1. Chapter 6: BUSINESS FORMATION
Choosing the Form that Fits

2. CHOICES, CHOICES, CHOICES
The form of ownership of a business is a big decision.
Form of ownership affects:
Operation
Start-up Costs
Profit Distribution
Taxes
Management Succession plans
Liability Exposure
Managerial Ability
Business Goals
The “Big Three” is Becoming the “Big Four”:
Sole Proprietorship
Partnership
Corporation
Limited Liability Company
There has been a large amount of growth in the number of LLCs which is becoming another one of the popular business formation types. The Big Three seems to becoming the Big Four.

3. BUSINESS FORMS: COMPARING THE NUMBERS

4. SOLE PROPRIETORSHIP: BUSINESS AT ITS MOST BASIC
Advantages:
Ease of Formation
Retention of Control
Pride of Ownership
Retention of Profits
Possible Tax Advantages
Disadvantages:
Limited Financial Resources
Unlimited Liability
Limited ability to attract and maintain talented employees
Lack of Permanence

5. MOST COMMON TYPES OF SOLE PROPRIETORSHIPS
Law firms, accountants, architects, computer system designers, consultants
2,752
Professional, Technical, and Scientific Services
Residential construction, commercial construction, specialty contractors
2,491
Construction
Car dealerships, restaurants, clothing stores, home & garden stores
2,416
Retail Trade
Automobile repair and body shops, laundries, personal services
1,995
Other Services
Physicians, dentists, chiropractors, psychologists, psychiatrists
1,762
Health Care
Source for Table: “Sole Proprietorship Returns”, by Kevin Pierce Statistics of Income Bulletin, Summer, 2005, Figure A, p.9; website: )

6. PARTNERSHIPS: TWO HEADS CAN BE BETTER THAN ONE
Advantages:
Pooled Financial Resources
Shared Responsibilities
Ease of Formation
Tax Advantages
Disadvantages:
Unlimited Liability
Disagreements
Difficulty in withdrawing from agreement
Lack of Continuity

7. GENERAL VS LIMITED PARTNERSHIPS
General Partnerships
All partners have the right to participate in the management of the firm and share in any profits/losses.
Limited Partnerships
All partners contribute financially and share in the profits but the limited partner(s)
cannot actively participate in management
have limited liability

8. LIMITED PARTNERSHIPS Limited Partnership – includes at least one
general partner and at
least one limited partner
Limited Liability Partnership –
All partners are actively
involved but they have some
form of limited liability. The
amount of liability differs
per state.

9. FAMILY LIMITED PARTNERSHIPS
Parents as general partners
Children as limited partners
Parents transfer assets to limited partners while still maintaining control, this strategy:
Reduces gift and inheritance taxes
Protects family assets from creditors and lawsuits
But watch out for the IRS – Family Limited Partnerships can attract tax auditors!

10. CORPORATIONS: AN ARTIFICIAL REALITY
A corporation is a legal entity, separate and distinct from its owners.
Corporations are owned by stockholders.
The Board of Directors
Elected by stockholders to oversee the operation of their company and protect their interests
Oversee the operation of corporation and protect investors’ interest
Establish mission and set objectives
Rarely get involved in day-to-day management
Responsible for monitoring the performance of the corporate officers

11. Articles of Incorporation
Corporate Name
Shares of stock the corporation is authorized to issue
Number of shares each owner will buy
Each owner’s contribution to obtain stock
Business of the corporation
Management structure of the corporation

12. CORPORATIONS Disadvantages: Advantages:
Expense/complexity of formation and operation
Double Taxation
Paperwork and Regulation
Conflicts of Interest
Advantages:
Limited Liability
Permanence
Easy to Transfer Ownership
Ability to Raise Capital
Specialized Management

13. OTHER TYPES OF CORPORATIONS: SAME BUT DIFFERENT
S Corporation
Closed Corporation
Non-profit Corporation
Review Table 5.1 from text.

14. COMPARING TYPES OF CORPORATIONS
KEY ADVANTAGE
LIMITATIONS
S Corp.
IRS does not tax earnings separately.
Stockholders have limited liability.
No more than 100 stockholders
Stockholders must be US citizens or permanent residents
Statutory Close Corp.
Not required to have a board or hold annual meetings.
Owners can participate in management while maintaining limited liability.
Limited number of stockholders.
Stockholders must offer shares to owner first before selling publicly
Not all states allow this corporation type
Nonprofit Corp.
Earnings are exempt from federal and state income taxes.
Members/directors have limited liability
Contributions made by individuals are tax-deductible
May have dues paying members but no stockholders.
Can’t distribute dividends.
Can’t make political donations.
Must keep accurate records to document tax-exemption.

15. LIMITED LIABILITY COMPANY: THE NEW KID ON THE BLOCK
Advantages:
Limited Liability
Tax Pass-Through
Simplified Management and Operation
Flexible Ownership
Disadvantages:
Franchise Taxes
Foreign Status in other States
State Law Differences
Limited to Select Industries

16. COMPARING BUSINESS FORMS
High
Low
HIGH
LOW
DEGREE OF PERSONAL LIABILITY
Sole
Proprietorships
Partnerships
Corporations
Low
High
Note the conflict between ease and perpetuity as well as liability. Comment how business form is an important decision.
LOW
HIGH
DEGREE OF COMPLEXITY AND PERPETUITY

17. CORPORATE RESTRUCTURING
Mergers – two companies agree to a combination of equals.
Acquisitions – when one firm buys another.
Large corporations constantly look for ways to grow and achieve competitive advantage.

18. TYPES OF MERGERS AND ACQUISITIONS
Type of Merger
Definition
Objective
Example
Horizontal
Combine firms in same industry.
Increase size
Increase market power
Gain efficiency
AT&T and SBC
Vertical
Combine companies with buyer-seller relationship.
Provide tighter integration and increase control
Time Warner and Turner Broadcasting
Conglomerate
Combination of unrelated companies.
Increase company’s diversity.
GE acquiring RCA
Click the link to the FTC website and review any Mergers and Acquisitions currently being reviewed/announced. Also, click the competition tab to review the FTC definitions of M&A as well as current cases and proceedings.

19. DIVESTITURES: WHEN LESS IS MORE
Divestitures allow the firm to streamline their operations and focus
Spin-off – setting up the division or part of the business as a separate company
Sell stock to existing stockholders
Carve-out – setting up a separate business from an operation
Sell stock to outside investors