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Choosing a Form of Ownership of SMEs

There is no one “best” form of There is no one “best” form of ownershipownership

The best form of ownership depends on The best form of ownership depends on an entrepreneur’s particular situationan entrepreneur’s particular situation

The key to choosing a form of The key to choosing a form of ownership is understanding how each ownership is understanding how each form’s characteristics affect an form’s characteristics affect an entrepreneur’s specific business and entrepreneur’s specific business and personal circumstances personal circumstances

Choosing a Form of Ownership

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Factors to ConsiderFactors to Consider Tax considerationsTax considerations Liability exposureLiability exposure Start-up capital requirementsStart-up capital requirements ControlControl Managerial abilityManagerial ability Business goalsBusiness goals Management succession plansManagement succession plans Cost of formationCost of formation

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Forms of Forms of OwnershipOwnership Sole ProprietorshipSole Proprietorship PartnershipPartnership CorporationCorporation S CorporationS Corporation Limited Liability CompanyLimited Liability Company Joint VentureJoint Venture

Data Source: Sources of Income, Internal Revenue Service.

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Forms of SMEs Business Ownership

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Data Source: Sources of Income, Internal Revenue Service.

Forms of SMEs Business Ownership

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Advantages of the Advantages of the Sole ProprietorshipSole Proprietorship

Simple to createSimple to create Least costly form to beginLeast costly form to begin Profit incentiveProfit incentive Total decision-making Total decision-making

authorityauthority No special legal restrictionsNo special legal restrictions Easy to discontinueEasy to discontinue

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Disadvantages of the Disadvantages of the Sole ProprietorshipSole Proprietorship Unlimited personal liabilityUnlimited personal liability

Liability Features of the Basic Forms of Liability Features of the Basic Forms of OwnershipOwnership

Sole ProprietorshipClaims of Sole Proprietor’s Creditors

Sole Proprietor’s Personal Assets

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Disadvantages of the Disadvantages of the Sole ProprietorshipSole Proprietorship

Limited access to capitalLimited access to capital Limited skills and Limited skills and

abilitiesabilities Feelings of isolationFeelings of isolation Lack of continuityLack of continuity

Unlimited personal liabilityUnlimited personal liability

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PartnershipPartnership An association of two or more An association of two or more

people who co-own a business for people who co-own a business for the purpose of making a profitthe purpose of making a profit

Take the time to create a written Take the time to create a written partnership agreement!partnership agreement!

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Advantages of the Advantages of the PartnershipPartnership Easy to establishEasy to establish Complementary skills of Complementary skills of

partnerspartners Division of profitsDivision of profits Larger pool of capitalLarger pool of capital

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Advantages of the Advantages of the PartnershipPartnership

Ability to attract limited Ability to attract limited partnerspartners

Minimal government Minimal government regulationregulation

FlexibilityFlexibility TaxationTaxation

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Disadvantages of the Disadvantages of the PartnershipPartnership Unlimited liability of at least one Unlimited liability of at least one

partnerpartner

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Types of PartnersTypes of Partners

General partnersGeneral partners Take an active role in managing a businessTake an active role in managing a business Have unlimited liability for the partnership’s Have unlimited liability for the partnership’s

debtsdebts Every partnership must have at least one Every partnership must have at least one

general partnergeneral partner Limited partnersLimited partners

Cannot participate in the day-to-day Cannot participate in the day-to-day management of a company management of a company

Have limited liability for the partnership’s debts Have limited liability for the partnership’s debts

Liability Features of the Basic Forms of Liability Features of the Basic Forms of OwnershipOwnership

Partnership

Claims of Partnership’s Creditors

Partnership’s AssetsGeneralPartner’sPersonalAssets

GeneralPartner’sPersonalAssets

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Disadvantages of the Disadvantages of the PartnershipPartnership

Capital accumulationCapital accumulation Difficulty in disposing of Difficulty in disposing of

partnership interestpartnership interest

Unlimited liability of at least one Unlimited liability of at least one partnerpartner

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Disadvantages of the Disadvantages of the PartnershipPartnership

Lack of continuityLack of continuity Potential for personality and Potential for personality and

authority conflictsauthority conflicts Partners bound by the law of Partners bound by the law of

agencyagency

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Limited PartnershipLimited Partnership A partnership composed of at least A partnership composed of at least

one general partner and one or more one general partner and one or more limited partnerslimited partners

The general partner in a limited The general partner in a limited partnership is treated exactly as in a partnership is treated exactly as in a general partnershipgeneral partnership

The limited partner has limited The limited partner has limited liability and is treated as an investor liability and is treated as an investor in the business in the business

Liability Features of the Basic Forms of Liability Features of the Basic Forms of OwnershipOwnership

Limited PartnershipClaims of Partnership’s Creditors

Partnership’s AssetsGeneralPartner’sPersonalAssets

LimitedPartner’sPersonalAssets

Barrier

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The CorporationThe Corporation A separate legal entity from its owners A separate legal entity from its owners Types of corporations:Types of corporations:

DomesticDomestic - a corporation doing business in the - a corporation doing business in the state in which it is incorporated state in which it is incorporated

ForeignForeign - a corporation chartered in one state - a corporation chartered in one state and doing business in another stateand doing business in another state

AlienAlien - a corporation formed in another country - a corporation formed in another country but doing business in the United States but doing business in the United States

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The CorporationThe Corporation Types of corporations:Types of corporations:

Publicly held Publicly held - a corporation that has a - a corporation that has a large number of shareholders and large number of shareholders and whose stock usually is traded on one whose stock usually is traded on one of the large stock exchangesof the large stock exchanges

Closely held Closely held - a corporation in which - a corporation in which shares are controlled by a relatively shares are controlled by a relatively small number of people, often family small number of people, often family members, relatives, or friends members, relatives, or friends

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Advantages of theAdvantages of theCorporationCorporation

Limited liability of the Limited liability of the stockholdersstockholders

Liability Features of the Basic Forms of Liability Features of the Basic Forms of OwnershipOwnership

CorporationClaims of Corporation’s Creditors

Corporation’s Assets

Shareholder’sPersonal Assets

Shareholder’sPersonal Assets

BarrierBarrier

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Advantages of theAdvantages of theCorporationCorporation

Ability to attract capitalAbility to attract capital Ability to continue indefinitelyAbility to continue indefinitely Transferable ownershipTransferable ownership

Limited liability of stockholdersLimited liability of stockholders

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Disadvantages of the Disadvantages of the CorporationCorporation Cost and time of incorporatingCost and time of incorporating ““Double taxation”Double taxation” Potential for diminished Potential for diminished

managerial incentivesmanagerial incentives

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Disadvantages of the Disadvantages of the CorporationCorporation Legal requirements and Legal requirements and

regulatory “red tape”regulatory “red tape” Potential loss of control by Potential loss of control by

founder(s)founder(s) Piercing the corporate veilPiercing the corporate veil

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S-CorporationS-Corporation No different from any other No different from any other

corporation from a legal perspectivecorporation from a legal perspective For tax purposes, however, an S- For tax purposes, however, an S-

corporation is taxed like a partnership, corporation is taxed like a partnership, passing all of its profits (or losses) passing all of its profits (or losses) through to the individual shareholdersthrough to the individual shareholders

To elect “S” status, all shareholders To elect “S” status, all shareholders must consent, and the corporation must consent, and the corporation must file with the IRS within the first must file with the IRS within the first 75 days of its tax year75 days of its tax year

Liability Features of the Basic Forms of Liability Features of the Basic Forms of OwnershipOwnership

S-Corporation

Claims of S-Corporation’s Creditors

S-Corporation’s Assets

Shareholder’sPersonal Assets

Shareholder’sPersonal Assets

BarrierBarrier

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S-CorporationS-Corporation Must be a U.S.-based corporationMust be a U.S.-based corporation No nonresident alien shareholdersNo nonresident alien shareholders Only one class of common stockOnly one class of common stock No more than 100 shareholders No more than 100 shareholders

(increased from 75)(increased from 75) No more than 20% of corporate income No more than 20% of corporate income

from passive investment sourcesfrom passive investment sources Corporations and partnerships cannot Corporations and partnerships cannot

be shareholdersbe shareholders

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Limited Liability Limited Liability Company (LLC)Company (LLC) Resembles an S-Corporation Resembles an S-Corporation

but is but is notnot subject to the same subject to the same restrictionsrestrictions

Two documents: Two documents: Articles of organizationArticles of organization Operating agreementOperating agreement

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Limited Liability Limited Liability Company (LLC)Company (LLC) An LLC cannot have more than An LLC cannot have more than

twotwo of these four corporate of these four corporate characteristics:characteristics: Limited liabilityLimited liability Continuity of lifeContinuity of life Free transferability of interestFree transferability of interest Centralized managementCentralized management

Liability Features of the Basic Forms of Liability Features of the Basic Forms of OwnershipOwnership

Limited Liability Company (LLC) Claims of LLC’s Creditors

LLC’s Assets

Member’sPersonal Assets

Member’sPersonal Assets

BarrierBarrier

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