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Instructor’s Manual – Chapter 4
Ferrell / Hirt / Ferrell:
Business
Chapter 4: Options for Organizing Business
CHAPTER FORECAST
This chapter examines three primary forms of business ownership—sole proprietorship, partnership, and
corporation—and weighs the advantages and disadvantages of each. These forms are the most often used
whether the business is a traditional bricks and mortar company, an online-only one, or a combination of both.
We also take a look at S corporations, limited liability companies, and cooperatives and discuss some trends in
business ownership. You may wish to refer to Table 4.1 to compare the various forms of business ownership
mentioned in the chapter.
LEARNING OBJECTIVES
LO 4-1
Define and examine the advantages and disadvantages of the sole proprietorship form of
organization.
LO 4-2
Identify two types of partnership and evaluate the advantages and disadvantages of the
partnership form of organization.
LO 4-3
Describe the corporate form of organization and cite the advantages and disadvantages of
corporations.
LO 4-4
Define and debate the advantages and disadvantages of mergers, acquisitions, and leveraged
buyouts.
LO 4-5
Propose an appropriate organizational form for a startup business.
LEARN THE TERMS
acquisition (p. 135)
articles of partnership (p. 121)
board of directors (p. 129)
common stock (p. 130)
cooperative (co-op) (p. 134)
corporate charter (p. 127)
corporation (p. 126)
dividends (p. 126)
general partnership (p. 121)
initial public offering (IPO) (p.
128)
joint venture (p. 133)
leveraged buyout (LBO) (p. 137)
limited liability company (LLC)
(p. 134)
limited partnership (p. 121)
merger (p. 135)
nonprofit corporations (p. 129)
partnership (p. 120)
preferred stock (p. 130)
private corporation (p. 127)
public corporation (p. 127)
quasi-public corporations (p.
129)
S corporation (p. 133)
sole proprietorships (p. 116)
stock (p. 126)
Instructor’s Manual – Chapter 4
LO 4-1
Define and examine the advantages and disadvantages of the sole
proprietorship form of organization.
•
Introduction
•
Sole Proprietorships
•
Advantages of Sole Proprietorships
•
Disadvantages of Sole Proprietorships
Ferrell / Hirt / Ferrell:
Business
Key Terms:
•
Sole proprietorships
Lecture Outline and Notes:
I.
Introduction
A. There are three principal forms of organizing a business, whether it is a traditional “brick and
mortar” organization, or a virtual corporation that does business exclusively through the Internet.
B. The three primary forms of business that we will examine are Sole proprietorship, Partnership, and
Corporation. (Table 4.1 & Figure 4.1))
1. Proprietorships far outnumber corporations, but they net far fewer sales and less income.
2. Partnerships are the least used form of business.
3. Corporations account for the majority of all U.S. sales and income but represent a relatively
small number of organizations in the United States.
II. Sole Proprietorships
A. Sole proprietorships are businesses owned by one person.
1. The most common form of business organization in the United States.
2. Typically small businesses employing fewer than 50 people.
Instructor’s Manual – Chapter 4
Ferrell / Hirt / Ferrell:
Business
B. Advantages of Sole Proprietorships
1. They have the advantage of a simple management structure and the ability to make
quick decisions.
2. Ease and Cost of Formation
a. Forming a proprietorship is easy and inexpensive, requiring only state and local
licenses and permits where applicable.
b. An entrepreneur starting a new sole proprietorship must find a suitable site from
which to operate the business.
c. Many small businesses started out in their founders’ garages.
3. Sole proprietorships have the advantage of secrecy as operating plans and financial
reports do not have to be disclosed to others.
4. All profits from the business belong to the owner.
5. The proprietor has complete control over how the business is run.
a. This control allows the proprietor to respond quickly to competitive conditions or
to changes in the economy.
6. Sole proprietorships have the greatest degree of freedom from government
regulation.
a. Nonetheless, proprietors must ensure that the follow all laws that do apply to
their business.
7. Taxation
a. Profits from the business are considered the personal income of the sole
proprietor and are taxed at individual tax rates.
b. The sole proprietor can also establish a tax-exempt retirement or profit-sharing
account, which is exempt from current income tax.
8. A sole proprietorship can be dissolved easily; the only legal condition is that all loans
must be paid off.
C. Disadvantages of Sole Proprietorships
1. The sole proprietor has unlimited liability in meeting the debts of the business; if the
business cannot pay its obligations, the owner’s personal, nonbusiness holdings might
have to be used to pay the debt.
Instructor’s Manual – Chapter 4
Ferrell / Hirt / Ferrell:
Business
2. Limited Sources of Funds
a. There are a limited number of financial sources from which the sole
proprietor can borrow (bank, friends, family, and the Small Business
Administration).
b. Additionally, sole proprietors might have to pay higher interest rates on funds
borrowed from banks than do large corporations because they are considered
higher risks.
c. The proprietor may have to pledge personal assets to guarantee loans.
3. The sole proprietor must be able to perform many functions and possess skills in
diverse areas such as management, marketing, finance, accounting, and
personnel.
4. The life expectancy of a sole proprietorship is directly related to that of the owner
and his or her ability to work.
5. It is usually difficult for a small sole proprietorship to offer the same wages,
benefits, and advancement possibilities that are often found in a large
corporation.
6. Taxation
a. Under current tax rates, sole proprietors pay a higher marginal tax rate than
do small corporations on income of less than $75,000.
b. The tax effect often determines whether a sole proprietor incorporates the
business.
D. An example of a sole proprietorship might be an entrepreneur opening up a
delicatessen. As a sole proprietor, he keeps his profits but is personally responsible for
all risks and financial obligations.
LO 4-2
Identify two types of partnership and evaluate the advantages and
disadvantages of the partnership form of organization.
•
Key Terms:
•
Partnership
Partnerships
•
General partnership
o
Types of Partnership
•
Limited partnership
o
Articles of Partnership
•
Articles of partnership
o
Advantages of Partnerships
o
Disadvantages of Partnerships
o
Taxation of Partnerships
Instructor’s Manual – Chapter 4
Ferrell / Hirt / Ferrell:
Business
III. Partnerships
A. Most states have a model law governing partnerships based on the Uniform Partnership Act,
which defines a partnership as “an association of two or more persons who carry on as coowners of a business for profit.”
1. Partnerships are the least used form of business organization.
B. Keys to success in a partnership include: (Table 4.2)
1. Keeping profit sharing and ownership equal
2. Partners’ skill sets should complement each other
3. Honesty is critical
4. Maintain face-to-face communication
5. Maintain transparency
6. Be aware of funding constraints so one partner does not get stuck with additional debt
7. To be successful, you need experience. So, tailor your business to your skills.
8. Family should be a priority, try to minimize business problems so you can enjoy your
family.
9. Do not fall in love with “the idea” and forget to actually implement the idea.
10. Be optimistic but also realistic in terms of sales, growth, and planning.
C. Types of Partnership
1. A general partnership involves partners sharing completely the management of a
business and the liability for its debts.
2. A limited partnership has at least one general partner who assumes unlimited liability
and at least one limited partner whose liability is limited to the amount of investment in
the business.
a. Limited partnerships exist for risky investment projects where the chance of loss is
great.
1) Limited partners are barred from participating in the management of the
business, but they share in the profits.
Instructor’s Manual – Chapter 4
Ferrell / Hirt / Ferrell:
Business
D. Articles of Partnership (Table 4.3)
1. Articles of partnership are legal documents that set forth the basic agreement
between partners.
2. Usually specify the money or assets each partner has contributed to the partnership
(called partnership capital); each partner’s individual management role or duty; how
the profits and losses of the partnership will be divided among the partners; and how
a partner may leave the partnership and any other restrictions that might apply to the
agreement.
E. Advantages of Partnerships
1. Ease of Organization
b. Starting a partnership requires little more than drawing up articles of
partnership.
c. The name of the partnership should be registered with the state.
2. Availability of Capital and Credit
d. When a business has several partners, the partnership can rely on a
combination of talents and pooled financial resources.
e. Partnerships tend to be larger than sole proprietorships and thus have greater
earning power and higher credit ratings.
3. Partnerships can provide diverse skills because partners are able to specialize in their
areas of expertise.
4. Small partnerships can react quickly to changes in the business environment.
5. The partnership has fewer regulatory controls over its activities than the public
corporation.
F. Disadvantages of Partnerships
1. Limited partners have no voice in management and bear most of the risk of the
business.
2. Partnerships may be subject to disagreements when the goals and objectives of one
partner change; many partnership disputes wind up in court.
3. Unlimited Liability
a. In general partnerships, the general partners have unlimited liability for total debts
the business incurs; this disadvantage increases if one partner has greater personal
financial resources.
b. The disadvantage is reduced for limited partners, who can only lose their initial
investment.
4. All partners are responsible for the business actions and decisions of all other partners.
Instructor’s Manual – Chapter 4
Ferrell / Hirt / Ferrell:
Business
5. Life of Partnership
a. A partnership is terminated upon the death or withdrawal of a partner.
b. In very large partnerships, provisions for continuation of the partnership may be
provided for in the articles of partnership.
c. Selling a partnership interest has the same effect as the death or withdrawal of a
partner, and it is difficult to place a value on the partner’s share of the partnership.
6. The distribution of the profits as specified in the articles of partnership may not reflect
each partner’s contribution.
7. Limited Sources of Funds
a. There are limits to sources of funds (capital) available to a partnership because there
is no public value placed on the business.
b. Partnerships may have to pay higher interest rates on borrowed funds than do large
corporations because they may be considered greater risks.
G. Taxation of Partnerships
1. Partnerships are quasi-taxable organizations, which means they do not pay taxes; the
individual partners report their share of the profits on their individual tax returns and are
taxed at the ordinary income tax rate for individuals.
H. An example of a successful partnership is Google, which arose out of a partnership between
Larry Page and Sergey Brin. Today, it is the world’s top search engine.
LO 4-3
Describe the corporate form of organization and cite the
advantages and disadvantages of corporations.
•
•
Corporations
o
Creating a Corporation
o
Types of Corporations
o
Elements of a Corporation
o
Advantages of Corporations
o
Disadvantages of Corporations
Other Types of Ownership
o
Joint Ventures
o
S Corporations
o
Limited Liability Companies
Key Terms:
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
•
Corporation
Stock
Dividends
Corporate charter
Private corporation
Public corporation
Initial public offering (IPO)
Quasi-public corporations
Nonprofit corporations
Board of directors
Preferred stock
Common stock
Joint Venture
S Corporation
Limited liability company
Cooperative (co-op)
Instructor’s Manual – Chapter 4
Ferrell / Hirt / Ferrell:
Business
IV. Corporations
A. A corporation is a legal entity created by the state, with assets and liabilities distinct from
those of the owner of the corporation.
1. Legally, a corporation has many of the rights, duties, and powers of a person, including
the right to receive, own, and transfer property. They can enter into contracts with
individuals or with other legal entities, and they can sue and be sued in court.
2. Represent the majority of sales and income in the U.S.
3. Corporations are typically owned by many individuals and organizations who own shares
of the business, called stock. Thus, corporate owners are called stockholders or
shareholders.
a. Stockholders can buy, sell, give or receive as gifts, or inherit their shares of stock.
b. Stockholders are entitled to all profits that are left after all the corporation’s other
obligations have been paid; these are distributed in the form of cash payments called
dividends.
c. However, some corporations may retain profits to expand the business.
B. Creating a Corporation
1. A corporation is created under the laws of the state in which it incorporates, a
procedure sometimes referred to as chartering.
a. In most states, the company name must end in “company,” “corporation,”
“incorporated,” or “limited” to show that the owners have limited liability.
b. The individuals who create the corporation are known as the incorporators.
c. Articles of incorporation must be completed and filed with the appropriate state
office (often the secretary of state).
Instructor’s Manual – Chapter 4
Ferrell / Hirt / Ferrell:
Business
d. Articles of incorporation contain basic information about the business, including:
1) Name and address of the corporation.
2) Objectives of the corporation.
3) Classes of stock (common, preferred, voting, nonvoting) and the number of
shares of each class of stock to be issued.
4) Expected life of the corporation (usually forever).
5) Financial capital required at the time of incorporation.
6) Provision for transferring shares of stock between owners.
7) Provisions for the regulation of internal corporate affairs.
8) Address of the business office registered with the state of incorporation.
9) Names and addresses of the initial board of directors.
10) Names and addresses of incorporators.
2. Based on the information in the articles of incorporation, a corporate charter is issued
by the state to create the corporation. The then owners establish the corporation’s
bylaws and elect a board of directors.
C. Types of Corporations
1. A corporation doing business in the state in which it is chartered is a domestic
corporation.
2. When a corporation does business in other states, it is then referred to as a foreign
corporation.
3. If a corporation does business outside the nation in which it is incorporated, it is termed
an alien corporation. (Table 4.4)
4. A private corporation is owned by only one person or a few people closely involved in its
management.
a. Private corporations do not offer stock for sale to the public.
b. Privately-owned corporations are not required to publicly disclose financial
information, but they must pay taxes.
c. The snack food company Mars is a private corporation.
Instructor’s Manual – Chapter 4
Ferrell / Hirt / Ferrell:
Business
5. A public corporation is one whose stock anyone may buy, sell, or trade.
a. Publicly-owned corporations must disclose financial information to the public under
specific laws that regulate the trade of stocks and other securities.
b. A private corporation may “go public” through an initial public offering (IPO) by
selling its stock so that it can be traded in public markets.
c. Public corporations may be “taken private” when one or a few individuals purchase
all of the firm’s stock so that it can no longer be traded publicly.
d. A list of the world’s largest corporations is compiled by Fortune. Large corporations
are not always profitable every year—in 2011, Fannie Mae had negative profits.
6. Quasi-public corporations are corporations owned and operated by federal, state, or
local government. These provide a service to citizens, rather than earn profits. Examples
are NASA and the United States Postal Service.
7. Nonprofit corporations focus on providing a service rather than earning a profit, but are
not owned by a government entity. Examples are Children’s Television Workshop, Elks
Clubs, the American Lung Association, the American Red Cross, museums, and private
schools.
D. Elements of a Corporation
1. The Board of Directors
a. The board of directors is elected by the stockholders to oversee the general
operation of the corporation.
b. The board of directors sets the long-range objectives of the corporation and sees
that the objectives are achieved on schedule.
c. The board members are legally liable for the mismanagement of the firm or for any
misappropriation of funds.
d. One of the board’s most important duties is to elect or hire the chairman of the
board, the president of the company, and the chief executive officer (CEO).
e. Directors can be from both inside and outside the company. Most boards include
outside directors because they are thought to be less biased in their assessment of
the company’s progress.
Instructor’s Manual – Chapter 4
Ferrell / Hirt / Ferrell:
Business
2. Corporations issue two types of stock: preferred and common.
a. Preferred stock usually allows no voting rights but confers preference in the
distribution of company profits.
1) 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 profits
before other stockholders do.
2) Most preferred stock carries a cumulative claim to dividends, which means that if
preferred stock dividends are not paid in one year, they accumulate to the next
year.
b. Common stock allows the owner voting rights.
1) Owners of common stock do not get any preferential treatment with regards to
dividends, but they do get some say in the operation of the corporation by voting
on board members and other important issues.
2) Common stockholders have a preemptive right to purchase new shares of the
common stock directly from the corporation.
E. Advantages of Corporations
1. The owners’ maximum liability or potential loss is equal to their original investment.
2. Stockholders can sell or trade shares of stock without causing the termination of the
corporation.
3. The corporation may continue its existence forever or until the owners agree to sell it or
to liquidate its assets.
4. External Sources of Funds
a. Long-term funds can be raised more easily by a public corporation than by
partnerships or sole proprietorships.
b. The firm can raise new funds by selling new shares or bonds to the public.
5. Readily available external financing makes it easier for a business to expand into national
and international markets.
Instructor’s Manual – Chapter 4
Ferrell / Hirt / Ferrell:
Business
F. Disadvantages of Corporations
1. The corporation pays taxes on its income, and stockholders pay taxes on the dividend
distributions they receive from the company.
2. The formation of a corporation can be costly and may require the services of an
attorney.
3. Financial and other proprietary information must be disclosed to shareholders,
creditors, and the Securities and Exchange Commission (SEC)—which oversees the
securities of corporations— …
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