CHAPTER 2.pptx

Small Business Finance
Ch 2: Legal forms of Business Organizations

Proprietorship
Partnership
Corporation
Legal Forms of Business Organizations
Business

Selection of organization type
Selection of organization type is based on
following factors
1. Ease of formation
2. Cost of formation
3. Liabilities of owners
4. Durability and stability of each firm
5. Directness of control and ease of
diraction legal status of activities

It is important to remember that a sole trader is usually a relatively
small business with little capital available for expansion and the capital
that has been invested comes from one source and that is the owner.
Example
 a local grocery store
 a local clothes store
 an artist
 freelance writer,
 IT consultant,
 freelance graphic designer
Proprietorship
The Small Business Administration's reports that sole proprietors account
for 73.2 percent of U.S. small businesses. The percentage of small businesses
that are corporations amounts to 19.5 percent.
a single person owns, manages and controls, all the business activities and
the individual who operates the business is called as a sole proprietor or, a sole
trader.

It is a common law form of organization.
No formal documents.
No incorporation fees or taxes.
Existence based on owner will.
Business may continue upon death of the owner.

Proprietorship- Characteristics
Single Ownership: It is a type of business unit, in which a single person
owns the entire business, i.e. all the assets and property belongs to the
proprietor. Accordingly, he bears all the risk associated with the enterprise.
Hence, the business ends up at his will or on his demise.
No sharing of Profit and Loss: Whatever income generated from the sole
proprietorship business, it belongs to the sole proprietor only.
Consequently, he alone bears all the losses incurred by the firm. There is
no sharing of the business profits and losses.
One man’s capital: The capital required to start the business or to continue
operations, is arranged and brought to the business by the sole proprietor
only, either from his personal resources or by borrowing, i.e. from the
bank, financial institutions, friends, relatives, etc.
Unlimited Liability: This is one of the major con of sole proprietorship
business, i.e. the liabilities are unlimited. In the event of loss, the personal
assets of the proprietor along with the business assets can be utilised to
discharge the dues of business.

Less Legal Formalities: The legal requirements for formation, operation and
closure of a sole tradership business is almost nil, even it does not need
registration. Although for the purpose of business, it can be registered with
local self-government, and obtain a certificate of registration.
One man Control: As only one person is in charge of all the activities, he has
full fledged control over it. Thus, the sole proprietor takes all the decision and
execute it, in the manner he wants.
There is no legal distinction between the proprietor and business; they are
one and the same thing in the eyes of the law. Sole proprietor uses his own
skills, intelligence and expertise to operate the business.
Proprietorship- Characteristics

Cost effectiveness.
High level of autonomy for the owner.
Simple business structure.
Simple to run tax-wise.
There are no retained earnings that create
complicated taxation issues.
All profits will be your personal property.
No agreements are necessary.
No reports of accounts are required.
Merits of Sole Proprietorship

A considerable reliance on the owner’s skill.
Reliance on owners financial position.
Lack of attention to succession planning.
Lack of support if the owner is unwell or
wants to do other things.
Unlimited liability.
Limited ability to secure additional
investment.
Demerits of Sole Proprietorship

The term partnership, is used to mean a business structure
wherein two or more individuals, come together for undertaking
a lawful business and have agreed to share the profits and
losses arising from it.
Partnership
Profit or loss sharing.
A common law organization.
Statutes vary from state to
state.
In states where no statutes
exist, the partnership
agreement may be implied.

Partnership assets.
Life time of Partnership.
Contractual obligation.
Liabilities.
Partnership- Characteristics

Membership: At least two persons are required to begin a partnership while the
maximum number of members is limited to 100. Further, all the individuals entering into
partnership must be legally competent to do so, as they have to enter into a contract to
become partners. Thus, minors, insolvent and lunatic persons cannot become members,
but a minor can be admitted to partnership, to share profits.
Unlimited liability: The members of a partnership have unlimited liability, i.e. they
are collectively and individually liable for the firm’s debts and obligations. So, if in case
business assets are not adequate to repay liabilities, personal assets of all or any partner
can be claimed by the creditors to realise the outstanding amount.
Sharing of profit and loss: The main purpose of the partnership is to share profit in
the agreed ratio. However, in the absence of any agreement between partners, the
business profits or losses are divided equally among all the partners.
Mutual Agency: The partnership business is undertaken by all the partners or any of the
partner, who acts on behalf of all the partners. So, every partner is a principal as well as
an agent. Further, the acts of partners bind each other as well as the firm.

Voluntary Registration: The registration of partnership is not mandatory, but it
is recommended, as it offers certain benefits, e.g. in case of any conflict among partners,
any partner can file suit against other partner or if there is any dispute between firm and
outside party, then also the firm can file a case against that party.
Continuity: There is a lack of continuity in partnership, like death, bankruptcy,
retirement or insanity of any partner can lead the partnership to end. Although, if the
remaining partners want to continue operations, they can do so by a fresh agreement.
Contractual Relationship: The relation subsisting between partners is due to the
contract, which may be oral, written or implied.
Transfer of interest: Mutual consent of all the partners is a must for transferring
the interest in the firm to any external party.
In a partnership, the decision making is done with the mutual consent of all the partners.
They share among themselves the decision making and control of the regular business
operation.

Partnership- Types
General Partnership: Partnership in which partners have unlimited and
joint liabilities. All the partners can take part in the management, and
they are bound by the acts of one another as well as of the firm.
Limited Partnership: The type of partnership in which except one partner
all the partners have limited liability.
Joint Ventures partnership: Joint Venture can be described as a business
arrangement, wherein two or more independent firms come together to
form a legally independent undertaking, for a stipulated period, to fulfill a
specific purpose such as accomplishing a task, activity or project.
This form of business organisation is easy to set up because it does not require
any fees or process. In addition to this, partners enjoy tax benefit, as in, the
profit earned or loss incurred by the business pass through to the partner’s
personal income tax return.

Name and address of the partners and the firm;
Name and nature of the business.
Amount and type of capital invested.
Duration of partnership.
Agency powers of the various partners.
Method of dividing profits and losses.
Profit or loss sharing ratio;
Salary or commission payable to the partner, if any;
Duties and powers of each partner;
Any other terms and conditions to run the business.
Partnership- Agreement

Easy Formation
availability of large resources – More Capital Available
Better decisions – Combined Talent, Judgment, and Skill
Flexibility in operations
Sharing risks
Protection of interest of each partner
Benefits of specialization
Partnership- Advantages
https://www.iedunote.com/partnership

Partners actions.
Shared Profits.
Chances of Disagreement.
Tax Deduction.
Uncertain and Limited Life.
Unlimited Liability
Lack of Continuity
Limited Resources
Partnership- Disadvantages

• A company is that form of business organization,
which is created by law. It refers to an association of
persons, created to undertake business activities,
having a separate legal existence, perpetual
succession and a common seal.
Corporations
The process of incorporating should be completed with the state’s
secretary of state corporate counsel and usually requires the services
of an attorney.

Membership: To form a private company, minimum two members are required,
whereas a public company can be formed if there are at least seven members.
Further, the maximum number of members in case of a private company can be 200
only, whereas there is no limit on the maximum number of members in the case of a
public company.
Incorporated Association: It can be formed only by the operation of law. So, it must
be registered under the Company’s Act, which makes it an artificial legal person.
Separate Legal Existence: It is distinct from its members and, any changes in the
membership of the company will not affect it. Hence, it can sue and be sued, come
into a contract and conduct business in its own name.
Artificial person: Although a company is regarded as a person in the eyes of law, it
cannot enjoy the rights and duties, as are enjoyed by natural citizens.
Perpetual Succession: It is formed with an intention, that it is going to last forever,
irrespective of the changes in membership, insolvency/death/lunacy of any member.
Therefore, nothing can affect the life of the company, and it can only be dissolved by
law.
Company Characteristics

Common Seal: As a natural person, a company is not able to sign its documents and so
for this purpose a common seal acts as a tool to sign the official documents. In other
words, the common seal indicates the official signature of the company. The officer
authorized to affix the seal, has to sign the documents for and on behalf of the company.
Limited liability: One of its most important features is the limited liability of the
shareholders. This means each shareholder is liable to the extent of the unpaid amount
on the shares held by him/her. In addition to this, in case of fully paid up shares, there is
no such liability.
Share transfer: Shares of a public limited company are freely transferable by the
shareholders. As against, a private limited company has some restrictions on the transfer
of shares.
Maintenance of Account books: A company has to prepare and keep books of accounts
and necessary documents, for each financial year, at their registered office or else they
have to pay the penalty if they fail to comply with the same.
Audit of accounts: On the recommendation of the board of directors, the shareholders
appoint a chartered accountant, for auditing company’s account at periodic intervals.
Company Characteristics

Corporations- Advantages
Separate legal entity.
Limited liability of stockholders.
Transferable ownership rights.
Continuous life.
Ease of capital accumulation.

Corporations- Disadvantages
Government regulation.
Corporate taxation.
Double taxation

Memorandum of Association
Memorandum of Association comprises of following important clauses:
1. Name Clause
2. Registered Office Clause:
3. Objective Clause
4. Liability Clause
5. Capital Clause
6. Association Clause
Corporations- Formation
https://businessjargons.com/memorandum-of-association.html

Memorandum of Association
Name Clause: The name of the company that must end with the term “limited”.
Also, it must be ensured that the name selected for the company should not
resemble with the name of any existing company.
Registered Office Clause: This clause requires to mention the registered office
address of the company.
Objective Clause: The objective clause requires to mention clearly the objective
behind the incorporation of the company, i.e. the purpose for which the company is
being established.
Liability Clause: This clause requires to mention the extent to which the
shareholders are liable to pay off the debt obligations in the event of the dissolution
of the company.
Capital Clause: Company’s authorized capital along with the nominal value of all
kinds of shares need to be disclosed here. Also, the company is required to state the
list of its assets over here.
Association Clause: As per this clause, the willingness of shareholders is required
with respect to their association with the company. For a public limited company
minimum, seven members are required to sign the memorandum, whereas in a case
of a private limited company minimum two members are required to do the same.

Article of association
Corporations- Formation
https://businessjargons.com/memorandum-of-association.html
Share capital, call of share, conversion of share into stock, transfer of
shares, share warrant, surrender of shares, etc.
Directors, their qualifications, appointment, remuneration, powers,
and proceedings of the board of directors meetings.
Voting rights of shareholders, by poll or proxies and proceeding of
shareholders general meetings.
Dividends and reserves, accounts and audits, borrowing powers and
winding up.

• After the articles of incorporation have been drawn up, the document
is filed with the appropriate official, usually the secretary of state.
• This official will issue a certificate of incorporation only after
confirming that the articles of incorporation adhere to the business
incorporation act and that the required fees have been paid.
• Upon issuance of the certificate usually called charter, the corporate
existence begins.
• It should be remembered that the corporation cannot start doing
business until a certain amount of the capital has been received,
usually $1,000.
Incorporation Procedure

• The bylaws govern the internal affairs of the corporate
firm. Although the statutes differ with respect to the
content, most bylaws contain provisions for the
regulation and management of the affairs of the
corporation and generally include the following:
• Time and place of annual and special meetings of the
shareholders.
• Voting rights.
• Board of directors (number, classification, election, term
of office, and regular and special meetings).
• Officers of the corporation.
• Committees of the board of directors.
Corporate Bylaws

• Bank accounts.
• Certificate seal.
• Books and records.
• Stock certificate (issuance, signature, and transfer
procedure).
• Dividends and reserves.
• Fiscal year and annual audits.
• Contracts.
• Amendment procedures.
Corporate Bylaws

Management Of The Corporation
The management of organization . Unlike That of
proprietorships is beside in its shareholders, Directors and
officers.
 The shareholders By Virtue of ownership are the true
managers of the enterprise as a practical except in small
firms.
 Shareholders cannot manage the operation therefore; they
elect and delegate the authority to manage to the board of
Directors.
The board, in turn Delegates the details of management to
the Officers.
 It should be pointed out that officers have no authority
unless that authority is properly delegated by the charter by
laws.

• The authority to act in certain areas cannot be
delegated to either the board or the officers;
generally these areas include
1. The sale of assets.
2. Merger and consolidation.
3. Amending the charter or bylaws.
Management of the corporation

Shareholders are the “owners” of a company, and they benefit from the
company's dividend payments and stock price appreciation. Managers are the
agents of shareholders and manage the company on a daily basis.
Shareholders as managers
Share holder manager affairs of corporation by
1 adopting the charter and by law
2 electing the board of director
3 approving and disapproving the board’s actions
each of there acts is accomplished through the voting
process

Voting Process
Statutes Rule
Statutes rule is every shareholder have right to cast one vote per share means
majority of stockholder can control every act.
All Act Conducting By Voting Process
Common Law
Under common law each stakeholder has right to cast 1 vote regardless of
number of share
This rule can be changed by statutes
Cumulative voting
Each share holder have number of votes equal to the number of voting share he
or she owned multiply by number of director to be elected

Voting Process
Only shareholder recoded is allowed for voting.
Share holder can accumulate the all votes and cast them of any
one or several directors.
Formula To Select The Number Of Director
Total number of share outstanding x number of directors desired + 1
Number of directors to be elected +1
In different state it is implemented by law to prepared list of shareholder as a
particular date 10 to 30 days before shareholder meeting and that list is final.
By proxy shareholder my authorize the other person or a group to vote the
stock by giving g power of attorney in written.
For this management has be able to perpetuate its self because they have
easy access to stockholder recorded.
proxy

Directors as managers
A director is a senior management professional who oversees an
aspect of an organization. Directors often oversee managers and
may assist them in managing a department, team or project. For
example, a director of human resources may oversee payroll
managers, hiring managers, benefits managers and recruiting
managers.
Board of directors perform following task
•Select the major officers of organization
•Delegate authorities to officers to operate the business unit
•Approve the board objectives of business operation
•Serve as a control unit with respect to predetermined objective
•Note: there powers may be limited or restricted by
statues, articles and bylaws.

As general rule directors in small business
performs as officers
The law holds director responsibility for their acts.
•Directors may be punished under common law if
they
•Make secret profit
•Waste the firm’s assets
•Lose the firm’s assets while committing acts of
negligence
•Allow the corporate entity to act outside it purposes
•Make fraudulent statements and acts

Director are also governed by statutes and they are liable
under the statutes for
1. Doing business without authorization
2. Allowing the corporate to perform an unlawful purpose
3. Issuing improper stock certificates
4. Failing to maintain proper entries in the books of accounts
5. Authorizing I legal dividends
6. Misappropriating corporate funds
7. Violating the law regarding political contribution
It is not a complete list but it is comprehensive to show the
nature of acts for which directors are responsibilities by law.

Shareholders also hold directors ,responsible for
their acts . in many instances it is the shareholder
who bring legal action against directors .in addition
share holder may relives directors of their duties if
they have sufficient reason t o believes that the
directors are not action in the shareholder best
interest.

Board member are not act individually . Rules and regulation are set by
charters or by law on the basis which board member act different task
These rule and regulation cover such items
1. Regular and special meeting
2. Time and place
3. Notice
4. quorum
5. Order of business
6. The presiding officer
Meeting Minutes Of Meetings
It should be emphasize that mints of both regular and special meetings of
directors must be carful drawn and maintained ,mostly court ruling are often
based on these record

Officers of the Corporation
officers oversee daily aspects of a business. Officers are also
directly involved in the daily management affairs of the business.
Officers of the Corporation
The statue will as a general rule set forth the minimum number
of Officers of a corporation, their titles, a general statement of
duties, and provisions for removal. The bylaws usually set forth
the officers’ qualifications, term officer, duties, and
compensation.

In order to qualify, a corporation must be a
small business corporation and must meet
the following requirements:
Must be a domestic corporation.
Must not have more than 100 shareholders.
Must include only eligible shareholders.
Must have only one class of stock.
S Corporation

Advantages of S Corporation
Tax savings.
Business expense tax credit.
Independent life.
Asset protection
Salary and dividend payments
Ease of conversion
S Corporation

Disadvantages of S Corp
1. Stricter Operational Processes.
2. Shareholder Compensation Requirements.
3. Strict qualification requirements
4. Rigid profit and loss allocation
5. Unplanned termination

A type of equity named after the portion of the
Internal Revenue Code that describes its
treatment under tax law.
Section 1244 of the tax code allows losses from
the sale of shares of small, domestic
corporations to be deducted as ordinary losses
instead of as capital losses up to a maximum of
$50,000 for individual tax returns or $100,000 for
joint returns.
Section 1244 Stock

For stock to qualify as IRC Sec. 1244 stock, the following
requirements contained in Reg. Sec. 1.1244 must be met.
The stock may be preferred or common stock.
The corporation issuing the stock must qualify as a small
business corporation at the time the stock is issued.
A taxpayer must transfer money or other property to the
issuing corporation in exchange for the stock.
The corporation must pass a "gross receipts" test at the
time any loss on the stock is sustained by a shareholder.
Section 1244 Stock

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CHAPTER 2.pptx