In chapter four, we consider the various options that are available for organizing a business. The organization of a business is very important as it affects how it operates, how much tax it pays, and how much control the owners have. We will consider the primary forms of business ownership that include sole proprietorship, partnerships, and corporations. In addition, the advantages and disadvantages of each form of organization will be discussed.
A business’s legal form of ownership affects how it operates, how much in taxes it pays and how much control its owners have.
Notice that sole proprietorships far outnumber corporations or partnerships in the United States, but that they bring in the smallest share of sales and income. Corporations tend to be much larger and therefore represent the majority of sales and income.
Many sole proprietorships focus on services.
Partnerships can consist of two or more individuals, or of organizations. Large organizations even occasionally form strategic partnerships in order to take advantage of the other’s knowledge and skills. A formal articles of partnership document is not always required, but is highly recommended as it formally lays out the terms of the partnership.
A limited partner’s primary role is to provide funding for the partnership. Limited partnerships are most common in risky industries where the chance of loss is great.
Legal documents that solidify the basic agreement between partners. Not all states require an articles of partnership, but it is highly recommended.
A limited partner’s primary role is to provide funding for the partnership. Limited partnerships are most common in risky industries where the chance of loss is great.
The corporation is what most people think of when they think of businesses. This is because they tend to be larger and more visible than other forms of business organization. They are also longer-lived. Stocks are shares of the business that individuals and organizations can purchase to become partial owners. Sometimes, a corporation’s profits are distributed to shareholders through dividends, which are cash payments that many (but not all) corporations make.
Every state has a different procedure for incorporation. Some states are considered easier than others.
These terms may seem strange to students. A foreign corporation is not a corporation from another country, but rather one doing business in a state in which it is not incorporated.
Private corporations tend to be smaller, and they do not issue stock. Private corporations go public through an initial public offering. Some private corporations are forced to go public in order to quickly raise funds (such as when a principle owner dies).
There are a number of different kinds of corporations that work a bit like hybrids. Quasi-public corporations and non-profits have different goals than most other corporations– namely, they are not motivated as much by profits.
Some of the important duties of the Board are to select the chairman of the board, and president and CEO of the company. Boards of directors are legally liable for mismanagement of the firm, even though many board members are not involved in day-to-day operations of the company. No matter how hands-off it is, the board remains legally culpable for the actions of a firm. Directors can come from within or outside the company. It is essential to have a knowledgeable, well-qualified and independent board of directors. Many companies in recent years could have staved off disaster if their boards had been better equipped to deal with problems.
Preferred stock owners are a special class because they receive dividends first. Most preferred stock shares have a cumulative claim to dividends, meaning if a company does not pay dividends one year, preferred stock holders will receive those accumulated dividends the next year. Common stockholders do not always get dividend payments, but they are the voting owners of the corporation and therefore get a say in the decisions of the business. Common stockholders also have preemptive right to purchase new shares of stock when they are issued (another perk over preferred shareholders).
The following are less common alternative types of business ownership. They all have their pros and cons.
S-Corporations, because of their limits on shareholders, tend to be smaller businesses. This may be a good organizational form for a small business, however, and is popular with entrepreneurs.
There are different ways to merge, as outlined in this slide.
Acquisitions are not always welcome by the corporation being acquired, and the business may fight the process.
Chapter five examines the expanding world of entrepreneurship and small business. We will investigate the importance of small business in the U.S. economy, specify the advantages of small-business ownership and summarize the disadvantages of small businesses. Let’s examine small business and the incredible economic impact that it has.
Many well-known large businesses started out as small businesses (Dell Computers, McDonald’s, Levi Strauss) run by entrepreneurs.
Defining what constitutes a small business can be difficult because “small” is a relative term. This text uses the Small Business Administration definition of a small business as defined in the slide.
Small businesses are vital to the global economy. They represent nearly all firms in the United States, and nearly half of sales. They are a key source of innovation and help to provide for the communities in which they are located.
Small business owners generally do not worry about achieving economies of scale; they can be more flexible and produce in smaller batches– therefore they often excel at customization
Many successful entrepreneurs share certain personality traits, as outlined in the table above.
Small businesses tend to be concentrated in industries where start-up costs are not high (such as retailing and services). However, certain areas of manufacturing and high technology can be appealing to small businesses as well. Small businesses can often provide a level of customization and personalized customer service that large businesses cannot.
Undercapitalization means lacking sufficient funds to operate business normally– this can be a major problem for small businesses.
Starting a business can be a daunting undertaking with a steep learning curve.
The business plan is an important document, as it helps to lay out systematically the plan for the business, its goals and how they are to be achieved.
Forms of business ownership were discussed in chapter 4.
A large hurdle for many small businesses will be finding sources of capital with which to start the business and keep it running– especially during the first few years when it may not be making a profit.
The owner is the most important source of financing for a new small business. Owners’ personal resources may be used to receive financing to help get the business off the ground. The owner can provide working capital too by reinvesting profits into the business or not drawing a full salary.
Venture capitalists can be an important source of funding– especially if your business is in an industry with high growth potential (such as renewable energy).
The Small Business Administration offers financial assistance to qualifying businesses . Most formal loans require collateral, which is a financial interest in the property or fixtures of the business. In the case that the loan is not paid off, the collateral serves to make up the loss.
Small businesses may obtain a line of credit from their suppliers called trade credit , which means that businesses can take possession of needed goods and pay suppliers later. Bartering is less common and involves trading goods/services for another business’s goods/services.
Buying a franchise has many benefits and can take the guesswork out of starting a business. However, franchisees often need to have a lot of capital at their disposal and must have stellar credit histories.
Being a small business owner can be a daunting challenge. Luckily, local and state governments, non-profits and the Small Business Administration all offer programs and classes that can help. Other small business owners can be a great resource for information and advice.
Shifting demographics will create new opportunities and threats for small businesses. Aging Baby Boomers, Generation Y’s unique needs and increasing immigrant populations are all changing the types of products and services that are most in demand in the United States.
Technological advances have created new ways for businesses to reach consumers and conduct business. They have also opened up new industries in which small businesses can find a niche. Energy is going to be a major industry of the future.
Even large companies can benefit from “acting small”.
Sole ProprietorshipBusinesses owned and operated by oneindividual; the most common form of businessorganization in the United States 15-20 million in the U.S. Nearly three-quarters of all businesses Men 2x more likely than women to start own business o Restaurants o Hair salons o Flower shops o Dog kennels o Independent grocery stores FHF 4-5
Sole ProprietorshipAdvantages DisadvantagesEase and cost of formation Unlimited liabilitySecrecy Limited sources of fundsDistribution and use of profits Limited skillsFlexibility and control of the business Lack of continuityGovernment regulation Lack of Qualified EmployeesTaxation Taxation FHF 4-6
PartnershipA form of business organization defined by theUniform Partnership Act as “an association of twoor more persons who carry on as co-owners of a businessprofit” General partnership Limited partnership Articles of Partnership • Legal documents that set forth the basic agreement between partners FHF 4-7
Two Types of PartnershipsGeneral PartnershipA partnership that involves a complete sharing in boththe management and the liability of the businessLimited PartnershipA business organization that has at least one general partner, who assumesunlimited liability, and at least one limited partner whose liability is limited to hisor her investment in the business FHF 4-8
Articles of Partnership Name, purpose, location Duration of the agreement Authority and responsibility of each partner Character of partners (i.e., general or limited, active or silent) Amount of contribution from each partner Division of profits or losses Salaries of each partner …continued on next page FHF 4-9
Articles of Partnership How much each partner is allowed to withdraw Death of partner Sale of partnership interest Arbitration of disputes Required and prohibited actions Absence and disability Restrictive covenants Buying and selling agreements FHF 4-10
PartnershipsAdvantages DisadvantagesEase of organization Unlimited liabilityCapital & credit Business responsibilityKnowledge & skills Life of the partnershipDecision making Distribution of profitsRegulatory controls Limited sources of funds FHF 4-11
CorporationsLegal entities created by the state whose assets andliabilities are separate from its ownersHave most of the rights of peopleTypically owned by shareholders /stockholdersA corporation is created (incorporated) under the laws of the state in which itincorporates The individuals creating the corporation are called incorporators FHF 4-12
Articles of IncorporationLegal documents filed with basic informationabout the business with the appropriate state office(often the Secretary of State)Common elements: Name & address of corporation Objectives of the corporation Classes of stock (common, preferred, voting, nonvoting) and number of shares of each class of stock Financial capital required at time of incorporation …continued on next page FHF 4-13
Articles of Incorporation Provisions for transferring shares of stock Regulation of internal corporate affairs Address of business office Names and addresses of the initial board of directors Names and addresses of the incorporators The state issues a corporate charter based on the information in the articles of incorporation. FHF 4-14
Types of Corporations A corporation doing business in the state in which it is chartered is a domestic corporation. When a corporation does business in other states, it is then referred to as a foreign corporation. If a corporation does business outside the nation in which it is incorporated, it is termed an alien corporation. FHF 4-15
Types of CorporationsPrivate CorporationA corporation owned by just one or a few people who areclosely involved in managing the businessPublic CorporationA corporation whose stock anyone may buy, sell, or tradeInitial Public OfferingA private corporation who wishes to go “public” to raise additional capital andexpand. The IPO is selling a corporation’s stock on public markets for the firsttime …continued on next page FHF 4-16
Types of CorporationsQuasi-Public CorporationCorporation owned and operated by the federal, state,or local governmentNASA, U.S. Postal ServiceNon-Profit CorporationFocuses on providing a service rather than earning a profit but is not owned bya government entityMercy Corps., The Conservation Fund FHF 4-17
Elements of a CorporationBoard of Directors: A group of individuals, electedby the stockholders to oversee the general operationof the corporation, who set the corporation’s long-rangeobjectives.Inside Directors Individuals who serve on a board and are employed by the corporation (usually executives of the corporation)Outside Directors Individuals who serve on a board who are not directly affiliated with the corporation (usually executives of other corporations) FHF 4-18
Stock OwnershipPreferred StockA special type of stock whose owners, though not generally having a say inrunning the company, have a claim to profits before other stockholders do.Common StockStock whose owners have voting rights in the corporation, yet do not receivepreferential treatment regarding dividends. FHF 4-19
CorporationsAdvantages DisadvantagesLimited liability Double taxationTransfer of ownership Forming a corporationPerpetual life Disclosure of informationExternal sources of funds Employee-owner separationExpansion potential FHF 4-20
Other Types of Business OwnershipJoint VentureA partnership established for a specific project or for a limited timeControl can be divided equally, or with one party taking more responsibility fordecision makingS-Corporation (S-Corp)Corporation taxed as though it were a partnership (no double-taxation) withrestrictions on shareholders.Very popular with entrepreneurs …continued on next page FHF 4-21
Other Types of Business Ownership: S-CorporationsSubchapter S-CorporationPopular because the form eliminates double-taxationCombines the taxation structure of partnerships with legalenvironment of C-corporationsQualifications: • Only 1 class of stock • Less than 100 shareholders • Shareholders must be U.S. citizens or residents …continued on next page FHF 4-22
Other Types of Business Ownership: Limited LiabilityLimited Liability Company (LLC)Form of ownership that provides limitedliability and taxation like a partnership butplaces fewer restrictions on members …continued on next page FHF 4-23
Other Types of Business Ownership: CooperativeCooperative (Co-Op)An organization composed of individuals or smallbusinesses that have banded together to reap the benefitsof belonging to a larger organization Can take many different forms (retail, housing, social, worker) Co-ops are increasingly popular with small farmers and artisans Gives small producers more power as a group FHF 4-24
Trends in Business OwnershipMergerThe combination of two companies (usually corporations)to form a new companyHorizontal merger: When firms that make and sell similar products merge.Vertical merger: When companies operating at different but related levels of anindustry merge.Conglomerate merger: When firms in unrelated industries merge. …continued on next page FHF 4-25
Trends in Business OwnershipAcquisitionThe purchase of one company by another, usually by buyingits stock and/or assuming its debt.Corporate raider: A company or individual who wants to acquire or take over anothercompany and first offers to buy some or all of its stock at a premium in a tender offer.Poison pill: The firm allows stockholders to buy more shares of a stock at lower pricesthan the current market value to head off a hostile takeover.Shark repellant: Management requires a large majority of stockholders to approve atakeover.White knight: A more acceptable firm that is willing to acquire a threatened company. …continued on next page FHF 4-26
Trends in Business OwnershipLeveraged Buyout (LBO)A purchase in which a group of investors borrows money from banksand other institutions to acquire a company (or a division of one), using theassets of the purchased company to guarantee repayment of the loan.Mergers and acquisitions (particularly the merger mania in the late 20thcentury) have been criticizedExecutives have to focus excessively on avoiding takeovers, not on managingthe business FHF 4-27
part Starting and Growing 2 A Business CHAPTER 4 Options for Organizing Business CHAPTER 5 Small Business, Entrepreneurship, and FranchisingFHF 5-2
Entrepreneurship[ ] The process of creating and managing a business to achieved desired objectives FHF 5-3
What is Small Business? “Smallness” is relative Small business is any independently owned and operated business, not dominant in its competitive area Employs less than 500 people FHF 5-4
Small Businesses Represent 64% of new net jobs, annually, created in the last 15 years 99.7% of all businesses employ fewer than 500 people 89% of businesses employ fewer than 19 people FHF 5-6
Small Business InnovationSmall businesses represent 55%of all innovationsAirplaneAudio tape recorderDouble-knit fabricFiber-optic examining equipmentHeart valveOptical scannerPersonal computerSoft contact lensesZipper … and much more FHF 5-7
Popular Industries for Small BusinessEspecially attractive industries to entrepreneurs:Retailing and wholesalingServicesManufacturingHigh technology FHF 5-9
Retailing and WholesalingSelling directly to consumersMusic storesSporting-goods shopsDry cleanersBoutiquesDrugstoresRestaurantsHardware stores FHF 5-10
Services and ManufacturingServicesService sector is 80% of U.S. jobs Attracts individuals whose skills are not required by large firmsManufacturingSmall manufacturers excel at customizationThe Malcolm Baldridge National Quality Award rewardsinnovative small manufacturing firms FHF 5-11
High TechnologyBusinesses that depend heavily on advancedscientific and engineering knowledge.40% of high-tech jobs are with small businessesThe government offers small business grants for high-techcompanies FHF 5-12
Small Business OwnershipAdvantages DisadvantagesIndependence High stress levelCosts High failure rate 50% of all new businesses fail within the first 5 yearsFlexibility Undercapitalization Lack of funds to operate normallyFocus Managerial inexperience or incompetenceReputation Inability to cope with growth FHF 5-13
Starting a Business Start with a concept or general idea Create a business plan Devise a strategy to guide planning & development Make decisions • Form of ownership • Financing • Acquire existing business or start new business? • Buy a franchise FHF 5-14
The Business Plan A precise statement of the rationale forthe business and a step-by-step explanationof how it will achieve its goals. Acts as a guideand reference document.Explanation of the businessAnalysis of competitionIncome/Expense estimates FHF 5-15
Forms of Business Ownership Sole Proprietorship Partnership Corporation FHF 5-16
Financial ResourcesProvide your own personal capitalCash moneyObtain capitalFinancing optionsLoansStocksEquity financing FHF 5-17
Equity Financing[ ] Selling or borrowing against the value of an asset such as an (automobile, insurance policy, savings account) to obtain funds to operate a business FHF 5-18
Venture Capitalists[ ] Persons/organizations that agree to provide funding for a new business in exchange for an ownership interest or stock. Usually requires a sharing of ownership/control FHF 5-19
Debt Financing[ Borrowing financial resources typically from a bank or lending institution– often collateral is needed ] FHF 5-20
Line of Credit[ An agreement by which a financial institution promises to lend a business a predetermined sum on demand ] FHF 5-21
Starting from Scratch vs. Buying an Existing BusinessStarting from scratch can be expensiveand will require a lot of promotional effortsto familiarize customers with the businessExisting businesses have the advantage of a built-in network ofcustomers, suppliers and distributorsReduces guessworkInvolves taking on any problems the business already had FHF 5-22
FranchisingA license to sell another’s products or to useanother’s name in business, or bothFranchiser The company that sells a franchiseFranchisee The purchaser of a franchise FHF 5-23
FranchisesAdvantages DisadvantagesTraining & support Fees and profit sharingBrand name appeal Standardized operationsNational advertising Restrictions on purchasingFinancial assistance Limited product lineProven products Possible market saturationGreater chance for success Less freedom in decisions FHF 5-24
Help for Small Business Managers Organizations and programs exist to help small businesses Small Business Administration Small Business Development Centers Service Corps of Retired Executives Active Corps of Executives Small Business Institutes U.S. and Local Departments of Commerce Other small businesses FHF 5-25
The Future for Small BusinessDemographic TrendsThe Baby BoomersGeneration Y (Millennials)Immigrants and shifting demographics …continued on next page FHF 5-26
The Future for Small BusinessTechnological & Economic TrendsInternet usage continues to increaseIncrease in service exportsEconomic turbulenceDeregulation of the energy market & alternative fuels FHF 5-27
Big Businesses Acting SmallCommon ApproachesLarge firms emulate smaller ones to improvebottom line Downsizing (Rightsizing) • Acting small from inception – Southwest Airlines Intrapreneurs • Individuals in large firms who take responsibility for the development of innovations within the organization FHF 5-28