1E03 Chapter 6- Forms of Business Ownership PDF

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1E03 CHAPTER 6: Forms of Business Ownership Starting a Small Business -

Sole Proprietorship - A business owned, and usually managed by one person (most common form of business ownership

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Partnership - when two or more parties legally agree to become co-owners of a business

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Corporation - a legal entity with authority to act and have liability separate from its owners

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Just because a business starts on one form of ownership , doesn't have to stay in that form. Many companies start out in one form, then add (or drop) a partner or two, and eventually may become corporations or franchisors

Advantages of Sole Proprietorships 1. Ease of starting and ending the business -

All you have to do to start a sole proprietorship is to buy or lease the needed equipment (e.g., a sae, a laptop, a tractor, a lawn mower, etc.) and put up some announcements saying you are in business.

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You may have to get a permit or license from the local government, but often that is no problem

2. Being your own boss 3. Pride of ownership 4. Retention of company profit -

Owners not only keep the profits earned but also benefit form increasing value as their businesses grow

5. No special taxes -

All profits of a sole proprietorship are taxed as the personal income of the owner, and the owner pays the normal personal income tax rate on that money.

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Another tax advantage for sole proprietors is that they can claim any business losses against other earned income. These losses would decrease the personal taxes they would need to pay.

6. Less regulation -

While proprietorships are regulated by the provincial/ territorial governments, and the proprietorship may have to be registered, overall they are less regulated than corporations

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As well, the administration of a proprietorship is less costly than that of a corporation.

Disadvantages of Sole Proprietorships 1. Unlimited liability - the risk of personal losses -

When you work for others, it is their problem if the business is not profitable

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When you own your own business, you and the business are considered one

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You have unlimited liability; that is, any debts or damages incurred by the business are your debts and you must pay them, even if it means selling your home, your car, or whatever else you won.

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This is a serious risk, and one that requires not only thought but also discussion with a lawyer, an insurance agent, an accountant, and others

2. Limited financial resources -

Funds available to the business are limited to the funds that the one (sole) owner can gather

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Often it is difficult to save enough money to start a business and keep it going

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The cost of inventory, supplies, insurance, advertising, rent, computers, utilities, and so many may be too much to cover alone.

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Since there are serious limits to how much money one person can raise, partnerships and corporations have a greater probability of obtaining the needed financial backing to start and equip a business and keep it going

3. Management difficulties -

All businesses need management; someone must keep inventory records, accounting records, tax records, and so forth.

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Many people skilled at selling things or providing a service are often not so skilled at keeping records.

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Sole proprietors often find it difficult to attract good, qualified employees to help run the business because they cannot compete with the salaries and benefits offered by larger companies

4. Overwhelming time commitment 5. Few fringe benefits -

You have no paid health insurance, no paid disability insurance, no pension plan, no sick leave, and no vacation pay

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These and other benefits may add up to 30% or more of a worker’s compensation

6. Limited growth -

Expansion is often slw since a sole proprietorship relies in its owner for most of its creativity, business know-how, and funding.

7. Limited lifespan -

If the sole proprietor dies, is incapacitated, or retires, the business no longer exists (unless it is sold or taken over by the sole proprietor’s heirs).

8. Possibly pay higher taxes -

If the business is profitable, it may be paying higher taxes than if it was incorporated as a Canadin Controlled Private Corporation (CCPC)

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That is, tax rates are more advantageous if the business is incorporated

Partnerships -

Two types of partnerships 1. General partnerships - all owners share in operating the business and in assuming liability for the business’ debts 2. Limited partnerships - has one or more general partners and one or more limited partners

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General partner - an owner (partner) who has unlimited liability and is active in managing the form.

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Every partnership must have at least one general partner

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Limited partner - an owner (partner) who invests money in the business but does not have any management responsibility or liability for losses beyond his or her investment.

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Limited liability - mean that the limited partner’s liability for the debts of the business is limited to the amount put into the business; therefore, personal assets are not at risk.

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Limited liability partnership (LLP) - another type of partnership created to limit the disadvantage of unlimited liability. It limits partner’s risk of losing their personal assets to the outcomes of only their own acts and omissions and those of people under their supervision - If you are a limited partner in an LLP, you can operate without fear that one of your partners might commit an act of malpractice resulting in a judgment that takes away your house, car, retirement plans, etc. as would be the case in a general partnership - LLPs, usually only available to groups of professionals (e.g., doctors, lawyers, and accountants), are governed by provincial legislation

Advantages of Partnerships 1. More financial resources 2. Shared management and pooled/ complementary skills and knowledge 3. Longer survival -

Partners are more likely to succeed than sole proprietorships because being watched by a partner can help a business person become more disciplined

4. Shared risk 5. No special taxes -

As with sole proprietorships, all profits of partnerships are taxed as the personal incomes of the owners, and the owners pay the normal income tax rate on that money.

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Similarly, any business losses can be used to decrease earned income from other sources

6. Less regulation

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Like sole proprietorship, a partnership is less regulated than a corporation

Disadvantages of Partnerships 1. Unlimited liability -

Each general partner is liable for the debts of the firm, no matter who was responsible for causing those debts

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You are liable for your partners’ mistakes as well as your own

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Like sole proprietors, general partners can lose their homes, cars, and everything else they own if the business loses a lawsuit or goes bankrupt.

2. Division of profits 3. Disagreements among partners -

For example, who has final authority over employees? Who works what hours? What if one partner wants to buy expensive equipment for the firm and the other partner disagrees?

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All terms of the partnership should be spelled out in writing to protect all parties and to minimize misunderstanding

4. Difficulty of termination -

Surprisingly, law firms have faulty partnership agreements (legal documents that specify the rights and responsibilities of each partner) and find that breaking up is hard to do.

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How do you get rid of a partner you do not like? It is best to decide such questions up-front in the partnership agreement

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In the absence of an agreement, provincial or territorial laws will determine some or all of the terms of the partnership.

5. Possibly pay higher taxes -

Similar to a sole proprietorship, if the partnership is very profitable, it may be paying higher taxes than if it was incorporated as a CCPC.

Corporations -

A corporation - a federally or provincially chartered legal entity with authority to act and have liability separate from its owners -

The corporation’s owners (called shareholders or stockholders, as they hold shares or stock of ownership in the company) are not liable for the

debts or any other problems of the corporation beyond the money they invest. -

Shareholders do not have to worry about losing their homes, cars, and other personal property if the business cannot pay its bills - a very significant benefit.

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A corporation not only limits the liability of owners, but it also enables many people to share in the ownership (and profits) of a business without working there or having other commitments to it.

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In Canada, corporations are divided into two classes: public and private

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A public corporation - has the right to issue stock (ownership in the company through shares) to the public, which means its shares may be listed on a stock exchange.This offers the possibility of raising large amounts of capital, regardless of the size of the company

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A private corporation is usually controlled by as small number of shareholders and its shares are not listed on a stock exchange -

There are approximately 1.8 million private corporations in Canada

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CCPCs have some advantages over public corporations, especially from a taxation perspective.

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CCPC Advantages include the following: -

a CCPC is eligible for the small-business deduction and as a result, pays a lower rate of federal tax (small-business rate) on the first $500,000 of active business income

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CCPCs have an additional month to pay taxes owed

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CCPCs are entitled to enhanced investment tax credits

Another important advantage for the owner of a private corporation is that he or she can issue stock to a child, or a spouse, making them co-owners of the company. This procedure is not available to a sole proprietor -

It is a simple and useful way of recognizing the contribution of these or other family members, or employees to the company

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a good way for the owner to prepare for retirement by gradually transferring ownership and responsibility to those who will be inheriting the business

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There is a formal procedure for forming a corporation that involves applying to the appropriate federal or provincial agency.

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It is also recommended that company owners seek the services of a competent lawyer and accountant prior to proceeding with any incorporation

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The procedure for large or public corporations is much more complex and expensive and definitely requires hiring a legal firm

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These costs can easily run into the thousands of dollars

Advantages of Corporations 1. Limited liability -

A major advantage of corporations is the limited liability of owners

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Limited liability - the owners of a business are responsible for losses only up to the amount they invest in it

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Many corporations in Canada have the letters Ltd. after their name, which speaks to this limited liability

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Others end their names with Inc. (for incorporated) or Corp. (for corporation) to indicate their status

2. Ability to raise more money for investment 3. Size -

Because they can raise large amounts of money to work with, big corporations can build modern factories or software development facilities with the latest equipment.

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They can hire experts or specialists in all areas of operation

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They can buy other corporations in different fields to diversify their business risks (what this means is that a corporation can be involved in many businesses at once so that if one is not doing well, the negative impact on the total corporation is lessened)

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In short, a large corporation with numerous resources can take advantage of opportunities anywhere in the world

4. Perpetual life -

Because corporations are separate from those who own them, the death of one or more owners does not terminate the corporation.

5. Ease of ownership change 6. Ease of attracting talented employees 7. Separation of ownership from management -

Corporate governance - reference to the process and policies that determine how an organization interacts with its stakeholders

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Corporate governance is necessary because of the evolution of public ownership.

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In public corporations, unlike sole proprietorships and partnerships, there is a separation between ownership and management. As a result, the board of directors was created.

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With corporate governance, rules outline how the organization is to be managed by the board of directors and the officers

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The board assumes many of the same responsibilities that would typically rest with the sole proprietor, partners or owners of a private corporation

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Board members are often chosen based on their business experience and level of expertise

Disadvantages of Corporations 1. Initial cost 2. Extensive paperwork 3. Double taxation -

Corporate income is taxed twice

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First the corporation pays tax on income before it can distribute any net income, as dividends, to shareholders.

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Then the shareholders pay tax on the dividends they receive from the corporation

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While this is double taxation, it is not excessive taxation, as the tax system is designed to provide some offsetting credits such as the dividend tax credit for investors

4. Two tax returns -

An individual who incorporates must file both a corporate tax return and an individual tax return

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Depending on the size of the corporation, a corporate return can be quite complex and require the assistance of a chartered professional accountant (CPA)

5. Size -

Size may be one advantage of corporations, but it can be a disadvantage as well

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Large corporations sometimes become too inflexible and tied down in red tape (i.e. have to follow many regulations) to respond quickly to market changes, and their profitability can suffer.

6. Difficulty of termination -

Once a corporation has started, it is relatively difficult to end

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Legal procedures are costly and more complex than for unincorporated companies

7. Possible conflict with shareholders and their board of directors -

Conflict may brew if the shareholders elect a board of directors who disagree with management

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Since the board of directors chooses the company’s officers, entrepreneurs serving as managers can find themselves forced out of the very company they founded

Business Regulations - Reporting and information -

all public corporations must file annual reports containing basic fata about themselves

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An annual report should include the name of the officers, how many shares have been issued, and the head office location

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Of course every corporation must also file an annual tax return containing financial statements and pay the necessary taxes during the year

Franchising -

A franchise agreement is an agreement whereby someone with a good idea for a business (the franchisor) sells the rights to use the business name and to sell a good or service (the franchise) to others (the franchisee) in a given territory.

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As you might suspect, both franchisors and franchisees have a stake in the success of the franchise

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Some students mistakenly identify franchising as an industry. It is not a specific industry. Rather, franchising is a business model; it is a method of distributing a good or service, or both, to achieve maximum market impact with a minimum investment

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It is not a separate form of business ownership from sole proprietorship, general proprietorship, limited partnership, public corporation, and private corporation, and it does not replace a form of business

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How the franchisee sets up the franchise business (i.e., sole proprietorship, partnership, or corporation) and operates it, however, is dependent on the advantages and disadvantages of each form of business ownership

Advantages of Franchises 1. Management and marketing assistance 2. Personal Ownership 3. Nationally recognized name -

It is one thing to open a gift shop or ice cream store. It is quite another to open a new Hallmark store or a Baskin-Robbins

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With an established franchise, you get instant recognition and support from a product group with established customers around the world

4. Financial advice and assistance -

Two major problems for small-business owners are arranging financing and learning to keep good records

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Franchisees get valuable assistance and periodic advice from people with expertise in these areas

5. Lower failure rate -

Historically, the failure rate for franchises has been lower than that of other business ventures. This is one reason why Canadians find them so attractive

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However, franchising has grown so rapidly that many weak franchises have entered the field, so you need to be careful and invest wisely

Disadvantages of Franchises 1. Large start-up costs -

Most franchises will demand a fee for the rights to the franchise. Fees for franchises can vary considerably. The startup capital range for College Pro Painters is $0 to $5,000 with $0 investments required.

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But if you want to own a Boston Pizza franchise, you will need more money. The franchise fee is $60,000 and one needs to have a minimum of $600,000 (unencumbered) for startup capital with between $1.7 to 42.6 million in investment is required.

2. Shared profit 3. Management regulation -

Management “assistance” has a way of becoming managerial orders, directives, and limitations.

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Franchisees feeling burdened by the company’s rules and regulations may lose the spirit and incentive of being their own bosses with their own businesses

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Often franchisees will band together to resolve their grievances with franchisors rather than erach fighting their battles alone

4. Coattail effects -

The actions or failures of other franchisees have an impact on your future growth and profitability

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Due to this coattai...