Lesson 5

From the Opportunity

to the Business Plan

The Organizational Plan

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 Developing the Management Team
Potential investors are interested in the management team, its
ability and their commitment to the new venture.
• Investors usually look for teams that operate the business full time.
• Investors perceive an entrepreneur taking a large salary as a lack of
commitment to the business.

The entrepreneur should consider the role of the board in

supporting management of the new venture.

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 Legal Forms of Business
Three basic forms are:
• Proprietorship.
• Partnership – a variation is the LLP.
• C corporation - a variation is the S corporation.
• One additional form is the Limited Liability Company (LLC).

The entrepreneur should evaluate the pros and cons of the legal
forms prior to submitting a business plan.

The entrepreneur should determine the priority of several

factors, including tax factors.

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 Ownership and Owner Liability
In a proprietorship, the owner
has full responsibility.
In a partnership, owners may
be general partners and/or
limited partners.
• The partnership is a legal
entity in a limited liability
partnership (LLP).
In the corporation, ownership
hinges on shares of stock
owned.
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A proprietor and a general
partner are liable for all aspects
of the business.
Corporation owners are liable
only for their investment.
Creditors may seize personal
assets of proprietors and general
partners.
• Limited partners are liable only
for their contributions.
• LLP is a form of LLC, both
protect personal assets.
 Startup Costs and Continuity of the Business
For a proprietorship, startup
costs are minimal.
A partnership agreement
requires legal advice, and fees.
• An LLP may be more complex.
The corporation is created only
by statute.
• Register and meet statutory
requirements.
• Filing fees, taxes and legal
fees.
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The death of a sole proprietor
terminates the business.
Death of a general partner
terminates the partnership.
• Buy out or take over of the
share may be allowed.
• Death of a limited partner has
no effect on continuity.
• They can be replaced – same
with an LLP.
The corporation has the most
continuity.
 Transferability and Capital Requirements
Sole proprietors may sell or Proprietors must take out loans
transfer any assets. or add personal capital.
Limited partners in a general • Borrowing may require
relinquishing equity.
partnership can sell anytime.
• General partners have to give Partnership agreements change:
first refusal, then may sell.
• If the partnership get a loan.
• LLPs do not allow transfers.
• If partners add funds.
Shareholders in a corporation
New capital for a corporation
may sell at any time.
can be raised:
• Shareholders agreements
• By selling stocks or bonds.
may limit some sales.
• By borrowing money in the
• The S corporation only allows
name of the corporation.
transfer to an individual.

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 Management Control and Distribution of Profits
The sole proprietor has the
most control over decisions.

In partnerships, majority rules. Proprietors receive all profits

but also receive all losses.
• Limited partners have no
control over business
The partnership agreement
decisions.
outlines distribution of profits
Management controls daily and losses.
business in a corporation.
Corporations distribute profits
• Long-term decisions may
through stockholder dividends.
require a stockholder vote.
• Stockholders affect operations
through the board.

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 Attractiveness for Raising Capital
In both the proprietorship and the partnership, the ability to
raise capital depends on:
• The success of the business.
• The capability of the entrepreneur.

Due to the personal liability advantages, the corporation is the

most attractive form of business for raising capital.
• Selling shares of stock, bonds, and/or compiling debt are all ways to
raise capital with limited liability.

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 Tax Rates for Various Forms of Business
A few major tax changes are noted but many unmentioned minor
differences can also be important to an entrepreneur.
• All C corporations receive a permanent tax cut from 35% to 21%.
• Pass through businesses receive a 20% reduction in taxable income
which expires in 2025.
• Exceptions include the 20% reduction for service-based pass through
businesses is only applicable to income after salary.
• Attorneys, doctors, realtors, engineers, and accountants.
• For other employee driven pass through organizations, the tax
deduction of 20% is limited to 50% of the company payroll.
• Restaurants and manufacturers.

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 The LLC versus the S Corporation
Venture capitalists desire the LLC or Limited Liability Company.

Regulation changes made the LLC more attractive.

• The LLC is automatically taxed as a partnership unless the
entrepreneur actively chooses to be taxed as a corporation.

The S corporation was once the most popular organizational

structure by new ventures.
• Growth has declined due to LLC acceptance in all 50 states.

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 The S Corporation
The S corporation combines the tax advantages of the
partnership and corporation.
• Income is shared equally and taxed as personal income and
shareholders may use deductions of the business.

Passing of the 1996 Small Business Protection Act loosened the

rules governing the S corporation, revised in 2004.
• The intent was to make the S corporation as advantageous as the LLC.

The S corporation status must be monitored and maintained.

• Requires an affirmation of shareholders and if lost, cannot be
reelected for five years and some costs.

The difference between it and the LLC are minimal.

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Advantages of an S Corporation Over a C Corporation
Capital gains or losses are taxed as personal income and shared
equally by the shareholders – the S corporation is not taxed.

Shareholders retain the same limited liability as C corporations.

S corporations are not subject to a minimum tax, unlike the C

corporation.

Stock is transferable to family members.

Stock may be voting or nonvoting.

The S corporation may use the cash method of accounting.

Corporate capital gains or losses are deductible directly by the

shareholders to offset other personal capital gains or losses.

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 Disadvantages of an S Corporation
Depending on the amount of net income, there may be a tax
advantage using the new 21% C corporation tax rate.

The S corporation cannot deduct most shareholder fringe

benefits.

The S corporation must adopt a calendar year for tax purposes.

Only one class of stock, common stock, is permitted.

The net loss of the S corporation is limited to the shareholder’s

stock plus loans to the business.

S corporations cannot have more than 100 shareholders.

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 The Limited Liability Company
Characteristics of the LLC, a partnership-corporation hybrid.
• Corporations have shareholders, partnerships have partners, the LLC
has members.
• No shares are issues, each member owns an interest in the business.
• Liability does not extend beyond the member’s capital contribution.
• Members may transfer their interest only with the unanimous written
consent of the remaining members.
• The IRS automatically taxes the LLC as a partnership.
• The standard term of an LLC is 30 years but dissolution is likely when:
• one member dies, the business is bankrupt, or all members choose to
dissolve the business.
• Laws governing the LLC differ from state to state.

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 Advantages of an LLC
An LLC has advantages over an S corporation.
• An LLC offers a distinct advantage in a highly leveraged enterprise.
• The LLC may have tax advantages in some states.
• One or more individuals, corporations, partnerships, trusts, or other
entities can join to form an LLC.
• Members share income, profit, expense, deductions, loss and credit,
and equity of the LLC among themselves.

A major concern is using an LLC in international business.

The LLC offers all the advantages of the C corporation but with a
pass through tax to members.

Venture capitalists like the LLC for its flexibility.

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 Designing the Organization
The design of the initial organization will be simple as the
entrepreneur may perform all of the functions alone.
• A common problem and a significant reason for failure is when the
entrepreneur is unwilling to give up responsibility or include others.
• If so, the entrepreneur may have difficulty transitioning from a startup
to a growing business that maintains success over time.

As the work increases, the organizational structure will expand.

• Effective interviewing and hiring must be in place.
• All design decisions involving personnel reflect the formal structure.
• An organization also has an informal structure, organizational culture,
which evolves over time and needs addressed by the entrepreneur.

The organization must identify the major activities required to

operate effectively.
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 Member’s Expectations in Design
The design of the organization is a formal and explicit indication
of what is expected of each member.

Expectations are grouped into five areas.

• Organizational structure – the organizational chart.
• Planning, measurement, and evaluation schemes – the goals and
objectives of the venture.
• Rewards – bonuses, promotion, and praise.
• Selection criteria – guidelines for hiring of each position.
• Training – on or off the job formal education or learning skills.

The organization’s design may be simple or complex.

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 Changing Roles in an Evolving Organization
As the organization evolves, the entrepreneur’s decision roles
become more critical for an effective organization.
• The primary concern is to adapt to changes and seek new ideas.
• When a new idea is found, the entrepreneur must initiate
development or delegate the responsibility.
• There will be a need to respond to pressure by “putting out fires.”
• The entrepreneur will become an allocator of resources, delegating
budgets and responsibilities.
• The entrepreneur becomes a negotiator as the only person with the
appropriate authority.

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 Building the Management Team and a Culture
The entrepreneur needs the right mix of people to assume the
responsibilities outlined in the organization structure.

The team must be able to accomplish three functions:

• Execute the business plan.
• Identify fundamental changes in the business as they occur.
• Adjust the plan based on changes that will maintain profitability.

First, the entrepreneur must define the skills and abilities

needed to meet the goals of the business plan.
• Consider the personality and character of each individual.
• The culture will be unique to each business.
• The entrepreneur must delegate to create a vibrant culture.

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 Strategies to Recruit an Effective Team
A desired culture must match the business strategy.

The workplace must motivate and reward good work.

There must be flexibility to try different things.

Spend extra time in the hiring process.

• People are more than their skills, character is important.

Understand the significance of leadership in the organization.

• Leadership should establish core values and provide tools so employees
can effectively complete their jobs, such as a reward system.

Finding an effective team and creating a positive culture is as

critical as having an innovative, marketable product.

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 The Role of the Board of Directors
The board of directors may serve a number of functions.
• Reviewing the operating and capital budgets.
• Developing long-term strategic plans for growth and expansion.
• Supporting day-to-day activities.
• Resolving conflicts among owners.
• Ensuring the proper use of assets.
• Developing a network of information sources.

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 Choosing a Board and the Sarbanes-Oxley Act
The intent was an independent functioning board of directors.
• Board members must “blowing the whistle” on any discrepancies.

Many startups do not plan to have a formal board of directors.

• Equity investors may insist on formation of a board and one board seat.
• Choose board members carefully to meet the following criteria:
• Those with skills, industry experience, and commitment to the mission.
• Those who will be informed and assist in important decisions.
• Those willing to exchange ideas and use their experience.

There should be an odd number of board members and they

should be regularly evaluated.

Compensation can be shares of stock, stock options, or cash.

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 The Board of Advisors
A board of advisors serves only in an advisory capacity and is not
subject to regulations of the Sarbanes-Oxley Act.

Meetings are less frequent and discuss important decisions.

A board of advisors is very useful in a family business.

The selection process is similar to selecting a board of directors.

• Compensate on a per meeting basis or with stock or stock options.
• Evaluate members as to their contribution to meeting the mission.

Board of advisors can provide important reality checks.

Flexibility makes these boards a desirable alternative to the

more formal boards of directors.

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 The Organization and Use of Advisors
The entrepreneur may need outside advisors, such as
accountants, bankers, lawyers, and market researchers.

Seek out the best advisors and involve them thoroughly.

Hiring and managing outside experts can be viewed as hiring

advice suppliers.

Even after the advisors are hired, the entrepreneur should

question their advice.

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