How a Business is Organized?

In business there are many legal (permitted by law) forms of organization. The form of organization means the type of ownership. The main differences be­tween the types of ownership are in their ability to raise capital, the size and continuity of the enterprise (business), the disposition (use) of profits, and the legal obligations (requirements) in the event (case) of bankruptcy. Each form has certain advantages and disadvantages. The three forms discussed in this lesson are the sole proprietorship, the partnership, and the corporation.

The form which requires the least amount of capital and personnel is the sole proprietorship. Sole means single, and the proprietor is the owner. Therefore, a sole proprietorship is a business owned and operated by a single person. This single person can start a business by simply purchasing the necessary goods and equipment and opening up shop. There are very few government and legal regulations (rules) to comply with (follow). The sole proprietor owns all the business assets (property), makes all the decisions, takes all the risks, and keeps all the profits of the business. The business itself pays no tax, but the owner must pay personal income taxes on his profits. If a sole proprietor is successful, he takes a lot of personal satisfaction in his enterprise. If he is not successful and he wants to close his business and start a new one, he simply has to sell his inventory (products or supplies) and equipment, pay his bills, close up shop, and begin a new activity.

There are good and bad aspects (things to consider) to the sole proprietorship form of organization. The sole proprietor has the opportunity to be successful, but he also runs the risk of financial ruin (takes a chance on losing all his money). The sole proprietor owns all the assets of the business, but he also has to supply all the capital (money), and his ability to borrow is limited to his personal amount of money and wealth (property). The owner enjoys his freedom to make decisions about his business, but he alone takes the responsibility for incorrect choices. He has the right to keep all the profits of the business. However, if he suffers a loss, he still owes (must pay) all the debts, and his legal liability (responsibility) to pay them may be more than his investment in the business. He must use his personal property to settle (pay) the debts of the business if he goes bankrupt.

A partnership presents a completely different set of problems. A partner­ship consists of two or more people who share the ownership of a business. A partnership should begin with a legal agreement covering the various aspects (parts) of the business. Two important items that need to be covered are exactly which assets (property) each partner is contributing (investing), as well as how the partnership can be changed or terminated (ended). This agreement is called the articles of co-partnership. It is not as complicated as the articles of incorporation. However, the articles of co-partnership indi­cate (show) that the initiation (beginnning) of a partnership is not as easy as the beginning of a sole proprietorship. Partners are like sole proprietors because they own all the assets, owe all the debts, make the decisions, and share the profits. They pay only personal income taxes on their share of the profits. If each partner has a different expertise (knowledge) in an important business area, the partnership has an advantage over the sole proprietorship in managerial ability (the talents of the people who run the business).

A partnership usually has more capital than a sole proprietorship. In a partnership the personal wealth of all the partners can be used to secure (get) loans and credit. This personal wealth may also be used to settle (pay) the debts of the business. Like the sole proprietorship, the partnership has unlimited financial liability (total responsibility) in the event of bankruptcy. Unlike the sole proprietorship where one owner-manager makes all the decisions, the smooth operation of a partnership requires both owners to agree on management policy (rules). If a partnership wished to cease (stop) doing business, the owners would have to agree on how to dissolve (break up) it.

The corporation is very different from both a sole proprietorship and a partnership. First of all, the corporation is a legal entity (organization) which is chartered (made legal) by the state in which it is incorporated (formed). In other words, a Los Angeles corporation is incorporated under the laws of the State of California. As a legal entity, the corporation can own property that is not the personal wealth of its owners. It also means that the corporation can enter into business agreements on its own. Forming a corporation is not easy. There are many legal procedures (steps) to follow. A corporation raises capital in a different way from the proprietorship or partnership. The ownership of the corporation is divided into shares of stock (parts of ownership). One stockholder or shareowner (owner) can buy, sell, and trade his shares without permission from the other owners. A corporation can raise large amounts of capital by selling shares of stock. The stock owners vote for a board (group) of directors who hire a president or chief executive officer to run the company. The board of directors also decides what to do with the corporation's profits. It usually retains (keeps) part of the profits for reinvest­ment in the company and distributes (pays off) the other part to the shareholders as dividends. Unlike

the sole proprietorship and the partnership, the liability of a corporation is limited to (may not be more than) the value of the assets of the company. The personal wealth of the stockholders cannot be used to pay debts in case of bankruptcy. Corporations do not operate like other forms of business because the ownership can be easily transferred (changed) through stock sales.

There are favorable and unfavorable points to consider (think about) with regard to the corporate form of ownership. The corporation has access to (can use) large amounts of capital and has limited liability, but its activities are closely monitored (watched) by government agencies. The Securities and Exchange Com­mission regulates the stock trades. A large corporation has a lot of managers who can specialize in different aspects of the business. How­ever, the corporation must have good organization for efficient (good) opera­tion. Another important disadvantage of the corporation is that its profits are taxed twice. The profits are taxed once as corporate profits, and then the individual stockholders pay personal income taxes on their dividends (profits from stocks).

The three types of legal organization discussed in this lesson show different possibilities and limitations. The best form for a particular enterprise depends on its capital requirements and the number of owners.

Vocabulary Building Introduction

Sometimes the meaning of a new word can be learned by analyzing the word. Analysis means looking at the different parts of something. The word ownership, for example, is made up of the verb own followed by two suffixes, -er and -ship. Sometimes when a suffix is added to a word, the spelling is changed. Close analysis of the word will show its parts.

Date: 2015-02-16; view: 2311