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CHAPTER 6. FORMS OF BUSINESS OWNERSHIP
Part 1: Learning Objectives
1. Explain the advantages and the disadvantages of a sole proprietorship and a
partnership.
2. Describe the similarities and differences between C corporations and S corporations.
3. Understand the characteristics of a limited liability company.
4. Explain the process of creating a legal entity for a business.
Part 2: Class Instruction
Introduction
The most important issues entrepreneurs should consider when they are evaluating the
various forms of ownership include:
Business goals
Management succession plans
Cost of formation
The major forms of ownership discussed in this chapter include: Sole proprietorship,
general partnership, limited partnership, corporation, S corporation, and limited liability
The Sole Proprietorship. The sole proprietorship is the most popular type of
ownership, defined as business owned and managed by one individual.
The Advantages of a Proprietorship. Advantages of the sole proprietorship include:
Easy to discontinue
The Disadvantages of Proprietorship. Disadvantages include:
Unlimited personal liability means that the sole proprietor is personally liable for
all of the business’s debts, as the owner is the business.
Limited skills and capabilities
defined by the partnership agreement, a document that states in writing the terms under
which the partners agree to operate and that protects each partner’s interest in the
business.
If no partnership agreement exists, the Revised Uniform Partnership Act (RUPA) codifies
the body of law dealing with partnerships in the United States. It specifies three key
Easy to establish
Complementary skills
Division of profits
Larger pool of capital
Ability to attract limited partners
Copyright © 2019 Pearson Education, Inc.
Chapter 6, Page 101
General partners – partners share in owning, operating, and managing a business.
All partners have unlimited personal liability.
Limited partners – are financial investors in a partnership, cannot participate in the
day-to-day management, and have limited liability. If the business fails they only
lose the money they have invested in it.
Silent partners – are not active in a business but generally are known to be
members of the partnership.
partners are treated as investor.
Additional partnership advantages include: minimal governmental regulation, flexibility,
and taxation.
The Disadvantages of the Partnership. Disadvantages include:
Unlimited liability of at least one partner
all limited partners, giving them the advantage of limited liability for the debts of the
partnership. Most states restrict LLPs to certain types of professionals, such as attorneys,
physicians, dentists, and accountants.
Consider using You Be the Consultant: “Making a Partnership Work” at this point.
Corporations LO 2
creditors often require the founders of small corporations to personally guarantee loans
made to the business. Courts ignore the limited liability shield when an entrepreneur uses
corporate assets for personal reasons, fails to act in a responsible manner and creates an
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Chapter 6, Page 102
unwarranted level of financial risk for the stockholders, makes financial
misrepresentations, or takes actions in the name of the corporation that were not
authorized by the board of directors. Refer to Table 6.1, Avoiding Legal Tangles in a
Corporation.
Corporations have the power to raise large amounts of capital by selling shares of
ownership to outside investors. A closely held corporation has shares that are controlled
by a relatively small number of people, and the stock is passed from one generation to the
next instead of being traded on any stock exchange. A publicly held corporation has a
large number of shareholders, and its stock usually is traded on one of the large stock
exchanges.
receive. This double taxation is a distinct disadvantage of the C corporation form of
ownership. If a company intends to seek investment from venture capital or other form of
private equity, it should be established as a C corporation. Advantages of a corporation
include:
Limited liability of stockholders
Double taxation
Potential for diminished managerial incentives
Legal requirements and regulatory red tape
Potential loss of control by the founder(s)
S Corporations
and S Corporation or Limited Liability Company.
The criteria for businesses seeking “S” status are that the venture must:
Be a domestic (U.S.) corporation
Copyright © 2019 Pearson Education, Inc.
Chapter 6, Page 103
Limit shareholders to individuals, estates, and certain types of trusts
Cannot include partnerships, corporations, or nonresident aliens as
shareholders
Not have more than 100 shareholders
Have only one class of common stock so all shares have the same rights
Must be an eligible corporation; certain financial institutions, insurance
companies, and domestic international sales corporations are ineligible.
Advantages of an S corporation include:
Retains all of the advantages of regular corporations
Passes all profits/losses through to individual shareholders
of earnings to the shareholders to cover the taxes they will owe, retain one-
third of earnings to fund growth, and earmark the final one-third to pay down
debt, fund debt, or distribute to the owners as a return on their investment.
Many fringe benefits cannot be deductible business expenses
Choosing an “S” corporation wisely is important to optimize the advantages this entity
currently imposed on S corporations and offer more flexibility than S corporations. LLCs
offer many of the advantages of both, but are not subject to the restrictions incurred by
“S” corporations. LLCs offer the tax advantage of a partnership, the legal protection of a
corporation, and maximum operating flexibility. These advantages make the LLC an
attractive form of ownership for smaller companies across many industries.
How to Create a Legal Business Entity LO 4
C corporations, S corporations, and LLCs can be costly and time consuming to establish
and to maintain. Many entrepreneurs hire attorneys to handle the process, but in most
which to establish the entity. Most will choose the state in which they will operate.
Refer to Table 6.3, Characteristics of the Major Forms of Ownership.
Part 3: Chapter Exercises
You Be the Consultant: “Making a Partnership Work”
1. Research relationships between partners and add at least three guidelines to
those listed above. (LO 1) (AACSB: Interpersonal relations and teamwork)
2. Develop a list of the behaviors that are almost certain to destroy a partnership.
(LO 1) (AACSB: Interpersonal relations and teamwork)
