Organizational Forms

Sole ProprietorshipPartnershipCorporationSubchapter S CorporationLimited Liability PartnershipLimited Liability CompaniesLimited PartnershipNon-Profit Entity

Important Considerations

Control: How many cooks are in the kitchen?Flexibility: A sports car or a battleship?Liability: Who gets left holding the bag?Longevity: Nobody lives forever…Access to Capital: Sweat equity or OPM?Taxation: Once, twice, or not at all?Bureaucratic BS: How red is the tape?Cost: Pay a little or pay a lot?

Sole Proprietorship

Simplest to start and maintain Most common structure Least costly Highest personal risk Income is taxed as personal income

Sole Proprietorship Taxation Taxable income “passes through”

the business Personal income and business

income are combined and taxed as one

May put you in a higher tax bracket Losses can be used to offset

personal income

Sole Proprietorship Taxes

Form 1040 Schedule C or Schedule C-EZ: Profit

and Loss From Business -- Sole Proprietorship

Form 1040 ES: Acceleration Estimate Tax for Individuals -- Must estimate expected income tax for the coming year

Quarterly vouchers and payments

Sole Proprietorship Legal Stuff

No registration required if business is in your own name

If you change the name or use anything other than your own name, must file Certificate of Conducting Business Under An Assumed Name with Secretary of State.

Right of Survivorship Document – Says what will happen in case of your death

To end business – Liquidate assets, pay off debts, and walk away.

Sole Proprietorship Summary

Control: You’ve got it allFlexibility: It’s your decision (alone)Liability: You’ve got it allLongevity: Nobody lives forever…Capital: Your money, bank debt, and trade

creditTaxation: Once, but not many breaksBureaucratic BS: Almost noneCost: Very little

Partnership

Use if more than one person’s capital Can be oral or written, but non-idiots

put it in writing Terminates with the death of any

partner in most states – Can use “Key Man” insurance to provide for the continuation of the partnership

Liability is joint and several unless there are limited partners

Partnership Taxes

Form 1040 with proportional share of partnership income

Form 1065: US Partnership Return of Income

Schedule K-1: Partner’s Share of Income Credits, Deductions, etc.

Each partner calculates and files an estimated tax

Quarterly vouchers and payments

Types of Partnerships

General Partnership Partners are equally liable (joint and

several) Share workload and decision making Operates on a calendar year Generally cash-based accounting

Types of PartnershipsLimited Partnership One or more partners are merely

investors and do not participate in running the business or making decisions.

Limited partners have share of ownership but liability is limited to the amount of the investment

Must have at least one general partner

Partnership Legal Stuff

The partnership name and information about the partners must be filed

Written partnership agreement is optionalEstate planning (what happens when a partner

dies) is essential, but complicatedAll personal assets of all general partners are at riskPartnership terminates with the death of any partner

unless partnership agreement specifies otherwise

Partnership SummaryControl: Shared between the partnersFlexibility: Now it’s a committee...Liability: Joint and severalLongevity: Nobody lives forever…Capital: Partners’ money and some debtTaxation: Once, but not many breaksBureaucratic BS: Some - Partnership

agreements, more stringent recordsCost: Very little

Corporations Most difficult and costly to set up Provides the most benefits to the owners Separate legal entity – provides limited liability for

all owners Best access to capital markets Easiest in which to transfer ownership Income is taxed twice – once at the corporate

level and once at the personal level – but otherwise gets very favorable tax treatment

Most closely scrutinized by the US Government and (if publicly traded) by the SEC

The Corporate Form of Organization

OwnershipThe shareholders (also known as

stockholders or equity holders) are the owners of the corporation.

ControlUltimate control rests with the shareholders,

but the managers control the day to day operations.

Risk BearingWhile all parties associated with the

corporation bear risk, shareholders bear all residual risk.

Flow of Control in a Corporation

Shareholders

Board of Directors

Managers

Corporation Taxes

VERY complicated and constantly changing

Owners file a Form 1040 with personal and dividend income included

The Corporation files a Form 1120 – US Corporation Income Tax Return – if gross receipts, total income, or total assets are over $500,000

Form 1120A (Short form) if any of the three are under $500,000 (… some other rules)

Corporation Summary

Control: LOTS of cooksFlexibility: Now it’s a BIG committee...Liability: Limited personal liabilityLongevity: Nobody lives forever… So what?Capital: Best access of all formsTaxation: Twice, but many deductions and

breaksBureaucratic BS: Lots and lots and lots

and…Cost: Can be substantial

Rights of Ownership in Corporations

Dividend RightsVoting Rights

majority votingone vote per share per directorcannot combine votes

cumulative votingdirectors are voted on jointlycan cast all votes for a single candidate

Rights of Ownership (contd.)

Liquidation RightsOwners have the right to a

proportional share of the firm’s residual value in the event of liquidation, after other senior claims are paid.

Preemptive RightsOwners have the right to subscribe

proportionally to any new shares issued by the firm.

Forming a Corporation

What do you need? $50 (In Mississippi) Company name (unique) Directors Business address [Federal Tax ID] [Corporate Charter]

Interesting Statistics

Number of US businesses Number of US businesses by revenue size Number of US corporations by Industry Number of US sole proprietorships by

industry Number of US partnerships by industry Number of businesses by state Most popular small businesses

Businesses by State

BusinessesByState.xls

Need Help?

Small Business Development CenterSec. Of State - www.sos.state.ms.usMyCorporation.com Incorporate USA Company Corporation CorpAmericaBizFilings.comQuick-Inc.com

Subchapter S Corporation

Owners retain limited liability Taxed as a partnership - eliminates

double taxation and makes it easier for owners to be compensated

All profits are taxed and distributed annually

Subchapter S Corporation

A corporation can elect S-Corp status within 75 days of formation if:

1. It is a domestic corporation (i.e., it operates in the state in which it is franchised

2. There is only one class of stock3. It has 75 or fewer stockholders4. All stockholders are US citizens or

resident aliens5. There are no subsidiaries

Limited Liability Company (LLC)

Owned by “members” who may run the company or appoint managers to do it

Members and managers have limited liabilityTaxed like a Subchapter S Corporation

without having to conform to the S Corp restrictions

Limited liability can make it harder to raise capital - may require personal guarantees

Limited Liability Partnership (LLP)

Also called a Professional CorporationUsed primarily by those who render

professional services - lawyers, doctors, architects, social workers, etc.

Some tax advantages - possible tax shelter

Not much liability limitation

Information Sources

The Quick-Inc Guide to Business Entities

LLCs on MyCorporation.comLLCs on BizFilings.com

BizFilings.com Comparison of:C Corp to S Corp, S Corp to LLC, C Corp to LLC

Piercing the Corporate Veil

Creditors may attempt to recover money from shareholders if:

The business was initially underfunded or “thinly capitalized”

The owners failed to treat the business as a separate entity themselves:

Fail to use Inc. or Corp or LLC in dealingsCo-mingle assets or fundsFail to keep good records and hold meetings

The Goal of the Firm

Better defined than profits Is an objective external measure Considers timing of cash flows Considers all internal and external

factors Considers risk differences between

alternative courses of action

“Maximize Shareholder Wealth”

Three Types of Decisions

Investment DecisionsHow should capital be invested?

Financing DecisionHow should the assets be financed?

Managerial DecisionsHow large should the firm be?How fast should it grow?Should the firm grant credit to a customer?How should the managers be compensated?

The Investment Vehicle Model of the Firm Investors provide financing to the firm

in exchange for financial securities. Firm invests these funds in assets. Income generated by the firm is

distributed to the investors. Managers act in the best interest of

the shareholders, and take actions to maximize shareholder wealth.

The Investment Vehicle Model of the Firm

TheWorld Investors

The Firm

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Dec

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Fina

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FinancialIntermediaries

FinancialMarkets

Corporate Financial Management

Financial Markets and Intermediaries Investments

Exchange of Money and Financial

Assets

Exchange of Money and Real Assets

The Accounting Model of the Firm

Balance sheet view of the firm. Investment decisions are represented

on the asset (i.e. left hand) side of the balance sheet.

Financing decisions are represented on the liabilities and equity (i.e. right hand) side of the balance sheet.

Long Term LiabilitiesLong Term DebtCurrent Debt

The Investment Decision

Current AssetsCashMarketable SecuritiesAccounts ReceivableInventory

The Accounting Model of the Firm

The Financing Decision

Current LiabilitiesAccounts PayableCurrent Debt

Shareholder’s EquityCommon StockRetained Earnings

Total Fixed AssetsTangible Fixed AssetsIntangible Fixed Assets

Net Working Capital

Set of Contracts Model of the Firm The firm has contracts with a large

number of stakeholders. These contracts may be explicit or

implicit. Contracts may also be contingent on

particular future outcomes. The model recognizes that conflicts of

interest may exist between the various stakeholders.

Set of Contracts Model of the Firm

PreferredStockholders

Banks

CommonStockholders

Bondholders

Customers

Governments

Communities

Creditors

ManagersSuppliers

Society

Environment

Employees

The Firm

The Agency Model of the Firm

Managers have day-to-day operational control of the modern corporation and are supposed to act as agents for the shareholders.

Managers have goals that differ from those of the shareholders.

Shareholders must incur costs to make sure that their "agents" act in their best interests.

Monitoring costs Incentive costs

Notes on sources for this presentation

This presentation includes material provided in the Chapter 2 slide presentation for Corporate Finance by Emery and Finnerty (Prentice Hall)

and

Chapter 3 in Ready or Not, Get Set Go by Sheila Taylor-Downer (Professional Prodigy, Inc.)