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8-1 Introduction • Capital, revenue and cost are deeply intertwined—

actions taken to modify one component usually have an effect on the other two.

• Launching a new venture normally requires an infusion of capital during the early stages. – Before capital can be raised, the venture must establish

a legal form that will enable it to solicit and raise debt or equity capital.

– All entrepreneurs must decide what type of legal form they should use as the structural basis of their company.

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Ch 8 Outline

1. Introduction

2. Sole Proprietorships

3. Partnerships

4. Limit Liability Companies

5. Corporations

6. Non-Profit Corporations

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Legal Forms of Ownership1. Sole Proprietorship2. Partnership

a. General Partnershipb. Limited Partnershipc. Limited Liability Partnership

3. Corporationa. C-Corp.b. S-Corp.c. 5-1 c (3) (Not-for-Profit) Corp.

4. Limited Liability Company

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Popularity of Business Ownership Forms

73%

20%

7%

0%

20%

40%

60%

80%

100%

Sole Proprietorships Corporations Partnerships

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8-2b Disadvantages of a Sole Proprietorship

• Disadvantages of a sole proprietorship include:– Unlimited liability – Difficulty in raising capital – Limitations in managerial ability – Lack of stability – Demands on time – Difficulty in hiring and keeping highly

motivated employees

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8-2a Advantages of a Sole Proprietorship

• Advantages of a sole proprietorship include:– Ease of starting – Control– Sole participation in profits and losses– Use of owner’s abilities– Tax breaks– Secrecy– Ease of dissolving

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Partnership—UPA’s Definition:

“An association of two or more persons, to carry on as co-owners, a business for profit”.

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General Partnership

Regardless of the percentage of the business they own, general partners have authority to act and make binding decisions as owners of the business. Each general partner is liable for all the debts of the business.

  Partners generally share profits and losses according to a plan specified

by an agreement between or among them. With the authority to act as an owner, each general partner can engage the

partnership in binding agreements. Unless a partnership agreement prevents a general partner from making

such agreements, the partnership is responsible for all actions of each owner.

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Limited Partnership

All partnerships must have at least one general partner. A limited partnership includes one or more general partners and one or more limited partners.  

The general partners arrange and run the business while the limited partners are investors only.

The limited partner investors receive special tax advantages and protection from liability.  

These partners legally may have no say in managing the business. If this requirement is violated, the “limited” status is dissolved.

These partnerships are usually found in service industries or in professional firms such as real estate and dentistry.

They are also used extensively to enable various international arrangements. In some states, a special notice must be filed in the county or district in

which the limited partnership has its offices.

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Business Partnerships

General PartnershipsGeneral Partnerships Limited PartnershipsLimited Partnerships

UnlimitedUnlimitedLiabilityLiability

UnlimitedUnlimitedLiabilityLiability

Equal Equal PartnersPartners

Equal Equal PartnersPartners

ShareShareOwnershipOwnership

ShareShareOwnershipOwnership

LimitedLimitedLiabilityLiability

LimitedLimitedLiabilityLiability

UnequalUnequalPartnersPartners

UnequalUnequalPartnersPartners

PassivePassiveInvestorsInvestors

PassivePassiveInvestorsInvestors

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8-3b Advantages of a Partnership

• Advantages of a partnership include: – Greater access to capital – Combined managerial skills – Ease of starting– Clear legal status– Tax advantages

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8-3c Disadvantages of a Partnership

• Disadvantages of a partnership include:– Unlimited liability– Potential disagreements – Investment withdrawal difficulty – Limited capital availability– Instability

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Corporation:

A (separate) legal entity with the power to own property and to conduct business.

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Corporations

Enter IntoEnter IntoContractsContractsEnter IntoEnter IntoContractsContracts

Own andOwn andSell PropertySell Property

Own andOwn andSell PropertySell Property

Sue andSue andBe SuedBe SuedSue andSue andBe SuedBe Sued

Enjoy LimitedEnjoy LimitedLiabilityLiability

Enjoy LimitedEnjoy LimitedLiabilityLiability

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Advantages of a CorporationThe power and presence of corporations in American business suggest that

this form has certain advantages over other forms of business ownership:         Limited liability: A person investing funds in a corporation receives

shares of stock and becomes an owner.  o In a corporation, the liability for the shareholder equals the amount of

funds invested.o Thus, if the business is forced to liquidate, each owner loses only the

amount of money he or she has invested.         Skilled management team: The board of directors has the duty of

hiring professional Managers, and the owners delegate their power of operating the business to these managers.  

o Professional managers are trained and experienced career executives. o They may own shares of stock in the business but usually not enough to

control the corporation.        

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Advantages of a Corporation (cont.)

Transfer of ownership: Shareholders have the right to sell their shares of a corporation's stock to whomever they please, barring a legal restriction on some closed corporations.  

These shares of ownership can be sold whenever the shareholder desires and at the price the buyer is willing to pay.

Greater capital base: The size of a proprietorship or partnership is limited to the amount of capital that one or several people have available and is willing to invest.  

Corporations, however, can attract capital from a large number of investors by selling shares of stock.

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Advantages of a Corporation (cont.)

Stability: State law varies, but a corporation can usually be chartered to operate indefinitely. Shareholders' deaths, retirement, or sale of stock need not dissolve the business.

 

The corporation's policies may be altered by the sale of large blocks of stock, but the business will go on.

Nor will the death or retirement of the president of the board or the chief executive officer stop the corporation from doing business.

 

 Legal-entity status: A corporation can purchase property, make contracts, or sue and be sued in its corporate name.

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S-Corporations

To qualify as an S-Corp., a business must meet the following requirements:

It must be incorporated within the U.S.

It can only sell one type of stock (common stock).

All shareholders must be natural persons, estates or trusts.

All shareholders must be residents of the U.S.

No shareholder can be a partnership or corp.

Some states limit the number of shareholders (usually to 100).

No more than 20% of its income can come from passive activities (e.g. investing in shares of other corps.).

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Disadvantages of a Corporation

Difficulty and expense of starting. Starting a corporation involves applying for a charter from a state.

o Each state has its own set of laws; these laws must be considered before an entrepreneur decides where to incorporate.

o An attorney should be hired to complete legal forms. Attorney fees and state charter fees must be paid.

o The chosen state then reviews the application and issues a charter that specifies various restrictions on operations.

  Lack of control. The individual shareholder has little control over the

operations of the corporation except to vote for a slate of individuals for the board of directors.  

o The buying and selling of shares of stock is the only real control an owner has.

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Disadvantages of a Corporation (Cont.)

Multiple taxation and fees. In addition to an annual franchise tax in the state of incorporation, an annual payment is required by most states for the right to operate as a corporation.  

o No such fees are charged to a proprietorship or partnership. Some states levy a corporate income tax on those monies earned within the state.

o At the federal level, the corporation has to pay taxes on its profits.  Lack of secrecy. A corporation must provide each shareholder with an annual

report.  o In a closed corporation, the few reports that are circulated usually won't get into

the hands of nonowners. o But when a large number of reports are issued, the reports become public

knowledge.o Public disclosure enables competitors and other outsiders to see the corporation's

financial condition.

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Disadvantages of a Corporation (Cont.)

Lack of personal interest. In most large corporations, management and ownership are separate.  

o This separation can result in a lack of personal interest in the success of the corporation.

o If the managers are also shareholders, personal interest is enhanced. o It is assumed that employees who are also owners will work harder for the success of

the business, but the accuracy of this assumption is an individual matter. o Most managers have pride in their work and want any business they are involved with

to succeed. Credit limitations. Banks and other lenders have to consider the limited liability of the

owners of a corporation.  o If the corporation fails, its creditors can look only to the assets of the business to

satisfy claims. o For partnerships, the creditors can rely on personal assets of the partners to pay off

business debts.

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8-4 Limited Liability Company• The limited liability company (LLC) is a

relatively new legal form that has now been adopted in all fifty states. – The LLC limits the liability exposure of all investors to

the amount of their investment. • Anyone can participate in the management and still have

limited liability protection.

– To form a limited liability company (LLC), business owners must file formal articles of organization with their state's LLC filing office and comply with other state filing requirements.• LLC can have an unlimited number of investors, known as

members. • It is also required to prepare an operating agreement.

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8-4a Advantages of a Limited Liability Company

• Advantages of a limited liability company include:– Limited liability– Pass-through taxation– Investors can manage – Unlimited membership – Ease of organizing

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8-4b Disadvantages of a Limited Liability Company

• The disadvantages of an LLC are due primarily to its relatively recent adoption by state legislatures. – Many people still don’t understand it well, and courts

have only begun to form a record of common law.

• Other disadvantages include:– Difficulty raising money

– No continuity of life

– Limited transferability