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Copyright 2008 Prentice Hall Publishing 1Chapter 5: Forms of Ownership

Forms of Business

OwnershipChapter 5

Forms of Business

OwnershipChapter 5

Copyright 2008 Prentice Hall Publishing 2

Choosing a Form of Choosing a Form of OwnershipOwnership

There is no one “best” form of There is no one “best” form of ownership.ownership.

The best form of ownership depends The best form of ownership depends on an entrepreneur’s particular on an entrepreneur’s particular situation.situation.

Key: Understanding the Key: Understanding the characteristics of each form of characteristics of each form of ownership and how well they match ownership and how well they match an entrepreneur’s business and an entrepreneur’s business and personal circumstances. personal circumstances.


Factors Affecting the Factors Affecting the ChoiceChoice

Tax considerationsTax considerations Liability exposureLiability exposure Start-up and future capital Start-up and future capital

requirementsrequirements ControlControl Managerial abilityManagerial ability Business goalsBusiness goals Management succession Management succession

plansplans Cost of formationCost of formation


Major Forms of Major Forms of OwnershipOwnership

Sole ProprietorshipSole Proprietorship PartnershipPartnership CorporationCorporation S CorporationS Corporation Limited Liability CompanyLimited Liability Company Joint VentureJoint Venture

Source: BizStats.com/businesses.htm

Forms of Business OwnershipPercentage of Businesses

Sole proprietorships71.6%

Partnerships5.4%

Corporations20.2%

Limited Liability Companies

2.9%

Forms of OwnershipPercentage of Business Sales

Sole proprietorships4.9%

Corporations84.7%

Partnerships8.8%

Limited Liability Companies

1.7%

Source: BizStats.com/businesses.htm


Advantages of the Sole Advantages of the Sole ProprietorshipProprietorship

Simple to createSimple to create Least costly form to beginLeast costly form to begin Profit incentiveProfit incentive Total decision-making authorityTotal decision-making authority No special legal restrictionsNo special legal restrictions Easy to discontinueEasy to discontinue


Disadvantages of the Disadvantages of the Sole ProprietorshipSole Proprietorship

Unlimited personal liabilityUnlimited personal liability Limited skills and capabilitiesLimited skills and capabilities Feelings of isolationFeelings of isolation Limited access to capitalLimited access to capital Lack of continuityLack of continuity


Liability Features of the Basic Liability Features of the Basic Forms of OwnershipForms of Ownership

Sole Proprietorship

Claims of Sole Proprietor’s CreditorsClaims of Sole Proprietor’s Creditors

Sole Proprietor’s Personal AssetsSole Proprietor’s Personal Assets


PartnershipPartnership

An association of two or more An association of two or more people who co-own a business for people who co-own a business for the purpose of making a profit.the purpose of making a profit.

AlwaysAlways wise to create a wise to create a partnership agreement.partnership agreement.

Best partnerships are built on Best partnerships are built on trust and respect. trust and respect.


Advantages of the Advantages of the PartnershipPartnership

Easy to establishEasy to establish Complementary skills of Complementary skills of

partnerspartners Division of profitsDivision of profits Larger pool of capitalLarger pool of capital Ability to attract limited Ability to attract limited

partnerspartners


Types of PartnersTypes of Partners General partnersGeneral partners

Take an active role in managing a Take an active role in managing a business.business.

Have unlimited liability for the Have unlimited liability for the partnership’s debts.partnership’s debts.

Every partnership must have at least one Every partnership must have at least one general partner.general partner.

Limited partnersLimited partners Cannot participate in the day-to-day Cannot participate in the day-to-day

management of a company. management of a company. Have limited liability for the Have limited liability for the

partnership’s debts. partnership’s debts.


Advantages of the Advantages of the PartnershipPartnership

Easy to establishEasy to establish Complementary skills of partnersComplementary skills of partners Division of profitsDivision of profits Larger pool of capitalLarger pool of capital Ability to attract limited partnersAbility to attract limited partners

Little government regulationLittle government regulation FlexibilityFlexibility TaxationTaxation


Disadvantages of the Disadvantages of the PartnershipPartnership

Unlimited liability of at least one Unlimited liability of at least one partnerpartner

Capital accumulationCapital accumulation Difficulty in disposing of Difficulty in disposing of

partnership interestpartnership interest Lack of continuityLack of continuity Potential for personality and Potential for personality and

authority conflictsauthority conflicts Partners bound by law of agencyPartners bound by law of agency


Liability Features of the Basic Forms of Liability Features of the Basic Forms of OwnershipOwnership

Partnership

Claims of Partnership’s CreditorsClaims of Partnership’s Creditors

Partnership’s AssetsPartnership’s AssetsGeneralPartner’sPersonalAssets

GeneralPartner’sPersonalAssets




Limited PartnershipLimited Partnership

A partnership composed of at A partnership composed of at least one general partner and least one general partner and one or more limited partners.one or more limited partners.

General partner in this General partner in this partnership is treated exactly as partnership is treated exactly as in a general partnership.in a general partnership.

Limited partner has limited Limited partner has limited liability and is treated as an liability and is treated as an investor in the business. investor in the business.


CorporationCorporation

A separate legal entity from its A separate legal entity from its owners.owners.

Types of corporations:Types of corporations: DomesticDomestic – a corporation doing business – a corporation doing business

in the state in which it is incorporated.in the state in which it is incorporated. ForeignForeign – a corporation doing business – a corporation doing business

in a state other than the state in which in a state other than the state in which it is incorporated. it is incorporated.

AlienAlien – a corporation formed in another – a corporation formed in another country but doing business in the United country but doing business in the United States. States.


CorporationCorporation Types of corporations:Types of corporations: Publicly heldPublicly held – a corporation that – a corporation that

has a large number of shareholders has a large number of shareholders and whose stock usually is traded on and whose stock usually is traded on one of the large stock exchanges.one of the large stock exchanges.

Closely heldClosely held – a corporation in which – a corporation in which shares are controlled by a relatively shares are controlled by a relatively small number of people, often family small number of people, often family members, relatives, or friends. members, relatives, or friends.


Advantages of the Advantages of the CorporationCorporation

Limited liability of stockholdersLimited liability of stockholders Ability to attract capitalAbility to attract capital Ability to continue indefinitelyAbility to continue indefinitely Transferable ownershipTransferable ownership



Corporation

Claims of Corporation’s CreditorsClaims of Corporation’s Creditors

Corporation’s AssetsCorporation’s Assets

Shareholder’sPersonal AssetsShareholder’sPersonal Assets


BarrierBarrierBarrier

Barrier


Disadvantages of the Disadvantages of the CorporationCorporation

Cost and time of incorporatingCost and time of incorporating Double taxationDouble taxation Potential for diminished Potential for diminished

managerial incentivesmanagerial incentives Legal requirements and Legal requirements and

regulatory “red tape”regulatory “red tape” Potential loss of control by Potential loss of control by

founder(s)founder(s)


S CorporationS Corporation

No different from any other No different from any other corporation from a legal perspective.corporation from a legal perspective.

For tax purposes, however, an S For tax purposes, however, an S corporation is taxed like a corporation is taxed like a partnership, passing all of its profits partnership, passing all of its profits (or losses) through to individual (or losses) through to individual shareholders.shareholders.

To elect “S” status, all shareholders To elect “S” status, all shareholders must consent, and the corporation must consent, and the corporation must file with the IRS within the first must file with the IRS within the first 75 days of its tax year.75 days of its tax year.



S-Corporation

Claims of S-Corporation’s CreditorsClaims of S-Corporation’s Creditors

S-Corporation’s AssetsS-Corporation’s Assets




Barrier


Limited Liability Limited Liability Company (LLC)Company (LLC)

Resembles an S corporation but Resembles an S corporation but is is notnot subject to the same subject to the same restrictions.restrictions.

Two documents required: Two documents required: Articles of organizationArticles of organization Operating agreementOperating agreement


Limited Liability Limited Liability Company (LLC)Company (LLC)

An LLC cannot have more than An LLC cannot have more than twotwo of these four corporate of these four corporate characteristics:characteristics: Limited liabilityLimited liability Continuity of lifeContinuity of life Free transferability of interestFree transferability of interest Centralized managementCentralized management



Limited Liability Company (LLC)

Claims of LLC’s Creditors Claims of LLC’s Creditors

LLC’s Assets LLC’s Assets

Member’sPersonal AssetsMember’sPersonal Assets

Member’sPersonal AssetsMember’sPersonal Assets


Barrier

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