Financing Enterprise Chapter_1_4_

Forms of Business Ownership

Chapter Overview

Learning Objectives

1. Understand sole proprietorships, including their six advantages and disadvantages.

2. Learn about partnerships and their six advantages and three disadvantages.

3. Understand corporations, focusing on their four advantages and six disadvantages.

4. Learn about corporate governance and the three groups that ensure good governance.

5. Explore mergers and acquisitions as strategies for growth and their associated advantages and risks.

6. Define strategic alliances and joint ventures, understanding why companies might choose these over mergers or acquisitions.

Introduction

Choosing a business ownership form is a crucial step when starting a business. This decision can be complicated and will significantly affect owners, employees, and customers. It is important to consider long-term goals and how much risk one is willing to take. As businesses grow and change, ownership structures may also need adjustments.

Forms of Business Ownership

The three main types of business ownership include:

1. Sole Trader (Sole Proprietorship)

2. Partnership

3. Corporation

Summary Table of Business Ownership Forms

1. Sole Trader

• Control: One owner has complete control.

• Profits and Taxation: Profits and losses are taxed as personal income.

• Liability Exposure: The owner has unlimited personal liability for business debts.

• Ease of Establishment: Simple to set up with few legal requirements.

2. Partnerships

• cProfits and Taxation: Profits are divided among partners and taxed as personal income.

• Liability Exposure: General partners have unlimited liability; limited partners are only liable for their investment.

• Ease of Establishment: Similar to sole traders but requires a partnership agreement.

3. Corporation

• Control: Ownership is divided among multiple shareholders; management is separate from ownership.

• Profits and Taxation: Profits are taxed at corporate rates, and dividends are taxed for shareholders.

• Liability Exposure: Shareholder liability is limited to their investment.

• Ease of Establishment: More complex and costly to establish than sole traders.

Sole Traders

A sole trader is a business owned by one individual, commonly found in farms, retail stores, and various small service sectors.

Advantages of Sole Traders

1. Simplicity: Minimal paperwork needed.

2. Single Layer of Taxation: Profits treated as personal income.

3. Privacy: Few reporting obligations beyond tax filings.

4. Flexibility and Control: Owners can make decisions independently.

5. Fewer Limitations: Owners retain all profits.

6. Personal Satisfaction: Fulfillment from being one’s own boss.

Disadvantages of Sole Traders

1. Financial Liability: Unlimited personal liability for business debts.

2. Demands on the Owner: Can be stressful and isolating.

3. Limited Expertise: Owner may lack skills in critical business areas.

4. Resource Limitations: Hard to access funding.

5. No Employee Benefits: Miss out on benefits offered by larger firms.

6. Finite Lifespan: Business ends if the owner passes away.

Partnerships

Partnerships involve two or more individuals pooling together their resources but are not incorporated.

Types of Partnerships

• General Partnership: All partners share decision-making and liability.

• Limited Partnership: Some partners manage while others limit their liability to their investment.

Advantages of Partnerships

1. Simplicity: Establishment is easy.

2. Single Layer of Taxation: Profits taxed as personal income.

3. More Resources: Shared funds and expertise.

4. Cost Sharing: Sharing operational costs reduces individual burdens.

5. Broader Skill Base: Multiple partners provide diverse expertise.

Disadvantages of Partnerships

1. Unlimited Liability: Similar risks as sole traders in general partnerships.

2. Potential for Conflict: More partners can lead to disagreements.

3. Limited Life: Partnerships can end if a partner exits or dies.

The Partnership Agreement

A good partnership agreement outlines roles, profit-sharing, and decision-making, helping to maximize advantages and minimize disadvantages.

Corporations

Corporations are legal entities separate from their owners, owned by shareholders.

Types of Corporations

• Private Corporations: Limited to around 50 shareholders, not publicly traded.

• Public Corporations: Shares sold publicly and traded on stock exchanges.

Advantages of Corporations

1. Ability to Raise Capital: Can sell shares and bonds.

2. Liquidity: Shares are easily transferable in public markets.

3. Longevity: Corporations can continue beyond the life of their founders.

4. Limited Liability: Shareholders are only at risk for their investment.

Disadvantages of Corporations

1. Cost and Complexity: More expensive to set up.

2. Reporting Requirements: Must disclose detailed financial information.

3. Managerial Demands: Executives spend much time on external communications.

4. Possible Loss of Control: Shareholders can influence management through voting.

5. Double Taxation: Profits taxed and then dividends taxed again.

Types of Corporations (cont.)

• Public Companies Limited by Shares: Liability limited to share price.

• Public Companies Limited by Guarantee: Often not-for-profit entities.

• Unlimited Public Companies: Shareholders may face unlimited liability.

• No Liability Companies: Limited mainly to certain industries.

Corporate Governance

Corporate governance involves policies ensuring ethical company conduct. Shareholders elect a board responsible for governance.

Shareholders and Corporate Governance

Shareholders typically vote on important company decisions during annual meetings.

Board of Directors

Elected by shareholders, the board selects executives and guides the corporation's direction.

Corporate Officers

Top executives manage the corporation, including roles like CEO, CFO, and COO.

Mergers and Acquisitions

• Merger: A combination of two companies into one.

• Acquisition: One company gains control over another.

Advantages of Mergers and Acquisitions

1. Increases buying power through combined resources.

2. Enhances revenue via cross-selling products.

3. Expands market share through product combination.

4. Gains new expertise from acquired firms.

5. Improvements possible through overhauling management.

6. Reduces costs by eliminating unnecessary overlap.

Disadvantages of Mergers and Acquisitions

1. Complex financing processes.

2. Difficult decision-making after a merger.

3. Need to align marketing strategies.

4. Challenges in integrating different systems.

5. Potential layoffs and job changes causing disruptions.

6. Merging corporate cultures can lead to conflict.

Hostile Takeovers

An acquisition made without management’s consent, which can happen through direct offers to shareholders or proxy fights. Companies may use various defenses to protect against such takeovers.

Strategic Alliances and Joint Ventures

• Strategic Alliance: Long-term partnerships for joint product development.

• Joint Venture: A legally formed partnership for shared business objectives.