Types of Organizations Forms of Business Ownership

Types of Organizations Forms of Business Ownership 3 major forms of business 1. Sole / single proprietorship  One owner  Source of investment: personal funds  Examples: bakery, flowershop, meat market 2. Partnership  2+ owners, general partners, limited partners  Source of investment: personal funds of partners  Examples: law / accounting firms, medical / dental practices Combination: Cooperatives  a combination of several sole proprietorships and/or partnerships for greater production and marketing power 3 major forms of business (cont’d) Corporation Owned by the shareholders = investors Under control of the Board of Directors, which is elected by the stockholders Source of investment: stock issues Stock: A share of ownership in a corporation Two types: Common Stock & Preferred Stock How a corporation issues Stock issues (= sells) stock (= shares) Corporation XYZ Shareholders of Corporation XYZ Other Investors Proportions of U.S. Firms in Terms of Type of Business and Sales Revenue 3 Transfer of ownership in a corporation Corporation XYZ Shareholders of Corporation XYZ Exchange stock (= shares) Other investors Sole Proprietorship/Partnership Advantages  Freedom  Simple to form  Low start up costs  Tax benefits Disadvantages  Unlimited Liability  Limited resources  Limited fundraising capability  Lack of continuity Unlimited Liability Legal principle holding owners responsible for paying off all debts of a business Corporation Advantages Disadvantages  Limited financial liability  Double taxation  Ease of transfer of  Complicated and ownership expensive to form and manage  Legal entity  Subject to disclosure  Perpetual life requirements by the Easier access to $$$ / government (the SEC = capital to grow the Securities & Exchange business (= stronger Commission) fundraising capability) The concept of Double Taxation Income Statement Corporation Sales $100 Expenses 80 Pre-tax income $ 20 Taxes (e.g. 50%) 10 Net income $ 10 Personal Income Statement Income from dividends Taxes (e.g. 30%) Net income $10 $3 $7 Shareholder„s Role of the (common) Stockholders (= Owners) Rights  Elect the Board of Directors  Benefit from stock appreciation (increase in value)  Receive dividends  Appoint auditors to judge the company‟s financial statements  Approve the issue of new shares / stocks or the repurchase of existing stocks Risks  The value of stock declines.  Dividends are cut or not paid.  In case of bankruptcy, the stockholders are last in line to receive compensation (usually nothing is left). Roles in Corporate Governance Process: election Process: hire / appointment 9 Role of the Board of Directors Responsibilities:  Represent the stockholders  Fulfill objective: maximize shareholders’ wealth  Make sure that management acts in the best interest of stockholders  Hire the company president  Declare dividends  Set policy  Focus on “big picture” issues, not day-to-day management Role of the President / CEO (Chief Executive Officer)  Manage the day-to-day operations  Hire and supervise other managers Types of Corporations—Comparisons Special forms of changes in ownership Merger:  The union of two corporations to form a new corporation Acquisition:  A larger company buying a smaller one Divestiture  A firm selling off one or more of its business units (often unrelated or underperformin Setting up one or more of the company‟s units as new businesses (purpose: to raise capital) Spin-off  Joint venture  2 companies setting up a new (outside) company for collaboration and joint ownership, often in another country In the news -Examples of changes in ownership 1. 2. JPMorgan Chase to Buy Bear Stearns for $240 Million (Bloomberg News, March 17, 2008)   Ten angry beer drinkers have filed a federal lawsuit Wednesday, Sept. 10, 2008, claiming Belgium-based InBev's $52 billion purchase of AnheuserBusch Cos. Inc. would violate U.S. antitrust law if completed as planned in the coming months. (Associated Press, Sept. 11, 2008) The U.S. Department of Justice will require Verizon to sell off Unicel's mobile phone infrastructure in six areas of Vermont, New York and Washington (ITBusinessEdge, 6/10/2008)   Lehman Brothers will spin off to its shareholders $25 billion to $30 billion of its commercial real estate assets into a separate publicly-traded company (2009) to strengthen its balance sheet & keep the value of the real estate company (The New York Observer, Sept. 10, 2008) UOP, a subsidiary of conglomerate Honeywell, announced today that it has signed a letter of intent with bio-oil veteran Ensyn to form a joint venture to produce second generation biofuels for power generation, heating and eventually transportation. UOP, a subsidiary of conglomerate Honeywell, announced today that it has signed a letter of intent with bio-oil veteran Ensyn to form a joint venture to produce second generation biofuels for power generation, heating and eventually transportation. (Earth2Tech, Sept. 10, 2008) Sole Proprietorship (Business owned by an individual) Partnership (Two or more persons as co-owners) Corporation (Operates as legal entity separate from its owners – ownership interest represented by shares of stock) Greatest organizational requirements and cost of formation Organizational Requirements and Costs Liability of Owners Minimal if any May be somewhat more (depends upon approach in forming the partnership) Unlimited personal liability for business obligations Unlimited liability (except for limited partners in “limited partnership”; still must be at least one general partner w/ unlimited liability) Liability is limited to amount of shareholder’s investment (i.e. no recourse to personal assets) Continuity of Business Transferability of Ownership Business generally ceases with withdrawal or death of owner Limited Depends upon partnership agreement Continues regardless of owner withdrawal or death Ownership of shares is readily transferable Limited marketability of partnership interest Management Control & Regulation Ability to Raise Capital Owner retains complete control and authority. Minimal regulation. Shared management responsibility and authority among partners. Shareholders appoint Board of Directors that in turn hires management. Corporate management serves as agent for owners. Greater regulation. Greatest ease in raising substantial capital from external investors and lenders Limited May be somewhat less limited (i.e. multiple partners, potential for limited partners as investors in limited partnership, increase in potential borrowing capacity) Partnership files informational tax return. Partnership income is reportable and taxed on partners’ personal income tax returns Income Taxes Business income is reportable and taxed on the individual’s personal income tax return Corporation files tax return and pays tax due on corporate earnings (dividends paid to shareholders result in “double taxation” of corporate income) Comparative Summary: Three Forms of Business Business Form Proprietorship Liability Personal, limited Continuity Ends with death or decision of owner Ends with death or decision of any partner Management Personal, unrestricted Investment Sources Personal General Partnership Personal, unlimited Unrestricted or depends on partnership agreement Under control of board of directors, which is selected by stockholders Personal by partner(s) Corporation Capital invested As stated in charter, perpetual or for specified period of years Purchase of stock Table 3–1 Creating a Corporation 3 basic steps:     Consult an attorney Develop articles of incorporation Develop by-laws Select a state in which to incorporate Considerable tax and regulatory disparity File corporate documents 7