Business Organization

September 29, 2009

The Three Kinds of Organization

Single Proprietorship

Partnership

Corporation

Most businesses are small.

But most business is done by big businesses.

Most small businesses fail within their firstfive years.

John Kenneth Galbraith claimed that NorthAmerican business is characterised by oligopolyrather than competition.

Time Warner, Disney, Murdoch, Bertlemann and Viacom(formerly CBS)

Detecting Oligopoly: the `four-firm concentration’:

UK supermarkets: 74.4%UK brewers: 85%US music: 80%US breakfast cereals: 80-90%US auto top three: 60%US computers: 65%

Counterexample: Internet porn

The Single Proprietorship

Advantages: Simple

Total Control

Can use money as you like

Disadvantages: Can lose all you own

Limited capital

Limited expertise

The Single Proprietorship

Advantages: Simple

Total Control

Can use money as you like

Disadvantages: Can lose all you own

Limited capital

Limited expertise

Cash Flow Problems

You have an idea that can make $150 000 in the firstyear, for an investment of $80 000.

But you have to get the $80 000 first. How?

i)Buy on credit

Can do this explicitly, or just pay bills late.Either way costs about 25% plus loss of goodwill. Many suppliers offer a 2% discount forprompt payment.

Cash Flow Problems

You have an idea that can make $150 000 in the firstyear, for an investment of $80 000.

But you have to get the $80 000 first. How?

i)Buy on creditii)Talk to the bank

Bank will ask, ``What’s the collateral?’’

Mortgageable property? Track record?If not, they charge a risk premium.

Cash Flow Problems

You have an idea that can make $150 000 in the firstyear, for an investment of $80 000.

But you have to get the $80 000 first. How?

i)Buy on creditii)Talk to the bankiii)Government help

Bureaucratic overhead, may not be worth it.

Partnership

Advantages Disadvantages

More capital

Easier Credit

More Talent

Retain ValuableEmployees

Liable for debts

Limited Credit

Arguments

Frozen Investment

Liability for Debts

The general partners are jointly and severally liablefor the debts of the partnership.

The only way to get out of this is to be a limited partner.

The partnership may include the names of the generalpartners in the firm’s name, but not the word `Limited’

A partnership must be registered according to the law in the province.

Incorporating

Advantages Disadvantages

Limited liability

More capital

Professional management

Costs money

Corporate Tax

Lack of privacy

Loss of Control

Registration

In BC, you have to submit a Memorandum of Associationto the Registrar of Joint Stock Companies. This specifieswho is applying, the amount of share capital, and theresponsibility for debt. (If the shareholders’ liability islimited, the word `Limited’ must be the last word in thecompany name.

Some provinces have a slightly different system, theletters patent.

The Corporation

A corporation is a business which is legally distinct fromits shareholders; that is, a corporation can owe money without its shareholders being responsible for the debt.

Corporations are of two kinds, public and private.

A private corporation has between 3 and 50 shareholders,and shares can be transferred only with the approval of the Board of Directors. The public must not be invitedto buy shares.

A public corporation can have as many shareholdersas it likes and can sell shares to anyone.

Tax Advantages and Disadvantages

Once you are incorporated, that part of the firm’s income that comes to you gets taxed twice – onceat the corporate rate, once as it goes from thecorporation to your pocket.

Nevertheless, you can use incorporation to reducethe tax you pay….

Tax Advantages and Disadvantages

Company(Pre-tax)

Company(After-tax)

You

25%

25%

Tax Advantages and Disadvantages

Company(pays wages)

You

60%

Tax Advantages and Disadvantages

Company

You

Selling Shares

Once you’re a corporation, how do you actually go aboutselling stock?

For a small company, you usually have an investment banking firm act as an intermediary. They will marketyour shares and take a cut – perhaps 25% -- to pay for their efforts.

If you’re a big company, the investment banker may underwrite the stock, that is, guarantee to buy all you want to sell.

How much stock can you reserve for yourself?

Accounting

A company needs to monitor its internal cash flows so itcan diagnose its state of health.

The two most important monitoring documents are theIncome Statement and the Balance Sheet.

These must be available to be checked by independentauditors, and made available to potential investors.

Several diagnostic instruments can be applied to theaccounting data.

Current Assets Fixed Assets

Current Liability

Long-Term Liability

Owed this year

Owed in the more distant future

Diagnostics

Current ratio = Total Current Assets

Total Current Liabilities

Working capital = Current Assets – Current Liabilities

Diagnostics

Acid-test ratio = Cash & Accounts Receivable

Total Current Liabilities

(After-Tax) MARR = After-Tax Profits

Total Assets