Chapter 21 Notes - Forms of Business Organization PDF

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CHAPTER TWENTY-ONE:Forms of Business OrganizationINTRODUCTIONEach type of business organization has advantages and disadvantages. For instance, in a sole proprietorship, the owner has control. However, with control comes responsibility. Determining which form of business organization is best is a di...

Description

CHAPTER TWENTY-ONE: Forms of Business Organization

INTRODUCTION Each type of business organization has advantages and disadvantages. For instance, in a sole proprietorship, the owner has control. However, with control comes responsibility. Determining which form of business organization is best is a difficult yet important decision. As you read the chapter, you should step into the shoes of each person or group making the decision.

LEARNING OBJECTIVES After reading this chapter, you will be able to answer the following questions: , What are the major forms of business organizations? , What are the advantages of each alternative form of business organizations? , What is the special significance of the operating agreement in a Limited Liability Company? , What are the differences among the different forms of business organizations? , What are the specialized forms of business organizations?

SATISFYING THE LEARNING OBJECTIVES

What are the major forms of business organizations? Exhibits 21-1, 21-2, 21-3, 21-4, 21-5, 21-6, and 21-7 in the textbook are very helpful in understanding the advantages and disadvantages of different forms of business organizations. In a sole proprietorship, a person is in business alone and is in sole control over management and profits. It is the simplest form of business organization, owner is the business. Owner has 100% of liability; personal assets subject to company's debts. Also,

no continuity on death of owner – when owner dies, business dies. A sole proprietor is personally responsible for the acts of his or her employees committed within the course and scope of employment. A partnership is a voluntary association between two or more parties who carry on a business for profit. Partners have, depending on partnership parameters, ownership, control, income and liability allotments shared. A partnership can hold title to property. For tax purposes, a partnership is a pass through entity, meaning it has no tax liability. Everything is passed on to the partners. General partnership – all partners have equal ownership and management authority; each partner is responsible for 100% of the partnership liabilities. Limited partnership – must have at least one general partner and one or more limited partners. Generally formed with the filing of a Certificate of Limited Partnership which is similar to the Articles of Incorporation for a corporation and this is typically filed with the Secretary of State in the state of formation. The general partner manages or runs the day to day business of the partnership and is personally liable to partnership creditors. Limited partners are liable only to the extent of their investment in the partnership. Limited partners must have no ability to control the partnership in order to preserve their limited liability. They are treated solely as investors. Three conditions to maintain their limited liability: Limited partner must have complied in good faith with the requirement that a certificate of limited partnership be filed; Limited partner does not participate in the control of the business; and The limited partner's surname is not part of the partnership name. Limited liability partnership – used in professional businesses – all of the partners assume liability for any partner’s professional malpractice, up to the extent of the partnership assets A corporation is a legal entity formed by issuing stock to investors who are the owners of the corporation; is a separate legal entity apart from its owners. The shareholders then elect a board of directors who then elect officers to run the day to day operations of the corporation. Name must usually include word “corporation” or “company” or an associated abbreviation (“Inc.,” “Co.,”, “Corp.”) Governed by articles of incorporation and bylaws.

Subchapter C corporations are double-taxed. The corporation pays income tax on its profits (tax #1). The corporation then distributes those profits to its shareholders in the form of dividends. The shareholders pay income tax on the dividends (tax #2). Subchapter S corporations allow for single taxation (at the shareholder level) by being treated by the IRS as a partnership with pass through of profits and losses. A limited liability company (“LLC”) has limited liability like a corporation, but is taxed like a partnership. Some states require at least two members, and some states (Arkansas) allow only one. The name typically must contain the words or abbreviation for LLC. An LLC requires an Operating Agreement, and the appointment of a manager who may or may not be a member. Members are limited in liability to their investment. The LLC can elect to be taxed as a corporation – otherwise, it is taxed as a partnership with pass throughs for tax purposes. An LLC may have foreign investors and there is no limit on the number of members. Not required to keep annual minutes, and members are not prevented from operating the LLC.

What are the advantages of each alternative form of business organizations? Sole proprietorship Ease of creation Owner is in total control of management Owner keeps all profits Taxes are simple and owner takes all write-offs Partnership Ease of creation Income of business is personal income Business losses can be deducted from taxes

Corporation Limited liability for shareholders Ease of raising capital by issuing stock Profits are taxed as income to the shareholders, not the partners Limited Liability Corporation Limited liability for shareholders Tax advantages of a partnership Management flexibility May have foreign investors No limit on the number of members Not required to keep annual minutes

What is the special significance of the operating agreement in a Limited Liability Company? The special significance of the operating agreement is that failure to have such an agreement may result in the court imposing standards on the company very different from what the members had in mind when forming the company. Also, once the parties enter into an operating agreement, the courts will enforce the agreement. The operating agreement can provide for a definite termination date, terms of dissolution, distribution of assets, how the company will be managed, how interests may be transferred, and the like.

What are the differences among the different forms of business organizations? Review Exhibit 21-5 to compare the sole proprietorship, general partnership, limited partnership, and corporation in terms of: Legal position Control considerations Liability Lifetime

Taxation Transferability of ownership

What are the specialized forms of business organizations? A cooperative is a non-profit organization in which members pool their resources to gain some type of advantage in the market. A joint stock company is a mixture of a partnership and a corporation. A syndicate is an investment group that comes together to finance a specific large product. A joint venture is an association between two or more parties wherein the parties share profits and management responsibilities with respect to a single, specific project or undertaking, such as financing, producing goods, selling goods, securities, and commodities. Generally they are taxed as partnerships. A franchise is an arrangement in which the owner of a trademark, trade name, copyright, or license (the franchisor), licenses the use of that right to another (the franchisee) for particular terms. A franchise agreement outlines the details regarding payment, location, business practices and agreements, prices, and how and when the franchise relationship can be terminated. Typically it calls for payments and exclusive distribution of the Franchise product. Franchisor must typically provide a certain level of support to the franchisee and will set certain standards that the franchisee must maintain. Franchisee will typically retain control over day-to-day management decisions, such as hiring and supervision of employees. Chain-style franchises are franchises where the franchisee operates under the franchisor’s name and follows the franchisor’s standards and business methods (for example, McDonald’s, Burger King) Distributorships are franchises in which the franchisee is authorized to sell the franchisor’s products (for example, car dealers). Manufacturing arrangements are franchises in which the franchisee is authorized to manufacture the franchisor’s product....