Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited. PowerPoint Presentation by Thomas M c Kaig, Ryerson University Selecting the Management Team and Form of Organization 9

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited. 9-2 Looking Ahead After studying this chapter, you should be able to: 1. Describe the characteristics and value of a strong management team. 2.Identify the common legal forms of organization used by small businesses and describe the characteristics of each. 3.Identify factors to consider in choosing among the primary legal forms of organization. 4.Describe the effective use of boards of directors and advisory councils. 5.Explain how different forms of organization are taxed by the federal government.

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited. 9-3 The Management Team Management team:  Consists of managers and other key persons who give a company its general direction Characteristics of a Strong Management Team  Capable of securing the resources needed to make business a success  Reassures investors about their investment and the continuity of business  Diversity of talent makes the team stronger than an individual entrepreneur

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited. 9-4 Complementary Management Team Building a Complementary Management team:  Competencies required depends on type of business Combination of education and experience Requires achieving a balance of skills and competence in functional areas  Designing a management structure that defines relationships and responsibilities Outside professional support:  Supplements the skills of a management team  Active board of directors can counsel and guide

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited. 9-5 Legal Forms of Organization In launching a new business, an entrepreneur must choose a form of legal organization. The most common options are:  Sole proprietorship  Partnership  Corporation

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited. 9-6 Forms of Legal Organization Common Forms of Legal Organization Federal Corporation Sole Proprietorship Partnership Corporation Provincial Corporation Limited Partnership General Partnership Figure 9-1

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited. 9-7 The Sole Proprietorship Option Sole Proprietorship  A business owned by one person  Disadvantages Unlimited personal liability No tax free benefits Death/incapacity of owner terminates business  Advantages Ownership of the company name and assets may be transferred. There is generally no registration or filing fee. Freedom from interference

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited. 9-8 The Partnership Option Partnership  A legal entity formed by two or more co-owners to carry on a business for profit. Partner Qualifications  Required: of legal age to contract  Desired: Honest, healthy, capable, and compatible Questions about Partnership Formation  What is our business concept?  How are we going to structure ownership?  Why do we need each other?  How do our lifestyles differ?

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited. 9-9 The Limited Partnership Limited Partnership  This form of ownership consists of at least one general partner and one or more limited partners  General partner a partner in a limited partnership who has unlimited personal liability  Limited partner a partner in a limited partnership who is not active in its management and has limited personal liability

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited Sharing Workload Sharing Financial Burden Sharing Emotional Burden Procuring Executive Talent Companionship Interpersonal Conflicts Dilution of Equity Dissatisfaction with Partner Absence of One Clear Leader Frustration of Not Calling Own Shots AdvantagesDisadvantages The Advantages and Disadvantages of Partnerships

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited Partnership Terms Articles of Partnership  A document that states explicitly the rights and duties of partners. Agency Power  The ability of any one partner to legally bind (e.g., borrow money) the other partners.

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited Rights and Duties of Partners in a Partnership Agreement Date and formation of partnership Names and addresses of partners Statement of fact of partnership Statement of business Name and location of the business Amount invested by each partner Sharing ratio for profits & losses Partner’s right if any re: withdrawal of funds for personal use Provision for accounting records and their accessibility to partners Specific duties of each partner Provision for dissolution and sharing of the net assets Restraint on partner's assumption of special obligations, such as endorsing a note of another Provision for protection of surviving partners decedent’s estate, and so forth in the even of a partner’s death

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited The Corporation Option Corporation  A business organization that exists as a legal entity and provides limited liability for its owners. Legal Entity  A business organization that is recognized by the law as having a separate legal existence

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited Articles of Association Restrictions if any on share transfers Names and addresses of incorporator and first year’s directors Name of company Restrictions, if any, on business the corporation may carry on Location of principal office Classes, voting privileges and, maximum number of shares the corporation is allowed to issue

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited Rights and Legal Status of Shareholders Share Certificate  A document specifying the number of shares owned by a shareholder Pre-emptive Right  The right of shareholders to buy new shares before they are offered to the public. Legal Status  Ownership provides control over the firm.  Ownership limits liability to investment in the firm.  Ownership can be transferred without affecting the firm’s operations

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited Limited Liability of Shareholders For most shareholders, their limited liability is a major advantage of the corporate form of organization. Their financial liability is limited to the amount of money they invest in the business.

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited Death or Withdrawal of Shareholders Unlike a partnership interest, ownership in a corporation is readily transferable. Exchange of shares is sufficient to convey an ownership interest to a different individual. Shares of large corporations are exchanged constantly without noticeable effect on the operation of the business. For a small firm, a change of owners can involve numerous complications

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited Issues in Choosing an Organizational Form Factors that affect the choice of the firm’s structure:  Initial organizational costs and requirements  Limited versus unlimited liability for the owners  Continuity of business  Transferability of ownership  Management control  Attractiveness for raising equity capital  Income taxes

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited Comparison of Legal Forms of Organization Sole proprietorship General partnership Corporation Form of organization preferred Minimum requirements; generally no registration or filing fee Minimum requirements; generally no registration or filing fee; written partnership agreement not legally requiredbut strongly suggested Most expensive and greatest requirements; filing fees; compliance with provincial regulations for corporations Proprietorship or general partnership Unlimited liability Liability limited to investment in company Corporation Limited to proprietor’s personal capital Limited to partner’s ability and desire to contribute capital Usually the most attractive form for raising capital Corporation Form of Organization Initial Organizational Requirements and Costs Liability of Owners Attractiveness for Raising Capital Table 9-1

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited The Board of Directors and Duties Board of Directors  The governing body of a corporation, elected by the shareholders  Inside directors Board members who work for the firm  Outside director Board members who do not work for the firm Duties  Elect the firm’s officers (top management)  Approve management’s plans and policies  Review performance and declare dividends

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited The Board of Directors and Advisory Councils Contributions of Board of Directors  Bring knowledge and experience Review policy decisions Provide general direction Monitor the firm’s ethical behaviour Mediate and resolve disputes among top management Alternative: Advisory Council  Provides advice but does not have the fiduciary responsibility for the direction of the firm.

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited Federal Income Taxes Sole Proprietorship  Self-employed persons are taxed on their business incomes at tax rates set for individuals. Partnership  The partnership does not pay taxes; allocated shares of income from partnership are taxed as personal income for each of the partners. Corporation  As a separate legal entity, it reports its income and pays any taxes related to these profits.

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited Federal Income Taxes and Sole Proprietorship Sole Proprietorship Example of taxes due from a married couple with $150,000 in income from the business that they operate as self- employed persons, Tax Rate 0to43,850 15% 43,851 to105,950 28% 105,951 to161,450 31% 161,451 to288,350 36% Overto288,350 40% Range of Taxable Income IncomeTax RateTaxes First43,850 15%6, Next62,100 28%17, Next44,050 31%13, Total150,000 37,621.00

Chapter 9 Copyright © 2003 by Nelson, a division of Thomson Canada Limited Federal Income Taxes and Corporations Corporations Example of taxes due from the profits of a corporation. Any profits of the corporation that are distributed to the shareholders are taxed again as personal income. Range of Taxable IncomeTax Rate $0to$50,00015% $50,001to$75,00025% $75,001to$100,00034% $100,001to$335,00039% Income x Tax Rate=Taxes First$50,00015%$7,500 Next$25,00025%$6,250 Next$25,00034%$8,500 Remaining$50,00039%$19,500 Total$150,000$41,750