Factors Affecting the Choice

• Tax considerations:
• The amount of net income an entrepreneur expects the business to generate
and the tax bill the owner must pay
• Year-to-year fluctuations in a company's income
• Liability exposure:
• Certain forms of ownership offer business owners greater protection from
personal liability that might result from financial problems, faulty products,
lawsuits, & a host of other difficulties
• Need to decide the extent to which they are willing to assume personal
responsibility for companies' financial obligations
• Start-up and future capital requirements:
• How much capital an entrepreneur needs and where he or she plans to get it
• As a business grows, some forms of ownership make it easier to attract
extremal growth capital than others.
Factors Affecting the Choice
• Control
• How much control they are willing to sacrifice in exchange for help from other
people to build a successful business.
• Managerial ability:
• Lack of ability or experience in key areas: Need to bring in other owners who can
provide the necessary skills for the company to succeed
• Business goals:
• How big and how profitable an entrepreneur plans for the business
• Switch forms of ownership as they grow: Extremely complex and expensive.
• Management succession plans:
• Need to look ahead to the day when they will pass their companies on to the next
generation or to a buyer
• Cost or formation
• Some forms of ownership: Much more costly and involved to create
Major Forms of Ownership
• Sole Proprietorship
• General Partnership
• Limited Partnership
• Corporation
• S Corporation
• Limited Liability Company
Sole Proprietorship
The most popular type of ownership, defined as business owned &
managed by one individual
Advantages Disadvantages
• Simple to create • Unlimited personal liability
• least costly form to begin • Personally liable for all of the
• Profit incentive business's debts.
• Total decision making authority • Limited skills and capabilities
• No special legal restrictions • Feelings of isolation
• Easy to discontinue • Limited access to capital
• Lack of continuity of the
business
Partnership
• An association of two or more people who co-own a business for the
purpose of making a profit.
• Always wise to create a partnership agreement:
• A document that states in writing the terms under which the partners agree
to operate the partnership and that protects each partner's interests in the
business.
• Need to specify
• The share of ownership
• The share of business's profits and losses .
• The right to participate in managing the operation of the partnership
• Partners' general obligations such as sharing any business losses, working
without salary
Partnership
Advantages Disadvantages
• Easy to establish • Unlimited liability of at least one
• Complementary skills of partners partner
• Division of profits • Capital accumulation
• Larger pool of capital • Difficulty in disposing of
• Ability to attract limited partners partnership interest
• Minimal government regulation • Potential for personality &
• Flexibility: Respond quickly & authority conflicts
creatively to changing market • Partners are bound by the law of
conditions & new opportunities agency
• Taxation: Partners pay income tax
on their distributive shares at their
individual tax rates
Types of Partners
• General partners:
• Partners share in owning, operating, and managing a business.
• All partners have unlimited personal liability.
• Limited partners:
• Financial investors in a partnership, cannot participate in the day-to-day
management, and have limited liability
• If the business fails they only lose the money they have invested in it.
• Silent partners:
• Not active in a business but generally are known to be members of the
partnership.
• Dormant partners:
• Neither active nor generally known to be associated with the business.
Types of Partners
• Limited partnership:
• Composed of least one general partner & at least one limited partner
• No limit on the total number of limited partners.
• General partner: The same as in a general partnership
• Limited partners: investor.
• Additional partnership advantages include: minimal governmental
regulation, flexibility, and taxation.
Limited Liability Partnerships
• All partners in a business are limited partners.
• Gives the advantage of limited liability for the debts of the
partnership.
• Does not pay taxes: Pass income to the limited partners who pay
taxes on their share of the company's income.
• Restrict LLPs to certain types of professionals, such as attorneys,
physicians, dentists, and accountants.
Corporations
• An artificial being, invisible, intangible, and existing only in contemplation
of the law
• A separate entity apart from its owners, and may engage in business, make
contracts, sue and be sued, and pay taxes.
• The owners of a corporation: Not personally liable for the actions of the
corporation
Limitation:
• Due to risky start-up, often require the founders of small corporations to
personally guarantee loans made to the business to get the loans
• Ignore the limited liability shield when
• Use corporate assets for personal reasons,
• Fail to act in a responsible manner & create an unwarranted level of financial risk
• Make financial misrepresentations, or
• Take actions in the name of the corporation that were not authorized by the board of
directors
Corporations
• Power to raise large amounts of capital by selling shares of ownership
to outside investors
• Closely held corporation:
• Shares that are controlled by a relatively small number of people
• Stock is passed from one generation to the next instead of being traded on
any stock exchange.
Avoiding Legal Tangles in a Corporation
Entrepreneurs should take these steps to avoid legal problems if they own a
corporation:
● Identify the company as a corporation by using “Inc.” or “Corporation” in
the business name.
● File all reports and pay all necessary fees required by the state in a timely
manner.
● Hold annual meetings to elect officers and directors.
● Keep minutes of every meeting of the officers and directors, even if it takes
place in the living room of the founders.
● Make sure that the corporation’s board of directors makes all major
decisions.
● Make it clear that the business is a corporation - officers should sign all
documents in the
● Keep corporate assets and the personal assets of the owners separate.
C Corporations
• Traditional form of incorporation.
• A separate legal entity
• Double taxation: A disadvantage of the corporate form of ownership
in which the corporation's profits are taxed twice
• At the corporate rate on profit before dividends
• At the individual rate on the portion of profits distributed to
shareholders as dividends.
• Establishing as a corporation: When a company intends to seek
investment from venture capital or other form of private equity
S Corporation
• Established specifically for small, closely held businesses to alleviate the
owners from the double taxation
• No different from any other corporation from a legal perspective.
• Taxed like a partnership, passing all of its profits (or losses) through to
individual shareholders.
• The criteria for businesses seeking "S" status are that the venture must:
• Be a domestic (U.S.) corporation
• Limit shareholders to individuals, estates, and certain types of trusts
• Cannot include partnerships, corporations, or nonresident aliens as shareholders
• Not have more than 100 shareholders
• Have only one class of common stock so all shares have the same rights
• Must be an eligible corporation
• {Ineligible: Certain financial institutions, insurance companies, & domestic international sales
corporations}
S Corporation
• To elect "S" status, all shareholders must consent, and the
corporation must file with the IRS with the first 75 days of its tax year.
• Follow 1/2, 1/3, 1/3 rule of thumb:
• Distribute one third of earnings to the shareholders to cover the taxes they
will owe, retain one third of earnings to fund growth, and earmark the final
one-third to pay down debt, fund debt, or distribute to the owners as a return
on their investment.
A corporation seeking S status must meet the following criteria:
● It must be a domestic corporation.
● It can only have only allowable shareholders, including individuals,
certain trusts, and estates.
● It cannot include partnerships, corporations, or nonresident aliens as
shareholders.
● It cannot have more than 100 shareholders.
● It can only issue one class of stock. However, S corporations can issue
shares of stock with
different voting rights.
● It cannot be an ineligible corporation, such as certain financial
institutions, insurance companies, and domestic international sales
corporations.
Limited Liability Company (LLC)
• Resembles, but more flexibility than an S Corporation An attractive form of
ownership for smaller companies
• Limited personal liability for the owners for the debts of the business,
providing a significant advantage over sole proprietors and partnerships
• Offer the tax advantage of a partnership, the legal protection of a
corporation, and maximum operating flexibility
• Creating LLC: Much like creating a corporation, require two documents :
• Articles of organization: Create an LLC by establishing its name and address, method of
management, its duration, etc. –
• Operating agreement: Establish for an LLC the provisions governing the way it will
conduct business.
• Disadvantages: Expensive to create & require in some states to pay special fees,
limited life spans, & undeductable cost of employee benefits as a business
expense.
Creating a Legal Business Entity
• C corporations, S corporations, & LLCs: Costly & time consuming to
establish and to maintain.
• Cheaper to complete all requirements by entrepreneurs, but not
always the best idea & need to be very cautious
• The average cost to create a legal business entity is about $1,000, but
it can range from $500 to $5,000.
• Can use Web sites like MyCorporation and BizFilings and incorporate
for just $100.
• Need to be careful due to high cost of filing incorrectly • Need to
choose a state in which to establish the entity & the state in which
they will operate
• States have different regulations on forming business entities
• May need to hire attorneys to handle the process
Buying an Existing Business
• The process of business acquisition
• Require a due diligence process that involves analyzing and evaluating an existing
business
• Need to reveal both the negative and the positive aspects of an existing business.
• Key questions to consider before buying an existing business.
• Is it the right type of business for sale in a market in which you want to operate?
• What experience do I bring to the venture?
• What is the success potential?
• What changes are needed-& how extensive are they--to realize the full potential of
the value of the business?
• What price and payment method are reasonable for you and acceptable to the
seller?
• Is the seller willing to finance part of the purchase price?
• Will the company generate sufficient cash to pay for itself and leave you with a
suitable rate of ROR?
• Should you be starting a business & building it from the group up rather than buying
an existing one?
Advantages of Buying an existing Business
• A successful existing business may continue to be successful.
• An existing business may already have a superior location.
• Employees and suppliers are established.
• Installed equipment with known productive capacity.
• Inventory is in place
• Trade credit is established.
• A turnkey business already has operating processes in place,
• The new owner can use the experience of the pervious owner.
• Easier access to financing.
• High value is possible if the current owner sell quickly at a bargain
price.
Disadvantages of Buying an Existing Business
• Cash requirements may be higher than if starting a new business,
• Business may be losing money.
• Paying for ill will of the previous owner used improper business
behavior or unethical practices.
• Employees inherited with the business may not be suitable.
• The business location may have become/is unsatisfactory.
• Equipment and facilities may be obsolete or inefficient.
• Change and innovation are difficult to implement.
• Inventory may be outdated or obsolete.
• Accounts receivable may be worth less than face value.
• The business may be overpriced.
Like Fuzzy’s, unprofitable businesses often result from at least one of the following
problems:
● High inventory levels
● Excessively high wage and salary expenses due to excess pay or inefficient use of
personnel
● Excessively high compensation for the owner
● Inadequate accounts-receivable collection efforts
● Excessively high rental or lease rates
● High-priced maintenance costs or service contracts
● Poor location or too many locations for the business to support
● Inefficient equipment
● Intense competition from rivals
● Prices that are too low
● Low profit margins
● Losses due to employee theft, shoplifting, and fraud