School of Mechanical And

Industrial Engineering

Engineering Entrepreneurship
(MEng5392)

Lecture 3
Choosing the Legal form of an Ownership

Prepared by: Fekadu B.

1
February: 2024
 Part Three:
Choosing The Legal Form of an Ownership
I. Introduction
II. Going in to business
III. What is ownership
IV. Legal requirements and forms of Ownership
V. Advantage and disadvantage for each types
of ownership

2
 Introduction
 Entrepreneurs have a vision about what a business might be
looks like.
 When thinking about the positives, the vision is probably one of
good fortune and success.
 But, as you can imagine, unfavorable things may happen.
 Revenues may not be enough to
Pay all the bills,
Accidents, and Many other contingencies may happen
 Generally the entrepreneur has financial responsibilities
that must be meet.
 The legal form under which the firm operates can have an
impact on the financial position of the entrepreneur.
3
 I. Going in to Business
 There are several ways of going into business and becoming an
owner of the business.
 You can:
 Purchase an existing business
 Enter a family business
 Purchase a franchise
Start your own business
Purchase an existing business
 Buying a business can be a good way to skip some of the
startup costs and growing pains of starting a business from
scratch, like launching a product or service or building a
4 customer base.
 Purchase an existing business
But, buying an existing business comes with its own risks,
and the process to close the deal is complicated.
 How to buy an existing business is have its Owen steps
Find a business you want to buy
Learn/study why the business is for sale
Evaluate the business earnings/profits.
Issue a letter of intent.
Do your due diligence.
Secure financing.
Close the deal.
5
 Purchase an existing business
Advantages
Existing businesses already have customers, suppliers, and
procedures.
Seller of the business may be willing to train the new owner.
 There are existing financial records.
 Financial arrangements may be easier.
Disadvantages
Business may be for sale because it is not making a profit.
Problems may be inherited with the purchase of an existing
business.
Many entrepreneurs may not have the capital needed to
6
purchase an existing business.
 Entering a family business
A family-owned business may be defined as any business in
which two or more family members are involved and the
majority of ownership or control lies within a family.
For working in a family business you should be:
Observe and analyze the business
 Avoid mistakes and stress
Do not neglect data security
 Balance both work and life
 Have good awareness
 Schedule regular meetings
 Have good motivation
 Have knowledge of marketing
7
Entering a family business
Advantages
A business can remain in the family for generations.
 Some people enjoy working with relatives.
 Trust and authenticity
Disadvantages
Senior management positions are often held by family members who
may not be the best qualified.
difficult to retain qualified employees who are not members of the
family.
Family politics may affect decisions regarding the business.
difficult to separate business life and private life
difficult to set policies and procedures to make decisions.
8
 Purchase a Franchise
A franchise: is a legal agreement in which the franchisor gives
the franchisee the right to distribute and sell the franchisor's
goods and services and to use its business name and model for
specified period and geographical area.
The two parties to a franchise agreement are franchisor and
franchisee
franchisor is the owner of the parent company/ business
that provides the product/service,
 franchisee, the distributor of a franchised product/service
 Or simply:
Franchisee : A person who purchases a franchise agreement.
Franchisor : The person or company who sells a franchise.
9
 Purchase a Franchise
Advantages of purchasing a franchise business
An established product or service is being provided.
Franchisors often offer management, technical, and other
assistance.
Equipment and supplies may be less expensive.
A guarantee of consistency attracts customers.
Disadvantages of purchasing a franchise business
 The cost of franchises may be high, which can reduce profits.
 Franchise owners are limited in the decisions they can make
regarding the business.
 The performance of other franchises impact on the franchisee.
 The franchise agreement may be terminated by the franchisor.
10
 Operating Costs of a Franchise
 The initial franchise fee: is the one-time payment made by a
franchisee to the franchisor for joining the franchise
system, usually upon signing the Franchise Agreement.
Start-up costs: are the costs associated with beginning a
business.
 Royalty fees: is an ongoing fee that the franchisee pays to
the franchisor.
The franchisor uses the royalty fees to support its existing
franchisees and maintain and grow the franchise system.
Royalty fees: are weekly/monthly payments.
Advertising fees: are fees paid to support advertising of the
franchise as a whole.
11
 Management buy-outs and buy-ins
 A management buy-out is the purchase of a business by
its existing management team or
 A management buy-out: is a transaction where a
company’s management team purchases the assets and
operations of the business they manage.
 Management buy-in is the purchase of a business by an
external management team managers.
 A management buy-in is where a group of managers buys into
an existing firm, usually replacing those who have been
running it.
 This type of action can occur when a company appears to
be under valued, poorly managed, and requires succession.
12
 Start your own business
Starting a business involves many activities related to
organizing the enterprise
 From some activities for starting business are
Planning,
Making key financial decisions, and
Completing a series of legal activities.
 The process Starting a business includes:
Generating of an idea for the enterprise called concept development,
Researching the idea's potential for success, and
Writing a business plan.
Someone who is starting a new business is called an
13
entrepreneur.
 Start your own business
 Most entrepreneurs used those steps to start their Owen
business
Generating of an idea
Conduct market research
Write your business plan
 Fund your business
Pick your business location
Choose a business structure
Choose your business name
Register your business
Get federal and state tax IDs
Apply for licenses and permits
14
Open a business bank account
 Start your own business
Advantages & Disadvantages starting Own Business
Advantages
Financial Rewards
Personal Satisfaction and Growth
Being your own boss.
You can be flexible around the hours you work
You can avoid the distractions and noise of the workplace
Disadvantage:
A lack of contact with other people and businesses
Financial Risk/lose
 Stress and Health Issues
15 High Competition
 II. What is ownership
 Ownership: is the state, fact, or the right of owning/possessing
something
 Ownership: may also refer to an organization or group of
owners.
Ownership: is the exclusive and ultimate legal right to a lawful
claim or title.
 If you have ownership, you can possess, enjoy, sell, give away,
destroy, an item of property.
 Ownership does not only refer to people, but also to other
entities.
 For example, the government is the owner of a state
company.
16 Also, a holding company owns its subsidiary businesses.
 Choose Suitable form of ownership
 Choosing suitable form of ownership for determination of
the:
Division of Profits
Extent of liability
Extent of Risk
Division of Power
Control of Owner and
Long term commitment.

17
 Legal requirements and Forms of ownership
Legal requirements of ownership in business
1. Protect personal assets
2. Understand and insure workers of the business
3. Ensure not skimp out on general liability insurance
4. Ensure not violating trademarks
5. Check if the industry forget about federal taxes
6. Check if the industry needs licensing
7. Hire a good lawyer
8. Keep pace with business needs and the custom of society.
9. Acquire legal title to property (assets) for the purpose of
controlling them and
18 10. Enjoy the gains of profits from such possession and use.
 Forms of ownership
 The most common forms of ownerships currently in wide
use by business are:
Sole proprietorship
Partnership
Corporations and
Cooperatives
 Each form of ownership has a characteristic of
Internal structure,
Legal status,
Size
Field to which it is best suited and
19
Key advantages and disadvantages
 Forms of ownership

20
 Sole proprietorship
 It is an individual or single ownership
 These firms are owned by one person, usually the individual
who has day-to-day responsibility for running the business.
 The sole proprietorship is a form of business organization in
which,
 An individual introduces his capital,
Use of his own skill and intelligence in the management of its
affairs and
It is solely responsible for the results of its operation.
 This form is known also as individual or single
proprietorship, sole ownership or individual enterprise.
 Example: Photo studio, bookshop, bakeries, small town
21 restaurants, retail stores, radio and watch repair shops.
 Advantages of Sole proprietorships
a. Ease and low cost of formation and dissolution:-
 There are no restrictions on either starting or terminating small
business operations.
b. Direct motivation and personal care
c. Freedom and promptness of action
 The sole proprietor can take his own decision and there is none to
question his authority.
 The sole proprietor can take prompt/quick decisions especially
when an emergency arises.
d. Business confidentiality
e. Single Tax:- The proprietorship does not pay tax as a business.
Profits from the business are the personal income of the
22
owner and are declare on his individual income tax return.
 Disadvantages of sole proprietorship
A. Limited resources and size:-the capacity and skill are very
limited. Lending institutions and suppliers may not be willing to
cooperate because it is neither safe nor dependable which results
in making the business to remain limited in size.
B. Limited Managerial Skill:- in complex and difficult condition
which requires different expertise knowledge
C. Unlimited liability:-The sole proprietor will be legally liable
for all debts of the business , a source of courage and real
devotion, limit his activities only in specified areas
D. Uncertain future. Death of the owner terminates the business
E. Difficulty in hiring and keeping high achievement
employees
23
 Partnership
 The association of two or more persons to carry as co-owners
of a business where the relationship is based on agreement is
called partnership.
 This form of a business requires the existence of two or more
persons entering into a contractual relationship.
 This contract, which is an agreement between the parties, is
known as a memorandum of association or article of
partners’ deed.
 The Partners should have a legal agreement that sets,
 how decisions will be made,
 how profits will be shared,
 how disputes will be resolved.
24
 Kinds of Partners
1. A general partner
Assumes unlimited liability and is usually active in managing the
business.
Most partners are general partners.
2. A limited or special partner
Assumes limited liability, risking only his /her investment in the
business.
Limited partners may not be active in management, and their
names are not used in the name of the business.
3. A secret partner
Takes an active role in managing a partnership but whose
identities are unknown to the public. i.e. the general public does
not know of this person’s partnership status.
25
 Kinds of Partners
4. A silent partner
 As opposed to a secret partner, a silent partner, his identities and
involvement, is known to the general public, but is inactive in managing
the partnership business
5. Senior partners
 Assume major roles in management because of the long tenure
(possession), amount of investment in the partnership, or age.
 They normally receive large shares of the partnership’s profits.
6. Junior partners
 Are generally younger partners in tenure, have only small investment in
the firm, and are not expected to make major decision. They assume
limited role in the partnership’s management and receive a smaller share
of the partnership’s profits.
 See others…
26
 Advantages of partnership
1. Ease of starting
2. Increased source of capital:-
Partnership can offer creditors less risk than a sole proprietorship;
it is often an attractive investment.
3. Combined managerial skill
4. Definite legal status
Today’s partner can be assured that a competent lawyer can answer
virtually any questions he/she might have about this form of
ownership. i.e. lawyers can provide a sound legal advice about
partnership issues.
6. Motivation of important employees
7. Reduced risk

27
 Disadvantages of partnership
1. Unlimited liability
2. Risk of implied authority
 The fault and miss judgment made by a single partner binds the
firm and the remaining partners.
Thus, they are liable for the debts made by the partner.
3. Lack of harmony…on agreement or synchronizing
4. Lack of continuity/instability
If any one of the general partners dies, withdraws because of
mentally or physically incapable (injured), the partnership ends.
5. Investment withdrawals difficulty/frozen-investment

28
 3. Corporation
A corporation is a legal entity created by individuals, stock
holders or shareholders, with the purpose of operating for
profit.
Corporations are allowed to enter into contracts, sue and be
sued, own assets, remit federal and state taxes, and borrow
money from financial institutions.
A corporation, is an legal entity authorized and recognized by
law,
distinctive name, and
a common seal, comprising of transferable shares of fixed
values, and carrying limited liability
A corporation is company controlled by a group of people who
own shares in the company’s ownership.
29
 The shareholders dictate who runs the company and how it
conducts business, then receive profits based on the shares of
stock that they own.
 Corporations can raise funds more easily and readily than
partnerships and sole proprietorships and often have access to
more starting capital to boot.
Types of Corporations
C-corporation:
The most common type of corporation.
 It protects the entrepreneur from being personally sued for the
actions and debts of the corporation.
 more than 100 share holders or owners
 double taxed (first as a corporate income tax, then as a
30 personal income tax when the owners take their profits)
 Types of Corporations
 S-corporation:
A corporation that is taxed like a sole proprietorship or
partnership with each shareholder paying tax on the amount of
their proportionate shares.
Less than 100 share holders
single taxed
Shareholders protection against the business's liabilities.
 The term "S-Corporation" doesn't mean "small corporation."
 S-Corporations: are a subset of a corporation.
First, a corporation must be formed, then the S-Corp status
may be elected.

31
 Cont…
 Nonprofit corporation: Legal entities that make money for
reasons other than the owner’s profit.
Examples:
Churches
Charities
education foundations
trade associations
 Limited Liability Company (LLC): A new type of business
ownership that provides limited liability and tax advantages.
 Examples:
Law firms
Medical firms
32
 Characteristics of Corporation
1. Separate legal entity
It can sue or be sued.
It has the right to manage its own affairs.
Shareholders cannot be liable for the acts of the corporation
2. Limited liability
Since the corporation has separate legal entity its debts are its
own.
The assets and liabilities, rights and obligations incidental to
the company’s activities
 assets and liabilities, rights and obligations respectively of the
company and not of its members.
33
 Characteristics of Corporation
3. Transferability of shares
 It is easy to transfer ownership in a corporation.
 A stockholder may sell stock to another person and transfer
the membership and membership interest freely without
consulting other stockholders.
4. Perpetual existence
 Death, insanity, retirement and withdrawal of shareholders
will not affect the company.

34
 Characteristics of Corporation
5. Common seal
 A corporation has a common seal with the name of the company
engraved on it.
 Common seal is used as a substitute for its signature through it
acts through its agents.
6. Separation of ownership from management
7. Supervision
[Link] Constitution
 On the creation of a company, the promoters must file certain
documents with the Registrar of Companies.
 These include the Article of Association and the Memorandum
of Association.
35
 Advantages of a corporation
1. Financial strength
2. Limited liability
[Link] of expansion
 Corporations have greater potential than sole proprietorship or
partnerships
4. Managerial efficiency
 Corporations enjoy the advantage of efficient management by hiring
specialist’s skilled persons to become members of the board of directors
to mange the corporation
5. Ease in transferring ownership
6. Legal entity status
 A corporation can purchase property, make contracts, sue and be
sued in the corporate name.
36
 Disadvantages of a Corporation
1. Difficulty of formation
 It is time consuming and cumbersome/not manageable to
establish corporations unlike the other forms of businesses.
2. Lack of owner’s/manager’s personal interest
 These forms of organizations are managed by directors, hired
officials, and employees who may not be expected to have such
an interest in the success of the business as the individual owner
or partner would have in his own business.
3. Delay in decision-making…it needs official meeting of
managers or board
[Link] of secrecy….openness…lack of privacy
[Link] taxation
37
 4. Cooperatives
 It is an organization owned by members/customers who pay
an annual membership fee and share in any profits (if it is profit
making organization).
 Cooperatives are people centered enterprises owned,
controlled and run by members to realize their common
economic, social, and cultural needs and aspirations.
 Cooperatives bring people together in a democratic and equal
way.
 Whether the members are the customers, employees, users or
residents, cooperatives are democratically managed by the 'one
member, one vote' rule.
Owners, managers, workers, and customers are all the same
38 people in this form of Cooperatives.
 4. Cooperatives
Cooperatives enterprise dependent on
Who owns the enterprise
Who controls the enterprise
Who uses the enterprise
Who gets the profits
Democratic member control
The people who own and control and finance the co-operative are
those who use it.
 Democratic member control is exercised by:
Voting at annual and membership meetings
Electing Board of Directors
Making decisions on major co-operative issues
 Cont…
Corporative: has the following principles:
Members have an equal vote in decisions
Membership is open to every one who fulfills specified conditions
(e.g. Number of hour worked)
Assets controlled and usually owned jointly by members
Profit shared equally between members with limited interest payment
on loans made by members;
Members benefit from participation, not investment

40
 Types of Cooperative
 Credit Cooperative is one that promotes and undertakes
savings and lending services among its members.
It generates to provide financial assistance and other related
financial services to its members for productive and provident
purposes.
Service Cooperative is one engages in medical and dental
care, hospitalization, transportation, insurance, housing, labor,
electric light and power, communication, professional and other
services.
Advocacy Cooperative which promotes and advocates
cooperatives among its members and the public through socially-
oriented projects, education and training, research and
communication, and other similar activities.
 TYPES OF COOPERATIVE
Marketing Cooperative is one which engages in the supply of
production inputs to members and markets their products.
Multipurpose Cooperative is one which combines two or
more of the business activities of these different types of
cooperatives.
Consumers Cooperative is one primary purpose of which is
to procure and distribute commodities to members and non-
members.
 Producers Cooperative It is formed and operated by its
members to undertake the production and processing of raw
materials or goods produced by its members into finished or
processed products for sale by the cooperative to its members
and non-members…See others…..
Brief summary of the common business forms of ownership
1. Ownership
Sole proprietorship Individual
Partnership No limit on number of partners
Corporation No limit on number of shareholders
2. Liability of owners
Sole proprietorship Individual liable for business liabilities
Partnership – general All Individuals liable for all business liabilities
Partnership – limited Limited partners liable for amount of capital
contribution
Corporation Shareholders liable for amount of capital
contribution
3. Cost to start
Sole proprietorship Trade name filing fees
Partnership – general Partnership agreement, legal cost, Trade name filing
Partnership – limited fees.
Corporation Created by statute, article of incorporation, filing
fees, taxes, fees for states in which corporation
registers to do business
4. Continuity of business
Sole proprietorship Death dissolves business
Partnership – general Death/withdrawal of 1 partner terminates business unless
agreement stipulates otherwise
Partnership – limited Death/withdrawal has no effect on continuity

Corporation Death/withdrawal of owner has no effect on continuity

5. Transferability of interest
Sole proprietorship Complete freedom to sell/transfer
Partnership – general General partners can transfer only with consent of all
other general partners
Partnership – limited Limited partners can sell interest without consent of
general partners
Corporation-regular Shareholders can sell or buy stock at will. Some transfers
might be restricted.
Corporation-s Shareholders can only sell stock to an individual

6. Management control
Sole proprietorship Owners make all decisions
Partnership – general All partners have equal control, majority rules
Partnership – limited Only general partners have control of business
Corporation Majority Shareholders have control, day to day control with
management
 7. Distribution of profits
Sole proprietorship Owners receives all profits/losses
Partnership Distributed according to agreement and capital contribution
Corporation Shareholders received profits through dividends
8. Tax attributes
Sole proprietorship = owner
 No double tax
 No capital stock/retained earnings penalty
Partnership
 Limited partners = share of profits but no liability
 Income distributed based on agreement
Corporation = separate entity
 More deductions/expenses available
 Double taxation of dividends
 Generally, the most attractive form of business ownership
meets the specific needs of the business and its owners in these
eight areas:
 Tax considerations
 Liability exposure
 Start-up and future capital requirements
 Control
 Managerial ability
 Business goals
 Management succession plans
 Cost of formation
 Business owners may need to make concessions due to the
trade-offs associated with eight these factors.
Summary!!!
 Filing fee: A fee charged by a public official to
accept a document for processing.
 It is important that every new business enterprise
should be registered under one of the legal forms of
business ownership.
 The entrepreneur should therefore decide the form of
business ownership that would be appropriate for
his/her new business
49