Exam #2 (Chapters 4-6)- Introduction to Business
Sole Proprietorship
Definition: A business owned and operated by one individual; it is the most common form of business organization in the US.
Focus: Typically on services rather than manufacturing, often employing fewer than 50 people.
Demographics: Nearly three-quarters of US companies have a large percentage of women owners.
Credit and Funding: Historically, sole proprietorships have had less access to credit (often due to tax and finance contexts), though local experiences can vary (e.g., the Pennsylvania startup scene demonstrates this variation).
Market Share: Sole proprietorships account for the largest percentage of businesses, well over 70\%
*, surpassing partnerships, C corporations, and other forms.
Taxation: Profits are taxed as the owner's personal income and are reported on their individual tax return.
Advantages:- Easy and low-cost to form.
High level of secrecy/privacy if operations are kept private.
The owner keeps all profits and maintains flexible, autonomous control.
Generally subject to minimal government regulation.
Easy to dissolve if the owner decides to cease business operations.
Disadvantages:- Unlimited Liability: The owner is personally liable for all business debts and obligations, potentially risking personal assets like their home.
Funding Limitations: Capital typically originates from the owner's personal funds or close associates (family/friends).
Managerial Burden: The owner is responsible for all tasks; there is no separate management layer.
Hiring Challenges: The inability to offer competitive wages and extensive benefits can limit the ability to attract strong employees.
Tax Consideration: Profits are taxed at individual income rates, which depending on the income level, can be higher than corporate tax rates.
The business may cease to exist if the owner exits.
Operations Notes:- The sole proprietor serves as both manager and decision-maker; all other stakeholders depend on the owner's leadership.
Operational flexibility can be high, but the business's success is directly tied to the owner's skills and resources.
Partnership
Definition: An association of two or more persons who carry on as co-owners of a business for profit, as defined by the Uniform Partnership Act.
Forms:- General Partnership: All partners are actively involved in management and bear unlimited liability.
Limited Partnership: Requires at least one general partner with unlimited liability and active management, and at least one limited partner whose liability is restricted to their investment. Limited partners typically do not participate in day-to-day management.
Why Choose a Partnership: Offers greater management capabilities, broader skill sets, shared resources, and potentially better access to capital compared to a sole proprietorship.
Advantages:- Profits are shared among partners according to the partnership agreement.
Access to complementary skills and resources, leading to stronger overall management potential.
Easier access to capital than a sole proprietorship, as there are two or more individuals to approach lenders.
Philosophical/Ethical Approach: Emphasizes trust, ethics, and compliance, requiring effective communication and transparency to maintain stakeholder trust.
With two or more owners, there is potential for improved work-life balance and delegation of responsibilities.
Disadvantages:- Unlimited Liability: Partners can be jointly and severally liable for the debts of the partnership.
Changes in partnership necessitate new or updated partnership agreements and legal filings, making evolving arrangements complex.
Selling or exiting a partnership can be difficult, as the transfer of ownership is not as straightforward as with a corporation.
Profit distributions may be uneven if partners contribute differently (e.g., one partner handles marketing/sales/finance while another focuses on product development).
Taxation: Partnerships themselves do not pay income tax; profits pass through to partners and are taxed on their personal returns. The IRS reviews partnership returns in conjunction with individual returns and the terms of the partnership agreement (e.g., 50/50 versus 60/40 splits).
Taxation Specifics: Each partner's share of profits is taxable to that partner under their individual tax rate:
\text{Tax}{i} = s{i} \times t{\text{indiv}} where s{i} is the partner's share of profits and t_{\text{indiv}} is the individual income tax rate.
Key Concepts:- Articles of Partnership: Legal documents that outline the roles, responsibilities, profit sharing, and procedures for the admission or removal of partners.
Management and liability structures must be clearly defined to mitigate potential disputes and address unlimited liability.
Corporation
Definition: A legal entity created by the state, where assets and liabilities are separate from those of its owners (stockholders).
Key Properties:- Can own property, enter into contracts, and sue or be sued.
Stockholders own shares of the company.
Possesses a distinct legal existence from its owners.
Capable of perpetual existence and easy transfer of ownership via stock sales.
Stockholders elect a board of directors to oversee management; the board then hires executives (e.g., CEO).
Forms and Classifications:- Domestic Corporation: Conducts business within the state in which it was chartered.
Foreign Corporation: Conducts business outside the state in which it was chartered.
Alien Corporation: Conducts business outside the nation in which it was incorporated.
Private Corporation: Stock is closely held by insiders, not publicly traded, and typically not required to disclose financial information publicly.
Public Corporation: Stock is available for public trading, may be listed on stock exchanges, and is subject to public reporting requirements.
Quasi-Public Corporation: Owned and operated by government bodies (federal, state, or local).
Non-Profit Corporation: Focuses on providing services rather than generating profit; has a quasi-public nature.
Stock and Dividends:- Common Stock: Owners typically have voting rights, but dividends are not guaranteed.
Preferred Stock: Generally has no voting rights but is given priority for dividend payments.
Dividends are paid from profits at the discretion of the corporation and are not guaranteed.
Advantages:- Limited Liability: Shareholders are not personally liable for corporate debts beyond their investment in the company.
Perpetual Life: The company's existence continues regardless of changes in ownership or management.
Easier Access to Funding: Corporations can access large pools of capital, issue stock, and leverage relationships with suppliers and lenders.
Easy transfer of ownership through stock sales.
Disadvantages:- Double Taxation: Profits are taxed at the corporate level, and then dividends paid to shareholders are taxed again at the individual level (unless structured as an S Corporation or LLC with different tax treatment).
Formation and Ongoing Compliance Costs: Involves federal, state, and local filing requirements, along with continuous regulatory and reporting obligations.
Potential Agency Problems: Misalignment of interests can occur between management and shareholders (e.g., management reinvesting profits versus shareholders desiring dividend payments).
Special Corporate Forms:- S Corporation: Taxed as a pass-through entity (like a partnership) but maintains corporate status. Limited to 100 shareholders, all of whom must be U.S. residents or citizens. Profits pass through to shareholders for tax purposes.
Limited Liability Company (LLC): Offers limited liability with flexible tax treatment. By default, it's taxed as a partnership but can elect corporate taxation. It has fewer restrictions on members than an S corporation.
Partially Public/Private Considerations: Public corporations often have publicly traded stock, while private corporations have stock held by a small group of insiders and are not required to disclose public financial information.
S Corporation
Definition: A form of corporation taxed as if it were a partnership; it allows profits and losses to pass through to shareholders for tax purposes, thereby avoiding double taxation at the corporate level.
Eligibility and Limitations:- Limited to up to 100 shareholders.
All shareholders must be residents or citizens of the United States.
All shareholders must be in the same country.
Often utilized by professional service firms (e.g., doctors, lawyers, CPAs).
Tax Treatment: Profits pass through to shareholders for personal tax treatment; there is no corporate-level tax, unlike a C corporation.
Practical Notes: Combines corporate structure with pass-through tax advantages, but requires careful compliance with eligibility rules.
Limited Liability Company (LLC)
Definition: A form of business ownership that provides limited liability and pass-through taxation, blending features of partnerships and corporations.
Tax Treatment: By default, it is taxed as a partnership (pass-through taxation), but it can elect to be taxed as a corporation if that is more advantageous.
Characteristics: Fewer restrictions on members than an S corporation; suitable for professionals (engineers, doctors, lawyers) and other small business owners seeking limited liability with flexible management.
Cooperatives (Co-ops)
Definition: Organizations composed of individuals or small businesses that band together to reap the benefits of a larger entity.
Examples: Pocono Produce, Ace Hardware, Florida orange juice producers, Ocean Spray.
Rationale: Members jointly own and control the cooperative to achieve economies of scale, shared services, or enhanced purchasing power.
Mergers, Acquisitions, and Related Trends
Mergers:- Definition: The combination of two companies (often corporations) to form a new entity.
Types:- Horizontal Merger: Companies in the same industry combine (e.g., Lockheed and Martin; American Airlines and US Airways; United and Continental).
Vertical Merger: A company acquires a business in a different stage of the same supply chain (e.g., McDonald's acquiring a potato farm).
Conglomerate Merger: Unrelated businesses combine (e.g., ShopRite acquiring Hertz).
Acquisitions:- Definition: One company purchases another, typically by acquiring a majority of its stock.
Notable Trend: Consolidation frequently occurs through acquisitions by large firms (e.g., Dow acquiring DuPont).
Corporate Raiders and Tender Offers:- Tender Offer: An offer to purchase some or all of a target company's stock at a premium to the market price, often initiating a hostile takeover.
Corporate Raider: An entity that seeks to acquire control of a company, sometimes facing resistance from current management.
Anti-Takeover Measures (to deter hostile takeovers):- Poison Pill: Allows existing shareholders to buy more shares at a discount to deter an unwanted bidder.
Shark Repellent: Requires a large majority (e.g., 80\%) of stakeholders to approve any takeover.
White Knight: Involves seeking a more friendly company to acquire the target instead of the hostile bidder.
Leveraged Buyout (LBO):- Definition: An acquisition funded largely through borrowed funds, typically secured by the assets of the target company.
Example: Dell went private via an LBO.
Notable Mergers and Value References:- AOL-Time Warner: around 165 billion.
Dow-DuPont: around 130 billion.
Trends and Implications: Leads to concentration of ownership and scale economies, increased competition, and strategic realignment through mergers and acquisitions.
Practical and Ethical Implications
The choice of business structure significantly impacts liability, taxation, funding opportunities, and control rights for owners.
Partnerships demand high levels of trust, transparency, and clear agreements to prevent disputes.
Corporations provide liability protection and growth potential but require meticulous governance to manage conflicts of interest and ensure regulatory compliance.
S corporations and LLCs offer alternative structures that combine tax efficiency with liability protection, each with its own eligibility rules and compliance requirements.
Mergers, acquisitions, and anti-takeover strategies influence corporate strategy, leadership, and workforce stability. Ethical considerations include fair treatment of stakeholders and transparency during transitions.
Key Definitions and Concepts (Recap)
Articles of Partnership: A legal document detailing the agreement among partners.
Partnership Act: The statutory framework that governs partnerships.
Corporate Charter: A state-issued legal document that formally establishes a corporation.
Board of Directors: Elected by stockholders to oversee management; legally liable for mismanagement under laws such as the Sarbanes-Oxley Act; typically a mix of insiders and outsiders (often around 50/50).
Domestic/Foreign/Alien Corporation: Classifications based on where the company operates in relation to where it was chartered.
Private vs. Public Corporation: Differ in privacy and disclosure requirements; public corporations issue stock on public markets and are subject to stricter reporting.
Initial Public Offering (IPO): The first sale of stock to the public.
Dividend: A distribution of profits to stockholders; preferred stock may be given preference.
Mutual Benefits of Co-ops: Achieving scale economies and shared services among members.
Quick Formula References (Tax Contexts)
Sole Proprietorship (SP): The owner's tax liability on business profit is calculated as:
\text{Tax}{\text{SP}} = \text{Profit}{\text{SP}} \times t_{\text{indiv}}
Partnership: For each partner i
, their tax liability on their share of profits is:
\text{Tax}{i} = s{i} \times t{\text{indiv}} where s{i} is the partner's share of profits.
C Corporation: Profits are taxed twice: first at the corporate level, and then dividends are taxed at the shareholder level.- Corporate tax:
\text{Tax}{\text{corp}} = \text{Profit}{\text{corp}} \times t_{\text{corp}}
Tax on distributed dividends (D):
\text{Tax}{\text{dividend}} = D \times t{\text{indiv}}
S Corporation / LLC (pass-through): Profits pass through directly to owners and are taxed at individual income rates, similar to partnerships.
The Entrepreneurial Spirit: Building and Sustaining Businesses
The Essence of Entrepreneurship
Definition: Entrepreneurship is defined as the willingness to accept the risk of starting and running a business.
Vital Role: Entrepreneurs play a crucial role in the U.S. and global economies by introducing new ideas, technologies, and innovative approaches.
Distinguishing Factor: Success in entrepreneurship is attributed to individuals with an idea and the courage to take the necessary risks to bring that idea to market.
Example of Persistence: Hershey's founder notably failed with candy companies in Chicago and New York before achieving success, illustrating the importance of perseverance.
Notable Entrepreneurs and Their Journeys
E.I. DuPont: Founded his company in Wilmington, Delaware, in 1802
.
George Eastman (Kodak): Borrowed 3,000
in 1880
to establish the Kodak company.
Henry Ford: Showed great perseverance in developing automobiles despite widespread skepticism.
Jeff Bezos (Amazon): Revolutionized retail by adapting the Sears catalog model and transitioning it entirely online.
Age and Entrepreneurship
It's Never Too Early: Many individuals start businesses while still in school (e.g., Jack Dell).- Advantages for Young Entrepreneurs:- Potential for long-term financial returns.
- A keen ability to identify unmet market needs.
- Fewer financial burdens such as mortgages or children.
- Ability to subsist on limited funds and endure long working hours.
- Fewer personal disruptions, allowing for concentrated effort on new ideas.
- Greater adaptability and a higher tolerance for risk.
<!-- -->It's Never Too Late: More Americans over 65 are starting businesses at a higher rate than those aged 24 to 34 .- Advantages for Older Entrepreneurs:- Possess greater experience.
- Often have more financial resources to fund startups.
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Why People Take the Entrepreneurial Risk (Four Major Reasons)
Seeing an Opportunity: Identifying an unmet need that customers are seeking but unable to find.
The Profit Motive: Enjoying the financial rewards and profits that result from success within a free-market system.
Independence: The desire to be one's own boss and not report to anyone.
The Challenge: The drive to undertake a venture and bring an idea to successful fruition.
Attributes and Qualities of a Successful Entrepreneur
Self-Directed: Capable of guiding one's own efforts and motivation.
Self-Nurturing: Able to maintain enthusiasm and motivation through challenges.
Action-Oriented: Proactively takes steps towards goals, avoiding procrastination.
High Energy: Possesses the stamina to sustain the demanding work required.
Tolerance for Uncertainty: Accepts that not all answers will be immediately known, and challenges will inevitably arise in new ventures.
Belief in Oneself: Maintains confidence even when others express doubt.
Steps to Cultivate an Entrepreneurial Idea
Find Unmet Needs: Identify problems for which you can provide solutions to customers.
Seek Mentorship: Find experienced individuals who can offer guidance and help fill skill gaps.
Stay Focused: Concentrate on specific tasks and priorities to avoid divergence.
Conduct Research and Test Products: Validate your ideas and offerings through thorough investigation and testing.
Always Move Forward: Act quickly, as others may have similar ideas; being first to market often confers a significant advantage.
Be Willing to Sacrifice: Prioritize your business idea over other personal activities.
Learn from Failures: Acknowledge that not all ideas will lead to opportunities, but failures provide valuable lessons (as exemplified by Hershey's experience).
Personal Introspection and Opportunity Identification
Ask Key Questions: Engage in self-reflection and critical questioning to identify viable opportunities.
Small Business Funding and SBA Loan Programs
Standard 7(a) loans: Loans made by a financial institution that the government will repay if the borrower stops making payments. The maximum individual loan guarantee is capped at 5 million.
Microloans: Amounts ranging from 100 to 50,000 to people such as single mothers and public housing tenants.
SBA Express: A program that accelerates the SBA response time to 36 hours. Loan limit 350,000.
Export Express: Loans made to small businesses wishing to export. The maximum guaranteed loan amount is 500,000.
International Trade Loans: Long-term financing to businesses that are expanding because of growing export sales or that have been adversely affected by imports and need to modernize to meet foreign competition. Loan limit 5 million.
Community Adjustment and Investment Program (CAIP): Loans to businesses to create new, sustainable jobs or to preserve existing jobs in eligible communities that have lost jobs due to changing trade patterns with Mexico and Canada following the adoption of NAFTA.
504 certified development company (CDC) loans: Loans for purchasing major fixed assets, such as land and buildings for businesses in eligible communities, typically rural communities or urban areas needing revitalization. The maximum guaranteed loan amount is 5 million for meeting the job creation criteria or a community development goal. The business must create or retain one job for every 65,000 (100,000 for small manufacturers) provided by the SBA.
CAPLine loans: Loans to help small businesses meet their short-term and cyclical working capital needs. The maximum CAPLine loan is 5 million.
Introduction to Management
Business Management 101: Core Concepts and Practices
Definition of Management: It is a process used to accomplish an organization's goals.
Evolution of Managers:- Historically, managers were perceived as 'bosses' who simply directed employees.
Today, managers must:- Gain trust and secure employee buy-in for the organization's vision.
Provide guidance, coaching, motivation, and training.
Take corrective action when necessary.
Modern Manager Role: They function more as facilitators and collaborators, rather than just supervisors.
Essential Managerial Skills: Effective managers possess strong skills in communication, teamwork, planning, organizing, motivating, and leadership.
The Four Pillars of Management (POLE Framework)
Management achieves organizational goals by utilizing organizational resources (people, equipment, information) through these four critical functions:
1. Planning
Definition: Anticipating future trends and determining the optimal strategies and tactics to achieve an organization's goals.
Key Activities:- Identifying required resources, including the necessary number and skill sets of personnel.
Establishing clear action items and standards to monitor progress effectively.
2. Organizing
Definition: Designing the structure of the organization and creating conditions and systems where everyone and everything works cohesively to achieve goals.
Key Activities:- Recruiting, training, and developing personnel, including preparing them for upward mobility.
Ensuring that the right person (a qualified and competent individual) is assigned to the right job with the necessary resources and authority to achieve defined goals.