Organizational Forms

Sole Proprietorship

Partnership

Corporation

Subchapter S Corporation

Limited Liability Partnership

Limited Liability Companies

Limited Partnership

Non-Profit Entity

Important Considerations

Control: How many cooks are in the kitchen?

Flexibility: A sports car or a battleship?

Liability: Who gets left holding the bag?

Longevity: Nobody lives forever…

Access to Capital: Sweat equity or OPM?

Taxation: Once, twice, or not at all?

Bureaucratic BS: How red is the tape?

Cost: Pay a little or pay a lot?

Sole Proprietorship

Simplest to start and maintain Most common structure Least costly Highest personal risk Income is taxed as personal income

Sole Proprietorship Taxation Taxable income “passes through”

the business Personal income and business

income are combined and taxed as one

May put you in a higher tax bracket Losses can be used to offset

personal income

Sole Proprietorship Taxes

Form 1040 Schedule C or Schedule C-EZ: Profit

and Loss From Business -- Sole Proprietorship

Form 1040 ES: Acceleration Estimate Tax for Individuals -- Must estimate expected income tax for the coming year

Quarterly vouchers and payments

Sole Proprietorship Legal Stuff

No registration required if business is in your own name

If you change the name or use anything other than your own name, must file Certificate of Conducting Business Under An Assumed Name with Secretary of State.

Right of Survivorship Document – Says what will happen in case of your death

To end business – Liquidate assets, pay off debts, and walk away.

Sole Proprietorship Summary

Control: You’ve got it allFlexibility: It’s your decision (alone)Liability: You’ve got it allLongevity: Nobody lives forever…Capital: Your money, bank debt, and trade

creditTaxation: Once, but not many breaksBureaucratic BS: Almost noneCost: Very little

Partnership

Use if more than one person’s capital Can be oral or written, but non-idiots

put it in writing Terminates with the death of any

partner in most states – Can use “Key Man” insurance to provide for the continuation of the partnership

Liability is joint and several unless there are limited partners

Partnership Taxes

Form 1040 with proportional share of partnership income

Form 1065: US Partnership Return of Income

Schedule K-1: Partner’s Share of Income Credits, Deductions, etc.

Each partner calculates and files an estimated tax

Quarterly vouchers and payments

Types of Partnerships

General Partnership Partners are equally liable (joint and

several) Share workload and decision making Operates on a calendar year Generally cash-based accounting

Types of Partnerships

Limited Partnership One or more partners are merely

investors and do not participate in running the business or making decisions.

Limited partners have share of ownership but liability is limited to the amount of the investment

Must have at least one general partner

Partnership Legal Stuff

The partnership name and information about the partners must be filed

Written partnership agreement is optional

Estate planning (what happens when a partner dies) is essential, but complicated

All personal assets of all general partners are at risk

Partnership terminates with the death of any partner unless partnership agreement specifies otherwise

Partnership Summary

Control: Shared between the partners

Flexibility: Now it’s a committee...

Liability: Joint and several

Longevity: Nobody lives forever…

Capital: Partners’ money and some debt

Taxation: Once, but not many breaks

Bureaucratic BS: Some - Partnership agreements, more stringent records

Cost: Very little

Corporations Most difficult and costly to set up Provides the most benefits to the owners Separate legal entity – provides limited liability for

all owners Best access to capital markets Easiest in which to transfer ownership Income is taxed twice – once at the corporate

level and once at the personal level – but otherwise gets very favorable tax treatment

Most closely scrutinized by the US Government and (if publicly traded) by the SEC

The Corporate Form of Organization

Ownership

The shareholders (also known as stockholders or equity holders) are the owners of the corporation.

Control

Ultimate control rests with the shareholders, but the managers control the day to day operations.

Risk Bearing

While all parties associated with the corporation bear risk, shareholders bear all residual risk.

Flow of Control in a Corporation

Shareholders

Board of Directors

Managers

Corporation Taxes

VERY complicated and constantly changing

Owners file a Form 1040 with personal and dividend income included

The Corporation files a Form 1120 – US Corporation Income Tax Return – if gross receipts, total income, or total assets are over $500,000

Form 1120A (Short form) if any of the three are under $500,000 (… some other rules)

Corporation Summary

Control: LOTS of cooksFlexibility: Now it’s a BIG committee...Liability: Limited personal liabilityLongevity: Nobody lives forever… So what?Capital: Best access of all formsTaxation: Twice, but many deductions and

breaksBureaucratic BS: Lots and lots and lots

and…Cost: Can be substantial

Rights of Ownership in Corporations

Dividend Rights

Voting Rightsmajority voting

one vote per share per director

cannot combine votes

cumulative votingdirectors are voted on jointly

can cast all votes for a single candidate

Rights of Ownership (contd.)

Liquidation RightsOwners have the right to a

proportional share of the firm’s residual value in the event of liquidation, after other senior claims are paid.

Preemptive RightsOwners have the right to subscribe

proportionally to any new shares issued by the firm.

Forming a Corporation

What do you need? $50 (In Mississippi) Company name (unique) Directors Business address [Federal Tax ID] [Corporate Charter]

Interesting Statistics

Number of US businesses Number of US businesses by revenue size Number of US corporations by Industry Number of US sole proprietorships by

industry Number of US partnerships by industry Number of businesses by state Most popular small businesses

Businesses by State

BusinessesByState.xls

Need Help?

Small Business Development Center

Sec. Of State - www.sos.state.ms.us

MyCorporation.com

Incorporate USA

Company Corporation

CorpAmerica

BizFilings.com

Quick-Inc.com

Subchapter S Corporation

Owners retain limited liability

Taxed as a partnership - eliminates double taxation and makes it easier for owners to be compensated

All profits are taxed and distributed annually

Subchapter S Corporation

A corporation can elect S-Corp status within 75 days of formation if:

1. It is a domestic corporation (i.e., it operates in the state in which it is franchised

2. There is only one class of stock

3. It has 75 or fewer stockholders

4. All stockholders are US citizens or resident aliens

5. There are no subsidiaries

Limited Liability Company (LLC)

Owned by “members” who may run the company or appoint managers to do it

Members and managers have limited liability

Taxed like a Subchapter S Corporation without having to conform to the S Corp restrictions

Limited liability can make it harder to raise capital - may require personal guarantees

Limited Liability Partnership (LLP)

Also called a Professional CorporationUsed primarily by those who render

professional services - lawyers, doctors, architects, social workers, etc.

Some tax advantages - possible tax shelter

Not much liability limitation

Information Sources

The Quick-Inc Guide to Business Entities

LLCs on MyCorporation.com

LLCs on BizFilings.com

BizFilings.com Comparison of:C Corp to S Corp, S Corp to LLC,

C Corp to LLC

Piercing the Corporate Veil

Creditors may attempt to recover money from shareholders if:

The business was initially underfunded or “thinly capitalized”

The owners failed to treat the business as a separate entity themselves:

Fail to use Inc. or Corp or LLC in dealings

Co-mingle assets or funds

Fail to keep good records and hold meetings

The Goal of the Firm

Better defined than profits Is an objective external measure Considers timing of cash flows Considers all internal and external

factors Considers risk differences between

alternative courses of action

“Maximize Shareholder Wealth”

Three Types of Decisions

Investment Decisions

How should capital be invested?

Financing Decision

How should the assets be financed?

Managerial Decisions

How large should the firm be?

How fast should it grow?

Should the firm grant credit to a customer?

How should the managers be compensated?

The Investment Vehicle Model of the Firm

Investors provide financing to the firm in exchange for financial securities.

Firm invests these funds in assets. Income generated by the firm is

distributed to the investors. Managers act in the best interest of

the shareholders, and take actions to maximize shareholder wealth.

The Investment Vehicle Model of the Firm

TheWorld

Investors

The Firm

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FinancialIntermediaries

FinancialMarkets

Corporate Financial Management

Financial Markets and Intermediaries Investments

Exchange of Money and Financial

Assets

Exchange of Money and Real Assets

The Accounting Model of the Firm

Balance sheet view of the firm. Investment decisions are represented

on the asset (i.e. left hand) side of the balance sheet.

Financing decisions are represented on the liabilities and equity (i.e. right hand) side of the balance sheet.

Long Term Liabilities

Long Term Debt

Current Debt

The Investment Decision

Current Assets

Cash

Marketable Securities

Accounts Receivable

Inventory

The Accounting Model of the Firm

The Financing Decision

Current Liabilities

Accounts Payable

Current Debt

Shareholder’s Equity

Common Stock

Retained Earnings

Total Fixed Assets

Tangible Fixed Assets

Intangible Fixed Assets

Net Working Capital

Set of Contracts Model of the Firm The firm has contracts with a large

number of stakeholders. These contracts may be explicit or

implicit. Contracts may also be contingent on

particular future outcomes. The model recognizes that conflicts of

interest may exist between the various stakeholders.

Set of Contracts Model of the Firm

PreferredStockholders

Banks

CommonStockholders

Bondholders

Customers

Governments

Communities

Creditors

ManagersSuppliers

Society

Environment

Employees

The Firm

The Agency Model of the Firm

Managers have day-to-day operational control of the modern corporation and are supposed to act as agents for the shareholders.

Managers have goals that differ from those of the shareholders.

Shareholders must incur costs to make sure that their "agents" act in their best interests.

Monitoring costs Incentive costs

Notes on sources for this presentation

This presentation includes material provided in the Chapter 2 slide presentation for Corporate Finance by Emery and Finnerty (Prentice Hall)

and

Chapter 3 in Ready or Not, Get Set Go by Sheila Taylor-Downer (Professional Prodigy, Inc.)