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Forms of Business Ownership and Buying an Existing Business

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Section 2: The Entrepreneurial Journey Begins

Explain the advantages and disadvantages of a sole proprietorship and a partnership.

Describe the similarities and differences of the C corporation and the S corporation.

Understand the characteristics of the limited liability company.

Explain the process of creating a legal entity for a business.

Understand the advantages and disadvantages of buying an existing business.

Define the steps involved in the right way to buy a business.

Understand how the negotiation process works and identify the factors that affect it.

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There is no one “best” form of ownership.

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

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

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Tax considerationsLiability exposureStart-up and future capital requirementsControlManagerial abilityBusiness goalsManagement succession plansCost of formation

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Sole ProprietorshipGeneral PartnershipLimited PartnershipCorporationS CorporationLimited Liability Company

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Simple to create

Least costly form to begin

Profit incentive

Total decision making authority

No special legal restrictions

Easy to discontinue

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Unlimited personal liability

The company’s debts are the owner’s debts.

Limited skills and capabilities

Feelings of isolation

Limited access to capital

Lack of continuity of the business

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

Always wise to create a partnership agreement: states in writing the terms under which the partners agree to operate the partnership and that protects each partner’s interests in the business.

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Three key elements of any partnership under RUPA:

1. Common ownership in a business.

2. Agreement on how the business’s profits and losses will be shared.

3. The right to participate in managing the operation of a partnership.

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Easy to establish

Complementary skills of partners

Division of profits

Larger pool of capital

Ability to attract limited partners

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General partners:Take an active role in managing a business.Have unlimited liability for the partnership’s

debts.Every partnership must have at least one

general partner.Limited partners:

Cannot participate in the day-to-day management of a company.

Have limited liability for the partnership’s debts.

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Two types of limited partners:1. Silent partners: Not active in a business but are

generally known to be members of the partnership

2. Dormant partners: Neither active nor generally known to

be associated with the business

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Easy to establishComplementary skills of partnersDivision of profitsLarger pool of capitalAbility to attract limited partnersMinimal government regulationFlexibilityTaxation

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Unlimited liability of at least one partner

Capital accumulationDifficulty in disposing of partnership

interest without dissolving the partnership

Potential for personality and authority conflicts

Partners bound by law of agency

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All partners in a business are limited partners.

Gives the advantage of limited liability for the debts of the partnership.

Does not pay taxes – income is passed through to the limited partners who pay taxes on their share of the company’s income.

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Corporation: a separate legal entity from its owners.

Types of corporations:Publicly held: a corporation that has a large

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

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

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Identify the company as a corporation by using “Inc.” or “Corporation” in the business name.

File all reports and pay all necessary fees required by the state in a timely manner.

Hold annual meetings to elect officers and directors.

Keep minutes of every meeting (formal and informal) of the officers and directors.

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Be sure that the corporation’s board makes all major decisions.

Make it clear that the business is a corporation – officers should sign all documents in the corporation’s name.

Keep corporate assets and the personal assets of the owners separate.

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(continued)

Traditional form of incorporation.Pays taxes at the corporate tax rate and

stockholders also pay taxes on dividends they receive at their individual tax rates.Double taxation: a disadvantage of the

corporate form of ownership in which the corporation’s profits are taxed twice, once at the corporate rate and again at the individual rate on the portion of profits distributed to shareholders as dividends.

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No different from any other corporation from a legal perspective.

An S corporation is taxed like a partnership, passing all of its profits (or losses) through to individual shareholders.

To elect “S” status, all shareholders must consent, and the corporation must file with the IRS within the first 75 days of its tax year.Follow 1/3, 1/3, 1/3 rule of thumb.

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Resembles an S Corporation but is not subject to the same restrictions.

Two documents required: 1. Articles of organization: creates an

LLC by establishing its name and address, method of management, its duration, etc.

2. Operating agreement: establishes for an LLC the provisions governing the way it will conduct business.

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The average cost to create a legal business entity is about $1,000, but it can range from $500 to $5,000.Can use Web sites like MyCorporation and

BizFilings and incorporate for just $100.But, be careful! The cost of filing

incorrectly can be high.States have different regulations on

forming business entities.

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Is the right type of business for sale in the market in which you want to operate?

What experience do you have in this particular business and the industry in which it operates? How critical is experience in the business to your ultimate success?

What is the company’s potential for success?What changes will you have to make – and

how extensive will they have to be – to realize the business’s full potential?

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What price and payment method are reasonable for you and acceptable to the seller?

Is the seller willing to finance part of the purchase price?

Will the company generate sufficient cash to pay for itself and leave you with a suitable rate of return on your investment?

Should you be starting a business and building it from the ground up rather than buying an existing one?

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(continued)

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It may continue to be successfulIt may already have the best locationEmployees and suppliers are establishedEquipment is already installedInventory is in place and trade credit is

establishedIt’s turnkeyNew owners can “hit the ground running”New owners can use the previous owner’s

experienceFinancing is easier to obtainIt’s a bargain!

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The financial costs are highIt’s a “loser”Previous owner may have created ill will“Inherited” employees may be unsuitableThe location may have become unsatisfactoryEquipment and facilities may be obsolete or

inefficientChange and innovation can be difficult to

implementInventory may be outdated or obsoleteAccounts receivable may be worth less than face

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Study: 50 to 75% of all business sales that are initiated fall through.

The right way:

Analyze your skills, abilities, and interests.

Develop a list of criteria Prepare a list of potential candidates. Investigate and evaluate candidate

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Explore financing optionsPotential source: the seller

Negotiate a reasonable deal Ensure a smooth transition

Communicate with employeesBe honestListenConsider asking the seller to serve

as a consultant through the transition

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Go into negotiations with a list of objectives ranked in order of priority.

Try to understand what the seller’s priorities are.

Work to establish a cooperative relationship based on honesty and trust.Avoid an “if you win, then I lose”

mentalityLook for areas of mutual benefit

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