sws 2006 1 chapter 8 the types of businesses in a free enterprise system

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CHAPTER 8CHAPTER 8 THE TYPES OF BUSINESSES THE TYPES OF BUSINESSES

IN A FREE ENTERPRISE IN A FREE ENTERPRISE SYSTEMSYSTEM

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An An economic institutioneconomic institution is is an organization or idea that an organization or idea that influences economic behaviorinfluences economic behavior..

The basic economic institution The basic economic institution in the capitalist system of the in the capitalist system of the United States is the United States is the businessbusiness. . Businesses determine much of Businesses determine much of how the economy operates. how the economy operates.

What is an economic institution?What is an economic institution?

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Starting a business requires more than Starting a business requires more than natural resources, labor, and capital. natural resources, labor, and capital.

An An entrepreneurentrepreneur is an individual who is an individual who is willing to organize and manage a is willing to organize and manage a business in order to make a profit.business in order to make a profit. The The entrepreneurentrepreneur answers the basic answers the basic

economic questions about economic questions about what, how, and what, how, and for whomfor whom a good or service will be a good or service will be produced.produced.

He/she assumes He/she assumes ALLALL the the RISKRISK..

How to start an economic institution?How to start an economic institution?

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Many of the nation’s Many of the nation’s entrepreneursentrepreneurs became famous for their ability to became famous for their ability to organize and manage.organize and manage. Andrew Carnegie in steel, Andrew Carnegie in steel, John D. Rockefeller in oil, John D. Rockefeller in oil, Henry Ford in automobiles, Henry Ford in automobiles, Bill Gates in computers, Bill Gates in computers, Ray Kroc (McDonald’s) in fast foods, Ray Kroc (McDonald’s) in fast foods, and Liz Claiborne in clothing.and Liz Claiborne in clothing.

Examples of entrepreneurs?Examples of entrepreneurs?

Entrepreneurs often are successful because Entrepreneurs often are successful because they see opportunities where others do not. they see opportunities where others do not.

People thinking of starting a business People thinking of starting a business should watch for opportunities and acquire should watch for opportunities and acquire the training that will increase their the training that will increase their chances of success.chances of success.

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Entrepreneurs must make many decisions as Entrepreneurs must make many decisions as they start up new businesses. they start up new businesses.

One of the first decisions they face is what One of the first decisions they face is what form of business organization best serves form of business organization best serves their interests. their interests.

A business organization is an establishment A business organization is an establishment formed to carry on commercial enterprise. formed to carry on commercial enterprise.

In other words, a In other words, a business organizationbusiness organization is a is a company and these business organizations can be set-company and these business organizations can be set-up as a:up as a:

(1) (1) sole proprietorshipsole proprietorship

(2) (2) partnershippartnership, or, or

(3) (3) corporationcorporation (private or public) (private or public)

WHAT STRATEGIES DO WHAT STRATEGIES DO ENTREPRENEURS USEENTREPRENEURS USE??

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Sole ProprietorshipsSole Proprietorships The Role of Sole Proprietorships:The Role of Sole Proprietorships:

THE TYPES OF BUSINESSES THE TYPES OF BUSINESSES ORGANIZATIONSORGANIZATIONS

A A sole proprietorshipsole proprietorship is a business owned is a business owned and managed by a and managed by a singlesingle individual. individual.

That person earns That person earns allall of the firm's profits of the firm's profits and is responsible for and is responsible for allall of the firm's debts. of the firm's debts.

This type of firm is by far the most popular This type of firm is by far the most popular in the United States. According to the in the United States. According to the Internal Revenue Service, about Internal Revenue Service, about 75 percent75 percent of all businesses are sole proprietorships.of all businesses are sole proprietorships.

Most sole proprietorships are small.Most sole proprietorships are small. Why?Why?

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Sole ProprietorshipsSole Proprietorships AdvantagesAdvantages of Sole Proprietorships: of Sole Proprietorships: 1.)1.) Easy to Start:Easy to Start: While you need to do more than just While you need to do more than just

hang out a sign to start your own business, a sole hang out a sign to start your own business, a sole proprietorship is simple to establish. proprietorship is simple to establish.

With just a small amount of paperwork and legal With just a small amount of paperwork and legal expense, just about anyone can start a sole expense, just about anyone can start a sole proprietorship.proprietorship.

To start a new business, a sole proprietor must To start a new business, a sole proprietor must meet a small number of government requirements, meet a small number of government requirements, which can vary from city to city and state to state.which can vary from city to city and state to state.1.1. Name:Name: If not using this or her own name as the name of If not using this or her own name as the name of

the business, a sole proprietor must register a business the business, a sole proprietor must register a business name.name.

2.2. AuthorizationAuthorization:: Sole proprietors must obtain a Sole proprietors must obtain a business business licenselicense

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Sole ProprietorshipsSole Proprietorships AdvantagesAdvantages of Sole Proprietorships: of Sole Proprietorships: 2.)2.) Few Regulations:Few Regulations: A proprietorship is the A proprietorship is the

least-regulatedleast-regulated form of business organization. form of business organization. Even the smallest business, however, is subject Even the smallest business, however, is subject

to some regulation, especially industry-specific to some regulation, especially industry-specific regulations.regulations.

For example, a gourmet soft pretzel stand would be For example, a gourmet soft pretzel stand would be subject to health codes, and a furniture refinishing subject to health codes, and a furniture refinishing business would be subject to codes regarding dangerous business would be subject to codes regarding dangerous chemicalschemicals

Most importantly, because they require little Most importantly, because they require little legal paperwork, sole proprietorships are legal paperwork, sole proprietorships are usually usually the least expensive form of ownership to the least expensive form of ownership to establish.establish.

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Sole ProprietorshipsSole Proprietorships AdvantagesAdvantages of Sole Proprietorships: of Sole Proprietorships: 3.)3.) Owner makes all profit:Owner makes all profit: If the business If the business

succeeds, the owner does not have to share the succeeds, the owner does not have to share the success with anyone else.success with anyone else.

4.)4.) Total control of decisions:Total control of decisions: sole proprietors sole proprietors can run their businesses as they wish. can run their businesses as they wish.

This means that they can respond quickly to This means that they can respond quickly to changes in the marketplace.changes in the marketplace.

5.)5.) Easy to Discontinue:Easy to Discontinue: Finally, if sole Finally, if sole proprietors decide to stop operations and do proprietors decide to stop operations and do something else for a living, they can do so easily. something else for a living, they can do so easily.

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Sole ProprietorshipsSole Proprietorships DisadvantagesDisadvantages of Sole Proprietorships: of Sole Proprietorships:

THE TYPES OF BUSINESSESTHE TYPES OF BUSINESSES

1.)1.) Unlimited Personal Liability:Unlimited Personal Liability: Sole proprietors Sole proprietors are fully and personally responsible for all their are fully and personally responsible for all their business debts.business debts.

2.)2.) Limited Access To Resources:Limited Access To Resources: Many small Many small business owners use all of their available savings business owners use all of their available savings and other personal resources to start up their and other personal resources to start up their businesses. This makes it difficult or impossible for businesses. This makes it difficult or impossible for them to expand quickly.them to expand quickly.

Also, they may lack Also, they may lack HUMAN CAPITALHUMAN CAPITAL, which would make , which would make their business suffer.their business suffer.

3.)3.) When owner dies, the business dies:When owner dies, the business dies: when when owner dies or retires the company ceases to exist, owner dies or retires the company ceases to exist, unless given to someone else.unless given to someone else.

4.)4.) No Fringe Benefits:No Fringe Benefits: No healthcare plan, dental No healthcare plan, dental coverage, 401k retirement plan, or paid vacationscoverage, 401k retirement plan, or paid vacations

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PartnershipsPartnerships (two or more owners who split (two or more owners who split responsibility of the management of the responsibility of the management of the company)company)Types of Partnerships:Types of Partnerships:


1.)1.) General partnerships:General partnerships: Partners in a general Partners in a general partnership share partnership share equallyequally in both responsibility and in both responsibility and liability.liability.

2.)2.) Limited partnerships:Limited partnerships: In a limited partnership, In a limited partnership, only only oneone partner is required to be a general partner. partner is required to be a general partner.

That is, onlyThat is, only ONEONE partner has partner has UNLIMITEDUNLIMITED personal personal liability for the firm’s actions. The remaining partner or liability for the firm’s actions. The remaining partner or partners contribute only money.partners contribute only money.

The main advantage of being a general partner is in The main advantage of being a general partner is in having control of the business. The main drawback, of having control of the business. The main drawback, of course, is the extent of liability.course, is the extent of liability.

3.)3.) Limited liability partnerships (LLP):Limited liability partnerships (LLP): In this type of partnership, all partners are limited In this type of partnership, all partners are limited

partners. An LLP functions like a general partnership, partners. An LLP functions like a general partnership, except that all partners are limited from personal liability except that all partners are limited from personal liability from another partner’s mistakes. from another partner’s mistakes.

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1.)1.) Easy to Start:Easy to Start: Like proprietorships, partnerships Like proprietorships, partnerships are easy and inexpensive to establish. The law does are easy and inexpensive to establish. The law does not require a written partnership agreement. not require a written partnership agreement. (FEW REGULATIONS)(FEW REGULATIONS)

2.)2.) Little government regulation:Little government regulation: Like sole Like sole proprietorships, partnerships are subject to little proprietorships, partnerships are subject to little government regulation.government regulation.

3.)3.) Shared Decision Making and Specialization:Shared Decision Making and Specialization: divide divide up the workup the work

4.) 4.) Pool of capital:Pool of capital: combine the money of two in order combine the money of two in order to get startedto get started

5.)5.) Not liable for other partners actions:Not liable for other partners actions: ONLY for an ONLY for an LLPLLP

AdvantagesAdvantages of Partnerships: of Partnerships:

PartnershiPartnershi

psps


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1.)1.) Unlimited Liability:Unlimited Liability: both partners are liable both partners are liable for actions of each other (for actions of each other (except in an LLPexcept in an LLP))

each partner could lose what they put into the each partner could lose what they put into the partnershippartnership

Choose business partners carefullyChoose business partners carefully

2.)2.) Loss of individual control:Loss of individual control: share decision- share decision-makingmaking

3.)3.) Disagreements:Disagreements: if a conflict starts, then the if a conflict starts, then the business could suffer because of the business could suffer because of the disagreementdisagreement

DisadvantagesDisadvantages of Partnerships: of Partnerships:

PartnershiPartnershi

psps THE TYPES OF BUSINESSESTHE TYPES OF BUSINESSES

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CorporationsCorporations defined:defined:

CorporatioCorporatio

nsns THE TYPES OF BUSINESSESTHE TYPES OF BUSINESSES

The most The most complexcomplex form of a business form of a business organization is the corporation.organization is the corporation.

A A corporationcorporation is a is a legal entitylegal entity or or being, owned by individual stockholders, being, owned by individual stockholders, each of whom faceseach of whom faces limited liabilitylimited liability for for the firm’s debts. the firm’s debts.

Stockholders own Stockholders own stockstock, also called , also called sharesshares, which represent their portion , which represent their portion of ownership in the corporation. of ownership in the corporation.

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The stock might be listed with the National The stock might be listed with the National Association of Securities Dealers Automated Association of Securities Dealers Automated Quotation (NASDAQ).Quotation (NASDAQ).

The largest corporations are usually listed on The largest corporations are usually listed on the the New York Stock Exchange (NYSE).New York Stock Exchange (NYSE).

Selling stock is not the only way a corporation Selling stock is not the only way a corporation can raise capital to develop or expand. can raise capital to develop or expand.

It can also sell debt by issuing It can also sell debt by issuing bondsbonds. . A A bondbond promises to pay a stated rate of interest over promises to pay a stated rate of interest over

a stated period of time; it also promises to repay the a stated period of time; it also promises to repay the full amount borrowed at the end of that time.full amount borrowed at the end of that time.

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ns:ns: THE TYPES OF BUSINESSESTHE TYPES OF BUSINESSES

A corporation has the following structure:A corporation has the following structure:

Board of DirectorsBoard of Directors

(some of the board members (some of the board members are stockholder and some ARE are stockholder and some ARE

NOTNOT))

Stockholders

(owners of stock)

Chief Executive Officer (CEO)

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Two Types of Corporations:Two Types of Corporations:



1.) 1.) Private CorporationsPrivate Corporations:: Some corporations Some corporations issue stock to only a few people, often family issue stock to only a few people, often family members. These stockholders rarely trade members. These stockholders rarely trade their stock, but pass it on within families. their stock, but pass it on within families.

2.) 2.) Publicly Traded CorporationsPublicly Traded Corporations:: It has many It has many shareholders who can buy or sell stock on shareholders who can buy or sell stock on the open market. the open market. Stocks are bought and sold at financial markets called Stocks are bought and sold at financial markets called

stock exchanges, such as the New York Stock Exchange or stock exchanges, such as the New York Stock Exchange or

Chicago Exchange.Chicago Exchange.

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1.)1.) Very Little Liability:Very Little Liability: A corporation is defined as an A corporation is defined as an ""entityentity"" because it has a legal identity separate from because it has a legal identity separate from those of its owners. A corporation pays taxes, may those of its owners. A corporation pays taxes, may engage in business, make contracts, sue other engage in business, make contracts, sue other parties, and get sued by others.parties, and get sued by others.

2.)2.) Many Resources are Available:Many Resources are Available: not only do not only do corporations have more access to corporations have more access to physical capitalphysical capital, , they have access to human capital they have access to human capital (well educated (well educated business leaders)business leaders)

3.) 3.) Continues after death of Owner:Continues after death of Owner: a corporation will a corporation will not cease to exist if the owner passes, or retires.not cease to exist if the owner passes, or retires.

4.)4.) Easy to Raise Money for it:Easy to Raise Money for it: through the sells of stock through the sells of stock a company can raise money to fund operations.a company can raise money to fund operations.

AdvantagesAdvantages of Corporations: of Corporations:



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1.)1.) Owner has little control:Owner has little control: he/she has he/she has little control over the company. They little control over the company. They have to listen to the Board of Directors have to listen to the Board of Directors and the stockholders.and the stockholders.

2.)2.) Does NOT React quickly to changes in Does NOT React quickly to changes in the market:the market: corporations are huge corporations are huge bureaucraciesbureaucracies and they are not quick to and they are not quick to response to the marketplaces.response to the marketplaces. Everything has to be approved by the Board of Everything has to be approved by the Board of

Directors (which takes valuable time)Directors (which takes valuable time)

DisadvantagesDisadvantages of Corporations: of Corporations:



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Chapter 8 Focus Chapter 8 Focus QuestionsQuestions

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Chapter 8 Focus Chapter 8 Focus QuestionsQuestions1.1. What is the main difference between a What is the main difference between a

limited liability partnership and a limited limited liability partnership and a limited liability company?liability company? A: Both are taxed as a partnership. But a A: Both are taxed as a partnership. But a

LLC can have more than one member that LLC can have more than one member that guarantees financial obligations, meaning guarantees financial obligations, meaning there is less personal liability to owners. If there is less personal liability to owners. If you are a existing partnership, it is easier to you are a existing partnership, it is easier to convert to a LLP (very hard to convert to a convert to a LLP (very hard to convert to a LLC)LLC)

2.2. What are the advantages of a partnership What are the advantages of a partnership and a corporation? and a corporation? A: A partnership and corporation benefit from A: A partnership and corporation benefit from

having access to more resources (physical and having access to more resources (physical and human capital). They both have access to more human capital). They both have access to more money. Sole proprietorship do not have these money. Sole proprietorship do not have these advantages.advantages.

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Chapter 8 Section Chapter 8 Section QuestionsQuestions

8.1 Q#4: Why wasn’t the Bell Labs employee 8.1 Q#4: Why wasn’t the Bell Labs employee who invented the 1who invented the 1stst transistor an transistor an entrepreneur?entrepreneur? A: He did not take any risk to attempt to mass A: He did not take any risk to attempt to mass

produce and market his invention.produce and market his invention.

8.2 Q#3: Why are many sole proprietorships 8.2 Q#3: Why are many sole proprietorships run by part-time entrepreneurs who earn run by part-time entrepreneurs who earn most of their income by being employed by most of their income by being employed by another firm?another firm? A: Many sole proprietorships are too small to A: Many sole proprietorships are too small to

generate enough profit to cover expenses (so the generate enough profit to cover expenses (so the owner has to work somewhere else to support his owner has to work somewhere else to support his business and family)business and family)

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8.3 Q#4: If publicly traded corporations 8.3 Q#4: If publicly traded corporations account for ONLY 1% of all corporations, account for ONLY 1% of all corporations, why should society care what they do?why should society care what they do?A: Though there are few publicly held A: Though there are few publicly held

corporations, they tend to be huge and control corporations, they tend to be huge and control a majority of the market and economy.a majority of the market and economy.

CR Q#23: Corporations are:CR Q#23: Corporations are:a.a. The most common type of businessThe most common type of business

b.b. The easiest form of business to startThe easiest form of business to start

c.c. The type of business the is best able to raise fundsThe type of business the is best able to raise funds

d.d. The least-regulated form of businessThe least-regulated form of business


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CR Q#32: Which of the following is not true CR Q#32: Which of the following is not true of private corporations?of private corporations?

a.a. They exist to earn a profitThey exist to earn a profitb.b. They must reorganize when an owner diesThey must reorganize when an owner diesc.c. Their income is taxed more than employee earningsTheir income is taxed more than employee earningsd.d. They are treated as an individual separate from They are treated as an individual separate from

their owners by the law their owners by the law (limited liability: the (limited liability: the corporation would be punished for wrong doings corporation would be punished for wrong doings and not the ownersand not the owners))

CR Q#35: Paul and his flower shop. He put CR Q#35: Paul and his flower shop. He put in a lot of work but his shop still failed in a lot of work but his shop still failed and he had a lot of debt to pay the bank. and he had a lot of debt to pay the bank. Why would it have been better for him to Why would it have been better for him to organize his business as a corporation?organize his business as a corporation?

Paul would not have been liable for the debt of the Paul would not have been liable for the debt of the company, he would not have lost his home in the company, he would not have lost his home in the bankruptcy proceedings, and he could have shared the bankruptcy proceedings, and he could have shared the management responsibility with other ownersmanagement responsibility with other owners


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END CHAPTER 8END CHAPTER 8

sws 2006 1 chapter 8 the types of businesses in a free enterprise system

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