Part 3 – Comparison of Forms of Business Ownership
Part 2 – How to Form a Business, Corporations
You don’t have to be a big business to form a corporation. A corporation, sometimes known as a C corp., is chartered with the secretary of state, and is a unique “person” with separate liability from its owners, known as stockholders. The biggest advantage of forming a corporation is that it limits the stockholders’ liability to the amount they’ve invested; they do not have personal liability for the debts or other problems of the company. A corporation also allows multiple people to share in the ownership, and hopefully the profits, of a business without the necessity of working there or other commitments to the company. Corporations choose whether to offer ownership to outside investors or to remain proviately held.
As previously stated, a corporation offers limited liability for its owners. Additional advantages include the ability to sell stock to raise money from investors; to borrow money from banks or investors; perpetual life, i.e. the company does not terminate with the death of its owner(s); ease of ownership change; ability to offer stock options to attract valuable employees; and to raise money separate from getting investors involved in management of the business.
The corporate heirarchy, from the top down, begins with the owners/stockholders who elect the board of directors, the board hires officers, the officers set the corporate objectives and hire management, the managers supervise the employees, and the employees perform the functions of the business. Thus the owners help dictate who runs the company, but not its day to day operations.
There are also disadvantages to corporate entities, including the initial set up costs; paperwork, both initially and ongoing; double taxation – first the corporation pays tax on its income before any is distributed to stockholders as dividends, then the stockholders pay income taxes on the dividends they receive; two tax returns, a corporate return and individual return; once started a corporation is hard to end; and finally the potential for conflict between directors and management.
While we are all aware of many large corporations, IBM, AT&T, Apple, many corporations are small business owners who typically do not issue stock to outsiders, focusing more on limited liability and possible tax benefits.
An S corp. is a regular corporation that elects to be taxed like a partnership, thus avoiding double taxation. Profits of an S corp. are taxed only as the personal income of the shareholders. In order to qualify to make this election, the company cannot have more than 100 shareholders, must have shareholders that are individuals or estates, and who are citizens or permanent residents of the United States, must have only one class of stock, and must derive no more than 25% of its income from passive sources. If an S corp. loses its status as such, it must wait five years to make another S election.
Finally, there’s an interesting hybrid known as a limited liability company. This entity does not have the formal requirements of a C corp. and has the tax advantages of an S corp. It offers limited liability to its members; is taxed as a partnership, though it can choose to be taxed as a corporation; does not have the same ownership restrictions as an S corp.; has flexible distribution of profits and losses, which do not have to be distributed in proportion to the money each person invests, but is by agreement of the members; anddoes not have to comply with the ongoing operating requirements of a corporation, such as annual meetings, minutes and written resolutions, though an operating agreement is a good document to put in place.
LLCs have disadvantages as well, including limitations on transferabiity of membership interests; a limited life span, which could be triggered by the death of a member; inability to deduct fringe benefits, thus few incentives available for employees; although less paperwork than a corporation, more than a sole proprietorship; and members must pay self employment taxes on their profits.
Determining the appropriate form for your business typically involves input from both a lawyer and an accountant to ensure you create the best opportunity for you and your company.
Part 1 – How to Form a Business, Sole Proprietorship and Partnership
The form of your business can have a tremendous impact on its long-term success. The three major forms of business ownership are sole proprietorships, partnerships and corporations. Each has pros and cons.
A sole proprietorship is a business owned and usually managed by one person. When two or more people legally agree to become co-owners of a business, it’s called a partnership. While these two forms of organization are relatively easy to form, there are advantages to creating an entity that is distinct from its owners. A corporation is a separate legal entity with authority to act and have liability apart from its owners. There are several options for a corporate entity, the most popular being the limited liability company, or LLC.
This is the easiest to start and end, all you need to do is just start or stop, as the case may be. You may need a license from your local government, but this is typically a simple task. All of the sole proprietorship’s profits are taxed as personal income of the owner, and the owner pays normal income tax on that money. However, the owners do have to pay the self-employment tax (social security and medicare), and have to estimate their taxes and make quarterly payments to the government to avoid penalties.
On the down side, a sole proprietorship offers no protection to its owner in terms of liability. In fact, the sole proprietor has unlimited liability, including the risk of personal losses. The sole proprietor and business are treated as one, so any debts or damages incurred by the business are those of the owner. This is a serious risk to be discussed with a lawyer, accountant, insurance agent and others.
A partnership is a legal form of business with two or more owners. It can be a general partnership, a limited partnership or a limited liability partnership, and while not always required, it is wise to put the relationship in writing. In a general partnership, all owners share in operating the business and assuming liability for the business’s debts. A limited partnership has one or more general partners and one or more limited partners. The general partner is an owner with unlimited liabiity and is active in managing the company. Every general partnership has to have at least one general partner. A limited partner is an owner who invests money in the business but does not have any management responsibility or liability for losses beyond her investment. Limited liability means that her liability for the company’s debts is limited to the amount she put into the company, and her personal assets are not at risk. The limited liability partnership (LLP) was created to limit the disadvantage of unlimited liability. It limits the partners’ risk of losing their personal assets to the outcomes of their own acts and omissions as well as those they supervise. A limited partner in an LLP can operate without fear that one of his partners might commit an act of malpractice resulting in a judgment that relieves him of his personal assets. Many states, however, do not extend this personal protection to contractual liabilities such as bank loans, leases or business debt of the LLP.
It may be easier to own and mange a business with one or more partner. While you might excel at marketing, your partner might be skilled at accounting. When two or more people pool their money and credit, paying the rent, utilities and other bills becomes easier. It is also easier to manage the day-to-day affairs of the business when you have partners. Having one or more partner can free up time for you away from the business, as well as provide different skills and perspectives. Partnerships tend to survive longer than sole proprietorships, and like a sole prop, the profits of parnerships are taxed as personal income of the owners.
On the flip side, conflict and tension are always possible when two or more people are involved. In addition, sharing risk also means sharing profits. Plus, each general partner is liable for the debts of the business, regardless of who caused the problem. A general partner is liable for her partner’s mistakes as well as her own so, like a sole prop, her personal assets are at risk. A partnership is also more difficult to terminate than the sole prop. Although you can quit, questions remain about who gets what and what happens next.
Part 3 – Corporate Social Responsibility
Corporate social responsibility (CSR) refers to companies as good citizens, concerned with the welfare of society and not just the owners. CSR is based on fairness, integrity and respect. While a company’s loyalty and obligation is to its owners, being a good corporate citizen can increase profitability in the long run. Companies with a good CSR reputation are cosidered ethical and often attract and retain better employees, enjoy greater employee loyalty, and draw more customers.
There are a variety of methods for CSR, including corporate philanthropy, corporate social initiatives, corporate responsibility and corporate policy. In addition to money, many companies allow their employees to volunteer during company time.
We know that companies have a responsibility to customers, pleasing them by offering real value. All things being equal, customers tend to favor the socially conscious company over its less socially conscious competitors. In fact, customers are often willing to pay more for goods from the socially responsible company. Thus CSR is also a tool to attract new customers. The question then becomes, how to make customers aware. Social media has become a low-cost, efficient way of conveying a company’s CSR efforts, allowing companies to reach and interact with a broad and diverse audience. However the company must live up to its hype or face dire consequences. If a company does not follow through on its CSR as claimed, it loses customers’ trust; customers do not want to do business with a company they don’t trust.
Many investors also believe that it makes financial sense to invest in companies engaged in CSR , and that ethical behavior adds to the bottom line.
Companies that treat their employees with respect usually earn the respect of their employees. This mutual respect can have a significant impact on the company’s profit. Retaining good employees saves money, is good for business and also good for morale. A disgruntled employee can wreak havoc on a business, thus loss of employee commitment, confidence and trust in the company can be extremely costly.
CSR has many benefits, each of which can increase a company’s profitability while also doing good for society as a whole.
Part 2, Business and Wealth Building
Standard of Living and Quality of Life
Entpreneurs such as Sam Walton (Walmart), Bill Gates (Microsoft), Jeff Bezos (Amazon) and Sara Blakely (Spanx) not only became wealthy themselves, they also provide employment for many other people.
Businesses and their employees pay taxes that the federal government and local communities use to build hospitals, schools, libraries, playgrounds, roads and other public facilities. Taxes also help keep the environment clean, support people in need, and provide police and fire protection. Thus, the wealth businesses generate and the taxes they pay help everyone in their communities. A nation’s businesses are part of an economic system that contributes to the standard of living and quality of life for everyone in the country.
Standard of living refers to the amount of goods and services people can buy with the money they have. The United States enjoys a high standard of living largely because of the wealth created by its businesses.
Quality of life refers to the general well-being of a society in terms of its political freedom, natural environment, education, health care, safety, amount of leisure, and rewards that add to the satisfaction and joy that other goods and services provide. Maintaining a high quality of life requires the combined efforts of businesses, non-profit organizations, and government agencies. Remember, there is more to quality of life than simply making money.
Responding to the Various Business Stakeholders
Stakeholders are the people who stand to gain or lose by the policies and activities of a business and whose concerns the business needs to address. These include customers, employees, stockholders, suppliers, dealers (retailers), bankers, people in the surrounding community, the media, environmentalists, competitors, unions, critics and elected government leaders.
A primary challenge for organizations in the 21st century is to recognize and respond to the needs of their various stakeholders. For example, the need for the business to be profitable may be balanced against the needs of the employees to earn sufficient income or the need to protect the environment. Ignore the media and they might attack your business with articles that hurt your sales. Oppose the local community and it may stop you from expanding.
Staying competitive may call for outsourcing. Outsourcing means contracting with other companies to do some or all of the functions of the company, like its production or accounting tasks. Insourcing is the opposite side of that coin, which can create many new jobs to help offset those jobs being outsourced. While it may be legal and profitable to outsource, is it best for all stakeholders? Business leaders must make outsourcing decisions based on all factors; pleasing stakeholders is not easy and often calls for trade-offs.
Using Business Principles in Non-Profit Organizations
Despite their efforts to satisfy their stakeholders, business can’t do everything needed to make a community all it can be. Non-profit organizations, such as public schools, civic associations, charities, and groups devoted to social causes, also make a major contribution to the welfare of society. A non-profit organization is an organization whose goals do not include making a personal profit for its owners or organizers. Non-profit organizations often do strive for financial gains, but they use them to meet their social or education goals rather than for personal profit.
Your interests may lead you to work for a non-profit organization. You will still need to learn and understand business skills such as information management, leadership, marketing and financial management.