Selecting A Form Of Business Ownership

Selecting A Form of Business Ownership

Outline

Introduction

A. The Learning Goals of this chapter are to:

1. Describe the advantages and disadvantages of a sole proprietorship.

2. Describe the advantages and disadvantages of a partnership.

3. Desribe the advantages and disadvantages of a corporation.

4. Explain how the potential return and risk of a business are affected by its form of ownership.

5. Describe methods of owning existing businesses.

B. One of the most important decisions an entrepreneur must make when establishing a new business is the form of ownership. This chapter examines the major forms of business ownership and identifies ways investors can become owners of existing businesses.

I. Sole Proprietorship

A sole proprietorship is a business owned by a single owner. The owner is called the sole proprietor. About 70 percent of all firms in the United States are organized as sole proprietorships. However, since most sole proprietorships are small, they generate less than 10 percent of all business revenue.

A. Characteristics of Successful Sole Proprietors

1. They are willing to accept sole responsibility for the firm's performance. The success or failure of the firm rests squarely on the shoulders of the sole proprietor.

2. They are willing to work long hours. The owner must often work more than the typical work day put in by employees. They are on call at all times, and may have to fill in for a sick worker.

3. Most successful sole proprietors also have strong organizational skills, leadership skills, and communication skills

4. Many successful sole proprietors have had previous experience working in the industry in which they are competing. This experience gives them an edge in understanding the competition and the wants and needs of their customers.

B. Advantages of a Sole Proprietorship

1. Since there is only one owner, all earnings go to the sole proprietor.

2. Although the owner must register the name of the business with the state, and may have to obtain an occupational license, the legal requirements of establishing a sole proprietorship are minimal. This ease of formation is an attractive advantage of a sole proprietorship.

3. The sole proprietor is his or her own boss and has complete control over the way the firm is run. This eliminates the chance that disagreements among owners will create conflicts and delay decision making.

4. Earnings of a sole proprietorship are considered personal income and may be subject to lower taxes than the earnings of other forms of business.

C. Disadvantages of a Sole Proprietorship

1. Just as the owner enjoys all profits, the sole proprietor also incurs all losses. There are no other owners to share this burden.

2. There is no limit on the amount of debts for which a sole proprietor is liable. For example, if the business is sued, the owner is personally liable for the entire judgment. This unlimited liability is a major drawback of owning a sole proprietorship.

3. A sole proprietor often has very limited access to funds. This means that businesses that require heavy initial investments are seldom operated as sole proprietorships.

4. Sole proprietors may have limited skills. They may find themselves forced to make decisions in areas of business operations where they lack expertise.

II. Partnership

A partnership is a business that is co-owned by two or more people. The owners of the business are called partners. About 10 percent of all firms are organized as partnerships.

A. Types of Partnership

1. In a general partnership, all partners have unlimited liability. They are personally liable for all obligations of the firm.

2. In a limited partnership, some of the partners have limited liability. These limited partners share in the firm's profits or losses, but do not take an active role in managing the company. However, a limited partnership must have at least one general partner who accepts unlimited liability. The general partner manages the company, receives a salary, and participates in the firm's profits or losses.

B. Advantages of a Partnership

1. Additional funding: The presence of more than one owner means that more than one person is providing funding for the business.

2. Shared losses: Any losses are absorbed by more than one owner.

3. Ability to specialize: Unlike a sole proprietorship, where the single owner must be a "jack of all trades," a partnership allows partners to focus on areas of specialization. This can improve efficiency.

C. Disadvantages of Partnerships

1. Shared control: With more than one owner, the possibility exists that owners can disagree about how the business should be run. This can delay decision making and create ill will among the partners.

2. Unlimited liability: All general partners have unlimited liability. If the partnership is sued or encounters severe financial difficulty, the owners can lose much more than the amount they have invested in the company.

3. Shared profits: Any profits earned by the partnership must be shared among all partners.

D. Some small companies with 100 or fewer owners that satisfy certain criteria can avoid the problem of unlimited liability by forming an S-corporation. This type of business provides owners with limited liability, but is taxed like a partnership.

E. Another type of partnership that has become increasingly popular in recent years is the limited liability company (LLC). An LLC is a company that has all of the regular features of a general partnership, but also offers limited liability to the partners. It typically protects a partner's personal assets from the negligence of other partners. The precise rules governing the liability protection offered by an LLC vary from state to state.

III. Corporation

A. A corporation is a state-chartered business entity that pays