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

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

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

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 Data Source: Statistics of Income Bulletin, Internal Revenue Service, October, 2003

Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 8 Advantages of the Sole Proprietorship Simple to create Simple to create Least costly form to begin Least costly form to begin Profit incentive Profit incentive Total decision making authority Total decision making authority No special legal restrictions No special legal restrictions Easy to discontinue Easy to discontinue

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

Liability Features of the Basic Forms of Ownership Sole Proprietorship Claims of Sole Proprietor’s Creditors Sole Proprietor’s Personal Assets

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

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

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

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

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

Liability Features of the Basic Forms of Ownership Partnership Claims of Partnership’s Creditors Partnership’s Assets General Partner’s Personal Assets General Partner’s Personal Assets General Partner’s Personal Assets General Partner’s Personal Assets

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

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

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

Liability Features of the Basic Forms of Ownership Limited Partnership Claims of Partnership’s Creditors Partnership’s Assets General Partner’s Personal Assets General Partner’s Personal Assets Limited Partner’s Personal Assets Limited Partner’s Personal Assets Barrier

Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 21 The Corporation A separate legal entity from its owners. A separate legal entity from its owners. Types of corporations: Types of corporations:  Domestic - a corporation doing business in the state in which it is incorporated.  Foreign - a corporation chartered in one state and doing business in another state.  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 22 The Corporation Types of corporations: 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.

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

Liability Features of the Basic Forms of Ownership Corporation Claims of Corporation’s Creditors Corporation’s Assets Shareholder’s Personal Assets Shareholder’s Personal Assets Shareholder’s Personal Assets Shareholder’s Personal Assets Barrier

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

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

Chapter 3 Forms of Ownership Copyright 2006 Prentice Hall Publishing Company 27 S Corporation No different from any other corporation from a legal perspective. 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. 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. 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.

Liability Features of the Basic Forms of Ownership S-Corporation Claims of S-Corporation’s Creditors S-Corporation’s Assets Shareholder’s Personal Assets Shareholder’s Personal Assets Shareholder’s Personal Assets Shareholder’s Personal Assets Barrier

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

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

Liability Features of the Basic Forms of Ownership Limited Liability Company (LLC) Claims of LLC’s Creditors LLC’s Assets Member’s Personal Assets Member’s Personal Assets Member’s Personal Assets Member’s Personal Assets Barrier