Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Forms of Business Ownership CHAPTER 5

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Choosing a Form of Ownership There is no one “best” form of ownership. There is no one “best” form of ownership. The best form of ownership depends on an entrepreneur’s particular situation. The best form of ownership depends on an entrepreneur’s particular situation. Key: Understanding the characteristics of each form of ownership and how well they match an entrepreneur’s business and personal circumstances. Key: Understanding the characteristics of each form of ownership and how well they match an entrepreneur’s business and personal circumstances.

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Factors Affecting the Choice Tax considerations Tax considerations Liability exposure Liability exposure Start-up and future capital requirements Start-up and future capital requirements Control Control Managerial ability Managerial ability Business goals Business goals Management succession plans Management succession plans Cost of formation Cost of formation

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Major Forms of Ownership Sole Proprietorship Sole Proprietorship Partnership Partnership Corporation Corporation S Corporation S Corporation Limited Liability Company Limited Liability Company Joint Venture Joint Venture

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership FIGURE 5.1 (A) Forms of Business Ownership – Percentage of Business

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership FIGURE 5.1 (B) Forms of Business Ownership - Percentage of Sales

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership FIGURE 5.1 (C) Forms of Business Ownership - Percentage of Profits

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Advantages of the Sole Proprietorship Simple to create Simple to create Least costly form to begin Least costly form to begin Profit incentive Profit incentive Total decision making authority Total decision making authority No special legal restrictions No special legal restrictions Easy to discontinue Easy to discontinue

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Disadvantages of the Sole Proprietorship Unlimited personal liability Unlimited personal liability

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Liability Features of the Basic Forms of Ownership Sole Proprietorship Claims of Sole Proprietor’s Creditors Sole Proprietor’s Personal Assets

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Disadvantages of the Sole Proprietorship Unlimited personal liability Unlimited personal liability Limited skills and capabilities Limited skills and capabilities Feelings of isolation Feelings of isolation Limited access to capital Limited access to capital Lack of continuity of the business Lack of continuity of the business

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Partnership An association of two or more people who co-own a business for the purpose of making a profit. An association of two or more people who co-own a business for the purpose of making a profit. Always wise to create a partnership agreement. Always wise to create a partnership agreement. The best partnerships are built on trust and respect. The best partnerships are built on trust and respect.

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Advantages of the Partnership Easy to establish Easy to establish Complementary skills of partners Complementary skills of partners Division of profits Division of profits Larger pool of capital Larger pool of capital Ability to attract limited partners Ability to attract limited partners

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Types of Partners General partners General partners Take an active role in managing a business. Take an active role in managing a business. Have unlimited liability for the partnership’s debts. Have unlimited liability for the partnership’s debts. Every partnership must have at least one general partner. Every partnership must have at least one general partner. Limited partners Limited partners Cannot participate in the day-to-day management of a company. Cannot participate in the day-to-day management of a company. Have limited liability for the partnership’s debts. Have limited liability for the partnership’s debts.

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Advantages of the Partnership Easy to establish Easy to establish Complementary skills of partners Complementary skills of partners Division of profits Division of profits Larger pool of capital Larger pool of capital Ability to attract limited partners Ability to attract limited partners Minimal government regulation Minimal government regulation Flexibility Flexibility Taxation Taxation

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Disadvantages of the Partnership Unlimited liability of at least one partner Unlimited liability of at least one partner

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Liability Features of the Basic Forms of Ownership Partnership Claims of Partnership’s Creditors Partnership’s Assets GeneralPartner’sPersonalAssetsGeneralPartner’sPersonalAssetsGeneralPartner’sPersonalAssetsGeneralPartner’sPersonalAssets

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Disadvantages of the Partnership Unlimited liability of at least one partner Unlimited liability of at least one partner Capital accumulation Capital accumulation Difficulty in disposing of partnership interest without dissolving the partnership Difficulty in disposing of partnership interest without dissolving the partnership Lack of continuity Lack of continuity Potential for personality and authority conflicts Potential for personality and authority conflicts Partners bound by law of agency Partners bound by law of agency

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Limited Partnership A partnership composed of at least one general partner and one or more limited partners. A partnership composed of at least one general partner and one or more limited partners. A general partner in this partnership is treated exactly as in a general partnership. A general partner in this partnership is treated exactly as in a general partnership. A limited partner has limited liability and is treated as an investor in the business. A limited partner has limited liability and is treated as an investor in the business.

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Corporation A separate legal entity from its owners. A separate legal entity from its owners. Types of corporations: Types of corporations: Domestic – a corporation doing business in the state in which it is incorporated. Domestic – a corporation doing business in the state in which it is incorporated. Foreign – a corporation doing business in a state other than the state in which it is incorporated. Foreign – a corporation doing business in a state other than the state in which it is incorporated. Alien – a corporation formed in another country but doing business in the United States. Alien – a corporation formed in another country but doing business in the United States.

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Corporation Types of corporations: Publicly held – a corporation that has a large number of shareholders and whose stock usually is traded on one of the large stock exchanges. Publicly held – a corporation that has a large number of shareholders and whose stock usually is traded on one of the large stock exchanges. Closely held – a corporation in which shares are controlled by a relatively small number of people, often family members, relatives, or friends. Closely held – a corporation in which shares are controlled by a relatively small number of people, often family members, relatives, or friends.

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Advantages of the Corporation Limited liability of stockholders Limited liability of stockholders

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Liability Features of the Basic Forms of Ownership Corporation Claims of Corporation’s Creditors Corporation’s Assets Shareholder’s Personal Assets Shareholder’s Personal Assets Shareholder’s Personal Assets Shareholder’s Personal Assets barrier

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Advantages of the Corporation Limited liability of stockholders Limited liability of stockholders Ability to attract capital Ability to attract capital Ability to continue indefinitely Ability to continue indefinitely Transferable ownership Transferable ownership

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Disadvantages of the Corporation Cost and time of incorporation process Cost and time of incorporation process Double taxation Double taxation Potential for diminished managerial incentives Potential for diminished managerial incentives Legal requirements and regulatory “red tape” Legal requirements and regulatory “red tape” Potential loss of control by founder(s) Potential loss of control by founder(s)

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership S Corporation No different from any other corporation from a legal perspective. No different from any other corporation from a legal perspective. An S corporation is taxed like a partnership, passing all of its profits (or losses) through to individual shareholders. An S corporation is taxed like a partnership, passing all of its profits (or losses) through to individual shareholders. To elect “S” status, all shareholders must consent, and the corporation must file with the IRS within the first 75 days of its tax year. To elect “S” status, all shareholders must consent, and the corporation must file with the IRS within the first 75 days of its tax year.

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Liability Features of the Basic Forms of Ownership S-Corporation Claims of S-Corporation’s Creditors S-Corporation’s Assets Shareholder’s Personal Assets Shareholder’s Personal Assets Shareholder’s Personal Assets Shareholder’s Personal Assets barrier

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Limited Liability Company (LLC) Resembles an S Corporation but is not subject to the same restrictions. Resembles an S Corporation but is not subject to the same restrictions. Two documents required: Two documents required: Articles of organization Articles of organization Operating agreement Operating agreement

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Limited Liability Company (LLC)  An LLC cannot have more than two of these four corporate characteristics: 1. Limited liability 2. Continuity of life 3. Free transferability of interest 4. Centralized management

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Liability Features of the Basic Forms of Ownership Limited Liability Company - LLC Claims of LLC’s Creditors LLC’s Assets Member’s Personal Assets Member’s Personal Assets Member’s Personal Assets Member’s Personal Assets barrier

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership The Professional Corporation  Designed for professions – lawyers, doctors, dentists, accountants and other professionals  Created in the same manner as a corporation  Identified by the abbreviations:  P.C. – Professional Corporation  P.A. – Professional Association  S.C. – Service Corporation

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership The Joint Venture Much like a partnership, but it:  Is formed for a specific purpose  Has a beginning and an end

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership Conclusion  The “right” choice of the form of ownership is unique to every entrepreneur and their business.  Each form has advantages and disadvantages.  The entrepreneur must be thoughtful and strategic about this important decision.

Copyright © 2011 Pearson Education, Inc. Publishing as Prentice Hall Ch, 5: Forms of Business Ownership All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of the publisher. Printed in the United States of America.