Selecting the Management Team and Form of Business Organization

Corporation Sole Proprietor Partnership

 Initial organizational costs and requirements  Limited versus unlimited liability for the owners  Continuity of business  Transferability of ownership  Management control  Attractiveness for raising new equity capital  Income taxes

 Sole Proprietorship  Partnership  Corporation ◦ Subchapter S Corporation ◦ C-Corporation  Other legal form of Ownership ◦ Limited Liability Company

Sole proprietorships Partnerships Corporations

Four Characteristics:  Single owner.  Bears all responsibility.  Represents 70% of all firms in U.S.  Generate less than 10 percent of all business revenue.

 Advantages: ◦ Easy and inexpensive to create ◦ Least regulated form of ownership ◦ Business pays no taxes. Owner pays personal income taxes which is a lower rate than the corporate tax rate.

 Advantages ◦ Owner is boss ◦ Owner receives all profits ◦ Owner knows employees and customers ◦ Owner can act quickly in making decisions ◦ Owner is free of much red tape

 Disadvantages: ◦ Unlimited liability ◦ Full responsibility for all debts ◦ Owners personal assets are at risk (i.e., home, car, etc.) ◦ Upon death, the business dissolves

Sole Proprietorship Claims of Sole Proprietor’s Creditors Sole Proprietor’s Personal Assets Copyright © 2009 Pearson Education, Inc. Publishing as Prentice Hall

 A business with two or more owners  Partners do not have to share a business equally  How the partnership interests are divided are spelled out in the Partnership Agreement.

 Advantages of Partnerships ◦ Ease of formation ◦ Availability of capital ◦ Diversity of managerial expertise ◦ Flexibility to respond to changing business conditions ◦ Relative freedom from government control  Disadvantages of Partnerships ◦ Unlimited liability for general partners ◦ Potential for conflict between partners ◦ Limited life ◦ Sharing of profits ◦ Difficulty in leaving a partnership Why would a new business venture choose to operate as a partnership, and what downside would the partners face?

 Advantages ◦ Inexpensive and easy to create ◦ Share ideas, abilities, and financial obligations ◦ Owners pay taxes as personal income which is taxed at lower rate.

 Advantages ◦ Skills & abilities pooled ◦ Sources of income increased ◦ Credit position improved ◦ Contribution of goodwill

 Advantages ◦ Increased concern in business management ◦ Less tax burden ◦ Elimination of competition ◦ Operating economies

 Disadvantages ◦ Unlimited financial liability ◦ Disagreement among partners  Personality conflicts ◦ Each partner bound by contracts of others ◦ Partners held liable for each other’s actions

Types of Partners  General partners ◦ Take an active role in managing a business ◦ Have unlimited liability for the partnership’s debts ◦ Every partnership must have at least one general partner  Limited partners ◦ Cannot participate in the day-to-day management of a company ◦ Have limited liability for the partnership’s debts

 Purpose & duration of partnership  Roles, responsibilities, compensation  Contributions  Procedures for adding/removing partners  Buy-out procedures  Dispute resolution  Financial arrangements  Dissolving the partnership  Valuation Source: American Express Small Business Exchange, home3.americanexpress.com/smallbusiness

Corporation : A legal entity with an existence and life separate from its owners, who therefore are not personally liable for its debts; it can own property, enter into contracts, sue and be sued, and operate under terms of its state charter.

 C-Corporation  Subchapter S Corporation ◦ Limited Liability Corporation

1. 1. Select company’s name Write and file Articles of Incorporation paperwork Pay fees and taxes Hold organizational meeting Adopt bylaws, elect directors, pass operating resolutions

Organizational Structure of Corporations Stockholders Directors Officers (Top Management) President Vice Treasurer Secretary President elect

 Registered by the state and operates apart from its owners  A corporation lives-on after the owners die or have sold interest  Ownership is represented by shares of stock, public or private

 Elect members of board of directors who are responsible for establishing general policies of the firm  Elect president and other key officers who run the business  Earn return on investment in two ways  May receive dividends  Stock may increase in value

◦ Stockholders  Own the corporation  Can sell or transfer shares at any time  Entitled to receive profits in the form of dividends ◦ Board of Directors  Elected by stockholders  Govern the firm ◦ Officers  Carry out the goals and policies set by the board ◦ C Corporations, S Corporations & Limited Liability Companies  Major types of corporations

 Privately Held ◦ Ownership is restricted to small group of investors. ◦ Stock is not traded publicly.  L. L. Bean, Polo, Ralph Lauren, Publix.  Publicly Held ◦ Larger corporations. ◦ Stock is traded publicly. ◦ Act of initially issuing stock: “going public.”

Business Economics

 The most common corporate form for large businesses (i.e., Federal Express, Microsoft)  Can create status that may assist in getting loans  Shareholders are owners of the corporation – 75 or more  Required to have an elected Board of Directors to make decisions for the company  Structured to accommodate employee benefits; i.e., pensions, retirement plans, and profit sharing

Advantages  limited liability  easy to get financing  easy to transfer ownership  perpetual life- span  tax deductions  available source of incomeDisadvantages  taxes are higher  double taxation of profits  costly & complex to form (hire attorney)  government restrictions & regulations  record keeping for stockholders complex Corporations

1.S corporations 1. S corporations organized like a corporation, but avoids double taxation of profits by routing income and losses through stockholders 2.Limited liability companies (LLC) 2. Limited liability companies (LLC) offers same limited liability as a corporation, but may be taxed as either a partnership or corporation

 The S corporation – 75 or fewer employees ◦ Taxed as a partnership ◦ Provides lower taxes ◦ Limited liability ◦ Profits are part of individual tax return ◦ Transfer of ownership

 Designed for owners of smaller companies who want the liability protection of a corporation, but want to avoid double taxation ◦ Pass-through Taxation: Profits are taxed once at shareholder’s personal tax rate ◦ Shareholders liable to amount invested  In smaller private corporations, the founders generally hold all–or a majority–of the stock.

Disadvantages  Regulations may vary from state to state which impact taxation and liability  Costly to set up and follow corporate rules  All shareholders must be U.S. citizens  Personal finances separate from corporation finances  Increased banking, accounting, legal costs S – Corporations

 The limited liability company  Acts as a corporation ◦ Pay personal income taxes on business profits  Avoids double taxation ◦ Provides limited liability ◦ Less formal requirements than corporation

Pros  Protection of personal assets  Avoid double- taxation of profits  Flexible management & organization  Good for foreign investorsCons Often required to have a limited life (< 30 years) Not corporations, so can not issue stock Source: The Company Corporation,

1. 1. Cooperatives Joint ventures Franchises

 Formed by people with similar interests, such as customers and suppliers  lower costs  increased economic power  share in profits  Members/owners pay annual fees  Common in: ◦ agriculture ◦ hardware/lumber ◦ grocery

Joint Venture: 2 or more companies form an alliance to pursue a specific project, usually for a specific time period

◦ Business owner does not have to start from scratch ◦ Buys a business concept with a proven product and operating methods ◦ Franchisor provides:  Management training and assistance  Use of a recognized brand name, product, and operating concept  Financial assistance

Franchising: business organization in which a franchisor supplies the product concept to the franchisee, who sells the goods or services

Advantages  increased opportunity to expand (franchisor)  recognized name, product, and operating concept (franchisee)  management training and assistance (franchisee)  financial assistance (franchisee) Disadvantages  loss of control (franchisor)  costs of franchising  restricted operating freedom (franchisee)

◦ Companies use mergers and acquisitions for strategic reasons such as  Growth or diversification of product lines  Increased market share  Economies of scale  Financial restructuring to increase company value to stockholders

Merger: The combination of 2 or more firms to form a new company, which often takes a new corporate identityAcquisition: The purchase of a corporation by another corporation or investment group

Reduced:  costs  overlap in operations  competition Increased:  purchasing power  market share

Horizontal mergers 1. Horizontal mergers ◦ same industry, same stage of production Vertical mergers 2. Vertical mergers ◦ same industry, different stages of production

Types of Mergers Conglomerate mergers 3. Conglomerate mergers ◦ different industries Leveraged buyouts 4. Leveraged buyouts ◦ corporate takeovers with borrowed money

Increases in:  Niche markets  Variety in franchises  Expect more franchised goods & services that ease consumers’ busy lives (Source: Entrepreneur, Jan. 2000, p. 157)  Consolidation through mergers & acquisitions  Mergers across national borders

Types of Businesses One way to classify businesses is to group them by the kind of products they provide: Producing raw goods Processing raw goods

Types of Businesses Manufacturing goods from raw or processed goods Distributing goods Providing services

Producers A producer is a business that gathers raw products in their natural state. Raw goods are materials gathered in their original state from natural resources such as land and water.

Processors Processors change raw materials into more finished products. Processed goods are made from raw goods and may require further processing.

Manufacturers Manufacturers are businesses that make finished products out of processed goods. The finished products need no further processing and are ready for market.

Intermediaries A wholesaler, also known as a distributor, distributes goods.

Intermediaries Wholesalers buy goods from manufacturers in huge quantities and resell them in smaller quantities to their customers, usually other companies.

Intermediaries A retailer purchases goods from a wholesaler and resells them to the consumer, or the final buyer of the goods.

Service Businesses Service businesses provide services rather than goods. Services are the products of a skill or an activity, such as hairstyling and car repair.

Service Businesses Some service businesses meet needs, such as medical clinics and law firms. Some provide conveniences, such as taxi companies and copy shops.