Chapter ppt_06.pptx

Section 2:
The Entrepreneurial Journey Begins
Copyright © 2019, 2016, 2014 Pearson Education, Inc. All Rights Reserved

Copyright © 2019, 2016, 2014 Pearson Education, Inc. All Rights Reserved.
Essentials of Entrepreneurship and Small
Business Management
Ninth Edition
Chapter 6
Forms of Business Ownership

Learning Objectives
1. Explain the advantages and disadvantages of sole
proprietorships and partnerships.
2. Describe the similarities and differences of C corporations and
S corporations.
3. Understand the characteristics of a limited liability company.
4. Explain the process of creating a legal entity for a business.

Choosing a Form of Ownership
• There is no one “best” form of ownership.
• The best form of ownership depends on an entrepreneur’s
particular situation.
• Key: Understanding the characteristics of each form of
ownership and how well they match an entrepreneur’s
business and personal circumstances.

Factors Affecting the Choice
• Tax considerations
• Liability exposure
• Start-up and future capital requirements
• Control
• Managerial ability
• Business goals
• Management succession plans
• Cost of formation

Major Forms of Ownership
• Sole Proprietorship
• General Partnership
• Limited Partnership
• Corporation
• S Corporation
• Limited Liability Company

Percentage of Business (1 of 3)
Figure 6.1 Forms of Business Ownership: (a) Percentage of
Businesses, (b) Percentage of Sales, and (c) Percentage of
Net Income
Source: Based on data from Sources of Income, Internal Revenue Service.

[Figure 6.1 Continued]

Advantages of a Sole Proprietorship
• Simple to create
• Least costly form to begin
• Profit incentive
• Total decision making authority
• No special legal restrictions
• Easy to discontinue

Disadvantages of a Sole Proprietorship
• Unlimited personal liability
– The company’s debts are the owner’s debts.
• Limited skills and capabilities
• Feelings of isolation
• 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: states in
writing the terms under which the partners agree to
operate the partnership and that protects each partner’s
interests in the business.

Revised Uniform Partnership Act
• Three key elements of any partnership under RUPA:
– Common ownership in a business.
– Agreement on how the business’s profits and losses
will be shared.
– The right to participate in managing the operation of a
partnership.

Advantages of the Partnership (1 of 2)
• Easy to establish
• Complementary skills of partners
• Division of profits
• Larger pool of capital
• Ability to attract limited partners

Types of Partners
• General Partners:
– Take an active role in managing a business.
– Have unlimited liability for the partnership’s debts.
– Every partnership must have at least one general
partner.
• Limited Partners:
– Cannot participate in the day-to-day management of a
company.
– Have limited liability for the partnership’s debts.

Types of Limited Partners
Two Types of Limited Partners:
• Silent Partners:
– Not active in a business but are generally known to be
members of the partnership
• Dormant Partners:
– Neither active nor generally known to be associated
with the business

Advantages of the Partnership (2 of 2)
• Easy to establish
• Complementary skills of partners
• Division of profits
• Larger pool of capital
• Ability to attract limited partners
• Minimal government regulation
• Flexibility
• Taxation

Disadvantages of the Partnership
• Unlimited liability of at least one partner
• Capital accumulation
• Difficulty in disposing partnership interest without
dissolving the partnership
• Potential for personality and authority conflicts
• Partners bound by law of agency

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 – income is passed through to the
limited partners who pay taxes on their share of the
company’s income.

Corporations
• Corporation: a separate legal entity from its owners.
• Types of corporations:
– Publicly held: a corporation that has a large number of
shareholders and whose stock usually is traded on one
of the large stock exchanges.
– Closely held: a corporation in which shares are
controlled by a relatively small number of people, often
family members, relatives, or friends.

Avoiding Legal Tangles (1 of 2)
• 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 (formal and informal) of the
officers and directors.

Avoiding Legal Tangles (2 of 2)
• Be sure that the corporation’s board makes all major
decisions.
• Make it clear that the business is a corporation – officers
should sign all documents in the corporation’s name.
• Keep corporate assets and the personal assets of the
owners separate.
• Never sign or negotiate corporate documents, such as
contracts and other agreements, or sign official corporate
correspondence, as an owner or shareholder.

C Corporation
• Traditional form of incorporation.
• Pays taxes at the corporate tax rate and stockholders also
pay taxes on dividends they receive at their individual tax
rates.
– Double taxation: a disadvantage of the corporate form
of ownership in which the corporation’s profits are
taxed twice, once at the corporate rate and again at the
individual rate on the portion of profits distributed to
shareholders as dividends.

S Corporation
• No different from any other corporation from a legal
perspective.
• An S corporation is taxed like a partnership, passing all of
its profits (or losses) through to individual shareholders.
• To elect “S” status, all shareholders must consent, and the
corporation must file with the IRS within the first 75 days of
its tax year.
– Follow 1/3, 1/3, 1/3 rule of thumb.

Tax Rate Comparison
Table 6.2 Tax Rate Comparison: C Corporation and S
Corporation or Limited Liability Company
Blank C Corporation S Corporation or LLC
Corporate or limited liability company net income $500,000 $500,000
Maximum corporate tax 35% 0%
Corporate tax $175,000 0
After-tax income $325,000 $500,000
Maximum shareholder tax rate 39.6% 39.6%
Shareholder tax $65,000* $198,000**
Total tax paid $240,000 $198,000
(Corporate tax plus shareholder tax) Blank Blank
Total tax savings by choosing an S corporation or
limited liability company = $42,000
blank blank
*Using the marginal 20% tax rate on dividends: $325,000 × 20% = $65,000.
**Using the marginal 39.6% tax rate on ordinary income: $500,000 × 39.6% = $198,000.
Source: U.S. Small Business Administration, 2010.

Limited Liability Company (LLC)
• Resembles an S Corporation but is not subject to the
same restrictions.
• Two documents required:
– Articles of organization: creates an LLC by
establishing its name and address, method of
management, its duration, etc.
– Operating agreement: establishes for an LLC the
provisions governing the way it will conduct business.

Creating a Legal Business Entity
• 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.
– But, be careful! The cost of filing incorrectly can be
high.
– States have different regulations on forming business
entities.

Conclusion
• To choose the best form of ownership, consider the
characteristics of each form.
• Evaluate tax considerations, liability exposure, start-up and
future capital requirements, amount of control over the
company, managerial ability, business goals, management
succession plans, and cost of formation.
• The forms of business ownership include sole
proprietorship, general partnership, limited partnership, C
corporation, S corporation, and limited liability company.

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