5.

0 Starting and Operating a Business

Lecture Objectives
 Describe the advantages and disadvantages of sole
proprietorship.
 Describe the advantages and disadvantages of a partnership.
 Describe the advantages and disadvantages of a corporation.
 Explain how the potential return and risk of a business are
affected by its form of ownership.
 Describe methods of owning existing businesses.

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Selecting a Form of Business
Ownership

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 Sole Proprietorship

 Sole proprietorship – a business owned by a single owner

 Can obtain loans but these loans do not represent ownership
 Obligated to repay loan with interest but does not need to
share ownership with creditors
 Sole Proprietor – owner of a sole proprietorship

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 Characteristics of Successful Sole
Proprietors
 Sole proprietors
• Must be willing to accept full responsibility for the firm’s
performance
• Enormous work pressure than any other employee
• Must be willing to work flexible hours.
• On-call to substitute for sick/absent employees
• Encouraged by success of business to continue monitor operations
• Must exhibit strong leadership skills, be well organized &
communicate well with employees
• Previous experience is critical to understanding competition and
customer behavior
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 Advantages of a Sole Proprietorship

 Sole proprietors
• Must be willing to accept full responsibility for the firm’s performance
• Enormous work pressure than any other employee
• Must be willing to work flexible hours.
• On-call to substitute for sick/absent employees
• Encouraged by success of business to continue monitor operations
• Must exhibit strong leadership skills, be well organized &
communicate well with employees
• Previous experience is critical to understanding competition and
customer behavior

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 Disadvantages of a Sole Proprietorship

Owner Incurs All Losses

Just as they do not have to share profits, they are unable to share any losses. No other
owners are available to help cover the losses.
Unlimited Liability
There is no limit to the debts for which an owner is liable. If sued, owner is
personally liable for any judgment against the firm.
Limited Funds
With only one owner and limited funding, sole proprietors have difficulty engaging in
operations requiring substantial amount of money.
Limited Skills
With limited skills a sole proprietor may not be able to control all parts of the
business.
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 Partnership

 Partnership – a business co-owned by two or more people.

Partners – co-owners of a business
General Partnership – a partnership in which all partners have
unlimited liability; all partners are personally liable for all obligations of
a firm.
Limited Partnership – a firm that has some limited partners; where each
partner’s liability is limited to the value of their contribution in the
partnership. They are only investors and do not involve in management
of the business.
 General Partners – partners who manage the business, receive a salary,
share the profits or losses of the business and have unlimited liability.
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 Advantages of a Partnership

 Additional Funding
With more partners, more money is made available for business
expansion.
 Losses are Shared
Any business losses that the partnership incurs are spread across all of
the partners.
 More Specialization
Partners focus on their areas of specialization and serve a variety of
customers.

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 Disadvantages of a Partnership
 Control is Shared
Decision making in partnership must be shared. Disagreeing on how the
business should be run can destroy both personal and business
relationships.
 Unlimited Liability
General partners in a partnership are subject to unlimited liability, just
like sole proprietors.
 Profits are Shared
Any profits that the partnership generates must be shared among the
partners. The more partners there are, the smaller the amount of a given
level of profits that will be distributed to any individual partner.
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 Partnership ..cont…

 S-Corporations
A firm that has 100 or fewer owners and satisfies other criteria. The
earnings are distributed to the owners and taxed at the respective
personal income tax rate of each owner.
Owners have limited liability

 Limited Liability Company (LLC)

A firm that has all the favourable features of a typical general
partnership but also offers limited liability for the partners.
Typically protects a partner’s personal assets from the negligence of
other partners in the firm.
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 Corporation
 Definitions
 Corporation – a state-chartered entity that pays taxes and is legally distinct
from its owners
 Charter – a document used to incorporate a business. The charter describes
important aspects of the corporation such as name of the firm, stock issued, and
the firm’s operations.
 Bylaws – general guidelines for managing a firm

 Since the shareholders of a corporation are legally separated from the entity, they
have limited liability, meaning they are not held responsible for the firm’s actions.
 Shareholders elect members of the board of directors entrusted to establish
general policies of the firm.
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 Corporation ..cont..
 How Stockholders Earn a Return
 Stockholders earn a return on their investment in two ways:
1. They may receive dividends from the firm which is a portion of
the firm’s recent earnings over the last three months that are
distributed to stockholders
2. The stock they hold may increase in value. When the firm
becomes more profitable, the value of its stock tend to rise,
meaning that the value of stock held by owners has increased.
Thus they can benefit by selling their stock at a much higher
price than they paid for it.

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 Corporation..cont..

 Private Vs Public Corporation

People become owners of a corporation by purchasing shares:
1. Privately held – ownership is restricted to a small group of
investors
2. Publicly held – shares can be easily purchased or sold by
investors
3. Going public – the act of initially issuing stock to the
public

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 Advantages of a Corporation

 Limited Liability
 Owners of a corporation have limited liability, whereas sole proprietors and
general partners typically have unlimited liability
 Access to Funds
 A corporation can easily access funds by issuing new stock. This allows
corporations the flexibility to grow and to engage in new business ventures.
Sole proprietorships and partnerships have less access to funding when they
wish to finance expansion. To obtain more funds, they may have to rely on
their existing owners or loans from creditors.
 Transfer of Ownership
 Investors in large, publicly traded companies can normally sell their stock in
minutes by calling their stockbrokers or by selling it online over the internet.
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Disadvantages of a Corporation
 High Organizational Expense
• Organizing a corporation is normally more expensive than creating the
other forms of business because of the necessity to create a corporate
charter and file it with the state.
 Financial Disclosure
• When the stock of a corporation is traded publicly, the investing public
has the right to inspect the company’s financial data, within certain limits.
 Agency Problems
• Publicly held corporations are normally run by managers who are
responsible for making decisions for the business that will serve the
interests of the owners. When managers do not act as responsible agents
for the shareholders who own the business, a so-called agency problem
results.
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 Disadvantages of a Corporation
High Taxes
• Since the corporation is a separate entity, it is taxed
separately from its owners. The annual taxes paid by a
corporation are determined by applying the corporate tax rate
to the firm’s annual earnings. The corporate tax rate is
different from personal tax rate.
• E.g., a corporation earns USD10 million this year and assume
that the applicable corporate tax is 30 percent this year
Earnings before Tax = $10, 000, 000
Corporate Tax = 3, 000, 000 (30% x 10, 000, 000)
Earnings after Tax = $7, 000, 000
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Disadvantages of a Corporation
High Taxes
• If any of the after tax earnings are to be paid to the owners as dividends, the
dividends represent personal income to the stockholders. The stockholders will pay
personal income taxes on the dividends.
• E.g., Assuming that from previous example that the $7million after tax earning is
taxed at 10 percent.

Dividends Received = K7, 000, 000

Tax Paid on Dividends = 700, 000 (10% x 7, 000, 000)
Income after Tax = K6, 300, 000

Combining the corporate tax and personal income tax, total tax paid as a result of the
profit is 37% of K10 million.
3, 000, 000 + 700, 000 = 3, 700, 000
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Illustration of Double Taxation

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Comparison of Tax Effects on Corporation & Sole
Proprietorship

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 Comparing Forms of Business
Ownership

• No single form of business ownership is ideal for all

business owners.
• An individual may set up a sole proprietorship.
• While a group of people can opt for a partnership or to
further limit their liability can consider privately held
corporation.
• As the corporation grows over time and need finance for
extension, it may convert to a publicly held corporation.

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How Ownership Can Affect Return and
Risk

• When business owners assess a possible investment in any

business, they consider both the potential return and the risk
from that type of investment.
Impact of Ownership on the Return on Investment
• Return on investments in a firm is derived from the firm’s
profits. When a firm generates earnings, it pays a certain portion
of it as taxes.

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How Ownership Can Affect Return and
Risk

Definitions
• Equity – the total investment by a firm’s stockholders
• Return on Equity (ROE) – earnings as a proportion of the
firm’s equity.
Impact of Ownership on Risk
Risk – the degree of uncertainty about a firm’s future earnings
• Since sole proprietorship are smaller with very limited funds,
they are generally riskier than other forms of business
ownership.

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Methods of Owning and Operating A
Business

There are four methods of owning and operating a

business
(1) Starting from scratch
(2) Taking over family business
(3) Buying an existing business
(4) Franchising

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 Obtaining Ownership of an Existing
Business

Some people become the sole owners without starting the

business. Below are most common methods:
• Assuming ownership of a family business
• Purchasing an existing business
• Franchising

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Starting A Business From Scratch

 Starting a business which was never been in

operation
 A potential owner and operator see a feasible
opportunity to venture into a business activity
 Has to have a plan to guide its operations

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 Assuming Ownership of a Family
Business

• Many people assume ownership of a family business after

having worked there for some time.
• Ideal way to own business as its performance is somewhat
predictable as long as key employees are there.
• If it has a successful history, new owner need to maintain that, or
• Revise management, marketing and financing policies.

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 Purchasing an Existing Business

• Business are sold almost everyday for various reasons

including financial difficulties and death or retirement of
owner.
• When deciding on purchasing an existing business, one must
assess their expertise to run the business or monitor managers.
• Next is to compare expected benefits against initial outlay
required to purchase it.

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 Franchising

• Franchise – an arrangement whereby a business owner allows

others to use its trademark, trade name, or copyright, under
specific conditions.
• Franchisor – a firm that allows others to use its trade name or
copyright, under specified conditions.
• Franchisee – a firm that is allowed to use the trade name or
copyright of a franchise
• Distributorship – a type of franchise in which a dealer is
allowed to sell a product produced by a manufacturer

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 Franchising…cont…

• Chain-style business – a type of franchise in which a firm is

allowed to use the trade name of a company and follow
guidelines related to the pricing and sale of the product.
• Manufacturing arrangement – a type of franchise in which a
firm is allowed to manufacture a product using a formula
provided by another company.

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 Advantages of Franchise

• Proven Management Style

 Franchisees look to the franchisors for guidance in production and
management.
• Name recognition
 Many franchises are nationally known because of advertising by
the franchisor. This provides the franchisee with name recognition
which can significantly increase the demand for the product
• Financial Support
 Some franchisees receive financial support from the franchisor,
which can ensure efficient start-up funds for the franchisee.
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 Disadvantages of Franchise
• Sharing Profits
 In return for services provided by the franchisor, the franchisee
must share profits with the franchisor. Annual fees paid by the
franchisee may be 8% or more of the annual revenue generated
by the franchise.
• Less Control
 The franchisee must abide by guidelines regarding product
production and pricing, and possibly other guidelines as well.
Consequently, the franchisee’s performance is dependent on these
guidelines. Owners are not allowed to revise some of the
guidelines.
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 Tutorial Exercise

1. Differentiate between a partnership and a

corporation
2. Discuss the steps to registering a corporation
3. List and discuss the four approaches to owning and
operating a business
4. Does the law requires sole proprietors and
partnerships to pay tax?
5. What is an agent?

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 Case Study

Manufacturer's Business Plan

Breakaway Bicycle Company is a small manufacturer of high-end bicycle frames. It builds both mountain bike and racing
bike frames for sale primarily to professional bicycle racers. However, increasing interest in mountain biking as a
competitive sport and the exposure that bike racing received as a result of the Olympics have provided BBC with an
opportunity to expand its business. Right now, a small number of BBC's frames are sold to non-professional riders who
want the very best equipment available, regardless of price.
In order to better serve this emerging market, BBC proposes to add additional workstations and designer/builders to
increase its capacity for custom frames. The BBC business plan envisions making better use of existing leased space and
leasing additional space to meet its needs. In addition, the frame-building equipment necessary to create three additional
workstations must be acquired.
Guiding Questions.
Q1. Do promotion and exposure into untapped market increase new product demand?
Q2. How does being the first mover into a business places you in a favourable situation to regulate the industry as leader?
Q3. Discuss how appreciation in demand with shortage in supply affects business image and success?
Q4. How does planning backed by marketing research affects business operation in its early stage?

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