Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall 5-1.

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall5-1

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall. 5-2

Chapter 5

Copyright © 2015 Pearson Education, Inc. publishing as Prentice Hall.

There is no one “best” form of ownershipThe best form of ownership depends on an

entrepreneur’s particular situationThe key to choosing a form of ownership is

understanding how each form’s characteristics affect an entrepreneur’s specific business and personal circumstances

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Number of Days to Start a Business in the United States


Factors to consider: Tax considerationsLiability exposureStart-up and future capital requirementsControlManagerial abilityBusiness goalsManagement succession plansCost of formationCost of maintaining

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Forms of Business Ownership


Sole proprietorship: the simplest and most popular form of ownershipThe sole proprietor is the only owner and ultimate

decision maker for the business

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Advantages of a Sole ProprietorshipSimple to createLeast costly form to establishProfit incentiveTotal decision-making authorityNo special legal restrictionsEasy to discontinue

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Disadvantages of the Sole ProprietorshipUnlimited personal liability

Failure of the business can ruin a sole proprietor financially

Limited access to capitalLimited skills and abilitiesFeelings of isolationLack of continuity for the business

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Partnership: an association of two or more people who co-own a business for the purpose of making a profit

Take the time to create a written partnership agreement: a document that states all of the terms of operating the partnership for the protection of each partner involved Addresses in advance potential conflicts

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A partnership agreement contains:1. Name of the partnership2. Purpose of the business3. Location of the business4. Duration of the partnership5. Names of the partners and their legal addresses6. Contributions of each partner to the business, at the

creation of the business and later7. Agreement on how the profits or losses will be

distributed8. Agreement on salaries or drawing rights against

profits for each partner

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9. Procedure for expansion through the addition of new partners

10.Distribution of the partnership’s assets if the partners voluntarily dissolve the partnership

11. Sale of the partnership interest12.Absence or disability of one of the partners13.Voting rights14.Decision-making authority15.Financial authority16.Handing tax matters17.Alterations or modifications of the partnership agreement

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The Uniform Partnership ActUniform Partnership Act: codifies the body of law

dealing with partnerships in the United StatesThree key elements:

1. Common ownership interest in a business 2. Sharing the business’s profits and losses3. Right to participate in managing the partnership

Partners must abide by: Duty of loyalty Duty of obedience Duty of care Duty to inform

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Advantages of the PartnershipEasy to establishComplementary skills Division of profitsLarger pool of capitalAbility to attract limited partnersLittle government regulationFlexibilityTaxation

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Disadvantages of the PartnershipUnlimited liability of at least one partnerCapital accumulationDifficulty in disposing of partnership interestPotential for personality and authority conflictsPartners are bound by the law of the agency

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Limited PartnershipsLimited partnership: a partnership composed of at

least one general partner and one or more limited partnersThe general partner in a limited partnership is

treated exactly as in a general partnershipThe limited partner has limited liability and is treated

as an investor in the business The limited partner does not take an active role in

managing the business

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Limited Liability PartnershipsLimited liability partnership: a partnership in

which all partners in the business are limited partners, having only limited liability for the debts and obligations of the partnership Usually restricted to professionals – attorneys,

physicians, dentists, accountants, etc.

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Corporation: an artificial legal entity created by the state that can sue or be sued in its own name, enter into and enforce contracts, hold the title to and transfer property, and be found civilly and criminally liable for violations of the law

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C-corporations: creations of the stateDomestic corporation: a corporation doing business

in the state in which it is incorporated Foreign corporation: a corporation chartered in one

state and doing business in another stateAlien corporation: a corporation formed in another

country but doing business in the United States

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Publicly held corporation: a corporation that has a large number of shareholders and whose stock usually is traded on one of the large stock exchanges

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

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Requirements for incorporation: 1. The corporation’s name2. The corporation’s statement of purpose3. The company’s time horizon4. Names and addresses of the incorporators5. Place of business6. Capital stock authorization7. Capital required at the time of incorporation’8. Provision for preemptive rights, if any, that are

granted to stockholders

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9. Restrictions on transferring sharesTreasury stockRight of first refusal

10.Names and addresses of the officers and directors of the corporation

11. Rules under which the corporation will operateBylaws

Corporate charter: approved articles of incorporation

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Advantages of the CorporationLimited liability of stockholdersAbility to attract capital

Private placementPublic offering

Ability to continue indefinitelyTransferable ownership

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Disadvantages of the CorporationCost and time involved in the incorporation processDouble taxationPotential for diminished managerial incentives

Stock optionStock ownership plan

Legal requirements and regulatory red tapePotential loss of control by the founders

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Professional CorporationsProfessional corporation: offers professionals such as lawyers, doctors, dentists, accountants, and others, the advantages of the corporate form of ownership

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S corporation: a distinction that is made only for federal income tax purposesNo different from any other corporation from a legal

perspectiveFor tax purposes, however, an S- corporation is taxed

like a partnership, passing all of its profits (or losses) through to the individual shareholdersTo elect “S” status, all shareholders must consent,

and the corporation must file with the IRS within the first 75 days of its tax year

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S-corporations must meet the following criteria:Must be a U.S.-based corporationNo nonresident alien shareholdersOnly one class of common stockNo more than 100 shareholders (increased from 75)No more than 25% of corporate income from passive

investment sourcesCorporations and partnerships cannot be

shareholders

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Advantages of an S CorporationAll of the advantages of a regular corporationPasses all of its profits or losses through to individual

shareholdersIncome is only taxed once at the individual tax rate

Avoids the double taxation disadvantage of the C corporation

Avoids the tax C corporations pay on assets that have appreciated in value and are sold

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Disadvantages of an S CorporationTax advantages may not be permanent

When is an S Corporation a Wise Choice?Beneficial to start-up companies that anticipate net

losses and to highly profitable firms with substantial dividends to pay to shareholders

Also attractive to companies that plan to reinvest most of their earnings to finance growth

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

Two documents: Articles of organizationOperating agreement

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An LLC cannot have more than two of these four corporate characteristics:Limited liabilityContinuity of lifeFree transferability of interestCentralized management

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Nonprofit organizationsUses revenues to pursue social value rather than to

create personal value for investors To form a non profit organization:

File the certificate of incorporationPurpose clause

Select individuals to serve on the board of directorsDevelop a mission statementEstablish bylaws and board policiesFile require forms with the IRSDevelop a fund-raising plan

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For-Profit Social Venture Primary goal is creating social value, but

financial viability is requiredDual focus

Double bottom lineAre subject to market forces

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New Forms of Social VenturesThe low-profit limited liability company (L3C) is a cross

between a nonprofit and a for-profit LLCBuilds on the structure of the existing LLC; it provides

the liability protection of a corporation, can sell shares of ownership, and is not tax exempt

Formed to pursue a social missionMeant to integrate the best of both the nonprofit and

the for-profit LLC by creating a market for investments in financially risky but socially beneficial activities

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The L3C Versus the Traditional LLC and Nonprofit


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Documents

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prentice hall

written partnership

best form of ownership

popular form of ownership

costly form

sole proprietorship

financial authority