BUSN Ch.6 Business Formation: Choosing the Form That Fits

LEARNING OBJECTIVES After studying this chapter, you will be able to: 6-1Describe the characteristics of the four basic forms of business ownership 6-2Discuss the advantages and disadvantages of a sole proprietorship 6-3Evaluate the pros and cons of the partnership as a form of business ownership 6-4Explain why corporations have become the dominant form of business ownership 6-5Explain why limited liability companies are becoming an increasingly popular form of business ownership 6-6Evaluate the advantages and disadvantages of franchising

Sole proprietorship

A business owned and usually managed by a single individual.

Partnership

A voluntary agreement under which two or more people act as co-owners of a business for profit.

Corporation

A legal entity separate and distinct from its owners, created by filing articles of incorporation.

Limited Liability Company (LLC)

A hybrid form of business ownership offering limited liability and flexible tax treatment.

Sole proprietorship liability

Unlimited personal liability for business debts and obligations. Advantages: None. Disadvantages: Personal debts incurred by business, risk of personal assets and home being seized.

General partnership

A partnership where all partners can actively manage and have unlimited liability. Advantages: Ability to pool financial resources, share responsibilities. Disadvantages: Unlimited liability for own and partners' mistakes, potential for disagreements, lack of continuity.

Limited partnership

Includes at least one general partner with unlimited liability and one limited partner with limited liability. Advantages: Combines financial contributions with limited risk for limited partners. Disadvantages: General partners assume unlimited liability; limited partners give up management rights.

Limited liability partnership (LLP)

A partnership where all partners have management rights and limited liability for company debts. Advantages: All partners can take an active role in management while offering limited liability. Disadvantages: Protection varies by state (full vs. partial shield), some states limit to specific professional businesses.

C Corporation

The most common type of corporation, offering limited liability to stockholders. Advantages: Limited liability, permanence, ease of transfer, ability to raise capital, specialized management. Disadvantages: Expense and complexity, double taxation, paperwork and regulation.

Corporate bylaws

The basic rules governing how a corporation is organized and how it conducts business. Advantages: Establishes clear structure and operational guidelines. Disadvantages: Strict compliance required, adds operational requirements.

Board of directors

Individuals elected by stockholders to oversee a corporation's operations and protect their interests. Advantages: Sets mission and strategic objectives, protects stockholder interests, provides oversight. Disadvantages: Can face conflicts of interest, high compensation packages despite poor performance.

Double taxation

Taxation of corporate earnings at the corporate level and again as personal income on dividends. Advantages: None. Disadvantages: Takes a big bite out of earnings distributed to shareholders.

Acquisition

A corporate restructuring in which one firm buys another. Advantages: Growth and competitive advantage. Disadvantages: Can be hostile; target firm ceases to exist independently.

Merger

A combination of two formerly independent businesses to form a new organization. Advantages: Combination of equals to achieve growth and synergies. Disadvantages: Regulatory approval can be challenging; integration complexity.

Horizontal merger

A combination of two firms that are in the same industry. Advantages: Increased market share, economies of scale. Disadvantages: Antitrust scrutiny, integration challenges.

Vertical merger

A combination of firms at different stages in the production of a good or service. Advantages: Better control over supply chain. Disadvantages: Complexity, coordination costs.

Conglomerate merger

A combination of two firms in unrelated industries. Advantages: Diversification of risk. Disadvantages: Managing entirely different businesses can be difficult.

Divestiture

The transfer of total or partial ownership of some of a firm's operations to investors or another company. Advantages: Streamlines operations, refocuses on core business, raises capital. Disadvantages: Loss of scale or revenue from divested unit.

Franchise

A licensing arrangement allowing a franchisee to use a franchisor's name, trademark, and methods for fees. Advantages: Less risk, training and support, brand recognition, easier access to funding. Disadvantages: Initial and ongoing costs, lack of control, negative halo effect, restrictions on sale and growth.

Franchise Disclosure Document (FDD)

A detailed description of a franchise that must be provided to a potential franchisee at least 14 days before signing. Advantages: Invaluable source of information to ensure informed decisions. Disadvantages: Long and complex document requiring careful study.

Advantages of Sole proprietorship

Ease of formation (minimal paperwork and costs), retention of control (be your own boss), pride of ownership (personal satisfaction), retention of profits (all profits go to you), and possible tax advantage (taxed only as personal income, avoiding double taxation).

Disadvantages of Sole proprietorship

Limited financial resources (tough to raise money), unlimited liability (personal debts and asset seizure), limited ability to attract and maintain talented employees (cannot pay high salaries/perks), heavy workload (long hours and stress), and lack of permanence (ceases to exist if owner dies/retires).

Advantages of Partnership

Ability to pool financial resources (stronger financial base), share responsibilities and complementary skills (ease workload and use talents), ease of formation (verbal or written agreement), and possible tax advantages (earnings pass through and are taxed as personal income).

Disadvantages of Partnership

Unlimited liability (liable for own and partners' mistakes/debts), potential for disagreements (can delay decision-making), lack of continuity (withdrawal changes relationships/ends partnership), and difficulty in withdrawing (remains personally liable for past debts).

Advantages of Corporation

Limited liability (stockholders not personally liable), permanence (continues operating independently of owners), ease of transfer of ownership (selling shares), ability to raise large amounts of financial capital (issuing stock or bonds), and specialized management (hiring professional managers).

Disadvantages of Corporation

Expense and complexity of formation and operation (articles, bylaws, meetings), complications in multiple states (registering as foreign corporation), double taxation (earnings and dividends taxed), paperwork and regulation (SEC reports), and possible conflicts of interest (executives pursuing own interests).

Advantages of Limited Liability Company (LLC)

Limited liability (all owners have limited liability), tax pass-through (elected pass-through taxation avoiding double taxation), simplicity and flexibility in management (no mandatory board meetings), and flexible ownership (any number of owners, foreign investors).

Disadvantages of Limited Liability Company (LLC)

Complexity of formation (articles of organization and fees), annual franchise tax (required by many states), foreign status in other states (registering when operating elsewhere), limits on types of firms (banks/insurance/nonprofits excluded), and differences in state laws (laws still evolving).