Part 3 Developing the New Venture Business Plan

Part 3 Developing the New Venture Business Plan CHAPTER 8 The Organizational Plan: Teams, Legal Forms, & Strategic Alliances Longenecker • Moore • Petty • Palich © 2008 Cengage Learning. All rights reserved. Power. Point Presentation by Charlie Cook The University of West Alabama

Looking AHEAD After you have read this chapter, you should be able to: 1. Describe the characteristics and value of a strong management team. 2. Explain the common legal forms of organization used by small businesses. 3. Identify factors to consider in choosing among the primary legal forms of organization, including tax consequences. 4. Describe the unique features and restrictions of five specialized organizational forms. 5. Explain the nature of strategic alliances and their uses in small businesses. 6. Describe the effective use of boards of directors and advisory councils. © 2008 Cengage Learning. All rights reserved. 2

Building a Management Team • Management Team Ø Managers and other key persons who give a company its general direction • Characteristics of a Strong Management Team Ø Capable of securing the resources needed to make business a success Ø Reassures investors about their investment and the continuity of business Ø Diversity of talent makes the team stronger than an individual entrepreneur © 2008 Cengage Learning. All rights reserved. 3

Building a Management Team (cont’d) • Team Building and Structure Ø The required combination of education and experience depends on the type of business and the nature of its operations Ø The key: achieving a balance of skills and competencies in functional areas Ø Designing an internal management structure that defines relationships and responsibilities v Outside professional support can supplement the skills of a management team v An active board of directors can provide counsel and guidance. © 2008 Cengage Learning. All rights reserved. 4

Building a Management Team (cont’d) Achieving Balance Expanding Social Networks Team Building and Structure

8 -1 Basic Forms of Legal Organization for Small Businesses © 2008 Cengage Learning.

8 -2 Percentage of Small Businesses by Legal Form of Organization Source: http: //www. irs. gov/pub/irs-soi/histab 22. xls, accessed February 5, 2007. 14 © 2008 Cengage Learning. All rights reserved. 7

The Sole Proprietorship Option • Sole Proprietorship Ø A business owned by one person. • Advantages Ø Receives all of the firm’s profits. Ø Holds title to all of the firm’s assets. Ø Can easily sell or transfer ownership of the company name and assets. Ø Requires no registration or filing fee. Ø Has absolute freedom from interference by other stakeholders. © 2008 Cengage Learning. All rights reserved. 8

The Sole Proprietorship Option (cont’d) • Disadvantages Ø Bears all business risk. Ø Is subject to all claims of creditors. Ø Has unlimited personal liability for business. Ø Receives no tax free benefits as an employee. Ø Death/incapacity of owner terminates business. Ø Is limited to the proprietor’s personal capital. Ø Is taxed on business income as personal income. © 2008 Cengage Learning. All rights reserved. 9

The Partnership Option • Partnership Ø A legal entity formed by two or more co-owners to carry on a business for profit. • Partner Qualifications Ø Required: of legal age to contract Ø Desired: Honest, healthy, capable, and compatible • Questions about Partnership Formation Ø What is our business concept? Ø How are we going to structure ownership? Ø Why do we need each other? Ø How do our lifestyles differ? © 2008 Cengage Learning. All rights reserved. 10

Partnership Insights • Capitalize on the unique advantages of a partnership. • Choose your partner carefully. • Be open, but cautious, about partnerships with friends. • Test-drive the relationship, if possible. • Create a combined vision for the business. • Prepare for the worst. © 2008 Cengage Learning. All rights reserved. 11

8 -3 The Advantages and Disadvantages of Partnerships © 2008 Cengage Learning. All rights

Rights and Duties of Partners • Partnership Agreement Ø A document that states explicitly the rights and duties of partners. • Agency Power Ø The ability of any one partner to legally bind (e. g. , borrow money) the other partners. © 2008 Cengage Learning. All rights reserved. 13

The C Corporation Option • Corporation Ø A business organization that exists as a legal entity and provides limited liability for its owners. • Legal Entity Ø A business organization that is recognized by the law as having a separate legal existence (“artificial being”); can be sued, hold property, and incur debt. • C Corporation Ø An ordinary, or regular, corporation chartered by the state and taxed by the federal government as a separate legal entity. © 2008 Cengage Learning. All rights reserved. 14

Corporate Charter: Articles of Incorporation • Name of company • Formal statement of formation • Voting privileges for each class of stock • Type of Business • Names of incorporators and directors • Location • Capital stockholders • Duration • Statement of limited liability for stockholders • Classes and preferences of stock • Number and par value of authorized shares © 2008 Cengage Learning. All rights reserved. • Statement of directors’ powers 15

Rights and Legal Status of Stockholders • Stock Certificate Ø A document specifying the number of shares of stock owned by a shareholder. • Pre-emptive Right Ø The right of current stockholders to buy new shares of stock before they are offered to the public. • Legal Status Ø Ownership provides control over the firm. Ø Ownership limits liability to investment in the firm. Ø Ownership can be transferred without affecting the firm’s operations. © 2008 Cengage Learning. All rights reserved. 16

Choosing an Organizational Form Initial Costs Continuity of the Business Extent of Liability Factors Affecting the Choice of a Firm’s Structure Income Taxes Attraction of Capital © 2008 Cengage Learning. All rights reserved. Transfer of Ownership Management Control 17

8 -4 Comparison of Basic Legal Forms of Organization Form of Organization Initial Organizational Requirements and Costs Liability of Owners Continuity of Business Sole proprietorship Minimum requirements; generally no registration or filing fee Unlimited liability Dissolved upon proprietor’s death General partnership Minimum requirements; generally no registration or filing fee; written partnership agreement not legally required but strongly suggested Unlimited liability Unless partnership agreement specifies differently, dissolved upon withdrawal or death of partner C corporation Most expensive and greatest requirements; filing fees; compliance with state regulations for corporations Liability limited to investment in company Continuity of business unaffected by shareholder withdrawal or death Form of organization preferred Proprietorship or partnership C corporation © 2008 Cengage Learning. All rights reserved. 18

8 -4 Comparison of Basic Legal Forms of Organization (cont’d) Form of Organization Transferability of Ownership Management Control Attractiveness for Raising Capital Income Taxes Sole proprietorship May transfer ownership in company name and assets Absolute management freedom Limited to proprietor’s personal capital Income is taxed as personal income to the proprietor General partnership Requires the consent of all partners Majority vote of partners required for control Limited to partners’ ability and desire to contribute capital Income is taxed as personal income to the partners C corporation Easily transferred by transferring shares of stock Shareholders have final control, but usually board of directors controls company policies Usually the most attractive form for raising capital Corporation’s income tax and the stockholder is taxed if and when dividends are received Form of organization preferred Depends on the circumstances C corporation Depends on the circumstances © 2008 Cengage Learning. All rights reserved. 19

Forms of Business—Federal Income Taxes • Sole Proprietorship Ø Self-employed persons are taxed on their business incomes at tax rates set for individuals. • Partnership Ø The partnership does not pay taxes; allocated shares of income from partnership are taxed as personal income for each of the partners. • Corporation Ø As a separate legal entity, it reports income and pays any taxes related to these profits. © 2008 Cengage Learning. All rights reserved. 20

Forms of Business—Federal Income Tax Sole Proprietorship Example of taxes due from a married couple with $150, 000 in income from the business that they operate as selfemployed persons. Range of Taxable Income Tax Rate $0–$15, 650 10% $15, 651–$63, 700 15% $63, 701–$128, 500 25% $128, 501–$195, 850 28% $195, 851–$349, 700 33% Over $349, 700 35% Income x Tax Rate = Taxes First $ 15, 650 10% $1, 565. 00 Next $ 48, 050 15% $7, 207. 50 Next $ 64, 800 25% $16, 200. 00 Next $ 21, 500 28% $6, 020. 00 Total $150, 000 © 2008 Cengage Learning. All rights reserved. $30, 992. 50 21

Forms of Business—Federal Income Tax Corporation Example of taxes due from profits of $150, 000 of a corporation. Any profits of the corporation that are distributed to the stockholders are taxed again as personal income. Range of Taxable Income Tax Rate $0–$50, 000 15% $50, 001–$75, 000 25% $75, 001–$100, 000 34% $100, 001–$335, 000 39% $335, 001–$10, 000 34% $10, 001–$15, 000 35% $15, 000, 001–$18, 333 38% Over $18, 333 35% Income × Tax Rate = Taxes First $ 50, 000 15% $7, 500 Next $ 25, 000 25% $6, 250 Next $ 25, 000 34% $8, 500 Next $ 50, 000 39% $19, 500 Total $150, 000 © 2008 Cengage Learning. All rights reserved. $41, 750 22

Taxes on Gains and Losses • Ordinary Income Ø Income earned in the ordinary course of business, including any salary • Capital Gains and Losses Ø Gains and losses from sale of property that are not part of the firm’s regular business • Section 1244 Stock Ø Special of class stock that allows the owner to claim an ordinary income tax-deductible loss should the stock become worthless © 2008 Cengage Learning. All rights reserved. 23

Specialized Forms of Organization • Limited Partnership Structure Ø General partner v Active in the business, personally liable for the debts of the business Ø Limited partners v Not active in the business, liability limited to investment in business Ø Income (taxable) or losses v Apportioned © 2008 Cengage Learning. All rights reserved. to each partner 24

Specialized Forms of Organization (cont’d) • S Corporation Ø Eligibility Requirements v No more than 100 stockholders v All stockholders must be individuals or trusts v Only one class of stock can be outstanding v Must be a domestic corporation v Must operate on a fiscal calendar year basis v No nonresident alien stockholders Ø Benefits v Liability limited to investment in corporation v Dividends avoid double taxation © 2008 Cengage Learning. All rights reserved. 25

Specialized Forms of Organization (cont’d) • Limited Liability Company Ø Stockholders have limited liability but pay personal income taxes on the business profits. v Easier to set up v More flexible v Tax advantages • Professional Corporation Ø Protects licensed professionals from liability of partners but not their personal liability. • Nonprofit Corporation Ø Serves civic, educational, charitable, or religious purposes but not for generation of profits. © 2008 Cengage Learning. All rights reserved. 26

Forming Strategic Alliances • Strategic Alliances Ø An organizational relationship that links two or more independent business entities in a common endeavor Ø Benefits v Reduced cycle times through shared resources v Increased performance through synergistic combinations of financial resources and creativity Ø Risk v Difficulty in establishing and maintaining alliances © 2008 Cengage Learning. All rights reserved. 27

Setting Up and Maintaining Successful Strategic Alliances • Steps in Building Strategic Alliances Ø Establish a healthy network of contacts. Ø Identify and contact individuals within a firm who are likely to return your call. Ø Outline the partner’s potential financial benefits from the alliance. Ø Learn to speak and understand the “language” of your partner. Ø Continue to monitor the progress of the alliance. © 2008 Cengage Learning. All rights reserved. 28

8 -5 Most Popular Small Business Alliances by Type These alliances include only relationships that are long-term in nature. 2 These alliances include agreements relating to programs, such as just-in-time supply or total quality management, that are relatively long-term in nature. 1 Source: “Strategic Alliances, ” National Small Business Poll, William J. Dennis, Jr. (ed. ), Vol. 4, No. 4 (Washington, DC: NFIB Research Foundation, 2004), pp. 1– 8. © 2008 Cengage Learning. All rights reserved. 29

Making the Most of a Board of Directors • Board of Directors Ø The governing body of a corporation, elected by the stockholders Ø Inside directors v Board members who work for the firm Ø Outside director v Board members who do not work for the firm • Duties Ø Elect the firm’s officers (top management) Ø Approve management’s plans and policies Ø Review performance and declare dividends © 2008 Cengage Learning. All rights reserved. 30

The Board of Directors (cont’d) • Contributions of Board of Directors Ø Bring knowledge and experience v Review policy decisions v Provide general direction v Monitor the firm’s ethical behavior v Mediate and resolve disputes among top management • Alternative: Advisory Council Ø Provides advice but does not have the fiduciary responsibility for the direction of the firm. © 2008 Cengage Learning. All rights reserved. 31

Key TERMS • • • • management team social network social capital reciprocation sole proprietorship unlimited liability partnership agreement agency power corporation legal entity C corporation corporate charter stock certificate © 2008 Cengage Learning. All rights reserved. • • • • pre-emptive right ordinary income capital gains and losses Section 1244 stock limited partnership general partner limited partner S corporation (Subchapter S corporation) limited liability company professional corporation nonprofit corporation organizational test strategic alliance board of directors advisory council 32