Learning Outcomes
- Recognize the benefits and drawback of the corporate form of doing business
Here is a quick review of some of the common ways to organize a business:
| Form of business | Advantages | Disadvantages |
|---|---|---|
| Sole Proprietorship | Easy and inexpensive to create | Unlimited liability, meaning business debts are personal debts |
| Flexibility and control to your liking | Limited internal expertise | |
| Few Government regulations | Limited access to financial capital | |
| Tax advantages if struggling | Not separate from owners lifespan | |
| Profits taxed once | ||
| Partnerships (General/Limited Partnerships) | Easy to organize | Possible conflict development between partners |
| Access to combined knowledge, skills and resources | Profits must be split between partners | |
| Few Government regulations | ||
| Profits taxed once at the partner level | ||
| Unlimited liability for general partners | ||
| Corporation | Limited liability | Double taxation |
| Virtually unlimited access to equity and debt financing = ability to generate vast profits | Subject to extensive government regulations, especially publicly traded corps | |
| Easy to transfer ownership (publicly traded) | Complex to organize and maintain | |
| Legal entity separate from owners with continuous life | ||
| Limited Liability Company | Simple to organize and operate | Possible conflict development between members |
| Flexible in nature | Profits must be split between members | |
| Can elect to be taxed as a partnership (or sole proprietor if single-member LLC) | ||
| Legal entity separate from owners with continuous life | ||
| S Corporation | Limited liability for owners | Restrictions on number and type of shareholders |
| Greater credibility for financing | ||
| Taxed like a partnership | ||
| Not as regulated as publicly traded corporation | ||
| Legal entity separate from owners with continuous life |
There are some other ways of doing business, such as franchising and co-ops.
Franchising
Franchising allows a franchisee to borrow the franchisor’s business model and brand for a specified period. It comes with a list of advantages including training on how to operate your franchise; systems and technologies for day-to-day operations; guidance on marketing, advertising and other business needs; and a network of franchise owners with whom you can share experiences.
The main disadvantages to this ownership structure are franchising fees, royalties on sales or profits, and tight restrictions to maintain ownership. Franchise owners also have limited control over their suppliers they can purchase from, are forced to contribute to a marketing fund they have little control over. If a franchisee wants to sell their business, the franchisor must approve the new buyer. Despite these disadvantages, franchises are great for owners who are looking for an ‘out of the box’ pathway to owning their own business.
In any case, the franchisee will have to select a form of doing business, such as sole-proprietor, partnership, LLC, or corporation.
Cooperative
Cooperatives, known as co-ops for short, are organizations owned and controlled by an association of members.
This form of ownership allows for a more democratic approach to control. In the co-op model, each share is worth the same number of votes, similar to the situation in a corporation with common stock. It also offers limited liability to its owners and equal profit distribution based on ownership percentage. Disappointingly, the democratic approach to decision making results in a longer decision making process as participation from all association members is required. Conflicts between members can also arise that have a big impact on the efficiency of the business. Co-operatives are often used when individuals or businesses decide to pool resources to achieve a common goal or satisfy a common need, such as employment needs or a delivery service.
In addition to all of these and numerous variations, such as PTPs (publicly traded partnerships), certain charitable organizations can be incorporated as public entities, not to be confused with publicly-traded corporations. A corporation that is organized to benefit society, with no shareholders, and no profit-motive, can elect to be exempt from taxation under IRC Section 501(c), but the regulations and oversight for these entities is strict. In addition, there is a whole other set of GAAP that applies to governmental and not-for-profit entities that is beyond the scope of this course.
In summary, what is important to note about a corporation is that the owners hold shares of stock that document their ownership rights and percentages. The most common form of ownership is called common stock, so these owners are called stockholders or shareholders (the terms are interchangeable).
Practice Question
