CyberSummary

INTRODUCTION

A business's form of ownership affects how it operates, how much tax it pays, and how much control its owners have.

SOLE PROPRIETORSHIPS

Sole proprietorships, businesses owned and operated by one individual, are the most common form of organization in the United States. They typically are small businesses employing fewer than 50 people. There are more than 17 million of them in the United States (73 percent of all businesses), but they account for only 5 percent of total business sales and 15 percent of total income.

Sole proprietorships have many advantages. Because they are generally managed by their owners, they can make decisions quickly. The formation of a sole proprietorship is relatively easy and inexpensive. Sometimes, they can even operate out of a garage or spare bedroom, but more often they buy or rent space specifically for the business. Sole proprietorships permit the greatest degree of secrecy because the owners are not required to discuss operating plans with anyone. All profits from a sole proprietorship belong to the owner, who alone decides how to use them. The sole proprietor has complete control over how the business is run and can respond quickly to competitive business conditions or to changes in the economy. Sole proprietorships also have the most freedom from government regulation. Profits from the business are considered personal income and are taxed at individual tax rates, which are lower than corporate tax rates for large companies. Finally, the sole proprietorship is easily dissolved as long as all debts have been paid.

Sole proprietorships have several disadvantages, but these depend on the goals and talents of the individual owner. The sole proprietor has unlimited liability in meeting the debts of the business and may have to use personal, nonbusiness holdings to pay off the venture's debts. Among the relatively few sources of money available to the sole proprietor are a bank, friends, family, the Small Business Administration, or his or her own funds. A sole proprietorship's credit standing reflects the owner's personal financial condition, and the owner may have to use personal assets to guarantee loans. The sole proprietor must be a generalist, performing many functions, including management, marketing, finance, accounting, bookkeeping, and personnel. The life expectancy of a sole proprietorship is directly related to that of the owner and his or her ability to work. It may be difficult to sell a proprietorship and at the same time assure customers that the business will continue to meet their needs. Because it is difficult for sole proprietorships to match the wages and benefits offered by large corporations and there is little room for advancement, they may have difficulty attracting and retaining qualified employees. Taxes may be an advantage or disadvantage depending on the sole proprietorship's income.

PARTNERSHIPS

Most states have partnership laws based on the Uniform Partnership Act, which defines a partnership as "an association of two or more persons who carry on as co-owners of a business for profit." Partnerships represent just 7 percent of U.S. businesses and account for only 7 percent of all sales and 13 percent of income.

A general partnership involves a complete sharing in the management of a business; each partner has unlimited liability for the debts of the business. A limited partnership has at least one general partner who assumes unlimited liability and management responsibility, and at least one limited partner whose liability is limited to his or her investment and who does not participate in the firm's management. A joint venture is a partnership of individuals and/or organizations established for a specific project or for a limited time.

Most states require articles of partnership, legal documents that set forth the basic agreement between the partners. Articles of partnership usually list the partnership capital (money or assets that each partner has contributed to the partnership), state each partner's individual role or duty, specify how the profits and losses of the partnership will be divided among the partners, and describe how a partner may leave the partnership and any other restrictions that might apply to the agreement.

Starting a partnership is easy, usually requiring little more than drawing up the articles of partnership. When a business has several partners, it benefits from the combination of talents and skills and pooled financial resources. Partnerships tend to be larger than sole proprietorships and, thus, have greater earning power and better credit ratings. They can provide diverse skills because partners can specialize in their areas of expertise. Small partnerships can react more quickly to changes in the business environment than can large partnerships and corporations. Partnerships have fewer regulatory controls affecting their financial activities than do public corporations and do not generally have to file public financial statements with government agencies.

Partnerships also have several disadvantages. Limited partners have no voice in the management of the business and may bear most of the risk. A clash in organizational cultures or a change in the goals of one partner may cause conflict. General partners have unlimited liability for the firm's debts, a real disadvantage when one partner has greater financial resources than the others. All partners are responsible for the business actions of the other partners. A partnership is terminated when a partner dies or withdraws; other partners who wish to continue the business face a disruption in business and a loss of finances and management skills. Selling a partnership interest is difficult because it is hard to assess the value of a partner's share. Partners share the profits in accordance with the articles of partnership which may be a disadvantage if the division of the profits does not reflect the work each partner puts into the venture. Partnerships have limited sources of funds because the business has no public value.

Partnerships are quasi-taxable organizations, meaning that they do not pay taxes when submitting the partnership's tax return to the Internal Revenue Service instead, the partners must pay individual taxes on their share of the profits. The tax return provides information about the organization's profitability and the distribution of profits among the partners.

CORPORATIONS

A corporation is a legal entity, created by the state, whose assets and liabilities are separate from its owners'. As a legal entity, a corporation can receive, own, and transfer property, enter into contracts with individuals or other corporations, and sue (or be sued) in court. Corporations account for 88 percent of all U.S. sales and 72 percent of all income. The owners of a corporation own shares of the firm, called stock, which can be traded. The stockholders are entitled to all profits that are left after all the corporation's other obligations have been paid. These profits are distributed in the form of cash payments called dividends.

A corporation is created under the laws of the state in which it incorporates. Each state has a specific procedure for incorporation, and most states require a minimum of three incorporators. A corporation's name cannot be similar to that of another business. The incorporators must file articles of incorporation with the appropriate state office containing basic information about the firm, such as: (1) name and address, (2) corporate objectives, (3) classes of stock and the number of shares for each class issued, (4) expected life of the corporation (usually forever), (5) financial capital required at the time of incorporation, (6) provisions for transferring shares of stock between owners, (7) provisions for the regulation of internal corporate affairs, (8) address of the business of lice registered with the state of incorporation, (9) names and addresses of the initial board of directors, and (10) names and addresses of the incorporators. Based on this information, the state issues a corporate charter to the company.

A domestic corporation does business in the state in which it is chartered; in other states where the corporation does business, it is a foreign corporation; in other countries, it is an alien corporation. A private corporation is owned by just one or a few people who are closely involved in managing the business; its stock is not traded publicly. A public corporation is one whose stock anyone may buy, sell, or trade. A private corporation may "go public" by selling stock to the public; a public corporation may be "taken private" when one or a few individuals purchase all the firm's stock so that it can no longer be sold publicly. Quasi-public corporations are owned and operated by a federal, state, or local government and provide a service to citizens. Nonprofit corporations focus on providing a service rather than earning a profit, but they are not owned by a government entity.

A board of directors, elected by the stockholders to oversee the general operation of the corporation, sets the long-range objectives of the corporation. The board is responsible for ensuring that the objectives are achieved on schedule and is legally liable for the mismanagement of the firm or for any misappropriation of funds. The board of directors hires corporate officers who are responsible to the directors for the management and daily operations of the firm. Directors may be employees and officers of the company (inside directors) or people unaffiliated with the company (outside directors).

There are two basic types of corporate ownership. Owners of preferred stock are a special class of owners because, although they generally do not have any say in running the company, they have a claim to any profits before any other stockholders do. Most preferred stock carries a cumulative claim to dividends, which means that if the company does not pay preferred-stock dividends in one year because of losses, the dividends accumulate to the next year. Although owners of common stock do not get such preferential treatment with regard to dividends, they do get some say in the operation of the corporation. Their ownership gives them the right to vote for members of the board of directors and on other important issues. Common stockholders may vote by proxy, which is a written authorization by which stockholders assign their voting privilege to someone else, who then votes for his or her choice at the stockholders' meeting. In most states, when the corporation decides to sell new shares of common stock in the marketplace, common stockholders have a preemptive right to purchase new shares of the stock from the corporation.

Corporations have some specific advantages over other forms of business ownership. Because the corporation's assets (money and resources) and liabilities (debts and other obligations) are separate from its owners', in most cases the stockholders are not held responsible for the firm's debts if it fails or is sued. Stockholders can transfer shares of stock to others without affecting the corporation, and they can do so without prior approval of other shareholders. A corporation is usually chartered to last forever unless its articles of incorporation state otherwise. Public corporations can raise long-term funds more easily than other forms of business because their stocks and bonds (debt securities) are traded in public markets. Because long-term financing is readily available, large corporations can easily expand into national and international markets.

The corporate form of organization also has several disadvantages. Corporations pay taxes on their income and, if profits are distributed in the form of dividends, the dividends are taxed a second time as part of the stockholders' income. The formation of a corporation can be costly. Corporations must make information available to their owners, usually in an annual report, which contains financial information and describes the company's operations, plans, and products. Public corporations must also file reports with the Securities and Exchange Commission (SEC), a government regulatory agency. Finally, the employees of a corporation are generally not stockholders and, consequently, they may feel that their work benefits only the stockholders and fail to see how they fit into the corporate picture.

OTHER TYPES OF OWNERSHIP

An S corporation is a form of business ownership that is taxed as though it were a partnership. Advantages include the simple method of taxation, limited liability of shareholders, perpetual life, and the ability to shift income and appreciation to others.

A limited liability company provides limited liability, as in a corporation, but is taxed like a partnership. Much like as S corporation, there are fewer restrictions on number and type of shareholder allowed.

A cooperative (co-op) is an organization composed of individuals or small businesses that have banded together to reap the benefits of belonging to a larger organization. A co-op is not intended to earn a profit, but rather to make its members more profitable or save money. A co-op can purchase supplies in large quantities and pass the savings on to its members. It can also help advertise and distribute its members' products more efficiently than each member could on an individual basis.

TRENDS IN BUSINESS OWNERSHIP: MERGERS AND ACQUISITIONS

Companies large and small achieve growth and improve profitability by expanding their operations, often by developing and selling new products or selling current products to new groups of customers in different geographic areas, and by merging with or purchasing other companies. A merger occurs when two companies (usually corporations) combine to form a new company. An acquisition occurs when one company purchases another by buying most of its stock. Mergers may be horizontal (between firms that make and sell similar products to the same customer), vertical (between firms that operate at different but related levels in an industry), or conglomerate (between firms in unrelated businesses). When a company (or a corporate raider) wants to acquire another company, it offers to buy some or all of the other company's stock at a premium over its current price in a friendly or hostile tender offer. To head off a hostile takeover attempt, a threatened company's managers may ask stockholders not to sell to the raider; file a lawsuit in an effort to abort the takeover; initiate a poison pill (whereby the firm allows stockholders to buy more shares of stock at prices lower than the current market value) or shark repellent (whereby management requires a large majority of stockholders to approve the takeover); seek a white knight (a more acceptable firm that is willing to acquire the threatened company); or take the company private. In a leveraged buyout (LBO), a group of investors borrows money from banks and other institutions to acquire a company (or a division of one), using the assets of the purchased company to guarantee repayment of the loan.

Some people view mergers and acquisitions favorably because they enable companies to gain a larger market share in their industries, to enhance their ability to compete, to acquire valuable assets such as new products or plants and equipment, to lower their costs, to boost their stock prices, and sometimes to make a quick profit. Critics argue that mergers hurt companies because they force managers to focus their efforts on avoiding takeovers rather than managing their companies effectively and profitably; sometimes force companies to take on a heavy debt burden to stave off a takeover; and damage employee morale and productivity, as well as the quality of the companies' products.