Study Notes on Business Structures

Three Major Forms of Business Structures

Introduction to Business Structures

  • The transcript starts with the context of business structure and ownership, highlighting the examples of Ben Cohen and Jerry Greenfield, the founders of Ben & Jerry's ice cream company.

Key Topics and Questions in Choosing Business Structure

  • When starting a business, one must consider various factors:

    • Cost of Setup: Do you want to minimize starting costs and avoid complex regulations?

    • Control: How much control over the business do you desire? What about profit sharing responsibilities?

    • Tax Considerations: Do you want to avoid special taxes?

    • Business Longevity: Is it important that the business survives beyond your involvement?

    • Financing: What are your financing needs and plans?

    • Liability: How much personal liability are you willing to accept?

Overview of Business Structures

  • The section introduces three main types of business ownership: Sole Proprietorship, Partnership, and Company (or Corporation).

  • Each has distinct advantages and disadvantages that relate to the key considerations outlined above.

Sole Proprietorship

Definition

  • A sole proprietorship is a business owned and operated by a single individual.

Characteristics

  • Control: Owner has complete control over decision-making.

  • Liability: Unlimited personal liability, meaning the owner is personally responsible for business debts.

  • Income: Business income is reported on the owner’s personal tax return.

  • Continuity: The business ceases to exist upon the owner's death.

  • Financing: Reliant on the owner's personal finances for startup and operational expenses.

Advantages

  • Ease of Formation: Low costs and minimal paperwork required to start and operate.

  • Complete Control: Owner retains full decision-making power.

Disadvantages

  • Unlimited Liability: Personal assets are at risk in case of business debt or litigation.

  • Resource Constraints: Difficulties in accessing finance, as it depends solely on personal credit and resources.

Partnership

Definition

  • A partnership involves two or more individuals who share ownership and the operation of a business.

Characteristics

  • Partners: Two or more individuals contribute to the business, thus sharing profits and responsibilities.

  • Liability: Each partner has unlimited liability, responsible for their own actions and those of other partners.

  • Agreement: A partnership agreement can help clarify contributions, responsibilities, profit-sharing, and conditions for dissolving the partnership.

Advantages

  • Resource Pooling: Enhanced access to capital and a wider range of skills.

  • Shared Responsibility: Partners share management duties and decision-making processes.

Disadvantages

  • Conflict Potential: Disputes may arise among partners, which can affect business operations.

  • Unlimited Liability: Similar to sole proprietorships, partners can be personally liable for business debts.

Company (Corporation)

Definition

  • A company is a legal entity separate from its owners, capable of entering contracts, borrowing, and being liable.

Characteristics

  • Ownership: Owned by shareholders.

  • Liability: Limited liability for shareholders, who are only accountable for the amount invested.

  • Continuity: The company can continue despite changes in ownership or the death of shareholders.

  • Financing: Can raise funds by issuing shares, making it easier to access capital for growth.

Advantages

  • Limited Liability: Protects shareholders' personal assets from the company's debts.

  • Access to Capital: Ability to issue shares to fund expansion.

  • Continuity: The existence of the company is not affected by individual shareholders’ circumstances.

Disadvantages

  • Costly to Establish: Higher start-up costs and ongoing regulatory compliance.

  • Double Taxation: Corporations often face taxation on profits and shareholders also pays tax on dividends.

  • Example: Ben Cohen and Jerry Greenfield opted to transition from being partners to a corporation to facilitate expansion and raise necessary capital for growth.

Other Business Ownership Types

  • Besides the three main types of business structures, business owners may choose alternative forms such as:

    • Association (both unincorporated and incorporated)

    • Cooperative

    • Franchise

    • Joint Venture

    • Not-For-Profit (NFP)

    • Trust

Summary Table of Business Structures

  • Sole Proprietorship: 1 Owner, Unlimited Liability, Low Costs, Control rests with Owner.

  • Partnership: 2 or More Owners, Unlimited Joint Liability, Low to Moderate Costs, Shared Decision-Making.

  • Company: Many Owners, Limited Liability, High Costs, Decisions made by Board of Directors.

This concludes the exhaustively captured information on the three major forms of business structures, crucial for a profound understanding of accounting and business management principles.