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Business Ownership
Chapter 7
3 Basic Types of Business Ownership
S o le P rop rie to rsh ip P artn ersh ip C orp ora tion
B u s in ess O w n ersh ip
Characteristics: compare & contrast
Formation Source of funding Liability Tax implications Management and control Transferability
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).
Compare and Contrast
Sole Proprietorship
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
Sole Proprietorship Advantages DisadvantagesFormation Easy establishment
Low start up cost
Source of funding Limited financial resources
Liability Unlimited Liability
Tax implications No corporate income taxes
Income tax deduction of business losses
Management and control
Self control of all operations
retention of all profit
Limited management resources and skills
Transferability Limited life
(lack of continuity)
Others Freedom, pride pressure
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.
Questions to answer before you start your own business:
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?
Partnership
A business that is owned and run by two or more people who share responsibilities, profits, and unlimited liability
A voluntary association of two or more persons to carry on a business as co-workers 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
Partnership Advantages DisadvantagesFormation Easy establishment
Source of funding
Combined financial resources
Easier capital and credit
Liability Unlimited Liability
Tax implications
No corporate income taxes
Management and control
Combined managerial knowledge and skills, shared responsibilities
Transferability Extended life Potential lack of continuity; difficult ownership transfer
Others Retention of profits Possible interpersonal conflicts and management disagreement
Types of Partners and Partnership 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
The Partnership Agreement
Articles of partnership• An agreement listing and explaining the
terms of the partnership• Should include
• 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
Voluntary Partnership(Articles of Partnership)
Names of partners Name of partnership Nature of business Time frame of operation Capital contribution Managerial power Rights and duties Accounting procedures P/L sharing Salaries Dissolution Property distribution
Disability issues Insurance coverage Sale of interest Divorce of one
partners Indemnity agreements Non-competition
agreement Leaves of absence
Limited Partnership
at least one general partner• Has to have agreement, with “Limited
Partnership” in business name• Promise to contribute in writing• Liability limited to investment
• Certificate for limited partner status
• Not involve in management
• Personal name not appear in business name
Corporation
A business that exists separately from its owners and is permitted to sell stocks
An artificial being, (a legal person), invisible, intangible, and existing only in contemplation of the law.
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
Corporation Advantages Disadvantages
Formation Difficulty / complex / high cost starting
Source of funding Greater Financial Capital(stock & loans)
Liability Liability Limited to the amount paid for stocks
Tax implications Double taxation
Management and control
Specialized Management
Internal Conflicts
Transferability Increased Liquidity Unlimited Life
Hostile takeover (tender offer)
Others Government regulations and paperwork
Corporate Ownership Corporate ownership
• Stock• The shares of ownership of a corporation
• Stockholder• A person who owns a corporation’s stock
Types of corporation• 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
Incorporation: the process of formation
Where to register: law, tax, employees, incentives Documents: Articles of Incorporation
• Name of corporation
• Names and addresses of all incorporators
• Share structure: common vs. preferred; vote; rights
• Statutory agent
Incorporator: natural person, corporation, (limited)
partnership, association
Where to incorporate In US, 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 in which it is incorporated
Alien corporation• A corporation chartered by a foreign government and
conducting business in the U.S.
Document: 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
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
• With voting rights
• No fixed dividend rate
• No right to declare dividend
• Right to share of assets at dissolution 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
• Priority in payment of dividends
• Some dividends at fixed rate, some guaranteed (cumulative preferred)
• Priority in assets distribution at dissolution
Dividend: A distribution of earnings to the stockholders
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 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
Bylaws: after formation
Operational rules: Define the authority of each elected officer Prescribe procedures for meetings Set terms of officers and directors
Corporate Governance Structure Shareholders: owners
• Preferred stocks: first to be paid; not voting right
• Common stocks: last to be paid; with voting right
Board of Directors: • Elected by shareholders
• Oversees corporate management: policies
Corporate Officers: CEO, President, VPs, (directors)• Hired by the board
• Day-to-day operations
Corporate Governance Structure
Shareholders: • Electing directors
• Voting on critical issues• Delegating votes:
– Proxy: temporarily transfer voting rights to others
– Pooling agreements: a contract to vote for the same thing
– Voting trust: turn shares to a trustee, with a certificate, the trustee votes according to agreements
Corporate Governance Structure
Board of directors:
strategic planning and policy making• 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 Executive Committee: management (3 board members) Audit Committee: watch dog (independent outside directors)
Corporate Governance Structure Corporate Officers
chairman of the board
president ; executive vice presidents
corporate secretary, treasurer,
other top executives Implement the chosen strategy and
direct the work of the corporation, periodically reporting results to the board and stockholders
Corporate Governance StructureHannas Natural Gas
http://www.mbi.com.cn/Html/About-jigou1.asp?ID=100
Sources of funding:
Short-term financing:• bank loans, credit lines• higher interest rates; shorter payback periods
Debt financing: bond• long-term promissory notes• fixed interest rate, tax deductible• rating
Special Types of Corporations
S corporation vs. C corporation
(for tax purpose, with limitations) LLC: Limited Liability Corporation Government-owned corporation Not-for-profit corporation
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
S-corporation
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
LLC Advantages disadvantages
Formation Difficulty/complexity starting
Source of funding Greater Financial Capital
Liability Limited Liability
Tax implications Double taxation
Management and control
Specialized Management
Transferability Increased Liquidity Unlimited Life
LLC Formation: articles of organization, with LLC in
business name Funding: member contribution as in partnership Liability: limited to contribution Tax: flow through (individual tax only) Management and Control: collective, delegate, hire Transferability: transferee becomes a member with
majority approval Dissolution and termination: death, withdrawal,
expulsion of a member, unanimous consent
C, SC, LLC
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)• the Federal Deposit Insurance Corporation
(FDIC)
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
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
Strategic Alliance
Two or more organizations collaborate on a project for mutual gain• Expand Market Share
• Access Technology
• Diversity Offerings
• Share Best Practices
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• Attain Specific Goals
• Share Strengths
• Spread Cost
• Minimize Risk
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
ESOP and Institutional Ownership
Employee Stock Ownership Plan:• Employee owns a substantial share of the
corporation• Employee trusts
Institutional Ownership:• Mutual funds• Pension funds
Corporate Growth throughJoining Companies
Mergers / Consolidations : two firms combine to create a new company
Acquisition: one firm buys another out right. The other firm becomes a part of the firm and only one firm’s name is retained, and it assumes automatically all assets and all liabilities of the other. increase product line
expand operations globalize
Business Combination Procedures
Board resolution: Notice to shareholders: Shareholder approval:
• Merger / consolidation: all shareholders have right to vote
*short-term merger: between a subsidiary and a parent that owns at least 90% of its stock
*appraisal rights: written objection before voting, right to sell shares to the corporation for fair value
*freeze-out: use merger as a way to buy back minority shares at low price
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
Acquisitions
Advantages :• Economies of Scale • Efficiencies • Synergies
Disadvantages :• High-Risk Corporate Debt
• Leveraged buyouts: a large fraction of the purchase price is debt financed (below investment grade); the shares no longer traded in the open market
• Management Distractions • Culture Clashes
Growth by Merger
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
Pros and Cons of Merger
advocates: • 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 opponents:
• 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
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.
Hostile Takeover Not solicited and approved by the target’s
management (proxy fight; tender offer)• a situation in which the management and board of
directors of the firm targeted for acquisition disapprove of the merger
Types• Tender offer:
• direct offer to shareholders• 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: • seek stockholder support at annual meeting
• a technique used to gather enough stockholder votes to control the targeted company
Defenses against Hostile Takeover
Poison pill: shareholder rights to buy future shares at bargain price
Golden parachute: generous payoff to management going out
Shark repellent: changes in company charter - staggered board, supermajority; fair price
White knight:
Ownership ChangesSeparating Companies
Divestiture: sell a part of the firm’s business operations• Focus on core business;• Sell unrelated or under-performing
Spin-off: sell part of the company to raise capital• set it up as a new and independent corporation
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