CHAPTER 4

SOLE PROPRIETORSHIPS
A sole proprietorship is a business that is owned by one person. It is the simplest form of business ownership
and the easiest to start. In most instances, the owner simply decides that he or she is in business and begins
operations. Sole proprietorships are most common in retailing, service, and agriculture.

ADVANTAGES OF SOLE PROPRIETORSHIPS

Most of the advantages that arise from sole proprietorship arise from the two main characteristics of this
form of ownership: simplicity and individual control.

 Ease of start-up and closure

It is the simplest and cheapest way to start a business. Often, start-up requires no contracts, agreements, or
other legal documents. The legal requirements are often limited to registering the name of the business and
obtaining any necessary licenses or permits. If the business does not succeed, the firm can be closed as easily
as it was opened.

 Pride of ownership
The owner deserves a great deal of credit for assuming the risks and solving the day-to-day problems
associated with operating sole proprietorships.

 Retention of all profits

Because all profits become the personal earnings of the owner, the owner has a strong incentive to succeed.
This direct financial reward attracts many entrepreneurs to the sole proprietorship form of business.

 No special taxes
Profits earned by a sole proprietorship are taxed as the personal income of the owner. They must report
financial information on their personal income tax returns and make estimated quarterly tax payments. They
do not pay the special state and federal income taxes that corporations pay.

 Flexibility of being your own boss

A sole proprietor is free to make decisions about the firm’s operations. They can switch from retailing to
wholesaling, move location, open a new store or close an old one without asking permission or waiting for
anyone’s approval.

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DISADVANTAGES OF SOLE PROPRIETORSHIPS

The disadvantages stems from the fact that these businesses are owned by one person. Some capable sole
proprietors experience no problems.

 Unlimited liability
It is a legal concept that holds a business owner personally responsible for all the debts of the business. If the
business fails, the owner’s personal property can be seized. It is perhaps the major factor that tends to
discourage would-be entrepreneur with substantial personal wealth from using the sole proprietor form of
business organization.

 Lack of continuity
Legally, the sole proprietor is the business. If the owner retires, dies, or is declared legally incompetent, the
business essentially ceases to exist. In many cases – especially when the business is a profitable enterprise –
the owner’s heirs take it over and either sell it or continue to operate it. An illness can be devastating if the
sole proprietor’s personal skills are what determine if the business is a success or a failure.

 Lack of money
Banks, suppliers, and other lenders usually are unwilling to lend large sums of money to sole proprietorships.
Only the sole proprietor can be held responsible for repaying such loans and the assets are usually limited.
Lenders also worry about the lack of continuity of sole proprietorship. The limited ability to borrow money
can prevent a sole proprietorship for growing.

 Limited Management Skills

The sole proprietor is often sole manager – in addition to being the only salesperson, buyer and accountant.
It is unlikely that the owner has expertise in all these areas.

 Difficulty in Hiring Employees

Potential employees may feel that there is no room for advancement in a firm whose owner assumes all
managerial responsibilities. The lure of higher salaries and increased benefits also may cause existing
employees to change jobs.

PARTNERSHIPS
A partnership is a voluntary association of two or more persons to act as co-owners of a business for profit. It
may consist of 2-20 partners. Regardless of the number of people involved, a partnership often represents a
pooling of special managerial skills and talents; at other times, it is the result of a sole proprietor’s taking on
a partner for the purpose of obtaining more capital.

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TYPES OF PARTNERS

General Partners – a general partner is a person who assumes full or shared responsibility for operating a
business. General partners are active in day-to-day business operations and each partner can enter into
contracts on behalf of the other partners. She/he also assumes unlimited liability for all debts, including
debts incurred by any other general partner without his or her knowledge or consent. A general partnership
is a business co-owned by two or more general partners who are liable for everything the business does.

Limited Partners – a limited partner is a person who invests money in a business, but who has no
management responsibility or liability for losses beyond his or her investment in the partnership. A limited
partnership is a business co-owned by one or more general partners who manage the business and limited
partners who invest money in it. Typically, the general partner or partners collect management fees and
receive a percentage of profits. Limited partners receive a portion of profits and tax benefits. A special type
of limited partnership is referred to as a master limited partnership (MLP) (sometimes referred to as a
publicly traded partnership or PTP) is a business partnership that is owned and managed like a corporation
but often taxed like a partnership. Units of ownership in MLPs can be sold to investors to raise capital and
often are traded on organized security exchanges. Originally there were tax advantages of forming a MLP
because profits from this special type of partnership were reported as personal income. MLPs thus avoided
the double taxation paid on corporate income.

ADVANTAGES OF PARTNERSHIPS
 Ease of start-up – The legal requirements is often limited to registering the name of the business and
obtaining any necessary licenses or permits.

 Availability of capital and credit – Because partners can pool their funds, a partnership usually has more
capital available than a sole proprietorship does. This additional capital, coupled with the general
partners’ unlimited liability, can form the basis for a better credit rating. Banks and suppliers may be
more willing to extend credit or approve larger loans to such a partnership than to a sole proprietor.

 Personal Interest – General partners are very concerned with the operation of the firm. They are
responsible for the actions of all other general partners, as well as for their own.

 Combined Business Skills and Knowledge – Partners often have complementary skills. The weakness of
one partner may be offset by another partner’s strength in that area. The ability to discuss important
decisions with another concerned individual often relieves some pressure and leads to more effective
decision making.

 Retention of profits – The partners share directly in the financial rewards and therefore are highly
motivated to do their best to make the firm succeed.

 No special taxes – Although a partnership pays no income tax, the International Revenue Service
requires partnerships to file an annual information return that states the names and addresses of all
partners involved in the business. It must also provide information about income and expenses and
distributions made to each partner.

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DISADVANTAGES OF PARTNERSHIPS

 Unlimited liability – Each partner is legally and personally responsible for the debts, taxes, and
actions of any other partner conducting partnership business. General partners thus run the risk of
having to use their personal assets to pay creditors. Many states allow partners to form a limited-
liability partnership (LLP) in which a partner may have limited-liability protection from legal action
resulting from the malpractice or negligence of the other partners.

 Management disagreements – Most of the problems that can develop in a partnership involves one
partner doing something that disturbs the other partner(s). When partners begin to disagree about
decisions, policies, or ethics, distrust may build and get worse as time passes.

 Lack of continuity – Partnerships are terminated if any one of the general partners dies, withdraws,
of is declared legally incompetent. The remaining partners can purchase that partner’s ownership
share.

 Frozen investment – It is easy to invest money in a partnership, but it is often difficult to get it out.
For example when remaining partners are unwilling to buy the share of the business that belongs to
a partner who retires or wants to relocate to another city. The partnership agreement should include
some procedure for buying out a partner. How easy or difficult it is to find an outsider to buy the
share depends on how successful the business is and how willing existing partners are to accept the
new partner.

THE PARTNERSHIP AGREEMENT

Articles of partnership
An agreement listing and explaining the terms of the partnership; written is preferable to oral.

Agreement should state:

• Who will make final decisions
• What each partner’s duties will be
• How much each partner will invest
• How much profit or loss each partner receives or is responsible for
• How the partnership can be dissolved

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COMPANIES
A corporation is an artificial person created by law, with most of the legal rights of a real person. These
include:
 The right to start and operate a business
 The right to buy and sell property
 The right to borrow money
 The right to sue or be sued
 The right to enter into binding contracts

Unlike a real person, they only exist on paper.

ADVANTAGES OF CORPORATIONS

 Limited liability – The owner’s financial liability is limited to the amount of money he or she has paid for
the corporation’s stock. If a corporation fails or is involved in a lawsuit and loses, creditors have a claim
only on the corporation’s assets, not the owners’ personal assets.

 Ease of raising capital – Corporations can borrow from lending institutions. They can also raise
additional sums of money by selling stock. Individuals are more willing to invest in corporations than any
other form of business because of limited liability.

 Ease of transfer of ownership – Willing buyers for stock are available for most stocks at the market
price. Ownership is transferred when the sale is made, and practically no restrictions apply to the sale
and purchase of stock issued by an open corporation.

 Perpetual life – Since it is essentially a legal “person”, a corporation exists independently of its owners
and survives them. The withdrawal, death, or incompetence of a key executive or owner does not cause
the corporation to be terminated.

 Specialised management – Corporations are able to recruit more skilled, knowledgeable, and talented
managers. It is because they pay bigger salaries, offer excellent fringe benefits, and are large enough to
offer considerable opportunity for advancement.

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DISADVANTAGES OF CORPORATIONS

 Difficulty and expense of formation – It can be a relatively complex and costly process. The use of an
attorney is usually necessary to complete the legal forms. The costs of incorporating, in terms of both
time and money, discourage many owners of smaller businesses from forming corporations.

 Government regulation and increased paperwork – A corporation must meet various government
standards before it can sell its stock to the public. It must file many reports and make periodic reports to
it stockholders about various aspects of the business. To prepare all the necessary reports, corporations
need the help of professionals on a regular basis.

 Conflict within the corporation – Because of the large employment basis, conflict is inevitable.

 Double taxation – Corporations must pay tax on their profits. In addition, stockholders must pay tax on
profits received as dividends. Corporate profits are thus taxed twice – once as corporate income and a
second time as the personal income of stockholders.

 Lack of secrecy – Because open corporations are required to submit detailed reports to government
agencies and to stockholders, they cannot keep their operations confidential. Competitors can study
these corporate reports and then use the information to compete more effectively.

CORPORATE GROWTH
GROWTH FROM WITHIN

Most corporations grow by expanding their present operations. Some introduce and sell new but related
products. Others expand the sale of present products to new geographic markets or to new groups in
geographic markets already served. For the most part, the firm continues to do what it has been doing, but
on a larger sale.

GROWTH THROUGH MERGERS AND ACQUISITIONS

Another way a firm can grow is by purchasing another company. The purchase of one corporation by another
is called a merger. An acquisition is essentially the same thing as a merger, but the term usually is reference
to a large corporation’s purchases of other corporations. Although most mergers and acquisitions are
friendly, hostile takeovers also occur.

A hostile takeover is a situation in which the management and board of directors of a firm targeted for
acquisition disapprove the merger.

When a merger or acquisition becomes hostile, a corporate raider – another company or wealthy investor –
may make a tender offer or start a proxy fight to gain control of the target company. A tender offer is an
offer to purchase the stock of a firm targeted for acquisition at a price just high enough to tempt
stockholders to sell their shares. Corporate raiders also may initiate a proxy fight.

A proxy fight is a technique used to gather enough stockholder votes to control a targeted company.

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Whether mergers are friendly or hostile, they are generally classified as horizontal, vertical or conglomerate.

Horizontal mergers
 A merger between firms that make and sell similar products or services in similar markets.
 This type of merger tends to reduce the number of firms in an industry = reduced competition.
 Reviewed carefully by federal agencies before they are approved in order to protect competition in the
marketplace.

Vertical mergers
 Firms that operate at different but related levels in the production and marketing of a product.
 Generally, one of the merging firms is either a supplier or a customer of the other.

Conglomerate mergers
 It takes place between firms in completely different industries.