Transcript Chapter Four - Queens College Economics

Chapter Four
Choosing a Form of
Business Ownership
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Learning Objectives
1. Describe the advantages and disadvantages
of sole proprietorships.
2. Explain the different types of partners and
the importance of partnership agreements.
3. Describe the advantages and disadvantages
of partnerships.
4. Summarize how a corporation is formed.
5. Describe the advantages and disadvantages
of a corporation.
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Learning Objectives
6. Examine special types of corporations,
including S-corporations, limited-liability
companies, government-owned
corporations, and not-for-profit corporations.
7. Discuss the purpose of a cooperative, joint
venture, and syndicate.
8. Explain how growth from within and growth
through mergers can enable a business to
expand.
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Sole Proprietorships
• A business that is owned (and usually
operated) by one person
• The simplest form of business ownership and
the easiest to start
• Many large businesses began as a small
struggling sole proprietorships
• The most widespread form of business
ownership
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Reasons People Go into
Business for Themselves
Source: Timothy S. Hatten, Small Business Management: Entrepreneurship and Beyond, 3rd ed. Copyright © 2006 by
Houghton Mifflin Company. Used by permission. Data from A Small Business Primer.
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Relative Percentages of Sole Proprietorships,
Partnerships, and Corporations in the U.S.
• Sole
proprietorships
are most
common in
retailing,
agriculture, and
the service
industries
Source: U.S. Bureau of the Census, Statistical Abstract of the United States, Washington, D.C.,
2008, p. 487 (www.census.gov).
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Advantages and Disadvantages of
Sole Proprietorships
ADVANTAGES
– Ease of start-up and
closure
– Pride of ownership
– Retention of all profits
– Flexibility of being your
own boss
– No special taxes
DISADVANTAGES
– Unlimited liability
• A legal concept that holds
a business owner
personally responsible for
all the debts of the
business
– Lack of continuity
– Lack of money
– Limited management
skills
– Difficulty in hiring
employees
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Class Exercise
• You want to own and manage your own business. To help you
evaluate your chances of success, answer these questions.
– Do you have any experience in a business like the one you
want to start?
– Have you worked for someone else as a supervisor or
manager?
– Have you saved any money? How much?
– Do you know how much money you will need to get your
business started?
– Do you know how much credit you can get from your
suppliers and bankers?
– Do you know the good and bad points about going it alone,
having a partner, and incorporating your business?
– What do you know about your potential customer?
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Partnerships
• A voluntary association of two or more persons to act as coowners of business for profit
• Less common form of ownership than sole proprietorship or
corporation
• No legal limit on the maximum number of partners; most
have only 2
• Large accounting, law, and advertising partnerships
have multiple partners
• Partnerships are usually a pooling of special talents or the
result of a sole proprietor taking on a partner
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Types of Partners
• General partner
– A person who assumes full or shared responsibility for
operating a business
– General partnership: a business co-owned by two or more
general partners who are liable for everything the business
does
• Limited partner
– A person who contribute capital to a business but has no
management responsibility or liability for losses beyond the
amount he or she invested in the partnership
– Limited partnership: a business co-owned by one or more
general partners who manage the business and limited
partners who invest money in it
– Master limited partnership (MLP): a business partnership
that is owned and managed like a corporation but taxed like
a partnership
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The Partnership Agreement
• Articles of partnership
– An agreement listing and explaining the terms of
the partnership
– Agreement should state
•
•
•
•
Who will make final decisions
What each partner’s duties will be
How much each partner will invest
How much profit or loss each partner receives or is
responsible for
• How the partnership can be dissolved
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Advantages and Disadvantages of
Partnerships
ADVANTAGES
– Ease of start-up
– Availability of capital and
credit
– Personal interest
– Combined business skills
and knowledge
– Retention of profits
– No special taxes
DISADVANTAGES
– Unlimited liability
– Management
disagreements
– Lack of continuity
– Frozen investment
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Corporations
• An artificial person created by law with most of the
legal rights of a real person, including the rights to
start and operate a business, to buy or sell property,
to borrow money, to sue or be sued, and to enter into
binding contracts
• There are 5.6 million corporations in the U.S.
• They comprise only 20% of all businesses, but they
account for 83.8 % of sales revenues
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The Seven Largest U.S. Industrial
Corporations, Ranked by Sales Revenue
Source: Fortune website at www.fortune.com, accessed September 12, 2008.
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Corporate Ownership
• Corporate ownership
– Stock
• The shares of ownership of a corporation
– Stockholder
• A person who owns a corporation’s stock
– Closed corporation
• A corporation whose stock is owned by relatively few
people and is not sold to the general public
– Open corporation
• A corporation whose stock is bought and sold on
security exchanges and can be purchased by any
individual
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Forming a Corporation
• Incorporation
– The process of forming a corporation
• Most experts recommend consulting a lawyer
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When Legal Help Is Required
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Forming a Corporation (cont’d)
• Where to incorporate
– Businesses can incorporate in any state they choose
– Some states offer fewer restrictions, lower taxes, and
other benefits to attract new firms
– Domestic corporation
• A corporation in the state in which it is incorporated
– Foreign corporation
• A corporation in any state in which it does business
except the one it which it is incorporated
– Alien corporation
• A corporation chartered by a foreign government and
conducting business in the U.S.
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Forming a Corporation (cont’d)
• Articles of incorporation
– A contract between the corporation and the state in
which the state recognizes the formation of the
artificial person that is the corporation
– Articles of incorporation includes
• Firm’s name and address
• Incorporators’ names and addresses
• Purpose of the corporation
• Maximum amount of stock and types of stock to be
issued
• Rights and privileges of stockholders
• Length of time the corporation is to exist
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Forming a Corporation (cont’d)
• Stockholders’ rights
– Common stock
• Stock owned by individuals or firms who may vote on
corporate matters but whose claims on profit and assets
are subordinate to the claims of others
– Preferred stock
• Stock owned by individuals or firms who usually do not
have voting rights but whose claims on dividends are
paid before those of common-stock holders
– Dividend
• A distribution of earnings to the stockholders of a
corporation
– Proxy
• A legal form listing issues to be decided at a
stockholders’ meeting and enabling stockholders to
transfer their voting rights to some other individual or
individuals
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Forming a Corporation (cont’d)
• Organizational meeting
– The last step in forming a corporation
• The incorporators and original stockholders
meet to elect their first board of directors
– Board members are directly responsible to
stockholders for how they operate the firm
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Corporate Structure
• Board of directors
– The top governing body of a corporation, the
members of which are elected by the
stockholders
– Responsible for setting corporate goals,
developing strategic plans to meet those
goals, and the firm’s overall operation
– Outside directors: experienced managers or
entrepreneurs from outside the corporation
who have specific talents
– Inside directors: top managers from within the
corporation
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Corporate Structure (cont’d)
• Corporate officers
– The chairman of the board, president,
executive vice presidents, corporate secretary,
treasurer, and any other top executive
appointed by the board
– Implement the chosen strategy and direct the
work of the corporation, periodically reporting
results to the board and stockholders
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Hierarchy of Corporate Structure
• Stockholders exercise a great deal of
influence through their right to elect the board
of directors
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Advantages and Disadvantages of
Corporations
ADVANTAGES
– Limited liability
• Each owner’s financial
liability is limited to the
amount of money that he
or she has paid for the
corporation’s stock
– Ease of raising capital
– Ease of transfer of
ownership
– Perpetual life
– Specialized management
DISADVANTAGES
– Difficulty and expense of
formation
– Government regulation
and increased
paperwork
– Conflict within the
corporation
– Double taxation
– Lack of secrecy
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Advantages and Disadvantages
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Special Types of Business Ownership
• S-corporations
– A corporation that is taxed as though it were a
partnership (income is taxed only as the personal
income of stockholders)
– Advantages
• Avoids double taxation of a corporation
• Retains the corporation’s legal benefit of limited liability
– S-corporation criteria
• No more than 100 stockholders allowed
• Stockholders must be individuals, estates, or exempt
organizations
• There can be only one class of outstanding stock
• The firm must be a domestic corporation
• There can be no nonresident-alien stockholders
• All stockholders must agree to the decision to form an Scorporation
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Special Types of Business Ownership
(cont’d)
• Limited-liability company (LLC)
– A form of business ownership that provides
limited-liability protection and is taxed like a
partnership
– Advantages
• Avoids double taxation of a corporation
• Retains the corporation’s legal benefit of limited
liability
• Provides more management flexibility
– Difference between LLC and S-corporation
• LLCs not restricted to 100 stockholders
• LLCs have fewer restrictions on who can be a
stockholder
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Advantages and Disadvantages
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Special Types of Business Ownership
(cont’d)
• Government-owned corporations
– A corporation owned and operated by a local,
state, or federal government
– Purpose
• To ensure that a public service is available
– Examples
• Tennessee Valley Authority (TVA), the National
Aeronautics and Space Administration (NASA), and
the Federal Deposit Insurance Corporation (FDIC)
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Special Types of Business Ownership
(cont’d)
• Not-for-profit corporations
– Corporations organized to provide social,
educational, religious, or other services, rather
than to earn a profit
– Charities, museums, private schools, and colleges
are organized as not-for-profits primarily to ensure
limited liability
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Cooperatives, Joint Ventures,
Syndicates
• Cooperatives
– Associations of individuals or firms whose purpose
is to perform some business function for its
members
– Members benefit from the efficiencies of the
cooperatives’ activities, such as reducing unit costs
by making bulk purchases and coordinating services
such as transportation, processing, and marketing
products
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Cooperatives, Joint Ventures,
Syndicates (cont’d)
• Joint ventures
– Agreements between two or more groups to form a
business entity in order to achieve a specific goal or to
operate for a specific period of time
– Example: Wal-Mart and India’s Bharti Enterprises
• Syndicates
– Temporary associations of individuals or firms
organized to perform a specific task that requires a
large amount of capital
– Most commonly used to underwrite large insurance
policies, loans, and investments
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Corporate Growth
• Growth from within
– Introducing new products
– Entering new markets
• Growth through mergers and acquisitions
– Merger: the purchase of one corporation by another;
essentially the same as an acquisition
– Hostile takeover: a situation in which the management
and board of directors of the firm targeted for
acquisition disapprove of the merger
– Tender offer: an offer to purchase the stock of a firm
targeted for acquisition at a price just high enough to
tempt stockholders to sell their shares
– Proxy fight: a technique used to gather enough
stockholder votes to control the targeted company
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Corporate Growth (cont’d)
• Current merger trends
– Takeover advocates say
• Companies that are taken over are made more
profitable and productive
• Proceeds from the sale of non-core
subsidiaries help pay off debt or enhance the
company
– Takeover opponents say
• Takeover threats force managers to spend time
on defense rather than vital business activities
• The only people who benefit from takeovers are
investment bankers, brokerage firms, and
takeover artists
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Corporate Growth (cont’d)
• Current merger trends
– Mergers during the first part of the 21st century will be
the result of cash-rich companies looking to enhance
their position in the marketplace
– There will be more mergers involving companies or
investors from other countries
– Future mergers and acquisitions will be driven by solid
business logic and the desire to compete
internationally
– There will be more leveraged buyouts
• A purchase arrangement that allows a firm’s managers
and employees or a group of investors to purchase the
company
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Biggest Mergers
Target
Acquirer
Value
Date
($ billions)
Mannesmann
Vodafone Airtouch
$172.2
2/2000
Time Warner
America Online
$112.1
1/2001
WarnerLambert
Pfizer
$111.8
6/2000
Mobil
Exxon
$85.6
12/1999
SmithKline
Glaxo Wellcome
$79.6
12/2000
Ameritech
SBC Communications
$76.2
10/1999
GTE
Bell Atlantic
$74.9
6/2000
Aventis SA
Sanofi-Synthelabo
$71.3
6/2004
Amoco
British Petroleum
$64.3
12/1998
Source: http://www.msnbc.msn.com/id/6880681/ Updated 7:24 PM.PT, Sun, February 15, 2009.
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Reasons for Merger/Acquisition
• Scale—gain revenue,
channels, etc.
• Geographic reach—access
new markets
• Customers—new lists
• Products—new products
for existing customers
• Segments—new vertical
markets
• Channels—new ways of
delivering same products
and services
• Employees—new talent
quickly
• Technology—adding key
capabilities
Source: “Preparing for the Merger/Acquisition Decision—How to Position Your Company in a Consolidating Collaboration &
Conferencing Marketplace,” Wainhouse Research, 2004, http://www.wainhouse.com/files/papers/wrprep4mna.pdf#search=%22%22merger%22%20%2B%20acquisition%20%2B%20trends%22
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Debate Issue: Should the Government
Restrict Corporate Merger Activity?
YES
• Takeovers and mergers do
nothing to increase the
productivity of the firm.
• Existing managers must
spend time and effort to
fend off hostile mergers—
time that could be invested
in product development.
• The only people that
benefit from corporate
takeovers and mergers are
the corporate raiders.
NO
• Firms that are taken over
are more productive
because unneeded assets
are sold.
• A takeover shakes up
existing management and
makes managers more
productive. Less productive
managers may be fired.
• Corporate raiders have a
basic right to take over a
firm if they can acquire
enough stock.
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Chapter Quiz
1. In the United States, the form of business ownership
that generates the largest amount of sales revenues
is the
a) sole proprietorship.
b) partnership.
c) corporation.
d) limited liability company.
e) S-corporation.
2. Which of the following is not an advantage of a sole
proprietorship?
a) Flexibility
b) No special taxes
c) Pride of ownership
d) Retention of all profits
e) Unlimited liability
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Chapter Quiz (cont’d)
3. A business co-owned by one or more general partners
who manage the business and limited partners who
invest money into it is called a
a) not-for-profit partnership.
b) limited partnership.
c) general partnership.
d) limited liability company.
e) S-partnership.
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Chapter Quiz (cont’d)
4. A corporation that received its corporate charter in
California and doing business in Oregon is called a(n)
____________corporation in Oregon.
a) alien
b) domestic
c) visiting
d) international
e) foreign
5. A ____________ is a merger between firms that make and
sell similar products or services in similar industries.
a) horizontal merger
b) vertical merger
c) conglomerate merger
d) hostile takeover
e) tender offer
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Answers to Chapter Quiz
1. In the United States, the form of business ownership
that generates the largest amount of sales revenues
is the
a) sole proprietorship.
b) partnership.
c) corporation. (Correct)
d) limited liability company.
e) S-corporation.
2. Which of the following is not an advantage of a sole
proprietorship?
a) Flexibility
b) No special taxes
c) Pride of ownership
d) Retention of all profits
e) Unlimited liability (Correct)
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Answers to Chapter Quiz (cont’d)
3. A business co-owned by one or more general partners
who manage the business and limited partners who
invest money into it is called a
a) not-for-profit partnership.
b) limited partnership. (Correct)
c) general partnership.
d) Limited liability company.
e) S-partnership.
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Answers to Chapter Quiz (cont’d)
4. A corporation that received its corporate charter in California
and doing business in Oregon is called a(n)
____________corporation in Oregon.
a) alien
b) domestic
c) visiting
d) international
e) foreign (Correct)
5. A ____________ is a merger between firms that make and sell
similar products or services in similar industries.
a) horizontal merger (Correct)
b) vertical merger
c) conglomerate merger
d) hostile takeover
e) tender offer
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