Ch 5 Forms of Business Ownership Copyright 2014

Choosing a Form of Ownership n There is no one “best” form of ownership. n The best form of ownership depends on an entrepreneur’s particular situation. n Key: Understanding the characteristics of each form of ownership and how well they match an entrepreneur’s business and personal circumstances. Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 -2

Factors Affecting the Choice n n n n Tax considerations Liability exposure Start-up and future capital requirements Control Managerial ability Business goals Management succession plans Cost of formation Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 -3

Major Forms of Ownership n n n n Sole Proprietorship General Partnership Limited Partnership Corporation S Corporation Limited Liability Company Joint Venture Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 -4

Percentage of Business Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education

Percentage of Sales Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education

Percentage of Net Income Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson

Advantages of the Sole Proprietorship n Simple to create n Least costly form to begin n Profit incentive n Total decision making authority n No special legal restrictions n Easy to discontinue Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 -8

Disadvantages of the Sole Proprietorship n Unlimited personal liability Ch, 5: Forms of Business

Liability Features of the Basic Forms of Ownership Sole Proprietorship Claims of Sole Proprietor’s Creditors Sole Proprietor’s Personal Assets Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 - 10

Disadvantages of the Sole Proprietorship n Unlimited personal liability n Limited skills and capabilities n Feelings of isolation n Limited access to capital n Lack of continuity of the business Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 - 11

Partnership n An association of two or more people who co-own a business for the purpose of making a profit. n Always wise to create a partnership agreement. n The best partnerships are built on trust and respect. Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 - 12

Advantages of the Partnership n Easy to establish n Complementary skills of partners n Division of profits n Larger pool of capital n Ability to attract limited partners Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 - 13

Types of Partners n General partners Take an active role in managing a business. n Have unlimited liability for the partnership’s debts. n Every partnership must have at least one general partner. n n Limited partners Cannot participate in the day-to-day management of a company. n Have limited liability for the partnership’s debts. n Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 - 14

Types of Partners Two types of limited partners: 1. Silent partners – not active in a business but are generally known to be members of the partnership 2. Dormant partners – neither active nor generally known to be associated with the business Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 - 15

Advantages of the Partnership n n n n Easy to establish Complementary skills of partners Division of profits Larger pool of capital Ability to attract limited partners Minimal government regulation Flexibility Taxation Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 - 16

Disadvantages of the Partnership n Unlimited liability of at least one partner Ch, 5:

Liability Features of the Basic Forms of Ownership Partnership Claims of Partnership’s Creditors General Partner’s Personal Assets Ch, 5: Forms of Business Ownership Partnership’s Assets Copyright © 2014 Pearson Education General Partner’s Personal Assets 5 - 18

Disadvantages of the Partnership n n n Unlimited liability of at least one partner Capital accumulation Difficulty in disposing of partnership interest without dissolving the partnership Potential for personality and authority conflicts Partners bound by law of agency Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 - 19

Limited Partnership n n n 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 limited partner has limited liability and is treated as an investor in the business. Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 - 20

Limited Liability Partnerships All partners in a business are limited partners. n Gives the advantage of limited liability for the debts of the partnership. n Does not pay taxes – income is passed through to the limited partners who pay taxes on their share of the company’s income. Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 - 21

Corporation n n A separate legal entity from its owners. Types of corporations: ► 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. ► Alien – a corporation formed in another country but doing business in the United States. Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 - 22

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. ► Closely held – a corporation in which shares are controlled by a relatively small number of people, often family members, relatives, or friends. Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 - 23

Advantages of the Corporation n Limited liability of stockholders Ch, 5: Forms of Business

Liability Features of the Basic Forms of Ownership Corporation Claims of Corporation’s Creditors barri er Corporation’s Assets Shareholder’s Personal Assets Ch, 5: Forms of Business Ownership er i r r a b Shareholder’s Personal Assets Copyright © 2014 Pearson Education 5 - 25

Advantages of the Corporation n Limited liability of stockholders n Ability to attract capital n Ability to continue indefinitely n Transferable ownership Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 - 26

Disadvantages of the Corporation n Cost and time of incorporation process n Double taxation

Average Tax Rate by Form of Ownership Ch, 5: Forms of Business Ownership Copyright

Disadvantages of the Corporation n Cost and time of incorporation process n Double taxation n Potential for diminished managerial incentives n Legal requirements and regulatory “red tape” n Potential loss of control by founder(s) Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 - 29

S Corporation n No different from any other corporation from a legal perspective. n An S corporation is taxed like a partnership, passing all of its profits (or losses) through to individual shareholders. n 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. Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 - 30

Advantages of an S Corporation Retains all of the advantages of regular corporation: ► Continuity of existence ► Transferability ► Limited Ch, 5: Forms of Business Ownership of ownership personal liability for owners Copyright © 2014 Pearson Education 5 - 31

Liability Features of the Basic Forms of Ownership S-Corporation Claims of S-Corporation’s Creditors barri er S-Corporation’s Assets Shareholder’s Personal Assets Ch, 5: Forms of Business Ownership er i r r a b Shareholder’s Personal Assets Copyright © 2014 Pearson Education 5 - 32

Disadvantages of an S Corporation n Entrepreneurs considering both S and C status should review the impact of the decision on their companies. n S corporation status is usually beneficial to start-up companies anticipating net losses because founders can use the loss to offset other income, and lower their tax bill. Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 - 33

Limited Liability Company (LLC) n Resembles an S Corporation but is not subject to the same restrictions. n Two documents required: 1. Articles of organization 2. Operating agreement Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 - 34

Liability Features of the Basic Forms of Ownership Limited Liability Company - LLC Claims of LLC’s Creditors barri er er i r r a b LLC’s Assets Member’s Personal Assets Ch, 5: Forms of Business Ownership Member’s Personal Assets Copyright © 2014 Pearson Education 5 - 35

The Professional Corporation n Designed for professions – lawyers, doctors, dentists, accountants and other professionals n Created in the same manner as a corporation n Identified by the abbreviations: ► P. C. – Professional Corporation ► P. A. – Professional Association ► S. C. – Service Corporation Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 - 36

The Joint Venture Much like a partnership, but it: ► Is formed for a

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. Ch, 5: Forms of Business Ownership Copyright © 2014 Pearson Education 5 - 38