Chapter 7 Business Ownership

3 Basic Types of Business Ownership

Characteristics: compare & contrast Formation Source of funding Liability Tax implications Management and control Transferability

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).

Compare and Contrast

Sole Proprietorship

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

Sole Proprietorship Advantages Disadvantages Formation Easy establishment Low start up cost Source of funding Limited financial resources Liability Unlimited Liability Tax implications No corporate income taxes Income tax deduction of business losses Management and control Self control of all operations retention of all profit Limited management resources and skills Transferability Limited life (lack of continuity) Others Freedom, pride pressure

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.

Questions to answer before you start your own business: 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?

Partnership

A business that is owned and run by two or more people who share responsibilities, profits, and unlimited liability A voluntary association of two or more persons to carry on a business as co-workers 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

Partnership Advantages Disadvantages Formation Source of funding Easy establishment Source of funding Combined financial resources Easier capital and credit Liability Unlimited Liability Tax implications No corporate income taxes Management and control Combined managerial knowledge and skills, shared responsibilities Transferability Extended life Potential lack of continuity; difficult ownership transfer Others Retention of profits Possible interpersonal conflicts and management disagreement

Types of Partners and Partnership 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 Should include 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

Voluntary Partnership (Articles of Partnership) Names of partners Name of partnership Nature of business Time frame of operation Capital contribution Managerial power Rights and duties Accounting procedures P/L sharing Salaries Dissolution Property distribution Disability issues Insurance coverage Sale of interest Divorce of one partners Indemnity agreements Non-competition agreement Leaves of absence

Limited Partnership at least one general partner Has to have agreement, with “Limited Partnership” in business name Promise to contribute in writing Liability limited to investment Certificate for limited partner status Not involve in management Personal name not appear in business name

Corporation

A business that exists separately from its owners and is permitted to sell stocks An artificial being, (a legal person), invisible, intangible, and existing only in contemplation of the law. 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

Corporation Advantages Disadvantages Formation Source of funding Difficulty / complex / high cost starting Source of funding Greater Financial Capital(stock & loans) Liability Liability Limited to the amount paid for stocks Tax implications Double taxation Management and control Specialized Management Internal Conflicts Transferability Increased Liquidity Unlimited Life Hostile takeover (tender offer) Others Government regulations and paperwork

Corporate Ownership Corporate ownership Types of corporation Stock The shares of ownership of a corporation Stockholder A person who owns a corporation’s stock Types of corporation 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

Incorporation: the process of formation Where to register: law, tax, employees, incentives Documents: Articles of Incorporation Name of corporation Names and addresses of all incorporators Share structure: common vs. preferred; vote; rights Statutory agent Incorporator: natural person, corporation, (limited) partnership, association

Where to incorporate In US, 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 in which it is incorporated Alien corporation A corporation chartered by a foreign government and conducting business in the U.S.

Document: 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

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 With voting rights No fixed dividend rate No right to declare dividend Right to share of assets at dissolution 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 Priority in payment of dividends Some dividends at fixed rate, some guaranteed (cumulative preferred) Priority in assets distribution at dissolution Dividend: A distribution of earnings to the stockholders

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 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

Bylaws: after formation Operational rules: Define the authority of each elected officer Prescribe procedures for meetings Set terms of officers and directors

Corporate Governance Structure Shareholders: owners Preferred stocks: first to be paid; not voting right Common stocks: last to be paid; with voting right Board of Directors: Elected by shareholders Oversees corporate management: policies Corporate Officers: CEO, President, VPs, (directors) Hired by the board Day-to-day operations

Corporate Governance Structure Shareholders: Electing directors Voting on critical issues Delegating votes: Proxy: temporarily transfer voting rights to others Pooling agreements: a contract to vote for the same thing Voting trust: turn shares to a trustee, with a certificate, the trustee votes according to agreements

Corporate Governance Structure Board of directors: strategic planning and policy making 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 Executive Committee: management (3 board members) Audit Committee: watch dog (independent outside directors)

Corporate Governance Structure Corporate Officers chairman of the board president；executive vice presidents corporate secretary, treasurer, other top executives Implement the chosen strategy and direct the work of the corporation, periodically reporting results to the board and stockholders

Corporate Governance Structure Hannas Natural Gas http://www.mbi.com.cn/Html/About-jigou1.asp?ID=100

Sources of funding: Short-term financing: Debt financing: bond bank loans, credit lines higher interest rates; shorter payback periods Debt financing: bond long-term promissory notes fixed interest rate, tax deductible rating

Special Types of Corporations S corporation vs. C corporation (for tax purpose, with limitations) LLC: Limited Liability Corporation Government-owned corporation Not-for-profit corporation

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

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

LLC Advantages disadvantages Formation Difficulty/complexity starting Source of funding Greater Financial Capital Liability Limited Liability Tax implications Double taxation Management and control Specialized Management Transferability Increased Liquidity Unlimited Life

LLC Formation: articles of organization, with LLC in business name Funding: member contribution as in partnership Liability: limited to contribution Tax: flow through (individual tax only) Management and Control: collective, delegate, hire Transferability: transferee becomes a member with majority approval Dissolution and termination: death, withdrawal, expulsion of a member, unanimous consent

C, SC, LLC

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) the Federal Deposit Insurance Corporation (FDIC)

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 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

Strategic Alliance Two or more organizations collaborate on a project for mutual gain Expand Market Share Access Technology Diversity Offerings Share Best Practices

Joint Ventures 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 Attain Specific Goals Share Strengths Spread Cost Minimize Risk 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

ESOP and Institutional Ownership Employee Stock Ownership Plan: Employee owns a substantial share of the corporation Employee trusts Institutional Ownership: Mutual funds Pension funds

Corporate Growth through Joining Companies Mergers / Consolidations : two firms combine to create a new company Acquisition: one firm buys another out right. The other firm becomes a part of the firm and only one firm’s name is retained, and it assumes automatically all assets and all liabilities of the other.  increase product line  expand operations  globalize

Business Combination Procedures Board resolution: Notice to shareholders: Shareholder approval: Merger / consolidation: all shareholders have right to vote *short-term merger: between a subsidiary and a parent that owns at least 90% of its stock *appraisal rights: written objection before voting, right to sell shares to the corporation for fair value *freeze-out: use merger as a way to buy back minority shares at low price

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

Acquisitions Advantages： Disadvantages： Economies of Scale Efficiencies Synergies Disadvantages： High-Risk Corporate Debt Leveraged buyouts: a large fraction of the purchase price is debt financed (below investment grade); the shares no longer traded in the open market Management Distractions Culture Clashes

Growth by Merger

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

Pros and Cons of Merger opponents: advocates: 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 opponents: 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

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.

Hostile Takeover Not solicited and approved by the target’s management (proxy fight; tender offer) a situation in which the management and board of directors of the firm targeted for acquisition disapprove of the merger Types Tender offer: direct offer to shareholders 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: seek stockholder support at annual meeting a technique used to gather enough stockholder votes to control the targeted company

Defenses against Hostile Takeover Poison pill: shareholder rights to buy future shares at bargain price Golden parachute: generous payoff to management going out Shark repellent: changes in company charter - staggered board, supermajority; fair price White knight:

Ownership Changes Separating Companies Divestiture: sell a part of the firm’s business operations Focus on core business; Sell unrelated or under-performing Spin-off: sell part of the company to raise capital set it up as a new and independent corporation