Chapter 3
Business Organizations
Types of Firms
• Sole proprietorship – a business owned and run
by one person.
• In 2000, 73% of all businesses in the U.S. were
sole proprietorships.
• Advantages of sole proprietorships:
-easy start-up
-flexible (can make decisions quickly)  management
is all you
-the profits are yours
-you are your own boss
-no business taxes; all income for you
-easy exit  pay your bills and stop working
Disadvantages of sole proprietorships
-unlimited liability  you are responsible for
everything
-it’s hard to borrow money
- Size and efficiency—you have to do everything
yourself. You may be good at some things
(making the product) but not at others
(keeping the financial records, doing the
insurance paperwork)
-limited management experience
-hard time finding qualified employees
-limited life – business dies when you die
Partnerships
• Partnerships – business jointly owned by two or
more persons.
• In 2000, partnerships accounted for 7.1% of
business organizations in the U.S.
• There are two types of partnerships:
*general partnerships – all partners actively run
the business
*limited partnership – at least one partner is not
active in running the business and has limited
responsibility for the debts & obligations of
the business.
Forming a Partnership
• It’s sort of like getting a marriage pre-nup.
• Legal papers are drafted that specify:
-how profits are divided.
-how new partners may join.
-how property is divided if the partnership ends.
Warning  You are responsible for the debts of
your partners!
Advantages of partnerships:
-easy to start
-easy to manage
-you get your share of the profits
-can attract financial capital easier than sole
proprietorships
-larger, so some economies of scale present
 More efficient operations (people can
specialize)
-easier to attract qualified employees
Disadvantages of partnerships:
-responsible for the acts of all the other partners
-if you are a limited partner, not involved in daily
activity, you only lose your original
investment
- limited life  when a partner dies or leaves, it
ends. It must be dissolved legally and
reorganized with the remaining partners.
(They usually want to keep the old name.)
-conflict between partners
-bankruptcy – if you’re not a limited partner, you
have to pay any debts!
Corporations
• Corporation – a form of business organization
that is recognized by the law as having all the
legal rights of an individual.
• They have the right to buy & sell property, enter
into legal contracts, and to sue & be sued.
• In 2000, corporations were 19.9% of business
organizations, but were responsible for 88.8%
of all sales.
Corporations
• Forming a Corporation:
– File for permission from the federal (national)
government or the state where your HQ will be
– “charter” is granted: states name, address,
purpose, number of shares of stock, etc.
– Sell stock (“IPO”) at an initial price
– Stock value goes up and down according to
your profitability
– Issue dividends (hopefully)
Stock?
• Stock – a certificate of ownership in a firm.
• Stockholders – a.k.a. – shareholders –
investors in a corporation (they own
stock).
• The money from the stockholders
(investors) is used to set up the firm.
This money is called financial capital.
Types of Stock
• Common stock – basic form of ownership
in a corporation. Each share is worth
one vote for the board of directors, who
run the company.
• Preferred Stock – non-voting shares of
stock, but these shareholders receive
profits before common stockholders.
Advantages of Corporations
• Easy to raise financial capital
1.) sell stock
2.) issue bonds  a written promise to repay the amount
borrowed in the future
• Hire professional managers
• Limited liability for the corporation’s owners: the
corporation itself is responsible for all debts,
not the owners. If it goes out of business,
stockholders do not have to repay the
corporation’s debts.
• Unlimited life – the firm doesn’t die when a
shareholder does.
Advantages of Corporations
• Ease of transferring ownership:
 If you don’t want to be part owner any more,
you just sell your stock.
 Much easier than a sole proprietorship trying to
find someone to buy the entire business.
Disadvantages of Corporations
• Difficult to start
• Shareholders have little say about how the
business is run
• Double taxation – the firms profits are
taxed and then the profit that is distributed
to shareholders is also taxed.
• Subject to government regulation.
Disadvantages of Corporations
Corporations are subject to more government
regulation than sole proprietorships and
partnerships.
 register with the state
 register with the Securities & Exchange
Commission—the SEC—to sell stock to the public
 publish info on their sales and profits on a
regular basis
 get approval to buy or merge with other
companies.
LLCs - “Limited Liability Company”
The
major advantage of a Sole
Proprietorship is no double taxation. Its
owner just calculates her profits and reports
them as her income, and pays income taxes.
The major disadvantage of a Sole
Proprietorship is its UNlimited liability.
For instance, if someone slips and falls in her
Sole Proprietorship, the injured person could
sue her for the business assets, her home, and
other personal assets of the proprietor.
LLCs - “Limited Liability Company”
 Forming
your company as an LLC instead of a
Sole Proprietorship keeps the major advantage and
loses the disadvantage: it keeps single taxation but
limits the liability of the owners for losses and
debts of the company.
 For instance, if a client slips and falls on the
property of an LLC, the injured person can only
sue for assets that belong to the company (not the
proprietor’s personal assets).
 Sole Proprietors can also take out “liability
insurance” in case of accident or injury.
The Role of Government
• The state governments began regulating
corporations in the mid-1800’s.
• Corporations in states with a lot of regulation
moved to states with less, so as a result state
regulations began to be lifted.
• In the early 1900’s, consumer groups demanded
regulation of giant corporations.
• Regulations of electric companies, insurance
companies, the phone company, and transportation
companies (Railroads & Airlines)
Era of Deregulation
• In the 1980’s, a wave of government
deregulation swept through Congress and
state legislatures.
• States competed for corporations to move to
their state for the reasons of job creation
and tax revenue.
Business Growth
• Businesses can grow in the following
ways:
1.) Reinvestment
2.) Merger
• Income statement – shows how much
money the business makes and spends.
Estimating Cash Flow
Depreciation: gradual wear and tear (the amount less
your stuff is worth at the end than it was at the
beginning)
income statement: report showing “gross” income, sales,
expenses to make your product, depreciation…
– and “net” income! (net income = profits after
taxes)
…after you add depreciation back in, you end up with
one type of Cash flow
– “positive” cash flow:
– or “negative” cash flow:
Growth through Re-Investment
• If you have a positive cash flow, you can:
– issue dividends to your stockholders; and/or
– reinvest those profits by using them to buy
new equipment, new technology, a new
factory (plant), or some other improvement to
your business. This is called “growth by
reinvestment.”
– As long as these investments are bigger than
the wear and tear (depreciation) on your
equipment, your company will grow.
Why Merge?
Merger: combining two or more businesses
to form a single firm.
1.) Grow faster
2.) Become more efficient
3.) Acquire or deliver a better product
4.) Eliminate a rival
5.) Change image
Types of Mergers
• Horizontal merger – when two or more firms
that make the same product join forces.
– Example: Nextel + Sprint = Sprint-Nextel
• Vertical merger – when firms involved in
different steps of the manufacturing or marketing
join together.
– Example: Time Warner Incorporated (a major cable operation) +
Turner Corporation (which produces CNN, TBS and other
programming) = Time Warner/AOL
Mergers
– Conglomerate: a firm that has at least four businesses,
each making unrelated products (no product has the
majority of sales). These companies don’t have “all their
eggs in one basket” and so can take some risks with new
products. (Panasonic, Sony, GE…)
Daewoo
Multinational
• Multinational - can be an ordinary
corporation or a conglomerate, but it has
manufacturing or service operations in
several different countries.
• Multinationals introduce new technology,
generate jobs, and produce tax revenues for
the host countries.
• Pay taxes in each country / must follow the
law of each country
Nonprofits
• Firms use scarce resources to produce goods and
services in order to make a profit for their
owners.
• Other organizations operate on a “not-for-profit”
basis
• A nonprofit organization operates like a
business to promote the collective interests of its
members rather than to seek financial gain for its
owners
Nonprofits
• Examples: schools, churches, hospitals, welfare
groups, and adoption agencies.
• Many of these organizations are legally
incorporated to take advantage of unlimited life
and limited liability.
• They are similar to profit-seeking businesses, but
do not issue stock, pay dividends, or pay income
taxes.
• The profits they produce are used to further the
goals of the group.
Goal of Cooperatives
• Cooperative - a voluntary association of
people formed to carry on some kind of
economic activity that will benefit its
members.
• Producer and worker cooperatives are
associations in which the members join in
production and marketing and share the
profits.
Cooperatives
• The consumer
cooperative is a
voluntary association
• They buy bulk
amounts of goods
such as food and
clothing on behalf of
its members.
• The goal is lower
prices for members.
Credit Unions
• An example of a cooperative is a
credit union
• It is a financial organization that
accepts deposits from, and makes
loans to, employees of a particular
company or government agency.
Labor Unions
– A labor union is an organization of workers in the
same industry. Examples are:
• UAW
• Teachers’ Unions like NEA
• Firefighters’ unions
• Screen Actors’ Guild
What is the purpose
of labor unions?
• To negotiate with management to get the
best working conditions they can, including:
–
–
–
–
–
pay
working hours (lunches & breaks)
health plan coverage & other benefits
vacation days
clean air and other environmental issues
This is called “collective
bargaining”
What can labor unions do if they
don’t get their way?
• Strike!
Professional Associations
• Many workers belong to professional societies,
trade associations, or academies. For example:
ABA, AMA, etc…
• Professional associations are similar to unions,
but the goal is usually keeping high standards for
the skill level and public perception of their
profession. Membership requires keeping their
standards.
• These associations also seek to influence
government policy on issues that are important to
them.
Business Organizations
• Chamber of Commerce: promotes the welfare of
its businesses by lobbying and education
• Better Business Bureau: provides info on local
companies, keeps records of complaints, offers
consumer education programs.
• Industry or Trade Associations: try to influence
government policy on imports, tariffs, minimum
wage, new construction, and regulations on free
enterprise
Direct & Indirect Role of Government
• The role is direct because the government supplies a good
or service that competes with private businesses OR that
could be provided by private companies instead.
– Many federal agencies are organized as government-owned
corporations. (USPS, FDIC, TVA)
• The government plays an indirect role when it acts as an
umpire to make sure the market economy operates
smoothly and efficiently.
– One such case is the regulation of public utilities, investor- or
municipal-owned companies that offer important products to the
public, such as water or electric service. They have few
competitors because the cost of doing this business is SO high
(laying pipe, wire, or cable for an entire city).
One last thing!
The government also acts in the economy
when it provides money to people who
wouldn’t otherwise have it:
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Social Security checks
Welfare
Veterans’ Benefits
College Student Financial Aid (loans & grants)
Unemployment insurance
The money these people spend influences the
goods and services offered in the economy.