Ch. 6: Forms of Business Ownership
Are there advantages to being a sole proprietorship?
-ease of formation -no specific corporate records to keep or reports to file (including tax reporting) -start-up phase is likely that operating costs greater than incoming revenues, so joined tax return with personal one is beneficial (the excess expense, net loss, can help offset the taxes you owe on any other sources of income you might have).
Why wouldn't I want to run my business as a sole proprietorship?
-exposed personal liability
What are the different types of partnerships?
-general partnerships -limited partnerships
Learning Objectives
6-1: (Sole Proprietorships) Discuss the advantages and disadvantages of a sole proprietorship. 6-2: (Partnerships) Discuss the advantages and disadvantages of a partnership and a partnership agreement. 6-3: (Corporations) Explain how a corporation is formed, and compare a corporation to other forms of business. 6-4: (Not-for-profits and Cooperatives) Explain the characteristic of not-for-profit organizations and cooperatives. 6-5: (Mergers and Acquisitions) Compare the different types of mergers and acquisitions, and explain why each occurs.
Can any business elect to be a S corporation?
Certain qualification requirements a business must meet...according to Internal Revenue Code, S corporation must have: -company must not have more than 100 shareholders -shareholders must be US citizen or residents -company must issue only one class of stock
How id a corporation structured?
Comprised of shareholders, a board of directors, corporate officers, first-line managers, employees.
Is it easier for corporations to get funding and to raise capital?
Corporations can raise money selling shares of ownership to specified group of individuals. When corporation significant size, can extend ownership by "going public" (selling shares of ownership in the corporation to the general public). Stock certificate is tangible evidence of investment and ownership. Lenders more likely to loan money to incorporated business as not limited to credit profile of a sole proprietor or general partners.
Are corporations taxed the same as other types of businesses?
Corporations have separate tax rates whereas sole proprietors and partners run business income through personal income tax statements and pay taxes at owner's or partners' tax rates. Corporate tax rate is 5% for first $50,000 of net income a business earns; same amount for sole proprietorship/partnership is 25%. Most corporations generate more than $50,000 in net income, and more than that in taxable income, businesses pay taxes at equal or higher rate than individual.
What are the advantages of cooperatives?
Form because group of individuals or businesses become dissatisfied with how marketplace is providing the goods/services they need, prices being sold, or quality -> unite so members have more bargaining power to negotiate within the marketplace and enjoy reduced cost.
Can a business have the protection of a corporation but not pay corporate taxes?
Goals of entrepreneurs: protect themselves from personal liability, have tax advantages of business income flow through individual tax return. Corporate structure protects owner's personal assets from being touched if face financial difficulty, but corporation taxed as separate entity. Meet both goals -> S corporation and limited liability company
Why is the term merger sometimes used over acquisition?
Has a better connotation, used to "save face;" said sometimes when an acquisition has happened.
Does it matter where a business is incorporated?
If corporation of fewer than 5 shareholders/members, easier and cheaper to incorporate in state where business has physical presence. For larger businesses, may be advantageous to incorporate in state that is more favorable to businesses, like Delaware, Nevada, Wyoming. Delaware most flexible and business-friendly statues. Nevada low filing fees and no state corporate income, franchise, personal income taxes. Wyoming similar.
Will partnerships work well when liability is a concern?
In some situations, especially if liability is a concern, neither a sole proprietorship nor a partnership will protect the owner(s) from unlimited risk.
What kinds of businesses are best suited as an LLC?
LLCs may be good choice for start-up businesses, for tad benefits but also easier to obtain financing because number of investors (owners) not restricted.
Are there any disadvantages of structuring a business as a corporation?
Lots of cumbersome steps: choose a name -> appoint directors -> file articles of incorporation -> draft bylaws -> hold a meeting of the board -> issue stock -> obtain licenses and permits -must record major decisions and keep record financial transactions in a double-entry bookkeeping system and file taxes regularly (quarterly or annually)
What goes into a partnership agreement?
May begin with a handshake; no formal documents are required to form one. Good idea to draw up a partnership agreement; formalizes the relationship between partners; like a prenuptial agreement. Helps settle conflicts when they arise and may prevent small misunderstandings from erupting into larger disagreements. Following points should be included: -capital contributions: amount of capital (money), equipment, supplies, technology, and other tangible things; -responsibilities of each partner; -decision-making process; -departure of partners; -addition of partners
Are all mergers and acquisitions mutually desired by both companies?
No, most acquisitions are friendly but some are unfriendly...referred to as "hostile takeovers"-acquiring firm makes a "tender offer," an offer to buy the target company's stock at a price higher than current value.
Can not-for-profit organizations act like corporations?
Not-for-profits are incorporated and are subject to most laws that govern for-profit organizations; receive limited liability protection when become incorporated and established as a separate legal entity; required to hold board meetings and keep complete books and records; do not issue shares of stock, and members may not receive personal financial benefit from organization's profits (other than salary as employee); some do provide employee benefits, like health insurance; once dissolve, organization's assets must go to another not-for-profit organization with similar mission.
chief information officer
Oversees all uses of IT and ensures the strategic alignment of IT with business goals and objectives.
How is an S corporation different from a C corporation?
S corporations do not pay corporate income taxes; instead, like with partnership/sole proprietorship, shareholders in an S corporation owe income taxes based on proportionate share of the business profits they receive and pay taxes through their own individual tax returns. Passing taxes through personal tax returns is primary advantage of forming business as S corporation; but even though don't pay corporate taxes like C corporations, must file a corporate tax return yearly. Also must comply with meeting and reporting requirements for C corporations.
Why do mergers and acquisitions occur?
Synergistic value created when new company can realize operating or financial economies of scale; combined firms lower costs by trimming redundancies in staff, sharing resources, obtaining discounts accessible to larger firm.
Are cooperatives not-for-profits?
While members motivated by profits, cooperatives themselves are not; any profits made by cooperative reinvested in organization ot continue maintaining and improving its functioning; or profits returned to members in proportion to their use of their cooperative, not their investment or ownership share. Cooperatives incorporated under state co-op statutes as businesses organized to serve their members; status is recognized by state and federal tax codes -> any distributed profits to member-owners are taxed at owner's level.
general partnership
a business where every partner participates in the daily management tasks of the business, and each has some degree of control over the decisions made. -simplest of all partnerships -share profits equally -> little worry about liability -each partner has unlimited liability for debts and obligations -> every partner liable for his or her own actions
conglomeration
a combination of a number of different, perhaps even unrelated, businesses into a single corporation. -Citicorp (banking services firm) and Travelers Group Inc. (insurance underwriting company) -> Citigroup Inc. (large financial service group)
C corporation
a corporation covered by the Subchapter C of the Internal Revenue Code.
product extension merger
a merger between two companies selling different but related products in the same market. -Adobe and Macromedia
market extension merger
a merger between two companies that sell the same product in different markets. -NationsBanks (East Coast, South) and Bank of America (West Coast)
vertical merger
a merger that occurs when two companies that have a company/customer relationship or a company/supplier relationship merge. -Walt Disney and Pixar -eBay and PayPal
horizontal merger
a merger that occurs when two companies that share the same product lines and markets are in direct competition with each other merge. -between Exxon and Mobil -USAirways and American Airlines
master limited partnership (MLP)
a partnership that is allowed to raise money by selling units of ownership to the general public; restricted mostly to certain businesses pertaining to the use of natural resources (petroleum, natural gas) and real estate.
leveraged buyout (LBO)
an attempt by employees, management, or a group of investors to purchase an organization primarily through borrowing. -can be friendly or hostile -good strategy in some instances but jobs often lost and companies often fail due to high debt loads resulting from the LBO
How does an S corporation handle personal liability?
best of both worlds: profits and losses pass through to shareholders, and corporate structure provides some limitations on personal liability of owners. Although owner's personal assets protected in case of large claim against corporation, the S corporation does not assume liability for an owner's personal wrongdoings...true for any corporate structure, whether C or S or LLC.
not-for-profit organization
business that does not pursue profits but instead seeks to service the community through social, educational, or political means. -generate revenue through fundraising and donations -after paying operating expenses (salaries, rent, purchase of inventory/supplies/materials/equipment) not-for-profits must apply for tax-exempt status with federal govt and sometimes states in which operate; to maintain tax-exempt status, must demonstrate that substantial portion of income or revenue spend on services to achieve their goals
limited liability company (LLC)
company in which the owners have limited personal liability for the debts and the actions of the company. -requires articles of organization, so is a separate legal entity -free of many of the annual meetings and reporting requirements imposed on S and C corporations, so simpler to maintain -do not issue stock; each member's ownership determined by value of his or her capital account
publicly owned corporation
corporations that are regulated by the Securities and Exchange Commission (SEC) because the shares of ownership can be traded on public stock exchanges. -shareholders serve as owners but no direct management involvement; influence corporate decisions by electing directors, overseeing laws and rules, and voting on major corporate issues
first-line managers
fill a supervisory role over those employees who carry out the day-to-day operations of a company.
shareholders
have ownership interest in a company.
capital
investments in the form of money, equipment, supplies, computers, and other tangible things of value.
limited partner
involved as investors and, as such, is personally liable only up to the amount of their investment in the business and must not actively participate in any decisions of the business. -must not actively participate in decisions of the business -only lose amount money contributed if damages
chief legal officer
might also be an executive position in a business
acquisition
occurs when one company completely buys out another company.
merger
occurs when two companies of similar size mutually agree to combine to form a new company.
stockholders
owners of a company, and although they do not have direct control over the day-to-day management of a company, they do have say in the composition of its board of directors.
limited liability partnership (LLP)
protects the partners not only from any debt or liability incurred by the business but also from the liability of another partner. -partner personally liable only for his or her own negligence
S corporation
regular corporation (C corporation) that has elected to be taxed under a special section of the Internal Revenue Code called Subchapter S. -has shareholders, and must comply with all other regulations involving traditional C corporations
chief financial officer (CFO)
reports directly to the CEO and is responsible for analyzing and reviewing the financial data, reporting financial performance, preparing budgets, and monitoring expenditures and costs.
chief operating officer (COO)
responsible for the day-to-day operations of the organization and reports directly to the CEO.
synergy
the effect achieved when two companies combine, in which the result is better than each company could achieve individually.
double taxation
the situation that occurs when taxes are paid on the same asset twice. -distribution of dividends; corporation first taxed on profit, then distributes net income to shareholders in form of dividends, which individuals must pay taxes on -> same pool money taxed twice
chief executive officer (CEO)
typically responsible for the entire operations of the corporation and report directly to the board of directors.
What are the advantages and disadvantages of a partnership?
-advantages: complimentary skills, more time available for marketing and sales, another source of creativity, more likely to work long hours since they have stake in business. -disadvantages: adding wrong partner -> problems, sharing profits and control, may have different work habits and styles, as business grows/changes partner may want take things in different direction.
characteristics of a partnership
-preliminary paperwork: no special forms needed; partnership agreement recommended. -period of existence: ends upon death or withdrawal of a partner unless otherwise provided for in a partnership agreement. -liability: unlimited liability. -operational requirements: minimal legal requirements. -management: roles specified in partnership agreement; partners generally have equal voice. -taxation: not a separate taxable entity; taxes paid through owner's personal tax return. -raising capital: funding raised through partner contributions.
How does one start a sole proprietorship?
Automatically one the minute you begin doing business by yourself; minimum might need to obtain a local license or permit, or might have to ensure you're operating in an area zoned for the type of business you are running. If hiring employees, will need to register company name and obtain an employer identification number (EIN) from the Internal Revenue Service (IRS).
As a business, how does a partnership compare to a sole proprietorship?
Similar; only different is number of people contributing resources and sharing profits/liabilities. Just as easy to form a partnership as to form a sole proprietorship; govt does not require any special forms/reports, but some local restrictions may apply for licenses and permits
What happens to a corporation when an owner leaves?
Sole proprietorships/partnerships dependent on their founding owners; when owner dies/leaves, usually are terminated. Corporations can theoretically live forever as their ownership can be transferred to different shareholders; shares of ownership are easily exchanged, so corporation will continue to exist should an owner die or wish to sell his or her interest in the business. Can continue forever if financially viable.
Why is a sole proprietorship a popular form of business ownership?
They are unincorporated businesses owned by a single individual. No legal paperwork is needed to establish one, so many small business owners are sole proprietors w/o noticing. Although only one owner, can have many employees. It ends when the proprietor dies or leaves the business; there is unlimited liability, however, so the person assumes all risk; minimum legal requirements; full control of management and operations; not a separate taxable entity (taxes paid through owner's personal tax return); funding mostly comes from owner (outside funding difficult to obtain).
cooperative
a business that is owned and governed by members who use its products or services, not by outside investors. -hardware stores, florists, hotels -eg: Florida's Natural Growers
sole proprietorship
a business that is owned, and usually operated, by a single individual.
limited partnership
a business where at least one partner controls a business's operations and is personally liable. -two types of partners: general and limited
S coporation
a private corporation with special benefits designed to help small businesses.
corporation
a specific form of business organization that is a legal entity separate from the owner or owners. -separate entity apart from owners; has legal right like an individual—can own property, assume liability, pay taxes, enter into contracts, sue and be sued
partnership
a type of business entity in which two or more entities (or partners) share the ownership and the profits and losses of the business.
general partner
full owner of the business who is responsible for day-to-day business decisions, and remain liable for all the debts and obligations of the business.
board of directors
group which sets policy for the corporation and makes the major business and financing decisions. -authorizes issuance of stock, approves loans to or from corporation, decides on major real estate transactions -responsible for hiring corporations major executives and that they do their jobs
types of mergers
horizontal, vertical, product extension, market extension, conglomeration
capital account
tracks the member's capital contributions to the LLC; profit and loss distributions also flow through the capital accounts in proportion to the ownership percentage each member has.
What's the difference between an LLC and an S corporation?
-ownership: S corporations restricted to amount of owners company can have, but LLC can have unlimited owners (members); LLC not limited to US residents and not subject to other ownership restrictions. -perpetual life: when member leaves LLC, LLC must dissolve unless all remaining members agree to conginue business; some states require a dissolution date be listen in LLC's article of organization...limited life span. -stock transfer: stock in an S corporation is freely transferable, whereas ownership interest in LLC is not, and transfer requires approval of other members. -profit and loss distributions: LLC can allocate its profits in whatever way owner agrees, but profits of S corporation allocated in proportion to a shareholder's interest; if 2 members own business, one at 75% and other at 25%, an LLC would allow profit to be allocated 50/50 whereas in S corporation the profits need to be distributed based on 75/25 ownership. -owner and employee benefits: S corporation offers fringe benefits to owners, like retirement plans, employee-provided vehicles, educational expenses; because S have stock, can offer employees stock options and other stock bonus incentives; LLCs limited in benefits and do not offer stock benefits to employees as they do not issue stock.
characteristics of a C corporation
-preliminary paperwork: incorporation paperwork must be filed with state and federal agencies; -period of existence: separate entity; existence not dependent on owners, founders; ownership transferred easily; -liability: owners (shareholders) not personally liable for debts of corporations; -operational requirements: must have board of directors, corporate officers, annual meetings, and annual reporting; -management: shareholders elect board of directors, which provides strategic management of corporation; board appoints senior management; -taxation: separate taxable entity. Corporation files own tax return; -raising capital: capital is raised through sale of stock and debt issue.
characteristics of an S corporation
-preliminary work: incorporation paperwork must be filed with state and federal agencies; -period of existence: separate entity; existence not dependent on owners, founders; ownership transferred easily; -liability: owners (shareholders) not personally liable for debts of corporation; -operational requirements: must have board of directors, corporate officers, annual meetings, and annual reporting; -management: shareholders elect board of directors, which provides strategic management of corporation; board appoints senior management; -taxation: profits and losses pass through owner's personal tax return; -raising capital: capital can be raised through sale of stock and debt; only common stock can be issued.
characteristics of an LLC
-preliminary work: organizational paperwork must be filed with state and federal agencies; -period of existence: ongoing existence is determined by requirements imposed by the state of formation; transferability is determined by the operating agreement; -liability: members are not personally liable for debts of the LLC; -operational requirements: some reporting/operating requirements, but far fewer than for corporations; -management: management details are described in an operating agreement; -taxation: taxes as a partnership, although it can elect to be taxed as a corporation; -raising capital: members may sell interests to raise capital; there may be operating agreement restrictions.
When does it make sense to form a corporation?
-some just to be able to end business name with "Company," "Co.," "Incorporated," "Inc." -can give start-up business an air of legitimacy, which can be a perceived benefit to prospective clients and lenders and potentially greater threat to competition -advantages not available with other business structures such as protecting against personal liability, perpetual existence, and raising capital.
largest not-for-profit organizations
1) The Y (YMCA) 2) Goodwill Industries International 3) Catholic Charities USA 4) United Way 5) The Salvation Army 6) American Red Cross 7) Easter Seals 8) Feeding America 9) Task Force for Global Health 10) Boys and Girls Clubs of America
How can a business owner protect his or her personal assets?
C corporation can be right choice for many small entities because it is a separate legal entity and is responsible for its own debts, obligations, and liabilities; can also be sued.
Are there disadvantages with mergers?
More than 1/2 all mergers fail wholly or partially; primary reason is poor integration following the transaction. Corporate cultures may clash, communications may break down. Conflicts may arise due to divided loyalties, hidden agendas, power struggles. Nerves due to elimination of jobs.
privately held (closed) corporation
Most cases: company's founder, management team, or group of private investors owns company; owners generally involved in management and daily operations of business and have more decision-making responsibilities than do shareholders of publicly owned corporations. Owners generally sole shareholders. Any shares of privately held corporations not traded on public stock exchange.
Are there advantages to being tax exempt?
Organization meeting qualifications of section 501(c)(3) of IRS code is a not-for-profit -> exempt from paying most federal and/or state corporate income taxes; may also be exempt from state sales and property taxes; can apply for grants and other public/private distributions and get discounts on postal rates and other services; donations to not-for-profits can be deducted from personal tax returns.
liability
all the debts and obligations owned by a business to outside creditors, suppliers, or other vendors. -can include breach of contract or losses associated from damages
Are there other things to consider when operating as a sole proprietorship?
mainly unlimited liability, but other: -financing/investment: more difficult to borrow money to help business grow since banks will be lending to you personally, not to your business; if decide to bring in investors who want a type of ownership in the company, the form of the business would need to be changed. -taxes: included in personal tax return; costs you pay for healthcare, retirement, other benefits are not tax deductible for the sole proprietorship itself, though may be able to deduct some on personal tax return. -selling: hard to sell sole proprietorship -financial sacrifices: owner often last person to get paid; may need to postpone owner's health care and retirement; often good to run a sole proprietorship as a part-time business and still work for someone else. -spreading yourself thin: all responsibilities of management duties fall on you; lots of paperwork and time involved in creating invoices, making sure payments are collected and salaries/benefits paid, as well as generating new businesses, following up on prior jobs, and marketing (all time consuming).
unlimited liability
means that if business assets are not enough to pay its debts, then personal assets, like the sole proprietor's house, personal investments, or retirement funds, can be used to pay the balance.
How are cooperatives structured?
members are most important; buy shares to help finance, elect directors to manage, create and amend bylaws that govern it; depend on members to volunteer for projects supported by the cooperative and serve on boards and committees. Board of directors appoints committees for specific purposes, like member relations and special audits; hires cooperative manager who handles daily affairs.