Choosing a Form of Ownership Chapter 3 Forms

Choosing a Form of Ownership Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 1

Choosing a Form of Ownership There is no one “best” form of ownership. n The best form of ownership depends on an entrepreneur’s particular situation. n The key to choosing a form of ownership is understanding how each form’s characteristics affect an entrepreneur’s specific business and personal circumstances. n Copyright 2006 Prentice Hall Publishing Company 2

Factors to Consider Tax considerations n Liability exposure n Start-up capital requirements n Control n Managerial ability n Business goals n Management succession plans n Cost of formation n Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 3

Forms of Ownership Sole Proprietorship n Partnership n Corporation n S Corporation n Limited Liability Company n Joint Venture n Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 4

Data Source: Statistics of Income Bulletin, Internal Revenue Service, October, 2003 Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 5

Data Source: Statistics of Income Bulletin, Internal Revenue Service, October, 2003 Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 6

Data Source: Statistics of Income Bulletin, Internal Revenue Service, October, 2003 Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 7

Advantages of the Sole Proprietorship 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 n Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 8

Disadvantages of the Sole Proprietorship n Unlimited personal liability Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 9

Liability Features of the Basic Forms of Ownership Sole Proprietorship Claims of Sole Proprietor’s Creditors Sole Proprietor’s Personal Assets Copyright 2006 Prentice Hall Publishing Company 10

Disadvantages of the Sole Proprietorship Unlimited personal liability n Limited access to capital n Limited skills and abilities n Feelings of isolation n Lack of continuity n Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 11

Partnership An association of two or more people who co-own a business for the purpose of making a profit. n Take the time to create a written partnership agreement! n Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 12

Advantages of the Partnership Easy to establish n Complementary skills of partners n Division of profits n Larger pool of capital n Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 13

Advantages of the Partnership Ability to attract limited partners n Little government regulation n Flexibility n Taxation n Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 14

Disadvantages of the Partnership n Unlimited liability of at least one partner Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 15

Liability Features of the Basic Forms of Ownership Partnership Claims of Partnership’s Creditors General Partnership’s Assets Partner’s Personal Assets Copyright 2006 Prentice Hall Publishing Company General Partner’s Personal Assets 16

Disadvantages of the Partnership Unlimited liability of at least one partner n Capital accumulation n Difficulty in disposing of partnership interest n Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 17

Disadvantages of the Partnership Lack of continuity n Potential for personality and authority conflicts n Partners bound by the law of agency n Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 18

Limited Partnership A partnership composed of at least one general partner and one or more limited partners. n The general partner in this partnership is treated exactly as in a general partnership. n The limited partner has limited liability and is treated as an investor in the business. n Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 19

Liability Features of the Basic Forms of Ownership Limited Partnership Claims of Partnership’s Creditors r e i r Bar Partnership’s Assets General Partner’s Personal Assets Limited Partner’s Personal Assets Copyright 2006 Prentice Hall Publishing Company 20

The Corporation A separate legal entity from its owners. n Types of corporations: n Ø Domestic - a corporation doing business in the state in which it is incorporated. Ø Foreign - a corporation chartered in one state and doing business in another state. Ø Alien - a corporation formed in another country but doing business in the United States. Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 21

The Corporation n Types of corporations: Ø Publicly held - a corporation that has a large number of shareholders and whose stock usually is traded on one of the large stock exchanges. Ø Closely held - a corporation in which shares are controlled by a relatively small number of people, often family members, relatives, or friends. Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 22

Advantages of the Corporation n Limited liability of the stockholders Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 23

Liability Features of the Basic Forms of Ownership Corporation Claims of Corporation’s Creditors r e i r Barr ier Corporation’s Assets Shareholder’s Personal Assets Copyright 2006 Prentice Hall Publishing Company 24

Advantages of the Corporation Limited liability of stockholders n Ability to attract capital n Ability to continue indefinitely n Transferable ownership n Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 25

Disadvantages of the Corporation Cost and time of incorporating n “Double taxation” n Potential for diminished managerial incentives n Legal requirements and regulatory “red tape” n Potential loss of control by founder(s) n Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 26

S Corporation n No different from any other corporation from a legal perspective. For tax purposes, however, an S corporation is taxed like a partnership, passing all of its profits (or losses) through to the individual shareholders. 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. Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 27

Liability Features of the Basic Forms of Ownership S-Corporation Claims of S-Corporation’s Creditors Barr ier r e i r Bar S-Corporation’s Assets Shareholder’s Personal Assets Copyright 2006 Prentice Hall Publishing Company 28

Limited Liability Company (LLC) Resembles an S Corporation but is not subject to the same restrictions. n Two documents required: n Ø Articles of organization Ø Operating agreement. Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 29

Limited Liability Company (LLC) n An LLC cannot have more than two of these four corporate characteristics: Ø Limited liability Ø Continuity of life Ø Free transferability of interest Ø Centralized management Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 30

Liability Features of the Basic Forms of Ownership Limited Liability Company (LLC) Claims of LLC’s Creditors Barr ier LLC’s Assets Member’s Personal Assets r e i r Bar Member’s Personal Assets Copyright 2006 Prentice Hall Publishing Company 31