Organizational Forms
Sole Proprietorship
Partnership
Corporation
Subchapter S Corporation
Limited Liability Partnership
Limited Liability Companies
Limited Partnership
Non-Profit Entity
Important Considerations
Control: How many cooks are in the kitchen?
Flexibility: A sports car or a battleship?
Liability: Who gets left holding the bag?
Longevity: Nobody lives forever…
Access to Capital: Sweat equity or OPM?
Taxation: Once, twice, or not at all?
Bureaucratic BS: How red is the tape?
Cost: Pay a little or pay a lot?
Sole Proprietorship
Simplest to start and maintain Most common structure Least costly Highest personal risk Income is taxed as personal income
Sole Proprietorship Taxation Taxable income “passes through”
the business Personal income and business
income are combined and taxed as one
May put you in a higher tax bracket Losses can be used to offset
personal income
Sole Proprietorship Taxes
Form 1040 Schedule C or Schedule C-EZ: Profit
and Loss From Business -- Sole Proprietorship
Form 1040 ES: Acceleration Estimate Tax for Individuals -- Must estimate expected income tax for the coming year
Quarterly vouchers and payments
Sole Proprietorship Legal Stuff
No registration required if business is in your own name
If you change the name or use anything other than your own name, must file Certificate of Conducting Business Under An Assumed Name with Secretary of State.
Right of Survivorship Document – Says what will happen in case of your death
To end business – Liquidate assets, pay off debts, and walk away.
Sole Proprietorship Summary
Control: You’ve got it allFlexibility: It’s your decision (alone)Liability: You’ve got it allLongevity: Nobody lives forever…Capital: Your money, bank debt, and trade
creditTaxation: Once, but not many breaksBureaucratic BS: Almost noneCost: Very little
Partnership
Use if more than one person’s capital Can be oral or written, but non-idiots
put it in writing Terminates with the death of any
partner in most states – Can use “Key Man” insurance to provide for the continuation of the partnership
Liability is joint and several unless there are limited partners
Partnership Taxes
Form 1040 with proportional share of partnership income
Form 1065: US Partnership Return of Income
Schedule K-1: Partner’s Share of Income Credits, Deductions, etc.
Each partner calculates and files an estimated tax
Quarterly vouchers and payments
Types of Partnerships
General Partnership Partners are equally liable (joint and
several) Share workload and decision making Operates on a calendar year Generally cash-based accounting
Types of Partnerships
Limited Partnership One or more partners are merely
investors and do not participate in running the business or making decisions.
Limited partners have share of ownership but liability is limited to the amount of the investment
Must have at least one general partner
Partnership Legal Stuff
The partnership name and information about the partners must be filed
Written partnership agreement is optional
Estate planning (what happens when a partner dies) is essential, but complicated
All personal assets of all general partners are at risk
Partnership terminates with the death of any partner unless partnership agreement specifies otherwise
Partnership Summary
Control: Shared between the partners
Flexibility: Now it’s a committee...
Liability: Joint and several
Longevity: Nobody lives forever…
Capital: Partners’ money and some debt
Taxation: Once, but not many breaks
Bureaucratic BS: Some - Partnership agreements, more stringent records
Cost: Very little
Corporations Most difficult and costly to set up Provides the most benefits to the owners Separate legal entity – provides limited liability for
all owners Best access to capital markets Easiest in which to transfer ownership Income is taxed twice – once at the corporate
level and once at the personal level – but otherwise gets very favorable tax treatment
Most closely scrutinized by the US Government and (if publicly traded) by the SEC
The Corporate Form of Organization
Ownership
The shareholders (also known as stockholders or equity holders) are the owners of the corporation.
Control
Ultimate control rests with the shareholders, but the managers control the day to day operations.
Risk Bearing
While all parties associated with the corporation bear risk, shareholders bear all residual risk.
Flow of Control in a Corporation
Shareholders
Board of Directors
Managers
Corporation Taxes
VERY complicated and constantly changing
Owners file a Form 1040 with personal and dividend income included
The Corporation files a Form 1120 – US Corporation Income Tax Return – if gross receipts, total income, or total assets are over $500,000
Form 1120A (Short form) if any of the three are under $500,000 (… some other rules)
Corporation Summary
Control: LOTS of cooksFlexibility: Now it’s a BIG committee...Liability: Limited personal liabilityLongevity: Nobody lives forever… So what?Capital: Best access of all formsTaxation: Twice, but many deductions and
breaksBureaucratic BS: Lots and lots and lots
and…Cost: Can be substantial
Rights of Ownership in Corporations
Dividend Rights
Voting Rightsmajority voting
one vote per share per director
cannot combine votes
cumulative votingdirectors are voted on jointly
can cast all votes for a single candidate
Rights of Ownership (contd.)
Liquidation RightsOwners have the right to a
proportional share of the firm’s residual value in the event of liquidation, after other senior claims are paid.
Preemptive RightsOwners have the right to subscribe
proportionally to any new shares issued by the firm.
Forming a Corporation
What do you need? $50 (In Mississippi) Company name (unique) Directors Business address [Federal Tax ID] [Corporate Charter]
Interesting Statistics
Number of US businesses Number of US businesses by revenue size Number of US corporations by Industry Number of US sole proprietorships by
industry Number of US partnerships by industry Number of businesses by state Most popular small businesses
Businesses by State
BusinessesByState.xls
Need Help?
Small Business Development Center
Sec. Of State - www.sos.state.ms.us
MyCorporation.com
Incorporate USA
Company Corporation
CorpAmerica
BizFilings.com
Quick-Inc.com
Subchapter S Corporation
Owners retain limited liability
Taxed as a partnership - eliminates double taxation and makes it easier for owners to be compensated
All profits are taxed and distributed annually
Subchapter S Corporation
A corporation can elect S-Corp status within 75 days of formation if:
1. It is a domestic corporation (i.e., it operates in the state in which it is franchised
2. There is only one class of stock
3. It has 75 or fewer stockholders
4. All stockholders are US citizens or resident aliens
5. There are no subsidiaries
Limited Liability Company (LLC)
Owned by “members” who may run the company or appoint managers to do it
Members and managers have limited liability
Taxed like a Subchapter S Corporation without having to conform to the S Corp restrictions
Limited liability can make it harder to raise capital - may require personal guarantees
Limited Liability Partnership (LLP)
Also called a Professional CorporationUsed primarily by those who render
professional services - lawyers, doctors, architects, social workers, etc.
Some tax advantages - possible tax shelter
Not much liability limitation
Information Sources
The Quick-Inc Guide to Business Entities
LLCs on MyCorporation.com
LLCs on BizFilings.com
BizFilings.com Comparison of:C Corp to S Corp, S Corp to LLC,
C Corp to LLC
Piercing the Corporate Veil
Creditors may attempt to recover money from shareholders if:
The business was initially underfunded or “thinly capitalized”
The owners failed to treat the business as a separate entity themselves:
Fail to use Inc. or Corp or LLC in dealings
Co-mingle assets or funds
Fail to keep good records and hold meetings
The Goal of the Firm
Better defined than profits Is an objective external measure Considers timing of cash flows Considers all internal and external
factors Considers risk differences between
alternative courses of action
“Maximize Shareholder Wealth”
Three Types of Decisions
Investment Decisions
How should capital be invested?
Financing Decision
How should the assets be financed?
Managerial Decisions
How large should the firm be?
How fast should it grow?
Should the firm grant credit to a customer?
How should the managers be compensated?
The Investment Vehicle Model of the Firm
Investors provide financing to the firm in exchange for financial securities.
Firm invests these funds in assets. Income generated by the firm is
distributed to the investors. Managers act in the best interest of
the shareholders, and take actions to maximize shareholder wealth.
The Investment Vehicle Model of the Firm
TheWorld
Investors
The Firm
Inve
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FinancialIntermediaries
FinancialMarkets
Corporate Financial Management
Financial Markets and Intermediaries Investments
Exchange of Money and Financial
Assets
Exchange of Money and Real Assets
The Accounting Model of the Firm
Balance sheet view of the firm. Investment decisions are represented
on the asset (i.e. left hand) side of the balance sheet.
Financing decisions are represented on the liabilities and equity (i.e. right hand) side of the balance sheet.
Long Term Liabilities
Long Term Debt
Current Debt
The Investment Decision
Current Assets
Cash
Marketable Securities
Accounts Receivable
Inventory
The Accounting Model of the Firm
The Financing Decision
Current Liabilities
Accounts Payable
Current Debt
Shareholder’s Equity
Common Stock
Retained Earnings
Total Fixed Assets
Tangible Fixed Assets
Intangible Fixed Assets
Net Working Capital
Set of Contracts Model of the Firm The firm has contracts with a large
number of stakeholders. These contracts may be explicit or
implicit. Contracts may also be contingent on
particular future outcomes. The model recognizes that conflicts of
interest may exist between the various stakeholders.
Set of Contracts Model of the Firm
PreferredStockholders
Banks
CommonStockholders
Bondholders
Customers
Governments
Communities
Creditors
ManagersSuppliers
Society
Environment
Employees
The Firm
The Agency Model of the Firm
Managers have day-to-day operational control of the modern corporation and are supposed to act as agents for the shareholders.
Managers have goals that differ from those of the shareholders.
Shareholders must incur costs to make sure that their "agents" act in their best interests.
Monitoring costs Incentive costs
Notes on sources for this presentation
This presentation includes material provided in the Chapter 2 slide presentation for Corporate Finance by Emery and Finnerty (Prentice Hall)
and
Chapter 3 in Ready or Not, Get Set Go by Sheila Taylor-Downer (Professional Prodigy, Inc.)