Transcript Chapter 6: BUSINESS FORMATION

CHAPTER 6: BUSINESS FORMATION
Choosing the Form that Fits
CHOICES, CHOICES, CHOICES
The form of ownership of a business is a
big decision.
Form of ownership affects:
• Operation
• Start-up Costs
• Profit Distribution
• Taxes
• Management Succession plans
• Liability Exposure
• Managerial Ability
• Business Goals
The “Big Three” is Becoming the
“Big Four”:
• Sole Proprietorship
• Partnership
• Corporation
• Limited Liability Company
BUSINESS FORMS: COMPARING
THE NUMBERS
SOLE PROPRIETORSHIP: BUSINESS AT
ITS MOST BASIC

Advantages:
 Ease
of Formation
 Retention
 Pride
of Control
of Ownership
 Retention
 Possible
of Profits
Tax
Advantages

Disadvantages:
 Limited
Financial
Resources
 Unlimited
Liability
 Limited
ability to
attract and maintain
talented employees
 Lack
of Permanence
MOST COMMON TYPES OF SOLE
PROPRIETORSHIPS
Professional, Technical,
and Scientific Services
• Law firms, accountants, architects, computer system
designers, consultants
• 2,752
Construction
• Residential construction, commercial construction,
specialty contractors
• 2,491
Retail Trade
• Car dealerships, restaurants, clothing stores, home
& garden stores
• 2,416
Other Services
Health Care
• Automobile repair and body shops, laundries,
personal services
• 1,995
• Physicians, dentists, chiropractors, psychologists,
psychiatrists
• 1,762
Source for Table: “Sole Proprietorship Returns”, by Kevin Pierce Statistics of Income Bulletin, Summer, 2005, Figure A, p.9; website: http://www.irs.gov/pub/irs-soi/03solp.pdf )
PARTNERSHIPS: TWO HEADS CAN BE
BETTER THAN ONE

Advantages:
 Pooled
Financial
Resources
 Shared
 Ease
 Tax
Responsibilities
of Formation
Advantages

Disadvantages:
 Unlimited
Liability
 Disagreements
 Difficulty
in
withdrawing from
agreement
 Lack
of Continuity
GENERAL VS LIMITED PARTNERSHIPS

General Partnerships
 All
partners have the right to participate in the
management of the firm and share in any
profits/losses.

Limited Partnerships
 All
partners contribute financially and share in the
profits but the limited partner(s)
 cannot
actively participate in management
 have limited liability
LIMITED PARTNERSHIPS
Limited Partnership –
includes at least one
general partner and at
least one limited partner
Limited Liability Partnership –
All partners are actively
involved but they have some
form of limited liability. The
amount of liability differs
per state.
CORPORATIONS: AN ARTIFICIAL REALITY



A corporation is a legal entity, separate and
distinct from its owners.
Corporations are owned by stockholders.
The Board of Directors

Elected by stockholders to oversee the operation of their company
and protect their interests

Oversee the operation of corporation and protect investors’ interest

Establish mission and set objectives

Rarely get involved in day-to-day management

Responsible for monitoring the performance of the corporate officers
Articles of Incorporation






Corporate Name
Shares of stock the corporation is authorized to issue
Number of shares each owner will buy
Each owner’s contribution to obtain stock
Business of the corporation
Management structure of the corporation
CORPORATIONS

Advantages:

Limited Liability

Permanence

Easy to Transfer Ownership

Ability to Raise Capital

Specialized Management

Disadvantages:

Expense/complexity of
formation and operation

Double Taxation

Paperwork and Regulation

Conflicts of Interest
LIMITED LIABILITY COMPANY: THE
NEW KID ON THE BLOCK

Advantages:
 Limited
 Tax
Liability
Pass-Through
 Simplified
Management and
Operation
 Flexible
Ownership

Disadvantages:
 Franchise
 Foreign
Taxes
Status in other
States
 State
Law Differences
 Limited
to Select
Industries
COMPARING BUSINESS FORMS
High
HIGH
Sole
Proprietorships
LOW
Low
DEGREE OF PERSONAL LIABILITY
Partnerships
DEGREE OF COMPLEXITY AND PERPETUITY
Low
LOW
Corporations
High
HIGH
CORPORATE RESTRUCTURING
Mergers – two companies
agree to a combination of
equals.
Acquisitions – when one
firm buys another.
Large corporations
constantly look for ways to
grow and achieve
competitive advantage.
TYPES OF MERGERS AND ACQUISITIONS
Type of Merger
Definition
Objective
Example
Combine firms in
same industry.
• Increase size
• Increase market power
• Gain efficiency
AT&T and SBC
Vertical
Combine companies
with buyer-seller
relationship.
• Provide tighter
integration and increase
control
Time Warner
and Turner
Broadcasting
Conglomerate
Combination of
• Increase company’s
unrelated companies.
diversity.
Horizontal
GE acquiring
RCA
DIVESTITURES: WHEN LESS IS MORE
Divestitures allow the firm to streamline their
operations and focus

Spin-off – setting up the division or part of the
business as a separate company
Sell stock to existing stockholders

Carve-out – setting up a separate business from
an operation
Sell stock to outside investors