CHAPTER 5 HOW TO FORM A BUSINESS Three major forms of business ownership are 1 sole proprietorships 2 partnerships and 3 corporations Sole proprietorship a business that is owned and usually managed by one person Partnership a legal form of business with two or more owners Corporation a legal entity with authority to act and have liability apart from its owners o Makes up only 20 percent of all businesses but earns 81 percent of total U S business receipts ADVANTAGES OF SOLE PROPRIETORSHIPS Ease of starting and ending the business Being your own boss Pride of ownership Leaving a legacy Retention of company profit No special taxes medicare DISADVANTAGES OF SOLE PROPIRETORSHIPS Unlimited liability the risk of personal losses o However owners do have to pay the self employment tax for social security and o Unlimited liability the responsibility of business owners for all of the debts of the business Limited financial resources Management difficulties Overwhelming time commitment Few fringe benefits Limited growth Limited life span PARTNERSHIPS master limited partnerships Several types of partnerships 1 general partnerships 2 limited partnerships 3 General partnership a partnership in which all owners share in operating the business and in assuming liability for the business s debts Limited partnership a partnership with one or more general partners and one or more General partner an owner partner who has unlimited liability and is active in limited partners managing the firm Limited partner an owner who invests money in the business but does not have any management responsibility or liability for losses beyond the investment personal assets are not a risk Master limited partnership MLP a partnership that looks much like a corporation in that it acts like a corporation and is traded on a stock exchange but is taxed like a partnership and thus avoids the corporate income tax Limited liability partnership LLP a partnership that limits partners risk of losing their personal assets to only their own acts and omissions and to the acts and omissions of people under their supervisions Uniform Partnership Act UPA defines three key elements of any general partnership as 1 common ownership 2 shared profits and losses and 3 the right to participate in managing the operations of the business ADVANTAGES OF PARTNERSHIPS More financial resources Shared management and pooled complementary skills and knowledge Longer survival No special taxes DISADVANTAGES OF PARTNERSHIPS Unlimited liability Division of profits Disagreements among partners Difficulty in termination CORPORATIONS Conventional corporation is a state chartered legal entity with authority to act and have liability separate from its owners its stockholders ADVANTAGES OF CORPORATIONS Limited liability only responsible for losses up to the amt they invested in it Ability to raise money for investment o Corporation types Alien corporation does biz in US but chartered in another country Domestic corporation does business in the state its chartered in Foreign corporation business in one state but is charted in another Closed private corporation stock held by few people isn t available to general public Open public corporation sells stock to general public Quasi corporation chartered by the gov as an approved monopoly to perform services to general public Professional corporation owners offer professional services doctors layers etc aren t publicly traded Nonprofit corporation doesn t seek personal profit Corporation operates in several countries Size Perpetual life Ease of ownership change Ease of attracting talented employees Separation of ownership from management DISADVANTAGES OF CORPORATIONS Initial cost o Owners elect board of directors Board of directors hire officers officers set corporate objectives and select managers Managers supervise employees employees Extensive paperwork Double taxation Two tax returns corporate tax return and an individual tax return Size Difficulty of termination Possible conflict with stockholders and board of directors S CORPORATIONS like sole proprietors and partnerships In order to qualify as an S Corporation a company must S corporation is a unique government creation that looks like a corporation but is taxed o Have no more than 100 shareholders o Have shareholders that are individuals or estates and who as individuals are citizens or permanent residents of the US o Have only one class of stock o Derive no more than 25 percent of income from passive sources rents royalties An S corporation that loses its S status may not operate under it again for at least five interest years LIMITED LIABILITY COMPANIES special eligibility requirements ADVANTAGES OF LLCs Limited liability company a company similar to an S corporation but without the Limited liability Choice of taxation Flexible ownership rules owners can be a person partnership or corp Flexible distribution of profits and losses Operating flexibility DISADVANTAGES OF LLCs No stock Limited life span Fewer incentives Taxes Paperwork company CORPORATE EXPANSION MERGERS AND ACQUISTIONS Merger the result of two firms forming one company Acquisition one company s purchase of the property and obligations of another Vertical merger the joining of two companies involved in different stages of related businesses soft drink company and an artificial sweetener maker Horizontal merger the joining of two firms in the same industry soft drink company and a mineral water company Conglomerate merger the joining of firms in completely unrelated industries diversifies business operations and investments a soft drink and snack food company Leveraged buyout LBO an attempt by employees management or a group of investors to purchase an organization primarily through borrowing Foreign companies have found the quickest way to grow is often to buy an established operation and bring the brands and technology home FRANCHISES Franchise agreement an arrangement whereby someone with a good idea for a business sells the rights to use the business name and sell a product or service to others in a given territory Franchisor a company that develops a product concept and sells other the rights to make and sell the products Franchise the right to use a specific business s name and sell its products or services to make and sell the product Franchisee a person who buys a franchise ADVANTAGES OF FRANCHISES Management and marketing assistance Personal ownership Nationally recognized name
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