Chapter Five Choosing a Form of Business Ownership

Copyright © Houghton Mifflin Company. All rights reserved Learning Objectives 1.Describe the advantages and disadvantages of sole proprietorships. 2.Explain the different types of partners and the importance of partnership agreements. 3.Describe the advantages and disadvantages of partnerships. 4.Summarize how a corporation is formed. 5.Describe the advantages and disadvantages of a corporation. 6.Discuss the purpose of an S-corporation, limited-liability company, and other special forms of business ownership. 7.Explain how growth from within and growth through mergers can enable a business to expand.

Copyright © Houghton Mifflin Company. All rights reserved Sole Proprietorships 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

Copyright © Houghton Mifflin Company. All rights reserved Reasons People Go Into Business for Themselves Source: Timothy S. Hatten, Small Business Management: Entrepreneurship and Beyond, 2 nd ed. Copyright © 2003 by Houghton Mifflin Company. Used by permission. Data from A Small Business Primer

Copyright © Houghton Mifflin Company. All rights reserved 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 website ( Statistical Abstract of the United States, 121st ed., Washington, D.C., 2001, p. 473.

Copyright © Houghton Mifflin Company. All rights reserved Advantages and Disadvantages of Sole Proprietorships ADVANTAGES –Ease of start-up (and shut down) –Retention of profits –Flexibility –Possible Tax Advantages DISADVANTAGES –Unlimited liability A legal concept that holds a business owner personally responsible for all the debts of the business –Lack of continuity –Lack of money –Limited management skills –Difficulty in hiring employees

Copyright © Houghton Mifflin Company. All rights reserved Class Exercise You want to own and manage your own business. To help you evaluate your chances of success, answer these questions. –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?

Copyright © Houghton Mifflin Company. All rights reserved Partnerships A voluntary association of two or more persons to act as co-owners of business 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

Copyright © Houghton Mifflin Company. All rights reserved Total Sales Receipts of American Businesses Although corporations account for only 20.1% of U.S. businesses, they bring in 87.1% of the sales receipts. Source: U.S. Bureau of the Census website ( Statistical Abstract of the United States, 121st ed., Washington, D.C., 2001, p. 473.

Copyright © Houghton Mifflin Company. All rights reserved Types of Partners 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

Copyright © Houghton Mifflin Company. All rights reserved The Partnership Agreement Articles of Partnership –An agreement listing and explaining the terms of the partnership –Agreement should state 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

Copyright © Houghton Mifflin Company. All rights reserved Advantages and Disadvantages of Partnerships ADVANTAGES –Ease of start-up –Availability of capital and credit –Retention of profits –Personal interest –Combined business skills and knowledge –Possible tax advantages DISADVANTAGES –Unlimited liability –Lack of continuity –Effects of management disagreements –Frozen investment

Copyright © Houghton Mifflin Company. All rights reserved Corporations 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 4.8 million corporations in the U.S. They comprise only 20% of all businesses, but they account for 87.1 % of sales revenues

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Copyright © Houghton Mifflin Company. All rights reserved Corporations (cont’d) Corporate Ownership –Stock The shares of ownership of a corporation –Stockholder A person who owns a corporation’s stock –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

Copyright © Houghton Mifflin Company. All rights reserved Forming a Corporation Incorporation –The process of forming a corporation Most experts recommend consulting a lawyer

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Copyright © Houghton Mifflin Company. All rights reserved Forming a Corporation (cont’d) Where to Incorporate –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 it which it is incorporated –Alien corporation A corporation chartered by a foreign government and conducting business in the U.S.

Copyright © Houghton Mifflin Company. All rights reserved Forming a Corporation (cont’d) The Corporate Charter –A contract (submitted as articles of incorporation) between the corporation and the state in which the state recognizes the formation of the artificial person that is the corporation –Charter 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

Copyright © Houghton Mifflin Company. All rights reserved Forming a Corporation (cont’d) 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 –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 –Dividend A distribution of earnings to the stockholders of a corporation –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

Copyright © Houghton Mifflin Company. All rights reserved Forming a Corporation (cont’d) 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

Copyright © Houghton Mifflin Company. All rights reserved Corporate Structure Board of Directors –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

Copyright © Houghton Mifflin Company. All rights reserved Corporate Structure (cont’d) Corporate Officers –The chairman of the board, president, executive vice presidents, corporate secretary, treasurer, or any other top executive appointed by the board –Implement the chosen strategy and direct the work of the corporation, periodically reporting results to the board

Copyright © Houghton Mifflin Company. All rights reserved Hierarchy of Corporate Structure Stockholders exercise a great deal of influence through their right to elect the board of directors

Copyright © Houghton Mifflin Company. All rights reserved Advantages and Disadvantages of Corporations ADVANTAGES –Limited Liability Each owner’s financial liability is limited to the amount of money that he or she has paid for the corporation’s stock –Ease of Raising Capital –Ease of Transfer of Ownership –Perpetual Life –Specialized Management DISADVANTAGES –Difficulty and Expense of Formation –Government Regulation –Double Taxation –Lack of Secrecy

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Copyright © Houghton Mifflin Company. All rights reserved Chapter Quiz 1.The most popular form of business ownership in the United States is a)corporations. b)partnerships. c)sole proprietorships. d)limited liability companies. e)S-corporations. 2.The legal concept that holds a business owner personally responsible for all the debts of the business is a)lack of continuity. b)pride of ownership. c)unrestricted liability. d)limited liability. e)unlimited liability.

Copyright © Houghton Mifflin Company. All rights reserved Chapter Quiz (cont’d) 3.Which of the following is an advantage of a partnership? a)Effects of management disagreements b)Availability of capital and credit c)Frozen investment d)Lack of continuity e)Closed management 4.To form a corporation, the incorporators submit __________ to the secretary of state. a)corporate charter b)corporate contract c)business contract d)corporation agreement e)articles of incorporation

Copyright © Houghton Mifflin Company. All rights reserved Chapter Quiz (cont’d) 5.A technique used to gather enough stockholder votes to control the targeted company is a(n) a)proxy fight. b)recapitalization plan. c)conglomerate takeover. d)tender offer. e)horizontal takeover.

Copyright © Houghton Mifflin Company. All rights reserved Answers to Chapter Quiz 1.The most popular form of business ownership in the United States is a)corporations. b)partnerships. c)sole proprietorships. d)limited liability companies. e)S-corporations. 2.The legal concept that holds a business owner personally responsible for all the debts of the business is a)lack of continuity. b)pride of ownership. c)unrestricted liability. d)limited liability. e)unlimited liability.

Copyright © Houghton Mifflin Company. All rights reserved Answers to Chapter Quiz (cont’d) 3.Which of the following is an advantage of a partnership? a)Effects of management disagreements b)Availability of capital and credit c)Frozen investment d)Lack of continuity e)Closed management 4.To form a corporation, the incorporators submit __________ to the secretary of state. a)corporate charter b)corporate contract c)business contract d)corporation agreement e)articles of incorporation

Copyright © Houghton Mifflin Company. All rights reserved Answers to Chapter Quiz (cont’d) 5.A technique used to gather enough stockholder votes to control the targeted company is a(n) a)proxy fight. b)recapitalization plan. c)conglomerate takeover. d)tender offer. e)horizontal takeover.