Choosing a Form of Business Ownership Chapter Four Choosing a Form of Business Ownership

Learning Objectives Describe the advantages and disadvantages of sole proprietorships. Explain the different types of partners and the importance of partnership agreements. Describe the advantages and disadvantages of partnerships. Summarize how a corporation is formed. Describe the advantages and disadvantages of a corporation. 4 | 2

Learning Objectives Examine special types of corporations, including S-corporations, limited-liability companies, government-owned corporations, and not-for-profit corporations. Discuss the purpose of a cooperative, joint venture, and syndicate. Explain how growth from within and growth through mergers can enable a business to expand.

Sole Proprietorships A business that is owned (and usually operated) by one person The simplest form of business ownership and the easiest to start Many large businesses began as a small struggling sole proprietorships The most widespread form of business ownership

Reasons People Go into Business for Themselves Source: Timothy S. Hatten, Small Business Management: Entrepreneurship and Beyond, 3rd ed. Copyright © 2006 by Houghton Mifflin Company. Used by permission. Data from A Small Business Primer.

Relative Percentages of Sole Proprietorships, Partnerships, and Corporations in the U.S. Sole proprietorships are most common in retailing, agriculture, and the service industries Source: U.S. Bureau of the Census, Statistical Abstract of the United States, Washington, D.C., 2008, p. 487 (www.census.gov).

Advantages and Disadvantages of Sole Proprietorships Ease of start-up and closure Pride of ownership Retention of all profits Flexibility of being your own boss No special taxes DISADVANTAGES Unlimited liability A legal concept that holds a business owner personally responsible for all the debts of the business Lack of continuity Lack of money Limited management skills Difficulty in hiring employees

Class Exercise You want to own and manage your own business. To help you evaluate your chances of success, answer these questions. Do you have any experience in a business like the one you want to start? Have you worked for someone else as a supervisor or manager? Have you saved any money? How much? Do you know how much money you will need to get your business started? Do you know how much credit you can get from your suppliers and bankers? Do you know the good and bad points about going it alone, having a partner, and incorporating your business? What do you know about your potential customer?

Partnerships A voluntary association of two or more persons to act as co-owners of business for profit Less common form of ownership than sole proprietorship or corporation No legal limit on the maximum number of partners; most have only 2 Large accounting, law, and advertising partnerships have multiple partners Partnerships are usually a pooling of special talents or the result of a sole proprietor taking on a partner

Types of Partners General partner A person who assumes full or shared responsibility for operating a business General partnership: a business co-owned by two or more general partners who are liable for everything the business does Limited partner A person who contribute capital to a business but has no management responsibility or liability for losses beyond the amount he or she invested in the partnership Limited partnership: a business co-owned by one or more general partners who manage the business and limited partners who invest money in it Master limited partnership (MLP): a business partnership that is owned and managed like a corporation but taxed like a partnership

The Partnership Agreement Articles of partnership An agreement listing and explaining the terms of the partnership Agreement should state Who will make final decisions What each partner’s duties will be How much each partner will invest How much profit or loss each partner receives or is responsible for How the partnership can be dissolved

Advantages and Disadvantages of Partnerships Unlimited liability Management disagreements Lack of continuity Frozen investment ADVANTAGES Ease of start-up Availability of capital and credit Personal interest Combined business skills and knowledge Retention of profits No special taxes

Corporations An artificial person created by law with most of the legal rights of a real person, including the rights to start and operate a business, to buy or sell property, to borrow money, to sue or be sued, and to enter into binding contracts There are 5.6 million corporations in the U.S. They comprise only 20% of all businesses, but they account for 83.8 % of sales revenues

The Seven Largest U.S. Industrial Corporations, Ranked by Sales Revenue Source: Fortune website at www.fortune.com, accessed September 12, 2008.

Corporate Ownership Corporate ownership Stock Stockholder The shares of ownership of a corporation Stockholder A person who owns a corporation’s stock Closed corporation A corporation whose stock is owned by relatively few people and is not sold to the general public Open corporation A corporation whose stock is bought and sold on security exchanges and can be purchased by any individual

Forming a Corporation Incorporation The process of forming a corporation Most experts recommend consulting a lawyer

When Legal Help Is Required

Forming a Corporation (cont’d) Where to incorporate Businesses can incorporate in any state they choose Some states offer fewer restrictions, lower taxes, and other benefits to attract new firms Domestic corporation A corporation in the state in which it is incorporated Foreign corporation A corporation in any state in which it does business except the one it which it is incorporated Alien corporation A corporation chartered by a foreign government and conducting business in the U.S.

Forming a Corporation (cont’d) Articles of incorporation A contract between the corporation and the state in which the state recognizes the formation of the artificial person that is the corporation Articles of incorporation includes Firm’s name and address Incorporators’ names and addresses Purpose of the corporation Maximum amount of stock and types of stock to be issued Rights and privileges of stockholders Length of time the corporation is to exist

Forming a Corporation (cont’d) Stockholders’ rights Common stock Stock owned by individuals or firms who may vote on corporate matters but whose claims on profit and assets are subordinate to the claims of others Preferred stock Stock owned by individuals or firms who usually do not have voting rights but whose claims on dividends are paid before those of common-stock holders Dividend A distribution of earnings to the stockholders of a corporation Proxy A legal form listing issues to be decided at a stockholders’ meeting and enabling stockholders to transfer their voting rights to some other individual or individuals

Forming a Corporation (cont’d) Organizational meeting The last step in forming a corporation The incorporators and original stockholders meet to elect their first board of directors Board members are directly responsible to stockholders for how they operate the firm

Corporate Structure Board of directors The top governing body of a corporation, the members of which are elected by the stockholders Responsible for setting corporate goals, developing strategic plans to meet those goals, and the firm’s overall operation Outside directors: experienced managers or entrepreneurs from outside the corporation who have specific talents Inside directors: top managers from within the corporation

Corporate Structure (cont’d) Corporate officers The chairman of the board, president, executive vice presidents, corporate secretary, treasurer, and any other top executive appointed by the board Implement the chosen strategy and direct the work of the corporation, periodically reporting results to the board and stockholders

Hierarchy of Corporate Structure Stockholders exercise a great deal of influence through their right to elect the board of directors

Advantages and Disadvantages of Corporations Limited liability Each owner’s financial liability is limited to the amount of money that he or she has paid for the corporation’s stock Ease of raising capital Ease of transfer of ownership Perpetual life Specialized management DISADVANTAGES Difficulty and expense of formation Government regulation and increased paperwork Conflict within the corporation Double taxation Lack of secrecy

Advantages and Disadvantages

Special Types of Business Ownership S-corporations A corporation that is taxed as though it were a partnership (income is taxed only as the personal income of stockholders) Advantages Avoids double taxation of a corporation Retains the corporation’s legal benefit of limited liability S-corporation criteria No more than 100 stockholders allowed Stockholders must be individuals, estates, or exempt organizations There can be only one class of outstanding stock The firm must be a domestic corporation There can be no nonresident-alien stockholders All stockholders must agree to the decision to form an S-corporation

Special Types of Business Ownership (cont’d) Limited-liability company (LLC) A form of business ownership that provides limited-liability protection and is taxed like a partnership Advantages Avoids double taxation of a corporation Retains the corporation’s legal benefit of limited liability Provides more management flexibility Difference between LLC and S-corporation LLCs not restricted to 100 stockholders LLCs have fewer restrictions on who can be a stockholder

Advantages and Disadvantages

Special Types of Business Ownership (cont’d) Government-owned corporations A corporation owned and operated by a local, state, or federal government Purpose To ensure that a public service is available Examples Tennessee Valley Authority (TVA), the National Aeronautics and Space Administration (NASA), and the Federal Deposit Insurance Corporation (FDIC)

Special Types of Business Ownership (cont’d) Not-for-profit corporations Corporations organized to provide social, educational, religious, or other services, rather than to earn a profit Charities, museums, private schools, and colleges are organized as not-for-profits primarily to ensure limited liability

Cooperatives, Joint Ventures, Syndicates Associations of individuals or firms whose purpose is to perform some business function for its members Members benefit from the efficiencies of the cooperatives’ activities, such as reducing unit costs by making bulk purchases and coordinating services such as transportation, processing, and marketing products

Cooperatives, Joint Ventures, Syndicates (cont’d) Agreements between two or more groups to form a business entity in order to achieve a specific goal or to operate for a specific period of time Example: Wal-Mart and India’s Bharti Enterprises Syndicates Temporary associations of individuals or firms organized to perform a specific task that requires a large amount of capital Most commonly used to underwrite large insurance policies, loans, and investments

Corporate Growth Growth from within Introducing new products Entering new markets Growth through mergers and acquisitions Merger: the purchase of one corporation by another; essentially the same as an acquisition Hostile takeover: a situation in which the management and board of directors of the firm targeted for acquisition disapprove of the merger Tender offer: an offer to purchase the stock of a firm targeted for acquisition at a price just high enough to tempt stockholders to sell their shares Proxy fight: a technique used to gather enough stockholder votes to control the targeted company

Corporate Growth (cont’d) Current merger trends Takeover advocates say Companies that are taken over are made more profitable and productive Proceeds from the sale of non-core subsidiaries help pay off debt or enhance the company Takeover opponents say Takeover threats force managers to spend time on defense rather than vital business activities The only people who benefit from takeovers are investment bankers, brokerage firms, and takeover artists

Corporate Growth (cont’d) Current merger trends Mergers during the first part of the 21st century will be the result of cash-rich companies looking to enhance their position in the marketplace There will be more mergers involving companies or investors from other countries Future mergers and acquisitions will be driven by solid business logic and the desire to compete internationally There will be more leveraged buyouts A purchase arrangement that allows a firm’s managers and employees or a group of investors to purchase the company

Biggest Mergers Target Acquirer Value Date Mannesmann ($ billions) Date Mannesmann Vodafone Airtouch $172.2 2/2000 Time Warner America Online $112.1 1/2001 Warner-Lambert Pfizer $111.8 6/2000 Mobil Exxon $85.6 12/1999 SmithKline Glaxo Wellcome $79.6 12/2000 Ameritech SBC Communications $76.2 10/1999 GTE Bell Atlantic $74.9 Aventis SA Sanofi-Synthelabo $71.3 6/2004 Amoco British Petroleum $64.3 12/1998 Source: http://www.msnbc.msn.com/id/6880681/ Updated 7:24 PM.PT, Sun, February 15, 2009.

Reasons for Merger/Acquisition Scale—gain revenue, channels, etc. Geographic reach—access new markets Customers—new lists Products—new products for existing customers Segments—new vertical markets Channels—new ways of delivering same products and services Employees—new talent quickly Technology—adding key capabilities Source: “Preparing for the Merger/Acquisition Decision—How to Position Your Company in a Consolidating Collaboration & Conferencing Marketplace,” Wainhouse Research, 2004, http://www.wainhouse.com/files/papers/wr-prep4mna.pdf#search=%22%22merger%22%20%2B%20acquisition%20%2B%20trends%22

Debate Issue: Should the Government Restrict Corporate Merger Activity? YES Takeovers and mergers do nothing to increase the productivity of the firm. Existing managers must spend time and effort to fend off hostile mergers—time that could be invested in product development. The only people that benefit from corporate takeovers and mergers are the corporate raiders. NO Firms that are taken over are more productive because unneeded assets are sold. A takeover shakes up existing management and makes managers more productive. Less productive managers may be fired. Corporate raiders have a basic right to take over a firm if they can acquire enough stock.

Chapter Quiz In the United States, the form of business ownership that generates the largest amount of sales revenues is the sole proprietorship. partnership. corporation. limited liability company. S-corporation. Which of the following is not an advantage of a sole proprietorship? Flexibility No special taxes Pride of ownership Retention of all profits Unlimited liability

Chapter Quiz (cont’d) A business co-owned by one or more general partners who manage the business and limited partners who invest money into it is called a not-for-profit partnership. limited partnership. general partnership. limited liability company. S-partnership.

Chapter Quiz (cont’d) A corporation that received its corporate charter in California and doing business in Oregon is called a(n) ____________corporation in Oregon. alien domestic visiting international foreign A ____________ is a merger between firms that make and sell similar products or services in similar industries. horizontal merger vertical merger conglomerate merger hostile takeover tender offer

Answers to Chapter Quiz In the United States, the form of business ownership that generates the largest amount of sales revenues is the sole proprietorship. partnership. corporation. (Correct) limited liability company. S-corporation. Which of the following is not an advantage of a sole proprietorship? Flexibility No special taxes Pride of ownership Retention of all profits Unlimited liability (Correct)

Answers to Chapter Quiz (cont’d) A business co-owned by one or more general partners who manage the business and limited partners who invest money into it is called a not-for-profit partnership. limited partnership. (Correct) general partnership. Limited liability company. S-partnership.

Answers to Chapter Quiz (cont’d) A corporation that received its corporate charter in California and doing business in Oregon is called a(n) ____________corporation in Oregon. alien domestic visiting international foreign (Correct) A ____________ is a merger between firms that make and sell similar products or services in similar industries. horizontal merger (Correct) vertical merger conglomerate merger hostile takeover tender offer