Unit 1, Lesson 2 Legal Forms of Business Ownership

1. AOFApplied Finance Unit 1, Lesson 2Legal Forms of Business Ownership

2. Sole proprietorship: Going it alone Characteristics: • Typical size: Very small • A single individual owns and operates the business • The “sole proprietor” is the owner of a sole proprietorship • The sole proprietorship can hire employees, but the owner cannot be an employee • Typical examples are small shopkeepers, artists, craftspeople, carpenters, consultants, and writers A potter is likely to be a sole proprietor.

3. Sole proprietorship advantages and disadvantages • Advantages: • Simple and inexpensive to create and operate • Least regulated of all business forms • All profits are reported on the owner’s personal income tax return • Disadvantages: • The owner is personally responsible for all actions of the business • The owner is personally liable for all business debts

4. General partnership: Sharing the responsibility • Characteristics: • Typical size: From two individuals to a large firm with many partners • The partners run the business but may not be employees of it • There is slightly more regulation than for a sole proprietorship • The owners sign a written partnership agreement about how to run the business What options might someone have if he no longer wanted to work with his partners?

5. General partnership advantages and disadvantages • Advantages: • Simple and inexpensive to create and operate • All profits are taxed as personal income to the partners • Disadvantages: • All partners are responsible for any actions taken in the name of the business by all other partners • All business debts are the personal responsibility of the partners Would you become business partners with a friend? What qualities would you want your partner to have?

6. Corporation: Putting up a wall • Characteristics: • Typical size: Ranges from one or two stockholders to millions of them • The corporation can hire employees, which may include the owners • In the eyes of the law, a corporation is treated like an individual: • It can own property • It can be sued • It must file a tax return Forming a corporation is like putting up a wall between the business and its owners’ personal assets. Why would the law give corporations some of the same rights as individuals?

7. Corporation advantages and disadvantages • Advantages: • Corporation owners are not responsible for the actions taken by the business • Debts are not the responsibility of the owners (limited liability) • The business can sell shares (stock) in the business to the public in order to raise capital Disadvantages: • Legally complex to start and operate • One of the two most regulated business forms (the limited liability company is the other) • Profits are taxed twice - once as corporation income, and again as investor income

8. Limited liability company (LLC): Bridging the gap • Characteristics: • Typical size: small to mid-sized businesses • LLCs combine some aspects of a partnership and some aspects of a corporation • Like a corporation, an LLC is treated as an individual for purposes of ownership and legal standing, but it is not taxed at the higher corporate rates

9. LLC advantages and disadvantages: • Advantages: • LLC partners have more flexibility to allocate profits and losses • Debts are not the responsibility of the partners (limited liability) • An LLC can choose to be taxed as the property of the owners (like a partnership) or an individual (like a corporation) Disadvantages: • Like a corporation, an LLC is governed by complex laws • The owners of an LLC normally can’t be employees • When a partner dies, the LLC is dissolved

10. Responding to changing conditions • Whichever legal form you choose at the start of your business, it doesn’t have to be permanent • This possibility should be part of your long-range business planning and strategy What conditions might raise the risk of personal liability?