Chapter 4
Choosing a Form of
Business Ownership
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LEARNING OBJECTIVES
4-1 Describe the advantages and disadvantages of sole
proprietorships.
4-2 Explain the different types of partners and the importance of
partnership agreements.
4-3 Describe the advantages and disadvantages of partnerships.
4-4 Summarize how a corporation is formed.
4-5 Describe the advantages and disadvantages of a corporation.
4-6 Examine special types of businesses, including S corporations,
limited-liability companies, and not-for-profit corporations.
4-7 Discuss the purpose of a joint venture and syndicate.
4-8 Explain how growth from within and growth through mergers can
enable a business to expand.
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Sole Proprietorships
Sole proprietorship – a business that is owned (and
usually operated) by one person
Although a few sole proprietorships are large and have
many employees, most are small.
Some of today’s largest corporations, including Walmart
and JCPenney, started out as sole proprietorships.
Sole proprietorships are the most popular form of
ownership when compared to partnerships and
corporations, but they rank last in sales revenues.
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FIGURE 4-1 Relative Percentages of Sole Proprietorships, Partnerships,
and Corporations in the United States
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FIGURE 4-2 Total Sales Receipts of Sole Proprietorships, Partnerships,
and Corporations in the United States
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Advantages of Sole Proprietorships
Ease of start-up and closure
• Sole proprietorship is the simplest way to start a
business.
Pride of ownership
Retention of all profits
• All profits become the personal earnings of the owner.
No special taxes
• Profits earned by a sole proprietorship are taxed as
the personal income of the owner.
Flexibility of being your own boss
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Disadvantages of Sole
Proprietorships
Unlimited liability – a legal concept that holds a
business owner personally responsible for all the debts
of the business
Lack of continuity
• If the owner retires, dies, or is declared legally incompetent, the
business essentially ceases to exist.
Lack of money
• Banks, suppliers, and other lenders usually are often unwilling to
lend large sums of money to sole proprietorships.
Limited management skills
• The sole proprietor must have expertise in a number of different
areas (sales, buying, accounting, etc.).
Difficulty in hiring employees
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Partnerships
Partnership – a voluntary association of two or
more persons to act as co-owners of a business
for profit
• Example: Before becoming incorporated, Procter &
Gamble was formed as a partnership.
This form of ownership is much less common
than the sole proprietorship or the corporation,
representing only about 10 percent of all
American businesses.
There is no legal maximum on the number of
partners a partnership may have.
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Types of Partners
General partner – a person who assumes full or
shared responsibility for operating a business
Limited partner – a person who invests money
in a business but has no management
responsibility or responsibility or liability for
losses beyond the amount he or she invested in
the partnership
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The Partnership Agreement
Articles of partnership – an agreement listing
and explaining the terms of the partnership
The partnership agreement should state:
• Who will make the final decisions
• What each partner’s duties will be
• The investment each partner will make
• How much profit or loss each partner receives or is
responsible for
• What happens if a partner wants to dissolve the
partnership or dies
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FIGURE 4-3 Articles of Partnership
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Advantages of Partnerships
Ease of start-up
Availability of capital and credit
• Because partners can pool their funds, a partnership usually has
more capital available than a sole proprietorship does.
Personal interest
Combined business skills and knowledge
• Partners often have complementary skills; the weakness of one
partner may be offset by another partner’s strength in that area.
Retention of profits
• All profits belong to the owners of the partnership.
No special taxes
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Disadvantages of Partnerships
Unlimited liability
• Each general partner is legally and personally responsible for the debts,
taxes, and actions of any other partner conducting partnership business,
even if that partner did not incur those debts or do anything wrong.
• Limited partners risk only their original investment.
• Many states allow partners to form a limited-liability partnership (LLP), in
which a partner may have limited-liability protection from legal action
resulting from the malpractice or negligence of the other partners.
Management disagreements
Lack of continuity
• Partnerships are terminated if any one of the general partners dies,
withdraws, or is declared legally incompetent; however, the remaining
partners can purchase that partner’s ownership share.
Frozen investment
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Corporations
Corporation – 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
Unlike a real person, a corporation exists only
on paper.
Corporations comprise about 18 percent of all
businesses, but they account for 82 percent of
sales revenues.
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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
• Example: Mars
Open corporation – a corporation whose stock can be
bought and sold by any individual
• Examples: General Electric, Microsoft, Nike
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TABLE 4-1 Ten Aspects of Business That May Require Legal Help
1. Choosing either the sole proprietorship, partnership, corporate, or some
special form of ownership
2. Constructing a partnership agreement
3. Incorporating a business
4. Registering a corporation’s stock
5. Obtaining a trademark, patent, or copyright
6. Filing for licenses or permits at the local, state, and federal levels
7. Purchasing an existing business or real estate
8. Creating valid contracts
9. Hiring employees and independent contractors
10. Extending credit and collecting debts
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Forming a Corporation (slide 1 of 6)
Where to Incorporate
A business is allowed to incorporate in any state that it
chooses.
• Most small- and medium-sized businesses are incorporated in
the state where they do the most business.
The decision on where to incorporate usually is based on
two factors:
1. The cost of incorporating in one state compared with the cost in
another state
2. The advantages and disadvantages of each state’s corporate
laws and tax structure
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Forming a Corporation (slide 2 of 6)
Where to Incorporate (continued)
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 in which it is incorporated
• Example: Sears Holding Corporation, the parent company of
Sears and Kmart, is incorporated in Delaware, where it is a
domestic corporation, but is a foreign corporation in the remaining
49 states.
Alien corporation – a corporation chartered by a foreign
government and conducting business in the United States
• Examples: Volkswagen AG, Samsung Corporation
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Forming a Corporation (slide 3 of 6)
The Corporate Charter
Articles of incorporation – a contract between a
corporation and the state in which the state recognizes
the formation of the artificial person that is the
corporation (often called a corporate charter)
Usually, the articles of incorporation include the following
information:
• The firm’s name and address
• The incorporators’ names and addresses
• The purpose of the corporation
• The maximum amount of stock and types of stock to be issued
• The rights and privileges of stockholders
• The length of time the corporation is to exist
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Forming a Corporation (slide 4 of 6)
Stockholders’ Rights
There are two basic types of stock.
1. Common stock – stock owned by individuals or firms who may
vote on corporate matters but whose claims on profits and
assets are subordinate to the claims of others
2. 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 owners
Generally, smaller corporations issue only common
stock.
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Forming a Corporation (slide 5 of 6)
Stockholders’ Rights (continued)
Perhaps the most important right of owners of both common and
preferred stock is to share in the profit earned by the corporation
through the payment of dividends.
• Dividend – a distribution of earnings to the stockholders of a
corporation
Other rights include:
• Receiving information about the corporation
• Voting on changes to the corporate charter
• Attending the corporation’s annual stockholders’ meeting
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 (slide 6 of 6)
Organizational Meeting
As the last step in forming a corporation, the
incorporators and original stockholders meet to
adopt corporate bylaws and elect a board of
directors.
• The board members are directly responsible to the
stockholders for the way they operate the firm.
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Corporate Structure
In a corporation, both the board of directors and the
corporate officers are involved in management.
• Board of directors – the top governing body of a corporation,
the members of which are elected by the stockholders
Board members can be chosen from within the corporation or from
outside it.
Their major responsibilities are to set company goals, develop
general plans (or strategies) for meeting those goals, oversee the
firm’s overall operation, and appoint corporate officers.
• Corporate officers – the chairman of the board, president,
executive vice presidents, corporate secretary, treasurer, and
any other top executive appointed by the board of directors
They help the board to make plans, carry out strategies established
by the board, hire employees, and manage day-to-day business
activities.
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FIGURE 4-4 Hierarchy of Corporate Structure
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Advantages of Corporations
Limited liability – a feature of corporate ownership that limits each
owner’s financial liability to the amount of money that he or she has
paid for the corporation’s stock
Ease of raising capital
• Corporations can not only borrow money but also raise additional sums
of money by selling stock.
Ease of transfer of ownership
Perpetual life
• Since it is essentially a legal “person,” a corporation exists
independently of its owners and survives them.
Specialized management
• Typically, corporations are able to recruit more skilled, knowledgeable,
and talented managers than proprietorships and partnerships.
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Disadvantages of Corporations
Difficulty and expense of formation
Government regulation and increased paperwork
• A corporation must register and meet various government
standards before it can sell its stock to the public.
Conflict within the corporation
Double taxation
• Corporate profits are taxed twice—once as corporate income
and a second time as the personal income of stockholders.
Lack of secrecy
• Because open corporations are required to submit detailed
reports to government agencies and to stockholders, competitors
can use this information to compete more effectively.
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TABLE 4-2 Some Advantages and Disadvantages of a Sole
Proprietorship, Partnership, and Corporation
Sole General Regular
Proprietorship Partnership C-Corporation
Protecting against
Difficult Difficult Easy
liability for debts
Raising money Difficult Difficult Easy
Ownership transfer Difficult Difficult Easy
Preserving
Difficult Difficult Easy
continuity
Government
Few Few Many
regulations
Formation Easy Easy Difficult
Income taxation Once Once Twice
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S Corporations
S corporation – a corporation that is taxed as though it were a
partnership
• In other words, the corporation’s income is taxed only as the personal
income of its stockholders.
S corporation criteria:
• No more than 100 stockholders are allowed.
• Stockholders must be individuals, estates, or certain trusts.
• The corporation has no nonresident, alien shareholders.
• There can be only one class of outstanding stock.
• The firm must be a domestic corporation eligible to file for S corporation
status.
• All stockholders must agree to the decision to form an S corporation.
Becoming an S corporation can be an effective way to avoid double
taxation while retaining the corporation’s legal benefit of limited
liability.
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Limited-Liability Companies
Limited-liability company (LLC) – a form of business
ownership that combines the benefits of a corporation
and a partnership while avoiding some of the restrictions
and disadvantages of those forms of ownership
• Example: BMW of North America
Advantages:
• Avoids double taxation of a corporation
• Retains the corporation’s legal benefit of limited liability
• Provides more management flexibility and fewer restrictions than
corporations
The difference between an S corporation and an LLC is
that an LLC is not restricted to 100 stockholders.
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TABLE 4-3 Some Advantages and Disadvantages of a Regular Corporation,
an S Corporation, and a Limited-Liability Company
Regular Limited- Liability
S Corporation
C-Corporation Company
Double taxation Yes No No
Limited liability
and personal Yes Yes Yes
asset protection
Management
No No Yes
flexibility
Restrictions on
the number of
No Yes No
owners/
stockholders
Internal
Revenue
Many Many Fewer
Service tax
regulations
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Not-for-Profit Corporations
Not-for-profit corporation – a corporation
organized to provide a social, educational,
religious, or other service rather than to earn a
profit
Various charities, museums, private schools,
colleges, and charitable organizations are
organized in this way, primarily to ensure limited
liability.
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Joint Ventures
Joint venture – an agreement 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: To take advantage of the production and marketing
expertise of General Mills and the worldwide presence of Nestle,
the two companies formed a joint venture called Cereal Partners
Worldwide.
Once the goal is reached, the period of time elapses, or
the project is completed, the joint venture is dissolved.
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Syndicates
Syndicate – a temporary association of individuals or
firms organized to perform a specific task that requires a
large amount of capital
• Example: A syndicate consisting of Goldman Sachs & Company,
Morgan Stanley, J.P. Morgan, and other Wall Street firms helped
U.S. Foods Holdings, a company that markets and distributes
fresh, frozen, and dry food and nonfood products to consumers
in the United States, sell stock to investors. With the syndicate’s
help, U.S. Foods raised over $1 billion through its initial public
offering and used the money to improve its cash balance and
fund growth and expansion.
Like a joint venture, a syndicate is dissolved as soon as
its purpose has been accomplished.
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Growth from Within
Most corporations grow by expanding their
present operations.
• Some introduce and sell new but related products.
• Others expand the sale of present products to new
geographic markets or to new groups of consumers in
geographic markets already served.
Example: Walmart was started by Sam Walton in 1962 with
one discount store. Today, Walmart has nearly 11,500 stores
in the United States and 27 other countries.
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Growth Through Mergers
and Acquisitions (slide 1 of 2)
Merger – the combining of two corporations or other
business entities to form one business
An acquisition is essentially the same thing as a merger,
but the term generally is used in reference to a large
corporation’s purchases of other corporations.
• To pay for an acquisition, a leveraged buyout may be used.
Leveraged buyout – a financing method that uses borrowed
money to pay for the company that is being taken over
Although most mergers and acquisitions are often
friendly, hostile takeovers also occur.
• Hostile takeover – a situation in which the management and
board of directors of a firm targeted for acquisition disapprove of
the merger
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Growth Through Mergers
and Acquisitions (slide 2 of 2)
Classifications of mergers:
• Horizontal merger – a merger between firms that
make and sell similar products or services in similar
markets
• Vertical merger – a merger between firms that
operate at different but related levels in the production
and marketing of a product
• Conglomerate merger – a merger between firms in
completely different industries
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FIGURE 4-5 Three Types of Growth by Merger
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Merger and Acquisition Trends
for the Future (slide 1 of 2)
The issue of whether mergers and acquisitions are good
for the economy and companies is still hotly debated.
• Takeover advocates argue that:
For companies that have been taken over, the purchasers have
been able to make the company more profitable and productive by
installing a new top-management team, reducing expenses, and
forcing the company to concentrate on the firm’s most important
business activities.
• Takeover opponents argue that:
Takeovers do nothing to enhance corporate profitability or
productivity.
The only people who benefit from takeovers are investment
bankers, brokerage firms, and takeover “artists,” who receive
financial rewards by manipulating corporations rather than by
producing tangible products or services.
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Merger and Acquisition Trends
for the Future (slide 2 of 2)
Most experts predict future mergers and
acquisitions will be the result of cash-rich
companies looking to acquire businesses that
will enhance their position in the marketplace or
an industry.
Analysts also anticipate more mergers that
involve companies or investors from other
countries.
Future mergers and acquisitions will be driven
by solid business logic and the desire to
compete in the international marketplace.
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