Entrepreneurship 5 PDF

10-5 Forms of Business Ownership Whether they intend to run small farms, large factories, or online e-tailers, entrepreneurs must decide which form of legal ownership best suits their goals: sole proprietorship, partnership, corporation, or co-operative. THE SOLE PROPRIETORSHIP The sole proprietor...

10-5 Forms of Business Ownership Whether they intend to run small farms, large factories, or online e-tailers, entrepreneurs must decide which form of legal ownership best suits their goals: sole proprietorship, partnership, corporation, or co-operative. THE SOLE PROPRIETORSHIP The sole proprietorship is a business owned and operated by one person. Legally, if you set up a business as a sole proprietorship, your business is considered to be an extension of yourself (and not a separate legal entity). Though usually small, a sole proprietorship may be as large as a steel mill or as small as a lemonade stand. While the majority of businesses in Canada are sole proprietorships, they account for only a small proportion of total business revenues. Advantages of a Sole Proprietorship Freedom may be the most important benefit of a sole proprietorship. Sole proprietors answer to no one but themselves, since they don't share ownership. A sole proprietorship is also easy to form. If you operate the business under your own name, with no additions, you don't even need to register your business name to start operating as a sole proprietor-you can go into business simply by putting a sign on the door. The simplicity of legal set-up procedures makes this form appealing to self-starters and independent spirits, as do the low start-up costs. Another attractive feature is the tax benefits. Most businesses suffer losses in their early stages. Since the business and the proprietor are legally one and the same, these losses can be deducted from income the proprietor earns from personal sources other than the business. Disadvantages of a Sole Proprietorship A major drawback is unlimited liability, which means that a sole proprietor is personally liable (responsible) for all debts incurred by the business. If the business fails to generate enough cash, bills must be paid out of the owner's pocket. Another disadvantage is lack of continuity; a sole proprietorship legally dissolves when the owner dies. Finally, a sole proprietorship depends on the resources of one person whose managerial and financial limitations may constrain the business. Sole proprietors often find it hard to borrow money to start up or expand. Many bankers fear that they won't be able to recover loans if the owner becomes disabled. THE PARTNERSHIP A partnership is established when two or more individuals (partners) agree to combine their financial, managerial, and technical abilities for the purpose of operating a business for profit. This form of ownership is often used by professionals such as accountants, lawyers, and engineers. Partnerships are often an extension of a business that began as a sole proprietorship. The original owner may want to expand, or the business may have grown too big for a single person to handle. There are two basic types of partners in a partnership. General partners are actively involved in managing the firm and have unlimited liability. Limited partners don't participate actively in the business, and their liability is limited to the amount they invested in the partnership. A general partnership is the most common type and is similar to the sole proprietorship in that all the (general) partners are jointly liable for the obligations of the business. The other type, the limited partnership, consists of at least one general partner (who has unlimited liability) and one or more limited partners. The limited partners cannot participate in the day-to-day management of the business or they risk the loss of their limited liability status. Advantages of a Partnership The most striking advan-lage of a general partnership is the ability to grow by adding talent and money. Partnerships also have an easier time borrowing funds than sole proprietorships. Banks and other lending institutions prefer to make loans to enterprises that are not dependent on a single indi-vidual. Partnerships can also invite new partners to join by investing money. Like a sole proprietorship, a partnership is simple to organize, with few legal requirements. Even so, all partnerships must begin with an agreement of some kind. It may be written, oral, or even unspoken. Wise partners, however, insist on a written agreement to avoid trouble later. This agreement should answer such questions as: Who invested what sums of money in the partnership? Who will receive what share of the partnership's profits? Who does what and who reports to whom? How may the partnership be dissolved? How will leftover assets be distributed among the partners? How would surviving partners be protected from claims by surviving heirs if a partner dies? How will disagreements be resolved? The partnership agreement is strictly a private document. No laws require partners to file an agreement with any government agency. Nor are partnerships regarded as legal entities. In the eyes of the law, a partnership is nothing more than two or more people working together. The partnership's lack of legal standing means that the partners are taxed as individuals. Disadvantages of a Partnership Unlimited liability is also the biggest disadvantage of a general partnership. By law, each partner may be pad personally liable for all debts of the partnership. And if any partner incurs sbt, even if the other partners know nothing about it, they are all liable if the offending partner cannot pay up. Another problem with partnerships is the lack of continuity. When one partner dies or pulls out, a partnership dissolves legally, even if the other partners agree to continue the business. A related drawback is the difficulty of transferring ownership. No partner may sell out without the other partners' consent. Thus, the life of a partnership may depend on the ability of retiring partners to find someone compatible with the other partners to buy them out. Finally, a partnership provides little or no guidance in resolving conflicts between the partners. For example, suppose one partner wants to expand the business rapidly and the other wants it to grow slowly. If under the partnership agreement the two are equal, it may be difficult for them to decide what to do. THE CORPORATION When you think of corporations you probably think of giant businesses such as Air Canada, Walmart, or BlackBerry. The very word "corporation" suggests bigness and power. Yet the tiny corner retailer has as much right to incorporate as a giant oil refiner. Both of them have the same basic characteristics that all corporations share-legal status as a separate entity, property rights and obligations, and an indefinite lifespan. (See Table 4.5 for a list of the top 10 corporations in Canada.) A corporation has been defined as "an artificial being, invisible, intangible, and existing only in contemplation of the law." As such, corporations may sue and be sued; buy, hold, and sell property; make products and sel them to nsumers; and commit crimes and be tried and punished for them. Simply..ined, a corporation is a business that is a separate legal entity, that is liable for its own debts, and whose owners' liability is limited to their investment. Shareholders— investors who buy shares of ownership in the form of stock—are the real owners of a corporation. (The different kinds of stockholders are described in Chapter 15.) Profits may be distributed to stockholders in the form of dividends, although corporations are not required to pay dividends. Instead, they often reinvest any profits in the business. Common stockholders have the last claim to any assets if the company folds. Dividends on common stock are paid on a per share basis (if a dividend is declared). Thus, a shareholder with 10 shares receives 10 times the dividend paid to a shareholder with one share. When investors cannot attend a shareholders' meeting, they can grant voting authority to someone who will attend. This procedure, called voting by proxy, is the way almost all individual investors vote. The board of directors is the governing body of a corporation. Its main responsibility is to ensure that the corporation is run in the best interests of the shareholders. The directors choose the president and other officers of the business and delegate the power to run the day-to-day activities of the business to those officers. The directors set policy on paying dividends, on financing major spending, and on executive salaries and benefits. Large corporations tend to have large boards with as many as 20 or 30 directors, whereas smaller corporations tend to have no more than five directors. Usually, these are people with personal or professional ties to the corpora-tion, such as family members, lawyers, and accountants. Each year, the Globe and Mail analyzes the governance practices of Canadian companies in four areas: board composition, compensation, shareholder rights, and disclosure. The top-ranked companies in 2012 were Sun Life Financial Inc., Bank of Nova Scotia., and Potash Corp. of Saskatchewan Inc. 62 Inside directors are employees of the company and have primary responsibility for the corporation. They are top managers, such as the president and executive vice-presidents. Outside directors are not employees of the corporation. Attorneys, accountants, university officials, and executives from other firms are commonly used as outside directors. Corporate officers are the top managers hired by the board to run the corporation on a day-to-day basis. The chief executive officer (CEO) is responsible for the firm's overall performance. Other corporate officers typically include the president, who is responsible for internal manage-ment, and various vice-presidents, who oversee functional areas such as marketing or operations. Types of Corporations A public corporation is one whose shares of stock are widely held and available for sale to the general public. Anyone who has the funds to pay for them can buy shares of companies such as Petro-Canada, Bombardier, or Air Canada. The stock of a private corporation, on the other hand, is held by only a few people and is not generally available for sale. The controlling group may be a family, employees, or the management group. Pattison and Cirque du Soleil are two well-known Canadian private corporations. Most new corporations start out as private corporations, because few investors will buy an unknown stock. As the corporation grows and develops a record of success, it may issue shares to the public to raise additional money. This is called an initial public offering (IPO). IPOs are not very attractive to investors during stock market declines, but they become more popular when stock markets recover. There were 52 IPOs in Canada in 2012, raising $1.8 billion in new equity.64 A public corporation can also "go private," which is the reverse of going public. Private equity firms buy publicly traded companies and then take them private. They often make major changes to company operations in order to increase its value. About a decade ago, many corporations converted to an income trust structure, which allowed them to avoid paying corporate income tax if they distributed all or most of their earnings to investors. For example, Bell Canada Enterprises could have avoided an $800 million tax bill in one year by becoming an income trust. The federal government estimated that it was going to lose billions of dollars of tax revenue because so many corporations were becoming income trusts. In a surprise move in 2006, the Canadian government announced that it would begin taxing income trusts more like corporations by 2011. This announcement caused a significant decline in the market value of income trusts and put an end to the rush to convert.65 In early 2013, there appeared to be renewed interest in income trusts. The reason? Income trusts distribute much of their cash flow to investors each month. Time will tell if this was a minor upswing or the rebirth of interest in this form of business.66 Formation of the Corporation The two most widely used methods of forming a corporation are federal incorporation under the Canada Business Corporations Act and provincial incorporation under any of the provincial corporations acts. The former is used if the company is going to operate in more than one province; the latter is used if the founders intend to carry on business in only one province. Except for banks and certain insurance and loan companies, any company can be federally incorporated under the Canada Business Corporations Act. To do so, articles of incorporation must be drawn up. These articles include such information as the name of the corporation, the type and number of shares to be issued, the number of directors the corporation will have, and the location of the company's operations. The specific procedures and information required for provincial incorporation vary from province to province. All corporations must attach the word "Limited" (Ltd./Ltée), "Incorporated" (Inc.), or "Corporation" (Corp.) to the company name to indicate clearly to customers and suppliers that the owners have limited liability for corporate debts. The same sorts of rules apply in other coun tries. British firms, for example, use PLC for "public limited company" and German companies use AG for "Aktiengesellschaft" (corporation). Advantages of Incorporation The biggest advantage of the corporate structure is limited liability, which means that the liability of investors is limited to their personal investment in the corporation. In the event of failure, the courts may seize a corporation's assets and sell them to pay debts, but the courts cannot touch the investors' personal possessions. If, for example, you invest $25 000 in a corporation that goes bankrupt, you may lose your $25 000, but no more, In other words, $25 000 is the extent of your liability. Another advantage of a corporation is continuity. Because it has a legal life independent of its founders and owners, a corporation can, in theory, continue forever. Shares of stock may be sold or passed on to heirs, and most corporations also benefit from the continuity provided by professional management. Finally, corporations have advantages in raising money. By selling stock, they expand the number of investors and available funds. The term "stock" refers to a share of ownership in a corporation. Continuity and legal status tend to make lenders more willing to grant loans to corporations. Disadvantages of Incorporation One of the disadvantages for a new firm in forming a corporation is the cost (approximately $2500). In addition, corporations also need legal help in meeting government regulations because they are far more heavily regulated than proprietorships or general partnerships. Some people say that double taxation is another problem with the corporate form of ownership. By this they mean that a corporation must pay income taxes on its profits, and then shareholders must also pay personal income taxes on the dividends they receive from the corporation. The dividend a corporation pays is the amount of money, normally a portion of the profits, that is distributed to the shareholders. Since dividends paid by the corporation are paid with after-tax dollars, this amounts to double taxation. Others point out that shareholders get a dividend tax credit, which largely offsets double taxation. THE CO-OPERATIVE A co-operative is an incorporated form of business that is organized, owned, and democratically controlled by the people who use its products and services, and whose earnings are distributed on the basis of use of the co-operative rather than level of investment. As such, it is formed to benefit its owners in the form of reduced prices and/or the distribution of surpluses at year-end. The process works like this: Suppose some farmers believe they can get cheaper fertilizer prices if they form their own company and purchase in large volumes. They might then form a co-operative, which can be either federally or provincially chartered. ices are generally lower to buyers and, at the end of the fiscal year, any surpluses are distributed to members on the basis of how much they purchased. If Farmer Jones bought 5 percent of all co-op sales, he would receive 5 percent of the surplus. The co-operative's start-up capital usually comes from shares purchased by the co-operative's members. Sometimes all it takes to qualify for membership in a co-operative is the purchase of one share with a fixed (and often nominal) value. Federal co-operatives, however, can raise capital by issuing investment shares to members or non-members. Co-operatives, like investor-owned corporations, have directors and appointed officers. Types of Co-operatives There are hundreds of different co-operatives, but they generally function in one of six main areas of business: Consumer co-operatives -These organizations sell goods to both members and the general public (e.g., Mountain Equipment Co-op). Financial cooperatives -These organizations operate much like banks, accepting deposits from members, giving loans, and providing chequing services (e.g., Vancouver City Savings Credit Union). Insurance co-operatives -These organizations provide many types of insurance coverage, such as life, fire, and liability (e.g., Co-operative Hail Insurance Company of Manitoba).  Marketing co-operatives - These organizations sell the produce of their farm members and purchase inputs for the production process (e.g., seed and fertilizer). Some, like Federated Co-operatives, also purchase and market finished products. Service co-operatives - These organizations provide members with services, such as recreation. Housing co-operatives— These organizations provide housing for members, who purchase a share in the co-operative, which holds the title to the housing complex. In terms of numbers, co-operatives are the least important form of own-ership. However, they are of significance to society and to their members and may provide services that are not readily available or that cost more than the members would otherwise be willing to pay. Table 4.6 compares the various forms of business ownership using different characteristics. Advantages of a Co-operative Co-operatives have many of the same advantages as investor-owned corporations, such as limited liability of owners and continuity. A key benefit of a co-operative relates to its structure. Each member has only one vote in the affairs of the co-operative, regardless of how many shares he or she owns. This system prevents voting and financial control of the business by a few wealthy individuals. This is particularly attractive to the less wealthy members of the co-operative. Unlike corporations, which are not allowed a tax deduction on dividend payments made to shareholders, co-operatives are allowed to deduct patronage refunds to members out of before-tax income. Thus, income may be taxed only at the individual member level rather than at both the co-operative and member level. 67 Disadvantages of a Co-operative One of the main disadvantages of co-operatives relates to attracting equity investment. Since the benefits from being a member of a co-operative arise through the level of use of the co-operative rather than the level of equity invested, members do not have an incentive to invest in equity capital of the co-operative. Another drawback is that democratic voting arrangements and dividends based purely on patronage discourage some entrepreneurs from forming or joining a co-operative.