Business Dynamics Ch5

What are the three major forms of business ownership?

1. Sole proprietorship

2. Partnerships

3. Corporations

Sole Proprietorship

A business that is owned, and usually managed. by one person.

Partnership

A legal form of business with two or more owners.

Corporation

A legal entity with authority to act and have liability separate from its owners.

Do businesses always remain in the form of ownership they were established under?

No, companies can change their form of ownership.

• Go from partnership or sole prop to a corporation, LLC, or a franchise.

What are the advantages to a sole proprietorship?

Easiest kind of business to explore; many people are sole proprietors, so there are many people you can consult

• Ease of starting and ending the business — just need to buy or lease the equipment and say that you’re in business; might need a permit or license from local gov.

  • stopping requires simply well… stopping

• Being your own boss

• Pride of ownership

• Leaving a Legacy — Owners can leave an ongoing business for future generations;—inheriting the family business

• Retention of company profits — Owners keep the 100% of the profits

• No Special Taxes — All profits are taxed as personal income.

  • Also have to pay self-employment tax (for SS and Medicare)

  • Also have to estimate taxes and make quarterly payments to government;—suffer penalties for nonpayment

What are the disadvantages of a sole proprietorship?

It’s often difficult to maintain a business. Costs of inventory, supplies, insurance, advertising, rent, computers, utilities, etc…

• Unlimited liability — As the owner of the business, any debts or damages incurred by the business fall on you.

  • This means possibly selling your personal assets (home, car, etc…)

    • ;— Starting a sole prop requires planning with lawyers, insurance agents, accounts, and others.

• Limited financial resources — Funds for the business are limited to the owners own financial means, and how much they can raise;—partnerships and corporations are often better at obtaining financial backing

• Management difficulties — Someone needs to keep inventory, accounting, and tax records

  • It’s also difficult to attract qualified employees since sole proprietorships make less than corporations or partnerships.

• Overwhelming time commitment — In order to maintain the business (balancing managing, training, and leisure time), owners often end up working for 12 hours a day and at least 6 days a week.

• Fringe benefits — As an proprietor, you lose the benefits that come with being an employee;—no paid health insurance, disability insurance, pension plan, sick leave, and no vacation pay.

• Limited growth — Slow expansion since sole proprietorships rely on their owners for creativity, knowledge, and funding

• Limited life span — Business dies if owner dies, is incapacitated, or retires.

  • The business will no longer exist unless it’s sold or taken over by the sole proprietor’s heirs.

What is a partnership? What are the types of partnerships?

A legal form of business with two or more owners.

1. General partnerships

2. Limited partnerships

3. Master limited partnerships (MLP)

4. Limited liability partnerships (LLP)

Limited Partnerships

A partnerships with one or more general partners and one or more limited partners.

What is a general partner, what’s a limited partner?

General partner — An owner who has unlimited liability and is active in managing the firm.

• Every partnership must have at least one general partner

Limited partner — An owner who invests money in the business but does not have any management responsibility or liability for loss beyond their investment

• Has limited liability

What is a Master Limited Partnership (MLP)?

A partnership that looks like a corporation

• Acts like a corporation in that it’s traded on a stock exchange

• Partnership part;—Is taxed like a partnership and thus avoids the corporate income tax

NOTE: MLPs are limited to specific industries

• — Gas, oil, and real estate

Limited liability partnerships (LLPs)

A partnership that limits partners’ risk of losing their personal assets to only their own acts and omissions an to the acts and omissions of people under their supervision.

• If you are a limited partner, you can operate without fearing if a partner commits malpractice.

  • NOTE: In many states, personal protection does NOT extend to contract liabilities such as bank loans, leases, and business debts the partnership takes on;—can lose personal assets if not dealt with

What is the UPA?

Uniform Partnership Act — replace earlier laws governing partnerships; defines three key elements of any general partnership as…

1. common ownership

2. shared profits and losses

3. right to participate in managing the operations of the business

What are the advantages of a partnership?

It’s often easier to manage a business with one ore more partners. They may have skills to offer—like inventory and accounting. Partners can provide money, support, and expertise.

• More financial resources — More people involved in the business means more money pooled together to run the business;—it’s easier to pay the expenses of the business

• Shared management and combined expertise — Easier to manage the business when the workload is spread among more than one person.

• Longer survival — Partnerships are more likely to succeed compared to sole proprietorships;—partners can hold each other accountable.

• No special taxes — Partnerships are taxes in the same way proprietorships are. Partners pay the normal income tax and must estimate their taxes and make quarterly payments or suffer the penalties;—same structure as sole props

What are the disadvantages of partnerships?

Tension can arise when there are disagreements between partners.

• Unlimited liability — General partners are liable for the debts of the firm, regardless of who was responsible for causing them;—you’re liable for your partners’ mistakes as well as your own

• Division of profits — Profits aren’t always divided evenly, disagreements may arise when discussing proper compensation.

  • a partner may put in more money and effort than the other

• Disagreements among partners — Disputes over money, authority, hiring or firing employees, hours worked, and purchasing machinery for the business can all cause conflicts in a partnership.

• Difficulty of termination — It’s not easy to get out of a partnership; difficult to figure out what happens to the business and who gets what.

What does the Model Business Corporation Act recommend be included in a partnerships agreement?

1. Name of business

2. Names and address of partners

3. Purpose, nature, and locations of the business

4. When the partnership is established and its continuity

5. Who will contribute what

6. Management responsibilities

7. Duties of partners

8. Salaries and drawing accounts of each partner

9. Provisions for sharing profits and losses

10. Accounting procedures

11. Requirements for adding partners

12. Any special restrictions, rights, or duties

13. Provision for a retiring partner

14. Provision for the purchase of a deceased or retired partner’s share

15. Provision for grievances

16. Provision for dissolution and distribution of assets

What is a C Corp?

A conventional corporation, a C corp, is a state-chartered legal entity with authority to act and have liability separate from its owners—its stockholders.

• Stockholders aren’t liable for the debts or problems of the corporation beyond the money they invest in it.

• Allows multiple people to share in the ownership of a business

• Corporations can either be private or public

What are the different types of corporations? What makes them different?

1. Alien corporations — Conduct business in the US, but are chartered (incorporated) in a foreign country

2. Domestic corporations — Do business in the state they are incorporated in

3. Closed (private) corporations — Have stock that is held by a few people and isn’t available to the general public

4. Open (public) corporations — Sell stock to the general public

5. Quasi-public corporations — Chartered by the government as an approved monopoly.

   • i.e.—public utilities

6. Professional corporations — Owned by individuals that offer professional services (doctors, lawyers, etc…).

   • Shares in professional corporations are NOT publicly traded.

7. Nonprofit corporations — Don’t seek personal profit for their owners

8. Multinational corporations — Operate in several countries

What are some advantages of being in a corporation?

Offer a good way to minimize risk and while maximizing investment into a company

• Limited liability

• Ability to raise more money for investment — Corporations can sell shares of its stock to generate money for the company to use to grow itself

• Size — Corporations can build and expand their business with the large amounts of money they raise.

• Perpetual life

• Ease of ownership change — It’s only necessary to sell stock to another person to relinquish ownership

• Ease of attracting talented employees — Can attract employees by offering benefits such as stock options

• Separation of ownership form management — Corporations can raise money from many different owners/stockholders without getting them involved in management

What are some disadvantages of corporations

• Initial cost — incorporation may cost thousands of dollars and require lawyers and accountants

• Extensive paperwork — corporations must keep detailed financial records, minutes of meetings, and more.

  • Many firms incorporate in Delaware because the laws make the process easier

• Double taxation — Corporate income is taxed twice

  • 1st time is on the corporation’s income; 2nd time is on the income tax stockholders pay on the dividends they receive.

  • States often tax corporations heavier than other enterprises, some special taxes only apply to corporations

• Two tax returns — A corporate and individual tax return must be filed for an individual who incorporates

• Size — Size can also be a disadvantage;—large corporations can become inflexible and suffer when the market changes.

• Difficulty of termination — Difficult to end a corporation

• Possible conflict with stockholders and board of directors — Can occur if stockholders elect a board that disagrees with management. Entrepreneurs can find themselves kicked out of the company they founded

  • i.e.— Steve Jobs

B corp

Can individuals incorporate?

Yes

Individuals who incorporate don’t typically issue stocks to outsiders. Their advantages are in the limited liability and potential tax benefits.

NOTE: You aren’t required to file for incorporation through a lawyer.

States also charge a fee for incorporating;—can range from 45 to 725 dollars

• Takes approx. 30 dayas

What is the process of incorporating?

Articles of incorporation are usually filed with the secretary of state’s office. Articles contain the following:

• Corporation’s name

• Names of people who incorporated it

• its purposes

• duration

• number of shares that can be issued, voting rights, and any other rights shareholders can have

• corporations minimum capital

• address of the corporation’s office

• the name and address of the person responsible for the corporation’s legal service

• the names and addresses of the first directors

• any public information the incorporators wish to include

• obtain a federal tax ID and apply using a SS-4 form from the IRS

Bylaws — Describe how the firm is to be operated from a legal and managerial point of view

• how, when, and where shareholders’ and directors’ meetings are held, and how long directors are to serve

• director’s authority

• duties and responsibilities of officers, and the length of their service

• how stock is issued

• other matters, including employment contracts

What is a S Corp?

An S corp, or nonprofit corporation looks like a corporation but is taxed like sole proprietorships and partnerships;—S corps have shareholders, directors, and employees, and the benefit of limited liability, but their profits are taxed only as the personal income of the shareholders (avoiding double taxation of C corps)

• Companies must qualify to become an S corp

  • — 1. Have no more than 100 shareholders (family counts as 1 shareholder)

  • — 2. Shareholders that are individuals or estates, and who (as individuals) are citizens or permanent residents of the US.

  • — 3. Have only one class stock

  • — 4. Derive no more than 25% of income from passive sources (rent, royalties, interest)

NOTE: If an S corp loses its status, it cannot be an S corp for at least 5 years

What is a LLC?

Limited liability companies (LLCs) are similar to S corps, but without the special requirements.

What are the advantages of an LLC??

• Limited liability

• Choice of taxation — LLCs can choose to be taxed as partnerships or as corporations

• Flexible ownership rules — LLCs do not have to comply with ownership restrictions like S corps do. Owners can be a person, partnership, or corporation.

• Flexible distribution of profits and losses — Members agree on percentage to be distributed

• Operating flexibility — LLCs have to submit articles of organizations, but they are NOT required to keep minutes, file written resolutions, or hold annual meetings.

  • LLCs also submit a written operating agreement similar to a partnership agreement

What are some disadvantages of an LLC?

• No stock — LLC ownership is nontransferable;—needs approval

• Fewer incentives — LLCs can’t deduct the cost of fringe benefits for members owning 2% or more of the company

• Taxes — Must pay self-employment taxes on their profits

• Paperwork — More paperwork than proprietorships, but less than corporations

Merger

The result of two firms forming one company

Acquisition

One company’s purchase of the property and obligations of another company

Vertical merger

The joining of two companies involved in different stages of related businesses

• Ensures a reliable supply of an ingredient and ensures consistency in quality of overall products

Horizontal merger

The joining of two firms in the same industry

• Allows companies to diversify or expand their product

Conglomerate merger

The joining of firms in completely unrelated industries

• Usually to diversify business operations and investments

What must mergers between large competitors prove to the FTC?

That the combined company does NOT limit competition unfairly

What is a LBO?

A leveraged buyout is an attempt by employees, management, or a group of investors to purchase an organization primarily through borrowing

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.

franchise

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

What are the advantages of a franchise?

franchises offer products and services that are reliable, convenient, and competitively priced.

• management and marketing assistance — new franchise locations have the help of the franchise when starting up;—like have a team of full-time consultants helping you out when you need them

• personal ownership — you enjoy most of the same benefits sole proprietors do.

  • just have to follow the rules and regulations of the franchise

• nationally recognized name — you reap the marketing benefits of having a nationally recognized name

• financial advice and assistance — access to advice and assistance from experts in the area

• lower failure rate

What are some disadvantages of franchises?

• large start-up costs — have to pay a fee for the rights to the franchise

  • can be $2,300 or $1.8 million

• shared profit — franchisers often demand a large share of the profits or a royalty

• management regulation — assistance can sometimes become orders, directives, and limitations, which can put a burden on its owerns

• coattail effects — the negative actions of 1 location can ruin the reputation of the franchise at other locations

  • i.e. — lettuce contamination at taco bell

• restrictions on selling — difficult to sell the business since you don’t technically own it, many restrictions coupled with reselling

• fraudulent franchisors — most franchises are small companies that aren’t as reliable

What other franchises exist??

• home-based franchises

• e-commerce

what is a 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.

• don’t have to pay the same taxes corporations have to pay