Chapter Five
Choosing a Form
of Business
Ownership
Learning Objectives
1. Describe the advantages and disadvantages of sole
proprietorships.
2. Explain the different types of partners and the importance
of partnership agreements.
3. Describe the advantages and disadvantages of
partnerships.
4. Summarize how a corporation is formed.
5. Describe the advantages and disadvantages of a
corporation.
6. Discuss the purpose of an S-corporation, limited-liability
company, and other special forms of business ownership.
7. Explain how growth from within and growth through
mergers can enable a business to expand.
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Textbook – Student Website
• http://college.hmco.com/business/phk/
business/8e/students/index.html
– Brief Chapter Outlines
– Transcripts of Audio Reviews
– Review Questions
– Flashcards
– Practice Tests
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Sole Proprietorships
• A business that is owned (and usually
operated) by one person
• The simplest form of business ownership and
the easiest to start
• Many large businesses began as a small
struggling sole proprietorships
• The most widespread form of business
ownership
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Relative Percentages of Sole Proprietorships,
Partnerships, and Corporations in the U.S.
• Sole proprietorships are most common in retailing,
agriculture, and the service industries
Source: U.S. Bureau of the Census website (www.census.gov), Statistical Abstract of the United States, 121st
ed., Washington, D.C., 2001, p. 473.
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Advantages and Disadvantages of Sole
Proprietorships
ADVANTAGES
– Ease of start-up (and shut
down)
– Retention of profits
– Flexibility
– Possible Tax Advantages
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DISADVANTAGES
– Unlimited liability
• A legal concept that holds a
business owner personally
responsible for all the debts of
the business
– Lack of continuity
– Lack of money
– Limited management skills
– Difficulty in hiring
employees
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Partnerships
• A voluntary association of two or more persons to
act as co-owners of business for profit
• Less common form of ownership than sole
proprietorship or corporation
• No legal limit on the maximum number of partners;
most have only 2
• Large accounting, law, and advertising partnerships
have multiple partners
• Partnerships are usually a pooling of special talents
or the result of a sole proprietor taking on a partner
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Total Sales Receipts of American Businesses
Although corporations account for only 20.1% of U.S.
businesses, they bring in 87.1% of the sales receipts.
Source: U.S. Bureau of the Census website (www.census.gov), Statistical Abstract of the United States, 121st ed.,
Washington, D.C., 2001, p. 473.
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Types of Partners
• General partner
– A person who assumes full or shared responsibility for operating a
business
– General partnership: A business co-owned by two or more general
partners who are liable for everything the business does
• Limited partner
– A person who contribute capital to a business but has no
management responsibility or liability for losses beyond the amount
he or she invested in the partnership
– Limited partnership: A business co-owned by one or more general
partners who manage the business and limited partners who invest
money in it
– Master limited partnership (MLP): A business partnership that is
owned and managed like a corporation but taxed like a partnership
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The Partnership Agreement
• Articles of Partnership
– An agreement listing and explaining the terms of
the partnership
– Agreement should state
•
•
•
•
Who will make final decisions
What each partner’s duties will be
How much each partner will invest
How much profit or loss each partner receives or is
responsible for
• How the partnership can be dissolved
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Advantages and Disadvantages of
Partnerships
ADVANTAGES
– Ease of start-up
– Availability of capital and
credit
– Retention of profits
– Personal interest
– Combined business skills
and knowledge
– Possible tax advantages
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DISADVANTAGES
– Unlimited liability
– Lack of continuity
– Effects of management
disagreements
– Frozen investment
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Corporations
• An artificial person created by law with most of the
legal rights of a real person, including the rights to
start and operate a business, to buy or sell
property, to borrow money, to sue or be sued, and
to enter into binding contracts
• There are 4.8 million corporations in the U.S.
• They comprise only 20% of all businesses, but they
account for 87.1 % of sales revenues
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Corporations (cont’d)
• Corporate Ownership
– Stock
• The shares of ownership of a corporation
– Stockholder
• A person who owns a corporation’s stock
– Closed corporation
• A corporation whose stock is owned by relatively few
people and is not sold to the general public
– Open corporation
• A corporation whose stock is bought and sold on
security exchanges and can be purchased by any
individual
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Forming a Corporation
• Incorporation
– The process of forming a corporation
• Most experts recommend consulting a lawyer
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Forming a Corporation (cont’d)
• Where to Incorporate
– Businesses can incorporate in any state they
choose
– Some states offer fewer restrictions, lower taxes,
and other benefits to attract new firms
– Domestic corporation
• A corporation in the state in which it is incorporated
– Foreign corporation
• A corporation in any state in which it does business
except the one it which it is incorporated
– Alien corporation
• A corporation chartered by a foreign government and
conducting business in the U.S.
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Forming a Corporation (cont’d)
• The Corporate Charter
– A contract (submitted as articles of incorporation)
between the corporation and the state in which
the state recognizes the formation of the artificial
person that is the corporation
– Charter includes
•
•
•
•
Firm’s name and address
Incorporators’ names and addresses
Purpose of the corporation
Maximum amount of stock and types of stock to be
issued
• Rights and privileges of stockholders
• Length of time the corporation is to exist
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Forming a Corporation (cont’d)
• Stockholders’ Rights
– Common stock
• Stock owned by individuals or firms who may vote on corporate
matters but whose claims on profit and assets are subordinate to
the claims of others
– Preferred stock
• Stock owned by individuals or firms who usually do not have
voting rights but whose claims on dividends are paid before those
of common-stock holders
– Dividend
• A distribution of earnings to the stockholders of a corporation
– Proxy
• A legal form listing issues to be decided at a stockholders’
meeting and enabling stockholders to transfer their voting rights
to some other individual or individuals
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Forming a Corporation (cont’d)
• Organizational Meeting
– The last step in forming a corporation
• The incorporators and original stockholders meet to
elect their first board of directors
– Board members are directly responsible to
stockholders for how they operate the firm
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Corporate Structure
• Board of Directors
– The top governing body of a corporation, the
members of which are elected by the
stockholders
– Responsible for setting corporate goals,
developing strategic plans to meet those goals,
and the firm’s overall operation
– Outside directors: experienced managers or
entrepreneurs from outside the corporation who
have specific talents
– Inside directors: top managers from within the
corporation
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Corporate Structure (cont’d)
• Corporate Officers
– The chairman of the board, president, executive
vice presidents, corporate secretary, treasurer, or
any other top executive appointed by the board
– Implement the chosen strategy and direct the
work of the corporation, periodically reporting
results to the board
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Hierarchy of Corporate Structure
• Stockholders exercise a great deal of
influence through their right to elect the
board of directors
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Advantages and Disadvantages of
Corporations
ADVANTAGES
– Limited Liability
• Each owner’s financial
liability is limited to the
amount of money that he or
she has paid for the
corporation’s stock
DISADVANTAGES
– Difficulty and Expense of
Formation
– Government Regulation
– Double Taxation
– Lack of Secrecy
– Ease of Raising Capital
– Ease of Transfer of
Ownership
– Perpetual Life
– Specialized Management
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Other Types of Business Ownership
• S-Corporations
– A corporation that is taxed as though it were a
partnership (income is taxed only as the personal income
of stockholders)
– Advantages
• Avoids double taxation of a corporation
• Retains the corporation’s legal benefit of limited liability
– S-corporation criteria
•
•
•
•
•
•
No more than 75 stockholders allowed
Stockholders must be individuals, estates, or certain trusts
There can be only 1 class of outstanding stock
The firm must be a domestic corporation
There can be no nonresident alien stockholders
All stockholders must agree to the decision to form an Scorporation
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Other Types of Business Ownership (cont’d)
• Limited-Liability Company (LLC)
– A form of business ownership that provides
limited-liability protection and is taxed like a
partnership
– Advantages
• Avoids double taxation of a corporation
• Retains the corporation’s legal benefit of limited
liability
– Difference between LLC and S-Corporation
• LLCs not restricted to 75 stockholders
• LLCs have fewer restrictions on who can be a
stockholder
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Other Types of Business Ownership (cont’d)
• Government-Owned Corporations
– A corporation owned and operated by a local,
state, or federal government
– Purpose
• To ensure that a public service is available
– Examples
• Tennessee Valley Authority (TVA), the National
Aeronautics and Space Administration (NASA), and
the Federal Deposit Insurance Corporation (FDIC)
– Quasi-government corporation
• Partly owned by the government and partly by private
citizens or firms
• Examples: Fannie Mae, Freddie Mac, Sallie Mae
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Other Types of Business Ownership (cont’d)
• Not-for-Profit Corporations
– Corporations organized to provide social, educational,
religious, or other services, rather than to earn a profit
– Charities, museums, private schools, and colleges are
organized as not-for-profits primarily to ensure limited
liability
• Cooperatives
– Associations of individuals or firms whose purpose is to
perform some business function for its members
– Members benefit from the efficiencies of the
cooperatives’ activities, such as reducing unit costs by
making bulk purchases and coordinating services such
as transportation, processing, and marketing products
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Other Types of Business Ownership (cont’d)
• Joint Ventures
– Agreements between two or more groups to form a
business entity in order to achieve a specific goal or to
operate for a specific period of time
– Example: Disney & Pixar
• Syndicates
– Temporary associations of individuals or firms organized
to perform a specific task that requires a large amount of
capital
– Most commonly used to underwrite large insurance
policies, loans, and investments
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Corporate Growth
• Growth from Within
– Introducing new products
– Entering new markets
• Growth Through Mergers and Acquisitions
– Merger: the purchase of one corporation by another;
essentially the same as an acquisition
– Hostile takeover: a situation in which the management
and board of directors of the firm targeted for acquisition
disapprove of the merger
– Tender offer: an offer to purchase the stock of a firm
targeted for acquisition at a price just high enough to
tempt stockholders to sell their shares
– Proxy fight: a technique used to gather enough
stockholder votes to control the targeted company
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Growth Through Mergers and Acquisitions
(cont’d)
• Steps to avoid hostile takeover
– Issue a new class of preferred stock that stockholders
can redeem at a premium after the raider assumes
control
– Allow existing shareholders to buy new stock at a
discounted price in order to increase the number of
existing shares
– Give golden parachute contracts to top executives
– Adopt a supermajority position requiring 2/3 to 3/4
majority of votes cast by stockholders to ratify a takeover
– Create staggered terms for board members
– Use leveraged capitalization (large amount of debt
capital and large cash distributions to stockholders)
– Find a white knight willing to take over the company
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Three Types of Growth by Merger
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Corporate Growth (cont’d)
• Current Merger Trends
– Takeover advocates say
• Companies that are taken over are made more
profitable and productive
• Proceeds from the sale of non-core subsidiaries help
pay off debt or enhance the company
– Takeover opponents say
• Takeover threats force managers to spend time on
defense rather than vital business activities
• The only people who benefit from takeovers are
investment bankers, brokerage firms, and takeover
artists
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Corporate Growth (cont’d)
• Current Merger Trends
– Mergers during the first part of the 21st century will be
the result of cash-rich companies looking to enhance
their position in the marketplace
– There will be more mergers involving companies or
investors from other countries
– Less borrowed money (debt capital) will be used to pay
for mergers and acquisitions
• Divestiture—the process of dismantling a company and selling off
different parts
– There will be more leveraged buyouts
• A purchase arrangement that allows a firm’s managers and
employees or a group of investors to purchase the company
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Textbook – Student Website
• http://college.hmco.com/business/phk/
business/8e/students/index.html
– Brief Chapter Outlines
– Transcripts of Audio Reviews
– Review Questions
– Flashcards
– Practice Tests
Copyright © Houghton Mifflin Company. All rights reserved.
5 - 37