Chapter 05 – How to Form a Business
1. The corporation is the most common form of business ownership.
2. The three major forms of business ownership in the U.S. are sole proprietorships,
partnerships, and corporations.
3. Few people today start their own business.
4. Once a business is established, it’s almost impossible to change from one form of business
ownership to another.
5. When two or more people legally agree to become co-owners of a business, the form of
business is called a partnership.
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6. A legal entity with authority to act and have liability separate from its owners is called a
partnership.
7. Corporations represent 20 percent of all the businesses in the U.S. and earn 81 percent of
the total U.S. business receipts.
8. A comparison of the three major forms of business ownership shows that sole
proprietorships are usually the most difficult type of business to establish.
9.
Chapter 05 – How to Form a Business
The first step in starting a sole proprietorship is to fill out a proprietorship charter
application form and file it with the state government.
10. It is usually easy to start and end a sole proprietorship.
11. The profits of a sole proprietorship are taxed as the personal income of the owner.
12. The sole proprietorship form of ownership tends to be attractive to people who want to
invest in a company without taking an active role in management.
13. A major advantage of sole proprietorships is that an owner has limited liability for the
debts of his or her business.
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14.
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One of the strengths of the sole proprietorship is its ability to sustain rapid growth by
raising large amounts of financial resources.
15. The debts of a business operated as a sole proprietorship are considered to be the personal
debts of the owner of the business.
16. A drawback of sole proprietorships is that they usually have limited access to additional
financial resources.
17. An advantage of forming a sole proprietorship is that it allows the owner to have more
time for leisure activities.
18.
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If a sole proprietorship fails, the owner may lose whatever was invested in the business,
however, the owner’s personal assets are not at risk.
Feedback: Sole proprietors have unlimited liability for the debts of their business. This means
that if their business gets into financial trouble they can lose their personal assets.
19. If the business is designated a sole proprietorship, profits are passed along to the owner.
For tax purposes, these profits are accounted for with any other personal income the
owner may have accumulated and taxed at the owner’s personal income tax rate.
Feedback: The profits of a sole proprietorship are passed through to the owner, and taxed at
the owner’s personal tax rate. However, owners do have to pay self employment tax (for
Social Security and Medicare). By law, sole proprietors are required to estimate their taxes
and make quarterly payments to the government or suffer penalties for nonpayment.
20. A difficulty that sole proprietors try to overcome is the fact that they have trouble
competing with large firms for expert talent. Large firms can usually pay better and offer
fringe benefits that are unaffordable to the sole proprietor.
Feedback: Sole proprietors often find it difficult to attract qualified employees to help run the
business because often they cannot compete with the salary and benefits offered by larger
companies.
21.
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Unlike partnerships, if sole proprietorships find themselves in bankruptcy, they need not
worry about a court of law requiring them to sell-off personal assets to pay for the debts of
the firm.
Feedback: Sole proprietorships have unlimited liability. This means that the proprietor is
financially responsible for all debts incurred by the company. In a court of law, a judge could
require the owner/proprietor to liquidate personal assets to pay the debts of the business.
22. Eric wants to start a business. He is attracted to the idea of being his own boss, and wants
to get started with a minimum of expense and hassle. He is confident in his abilities, and
the market he can draw from, so he is not particularly worried about financial risks. All of
these factors suggest that Eric may favor starting his business as a sole proprietorship.
Feedback: People who want to be their own boss often prefer to operate their business, at
least initially, as a sole proprietorship. An advantage of the sole proprietorship is that it is a
relatively easy and inexpensive form of business to set up. One drawback of a sole
proprietorship is that the owner has unlimited liability. However, at this time, Eric is not
worried about risk. The unlimited liability factor does not appear to be a problem for him.
23.
Chapter 05 – How to Form a Business
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Sandy Beech, a talented fashion designer who wants to start her own women’s swimwear
and beach towel line, is trying to decide which form of business ownership is right for her.
As a young mother who aspires to send her children to college some day, she does not
want to jeopardize her savings account in any way. In order to overcome these risks,
Sandy should start her business as a sole proprietorship.
Feedback: Sandy is concerned about the risk of losing personal assets if her business does not
succeed. Although the sole proprietorship is easy to set-up, it may not be the best form of
business ownership for Sandy due to her need to protect personal assets. She may want to
consider a form of ownership that provides limited liability.
24. Rocky Rhodes is convinced that he has a great idea for a new business. Unfortunately, the
type of business he wants to start would require a fairly high initial investment and Rocky
has a poor credit rating and very little personal wealth. Rocky would be unlikely to find
success if he organized his business as a sole proprietorship.
Feedback: Funds available to sole proprietorships are often limited to the amount the owner
can raise. Thus, Rocky’s business would probably have a hard time raising enough money if
he organized it as a sole proprietorship.
25. A general partner takes an active role in the management of the business.
26.
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All partners in a general partnership have limited liability for the debts of their firm.
27. In a general partnership, all partners share in management of the business and in the
liability for the firm’s debts.
28. In a general partnership, all partners are entitled to an equal share of the firm’s profits.
29. Limited partnerships are just like general partnerships, except that they are partners for a
limited time period.
30.
Chapter 05 – How to Form a Business
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A limited partner is an owner who assumes no management responsibility and has no
liability for losses beyond the amount invested.
31. A limited partnership consists of one or more general partners and one or more limited
partners.
32. Although shares of master limited partnerships can be purchased on one of the national
stock exchanges, these companies are taxed like partnerships.
33. The Uniform Partnership Act is law in every state except Louisiana.
34.
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According to the Uniform Partnership Act, the three key elements of any general
partnership are (1) shares of stock to represent ownership, (2) limited liability, and (3)
ease of ownership transfer.
35. According to the Uniform Partnership Act, the three key elements of any general
partnership are (1) common ownership, (2) shared profits and losses, and (3) the right to
participate in managing the operations of the business.
36. A recent study showed that partnerships are more likely to fail than sole proprietorships.
37. A major objective of limited liability partnerships (LLPs) is to limit each partner’s
personal liability to the consequences of their own acts and those of people under their
supervision.
38.
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One of the major disadvantages of a partnership is that profits must be divided equally.
39. A general partner has unlimited liability for the debts of the partnership only if he or she
personally approved the decisions that resulted in those debts.
40. In order to protect all parties and minimize misunderstandings among partners, all terms
of the partnership should be spelled out in writing.
41. One advantage of a partnership is that there is a simple process for partners to terminate
their business.
42.
Chapter 05 – How to Form a Business
Compared to sole proprietorships, an advantage of partnerships is their ability to obtain
more financial resources.
43. Setting up a partnership under the terms of a written agreement is a bad idea, because
written agreements tend to be too inflexible and impersonal.
44. Compared to sole proprietorships, partnerships offer the advantage of shared management
and pooled knowledge.
45. A limited partnership refers to a partnership set up for a temporary purpose, such as a real
estate development project.
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49. One method to avoid conflicts between partners is to solicit the services of a lawyer to
create a well-written partnership agreement.
Feedback: One of the most important tasks to achieve before forming a partnership is to
create a partnership agreement. The partnership agreement addresses a number of rules that
will govern the activities of the partnership, including but not limited to: the duties of each
partner; the rules for adding partners; contributions by each partner; and, how profits will be
distributed.
50. According to the Spotlight on Small Business box, titled, “The Ties That Bind”,
attributes such as trust and integrity are not something you should get overly concerned
about when selecting partners, due to the fact that this is a business decision, not a friendly
game of golf.
Feedback: Prospective partners should concern themselves with several aspects of the
business relationship, including the values shared by partners who are entering into business
together. Others things that you should ask yourself is whether the partners share the same
goals and whether each partner’s skills compliments the others.
51.
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The fairest way to handle profits in any partnership arrangement is to divide things evenly.
If there are two owners in the business, each gets 50%. If there are three owners (even if
one is a limited partner), each gets 33.333% of any accumulated profits.
Feedback: The partnership agreement should stipulate the way the business plans to share the
profits. The partnership may not necessarily divide the profits equally among members.
Several criteria may enter into the decision of how to share profits, including the expertise of
each partner, the investment amount of each partner, and the amount of time each partner
spends in the business.
52. Ted and Mark are partners in a dry cleaning business. They would like their brother Todd
to join them. Unfortunately, partnership law states that only two partners can participate in
a partnership.
Feedback: A partnership consists of two or more owners. Unless explicitly written in the
original partnership agreement, the partnership can add partners.
53. Connie is a general partner in a retail cookie store. Her personal assets are legally
protected from the debts of the business.
Feedback: As a general partner, Connie assumes unlimited liability for the debts of her
business.
54.
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54. (p. 117) Two of Diana’s friends have approached her about starting a new business.
Diana is willing to invest money in the business and share in its profits, but she has no
desire to be involved in the day-to-day management of the company, nor is she willing to
risk any amount beyond her initial investment. Diana’s preferences suggest that she
prefers a general partnership form of business ownership.
Feedback: In a general partnership, all partners share in the management of the business, and
have unlimited liability for the firm’s debts. Since Diana has no interest in managing a
company and wants to limit her risk, she is more suited for a Limited Partnership, where her
friends would serve as general partners and she would serve as a limited partner.
55. Emma Pebble and Chase Stone formed a partnership in a landscape business. Under their
arrangement, Emma actively manages the company and assumes unlimited liability for the
firm’s debts. Chase has invested several thousand dollars of his money with plans to share
in the profits, but does not actively make management decisions, nor will he assume
liability beyond his initial investment. Emma and Chase participate in a limited
partnership.
Feedback: A limited partnership consists of at least one general partner, who has unlimited
liability, and at least one limited partner, who risks only what he or she has invested. By law,
the limited partner cannot actively manage the partnership.
56.
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Sergio has agreed to become a partner in his brother’s horse breeding business. Since he
provided 30 percent of the money to start the firm and build an air-conditioned barn, he is
entitled to 30 percent of any profits the firm earns during its first year of operation.
Feedback: The division of profits in a partnership is negotiable and is not necessarily tied to
the amount of the initial investment.
57. After spending a summer down-under, two Oregon friends, Rick and Mick created a
general partnership to import emu from Australia to the U.S. After a year, Rick found
himself at the mercy of Mick who seemed to keep the books and seldom share the
financial results, even though Rick was out selling the emu idea to farmers and
ecologically conscious consumers; and, shipments were increasing. As their consultant,
one of the first things that you inquire about is whether they are familiar with the UPA
(Uniform Partnership Act), specifically the right to participate in managing the operations
of the business.
Feedback: The Uniform Partnership Act (adopted in every state except Louisiana) stipulates:
1) common ownership; 2) shared profits and losses; and, 3) the right to participate in
managing the operations of the business. Rick has the right to know and be provided with
regular financial statements that pertain to his business.
58.
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Marco is a limited partner in an e-commerce company. As a limited partner, Marco can be
involved with the company for a maximum of five years.
Feedback: A limited partner has limited liability and cannot actively manage the firm, but his
involvement is not restricted as to length of time.
59. According to the Spotlight on Small Business box, “The Ties That Bind”, it is really not
necessary to interview your prospective partner carefully, especially if they are an old
friend.
Feedback: The Spotlight on Small Business box suggests doing three things before starting a
partnership: (1) talk to people who have been in successful and unsuccessful partnerships; (2)
interview your prospective partner(s) very carefully; and (3) evaluate the decision skills of
your prospective partner(s).
60.
Chapter 05 – How to Form a Business
Last night as you scrolled through the TV channels to find an action flick, you came
across an old movie with tough guy, James Cagney, called “Yankee Doodle Dandy”.
Although not particularly your kind of movie, you stayed on that channel for a few
minutes because Cagney and another guy were in partnership together. They were arguing
over who was the senior partner and who was the junior partner, even though, clearly,
they started the business at the same time. If you were brought on board as their present-
day business advisor, you would explain to them that all partnerships have at least one
general partner (known as the senior partner) and one limited partner (known as the junior
partner).
Feedback: According to the Uniform Partnership Act adopted in every state except Louisiana,
partners have the right to 1) common ownership; 2) shared profits and losses; and, 3) the right
to participate in managing the operations of the business. In some cases, partners may have
differing skills and skill levels (or level of experience) of the other partners, but as partners
they are on equal-footing. A good partnership agreement will spell-out the details of the
partnership. Further, partnerships can be 1) general partnerships or 2) limited partnerships, but
these variations do not hold the senior/junior designation.
61. A conventional corporation is a state-chartered legal entity, with authority to act and have
liability separate from its owners.
62.