SME Chapter 3

Chapter 3: Forms of Ownership 1Copyright 2003 Prentice Hall Publishing Company

Choosing a Form of Ownership

Choosing a Form of Ownership

There is no one “best” form of ownership.There is no one “best” form of ownership. The best form of ownership depends on an The best form of ownership depends on an

entrepreneur’s particular situation.entrepreneur’s particular situation. The key to choosing a form of ownership The key to choosing a form of ownership

is understanding how each form’s is understanding how each form’s characteristics affect an entrepreneur’s characteristics affect an entrepreneur’s specific business and personal specific business and personal circumstances. circumstances.

Choosing a Form of Choosing a Form of OwnershipOwnership

Chapter 3: Forms of Ownership 3Copyright 2003 Prentice Hall Publishing Company

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

Chapter 3: Forms of Ownership 4Copyright 2003 Prentice Hall Publishing Company

Forms of OwnershipForms of Ownership

Sole ProprietorshipSole Proprietorship PartnershipPartnership CorporationCorporation

Forms of OwnershipPercent of Businesses

Corporation20.1%

Partnership7.7%

Sole Proprietorship72.2%

Forms of OwnershipPercent of Sales

Corporation87.1%

Partnership8.1%

Sole Proprietorship4.8%

Forms of OwnershipPercent of Income

Corporation69%

Partnership15%

Sole Proprietorship16%

Chapter 3: Forms of Ownership 8Copyright 2003 Prentice Hall Publishing Company

Advantages of the Sole Advantages of the Sole ProprietorshipProprietorship

Simple to createSimple to create Least costly form to beginLeast costly form to begin Profit incentiveProfit incentive Total decision making authorityTotal decision making authority No special legal restrictionsNo special legal restrictions Easy to discontinueEasy to discontinue

Chapter 3: Forms of Ownership 9Copyright 2003 Prentice Hall Publishing Company

Disadvantages of the Sole Disadvantages of the Sole ProprietorshipProprietorship

Unlimited personal liabilityUnlimited personal liability

Liability Features of the Basic Forms of OwnershipLiability Features of the Basic Forms of Ownership

Sole ProprietorshipSole Proprietorship

Claims of Sole Proprietor’s CreditorsClaims of Sole Proprietor’s Creditors

Sole Proprietor’s Personal AssetsSole Proprietor’s Personal Assets

Chapter 3: Forms of Ownership 11Copyright 2003 Prentice Hall Publishing Company

Disadvantages of the Sole Disadvantages of the Sole ProprietorshipProprietorship

Limited access to capitalLimited access to capital Limited skills and capabilitiesLimited skills and capabilities Feelings of isolationFeelings of isolation Lack of continuityLack of continuity

Unlimited personal liabilityUnlimited personal liability

Chapter 3: Forms of Ownership 12Copyright 2003 Prentice Hall Publishing Company

PartnershipPartnership

An association of two or more people who An association of two or more people who co-own a business for the purpose of co-own a business for the purpose of making a profit.making a profit.

Take the time to create a written Take the time to create a written partnership agreement!partnership agreement!

Chapter 3: Forms of Ownership 13Copyright 2003 Prentice Hall Publishing Company

Advantages of the PartnershipAdvantages of the Partnership

Easy to establishEasy to establish Complementary skills of partnersComplementary skills of partners Division of profitsDivision of profits Larger pool of capitalLarger pool of capital Ability to attract limited partnersAbility to attract limited partners Little government regulationLittle government regulation FlexibilityFlexibility TaxationTaxation

Chapter 3: Forms of Ownership 14Copyright 2003 Prentice Hall Publishing Company

Disadvantages of the PartnershipDisadvantages of the Partnership

Unlimited liability of at least one partnerUnlimited liability of at least one partner

Liability Features of the Basic Forms of OwnershipLiability Features of the Basic Forms of Ownership

PartnershipPartnership

Claims of Partnership’s CreditorsClaims of Partnership’s Creditors

Partnership’s AssetsPartnership’s AssetsGeneralPartner’sPersonalAssets

GeneralPartner’sPersonalAssets

GeneralPartner’sPersonalAssets

GeneralPartner’sPersonalAssets

Chapter 3: Forms of Ownership 16Copyright 2003 Prentice Hall Publishing Company

Disadvantages of the PartnershipDisadvantages of the Partnership

Capital accumulationCapital accumulation Difficulty in disposing of partnership Difficulty in disposing of partnership

interestinterest Lack of continuityLack of continuity Potential for personality and authority Potential for personality and authority

conflictsconflicts Partners bound by the law of agencyPartners bound by the law of agency

Unlimited liability of at least one partnerUnlimited liability of at least one partner

Chapter 3: Forms of Ownership 17Copyright 2003 Prentice Hall Publishing Company

Limited PartnershipLimited Partnership

A partnership composed of at least one A partnership composed of at least one general partner and one or more limited general partner and one or more limited partners.partners.

The general partner in this partnership is The general partner in this partnership is treated exactly as in a general partnership.treated exactly as in a general partnership.

The limited partner has limited liability The limited partner has limited liability and is treated as an investor in the and is treated as an investor in the business. business.

Liability Features of the Basic Forms of OwnershipLiability Features of the Basic Forms of Ownership

Limited PartnershipLimited PartnershipClaims of Partnership’s CreditorsClaims of Partnership’s Creditors

Partnership’s AssetsPartnership’s AssetsGeneralPartner’sPersonalAssets

GeneralPartner’sPersonalAssets

LimitedPartner’sPersonalAssets

LimitedPartner’sPersonalAssets

BarrierBarrier

Chapter 3: Forms of Ownership 19Copyright 2003 Prentice Hall Publishing Company

The CorporationThe Corporation

A separate legal entity from its owners. A separate legal entity from its owners. Types of corporations:Types of corporations:

DomesticDomestic - a corporation doing business in the - a corporation doing business in the state in which it is incorporated. state in which it is incorporated.

ForeignForeign - a corporation chartered in one state - a corporation chartered in one state and doing business in another state.and doing business in another state.

AlienAlien - a corporation formed in another - a corporation formed in another country, but doing business in the United States. country, but doing business in the United States.

Chapter 3: Forms of Ownership 20Copyright 2003 Prentice Hall Publishing Company

The CorporationThe Corporation

Types of corporations:Types of corporations: Publicly held Publicly held - a corporation that has a large - a corporation that has a large

number of shareholders and whose stock number of shareholders and whose stock usually is traded on one of the large stock usually is traded on one of the large stock exchanges.exchanges.

Closely held Closely held - a corporation whose shares are in - a corporation whose shares are in the control of a relatively small number of the control of a relatively small number of people, often family members, relatives, or people, often family members, relatives, or friends. friends.

Chapter 3: Forms of Ownership 21Copyright 2003 Prentice Hall Publishing Company

Advantages of theAdvantages of theCorporationCorporation

Limited liability of the stockholdersLimited liability of the stockholders

Liability Features of the Basic Forms of OwnershipLiability Features of the Basic Forms of Ownership

CorporationCorporationClaims of Corporation’s CreditorsClaims of Corporation’s Creditors

Corporation’s AssetsCorporation’s Assets

Shareholder’sPersonal AssetsShareholder’sPersonal Assets

Shareholder’sPersonal AssetsShareholder’sPersonal Assets

BarrierBarrierBarrier

Barrier

Chapter 3: Forms of Ownership 23Copyright 2003 Prentice Hall Publishing Company

Advantages of theAdvantages of theCorporationCorporation

Ability to attract capitalAbility to attract capital Ability to continue indefinitelyAbility to continue indefinitely Transferable ownershipTransferable ownership

Limited liability of stockholdersLimited liability of stockholders

Chapter 3: Forms of Ownership 24Copyright 2003 Prentice Hall Publishing Company

Disadvantages of the CorporationDisadvantages of the Corporation

Cost and time of incorporatingCost and time of incorporating ““Double taxation”Double taxation” Potential for diminished managerial Potential for diminished managerial

incentivesincentives Legal requirements and regulatory “red Legal requirements and regulatory “red

tape”tape” Potential loss of control by founder(s)Potential loss of control by founder(s)