1. 10-1 Chapter 10 Copyright © 2010 by Nelson Education Limited. Form of Organization and Legal Issues 10 PowerPoint Presentation by Ian Anderson, Algonquin College

2. 10-2 Chapter 10 Copyright © 2010 by Nelson Education Limited. Looking Ahead After studying this chapter, you should be able to: 1.Identify the common legal forms of organization used by small businesses and describe the characteristics of each. 2.Identify factors to consider in choosing among the primary legal forms of organization. 3.Describe the effective use of boards of directors and advisory councils. 4. Explain how different forms of organization are taxed by the federal government. 5. Understanding the major legal and regulatory issues businesses face

3. 10-3 Chapter 10 Copyright © 2010 by Nelson Education Limited. Legal Forms of Organization In launching a new business, an entrepreneur must choose a form of legal organization. The most common options are: –Sole proprietorship –Partnership –Corporation

4. 10-4 Chapter 10 Copyright © 2010 by Nelson Education Limited. Legal Forms of Organization Exhibit 10-1

5. 10-5 Chapter 10 Copyright © 2010 by Nelson Education Limited. The Sole Proprietorship Option Sole Proprietorship –A business owned and operated by one person –Disadvantages Unlimited personal liability No tax free benefits Death/incapacity of owner terminates business –Advantages Ownership of the company name and assets may be transferred. There is generally no registration or filing fee. Freedom from interference

6. 10-6 Chapter 10 Copyright © 2010 by Nelson Education Limited. The Partnership Option Partnership –A legal entity formed by two or more co-owners to carry on a business for profit. Partner Qualifications –Required: of legal age to contract –Desired: Honest, healthy, capable, and compatible Questions about Partnership Formation –What is our business concept? –How are we going to structure ownership? –Why do we need each other? –How do our lifestyles differ?

7. 10-7 Chapter 10 Copyright © 2010 by Nelson Education Limited. The Limited Partnership Limited Partnership –This form of ownership consists of at least one general partner and one or more limited partners –General partner a partner in a limited partnership who has unlimited personal liability –Limited partner a partner in a limited partnership who is not active in its management and has limited personal liability

8. 10-8 Chapter 10 Copyright © 2010 by Nelson Education Limited. Sharing Workload Sharing Financial Burden Sharing Emotional Burden Procuring Executive Talent Companionship Interpersonal Conflicts Dilution of Equity Dissatisfaction with Partner Absence of One Clear Leader Frustration of Not Calling Own Shots AdvantagesDisadvantages The Advantages and Disadvantages of Partnerships

9. 10-9 Chapter 10 Copyright © 2010 by Nelson Education Limited. Partnership Terms Articles of Partnership –A document that states explicitly the rights and duties of partners. Agency Power –The ability of any one partner to legally bind (e.g., borrow money) the other partners.

10. 10-10 Chapter 10 Copyright © 2010 by Nelson Education Limited. Rights and Duties of Partners in a Partnership Agreement Date and formation of partnership Names and addresses of partners Statement of fact of partnership Statement of business purpose(s) Duration of the business Name and location of the business Amount invested by each partner Sharing ratio for profits & losses Partner’s right if any re: withdrawal of funds for personal use Provision for accounting records and their accessibility to partners Specific duties of each partner Provision for dissolution and sharing of the net assets Restraint on partner's assumption of special obligations, such as endorsing a note of another Provision for protection of surviving partners decedent’s estate, and so forth in the even of a partner’s death

11. 10-11 Chapter 10 Copyright © 2010 by Nelson Education Limited. The Corporation Option Corporation –A business organization that exists as a legal entity and provides limited liability for its owners. Legal Entity –A business organization that is recognized by the law as having a separate legal existence

12. 10-12 Chapter 10 Copyright © 2010 by Nelson Education Limited. Articles of Association Restrictions if any on share transfers Names and addresses of incorporator and first year’s directors Name of company Restrictions, if any, on business the corporation may carry on Location of principal office Classes, voting privileges and, maximum number of shares the corporation is allowed to issue

13. 10-13 Chapter 10 Copyright © 2010 by Nelson Education Limited. Share Certificate –A document specifying the number of shares owned by a shareholder Pre-emptive Right –The right of shareholders to buy new shares before they are offered to the public. Legal Status –Ownership provides control over the firm. –Ownership limits liability to investment in the firm. –Ownership can be transferred without affecting the firm’s operations Rights and Status of Shareholders

14. 10-14 Chapter 10 Copyright © 2010 by Nelson Education Limited. Limited Liability of Shareholders For most shareholders, their limited liability is a major advantage of the corporate form of organization. Their financial liability is limited to the amount of money they invest in the business.

15. 10-15 Chapter 10 Copyright © 2010 by Nelson Education Limited. Death or Withdrawal of Shareholders Unlike a partnership interest, ownership in a corporation is readily transferable. Exchange of shares is sufficient to convey an ownership interest to a different individual. Shares of large corporations are exchanged constantly without noticeable effect on the operation of the business. For a small firm, a change of owners can involve numerous complications

16. 10-16 Chapter 10 Copyright © 2010 by Nelson Education Limited. Issues in Choosing an Organizational Form Factors that affect the choice of the firm’s structure: –Initial organizational costs and requirements –Limited versus unlimited liability for the owners –Continuity of business –Transferability of ownership –Management control –Attractiveness for raising equity capital –Income taxes

17. 10-17 Chapter 10 Copyright © 2010 by Nelson Education Limited. Comparison of Legal Forms of Organization Sole proprietorship General partnership Corporation Form of organization preferred Minimum requirements; generally no registration or filing fee Minimum requirements; generally no registration or filing fee; written partnership agreement not legally required but strongly suggested Most expensive and greatest requirements; filing fees; compliance with provincial regulations for corporations Proprietorship or general partnership Unlimited liability Liability limited to investment in company Corporation Limited to proprietor’s personal capital Limited to partner’s ability and desire to contribute capital Usually the most attractive form for raising capital Corporation Form of Organization Initial Organizational Requirements and Costs Liability of Owners Attractiveness for Raising Capital Exhibit 10-2

18. 10-18 Chapter 10 Copyright © 2010 by Nelson Education Limited. The Board of Directors and Duties Board of Directors –The governing body of a corporation, elected by the shareholders –Inside directors Board members who work for the firm –Outside director Board members who do not work for the firm Duties –Elect the firm’s officers (top management) –Approve management’s plans and policies –Review performance and declare dividends

19. 10-19 Chapter 10 Copyright © 2010 by Nelson Education Limited. The Board of Directors and Advisory Councils Contributions of Board of Directors –Bring knowledge and experience Review policy decisions Provide general direction Monitor the firm’s ethical behaviour Mediate and resolve disputes among top management Alternative: Advisory Council –Provides advice but does not have the fiduciary responsibility for the direction of the firm.

20. 10-20 Chapter 10 Copyright © 2010 by Nelson Education Limited. Federal Income Taxes Sole Proprietorship –Self-employed persons are taxed on their business incomes at tax rates set for individuals. Partnership –The partnership does not pay taxes; allocated shares of income from partnership are taxed as personal income for each of the partners. Corporation –As a separate legal entity, it reports its income and pays any taxes related to these profits.

21. 10-21 Chapter 10 Copyright © 2010 by Nelson Education Limited. Federal Income Taxes and Sole Proprietorship Sole Proprietorship Example of taxes due from a married couple with $150,000 in income from the business that they operate as self-employed persons Range of Taxable IncomeTax Rate $0to$37,88515% $37,886to$75,76922% $75,770to$123,18426% $123,185 and over29% Income x Tax Rate=Taxes First$37,88515% $5,682.75 Next$37,88422% $8,334.48 Next$47,41526%$12,327.90 Remaining$26,81629% $ 7,776.64 Total$150,000 $34,121.77

22. 10-22 Chapter 10 Copyright © 2010 by Nelson Education Limited. Federal Income Taxes and Corporations Corporations Taxable income under $400,000 is taxed at the federal corporate tax rate of 12%. Provincial tax rates vary. Any profits of the corporation that are distributed to the shareholders (dividends) are taxed again as personal income. INCOME TAX Small business income up to $400,000 11.0% Investment income 34.7%

23. 10-23 Chapter 10 Copyright © 2010 by Nelson Education Limited. Laws and Regulations Regulating Competition Competition Act (Federal) –Designed to maintain a competitive economy –Prohibits: Discounts not offered to all customers Tied selling Refusal to deal Exclusive dealing

24. 10-24 Chapter 10 Copyright © 2010 by Nelson Education Limited. Laws and Regulations Protecting Consumers Ontario Business Practices Act Canadian Consumer Packaging and Labelling Act Textile Labelling Act Food and Drug Act Hazardous Products Act Motor Vehicle Safety Act

25. 10-25 Chapter 10 Copyright © 2010 by Nelson Education Limited. Laws and Regulations Protecting Investors & Public Welfare Protecting Investors –Securities Act Promoting Public Welfare –Ontario Environmental Protection Act –Municipal health bylaws –Canadian Human Rights Act

26. 10-26 Chapter 10 Copyright © 2010 by Nelson Education Limited. Laws and Regulations Protecting Employee Rights Occupational health and safety acts Employment standards codes Workers’ compensation acts

27. 10-27 Chapter 10 Copyright © 2010 by Nelson Education Limited. Laws and Regulations Protecting Intangible Assets Trademarks, e.g., Sony, Acura Patents, e.g., Post-It notes Copyrights, e.g., songs, books Industrial Design Integrated Circuit Topography Plant Breeders’ Rights

28. 10-28 Chapter 10 Copyright © 2010 by Nelson Education Limited. Business Agreements Exhibit 10-5

29. 10-29 Chapter 10 Copyright © 2010 by Nelson Education Limited. Contracts Legally-binding agreements with employees, customers, suppliers and others –Offer –Voluntary agreement –Competent contracting parties –Legal act –Consideration –Form consistent with content