Professional Documents
Culture Documents
Lecture Objectives
Describe the advantages and disadvantages of sole
proprietorship.
Describe the advantages and disadvantages of a partnership.
Describe the advantages and disadvantages of a corporation.
Explain how the potential return and risk of a business are
affected by its form of ownership.
Describe methods of owning existing businesses.
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Selecting a Form of Business
Ownership
2
Sole Proprietorship
3
Characteristics of Successful Sole
Proprietors
Sole proprietors
• Must be willing to accept full responsibility for the firm’s
performance
• Enormous work pressure than any other employee
• Must be willing to work flexible hours.
• On-call to substitute for sick/absent employees
• Encouraged by success of business to continue monitor operations
• Must exhibit strong leadership skills, be well organized &
communicate well with employees
• Previous experience is critical to understanding competition and
customer behavior
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Advantages of a Sole Proprietorship
Sole proprietors
• Must be willing to accept full responsibility for the firm’s performance
• Enormous work pressure than any other employee
• Must be willing to work flexible hours.
• On-call to substitute for sick/absent employees
• Encouraged by success of business to continue monitor operations
• Must exhibit strong leadership skills, be well organized &
communicate well with employees
• Previous experience is critical to understanding competition and
customer behavior
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Disadvantages of a Sole Proprietorship
Additional Funding
With more partners, more money is made available for business
expansion.
Losses are Shared
Any business losses that the partnership incurs are spread across all of
the partners.
More Specialization
Partners focus on their areas of specialization and serve a variety of
customers.
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Disadvantages of a Partnership
Control is Shared
Decision making in partnership must be shared. Disagreeing on how the
business should be run can destroy both personal and business
relationships.
Unlimited Liability
General partners in a partnership are subject to unlimited liability, just
like sole proprietors.
Profits are Shared
Any profits that the partnership generates must be shared among the
partners. The more partners there are, the smaller the amount of a given
level of profits that will be distributed to any individual partner.
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Partnership ..cont…
S-Corporations
A firm that has 100 or fewer owners and satisfies other criteria. The
earnings are distributed to the owners and taxed at the respective
personal income tax rate of each owner.
Owners have limited liability
Since the shareholders of a corporation are legally separated from the entity, they
have limited liability, meaning they are not held responsible for the firm’s actions.
Shareholders elect members of the board of directors entrusted to establish
general policies of the firm.
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Corporation ..cont..
How Stockholders Earn a Return
Stockholders earn a return on their investment in two ways:
1. They may receive dividends from the firm which is a portion of
the firm’s recent earnings over the last three months that are
distributed to stockholders
2. The stock they hold may increase in value. When the firm
becomes more profitable, the value of its stock tend to rise,
meaning that the value of stock held by owners has increased.
Thus they can benefit by selling their stock at a much higher
price than they paid for it.
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Corporation..cont..
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Advantages of a Corporation
Limited Liability
Owners of a corporation have limited liability, whereas sole proprietors and
general partners typically have unlimited liability
Access to Funds
A corporation can easily access funds by issuing new stock. This allows
corporations the flexibility to grow and to engage in new business ventures.
Sole proprietorships and partnerships have less access to funding when they
wish to finance expansion. To obtain more funds, they may have to rely on
their existing owners or loans from creditors.
Transfer of Ownership
Investors in large, publicly traded companies can normally sell their stock in
minutes by calling their stockbrokers or by selling it online over the internet.
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Disadvantages of a Corporation
High Organizational Expense
• Organizing a corporation is normally more expensive than creating the
other forms of business because of the necessity to create a corporate
charter and file it with the state.
Financial Disclosure
• When the stock of a corporation is traded publicly, the investing public
has the right to inspect the company’s financial data, within certain limits.
Agency Problems
• Publicly held corporations are normally run by managers who are
responsible for making decisions for the business that will serve the
interests of the owners. When managers do not act as responsible agents
for the shareholders who own the business, a so-called agency problem
results.
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Disadvantages of a Corporation
High Taxes
• Since the corporation is a separate entity, it is taxed
separately from its owners. The annual taxes paid by a
corporation are determined by applying the corporate tax rate
to the firm’s annual earnings. The corporate tax rate is
different from personal tax rate.
• E.g., a corporation earns USD10 million this year and assume
that the applicable corporate tax is 30 percent this year
Earnings before Tax = $10, 000, 000
Corporate Tax = 3, 000, 000 (30% x 10, 000, 000)
Earnings after Tax = $7, 000, 000
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Disadvantages of a Corporation
High Taxes
• If any of the after tax earnings are to be paid to the owners as dividends, the
dividends represent personal income to the stockholders. The stockholders will pay
personal income taxes on the dividends.
• E.g., Assuming that from previous example that the $7million after tax earning is
taxed at 10 percent.
Combining the corporate tax and personal income tax, total tax paid as a result of the
profit is 37% of K10 million.
3, 000, 000 + 700, 000 = 3, 700, 000
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Illustration of Double Taxation
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Comparison of Tax Effects on Corporation & Sole
Proprietorship
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Comparing Forms of Business
Ownership
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How Ownership Can Affect Return and
Risk
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How Ownership Can Affect Return and
Risk
Definitions
• Equity – the total investment by a firm’s stockholders
• Return on Equity (ROE) – earnings as a proportion of the
firm’s equity.
Impact of Ownership on Risk
Risk – the degree of uncertainty about a firm’s future earnings
• Since sole proprietorship are smaller with very limited funds,
they are generally riskier than other forms of business
ownership.
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Methods of Owning and Operating A
Business
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Obtaining Ownership of an Existing
Business
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Starting A Business From Scratch
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Assuming Ownership of a Family
Business
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Purchasing an Existing Business
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Franchising
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Franchising…cont…
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Advantages of Franchise
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Case Study
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