Business Ownership Laws
Pre Reading Comment Chapter 3
Book has good discussion of small business start up
and the role of small business in job creation.
You may want to pay attention to this section to get some ideas for your
business plan.
The other area to focus is on the identification of
different types of business organizations
Business Plan
In your business plan you
will need to identify the type of organization that you want your business to
be, and why.
Lecture Notes
Lecture
Summary
The key components of this
lecture are:
Types of Business Organizations
In starting a business one
needs to determine the legal form of the business that is most desirable. There are differences in ease of creation,
tax treatment and liability associated with each form of business organization.
Sole Proprietorship The most common form of organization has the advantage
of treating income/loss as personal income/loss of the owner (this can be an
advantage for small business that often experience a loss). These are also very easy forms of business to
start. The biggest disadvantage of a
sole proprietorship is that unlimited liability of the business is treated as
personal liability of the individual owner.
In other words to satisfy debts or lawsuits of the business the courts
can take your house and personal savings.
General Partnerships - This is where multiple individuals are co-owners of
the business. An advantage of this form
of business is that multiple individuals can invest and share in the management
of the organization this allows the organization to grow in size and
complexity.
The biggest limitation of
this form of organization is again unlimited individual liability for
organizational debts. In addition,
managing the relationships between the partners can be a complex and time
consuming process.
Limited Partnerships Multiple individuals invest in and co-own the organization. However some of the partners (limited
partners) are not involved in the management of the organization and their
liability is limited to the extent of their investment. There are one or more general partners who
manage the organization and who have unlimited personal liability. While the early Dutch trading companies we referred
to would not have called themselves limited partnerships this is what they were
in todays terminology
The creation of a
partnership is not overly involved but does require the development of a
partnership agreement between the partners addressing how the partners will
mange the organization and their relationships.
Corporations - These are business organizations that are a separate legal entity. This means that for both tax and liability
issues they are treated independently of the owners. So owners in a corporation only have their
investment in the company at risk limited liability. The creation of a corporate entity is more
complicated and involved than the creations of a partnership or sole
proprietorship.
Depending on the type of
corporation, there can be a double taxation issue. This means that the profits of the
corporation are taxed as corporate profits when they are earned and then taxed
again as personal income when they are distributed to the owners.
As a result of the limited
liability associated with ownership, these corporations can much more easily
raise investment capital by selling a share in the ownership of the business
(shares of stock).
Some corporations are
closely or privately held meaning their ownership is control by a limited
number of individuals and is not available for sale to the general public. If you get involved in a privately held
corporation you need to remember that generally speaking whoever controls 51%
of the stock controls the corporation.
While state laws do provide some protection for minority stock holders,
being a minority stock holder is generally considered a very weak position and
one should be very careful about becoming a minority stockholder in a private
corporation.
However, the vast majority
of the larger corporations in the
Due to the nature of the
control and ownership of these organizations, their existence is not dependent
on any one individual and they can exist as long as they remain profitable.
Recently there have been
problems with the managers of some corporations using the assets of the
corporation for their personal benefit as opposed to acting in the best
interest of the stockholders. This has
resulted in several large organizations going bankrupt, with the investors losing
their money and the managers going to jail.
In response to these scandals the federal government has enacted the
Sarbanes-Oxley Law that restricts the actions of managers of public traded
corporations and significantly increases the record keeping and reporting
requirements of these organizations.
Limited Liability
Corporation LLC
A relatively new form of
business is the limited liability corporation.
These entities are treated as separate entities from the two or more
individuals who formed them. This provides
liability protection for the owners of the LLC.
These forms of business are typically taxed as a partnership. This is like a limited partnership however
the advantages of limited liability extent to all of the partners while the
organizations is taxed at the often more desirable partnership level.
Franchising
In addition to these forms
of ownership is the possibility of franchising.
This is where one organization sells the right to use its name and
trademark. Franchise agreements also
typically include lots of rules regarding the quality and price of goods and services
that can be sold. For example you could
buy a franchise to operate a KFC Store instead of starting your own restaurant
from scratch.
Activity 1
What do you see as the
advantages and disadvantages of being a franchisee?
In addition to the
for-profit organization types we have discussed there are two more broad
organizational options.
Governmental Entities these are school districts, local, state and
national government and most of the various entities created by these
organizations (like our university).
These organizations are not for sale, are not focused on generating a
profit and instead are focused on meeting the needs of the citizens as
expressed through the electoral process.
Not-For-Profit -
Organizations that are established to pursue some societal good that should
be stated in their mission statement.
These entities can (and should) generate revenue in excess of their
expenses to generate a margin. However,
unlike for-profit organizations, the profit is not ultimately returned to the
owners; it is instead used to further the mission of the organizations. These organizations are exempt from paying
income tax and in some cases do not pay property tax.
Some not-for-profit organizations
are also charities often referred to as 501-c-3s as a result of the tax
code designation that created them. To
be a 501C3 requires meeting a test for serving the public good and results in
contribution to the organization being deductible to the individual making the
contribution.
Activity 2
Identify the advantages and
disadvantages of using each of the six possible types of businesses. Since the franchise model can be used with
many of the previous models there will be some overlap in your analysis
Business Plan Activity:
Which organizational
approach is best for your planned business?
Justify your decision in terms of the support you need (both financial
and managerial) and the liability you are willing to assume. You should also recognize that while you may
want an organization that has limited or no liability, lenders may feel very
different. How, for instance, would you attract lenders to your business when
none of your personal property is at risk should you default on the loan?
Summary of Beyond the Book expectations for the
final
You should understand: