Choosing a Form of Business Ownership Chapter 4 Choosing a Form of Business Ownership

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. Examine special types of corporations, including S-corporations, limited-liability companies, and not-for-profit corporations. Discuss the purpose of a cooperative, joint venture, and syndicate. Explain how growth from within and growth through mergers can enable a business to expand.

…a business that is owned (and usually operated) by one person. Sole Proprietorship …a business that is owned (and usually operated) by one person.

Reasons People Go into Business for Themselves Source: Timothy S. Hatten, Small Business Management: Entrepreneurship and Beyond, 3rd ed. Copyright © 2006 by Houghton Mifflin Company. Used by permission. Data from A Small Business Primer.

The Small Business Administration website SBA Online The Small Business Administration website explores topics important to new and established businesses answers questions such as Which legal form is best? How to get financing? offers SBA answer desk where you can submit questions about specific concerns http://www.sbaonline.sba.gov

Forming a Sole Proprietorship Simplest form of ownership Easiest to start Owner decides to start business and begins operations Common in Retailing Service Agriculture

Figure 4.1: Relative Percentages of Sole Proprietorships, Partnerships, and Corporations in the U.S. Source: U.S. Bureau of the Census, Statistical Abstract of the United States, Washington, D.C., 2009, p. 483 (www.census.gov).

Figure 4.2: Total Sales Receipts of American Businesses Source: U.S. Bureau of the Census, Statistical Abstract of the United States, Washington, D.C., 2009, p. 483 (www.census.gov).

Advantages of Sole Proprietorships Ease of Start-up and Closure Pride of Ownership Retention of All Profits Flexibility of Being Your Own Boss No Special Taxes

Disadvantages of Sole Proprietorships Unlimited Liability Lack of Continuity Lack of Money Limited Management Skills Difficulty in Hiring Employees

Partnerships A voluntary association of 2 or more persons to act as co-owners of a business for profit Much less common than sole proprietorship or corporation No legal maximum on number of partners

Types of Partners General ─ person who assumes full or shared responsibility for operating a business Is active in day-to-day business operations Can enter into contracts on behalf of other partners Assumes unlimited liability Limited ─ person who contributes capital to a business but assumes no management responsibility or losses beyond amount he/she invested

National Association of Publicly Traded Partnerships Types of Partnerships General ─ business co-owned by 2 or more general partners who are liable for everything the business does Limited ─ business co-owned by 1 or more general partners who manage the business and limited partners who invest money in it Master Limited ─ owned and managed like a corporation but often taxed like a partnership National Association of Publicly Traded Partnerships www.naptp.org

Articles of Partnership …an agreement listing and explaining the terms of the partnership.

Figure 4.3: Articles of Partnership

Advantages of Partnerships Ease of Start-up Availability of Capital and Credit Personal Interest Combined Business Skills and Knowledge Retention of Profits No Special Taxes

Disadvantages of Partnerships Unlimited Liability Management Disagreements Lack of Continuity Frozen Investment

Corporation …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.

Table 4.1: The Seven Largest U.S. Industrial Corporations Source: Fortune website at www.fortune.com, accessed April 6, 2009.

Corporate Ownership Stock ─ shares of ownership of a corporation Stockholder ─ 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 can be bought and sold by any individual

Decide where to incorporate Forming a Corporation Consult a lawyer Decide where to incorporate Cost of incorporating Advantages/disadvantages of each state’s corporate laws and tax structure Choose corporate location Domestic corporation ─ in state in which it is incorporated Foreign corporation ─ in any state in which it does business except the one in which it is incorporated Alien corporation ─ chartered by a foreign government and conducting business in the U.S. Hold organizational meeting

Table 4.2: 10 Aspects of Business That May Require Legal Help

Corporate Charter …a contract between a corporation and the state in which the state recognizes the formation of the artificial person that is the corporation.

Charter and Articles of Incorporation Firm’s name and address Incorporators’ names and addresses Purpose of corporation Maximum amount of stock and types of stock to be issued Rights and privileges of stockholders Length of time corporation is to exist

Stockholders’ Rights Common Stock owned by individuals who vote on corporate matters and whose claims on profit/assets are subordinate to others Preferred Stock owned by individuals/firms who do not have voting rights, whose claims on dividends are paid before those of common-stock owners Dividend a distribution of earnings to stockholders Proxy legal form listing issues to be decided at stockholders’ meeting and enabling stockholders to transfer voting rights to other individual(s)

Corporate Dividends Paid to Stockholders Spotlight Source: U.S. Department of Commerce Bureau of Economic Analysis website at www.bea.gov, accessed April 13, 2009.

Corporate Structure Board of Directors top governing body of corporation, members are elected by stockholders Corporate Officers chairman of the board, president, executive vice- presidents, corporate secretary, treasurer, and other top executives appointed by board of directors

Advantages of Corporations Limited Liability Ease of Raising Capital Ease of Transfer of Ownership Perpetual Life Specialized Management

Disadvantages of Corporations Difficulty and Expense of Formation Government Regulation and Increased Paperwork Conflict within Corporation Double Taxation Lack of Secrecy

Table 4.3: Some Advantages and Disadvantages of a Sole Proprietorship, Partnership, and Corporation

Corporation taxed as partnership Criteria: S-Corporation Corporation taxed as partnership Criteria: No more than 100 stockholders Stockholders must be individuals, estates, or exempt organizations Only 1 class of stock Must be domestic corporation No nonresident-alien stockholders All stockholders must agree to S-corporation

Limited-Liability Company (LLC) Provides limited liability protection, taxed like a partnership Advantages: With 2 or more members = taxed as partnership avoiding double taxation,1 member = taxed as sole proprietorship Extends protection of personal assets More management flexibility when compared to corporations

Table 4.4: Some Advantages and Disadvantages of a Regular Corporation, S-Corporation, and Limited-Liability Company

Not-for-Profit Corporations …a corporation organized to provide a social, educational, religious, or other service rather than to earn a profit.

Cooperatives, Joint Ventures, and Syndicates Cooperative association of individuals or firms organized to perform some business function for members Joint Venture agreement between 2 or more groups to form business entity to achieve specific goal or operate for specific period Syndicate temporary association of individuals or firms organized to perform specific task requiring large amount of capital

Corporate Growth from Within Expand present operations Introduce/sell new related products Sell present products to new geographic markets / groups of consumers Growth from within has relatively little adverse effect on firm.

Corporate Growth Through Mergers/Acquisitions Merger purchase of one corporation by another Hostile takeover purchase in which management and board of directors of firm targeted for acquisition disapprove of merger Corporate raider Tender offer Proxy fight

Types of Mergers Horizontal between firms that make and sell similar products/services in similar markets Vertical between firms that operate at different levels in the production and marketing of a product Conglomerate between firms in completely different industries

Figure 4.5: Three Types of Growth by Merger

Biggest Mergers Target Acquirer Value Date Mannesmann ($ billions) Date Mannesmann Vodafone Airtouch 172.2 2/2000 Time Warner America Online 112.1 1/2001 Warner-Lambert Pfizer 111.8 6/2000 Mobil Exxon 85.6 12/1999 SmithKline Glaxo Wellcome 79.6 12/2000 Ameritech SBC Communications 76.2 10/1999 GTE Bell Atlantic 74.9 Aventis SA Sanofi-Synthelabo 71.3 6/2004 Amoco British Petroleum 64.3 12/1998 Source: MSNBC, www.msnbc.msn.com/id/6880681, February 15, 2009.

Current Merger Trends Takeover 21st Century Leveraged Buyout (LBO) Pro: makes company more profitable Con: does not enhance profitability; only ones who benefit are investment bankers, brokerage firms, takeover “artists” 21st Century Cash-rich companies acquire businesses to enhance their position in the marketplace More foreign companies/investors Leveraged Buyout (LBO) purchase arrangement allowing firm’s managers, employees, investors to purchase company, taking firm private

Chapter Quiz In the United States, the form of business ownership that generates the largest amount of sales revenues is the sole proprietorship. partnership. corporation. limited-liability company. S-corporation.

Chapter Quiz (cont.) Which of the following is not an advantage of a sole proprietorship? Flexibility No special taxes Pride of ownership Retention of all profits Unlimited liability

Chapter Quiz (cont.) A business co-owned by one or more general partners who manage the business and limited partners who invest money in it is called a not-for-profit partnership. limited partnership. general partnership. limited-liability company. S-partnership.

Chapter Quiz (cont.) A corporation that received its corporate charter in California and is doing business in Oregon is called a(n) ____________corporation in Oregon. alien domestic visiting international foreign

Chapter Quiz (cont.) A ____________ is a merger between firms that make and sell similar products or services in similar industries. horizontal merger vertical merger conglomerate merger hostile takeover tender offer