1. Choosing a Form of Business Ownership
Chapter Five
Choosing a Form of Business Ownership

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

3. Textbook – Student Website
business/8e/students/index.html
Brief Chapter Outlines
Transcripts of Audio Reviews
Review Questions
Flashcards
Practice Tests
Copyright © Houghton Mifflin Company. All rights reserved.

4. A business that is owned (and usually operated) by one person
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.

5. 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.

6. Advantages and Disadvantages of Sole Proprietorships
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.

7. 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.

8. 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.

9. Types of Partners General partner Limited 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.

10. 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.

11. Advantages and Disadvantages of Partnerships
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.

12. 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
Copyright © Houghton Mifflin Company. All rights reserved.

13. Copyright © Houghton Mifflin Company. All rights reserved.

14. 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.

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

16. Copyright © Houghton Mifflin Company. All rights reserved.

17. 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.

18. 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.

19. 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.

20. 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.

21. 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.

22. 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.

23. 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.

24. Advantages and Disadvantages of Corporations
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
Copyright © Houghton Mifflin Company. All rights reserved.

25. Copyright © Houghton Mifflin Company. All rights reserved.

26. Other Types of Business Ownership
S-Corporations
A corporation that is taxed as though it were a partnership (income is taxed only as the personal income of stockholders)
Advantages
Avoids double taxation of a corporation
Retains the corporation’s legal benefit of limited liability
S-corporation criteria
No more than 75 stockholders allowed
Stockholders must be individuals, estates, or certain trusts
There can be only 1 class of outstanding stock
The firm must be a domestic corporation
There can be no nonresident alien stockholders
All stockholders must agree to the decision to form an S-corporation
Copyright © Houghton Mifflin Company. All rights reserved.

27. Other Types of Business Ownership (cont’d)
Limited-Liability Company (LLC)
A form of business ownership that provides limited-liability protection and is taxed like a partnership
Advantages
Avoids double taxation of a corporation
Retains the corporation’s legal benefit of limited liability
Difference between LLC and S-Corporation
LLCs not restricted to 75 stockholders
LLCs have fewer restrictions on who can be a stockholder
Copyright © Houghton Mifflin Company. All rights reserved.

28. Other Types of Business Ownership (cont’d)
Government-Owned Corporations
A corporation owned and operated by a local, state, or federal government
Purpose
To ensure that a public service is available
Examples
Tennessee Valley Authority (TVA), the National Aeronautics and Space Administration (NASA), and the Federal Deposit Insurance Corporation (FDIC)
Quasi-government corporation
Partly owned by the government and partly by private citizens or firms
Examples: Fannie Mae, Freddie Mac, Sallie Mae
Copyright © Houghton Mifflin Company. All rights reserved.

29. Other Types of Business Ownership (cont’d)
Not-for-Profit Corporations
Corporations organized to provide social, educational, religious, or other services, rather than to earn a profit
Charities, museums, private schools, and colleges are organized as not-for-profits primarily to ensure limited liability
Cooperatives
Associations of individuals or firms whose purpose is to perform some business function for its members
Members benefit from the efficiencies of the cooperatives’ activities, such as reducing unit costs by making bulk purchases and coordinating services such as transportation, processing, and marketing products
Copyright © Houghton Mifflin Company. All rights reserved.

30. Other Types of Business Ownership (cont’d)
Joint Ventures
Agreements between two or more groups to form a business entity in order to achieve a specific goal or to operate for a specific period of time
Example: Disney & Pixar
Syndicates
Temporary associations of individuals or firms organized to perform a specific task that requires a large amount of capital
Most commonly used to underwrite large insurance policies, loans, and investments
Copyright © Houghton Mifflin Company. All rights reserved.

31. Corporate Growth Growth from Within
Introducing new products
Entering new markets
Growth Through Mergers and Acquisitions
Merger: the purchase of one corporation by another; essentially the same as an acquisition
Hostile takeover: a situation in which the management and board of directors of the firm targeted for acquisition disapprove of the merger
Tender offer: an offer to purchase the stock of a firm targeted for acquisition at a price just high enough to tempt stockholders to sell their shares
Proxy fight: a technique used to gather enough stockholder votes to control the targeted company
Copyright © Houghton Mifflin Company. All rights reserved.

32. Copyright © Houghton Mifflin Company. All rights reserved.

33. Growth Through Mergers and Acquisitions (cont’d)
Steps to avoid hostile takeover
Issue a new class of preferred stock that stockholders can redeem at a premium after the raider assumes control
Allow existing shareholders to buy new stock at a discounted price in order to increase the number of existing shares
Give golden parachute contracts to top executives
Adopt a supermajority position requiring 2/3 to 3/4 majority of votes cast by stockholders to ratify a takeover
Create staggered terms for board members
Use leveraged capitalization (large amount of debt capital and large cash distributions to stockholders)
Find a white knight willing to take over the company
Copyright © Houghton Mifflin Company. All rights reserved.

34. Three Types of Growth by Merger
Copyright © Houghton Mifflin Company. All rights reserved.

35. Corporate Growth (cont’d)
Current Merger Trends
Takeover advocates say
Companies that are taken over are made more profitable and productive
Proceeds from the sale of non-core subsidiaries help pay off debt or enhance the company
Takeover opponents say
Takeover threats force managers to spend time on defense rather than vital business activities
The only people who benefit from takeovers are investment bankers, brokerage firms, and takeover artists
Copyright © Houghton Mifflin Company. All rights reserved.

36. Corporate Growth (cont’d)
Current Merger Trends
Mergers during the first part of the 21st century will be the result of cash-rich companies looking to enhance their position in the marketplace
There will be more mergers involving companies or investors from other countries
Less borrowed money (debt capital) will be used to pay for mergers and acquisitions
Divestiture—the process of dismantling a company and selling off different parts
There will be more leveraged buyouts
A purchase arrangement that allows a firm’s managers and employees or a group of investors to purchase the company
Copyright © Houghton Mifflin Company. All rights reserved.

37. Textbook – Student Website
business/8e/students/index.html
Brief Chapter Outlines
Transcripts of Audio Reviews
Review Questions
Flashcards
Practice Tests
Copyright © Houghton Mifflin Company. All rights reserved.