Pride/Hughes/Kapoor Business, 109th Edition

Audio Review Transcript

Chapter 45 Choosing a Form of Business Ownership
1.Describetheadvantagesanddisadvantagesofsoleproprietorships
Howdoesabusinessorganizeitself?Whetheritisanebusinessoramoretraditional
business,thereareactuallythreeprimaryformsofbusinessownershipthesole
proprietorship,thepartnership,andthecorporation.Therearealsoseveralspecial
purposeformsofownership.
Letsstartbytalkingaboutsoleproprietorships.Asoleproprietorshipisa
businessthatisowned,andusuallyoperated,byoneperson.Itisthesimplestformof
ownershipandtheeasiesttostart.Infact,easeofstartupisoneofthefiveadvantagesof
thesoleproprietorship.MostofthebusinessesintheUnitedStatesaresole
proprietorships.Thesecondadvantageisprideofownership.Thethirdisthattheowner
retainsalltheprofits,sincethoseprofitsarehisorherpersonalearnings.Thefourth
advantageisflexibility.Theownermakesalldecisionsandsocanmakechanges
immediatelytoprofitfrommarketconditions.Thefifthadvantagerelatestotaxes.Since
theprofitsofasoleproprietorshiparetaxedonlyaspersonalincometotheowner,they
arenotsubjecttothedoubletaxationofcorporations.
Ofcourse,therearesomedisadvantagestothesoleproprietorshipaswell.The
firstofthefivedisadvantagesisunlimitedliability,whichisalegalconceptthatholdsa
businessownerpersonallyresponsibleforallthedebtsofthebusiness.Thismeansthatif
thebusinessfailsorisinvolvedinalawsuitandloses,theownerspersonalpropertycan
besoldtopaycreditors.Theseconddisadvantageisalackofcontinuity.Iftheownerdies
orisdeclaredlegallyincompetent,thebusinessesnolongerexists.Thethirddisadvantage
isalackofmoney.Banks,suppliers,andotherlendersareoftenunwillingtolendlarge
amountstosoleproprietorships.Thefourthdisadvantageisthelimitedmanagementskills
thatmostbusinesspeoplepossess.Evenanexperiencedbusinessownerisunlikelyto
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havesufficientskillsinalltheareasnecessarytosuccessfullyrunabusiness.Finally,the
fifthdisadvantageisadifficultyfindingandhiringcompetentemployees,sincethereis
rarelyroomforadvancementandalimitonthesalarythatcanbeoffered.(LO1ends)

2.Explainthedifferenttypesofpartnersandtheimportanceofpartnership
agreements
Inordertoreducesomeofthedisadvantages,somebusinessownersturntothe
partnership.Apartnershipisavoluntaryassociationoftwoormorepersonstoactasco
ownersofabusinessforprofit.Thoughmostpartnershipshavetwoowners,thereisno
legallimitonthenumberofpartnersthatmaybeinvolvedinabusiness.Infact,thereare
twodifferenttypesofpartnersandthreetypesofpartnerships.Onetypeofpartnerisa
generalpartner,apersonwhoassumesfullorsharedresponsibilityforoperatinga
business.Asaresult,ageneralpartnershipisabusinesscoownedbytwoormore
generalpartnerswhoareliableforeverythingthebusinessdoes.Thesecondtypeisthe
limitedpartner,whocontributescapitaltoabusinessbuthasnomanagement
responsibilityorliabilityforlossesbeyondtheamountheorsheinvestedinthe
partnership.Alimitedpartnership,then,isabusinesscoownedbyoneormoregeneral
partnerswhomanagethebusinessandlimitedpartnerswhoinvestmoneyinit.Thethird
typeofpartnershipiscalledamasterlimitedpartnership.Themasterlimitedpartnership,
orMLP,isabusinesspartnershipthatisownedandmanagedlikeacorporationbuttaxed
likeapartnership.ThismeansthatsharesinMLPscanbetradedonorganizedsecurity
exchanges,whichincreasetheavailablecapital,butprofitsareonlytaxedaspersonal
income.
Beforeenteringintobusiness,thepartnersmustdraftadocumentcalledarticles
ofpartnership.Thisagreementexplainsthelegaltermsofthepartnership,including
decisionmaking,contributions,duties,andthepercentageofprofitandlosseachis
entitledtoorresponsiblefor.(LO2ends)

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3.Describetheadvantagesanddisadvantagesofpartnerships
Therearesixadvantagestopartnerships.(1)Partnershipsareeasytostartup.(2)
Thereisgreateravailabilityofcapitalandcreditbecausepartnerscanpooltheirfunds.
(3)Theownersofthepartnershipretainallprofits.(4)Thereisincreasedpersonal
interestbythegeneralpartners.(5)Theabilitytocombinebusinessskillsandknowledge
meansthatstrengthscanoffsetweaknesses.And(6)taxadvantages,meaningthat
businessincomeistaxedonlyonce.Ofcourse,partnershipshavedisadvantagesaswell.
(1)Likesoleproprietorships,generalpartnersinpartnershipshaveunlimitedliability.(2)
Ifonepartnerdies,withdraws,orisdeclaredlegallyincompetent,thereisalackof
continuity.Unlikeasoleproprietorship,though,theotherpartnerorpartnerscanbuyout
theshareoftheonewhoisnolongerinvolved.(3)Theeffectofmanagement
disagreementscannotbeoverlooked.Egos,ambition,andmoneycanleadto
irreconcilablefriction.Andfinally(4),investmentmoneyisfrozenormoredifficulttoget
outofapartnership.(LO3ends)

4.Summarizehowacorporationisformed
Acorporationisanartificialpersoncreatedbylaw,withmostofthelegalrights
ofarealperson,includingtherightstostartandoperateabusiness,tobuyorsell
property,toborrowmoney,tosueorbesued,andtoenterintobindingcontracts.
Corporationsmakeupabout20%ofallbusinessesbuttheyaccountforalmost85%ofall
salesrevenues.Corporationsarequiteunlikeeitheroftheothertwoformsofbusiness.
Letsstartwithashortvocabularylesson.Thesharesofownershipinacorporationare
calledstock,andapersonwhoownsacorporationsstockiscalledastockholder.A
corporationwhosestockisownedbyrelativelyfewpeopleandisnotavailabletothe
publiciscalledaclosedcorporation.Incontrast,acorporationwhosestockisboughtand
soldonsecurityexchangesandcanbepurchasedbyanyindividualisanopen
corporation.Theprocessofformingacorporationiscalledincorporation.Abusinesscan

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incorporateinanystate.Inthestateinwhichitisincorporateditiscalledadomestic
corporation.Inanyotherstatewhereitdoesbusinessit'scalledaforeigncorporation.
Finally,acorporationcharteredbyaforeigngovernmentthatdoesbusinessintheUnited
Statesisanaliencorporation.
Anewcorporationbeginslifeinitschosenstatebysubmittingitsarticlesof
incorporationtothesecretaryofstate.Whenthesearticlesareapproved,theybecomethe
companyscorporatecharter,acontractbetweenthecorporationandthestateinwhich
thestaterecognizestheformationoftheartificialpersonthatisthecorporation.The
articlesofincorporationincludesuchinformationasthenamesandaddressesofthefirm,
andthepurposeofthecorporation,themaximumamountandtypesofstocktobeissued,
therightsandprivilegesofstockholders,andthelengthoftimethecorporationistoexist,
whichisgenerallyforever.Acorporationmayissuetwotypesofstockcommonand
preferred.Commonstockisownedbyindividualsorfirmswhomayvoteoncorporate
matters,butwhoseclaimsonprofitandassetsaresubordinatetotheclaimsofothers.
Preferredstockisownedbyindividualsorfirmswhousuallydonothavevotingrights,
butwhoseclaimsondividendsarepaidbeforethoseofcommonstockowners.Both
commonandpreferredstockholdershavetherighttoshareinthedistributionofearnings
ofthecorporationthroughdividends.Allstockholdersalsohavetherighttoattendthe
corporationsannualmeeting.Ifastockholdercannotattend,heorshemayvoteby
proxy,whichisalegalformlistingtheissuestobedecidedatthestockholdersmeeting
andenablingthestockholderstotransfertheirvotingrightstosomeotherindividualor
individuals.Thefinalstepinsettingupacorporationisanorganizationmeetingtoelect
thefirstboardofdirectors,thegoverningbodyofacorporationelectedbythe
stockholders.Theboardisresponsibleforsettingcompanygoalsanddevelopinggeneral
strategiesforreachingthosegoals.Corporateofficersareappointedbytheboardof
directors.Corporateofficersconsistofthechairmanoftheboard,thepresident,executive
vicepresidents,corporatesecretaryandtreasurer,oranyothertopexecutiveappointedby
theboard.(LO4ends)

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5.Describetheadvantagesanddisadvantagesofacorporation
Thereareseveralmajoradvantagesandrelativedisadvantagesforacorporation.
Thefiveadvantagesincludethefollowing.(1)Acorporationenjoyslimitedliability,
whichlimitseachownersfinancialliabilitytotheamountofmoneyheorshehaspaid
forthecorporationsstock.(2)Itisfareasiertoraisecapital,primarilyduetotheability
tosellstock.(3)Itiseasytotransferownership,simplybysellingstock.(4)A
corporationhasperpetuallife,sinceitdoesnotdependonthelifeorcompetencyofa
soleownerorpartner.Andfinally,(5)acorporationcanrecruitspecialized,talented
managementandofferlargersalariesandopportunityforadvancement.Ofcourse,to
offsettheseadvantages,thefivedisadvantagesinclude(1)thedifficultyandexpenseof
formation,(2)governmentregulation,(3)conflictwithintheorganization,especiallyin
competitivemarkets,(4)doubletaxation,sinceboththecorporation(asitscorporate
incometax)aswellastheowners(basedontheirdividends)aretaxedonitsearnings,
and(5)alackofsecrecy.(LO5ends)

6.ExaminespecialtypesofcorporationsincludingSCorporations,Limited
LiabilityCompanies,GovernmentOwnedCorporations,andNotForProfit
Corporations
Inadditiontothethreetypesoforganizationswehavejustdiscussed,several
othersareusedforspecialpurposes.OneistheScorporation,whichisacorporationthat
istaxedasthoughitwereapartnership.Anotherisalimitedliabilitycompany,orLLC,
whichprovideslimitedliabilityprotectionandistaxedlikeapartnership.LLCsare
similarinmanywaystoScorporations.Athirdtypeisagovernmentownedcorporation,
suchasNASAortheFDIC,whichisownedandoperatedbyalocal,state,orfederal
government.Afourthtypeisthenotforprofitcorporation,whichisorganizedtoprovide
asocial,educational,religious,orotherservice,ratherthantoearnaprofit,suchas
certaincharities,museums,andcolleges.(LO6ends)

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7.Discussthepurposeofacooperative,jointventure,andsyndicate
Yetanothertypeofspecialorganizationisacooperative,suchasOceanSpray
Cranberries,whichisanassociationofindividualsorfirmswhosepurposeistoperform
somebusinessfunctionforitsmembers.Asixthtypeisajointventure.Thisisan
agreementbetweentwoormoregroupstoformabusinessentityinordertoachievea
specificgoalortooperateforaspecificperiodoftime.Oncethegoalisreachedorthe
periodoftimeelapses,thejointventureisdissolved.Finally,wehaveasyndicate,which
isatemporaryassociationofindividualsorfirmsorganizedtoperformaspecifictaskthat
requiresalargeamountofcapital.Syndicatesareoftenformedtounderwritelarge
insurancepolicies.(LO7ends)

8.Explainhowgrowthfromwithinandgrowththroughmergerscanenablea
businesstoexpand
Sincemostcorporationstendtobebig,howcantheygrow?Generally,growthis
accomplishedtwoways,fromwithinorthroughmergersandacquisitions.Growthfrom
withininvolvesexpandingproductlinesandintroducingnewproductsandservices.
Mergersarethepurchaseofonecorporationbyanother.Sometimesthisisdoneina
friendlymanner,othertimesitishostile.Inthecaseofahostiletakeover,asituationin
whichthemanagementandboardofdirectorsofthefirmtargetedforacquisition
disapproveofthemerger,anothercompanymaymakeatenderoffer,whichisanofferto
purchasethestockofatargetedfirmatapricejusthighenoughtotemptstockholdersto
selltheirshares.Anotherstrategytoavoidahostiletakeoverisaproxyfight,atechnique
usedbyanothercompanytogatherenoughstockholdervotestocontrolthetargeted
company.Whethersuccessfulornot,mergersaregenerallyoneofthreetypes:horizontal,
betweenfirmsthatmakeandsellsimilarproducts;vertical,betweenfirmsthatoperateat
differentlevelsintheproductionandmarketingofaproduct;orconglomerate,whichis

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betweenfirmsincompletelyunrelatedindustries.Oftenmergersinvolveachangeintop
management.
Sowhatisthefutureofmergers?Mostexpertsnowpredictthatmergersandacquisitions
willresultfromcashrichcompanieslookingtoenhancetheirpositioninthemarketplace.
Analystsalsoanticipatemoreinternationalmergers.Anothertrendismergersdrivenby
businesslogicandthedesiretocompeteintheinternationalmarketplace.Otherexperts
predictmoreleveragedbuyouts,orLBOs,forthefuture.AnLBOisapurchase
arrangementthatallowsafirmsmanagersandemployeesoragroupofinvestorsto
purchasethecompany.Thebottomlineisthatnooneknowsforsure,whichmakesthis
anexcitingtimetobeinbusinessnomatterhowitisorganized.(LO8ends)

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