The Organizational Plan Chapter 9 The Organizational Plan McGraw-Hill/Irwin Copyright © 2010 by The McGraw-Hill Companies, Inc. All rights reserved.

Entrepreneur’s Adage #28 “Do well only what matters most; everything else just ok.” - Jordan

Developing the Management Team Investors will typically demand that the management team work full-time at a modest salary. Attempts to draw a large salary out of the new venture may be perceived as a lack of commitment to the business. Investors are “hyper-concerned” with the entrepreneur’s commitment to the venture.

Legal Forms of Business Three basic legal forms of business: Sole Proprietorship - Single owner, unlimited liability, controls all decisions, and receives all profits. Partnership - Two or more individuals having unlimited liability who have pooled resources to own a business. Corporation (C or S) - Most common form of corporation; regulated by statute; treated as a separate legal entity for liability and tax purposes.

Legal Forms of Business (cont.) New forms of business formations: Limited liability company (LLC) Limited liability partnership (LLP) S corporation

Three Forms of Business Formation

Three Forms of Business Formation (cont.)

Three Forms of Business Formation (cont.)

Tax Attributes of Forms of Business Tax Issues for Proprietorship IRS treats business as the individual owner; not regarded as a separate tax entity. All income appears on owner’s return as personal income. Tax advantages: No double tax when profits are distributed to owner. No corporate franchise taxes/fees or penalty for retained earnings accumulations. Tax Issues for Partnership (general) Tax advantages and disadvantages similar to sole proprietorship.

Tax Attributes of Forms of Business (cont.) Tax Issues for Partnership (limited) Has the advantage of limited liability. Treated the same as the LLC for tax purposes. Tax Issues for Corporation (C): Can take many deductions and expenses not available to proprietorship or partnership. Distribution of dividends is taxed twice. Double taxation can be “avoided” if income is distributed to entrepreneur(s) as salary. Salary is taxable to the recipient-stockholder as W-2 income.

Entrepreneur’s Adage #29 “Don’t get depressed when someone else beats you to the punch and launches your business idea before you do. It is going to happen. There’s always yet another idea to work on.” - Jordan

Other Tax Attributes of Various Legal Forms of Business

More Tax Attributes of Various Legal Forms of Business (cont.)

Even More Tax Attributes of Various Legal Forms of Business (cont.)

S Corporation A special type of corporation where profits are distributed to stockholders and taxed as personal income. Many restrictions on corporate characteristics Examples: 100 shareholder limit, shares only transferable to individuals The Small Business Protection Act of 1996 reduced some restrictions. In 2004, Congress responded to criticisms of the restrictions on S corporations as compared to LLCs. Intent was to make the S corporation as advantageous as the LLC. Status of the S corporation must be monitored, maintained and reported at regular intervals – otherwise “S” designation could be lost and fees will apply.

S Corporation (cont.) Advantages of an S Corporation Capital gains or losses are treated as personal income or losses. Limited liability protection. Not subject to a minimum tax. Transfer of stock to low-income-bracket family members Stock may be voting or nonvoting. Cash method of accounting allowed. General Advantage: “Limited Liability of a corporatiob, but taxed as a partnership.”

S Corporation (cont.) Disadvantages of an S Corporation Some restrictions for qualification. Potential tax disadvantages. Most fringe benefits not deductible for shareholders. Must have a calendar year for tax purposes (not true!) Only one class of stock is permitted. Net loss is limited to shareholder’s stock plus loans to business. (“At-risk” rules) No more than 100 shareholders.

The Limited Liability Company A partnership/corporation hybrid (like S Corp). Laws governing its formation differ by state. LLC has members, not stockholders. No shares issued; each member owns an interest as designated by the articles of organization. Liability does not extend beyond member’s capital contribution. Transfer of interest requires unanimous consent. Taxed as a partnership. Standard acceptable term is 30 years; continuity restricted.

The Limited Liability Company (cont.) Advantages of LLC Partners can add their proportionate shares of the LLC liabilities to their partnership interests. Most states do not tax LLCs. (not always true!) One or more (without limit) individuals, corporations, partnerships, trusts, or other entities can form an LLC. Members share income, profit, expense, deduction, loss and credit, and equity of the LLC among themselves.

The Limited Liability Company Versus S Corporation Venture capitalists prefer LLCs as a form of business entity. Mostly due to flexibility in allowing investors to invest. A new regulation allows LLCs to be taxed as a partnership. Founders must elect this option. The S corporation was the most popular choice of organization structure by new ventures and small businesses. Growth rate of S corporations has leveled off as acceptance of LLCs has grown.

Building the Management Team and a Successful Organization Culture Important factors in establishing an effective team: Desired culture must support the business strategy (not just a “big-company” thing) Employees must be motivated and rewarded for good work. Entrepreneur should try different motivational tactics. Spend extra time in the hiring process and involve as many associates as possible.

The Role of a Board of Directors Functions of the board of directors: Review operating and capital budgets. Select Top Management Team (CEO, CFO, CIO, etc.) Develop longer-term strategic plans for growth and expansion. Support day-to-day activities. Resolve conflicts among owners or shareholders. Ensure the proper use of assets (audit committee). Developing a network of information sources for the entrepreneurs. Are usually compensated with stock or money Can be subject to Sarbanes-Oxley rules

The Board of Advisors Serve only in an advisory capacity. No legal status; not subject to regulations stipulated in the Sarbanes-Oxley Act. Likely to meet less frequently. Useful in a family business. Selection process is similar to the process for selecting a board of directors. Advisors may be compensated on a per-meeting basis or with stock or stock options.

Entrepreneur’s Adage #30 “Just because you pay someone to do something, does not mean he/she will actually do it or do it well. This happens even when you pay them well. Use culture to your advantage where possible.” - Jordan