question

What are some important considerations one must take into account in regards to ownership before starting a business?

answer

Tax considerations, liability exposure, start-up and future capital requirements, control, managerial ability, business goals, management succession plans, cost of formation

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Sole Proprietorship

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(Simplest and most popular) business owned and managed by one individual; the business and the owner are one and the same in the eyes of law

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Advantages of a Sole Proprietorship

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• Simple to create • Least costly form of ownership to begin • Profit incentive • Total decision making authority • No special legal restrictions • Easy to discontinue

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Disadvantages of a Sole Proprietorship

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• Unlimited Personal Liability - sole proprietor is personally liable for all of the business' debt. (Company's debts are owner's debts, creditors can go after the owner's personal assets) • Limited skills and capabilities • Feeling of isolation (no one to help or offer feedback) • Limited access to capital • Lack of continuity of the business (sole proprietor dies, retires, or becomes incapacitated = business automatically terminates - unless a family member or employee can take over)

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Partnership

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Association of two or more people who co-own a business for the purpose of making a profit. (Partners must have mutual trust and respect) - income is "passed through" to the partners, who pay taxes on their shares of the company's income

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Partnership Agreement

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Document document that states in writing the terms under which the partners agree to operate the partnership and that protects each partner's interest in business (addresses legal and business issues)

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Advantages of a Partnership

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• Easy to establish • Complementary skills • Division of profits • Larger pool of capital • Ability to attract limited partners • Minimal gov't regulation • Flexibility • Taxation - partnership itself is not subject to taxation

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Partnership Charter

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Covers the interpersonal aspects of the partners' relationship s and serves as a helpful tool for managing the complexity of partnership relations

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General Partners

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Partners who share in owning, operating, and managing a business and who have unlimited personal liability for the partnership's debts (usually take on an active role of managing the business; every partnership must have at least one)

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Limited Partners

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Partners who make financial investment in a partnership, who do not take an active role in managing a business, and whose liability for the partnership's debts is limited to the amount the have invested (cannot participate in the day-to-day management of the company) - if participates over 500 hours per year, becomes a general partner

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Two Types of Limited Partners

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1) Silent Partners 2) Dormant Partners

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Silent Partners

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Not active in a business but generally are known to be members of the partnership

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Dormant Partners

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Are neither active nor generally known to be associated with the business

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Disadvantages of a Partnership

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• Unlimited liability of at least one partner • Capital accumulation • Difficulty in disposing of partnership interest (most partnership agreements restrict how partners can dispose of their shares of the business) • Potential for personality and authority conflicts • Partners are bound by the law of agency (one partner can make a decision that affects all other partners and is bound by law)

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Limited Partnership

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Partnership composed of at least one general partner and at least one limited partner

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Limited Liability Partnership (LLPs)

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Special type of limited partnership in which all partners, who in many states must be professionals, are limited partners

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Corporation (C Corporation)

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Separate legal entity apart from its owners that receives the right to exist from the state in which it is incorporated

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Domestic Corporation

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Corporation doing business in the state in which it is incorporated

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Foreign Corporation

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Corporation doing business in a state other than the one in which it is incorporated

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Alien Corporation

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Corporation formed in another country but doing business in the US

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Closely Held Corporation

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Corporation whose shares are controlled by a relatively small number of people, often family members, relatives, friends, or employees (stock is not exchanged, but is passed from one generation to the next)

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Publically Held Corporation

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Corporation that has a large number of shareholders and whose stock usually is traded on one of the large stock exchanges

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Preemptive Rights

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The rights of a corporation's original investors to purchase enough shares of future stock issues to maintain their original percentage of ownership in the company

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Treasury Stock

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The shares of its own stock that a corporation owns

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Right of First Refusal

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Provision requiring shareholders who want to sell their stock to offer it first to the corporation (usually in small publicly held corporations, so original (usually family) members can maintain control of the corporation)

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Bylaws

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The rules and regulations the officers and directors establish for a corporation's internal management and operation

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Advantages of Corporations

answer

• Limited Liability - except when owners deliberately commit crimes or fraud ("piercing the corporate veil") • Ability to attract capital - corporation is the most effective form of ownership to attract capital • Ability to continue indefinitely (ONLY form of organization that has this) • Transferable ownership

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Private Placement

answer

Fund-raising tool in which a company sells shares of its stock to a limited number of private investors

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Initial Public Offering (IPO)

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Fund-raising tool in which a company sells shares of its stock to the public

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Disadvantages of Corporations

answer

• Cost and time involved in the corporation process • Double taxation - corporation pays taxes first on a corporate level as a legal entity, then stockholders pay taxes on the portion of profits distributed as dividends at a personal level. • Potential for diminished managerial incentives (lack of loyalty and involvement) • Legal requirements and regulatory red tape - highly regulated • Potential loss of control by the founder(s) - sell shares = relinquish some control

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S Corporation

answer

Corporation that retains the legal characteristics of a regular (C) corporation but has the advantage of being taxed as a partnership if it meets certain criteria (must be domestic (US), can't have nonresident alien as a shareholder, can only issue one class of common stock, no more than 100 shareholders, less than 25% of gross revenues during 3 successive years must be from passive sources)

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Limited Liability Company (LLC)

answer

Relatively new form of ownership that, like an S corporation, is a cross between a partnership and a corporation; it is not subject to many of the restrictions imposed on S corporations. Owners are called "members". Offers tax advantage of a partnership, legal protection of a corporation, and maximum operating flexibility. Fastest growing form of business ownership

question

Two articles that must be filed to create an LLC

answer

1) Articles of Organization 2) Operating Agreement

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Articles of Organization

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The document that creates an LLC by its name, address, its method of management (board managed or member managed), its duration, names and addresses of each organizer, and other details

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Operating Agreement

answer

(Similar to corporation's bylaws) the document that establishes for an LLC the provisions governing the way it will conduct business (members' capital contributions, rights, roles, responsibilities, admission or withdrawal of members, distributions from the business, etc.

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Professional Corporation

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Offers professionals the advantages of the corporate form of ownership (usually protects from malpractice - ex: if one of 3 doctors makes a mistake, the others are not held liable)

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The Joint Venture

answer

Very much like a partnership, except it is formed for a specific purpose EX: putting on a festival (you provide land your friend provides acts, infrastructure, and everything else. You split the profits)

MGMT 451: Chapter 5 – Flashcards

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