) – business partners with egos, ambitions, and money on the line are especially susceptible to friction c) Lack of Continuity – partnerships are terminated if any one of the general partners dies, withdraws, or is declared legally incompetent – partnership agreement may permit surviving partners to continue the business after buying a deceased partner’s interest from his or her estate d) Frozen Investment – when remaining partners are unwilling to buy the share of the business that belongs to a partner who retires or wants to relocate to another city – a partner must find someone outside the firm to buy his or her share BEYOND THE PARTNERSHIP – main advantage of partnership is increased availability of capital and credit and combined business skills and knowledge of the partners – main disadvantage is the unlimited liability = can cause problems for a partner with substantial personal wealth
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Corporation
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– the right to start and operate a business – the right to buy or sell property – the right to borrow money – the right to sue or be sued – the right to enter into binding contracts – 6 million corporations in the US that comprise of 19% of business, but account for 81% of sales revenues CORPORATE OWNERSHIP *STOCK = shares of ownership of a corporation *STOCKHOLDER = people who own a corporation’s stock and thus own part of the corporation – may sell its stock to individuals or other companies that want to invest in the corporation – issue stock as a reward or a return to investors in place of cash payments *CLOSED CORPORATION = a corporation whose stock is owned by relatively few people and is not sold to the general public (Mars is a privately held, family-owned, closed corporation) *OPEN CORPORATION = one whose stock can be bought and sold by any individual FORMING A CORPORATION – if you decide that the corporate form is the best form of organization for you, most experts recommend that you begin the incorporation process by consulting a lawyer to be sure that all legal requirements are met pg. 116 Ten Aspects of Business That May Require Legal Help 1) Where to Incorporate a) the cost of incorporating in one state compared with the cost in another state b) the advantages and disadvantages of each state’s corporate laws and tax structure *DOMESTIC CORPORATION = a corporation in the state in which it is incorporated *FOREIGN CORPORATION = a corporation in any state in which it does business except the one in which it is incorporated *ALIEN CORPORATION = a corporation chartered by a foreign government and conducting business in the United States 2) The Corporate Charter – the incorporate(s) submits articles of incorporation to the secretary of state -> become a contract between a corporation and the state in which the state recognizes the formation of the artificial person that is the corporation 3) Stockholders’ Rights Two Basic Types of Stock a) *COMMON STOCK = stock owned by individuals or firms who may vote on corporate matters but whose claims on profits and assets are subordinate (lower in ranking) to the claims of others b) *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 4) Organizational Meeting – the last step in forming a corporation, the incorporators and original stockholders meet to adopt corporate by-laws and elect their first board of directors – the board members are directly responsible to the stockholders for the way they operate the firm CORPORATE STRUCTURE 1) Board of Directors = the top governing body of a corporation, the members of which are elected by the stockholders – stockholders are able to control the activities of the entire corporation through its directors because they are the group that elects the board of directors – for a small corporation, only one director is required in many states although you can choose to have more – major responsibilities of the board of directors are to set company goals and develop general plans (or strategies) for meeting those goals – responsible for the firm’s overall operation and appointing corporate officers 2) *CORPORATE OFFICERS = the chairman of the board, president, executive, vice presidents, corporate secretary, treasurer, and any other top executive appointed by the board of directors – the help the board to make plans, carry out strategies established by the board, hire employees, and manage day-to-day business activities Hierarchy of Corporate Structure Stockholders -> Board of Directors -> Officers -> Employees
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Corporation
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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
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Stock
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the shares of ownership of a corporation
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Stockholder
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a person who owns a corporation’s stock
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Closed Corporation
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a corporation whose stock is owned by relatively few people and is not sold to the general public
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Open Corporation
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a corporation whose stock can be bought and sold by any individual
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Domestic Corporation
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a corporation in the state in which it is incorporated
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Foreign Corporation
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a corporation in any state in which it does business except the one in which it is incorporated
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Alien Corporation
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a corporation chartered by a foreign government and conducting business in the United States
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Common Stock
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stock owned by individuals or firms who may vote on corporate matters but whose claims on profits and assets are subordinate (lower in ranking) to the claims of others
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Preferred Stock
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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
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Dividend
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a distribution of earnings to the stockholders of a corporation
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Proxy
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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
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Board of Directors
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the top governing body of a corporation, the members of which are elected by the stockholders
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Corporate Officers
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the chairman of the board, president, executive, vice presidents, corporate secretary, treasurer, and any other top executive appointed by the board of directors
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Advantages and Disadvantages of Corporations
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ADVANTAGES OF CORPORATIONS 1) *LIMITED LIABILITY = a feature of corporate ownership that limits each owner’s financial liability to the amount of money that he or she has paid for the corporation’s stock – if a corporation fails or is involved in a lawsuit and loses, creditors have a claim only on the corporation’s assets, not on the stockholders’ (owners’) personal assets – overcomes the problem of unlimited liability connected with sole proprietorships and general partnerships 2) Ease of Raising Capital – one of the most effect forms of business ownership for raising capital – corporations can borrow from lending institutions – they can raise additional sums of money by selling stock – individuals are more willing to invest in corporations than in other forms of business because of limited liability – sell their stock easily hopefully for a profit 3) Ease of Transfer of Ownership – practically no restrictions apply to the sale and purchase of stock issued by an open corporation 4) Perpetual Life – the withdrawal, death, or incompetence of a key executive or owner does not cause the corporation to be terminated 5) Specialized Management – corporations are able to recruit more skilled, knowledgeable, and talented managers than proprietorships and partnerships – they pay bigger salaries, offer excellent employee benefits, and are large enough to offer considerable opportunity for advancement DISADVANTAGES OF CORPORATIONS 1) Difficulty and Expense of Formation – forming a corporation can be a relatively complex and costly process – use of an attorney is usually necessary to complete the legal forms that are submitted to the secretary of state – costs of incorporating, in terms of both time and money, discourage many owners of smaller businesses from forming corporations 2) Government Regulation and Increased Paperwork – corporation must meet various government standards before it can sell its stock to the public – then must file reports on its business operations and finances with local, state, and federal governments – must make periodic reports to its stockholders about various aspects of the business 3) Conflict Within the Corporation – the pressure to increase sales revenue, reduce expenses, and increase profits often leads to increased stress and tension for both managers and employees 4) Double Taxation – corporations must pay a tax on their profits, and stockholders must pay a personal income tax on profits received as dividends (S-Corporation and the limited-liability company eliminate the disadvantage of double taxation because they are taxed like a partnership) 5) Lack of Secrecy – open corporations are required to submit detailed reports to government agencies and to stockholders, they cannot keep their operations confidential – every public corporation has to share some of its secrets with its competitors pg. 120 Sums up Advantages and Disadvantages
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Limited Liability
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a feature of corporate ownership that limits each owner’s financial liability to the amount of money that he or she has paid for the corporation’s stock
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Special Types of Business Ownership
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1) *S-CORPORATIONS (a corporation that is taxed as though it were a partnership) – corporation’s income is taxed only as the personal income of its stockholders – corporate profits or losses “pass through” the business and are reported on the owners’ personal income tax returns – Qualifications of S-Corporation pg. 121 2) *LIMITED-LIABILITY COMPANIES (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) a) can elect to be taxed as a corporation if there are benefits to offset the corporation rate double taxation b) provides limited-liability protection c) is not required to hold annual meetings and record meeting minutes – is not restricted to 100 stockholders like S-corporation – LLCs are less restricted and have more flexibility than S-corporations in terms of who can become an owner – limited-liability company doesn’t have to be small – experts predict this to be one of the most popular forms of business ownership available 3) *NOT-FOR-PROFIT CORPORATIONS (a corporation organized to provide a social, educational, religious, or other service rather than to earn a profit) – to improve communities and change lives ex: Habitat for Humanity = formed to provide homes for qualified lower income people who cannot afford housing *Sums up Advantages and Disadvantages of Regular Corporation, S-Corporation, and Limited-Liability Company pg. 121
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S-Corporation
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a corporation that is taxed as though it were a partnership
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Limited-Liability Company (LLC)
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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
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Non-For-Profit Corporation
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a corporation organized to provide a social, educational, religious, or other service rather than to earn a profit
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Cooperatives, Joint Ventures, and Syndicates
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*COOPERATIVES (an association of individuals or firms whose purpose is to perform some business function for its members) – purchase goods in bulk and distribute them to members; thus, the unit cost is lower than it would be if each member bought the goods in a much smaller quantity – most prevalent in agriculture – farmers use cooperatives to purchase supplies, to buy services such as trucking and storage, and to process and market their products *JOINT VENTURES (an agreement between two or more groups to form a business entity in order to achieve a specific goal or to operate for a specific period of time) – limited to one project – corporations as well as individuals, may enter into joint ventures – major oil producers often have formed a number of joint ventures to share the extremely high cost of exploring for offshore petroleum deposits – many U.S. companies are forming joint ventures with foreign firms in order to enter new markets around the globe – dissolves as soon as its purpose has been accomplished *SYNDICATE (a temporary association of individuals or firms organized to perform a specific task that requires a large amount of capital) – formed because no one person or firm is willing to put up the entire amount required for the undertaking – dissolves as soon as its purpose has been accomplished – used most commonly to underwrite large insurance policies, loans, and investments – to share the risk of default, banks have formed syndicates to provide loans to developing countries
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Cooperative
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an association of individuals or firms whose purpose is to perform some business function for its members
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Joint Venture
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an agreement between two or more groups to form a business entity in order to achieve a specific goal or to operate for a specific period of time
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Syndicate
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a temporary association of individuals or firms organized to perform a specific task that requires a large amount of capital
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Corporate Growth
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– seeking growth has to do with profit – a larger firm generally has greater sales revenue and thus greater profit – a business that does not grow is actually shrinking relative to the economy – a business that does not grow is actually shrinking relative to the economy – executives boost their power, prestige, and reputation through business growth GROWTH FROM WITHIN – most corporations grow by expanding their present operations – some introduce and sell new but related products – others expand the sale of present products to new geographic markets or to new groups of consumers in geographic markets already served – little adverse effect on a firm that is carefully planned and controlled GROWTH THROUGH MERGERS AND ACQUISITIONS *MERGER = the purchase of one corporation by another – acquisition is essentially the same thing as a merger, but the term usually is used in reference to a large corporation’s purchases of other corporations – have been fueled by the desire of financially secure firms to take over firms in financial trouble – being purchased is better than bankruptcy *HOSTILE TAKEOVER = a situation in which the management and board of directors of a firm targeted for acquisition disapprove of the merger – a corporate raider (another company or wealthy investor) may make a *tender offer or start a *proxy fight to gain control of the target company when merger or acquisition becomes hostile *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 – if corporate raider is successful and takes over the targeted company, existing management usually is replaced – “poison pills,” “shark repellents,” or “porcupine provisions” are used to maintain control of the firm and avoid the hostile takeover Different Types of Mergers (Friendly or Hostile) 1) Horizontal Mergers = a merger between firms that make and sell similar products or services in similar markets ex: AT and T-Mobile – tends to reduce the number of firms in an industry and thus may reduce competition – blocked mergers because government’s legal action was to protect the competitive environment and the consumers’ right to choose TELECOMMUNICATIONS (AT) + TELECOMMUNICATIONS (T-MOBILE) 2) Vertical Mergers = a merger between firms that operate at different but related levels in the production and marketing of a product – generally, one of the merging firms is either a supplier or a customer of the other SOCIAL MEDIA (TWITTER) + SOFTARE DEVELOPMENT (SUMMIFY) 3) Conglomerate Merger = takes place between firms in completely different industries FINANCIAL CONGLOMERATE (BERKSHIRE HATHAWAY) + INSURANCE, FURNITURE RENTAL, STEEL (WESCO FINANCIAL)
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Merger
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the purchase of one corporation by another
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Hostile Takeover
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a situation in which the management and board of directors of a firm targeted for acquisition disapprove of the merger
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Tender Offer
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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
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Proxy Fight
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a technique used to gather enough stockholder votes to control a targeted company
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Summary
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1) Describes the advantages and disadvantages of sole proprietorships 2) Explain the different types of partners and the importance of partnership agreements 3) Describe the advantages and disadvantages of partnerships 4) Summarize how a corporation is formed 5) Describe the advantages and disadvantages of a corporation 6) Examine the special types of corporations, including S-corporations, limited-liability companies, and not-for-profit corporations 7) Discuss the purpose of a cooperative, joint venture, and syndicate 8) Explain how growth from within and growth through mergers can enable a business to expand

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