Economics

Unit 7

Business Organizations

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East Independent School District, its trustees, administrators, or teachers, to promote any particular viewpoints or opinions

expressed in the documents over any others, nor do the viewpoints or opinions expressed in the documents necessarily reflect

those of the NEISD, its trustees, administrators or teachers.”

Sect 1: Sole Proprietorships

• A Sole Proprietorship

is a business owned

and controlled by one

person.

• It is the oldest,

simplest, and most

common type of

business

organization

Who Starts Sole Proprietorships?

• Sole Proprietorships tend to be

businesses that require small amounts of

financial capital (money) to start and

operate

• The financial resources of one person

often is limited

• Who…lawyers, plumbers, carpenters,

hairstylists, florists, farmers….

Advantages

• Three advantages of starting a Sole

Proprietorship are…

• …ease of start-up

• …full control

• …exclusive rights to profits

Easy Start-Up

• Getting your sole proprietorship started is

as easy as filling out a short application

with your local city, county, state (whoever

issues business licenses in your area)….

• …and paying the small fee for the license

• The minimal legal documents can usually

be filled out and submitted by the business

owner

Other Restrictions

• Sole proprietorships must also observe

zoning laws which might restrict where

certain kinds of businesses may operate

• Many areas do not permit businesses to

operate out of your home

• License laws have to be observed also

• …Doctors, child-care providers,

hairstylists..

Full Control

• Sole proprietors can act quickly to

problems and opportunities

• No need for lots of paperwork or group

discussions

• You are the boss…

• Sole proprietors can get a lot of

satisfaction by succeeding through their

own efforts

What Happens to Profits?

• In a sole proprietorship, the owner keeps it

all…

• The possibility of making big profits is a

prime motivator for people wanting to start

their own business

• Income taxes on earnings from a sole

proprietorship are reflected on the owners

personal Form1040, Schedule C

What’s the Downside?

• Sole proprietors also face some

formidable downsides…

• …unlimited liability

• …sole responsibility

• …limited growth potential

• …lack of longevity

Unlimited Liability

• Sole proprietors are personally

responsible for all business debts

• The responsibility for debts is called a

liability

• If your company cannot pay it’s debts the

owner is still responsible to use other

assets that they own to pay your business

debts

Sole Responsibility

• Owners of sole proprietorships need to have knowledge about all type of business functions…

• …technical skills

• …accounting/financial

• …banking

• …hiring/supervision

• These can create huge demands on your time, energy, satisfaction, accomplishment

Limited Growth Potential

• Most sole proprietors get their businesses

started with personal savings or borrowings

• Most individuals have limited financial assets

• Banks and other lenders will probably want

guarantees that you will be able to repay your

borrowing by requiring collateral

• Collateral is something of value that the

borrower agrees to give up if he or she is not

able to repay a loan

Limited Growth…

• Because most owners have limited

collateral, sole proprietorships often have

a limited potential for growth

• Lenders do not usually loan amounts of

money that exceed the value of a

borrowers collateral

Lack of Longevity

• Longevity is the length of time a business

operates

• Sole proprietorships are very dependent

on the health, commitment, and

competence of that one person

• The health or interest of that person is

vital, therefore the risk of failure is high

Sect. 2: Partnerships

• A business that is owned and controlled by

two or more people is called a partnership

• Generally businesses organized as

partnerships are the same type of

businesses that we also find as sole

proprietorships

Partnerships by Industry

• Partnerships

are found

across a wide

spectrum of

business types

Forms of Partnerships

• General partnerships are where each

partner shares equal decision-making

authority

• Each has unlimited authority but each one

is totally responsible for debts and other

financial losses

• General partners risk the loss of other

personal property if the business fails

Limited Partnerships

• In a limited partnership, partners may join

as investors only with the potential to

share in the profits of the business

• They do usually have an active advisory

role to play in the business

• They don’t risk the loss of other personal

property they may own

Advantages of Partnerships

• Ease of start-up

• Specialization

• Shared decision making

• Shared business losses

Easy Start-Up

• Partnerships are easy to start and require

the same permits and licenses to operate

as sole proprietorships

• Before going into business together two or

more people should develop a written

agreement called a partnership agreement

which spells out things like duties,

profit/loss sharing, etc.

Specialization

• Many businesses need multiple skill sets

to keep a business running smoothly

• Customer service, accounting, technical

skills, sales

• Partnerships can bring together people

with differing skills and interests to create

one successful business

Shared Decision Making

• Partners can consult with each other and

together come to decisions that might

minimize mistakes

• They can compare points of view instead

of relying on only one person’s business

skills and knowledge

Shared Business Losses

• A sole proprietor bears 100% of the losses

of their business

• Partners share losses according to the

terms set out in the partnership agreement

• Does not have to be 50/50

Other Partnership Advantages

• Two or more partners are better able to

raise capital than a sole owner

• Creditors are more willing to extend loans

for expansion and modernization to

partners because the risk is shared

• Multiple debtors are better able to repay

loans than single debtors

Disadvantages of Partnerships

• Most partnerships share the same

disadvantages that sole proprietorships

do…

• …unlimited liability

• …potential for conflict

• …lack of longevity

Unlimited Liability

• In a general partnership each partner has

total liability for debts of the business

• Each partner risks the loss of other

personal property that they own

• Each partner can lose more than their

investment in the business

Potential For Conflict

• A partnership is much like a marriage.

They might …

• …have personality conflicts

• …have different management styles

• …have poor communication skills

• …become unable to compromise

• These can lead to low employee morale,

delayed decision making, decreased

efficiency

Lack of Longevity

• Limiting factors in partnerships…

• …how long partners are willing to continue

working together

• …illness or death of either partner

• …conflicts among partners

Sect. 3: Corporations

• Sole proprietorships and partnerships are

dependent on and are managed by one or

more owners

• Corporations are legally distinct from their

owners and can be treated as if they were

individuals

• Corporations can own property, hire

workers, make contracts, pay taxes, sue

and be sued, make and sell products

What businesses are corporations?

• Any company can organize as a

corporation

• They tend to be from industries like food,

steel, oil, insurance,

• Corporations trend toward being larger in

size than sole proprietorships or

partnerships, but don’t necessarily have to

be larger

Earning comparisons of business

types

Forming a Corporation

• A corporation is much more difficult and

more expensive to start than a sole

proprietorship or partnership

• Legal help should be sought to get through

all of the paper work and legal issues

• The first step in forming a corporation is to

apply for a business license from the state

by writing an articles of incorporation

What’s in an Articles of

Incorporation?• Name and purpose of the proposed corporation

• Address of it’s corporate headquarters

• Method of fund raising the corporation will use

• Amount of money the corporation expects to

raise

• Names and addresses of the major corporate

officers

• Length of time the corporation is intended to

exist-either indefinitely or for a specific period of

time

What comes next?

• After the articles of incorporation are

submitted to the state they are reviewed

by state officials

• If everything is in order and is approved

the state grants a license or corporate

charter which permits the formation of the

new corporation

• Application = Articles of Incorporation

• License = Corporate Charter

Corporate Structure

• Corporations are more formally structured

than other business organizations

• At the top of a corporate structure is the

Board of Directors

• The Board of Directors may be made up of

people both inside and outside of the

company

• It is the corporations key decision-making

body

Duties of the Board of Directors &

Officers• The Board…

• …Sets policy

• …Selects and approves officers who will run

the companies day-to-day operations

• Officers …

• …are professional managers who will make

the company work smoothly

• …run the company in a way that is in keeping

with board decisions, policies, and plans

Typical Corporate Structure

Corporate Finances

• When the state issues a charter they also

authorize the new corporation to raise

funds in certain ways

• The most common way for a corporation

to raise funds is by selling stock

• Stock represents ownership of the firm

• Stock is issued in portions called shares

• Corporations can have thousands of

owners

Stock

• The charter normally spells out how many

shares of stock the new corporation is

authorized to sell

• Each share of stock represents a fractional

ownership of the company

• If you own one share of stock in a

company authorized to issue 100,000

shares of stock you own 1/100,000th of the

company

How can corporations raise

money?• Issue common stock

• Issue preferred stock

• Sell bonds

• Borrow money from traditional sources

• Corporations may use only one method to

raise money or a combination

Two Kinds of Stock

• Common stock gives shareholders a say

in how the company is run (one vote per

share owned) and a share of potential

dividends

• Preferred stock pays a guaranteed

dividend and is paid to preferred

stockholders before any profits go to

common stockholders

• Owners of preferred stock do not have a

say (vote) about how the business is run

Why Own Stock?

• People who buy stock (invest) do so because

they have hopes that the value of the stock

will increase over time

• Two ways to make money on stock…

• …if the value of the stock goes up you can

sell it if you can find someone to buy your

stock at a price you are willing to sell

• …profits, called dividends, are distributed to

stockholders as the company makes money

(also called a return on investment)

More About Raising Money

• Issuing (selling) stock is the most common

way for corporations to raise money

• Corporations can also raise money by

issuing corporate bonds

• A corporate bond is a certificate issued to

an investor in exchange for money

• A bond represents a loan from an investor

(no need to go to a bank)

Understanding Bonds

More About Bonds

• The owner of a bond is guaranteed a set

rate of interest over the life of the bond

• Bond owners…

• …do not have an ownership interest in the

company

• …do not have a say (vote) in how the

business is run

• …are people who agree to loan money at

interest to the company

More About Bonds

• Bondholders are repaid the principal of the

bond, plus interest

• The bond principal is the actual amount of

money that is loaned (also called the face

value)

• Interest is the amount of money paid in

exchange for the money loaned and is

expressed as a percentage rate

• Bonds have an maturity date that spells out

when the principal and final interest must be

repaid to the bond holder

Advantages of Corporations

• Stockholders have limited liability

• Cannot lose more than the amount

invested

• Other assets of stockholders cannot be

seized to pay corporate debts

• Stockholders can get back their money at

any time (in theory) by selling their stock to

someone who wants to buy at a price they

want to sell

Benefits to Corporations

• Corporation founders have limited liability

• Partners who incorporate are no longer

liable for loss of anything more than the

amount of their investments

• Ownership is separated from management

• …specialists handle complex assigned

tasks

• …managers run the day-to-day operations

More Corporate Benefits

• Capital can be raised more easily than

with sole proprietorships or partnerships

• …selling common stock

• …selling preferred stock

• …selling bonds

• …borrowing money through traditional

avenues (banks, etc.)

Longer Life (Longevity)

• A corporation’s lifetime is not dependent on a

single individual or a few individuals lifetime

• Corporate ownership can continue far beyond

the lifetime of the founders

• Ownership is constantly changing through the

buying and selling of common stock

• Survives changes in directors, officers, etc.

Longer Life (Longevity)

• Example: General Electric was founded in

1890 by…

• …Thomas Edison

Are there any disadvantages?

• Corporate charters can be difficult and

expensive to obtain

• Corporations are regulated more closely

than proprietorships or partnerships

• Corporations must publically disclose

financial information about it’s sales and

profits

• Decision making can be slow

Stockholder Issues

• Although stockholders are the “owners”,

they are removed from the actual running

of the business

• Their opinion is heard only as they vote

the number of shares they own

• They don’t get the sense of pride and

satisfaction that owners of proprietorships

and partnerships do

• They lack control, their power and

influence is limited

Shared Issues

• Taxes have to be paid twice on corporate

profits

• The corporation (a legal entity) pays taxes

on it’s earnings and then distributes profits

to stockholders with what is left

• Stockholders then must pay taxes

individually on the earnings of their stock

• Stockholders are sent a Form 1099 to be

used when owners file their taxes

Sect. 4: Other Forms of

Organization• Sole proprietorships, partnerships, and

corporations are the most common forms

of business organizations, but there are

more…

• …corporate combinations

• …franchises

• …cooperatives

• …non profit organizations

Corporate Combinations

• A big advantage of corporations is

economies of scale because of their size

• To get bigger, corporations must either

grow from within or legally combine with

another business

• The most common method of joining

businesses together is through a merger

• A merger occurs when one company joins

with or absorbs another

Types of Corporate Combinations

• The three most common types of

combinations are…

• …horizontal mergers

• …vertical mergers

• …conglomerates

Horizontal Combinations

• A merger between two or more companies

producing the same good or service is

called a horizontal combination

• …Texaco merging with Shell

• …Bank of America merging with Nations

Bank

• …Office Depot/Office Max

• …Men’s Warehouse/Jos. A. Banks

• …Time Warner Cable/(Charter) Spectrum

Vertical Combinations

• A merger between two or more companies

involved in different production phases of

the same good or service is called a

vertical combination

• United States Steel owns

• …iron mines

• …railroads

• …shipping lines

Conglomerates

• A merger of companies producing

unrelated products is known as a

conglomerate combination

• The unrelated companies operate as a

subsidiary of a parent company and most

often retains it’s own managers

• Let’s look at some conglomerates you

know…

Conglomerates You knowSource: http://www.thenation.com

DIRECTV

Negotiating

now to buy

all of

CNN/Time

Warner

Conglomerates You knowSource: http://www.thenation.com

Conglomerates You knowSource: http://www.thenation.com

Advantages of Combinations

• Efficiency

• …centralized decision making

• …eliminate overlapping jobs and

departments

• …lower costs (buying an existing business

is cheaper and faster than building new

factories, offices, hiring new workers, etc.

• …becoming bigger makes it even easier to

borrow more financial capital

Disadvantages of Combinations

• Higher unemployment due to eliminations

of duplicate jobs

• Low employee morale

• Reduced competition in the market place

• Higher prices

Franchises

• Businesses that share a name and sell the same

goods and services even though they are

separately owned

• The original company is the franchisor

• The company that pays a fee to use the name and

sell the goods is the franchise

• Some local franchise businesses include:

McDonalds, Subway, Churches, Taco Cabana,

KFC/Taco Bell, Long John Silvers

• The parent company sets standards, provides

product, advertises, trains franchise owners

McDonald’s Set Standards

Cooperatives

• Also known as co-op’s, these business

combinations are owned by their members

• They achieve savings through economies

of scale and pass the savings on to co-op

member/owners

• …building coops

• …farm products

• …credit unions

Non-Profit Organizations

• A business organization that does not focus on

financial gain

• A non-profit organization works in a businesslike

way to provide goods and services while pursuing

other goals

• …improving education

• …providing health care

• …museums, cultural institutions

• National NP: Red Cross, Scouting, Am. Heart

Assoc.

• Local NP: Operation Homefront, Guidedogs of TX,

SA Food Bank

More about non-profits…

• Structured like corporations: board,

officers, employees, etc.

• They enjoy longevity

• Usually sell products, charge fees for

services, or receive charitable

contributions

• The income of non-profits is not taxed by

the government

References

• Economics: Texas Edition: 2016. McGraw Hill Education

• Holt Economics; Texas Edition: 2003, Holt, Rinehart and

Winston