Forms of Farm Business Organization Chapter 14: Kay and Edwards

Agenda Life Cycle of the Farm Sole Proprietorships Partnerships Corporations

Life Cycle of the Farm Entry Growth Choosing farming as a career, selecting enterprises, acquiring and organizing resources, and establishing a financial base. Growth Expansion in the size of the business.

Life Cycle of the Farm Cont. Consolidation Debt reduction and increased efficiency are a priority. Exit Attention turns towards reducing risk, increasing liquidity, or transferring property to the next generation. Tax consequences of liquidation or transfer must be taken into consideration.

Common Forms of Business Organization Sole Proprietorship Partnership Corporation

Sole Proprietorship A form of business organization in which one operator or family owns the resources and provides the management. The owner owns and manages the business, assumes all the risk, and receives all the profits and losses. Established by starting to operate a business. There are no real constraints on the operation.

Sole Proprietorship Cont. Advantages Simplicity and flexibility. Disadvantages The owner is personally liable for any legal difficulties and debts related to the business. Limited by capital available to the single owner. Lack of business continuity.

Sole Proprietorship Cont. Taxes The owner pays income taxes on any business profit at the tax rates in effect for individuals or joint returns. Earned income is subject to self-employment and Medicare taxes.

Partnerships A form of business organization in which more than one operator owns the resources and/or provides management. Two types: General and limited

General Partnerships A partnership in which all partners are general partners; each participates in management and has unlimited financial liability for partnership actions. It is the most common form of ownership. Liabilities of general partners can extend to their personal assets.

Limited Partnerships A form of business in which more than one person has ownership, but some do not participate in management and have liability limited to their investment. Limited partnerships must have at least one general partner, but there can be an unlimited amount of limited partners.

Three Basic Characteristics of Partnerships A sharing of business profits and losses. Shared control of property, with possible shared ownership of some property. Shared management of the business (mainly for general partners).

Partnership Agreements Oral Oral agreements in most states are binding. With no written documentation, problems can arise based on fading memories. Unless otherwise written, the courts and the Uniform Partnership Act assume an equal partnership in every aspect of the business.

Partnership Agreements Written A written agreement should contain the following points: Management Property ownership and contributions Share of profit and losses Records Keeping Taxation Termination Dissolution

Factors Indicating a Legal Partnership If these factors exist between two or more parties, then a legal partnership may be implied: Joint ownership of assets Operation under a firm name A joint bank account A single set of business records Management participation by all parties Sharing of profits and losses

Advantages of a Partnership Easier and cheaper to form than a corporation. Much of the freedom is maintained within a partnership. Less records keeping necessary than a corporation. Could improve accessibility to capital over a sole proprietorship.

Disadvantages of a Partnership There is still the aspect of unlimited liability for each general partner. Poor business continuity. Must share management responsibility with other partners. Dissolution can be difficult. A well written partnership agreement is usually needed.

Taxation of a Partnership A partnership does not pay income taxes directly. It must file a tax return reporting the income and expenses of the partnership. The share of income from the partnership is reported on the partner's individual tax return and taxed at that partner's personal marginal tax rate.

Corporations A form of business organization in which the owners have shares in a separate legal entity that itself can own assets and borrow money. In legal terms it is considered a "person," separate and apart from its owners, managers, and employees. It has most of the basic legal rights and duties of an individual.

Three Groups Within a Corporation Shareholders These are the owners of the corporation. Each shareholder has one vote for each share of stock they own. Shareholders elect a board of directors. Board of Directors This group is responsible to the shareholders for the management of the business. They are elected once a year. This group elects a set of officers to run the business.

Three Groups Within a Corporation Cont. Officers This group runs the day to day operations of the business. This group is accountable to the board of directors. Note: In many small family farms, the shareholder, board of directors, and the officers are all one in the same.

Advantages of a Corporation It provides limited liability for all the shareholders. The most a shareholder can lose is his/her investment. It allows individuals to pool their resources and management. Credit may be easier to come by.

Advantages of a Corporation Cont. Continuity over time; a corporation does not die when an owner dies. There can be income tax advantages through tax rates and tax deductions. It is easier to allocate income among individuals by setting salaries, rents, and dividends.

Disadvantages of a Corporation More costly to form and maintain. Double taxation. Shareholder meetings must be held and reported to the state.