Starting a business venture

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Edwin Chase
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1 Business Formations

2 Starting a business venture Business Formations When starting a business venture, you ll need to decide how to structure your operation. There are many types of business formations, all with different implications. Before formally incorporating your business, learn more about each type to find the one that would work best. When you decide to incorporate, consider speaking with a lawyer and accountant to make sure you understand the issues regarding tax, liability, management, and formality of operation.

3 Type of Business Formations The Big Four Sole Proprietorship Owner and company same entity Partnership 2 or more people co-owners of a business Corporation 1 or more person Most complex has stockholders, board of directors and officers Limited Liability Company Non-corporate form Set up like partnership has limited liability protection like corporation

4 Sole Proprietorship This is a business run by one person who has not registered with the state. It does not require any papers to be filed, which makes it popular for small businesses. According to the Small Business Administration (SBA), over 70 percent of businesses in the United States are owned and operated by sole proprietors

5 Advantages of a Sole Proprietorship Easier setup It s much simpler and less expensive to start than starting a formal corporation. If you don t hire employees or set up a retirement plan, you won t even need to bother applying for an Employee Identification Number (EIN) from the IRS. You re entitled to all profits and responsible for all debts and liabilities. if you conduct business using a name other than your legal name, you will most likely need to register your business name as a fictitious business name ( DBA doing business as) with your local county or state government. Easier Operations Unlike other business formations, a sole proprietor can commingle business and personal assets, making it less complicated to maintain the funds and associated bank accounts. The sole proprietorship does not have a separate identity under the law, so you don t need to create a separate bank account and your customers can write checks to your name. More Control A sole proprietor has complete control and decision-making power over the business, which is unlike business formations that require meetings with shareholders or partners. And in the event you want to move onto something new, a sole proprietorship offers the liquidity to shut down the business without much notice or easily sell the business without the formalities that come with selling a corporation. Tax benefits Because a sole proprietor pays taxes on income from the business as part of his or her personal income tax payments, he or she avoids corporate tax payments.

6 Disadvantages of a Sole Proprietorship Increased liability Without formally incorporating, the business owner will be held directly responsible for any and all debts, losses, obligations of the business, and as a result of acts committed by company employees. Without enough funds from the business to cover the legal expenses, you are forced to use your personal assets, so you sell your home, clean out your bank accounts, and dip into your retirement funds. In contrast, members in a formal corporation share only limited liability and cannot be held personally liable for losses or violations. Harder to secure capital A lack of formalized incorporation. Sole proprietorships do not issue stocks like corporations do, making it difficult to generate capital. Banks are also less willing to provide loans to sole proprietorship because they are often perceived as less dependable when it comes to repayment. Lack of continuity When a sole proprietor dies, the business no longer exists. Even if the assets pass to the sole proprietor s heir, that person will have to start a new business by filing for new licenses and tax numbers, re-registering the name, etc. Tax disadvantages IRS views the business and business owner as the same entity, the owner must pay self-employment taxes and cannot deduct benefits that would normally be deductible for a corporation, like employee s health insurance premiums.

7 Sole Proprietorship Advantages Simplest, least expensive - ease of formation No special legal restrictions - Minimal paperwork Minimal fees No filing government Unless employees are hired - Federal Employer ID #(FEIN or EIN) Profits tax advantages - taxed as income Go to owner Flexibility - Freedom management Easy to discontinue Control of decisions Disadvantages Unlimited liability - Liable for all debts, losses, and taxes Personal assets at risk Limited skills and capabilities Limited operating and management skills limited capital - difficult to obtain loans Difficult to sell Lack of continuity No personal time

8 Group discussion Right after graduation your best friend's uncle, who is the manager of a local car dealership in a college town in California, wants her to remodel his showroom as well as the medium size apartment building he owns. He is determined to help her kick-start her design career and has already recommended her to other Ford dealerships in the region that all have outdated showrooms. Your friend is excited about the idea. She considers forming a sole proprietorship because she knows that they are simple to start. Please consider the idea and advice her whether or not she should do this. Type down at least a paragraph of your argument. PLEASE DO NOT COPY AND PASTE SENTENCES OR PARAGRAPHS FROM THE READINGS/LECTURE NOTES INTO YOUR RESPONSES!!! Instead, use your own words to describe the points you want to make. Everyone's need to offer a new point to consider or an argument that has not previously been made. Also, respond to at least two other students in a meaningful way. ("I agree or not" is not enough but to explain WHY.)

9 Partnership Similar to a sole proprietorship, a partnership is a business owned by two or more people that haven t filed to become a corporation or a limited liability company. The partners pay taxes on their shares of the business income on their personal tax returns and are jointly liable for the entire amount of any business debts, liabilities, and losses. There are three common types of partnerships general partnerships, limited partnerships, and joint ventures. Don t go into business with a friend because you will likely lose that friend

10 Partnerships Advantages Similar to sole proprietorship - ease of formation Complementary skills of partners Division of profits Easier to access to capital - easier to obtain loans or establish credit, capitol Ability to attract unlimited partners - complementary skills Silent partner - no managing skills, only invest Little government regulation no state filing fee Tax advantages each partner pays taxes on their share of profit Disadvantages More expensive than sole proprietorship Unlimited liability Disagreement between partners - conflict Responsible for other partners actions Lack of continuity - if one partner leaves, partnership might dissolved Profits are split Partnership Agreement is recommended

11 Corporation This type of formation, is usually used by very large businesses, as it comes with the most regulations and a less favorable tax structure. However, this is the only entity that can issue an unlimited amount of stock as well as different classes of stock. If you plan to raise money from outside investors or plan to go public, this is the formation you ll need to use. Composed of: shareholders/stockholders (owned by), directors (managed by), and officers (operated by)

12 Corporation Advantages Limited financial liability Only the amount they invest - for legal expenses Owners are protected from personal liability for company debts and obligations. Business tax deduction expenses Have continuity can easily transfer ownership Easier to obtain loan Ability to raise capitol by selling stocks A legal entity business is separated from owners and managers Disadvantages Most complicated Many paperwork Cost & time of incorporating more expensive to set up than partnerships and sole proprietorships. Tax disadvantages - Double taxation corporate profit is taxed stockholders are taxed on dividends Stockholders have little to say - Board of directors make all major decisions More heavily regulated by state and federal require annual stockholders meetings and require owners and directors to observe certain formalities File all of the reports & pay all necessary fees on time

13 Limited Liability Company (LLC) Most commonly referred to as an LLC, this is the most popular structure for small businesses. Formed by two or more members. It combines aspects of partnerships with the benefits of a corporation without many of the formalities. LLC is automatically taxed as a partnership. There is no limit on the number of owners, but the business cannot issue stock. It is a new form of business ownership.

Limited Liability Company Advantages Set up like partnership Limited liability protection benefits like corporation and asset protection Owners are protected from personal liability for company debts

14 Limited Liability Company Advantages Set up like partnership Limited liability protection benefits like corporation and asset protection Owners are protected from personal liability for company debts and obligations Simpler to operate than a corporationmanage like partnership Ability to attract unlimited partners - flexibility of partnership - complementary skills of partners Easier to access to capital - easier to obtain loans or establish credit, capitol Tax advantages like partnership - each partner pays taxes on their share of profit Owners called members shareholders Disadvantages Cost of setting up an LLC is roughly equivalent to setting up a corporation more expensive to set up than partnerships Not for businesses seeking to become public or to raise money in the capital markets Not publicly-held companies (not corporations) Requires annual fees and filing annual reports with the state same as corporate

ESSENTIALS OF ENTREPRENEURSHIP AND SMALL BUSINESS MANAGEMENT 6E Chapter 5: Forms of Business Organization

ESSENTIALS OF ENTREPRENEURSHIP AND SMALL BUSINESS MANAGEMENT 6E Chapter 5: Forms of Business Organization 5-1 Choosing a Form of Ownership There is no one best form of ownership. The best form of ownership depends on an entrepreneur s particular situation. Key: Understanding the characteristics of each form