ENTR 452 Chapter 9: The Organizational Plan/ Legal Forms of Organization

DEVELOPING THE MANAGEMENT TEAM Investors demand that the management team not operate the business as a part-time venture. It is assumed that the management team is prepared to operate the business full time and at a modest salary. An attempt to draw a large salary out of the new venture may be perceived as a lack of commitment to the business.

FACTORS TO CONSIDER WHEN CHOOSING A LEGAL FORM Tax considerations Liability exposure Startup and future capital requirements Control Management ability Business goals Management succession plans Cost of formation Good Summary in Chapter 9

SOLE PROPRIETORSHIP Most common form of business (over 70% of all businesses) Easy to set up/Easy to discontinue Total control Personal tax rate – Taxes reported on personal tax filing Personally liable for any damage/injury (unlimited) Limited access to capital

PARTNERSHIP Similar to a proprietorship except there is more than one owner (easy to set up/ends when one partner leaves) Should develop a partnership agreement (should file with an attorney, or with the state if possible) The Uniform Partnership Act (UPA) sets the rules and obligations – not complete, just basic rules General Partnership does NOT limit liability for all owners (unlimited liability for all general partners)

ADVANTAGES OF PARTNERSHIPS Easy to Establish Complementary Skills Division of Profits (no restrictions) Larger Pool of Capital (Shared Risk) Ability to Attract Limited Partners Little Government Regulation Flexibility Taxation

DISADVANTAGES OF PARTNERSHIPS Unlimited liability for at least one partner Raising capital can be difficult Difficulty in selling out of the business Potential for personality and authority conflicts

LIMITED AND LIMITED LIABILITY PARTNERSHIPS Allows a company to take on ‘limited’ partners (reduced or no liability) Limited partners take a part of the earnings but do not (and cannot) manage the company. Have at least one general partner whose liability is unlimited. States now recognize LLPs with no general partners Legal or accounting firms most often. There is a management (general) partner(s) who runs the company and takes on all of the personal risk, and employees/investors (limited partners) who work or put up money.

CORPORATIONS Separates the business from the individual by creating a new legal entity. (Cannot use corporate money for personal use). Generate most sales (86% of all business sales) and net income (66% of all profits) of all U.S. businesses. Technically shareholders (owners) are no longer liable for debts; however, most banks will require personal collateral for small businesses. Know the difference between domestic, foreign, and alien corporations.

BENEFITS OF CORPORATIONS Limited liability Easier for succession planning (death) than proprietorships or partnerships Easier to raise capital – can issue and sell corporate shares easier than partnership shares Set up relatively easily (not as difficult as most books indicate)

C vs. S CORPORATIONS C corporations are primarily for larger companies with many shareholders. S corporations cannot have more than 100 shareholders, must be domestic. Nonresident aliens cannot be shareholders in an S corporation. C corporations are “double taxed” -- They must pay tax at the corporate level (about 35%) and then again at the individual level (15%-39.6%).

C vs. S CORPORATIONS S corporation profits are passed directly to the owners and reported on personal taxes. C corporations can have various classes of stock (preferred, common, etc.) S corporations can only have one type of stock and must be domestic (U.S. Corporation)

LIMITED LIABILITY COMPANY Similar to “S” Corporation (similar fee and must turn in annual report) Taxes passed on like “S” Corp No limit on the number of “members” (no shareholders) Laws differ on LLC’s from state to state (should consider the term limits – usually 30 years) Still a new form of organization

BUILDING THE MANAGEMENT TEAM AND A SUCCESSFUL ORGANIZATION CULTURE A management team must be able to accomplish three functions: Execute the business plan. Identify fundamental changes in the business as they occur. Make adjustments to the plan based on changes in the environment and market that will maintain profitability.

BUILDING THE MANAGEMENT TEAM AND A SUCCESSFUL ORGANIZATION CULTURE Important factors in establishing an effective team: Desired culture must match business strategy. Employees must be motivated/rewarded for good work. Entrepreneur should be adaptable/flexible to change. Spend extra time in the hiring process. Core values and appropriate tools must be provided for employees to effectively complete their jobs.

THE ROLE OF A BOARD OF DIRECTORS Reviewing operating and capital budgets. Developing longer-term strategic plans for growth. Supporting day-to-day activities. Resolving conflicts among owners or shareholders. Ensuring the proper use of assets. Developing a network of information sources for the firm.

THE BOARD OF ADVISORS Selection process like a board of directors, but they serve only in an advisory capacity. No legal status; not subject to Sarbanes-Oxley Act. Likely to meet less frequently. Useful in a family business. Advisors may be compensated on a per-meeting basis or with stock or stock options.