There are three main forms of business ownership for small- and medium-sized enterprises: sole proprietorships, partnerships, and corporations. Each form has advantages and disadvantages related to factors like taxes, liability, capital requirements, and control. The best form depends on an entrepreneur's specific business and personal circumstances. Understanding how the characteristics of each form affect those circumstances is key to choosing the right ownership structure.

1. 3 Forms of Ownership of SMEs3 Forms of Ownership of SMEs CopyrightCopyright ©2012 Pearson Education, Inc. publishing as Prentice Hall©2012 Pearson Education, Inc. publishing as Prentice Hall 3-3-11
Choosing a Form of
Ownership of SMEs

2.  There is no one “best” form of ownershipThere is no one “best” form of ownership
 The best form of ownership depends onThe best form of ownership depends on
an entrepreneur’s particular situationan entrepreneur’s particular situation
 The key to choosing a form of ownershipThe key to choosing a form of ownership
is understanding how each form’sis understanding how each form’s
characteristics affect an entrepreneur’scharacteristics affect an entrepreneur’s
specific business and personalspecific business and personal
circumstancescircumstances
Choosing a Form of
Ownership
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3. 3 Forms of Ownership of SMEs3 Forms of Ownership of SMEs CopyrightCopyright ©2012 Pearson Education, Inc. publishing as Prentice Hall©2012 Pearson Education, Inc. publishing as Prentice Hall 3-3-33
Factors to ConsiderFactors to Consider
 Tax considerationsTax considerations
 Liability exposureLiability exposure
 Start-up capital requirementsStart-up capital requirements
 ControlControl
 Managerial abilityManagerial ability
 Business goalsBusiness goals
 Management succession plansManagement succession plans
 Cost of formationCost of formation

4. 3 Forms of Ownership of SMEs3 Forms of Ownership of SMEs CopyrightCopyright ©2012 Pearson Education, Inc. publishing as Prentice Hall©2012 Pearson Education, Inc. publishing as Prentice Hall 3-3-44
Forms ofForms of
OwnershipOwnership
 Sole ProprietorshipSole Proprietorship
 PartnershipPartnership
 CorporationCorporation
 S CorporationS Corporation
 Limited Liability CompanyLimited Liability Company
 Joint VentureJoint Venture

5. Data Source: Sources of Income, Internal Revenue Service.
0
10
20
30
40
50
60
70
80
90
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
East
West
North
Forms of SMEs Business Ownership
Chapter 3 Forms of Ownership 3-5Copyright ©2012 Pearson Education, Inc. publishing as Prentice Hall

6. Data Source: Sources of Income, Internal Revenue Service.
Forms of SMEs Business Ownership
0
10
20
30
40
50
60
70
80
90
1st Qtr 2nd Qtr 3rd Qtr 4th Qtr
East
West
North
Copyright ©2012 Pearson Education, Inc. publishing as Prentice HallChapter 3 Forms of Ownership 3-6

7. 3 Forms of Ownership of SMEs3 Forms of Ownership of SMEs CopyrightCopyright ©2012 Pearson Education, Inc. publishing as Prentice Hall©2012 Pearson Education, Inc. publishing as Prentice Hall 3-3-77
Advantages of the SoleAdvantages of the Sole
ProprietorshipProprietorship
 Simple to createSimple to create
 Least costly form to beginLeast costly form to begin
 Profit incentiveProfit incentive
 Total decision-makingTotal decision-making
authorityauthority
 No special legal restrictionsNo special legal restrictions
 Easy to discontinueEasy to discontinue

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Disadvantages of the SoleDisadvantages of the Sole
ProprietorshipProprietorship
 Unlimited personal liabilityUnlimited personal liability

9. Liability Features of the Basic Forms of OwnershipLiability Features of the Basic Forms of Ownership
Sole Proprietorship
Claims of Sole Proprietor’s CreditorsClaims of Sole Proprietor’s Creditors
Sole Proprietor’s Personal AssetsSole Proprietor’s Personal Assets
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3-9

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Disadvantages of theDisadvantages of the
Sole ProprietorshipSole Proprietorship
 Limited access to capitalLimited access to capital
 Limited skills and abilitiesLimited skills and abilities
 Feelings of isolationFeelings of isolation
 Lack of continuityLack of continuity
 Unlimited personal liabilityUnlimited personal liability

11. 3 Forms of Ownership of SMEs3 Forms of Ownership of SMEs CopyrightCopyright ©2012 Pearson Education, Inc. publishing as Prentice Hall©2012 Pearson Education, Inc. publishing as Prentice Hall 3-3-1111
PartnershipPartnership
 An association of two or more peopleAn association of two or more people
who co-own a business for thewho co-own a business for the
purpose of making a profitpurpose of making a profit
 Take the time to create a writtenTake the time to create a written
partnership agreement!partnership agreement!

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Advantages of theAdvantages of the
PartnershipPartnership
 Easy to establishEasy to establish
 Complementary skills of partnersComplementary skills of partners
 Division of profitsDivision of profits
 Larger pool of capitalLarger pool of capital

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Advantages of theAdvantages of the
PartnershipPartnership
 Ability to attract limited partnersAbility to attract limited partners
 Minimal government regulationMinimal government regulation
 FlexibilityFlexibility
 TaxationTaxation

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Disadvantages of theDisadvantages of the
PartnershipPartnership
 Unlimited liability of at least oneUnlimited liability of at least one
partnerpartner

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Types of PartnersTypes of Partners
 General partnersGeneral partners
 Take an active role in managing a businessTake an active role in managing a business
 Have unlimited liability for the partnership’s debtsHave unlimited liability for the partnership’s debts
 Every partnership must have at least one generalEvery partnership must have at least one general
partnerpartner
 Limited partnersLimited partners
 Cannot participate in the day-to-day managementCannot participate in the day-to-day management
of a companyof a company
 Have limited liability for the partnership’s debtsHave limited liability for the partnership’s debts

16. Liability Features of the Basic Forms of OwnershipLiability Features of the Basic Forms of Ownership
Partnership
Claims of Partnership’s CreditorsClaims of Partnership’s Creditors
Partnership’s AssetsPartnership’s AssetsGeneral
Partner’s
Personal
Assets
General
Partner’s
Personal
Assets
General
Partner’s
Personal
Assets
General
Partner’s
Personal
Assets
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Disadvantages of theDisadvantages of the
PartnershipPartnership
 Capital accumulationCapital accumulation
 Difficulty in disposing of partnershipDifficulty in disposing of partnership
interestinterest
 Unlimited liability of at least oneUnlimited liability of at least one
partnerpartner

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Disadvantages of theDisadvantages of the
PartnershipPartnership
 Lack of continuityLack of continuity
 Potential for personality and authorityPotential for personality and authority
conflictsconflicts
 Partners bound by the law of agencyPartners bound by the law of agency

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Limited PartnershipLimited Partnership
 A partnership composed of at least oneA partnership composed of at least one
general partner and one or more limitedgeneral partner and one or more limited
partnerspartners
 The general partner in a limitedThe general partner in a limited
partnership is treated exactly as in apartnership is treated exactly as in a
general partnershipgeneral partnership
 The limited partner has limited liabilityThe limited partner has limited liability
and is treated as an investor in theand is treated as an investor in the
businessbusiness

20. Liability Features of the Basic Forms of OwnershipLiability Features of the Basic Forms of Ownership
Limited Partnership
Claims of Partnership’s CreditorsClaims of Partnership’s Creditors
Partnership’s AssetsPartnership’s Assets
General
Partner’s
Personal
Assets
General
Partner’s
Personal
Assets
Limited
Partner’s
Personal
Assets
Limited
Partner’s
Personal
Assets
Barrier
Barrier
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21. 3 Forms of Ownership of SMEs3 Forms of Ownership of SMEs CopyrightCopyright ©2012 Pearson Education, Inc. publishing as Prentice Hall©2012 Pearson Education, Inc. publishing as Prentice Hall 3-3-2121
The CorporationThe Corporation
 A separate legal entity from its ownersA separate legal entity from its owners
 Types of corporations:Types of corporations:
 DomesticDomestic - a corporation doing business in- a corporation doing business in
the state in which it is incorporatedthe state in which it is incorporated
 ForeignForeign - a corporation chartered in one- a corporation chartered in one
state and doing business in another statestate and doing business in another state
 AlienAlien - a corporation formed in another- a corporation formed in another
country but doing business in the Unitedcountry but doing business in the United
StatesStates

22. 3 Forms of Ownership of SMEs3 Forms of Ownership of SMEs CopyrightCopyright ©2012 Pearson Education, Inc. publishing as Prentice Hall©2012 Pearson Education, Inc. publishing as Prentice Hall 3-3-2222
The CorporationThe Corporation
 Types of corporations:Types of corporations:
 Publicly heldPublicly held - a corporation that has a- a corporation that has a
large number of shareholders and whoselarge number of shareholders and whose
stock usually is traded on one of the largestock usually is traded on one of the large
stock exchangesstock exchanges
 Closely heldClosely held - a corporation in which shares- a corporation in which shares
are controlled by a relatively small numberare controlled by a relatively small number
of people, often family members, relatives,of people, often family members, relatives,
or friendsor friends

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Advantages of theAdvantages of the
CorporationCorporation
 Limited liability of the stockholdersLimited liability of the stockholders

24. Liability Features of the Basic Forms of OwnershipLiability Features of the Basic Forms of Ownership
Corporation
Claims of Corporation’s CreditorsClaims of Corporation’s Creditors
Corporation’s AssetsCorporation’s Assets
Shareholder’s
Personal Assets
Shareholder’s
Personal Assets
Shareholder’s
Personal Assets
Shareholder’s
Personal Assets
Barrier
BarrierBarrier
Barrier
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3-24

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Advantages of theAdvantages of the
CorporationCorporation
 Ability to attract capitalAbility to attract capital
 Ability to continue indefinitelyAbility to continue indefinitely
 Transferable ownershipTransferable ownership
 Limited liability of stockholdersLimited liability of stockholders

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Disadvantages of theDisadvantages of the
CorporationCorporation
 Cost and time of incorporatingCost and time of incorporating
 ““Double taxation”Double taxation”
 Potential for diminished managerialPotential for diminished managerial
incentivesincentives

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Disadvantages of theDisadvantages of the
CorporationCorporation
 Legal requirements and regulatoryLegal requirements and regulatory
“red tape”“red tape”
 Potential loss of control by founder(s)Potential loss of control by founder(s)
 Piercing the corporate veilPiercing the corporate veil

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S-CorporationS-Corporation
 No different from any other corporationNo different from any other corporation
from a legal perspectivefrom a legal perspective
 For tax purposes, however, an S-For tax purposes, however, an S-
corporation is taxed like a partnership,corporation is taxed like a partnership,
passing all of its profits (or losses) throughpassing all of its profits (or losses) through
to the individual shareholdersto the individual shareholders
 To elect “S” status, all shareholders mustTo elect “S” status, all shareholders must
consent, and the corporation must file withconsent, and the corporation must file with
the IRS within the first 75 days of its taxthe IRS within the first 75 days of its tax
yearyear

29. Liability Features of the Basic Forms of OwnershipLiability Features of the Basic Forms of Ownership
S-Corporation
Claims of S-Corporation’s CreditorsClaims of S-Corporation’s Creditors
S-Corporation’s AssetsS-Corporation’s Assets
Shareholder’s
Personal Assets
Shareholder’s
Personal Assets
Shareholder’s
Personal Assets
Shareholder’s
Personal Assets
Barrier
BarrierBarrier
Barrier
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S-CorporationS-Corporation
 Must be a U.S.-based corporationMust be a U.S.-based corporation
 No nonresident alien shareholdersNo nonresident alien shareholders
 Only one class of common stockOnly one class of common stock
 No more than 100 shareholders (increasedNo more than 100 shareholders (increased
from 75)from 75)
 No more than 20% of corporate incomeNo more than 20% of corporate income
from passive investment sourcesfrom passive investment sources
 Corporations and partnerships cannot beCorporations and partnerships cannot be
shareholdersshareholders

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Limited LiabilityLimited Liability
Company (LLC)Company (LLC)
 Resembles an S-Corporation but isResembles an S-Corporation but is
notnot subject to the same restrictionssubject to the same restrictions
 Two documents:Two documents:
 Articles of organizationArticles of organization
 Operating agreementOperating agreement

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Limited Liability CompanyLimited Liability Company
(LLC)(LLC)
 An LLC cannot have more thanAn LLC cannot have more than twotwo ofof
these four corporate characteristics:these four corporate characteristics:
 Limited liabilityLimited liability
 Continuity of lifeContinuity of life
 Free transferability of interestFree transferability of interest
 Centralized managementCentralized management

33. Liability Features of the Basic Forms of OwnershipLiability Features of the Basic Forms of Ownership
Limited Liability Company (LLC)
Claims of LLC’s CreditorsClaims of LLC’s Creditors
LLC’s AssetsLLC’s Assets
Member’s
Personal Assets
Member’s
Personal Assets
Member’s
Personal Assets
Member’s
Personal Assets
Barrier
BarrierBarrier
Barrier
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