SWS © 2011 CHAPTER 8 TYPES OF BUSINESS STRUCTURES.

SWS © 2011

CHAPTER 8CHAPTER 8 TYPES OF BUSINESS TYPES OF BUSINESS

STRUCTURESSTRUCTURES

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Starting a business requires more than Starting a business requires more than natural resources, labor, and capital. natural resources, labor, and capital.

An An entrepreneurentrepreneur is an individual who is an individual who is willing to organize and manage a is willing to organize and manage a business in order to make a profit.business in order to make a profit. The The entrepreneurentrepreneur answers the basic answers the basic

economic questions about economic questions about what, how, and what, how, and for whomfor whom a good or service will be a good or service will be produced.produced.

He/she assumes He/she assumes ALLALL the the RISKRISK..

How to start an economic institution?How to start an economic institution?

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Entrepreneurs must make many decisions as Entrepreneurs must make many decisions as they start up new businesses. they start up new businesses.

One of the first decisions they face is One of the first decisions they face is what what form of business organization best serves form of business organization best serves their intereststheir interests. .

A A business organizationbusiness organization is an establishment is an establishment formed to carry on commerce. formed to carry on commerce.

In other words, a In other words, a business organizationbusiness organization is a is a company and these business organizations can be set-company and these business organizations can be set-up as a:up as a:

(1) (1) corporationcorporation ((privateprivate or or publicpublic))

(2) (2) partnershippartnership, or, or

(3) (3) sole proprietorshipsole proprietorship

WHAT STRATEGIES DO WHAT STRATEGIES DO ENTREPRENEURS USEENTREPRENEURS USE??

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CorporationsCorporations Larger and more Larger and more

complexcomplex

THE TYPES OF BUSINESSESTHE TYPES OF BUSINESSES

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CorporationsCorporations defined:defined:

CorporatioCorporatio

ns:ns: THE TYPES OF BUSINESSESTHE TYPES OF BUSINESSES

The most The most complexcomplex form of a form of a business organization is the business organization is the corporation.corporation.

A corporation is a A corporation is a legal entitylegal entity or or being, owned by individual being, owned by individual stockholders, each of whom faces stockholders, each of whom faces limited liabilitylimited liability for the firm’s debts. for the firm’s debts.

Stockholders own Stockholders own stockstock, also called , also called sharesshares, which represent their , which represent their portion of ownership in the portion of ownership in the corporation. corporation.

Corporation’sCorporation’s Structure:Structure:



A corporation has the following general structure:A corporation has the following general structure:

Board of DirectorsBoard of Directors

(some of the board members ARE stockholder and some ARE NOT)

Stockholders

(owners of stock)

CEO

Regional Sales

Managers

Regional IT Managers

Customer Support Regional Managers

Regional Warehouse Managers

COOCFOCIO CMO

Customer Support

Managers

Warehouse Managers

Store Managers

Sales Managers

Controller of Accounting

Store EmployeesSalesmen

Customer Service Representatives

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CorporationsCorporations raise money through raise money through the sale of stocks and/or bonds:the sale of stocks and/or bonds:



BondsBonds:: LESS RISKLESS RISK because a because a bondbond promises to promises to

pay interest and to repay the full amount pay interest and to repay the full amount borrowed.borrowed.

You become the “bank” for the You become the “bank” for the corporationcorporation

Stock:Stock: MORE RISKMORE RISK because your money is lost because your money is lost

if the company goes bankrupt.if the company goes bankrupt. It is more of a gamble.It is more of a gamble.

The stock is registered with the The stock is registered with the Securities Securities and Exchange Commissionand Exchange Commission (SEC: the (SEC: the protector of investors)protector of investors)

The largest corporations are usually listed The largest corporations are usually listed on the on the New York Stock Exchange (NYSE).New York Stock Exchange (NYSE).

Some stocks for smaller companies many be Some stocks for smaller companies many be listed listed National Association of Securities National Association of Securities Dealers Automated QuotationDealers Automated Quotation ((NASDAQNASDAQ) ,) , AMEX AMEX (New York)., (New York)., or or OTCBBOTCBB (part of NASD).(part of NASD).

Selling stock is not the only way a Selling stock is not the only way a corporation can raise capital to corporation can raise capital to develop/expand. It can also develop/expand. It can also sell debtsell debt by by issuing issuing bondsbonds. . A A bondbond promises to pay a stated rate of promises to pay a stated rate of

interest over a stated period of time; it also interest over a stated period of time; it also promises to repay the full amount borrowed promises to repay the full amount borrowed at the end of that time (called a at the end of that time (called a maturity maturity datedate).).

How to raise money?How to raise money?



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Other World Exchange Other World Exchange MarketsMarkets


StocksStocks are bought and sold at financial markets are bought and sold at financial markets called stock exchanges, such as the…called stock exchanges, such as the…

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Three Types of Corporations:Three Types of Corporations:



1.) 1.) Private CorporationsPrivate Corporations:: Some corporations Some corporations issue stock to only employees or family issue stock to only employees or family members. These stockholders cannot trade members. These stockholders cannot trade (or sell) (or sell) their stock. their stock.

2.) 2.) Publicly-traded CorporationsPublicly-traded Corporations:: It has many It has many shareholders who can buy or sell stock on shareholders who can buy or sell stock on the open market. the open market. StocksStocks are bought and sold at financial markets are bought and sold at financial markets

called stock exchanges, such as the called stock exchanges, such as the New York New York Stock Exchange (NYSE)Stock Exchange (NYSE),, AMEX AMEX,, OTCBB OTCBB,, Tokyo Tokyo ExchangeExchange,, Vienna Stock Exchange Vienna Stock Exchange,, Chicago Chicago Stock ExchangeStock Exchange,, Johannesburg Stock Exchange Johannesburg Stock Exchange (South Africa)(South Africa),, Paris Stock Exchange Paris Stock Exchange,, Bombay Bombay Stock ExchangeStock Exchange, etc…, etc…

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Three Types of Corporations:Three Types of Corporations:



3.) 3.) “S”- Corporations“S”- Corporations: : A small corporation A small corporation that is taxed like a partnership, but as that is taxed like a partnership, but as individual stockholders.individual stockholders. Corporation pays Corporation pays NO federal tax on its NO federal tax on its

profitsprofits, instead the individual share owners , instead the individual share owners do. do. Each shareholder is responsible for Each shareholder is responsible for paying their share of the taxes (like a LLC).paying their share of the taxes (like a LLC).

Advantage:Advantage: if the business loses money, the if the business loses money, the individual shareholders can write down their individual shareholders can write down their personal income, resulting in less personal personal income, resulting in less personal taxes paid.taxes paid.

Advantage:Advantage: shareholders and employees of shareholders and employees of an S - corporation do not pay Medicare or an S - corporation do not pay Medicare or Social Security taxes (FICA). Social Security taxes (FICA).

Requirements:Requirements: Corporation can’t have more Corporation can’t have more than 75 shareholders.than 75 shareholders.

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1.)1.) Very Little Liability:Very Little Liability: A corporation is defined as A corporation is defined as an an ""entityentity"" because it has a legal identity separate because it has a legal identity separate from those of its owners. A corporation pays from those of its owners. A corporation pays taxes, engages in business, makes contracts, sues taxes, engages in business, makes contracts, sues other parties, and gets sued by others.other parties, and gets sued by others.

2.)2.) Access to Many Resources:Access to Many Resources: corporations have corporations have more access to more access to physical capitalphysical capital and they have and they have access to access to human capitalhuman capital. . (well educated business (well educated business leaders)leaders)

3.) 3.) Indefinite Life Indefinite Life (immortal)(immortal):: a corporation will not a corporation will not cease to exist if the owner passes, or retires.cease to exist if the owner passes, or retires.

4.)4.) Easy to Raise Money:Easy to Raise Money: through the sells of stock through the sells of stock a company can raise money to fund operations.a company can raise money to fund operations.

AdvantagesAdvantages of Corporations: of Corporations:



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1.)1.) Owner has Little Control:Owner has Little Control: he/she has he/she has little control over the company. They little control over the company. They have to listen to the Board of Directors have to listen to the Board of Directors and the stockholders.and the stockholders.

2.)2.) Does NOT React quickly to changes in Does NOT React quickly to changes in the market:the market: corporations are huge corporations are huge bureaucraciesbureaucracies and they are not quick to and they are not quick to response to the marketplaces.response to the marketplaces. Everything has to be approved by the Board Everything has to be approved by the Board

of Directors of Directors (which takes valuable time)(which takes valuable time)

DisadvantagesDisadvantages of Corporations: of Corporations:



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PartnershipsPartnerships Two or more owners who Two or more owners who split responsibility of the split responsibility of the

management of the management of the companycompany


PartnershipsPartnershipsTypes of Partnerships:Types of Partnerships:


1.)1.) General PartnershipsGeneral Partnerships:: Partners in a general Partners in a general partnership share partnership share equallyequally in both responsibility and in both responsibility and liability, but not in taxes (more on this later).liability, but not in taxes (more on this later).

EX: Bob, Sue & Tim are partners: 1/3, 1/3, 1/3 EX: Bob, Sue & Tim are partners: 1/3, 1/3, 1/3 split in liability and ownership.split in liability and ownership.

2.)2.) Limited Partnerships (L.P.)Limited Partnerships (L.P.):: In a limited In a limited partnership only partnership only oneone partner is required to be a partner is required to be a general partnergeneral partner. .

That is, onlyThat is, only ONEONE partner has partner has UNLIMITEDUNLIMITED personal liability personal liability for the firm’s actions. The for the firm’s actions. The remaining partner/partners contribute only remaining partner/partners contribute only money.money.

The main advantage of being theThe main advantage of being the general partner general partner is in having control of the business. The other is in having control of the business. The other investors do not take part in the management of investors do not take part in the management of the company.the company.

The main drawback, of course, is the The main drawback, of course, is the larger larger amount of personal liabilityamount of personal liability and maybe and maybe unattractive to investors/partnersunattractive to investors/partners:: WHY? WHY?

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PartnershipsPartnershipsTHE TYPES OF BUSINESSESTHE TYPES OF BUSINESSES

3.)3.) Limited Liability Partnerships (L.L.P.)Limited Liability Partnerships (L.L.P.):: In this type of partnership, all partners are In this type of partnership, all partners are

limited partnerslimited partners. An LLP functions like a . An LLP functions like a general partnership, except that all general partnership, except that all partners partners are limited from personal liabilityare limited from personal liability from another from another partner’s mistakes. partner’s mistakes. Good for businesses where partners want to Good for businesses where partners want to

take an active role in management.take an active role in management. Good news:Good news: If a partner screws up, you will If a partner screws up, you will

not be liable for their actions.not be liable for their actions. Bad news:Bad news: Company name (which is Company name (which is

associated with you) will go down the tubes.associated with you) will go down the tubes.

Types of Partnerships:Types of Partnerships:

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Types of Partnerships:Types of Partnerships:THE TYPES OF BUSINESSESTHE TYPES OF BUSINESSES

4.)4.) Limited Liability Company (L.L.C.)Limited Liability Company (L.L.C.):: In this type of partnership, all partners are In this type of partnership, all partners are

limited partnerslimited partners. . It is the same as a L.L.P., It is the same as a L.L.P., EXCEPT the tax EXCEPT the tax

benefitsbenefits..

Tax Benefits:Tax Benefits: individual partners are taxed individual partners are taxed at a personal level .at a personal level .((the IRS does not tax the revenues of the LLC, so the IRS does not tax the revenues of the LLC, so

money is savedmoney is saved)) EX:EX: If Bob and Tim start a business and the If Bob and Tim start a business and the

company makes $100,000. Then Bob and company makes $100,000. Then Bob and Tim pay less tax because they split the Tim pay less tax because they split the profit between them, thus only reporting profit between them, thus only reporting $50,000 each.$50,000 each.

Let’s take a closer look at tax rates…Let’s take a closer look at tax rates…

Marginal Tax Rate Single

10%10% $0 – $7,550$0 – $7,550

15%15% $7,551 – $30,650$7,551 – $30,650

25%25% $30,651 – $74,200$30,651 – $74,200

28%28% $74,201 – $154,800$74,201 – $154,800

33%33% $154,801 – $336,550$154,801 – $336,550

35%35% $336,551+$336,551+

THE TYPES OF BUSINESSESTHE TYPES OF BUSINESSES4.)4.) Limited Liability Company (L.L.C.)Limited Liability Company (L.L.C.)::

EX:EX: If Bob and Tim start a business and the If Bob and Tim start a business and the company makes $100,000. company makes $100,000. (Here are two ways this (Here are two ways this could play out)could play out)

Business Tax Rate based on $100,000: 34% = Tax: Business Tax Rate based on $100,000: 34% = Tax: $34,000.$34,000.

Personal Tax Rate based on $50,000: 25% = Tax: Personal Tax Rate based on $50,000: 25% = Tax: $12,500 each!$12,500 each!

NOTE: If the LLC itself had been taxed on the entire NOTE: If the LLC itself had been taxed on the entire $100,000 then the tax rate would be higher than $100,000 then the tax rate would be higher than 25%!25%!

Personal Tax Rate TablePersonal Tax Rate Table Taxable income Tax rate

First $50,000 First $50,000 15%15%

$50,001–$75,000 $50,001–$75,000 25%25%

$75,001–$100,000 $75,001–$100,000 34%34%

$100,001–$335,000$100,001–$335,000 39%39%

$335,001–$10,000,000$335,001–$10,000,000 34%34%

$10,000,001–$15,000,000$10,000,001–$15,000,000 35%35%

$15,000,001–$18,333,333$15,000,001–$18,333,333 38%38%

Over $18,333,333Over $18,333,333 35%35%

Business Tax Rate TableBusiness Tax Rate Table

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Marginal Tax Rate Single

10%10% $0 – $7,550$0 – $7,550

15%15% $7,551 – $30,650$7,551 – $30,650

25%25% $30,651 – $74,200$30,651 – $74,200

28%28% $74,201 – $154,800$74,201 – $154,800

33%33% $154,801 – $336,550$154,801 – $336,550

35%35% $336,551+$336,551+

THE TYPES OF BUSINESSESTHE TYPES OF BUSINESSES4.)4.) Limited Liability Company (L.L.C.)Limited Liability Company (L.L.C.):: Another Another

exampleexample

EX:EX: If the company makes $500,000 during the If the company makes $500,000 during the year.year.

There are 4 partners:There are 4 partners:

Solution: $500,000 / 4 = $125,000 Solution: $500,000 / 4 = $125,000 eacheach

Tax if an LLC: Tax if an LLC: $125,000 @ 28% = $35,000 $125,000 @ 28% = $35,000 (times 4 = (times 4 = $140,000$140,000))

Tax if NOT a LLC: Tax if NOT a LLC: $500,000 @ 34% = $500,000 @ 34% = $170,000$170,000

Personal Tax Rate TablePersonal Tax Rate Table Taxable income Tax rate

First $50,000 First $50,000 15%15%

$50,001–$75,000 $50,001–$75,000 25%25%

$75,001–$100,000 $75,001–$100,000 34%34%

$100,001–$335,000$100,001–$335,000 39%39%

$335,001–$10,000,000$335,001–$10,000,000 34%34%

$10,000,001–$15,000,000$10,000,001–$15,000,000 35%35%

$15,000,001–$18,333,333$15,000,001–$18,333,333 38%38%

Over $18,333,333Over $18,333,333 35%35%

Business Tax Rate TableBusiness Tax Rate Table

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THE TYPES OF BUSINESSESTHE TYPES OF BUSINESSES4.)4.) Professional Corporation (P.C.)Professional Corporation (P.C.)::

Professional Corporations (PCs) Professional Corporations (PCs) corporations are organized as corporations are organized as partnerships for the purpose of partnerships for the purpose of providing providing professional servicesprofessional services..

Typically professions Typically professions requiring a licenserequiring a license, , such as such as doctorsdoctors, , chiropractorschiropractors, , lawyerslawyers, , accountantsaccountants, , architectsarchitects, and , and engineersengineers that are required to form PCs.that are required to form PCs.

The formation of a PC involves additional The formation of a PC involves additional steps, such as approval by the appropriate steps, such as approval by the appropriate state licensing body & agreements to state licensing body & agreements to ethical codes.ethical codes.

PCs may be set up as L.L.C.s or L.L.P. or PCs may be set up as L.L.C.s or L.L.P. or L.P. or a general partnership.L.P. or a general partnership.

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Limited Liability Partnerships Limited Liability Partnerships (LLP)(LLP) vs.vs.

PartnershipsPartnershipsTypes of Partnerships:Types of Partnerships:


Limited Liability Company Limited Liability Company (LLC)(LLC) These two types are very similar as far as These two types are very similar as far as the the

limited personal liabilitylimited personal liability feature, however, feature, however, LLCs have LLCs have tax benefitstax benefits..

Also, a Also, a LLCLLC is better suited for those is better suited for those companies that may want (or need) to switch companies that may want (or need) to switch to a to a corporationcorporation structure in the future. structure in the future.

LLC contracts have provisions within them LLC contracts have provisions within them that makes it easier for the limited partners that makes it easier for the limited partners of the LLC to form a Board of Directors of the LLC to form a Board of Directors ((management board consisting of a chairmen management board consisting of a chairmen and usually the CEO, CFO and a few top and usually the CEO, CFO and a few top investorsinvestors).).

LLPs generally do not have this “LLPs generally do not have this “conversionconversion” ” feature within the partnership contract.feature within the partnership contract.

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1.)1.) Shared Decision Making and Shared Decision Making and Specialization:Specialization: divide up the work and divide up the work and the costs of the company.the costs of the company. Able to tap into Able to tap into HUMAN CAPITALHUMAN CAPITAL resources.resources.

2.) 2.) Combining of Capital:Combining of Capital: combine the combine the money and human resources money and human resources (intelligence)(intelligence) of two in order to get started.of two in order to get started.

3.)3.) Not Liable for other partners actions:Not Liable for other partners actions: if if one partner screws up, then the other is one partner screws up, then the other is not liable for the wrong-doing. not liable for the wrong-doing. ((DOES NOT DOES NOT APPLY FOR GENERAL PARTNERSHIPAPPLY FOR GENERAL PARTNERSHIP))

AdvantagesAdvantages of Partnerships: of Partnerships:

PartnershiPartnershi

psps


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1.)1.) Unlimited Liability:Unlimited Liability: all partners are liable for all partners are liable for actions of each other (actions of each other (only for General only for General PartnershipPartnership))

2.) 2.) Limited Liability:Limited Liability: each partner could lose what each partner could lose what they put into the partnership due to another they put into the partnership due to another partner’s actions…partner’s actions… ……so choose your business partners carefully!so choose your business partners carefully!

3.)3.) Loss of Individual Control:Loss of Individual Control: you must share the you must share the decision-making decision-making ((even in a LP, because the others even in a LP, because the others are giving you money, you have to listen to their are giving you money, you have to listen to their needsneeds))

4.)4.) Disagreements:Disagreements: if a conflict starts, then the if a conflict starts, then the business could suffer because of the business could suffer because of the disagreementdisagreement

DisadvantagesDisadvantages of Partnerships: of Partnerships:

PartnershiPartnershi

psps THE TYPES OF BUSINESSESTHE TYPES OF BUSINESSES

24

Sole ProprietorshipsSole ProprietorshipsThe smallest of them all, The smallest of them all,

but the most versatile and but the most versatile and easiest to start.easiest to start.


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Sole ProprietorshipsSole Proprietorships The Role of Sole Proprietorships:The Role of Sole Proprietorships:

THE TYPES OF BUSINESSES THE TYPES OF BUSINESSES ORGANIZATIONSORGANIZATIONS

A A sole proprietorshipsole proprietorship is a business is a business owned and managed by a owned and managed by a singlesingle individual. individual.

That person earns That person earns allall of the firm's of the firm's profits and is responsible for profits and is responsible for allall of of the firm's debts. the firm's debts.

This type of firm is by far the most This type of firm is by far the most popular in the United States. popular in the United States. According to the Internal Revenue According to the Internal Revenue Service, aboutService, about 75 PERCENT75 PERCENT of all US of all US businesses are sole proprietorships.businesses are sole proprietorships.

Most sole proprietorships are Most sole proprietorships are smallsmall.. Why?Why?

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Sole ProprietorshipsSole Proprietorships AdvantagesAdvantages of Sole Proprietorships: of Sole Proprietorships:

1.)1.) Easy to Start:Easy to Start: While you need to do more While you need to do more than just hang out a sign to start your own than just hang out a sign to start your own business, a sole proprietorship is simple to business, a sole proprietorship is simple to establish. establish.

With just a small amount of paperwork and With just a small amount of paperwork and legal expense, just about anyone can start a legal expense, just about anyone can start a sole proprietorship.sole proprietorship.

To start a new business, a sole proprietor To start a new business, a sole proprietor must meet a small number of government must meet a small number of government requirements, which can vary from city to city requirements, which can vary from city to city and state to state.and state to state.1.1. Name:Name: may use his/her own name as the name may use his/her own name as the name

of the business; a sole proprietor must register of the business; a sole proprietor must register some business name.some business name.

2.2. AuthorizationAuthorization:: sole proprietors must obtain a sole proprietors must obtain a business licensebusiness license..

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Sole ProprietorshipsSole Proprietorships AdvantagesAdvantages of Sole Proprietorships: of Sole Proprietorships: 2.)2.) Few Regulations:Few Regulations: A proprietorship is the A proprietorship is the

least-regulatedleast-regulated form of business organization. form of business organization. Most importantly, because they require little Most importantly, because they require little

legal paperwork, sole proprietorships are legal paperwork, sole proprietorships are usually usually the least expensive form of ownership the least expensive form of ownership to establish.to establish.

Does this mean they have NO Does this mean they have NO regulations?regulations?

Even the smallest business, however, is Even the smallest business, however, is subject to some regulation, especially subject to some regulation, especially industry-specific regulations.industry-specific regulations.

For example, a gourmet soft pretzel stand For example, a gourmet soft pretzel stand would be subject to health codes, and a would be subject to health codes, and a painting business would be subject to codes painting business would be subject to codes regarding dangerous chemicals.regarding dangerous chemicals.

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Sole ProprietorshipsSole Proprietorships AdvantagesAdvantages of Sole Proprietorships: of Sole Proprietorships: 3.)3.) Owner makes all profit:Owner makes all profit: If the business If the business

succeeds, the owner does not have to share succeeds, the owner does not have to share the success with anyone else.the success with anyone else.

4.)4.) Total control of decisions:Total control of decisions: sole sole proprietors can run their businesses as they proprietors can run their businesses as they wish. wish.

This means that they can respond This means that they can respond quickly to changes in the marketplace.quickly to changes in the marketplace.

5.)5.) Easy to Discontinue:Easy to Discontinue: Finally, if sole Finally, if sole proprietors decide to stop operations and do proprietors decide to stop operations and do something else for a living, they can do so something else for a living, they can do so easily. easily.

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Sole ProprietorshipsSole Proprietorships DisadvantagesDisadvantages of Sole Proprietorships: of Sole Proprietorships:


1.)1.) Unlimited Personal Liability:Unlimited Personal Liability: sole sole proprietors are fully and personally proprietors are fully and personally responsible for all their business debts & responsible for all their business debts & taxes on profits.taxes on profits.

2.)2.) Limited Access To Resources:Limited Access To Resources: Many Many small business owners use all of their small business owners use all of their available savings and other personal available savings and other personal resources to start up their businesses. This resources to start up their businesses. This makes it difficult or impossible for them to makes it difficult or impossible for them to expand quickly.expand quickly.

Also, they may lack Also, they may lack HUMAN CAPITALHUMAN CAPITAL, which would , which would make their business suffer.make their business suffer.

3.)3.) When owner dies, the business dies:When owner dies, the business dies: when owner dies or retires the company when owner dies or retires the company ceases to exist.ceases to exist.

4.)4.) No Fringe Benefits:No Fringe Benefits: No healthcare plan, No healthcare plan, dental coverage, 401k retirement plan, or dental coverage, 401k retirement plan, or paid vacationspaid vacations

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