Commerce 100: Canadian Business 1

Forms of Business Organization

What does “form of business organization” mean or refer to?

Why is the decision on the form of organization one of the most critical decisions made by the person starting a business?

Why is the decision on the form of ownership unique to and fundamental to the capitalist (market, consumer sovereignty) economic system?

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Forms of Business Organization

There are three generic (basic) ways to form a business:Sole proprietorship: unincorporated business which is

owned and operated by one person.

Partnership: unincorporated business which is owned by more than one person.

Corporation: incorporated business (distinct or separate legal entity) owned by one or several persons

Are any of these forms of organization the best in all situations?

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Forms of Business Organization

Sole ProprietorshipAdvantages- Easy to start and wind-up- Being your own boss, easy to resolve issues (as owner

managed)- Reduced government filing requirements (legal an tax)

Disadvantages- Limited access to financial resources- Unlimited liability- Difficult to sell or pass on to successors- Limited managerial expertise (generally no separation

of ownership and management)- Higher marginal tax rate on surplus earnings than

corporation

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Forms of Business Organization

PartnershipAdvantages- Relatively easy to start- Increased access to financial resources- Increased access to managerial and technical skills

Disadvantages- Unlimited liability- Prone to disagreement between partners- Difficult to wind-up- Higher marginal tax rate on surplus earnings than

corporation

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Forms of Business Organization

CorporationAdvantage- Increased access to financing- Limited liability- Ease of transfer of ownership interest- Perpetual life- Ability to separate ownership from management- Can be very large, economies of scale- Relatively cheap to start- Lower marginal tax rate on surplus earnings than

proprietorship or partnership

Disadvantage- Significant legal and tax filing requirements- Complex to start as separate legal entity

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Corporate Governance

As corporations are separate a distinct legal entities, there needs to be a way for shareholders to exercise

control over the corporation. This governance is achieved by:

1. Each common share has one vote. The vote is used to elect members to the Board of Directors. The more shares you have, the more votes.

2. The elected directors hire the president and other senior (executive) officers of the company. The Board approves strategic initiatives of the corporation and the annual operating budget.

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Corporate Governance

3. The president and other senior officers regularly meet (at least 1/4ly) with the Board to inform them of achievement of the corporation. Compare predicted and actual results This holds senior management accountable.

4. Board approves salary and bonus for officers. Seeks to ensure that officers are acting in ways which enhance the value of the corporation.

5. The officers set the objective and goals for the corporation. These are approved by the Board. Officers hire and supervise managers and employers

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Forms of Business Organization

Private corporations: a corporation whose shares are not traded in the public (stock) market.

Public corporation: a corporation whose shares are traded in the public (stock) market.

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Forms of Business Organization

Advantages of being a private company:1. Privacy, need not disclose financial or other information to

the public.

2. Fewer requirements to file information with the government (other than income tax return) and a few other statutory filings.

3. Not distracted by the short term fluctuations of the stock price, can focus on long term goals.

4. Avoid the need to meet (anonymous) shareholders requests and scrutiny. Can act much like your own boss, accountable to yourself or a limited number of individuals who you generally know personally.

5. Relative easy to govern, not affect by Sarbane-Oxley Act or other similar legislation.

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Forms of Business Organization

Disadvantage of being a private corporation:1. Limitations in access to financial (equity) capital.

2. Owner/manager cannot diversify risk, has all their savings invested in the business.

3. Difficult to sell ownership interest or get out.

4. Difficult to get professional management (limited separation of ownership from management).

5. Generally lacks the assistance of independent and qualified outside directors; poor(er) governance.