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Chapter 6: BUSINESS FORMATION

Chapter 6: BUSINESS FORMATION. Choosing the Form that Fits. CHOICES, CHOICES, CHOICES. The form of ownership of a business is a big decision. Form of ownership affects: Operation Start-up Costs Profit Distribution Taxes Management Succession plans.

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Chapter 6: BUSINESS FORMATION

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  1. Chapter 6: BUSINESS FORMATION Choosing the Form that Fits

  2. CHOICES, CHOICES, CHOICES The form of ownership of a business is a big decision. • Form of ownership affects: • Operation • Start-up Costs • Profit Distribution • Taxes • Management Succession plans • The “Big Three” is Becoming the “Big Four”: • Sole Proprietorship • Partnership • Corporation • Limited Liability Company

  3. SOLE PROPRIETORSHIP: BUSINESS AT ITS MOST BASIC • Advantages: • Ease of Formation • Retention of Control • Pride of Ownership • Retention of Profits • Possible Tax Advantages • Disadvantages: • Limited Financial Resources • Unlimited Liability • Limited ability to attract and maintain talented employees • Lack of Permanence

  4. MOST COMMON TYPES OF SOLE PROPRIETORSHIPS Source for Table: “Sole Proprietorship Returns”, by Kevin Pierce Statistics of Income Bulletin, Summer, 2005, Figure A, p.9; website: http://www.irs.gov/pub/irs-soi/03solp.pdf )

  5. BUSINESS FORMS: COMPARING THE NUMBERS Total Number of Businesses by Form of Ownership (Millions) Total Net Income by Form of Ownership ($Billions)

  6. PARTNERSHIPS: TWO HEADS CAN BE BETTER THAN ONE • Advantages: • Pooled Financial Resources • Shared Responsibilities • Ease of Formation • Tax Advantages • Disadvantages: • Unlimited Liability • Disagreements • Difficulty in withdrawing from agreement • Lack of Continuity

  7. LIMITED PARTNERSHIPS Limited Partnership – includes at least one general partner and at least one limited partner Limited Liability Partnership – All partners are actively involved but they have some form of limited liability. The amount of liability differs per state. Limited partners have limited liability.

  8. GENERAL VS LIMITED PARTNERSHIPS • General Partnerships • All partners have the right to participate in the management of the firm and share in any profits/losses. • Limited Partnerships • All partners contribute financially and share in the profits but the limited partner(s) cannot actively participate in management.

  9. FAMILY LIMITED PARTNERSHIPS • Parents as general partners • Children as limited partners • Parents transfer assets to limited partners while still maintaining control, this strategy: • Reduces gift and inheritance taxes • Protects family assets from creditors and lawsuits • But watch out for the IRS – Family Limited Partnerships can attract tax auditors!

  10. CORPORATIONS: AN ARTIFICIAL REALITY • A corporation is a legal entity, separate and distinct from its owners. • Corporations are owned by stockholders. • The Board of Directors establishes the mission and objectives. • The Board is elected by the stockholders to represent their interests.

  11. CORPORATIONS • Advantages: • Limited Liability • Permanence • Easy to Transfer Ownership • Ability to Raise Capital • Specialized Management • Disadvantages: • Expense/complexity of formation and operation • Double Taxation • Paperwork and Regulation • Conflicts of Interest

  12. OTHER TYPES OF CORPORATIONS: SAME BUT DIFFERENT • S Corporation • Closed Corporation • Non-profit Corporation

  13. COMPARING TYPES OF CORPORATIONS

  14. LIMITED LIABILITY COMPANY: THE NEW KID ON THE BLOCK • Advantages: • Limited Liability • Tax Pass-Through • Simplified Management and Operation • Flexible Ownership • Disadvantages: • Franchise Taxes • Foreign Status in other States • State Law Differences • Limited to Select Industries

  15. COMPARING BUSINESS FORMS HIGH DEGREE OF PERSONAL LIABILITY LOW Sole Proprietorships Partnerships Corporations LOW DEGREE OF COMPLEXITY AND PERPETUITY HIGH

  16. CORPORATE RESTRUCTURING Corporations look for: • Growth opportunities • Operational efficiencies • Competitive advantages Acquisitions – when one firm buys another. Mergers – two companies agree to a combination of equals.

  17. TYPES OF MERGERS AND ACQUISITIONS

  18. FRANCHISING: PROVEN METHODS FOR A PRICE • Not a form of ownership but an operation option. • Subway • Jiffy Lube • 7-Eleven • McDonalds • The franchisee uses the brand name, trademark and practices of the franchisor.

  19. FRANCHISING Ben & Jerry franchises its PartnerShops to non-profit corporations. • Advantages: • Less Risk • Training and Support • Brand Recognition • Access to Funding • Disadvantages: • Costs • Lack of Control • Negative Halo Effect • Growth Challenges • Restriction on Sale • Poor Execution

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