10
Form of
Organization and
Legal Issues
PowerPoint Presentation by
Ian Anderson, Algonquin College
Chapter 10
Copyright © 2010 by Nelson Education Limited.
10-1
Looking Ahead
After studying this chapter, you should be able to:
1.
Identify the common legal forms of organization used by
small businesses and describe the characteristics of each.
2.
Identify factors to consider in choosing among the primary
legal forms of organization.
3.
Describe the effective use of boards of directors and advisory
councils.
4.
Explain how different forms of organization are taxed by the
federal government.
5.
Understanding the major legal and regulatory issues
businesses face
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10-2
Legal Forms of Organization
• In launching a new business, an
entrepreneur must choose a form of legal
organization. The most common options
are:
– Sole proprietorship
– Partnership
– Corporation
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Legal Forms of Organization
Exhibit 10-1
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The Sole Proprietorship Option
• Sole Proprietorship
–A business owned and operated by one person
–Disadvantages
• Unlimited personal liability
• No tax free benefits
• Death/incapacity of owner terminates business
–Advantages
• Ownership of the company name and assets may be
transferred.
• There is generally no registration or filing fee.
• Freedom from interference
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The Partnership Option
• Partnership
– A legal entity formed by two or more co-owners to carry on a
business for profit.
• Partner Qualifications
– Required: of legal age to contract
– Desired: Honest, healthy, capable, and compatible
• Questions about Partnership Formation
– What is our business concept?
– How are we going to structure ownership?
– Why do we need each other?
– How do our lifestyles differ?
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The Limited Partnership
• Limited Partnership
– This form of ownership consists of at least one general
partner and one or more limited partners
– General partner
• a partner in a limited partnership who has unlimited
personal liability
– Limited partner
• a partner in a limited partnership who is not active in
its management and has limited personal liability
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10-7
The
Advantages and
Disadvantages
of
Partnerships
Advantages
Disadvantages
Sharing Workload
Interpersonal
Conflicts
Sharing Emotional
Burden
Dissatisfaction
with Partner
Procuring Executive
Talent
Absence of One
Clear Leader
Sharing Financial
Burden
Dilution of Equity
Companionship
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Frustration of Not
Calling Own Shots
10-8
Partnership Terms
• Articles of Partnership
–A document that states explicitly
the rights and duties of partners.
• Agency Power
–The ability of any one partner
to legally bind (e.g., borrow
money) the other partners.
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Rights and Duties of Partners in a
Partnership Agreement
•
•
•
•
•
•
•
•
•
Date and formation of partnership
Names and addresses of partners
Statement of fact of partnership
Statement of business purpose(s)
Duration of the business
Name and location of the business
Amount invested by each partner
Sharing ratio for profits & losses
Partner’s right if any re: withdrawal
of funds for personal use
• Provision for accounting records
and their accessibility to partners
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• Specific duties of each partner
• Provision for dissolution and
sharing of the net assets
• Restraint on partner's
assumption of special
obligations, such as endorsing a
note of another
• Provision for protection of
surviving partners decedent’s
estate, and so forth in the even
of a partner’s death
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10-10
The Corporation Option
• Corporation
– A business organization that exists as a legal
entity and provides limited liability for its
owners.
• Legal Entity
– A business organization that is recognized by
the law as having a separate legal existence
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Articles of Association
• Name of company
• Restrictions, if any, on
business the corporation
may carry on
• Location of principal
office
• Classes, voting privileges
and, maximum number
of shares the corporation
is allowed to issue
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• Restrictions if any on
share transfers
• Names and addresses of
incorporator and first
year’s directors
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Rights and Status of Shareholders
• Share Certificate
–A document specifying the number of shares owned by a
shareholder
• Pre-emptive Right
–The right of shareholders to buy new shares before they are
offered to the public.
• Legal Status
–Ownership provides control over the firm.
–Ownership limits liability to investment in the firm.
–Ownership can be transferred without affecting the firm’s
operations
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Limited Liability of Shareholders
• For most shareholders, their limited liability is a
major advantage of the corporate form of
organization. Their financial liability is limited to
the amount of money they invest in the business.
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Death or Withdrawal of Shareholders
• Unlike a partnership interest, ownership in a
corporation is readily transferable.
• Exchange of shares is sufficient to convey an
ownership interest to a different individual.
• Shares of large corporations are exchanged
constantly without noticeable effect on the
operation of the business.
• For a small firm, a change of owners can involve
numerous complications
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Issues in Choosing an
Organizational Form
• Factors that affect the choice of the firm’s
structure:
–Initial organizational costs and requirements
–Limited versus unlimited liability for the owners
–Continuity of business
–Transferability of ownership
–Management control
–Attractiveness for raising equity capital
–Income taxes
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10-16
Comparison of Legal Forms of
Organization
Form of
Organization
Initial Organizational
Requirements and Costs
Liability of
Owners
Attractiveness for
Raising Capital
Sole proprietorship
Minimum requirements;
generally no registration
or filing fee
Unlimited
liability
Limited to proprietor’s
personal capital
General partnership
Minimum requirements;
generally no registration or
filing fee; written partnership
agreement not legally
required but strongly
suggested
Unlimited
liability
Limited to partner’s
ability and desire to
contribute capital
Corporation
Most expensive and greatest
requirements; filing fees;
compliance with provincial
regulations for corporations
Liability limited
to investment
in company
Usually the most
attractive form for
raising capital
Form of
organization
preferred
Proprietorship or
general partnership
Corporation
Corporation
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Exhibit 10-2
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The Board of Directors and Duties
• Board of Directors
–The governing body of a corporation, elected by the
shareholders
–Inside directors
• Board members who work for the firm
–Outside director
• Board members who do not work for the firm
• Duties
–Elect the firm’s officers (top management)
–Approve management’s plans and policies
–Review performance and declare dividends
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The Board of Directors and
Advisory Councils
• Contributions of Board of Directors
–Bring knowledge and experience
•
•
•
•
Review policy decisions
Provide general direction
Monitor the firm’s ethical behaviour
Mediate and resolve disputes among top management
• Alternative: Advisory Council
–Provides advice but does not have the fiduciary
responsibility for the direction of the firm.
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Federal Income Taxes
• Sole Proprietorship
– Self-employed persons are taxed on their business incomes at
tax rates set for individuals.
• Partnership
– The partnership does not pay taxes; allocated shares of income
from partnership are taxed as personal income for each of the
partners.
• Corporation
– As a separate legal entity, it reports its income and pays any
taxes related to these profits.
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Federal Income Taxes and
Sole Proprietorship
Sole
Proprietorship
Example of taxes due from
a married couple with
$150,000 in income from
the business that they
operate as self-employed
persons
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Range of Taxable Income
$0 to $37,885
$37,886 to $75,769
$75,770 to $123,184
$123,185 and over
Tax Rate
15%
22%
26%
29%
Income x Tax Rate= Taxes
First
$37,885
15%
$5,682.75
Next
$37,884
22%
$8,334.48
Next
$47,415
26%
$12,327.90
Remaining $26,816
29%
$ 7,776.64
Total
$150,000
$34,121.77
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10-21
Federal Income Taxes and Corporations
Corporations
Taxable income under $400,000 is taxed at the federal
corporate tax rate of 12%. Provincial tax rates vary.
Any profits of the corporation that are distributed to the
shareholders (dividends) are taxed again as personal income.
INCOME
Small business income up to $400,000
Investment income
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TAX
11.0%
34.7%
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Laws and Regulations
Regulating Competition
• Competition Act (Federal)
– Designed to maintain a competitive economy
– Prohibits:
•
•
•
•
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Discounts not offered to all customers
Tied selling
Refusal to deal
Exclusive dealing
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Laws and Regulations
Protecting Consumers
• Ontario Business Practices Act
• Canadian Consumer Packaging and
Labelling Act
• Textile Labelling Act
• Food and Drug Act
• Hazardous Products Act
• Motor Vehicle Safety Act
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Laws and Regulations
Protecting Investors & Public Welfare
• Protecting Investors
– Securities Act
• Promoting Public Welfare
– Ontario Environmental Protection Act
– Municipal health bylaws
– Canadian Human Rights Act
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Laws and Regulations
Protecting Employee Rights
• Occupational health and safety acts
• Employment standards codes
• Workers’ compensation acts
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Laws and Regulations
Protecting Intangible Assets
•
•
•
•
•
•
Trademarks, e.g., Sony, Acura
Patents, e.g., Post-It notes
Copyrights, e.g., songs, books
Industrial Design
Integrated Circuit Topography
Plant Breeders’ Rights
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Business Agreements
Exhibit 10-5
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10-28
Contracts
• Legally-binding agreements with
employees, customers, suppliers and others
–
–
–
–
–
–
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Offer
Voluntary agreement
Competent contracting parties
Legal act
Consideration
Form consistent with content
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