Bus M30 Ch.5

S Corporation

- S corporations have shareholders, directors and employees, plus the benefit of limited liability. - Profits are taxed only as the personal income of the shareholder. -a. Have no more than 100 shareholders b. Have shareholders who are individuals or estates and are citizens or permanent residents of the U.S. c. Have only one class of outstanding stock d. Not have more than 25% of income derived from passive sources (rents, royalties, interest, etc.) 3. The TAX STRUCTURE of an S corporation isn't attractive to all businesses. 4. The benefits of S corporations change every time the tax rules change. • Profits are taxed only as the personal income of the shareholder • Good way to go if you don't want to involve and spend the money into the complexity of corporations • Pay less taxes • More regulation • Advantage for small-medium sized business • Protection

Corporations

1. Businesses do not have to be big to incorporate. 2. The corporation's owners (STOCKHOLDERS) are not liable for the debts of the corporation beyond the money they invest. • Only liable for their stock 3. Many people can share in the ownership of a business without working there. 4. Corporations can choose to offer ownership to outsiders or remain private.

INDIVIDUALS CAN INCORPORATE

1. By incorporating, individuals such as doctors and lawyers can save on taxes and receive other benefits of incorporation. 2. Small corporations usually do not issue stock to outsiders, so they don't have all the same advantages and disadvantages of large corporations.

DISADVANTAGES OF FRANCHISES

1. LARGE START UP COSTS a. Most franchises charge a fee for the rights to the franchise. b. Start-up costs can be as high as $2 million (for a Krispy Kreme franchise.) • Franchise Fee 2. SHARED PROFIT: The franchisor often demands a large share of the profits, or ROYALTY, based on sales, not profit. 3. MANAGEMENT REGULATION a. Some franchisees find the company's rules and regulations burdensome. b. In recent years, franchisees have banded together to resolve their grievances with franchisors. 4. COATTAIL EFFECTS a. The actions of other franchisees have an impact on the franchise's future growth and level of profitability, a phenomena known as a COATTAIL EFFECT. b. Franchisees must also watch for competition from fellow franchisees. 5. RESTRICTIONS ON SELLING a. Many franchisees face restrictions when reselling their franchises. b. Franchisors often insist on approving the new owner, who must meet their standards. 6. FRAUDULENT FRANCHISORS a. Most franchisors are not large systems; many are small, obscure companies. b. There has been an increase in complaints to the FTC about franchisors that delivered little or nothing that they promised.

ADVANTAGES OF CORPORATIONS

1. LIMITED LIABILITY a. Limited liability is probably the MOST SIGNIFICANT ADVANTAGE of corporations. b. The owners of a business are responsible for losses only up to the amount they invest. 2. ABILITY TO RAISE MORE MONEY FOR INVESTMENT a. To raise money, a corporation sells OWNERSHIP (STOCK) to anyone interested. b. It is also easier for corporations to obtain loans. c. Corporations can also borrow money from investors by issuing BONDS. 3. SIZE a. Because corporations can raise large amounts of money, they can build modern facilities. b. They can also hire experts in all areas of operation. c. They can buy other corporations in other fields to diversity their risk. d. Corporations have the size and resources to take advantage of opportunities anywhere in the world. e. Corporations do not have to be large to have these benefits. 4. PERPETUAL LIFE: The death of one or more owners does not terminate the corporation. 5. EASE OF OWNERSHIP CHANGE: Selling stock to someone else changes ownership. 6. EASE OF DRAWING TALENTED EMPLOYEES: Corporations can offer benefits such as STOCK OPTIONS—the right to purchase shares of the corporation for a fixed price. 7. SEPARATION OF OWNERSHIP FROM MANAGEMENT: Corporations can raise money from investors without having them involved in management.

ADVANTAGES OF PARTNERSHIPS

1. MORE FINANCIAL RESOURCES: Two or more people can pool their money and credit. • 2 savings, 2 mortgages, etc 2. SHARED MANAGEMENT AND POOLED/ COMPLEMENTARY KNOWLEDGE: Partners give each other time off and provide different skills and perspectives. • MORE MANAGEMENT 3. LONGER SURVIVAL: Partners are four times as likely to succeed as sole proprietorships. 4. NO SPECIAL TAXES: All profits of partners are taxed as personal income of the owners.

DISADVANTAGES OF PARTNERSHIPS

1. UNLIMITED LIABILITY a. Each GENERAL PARTNER is liable for the debts of the firm, no matter who was responsible for causing those debts. b. You are liable for your partners' mistakes as well as your own. 2. DIVISION OF PROFITS: Sharing profits can cause conflicts. • Need to make articles of partnership to terminate the business • Equal distribution of profits unless written in articles 3. DISAGREEMENTS AMONG PARTNERS a. Disagreements can arise over division of authority, purchasing decisions, and so on. b. Because of potential conflicts, all terms of partnership should be spelled out IN WRITING to protect all parties. • In WRITING AND DEFINE IT • Get a lawyer involved/ professional help= good investment • Pick your partners wisely (PPT) 4. DIFFICULTY OF TERMINATION a. It is not easy to get out of a partnership. b. For example: Who gets what and what happens next? c. It is best to make these decisions at the beginning. • Need to make articles of partnership to terminate the business • UPA is the governing legislation for partnerships E. Many ventures avoid the disadvantages of these forms of ownership by forming corporations.

DISADVANTAGES OF SOLE PROPRIETORSHIPS

1. Unlimited liability—the risk of personal losses a. You and the business are one. b. UNLIMITED LIABILITY is the responsibility of business owners for all of the debts of the business. 2. LIMITED FINANCIAL RESOURCES: Finance is limited to the funds that the sole owner can gather. 3. MANAGEMENT DIFFICULTIES: Many owners are not skilled at management and with details such as accounting. 4. OVERWHELMING TIME COMMITMENT a. The owner has no one with whom to share the burden. b. A business owner may work 12 hours a day. 5. FEW FRINGE BENEFITS: a. You have no paid vacation or health insurance. b. Fringe benefits can add up to 30% of a worker's income. 6. LIMITED GROWTH: Expansion is slow. 7. LIMITED LIFE SPAN. If the sole proprietor dies or leaves, the business ends.

THREE MAJOR FORMS OF BUSINESS OWNERSHIP

SOLE PROPRIETORSHIP, PARTNERSHIP, CORPORATION

ADVANTAGES OF SOLE PROPRIETORSHIPS

1.Ease of STARTING AND ENDING the business. a. After you rent or buy the equipment, all you need is a permit from the local government. b. To get out of business, you just quit. 2. BEING YOUR OWN BOSS. Working for yourself is exciting. 3. PRIDE OF OWNERSHIP. Sole proprietors take the risk and deserve the credit. 4. LEAVING A LEGACY behind for future generations 5. RETENTION OF COMPANY PROFITS. You don't have to share profits with anyone. 6. NO SPECIAL TAXES. Profits of the business are taxed as the personal income of the owner.

DISADVANTAGES OF CORPORATIONS

1.INITIAL COST a. Incorporation may cost thousands of dollars and involve lawyers and accountants. b. There are less expensive ways of incorporating in certain states. 2. EXTENSIVE PAPERWORK a. A corporation must keep detailed records. b. Many firms incorporate in Delaware because favorable laws make the process easier. 3. DOUBLE TAXATION: Corporate income is taxed twice. a. The CORPORATION PAYS TAX on income before it can distribute any to stockholders. b. The STOCKHOLDERS PAY TAX on the income they receive from the corporation. c. States often tax corporations more harshly than other enterprises. 4. TWO TAX RETURNS: A corporate owner must file both a corporate tax return and an individual tax return. • IBT- Income Corporation has before paying taxes. 45% ratio • IAT- 5. SIZE: Large corporations sometimes become inflexible and too tied down in red tape. 6. DIFFICULTY OF TERMINATION: A corporation is relatively difficult to end. 7. POSSIBLE CONFLICT WITH STOCKHOLDERS AND BOARD OF DIRECTORS. a. The board chooses the company's officers. b. An entrepreneur can be forced out of the very company he or she founded. 8. Many people feel the hassles of incorporation outweigh the advantages.

2 types of Partnerships

General Partnership or Limited Partnership

ADVANTAGES OF FRANCHISES

MANAGEMENT AND MARKETING ASSISTANCE, providing a greater chance of success through: a. an established product b. help in choosing a location c. assistance in all phases of operation d. intensive training e. local marketing efforts 2. PERSONAL OWNERSHIP: You are still your own boss, although you must follow the rules, regulations, and procedures of the franchise. 3. NATIONALLY RECOGNIZED NAME: You get instant recognition and support. 4. FINANCIAL ADVICE AND ASSISTANCE a. Franchisees get assistance arranging financing and learning to keep records. b. Some franchisors will even provide financing to potential franchisees. 5. LOWER FAILURE RATE a. Historically, the failure rate for franchises has been lower than that of other business ventures. b. However, because many weak franchises have entered the field, care is needed

CORPORATION EXPANSION:

MERGERS AND ACQUISITIONS

THREE MAJOR TYPES OF CORPORATE MERGERS

Vertical, Horizontal, Conglomerate

COOPERATIVE

a business owned and controlled by the people who use it—producers, consumers, or workers with similar needs who pool their resources for mutual gain. 1. There are about 47,000 cooperatives in the U.S. 2. Members democratically control these businesses by electing a board of directors that hires professional management. B. Some cooperatives are formed to give members

SOLE PROPRIETORSHIP

a business that is owned, and usually managed, by one person; it is the most common form.

LIMITED LIABILITY COMPANY (LLC

a company similar to an S corporation but without the special eligibility requirements.

FRANCHISOR

a company that develops a product concept and sells others the rights to make and sell the product

CORPORATION

a legal entity with authority to act and have liability separate from its owners - Stockholders are the owners -As an owner, your liability is limited

PARTNERSHIP

a legal form of business with two or more owners.

General Partnership

a partnership in which all owners share in operating the business and in assuming liability for the business's debts.

LIMITED LIABILITY PARTNERSHIP (LLP)

a partnership that limits partners' risk of losing their personal assets to only their own acts and omissions and the acts and omissions of the people under their supervision. a. Your partner's malpractice will not cost you your personal assets. b. In some states, personal protection does not extend to contract liabilities such as bank loans. • Lawyers, Doctors • If you're in a doctor's group and you get sued, only you get sued. You shield your partners

MASTER LIMITED PARTNERSHIP (MLP)

a partnership that looks much like a corporation (in that it acts like a corporation and is traded on a stock exchange) but is taxed like a partner¬ship and thus avoids the corporate income tax.

Limited Partnership

a partnership with one or more general partners and one or more limited partners.

CONVENTIONAL (C) CORPORATION

a state-chartered legal entity with authority to act and have liability separate from its owners.

S CORPORATIONS

a unique government creation that looks like a corporation but is taxed like sole proprietorships and partnerships.

DISADVANTAGES OF LLCS:

a. NO STOCK i. LLC ownership is nontransferable. ii. LLC members need the approval of the other members in order to sell their interest. b. LIMITED LIFE SPAN: LLCs have to identify dissolution dates in the articles of organization. • Termination date c. FEWER INCENTIVES: LLCs can't deduct the cost of fringe benefits or use stock options. d. TAXES: LLC members must pay self-employment taxes on profits. • 6% to social security e. PAPERWORK: More paperwork is required than for sole proprietors. • $2000-3000 4. The start-up cost for an LLC varies

ADVANTAGES OF LLCS:

a.LIMITED LIABILITY: Personal assets are protected. b. CHOICE OF TAXATION: LLCs can choose to be taxed as partnerships or as corporations. c. FLEXIBLE OWNERSHIP RULES: LLCs do not have to comply with ownership restrictions as S corporations do. d. FLEXIBLE DISTRIBUTION OF PROFITS AND LOSSES: Profit and losses don't have to be distributed in proportion to the money each person invests. e. OPERATING FLEXIBILITY: Reporting requirements are less than for a corporation.

FRANCHISE AGREEMENT

an arrangement whereby someone with a good idea for a business sells the rights to use the business name and sell a product or service to others in a given territory.

LEVERAGED BUYOUT

an attempt by employees, management, or a group of investors to purchase an organization primarily through borrowing. a. Borrowed funds are used to buy out the stockholders in the company. b. Employees, managers, or a group of investors then become the owners of the firm. -BEST BUY is an example right now

GENERAL PARTNER

an owner (partner) who has unlimited liability and is active in managing the firm.

LIMITED PARTNER

an owner who invests money in the business but does not have any management responsibility or liability for losses beyond the investment.

FRANCHISE

is the person who buys a franchise.

HORIZONTAL Merger

joins two firms in the same industry. a. It allows the firm to diversify or expand their products. b. Example: merger of a soft drink and a mineral water company.

ACQUISITIONS

one company's purchase of the property and obligations of another company

CONGLOMERATE MERGER

the joining of firms incompletely unrelated industries thereby diversifying business operations (example: merger of a soft drink company and a snack food producer.) • problems

VERTICAL MERGER

the joining of two companies involved in different stages of related businesses; (example: merger of a soft drink company and a company producing artificial sweetener.)

LIMITED LIABILITY

the responsibility of a business' owners for losses only up to the amount they invest; limited partners and shareholders have limited liability.

UNLIMITED LIABILITY

the responsibility of business owners for all of the debts of the business.

MERGERS

the result of two firms forming one company.

FRANCHISE

the right to use a specific business's name and sell its products or services in a given territory.