Introduction AEM1200, to Business Management
Wednesday 2/1-Friday 2/3 Business Ownership, Shareholders and Stakeholders
Forms of business ownership
Sole proprietorship Partnership Corporation Mixed Forms and LLC Franchise
Problems with the corporate form of ownership Corporate Social Responsibility and the Stakeholder Model
Forms of Business Ownership
Sole proprietorship
A business owned and managed by one person A legal form of business with two or more owners A legal entity with authority to act and have liability separate from its owners A legal entity that offers both limited liability and flexible tax treatment to its owners The right to use a specific business's name and sell its products or services in a given territory A business owned and controlled by the people who use it producers, consumers, or workers with similar needs who pool their resources for mutual gain.
Partnership
Corporation
Limited Liability Company
Franchise
Cooperatives
Ownerships, Partnerships and Corporations
Sole Proprietorships
Ease of formation Be your own boss / retention of control Pride of ownership Retain profit No special taxes Unlimited liability Limited financial resources Difficulty in mgmt. Time commitment Few fringe benefits Limited growth Limited life span
Partnerships
More financial resources Shared mgmt. Ease of formation Longer survival Disagreements among partners Difficult to terminate Unlimited liability Division of profits
Corporations
More money for investment Limited liability Separation of ownership/mgmt. Ease of ownership change Double taxation Perpetual life Size Initial cost Paperwork Two tax returns Termination difficult
Corporate governance
The relationship of a company to its shareholders and, more broadly, to society
The Board of Directors
Problems of Corporate Governance
The Agency Problem
Potential conflicts of interest between principals (eg. shareholders/ stakeholders) and agents (managers, especially top executives); Moral Hazard
occurs when a party insulated from risk behaves differently than it would behave if it were fully exposed to the risk.
Conflict of Interest
occurs when an individual is involved in multiple interests, one of which could possibly corrupt the motivation for an act in the other.
The Profit Motive
American corporations on average run a net financial surplus of 1.7 percent of the gross domestic product -- a drastic change from the previous 40 years, when they had maintained an average deficit of 1.2 percent of G.D.P. More recent studies have indicated that companies in Europe, Japan and China are also running unprecedented surpluses. The reason for all this saving ... is that public companies have become obsessed with quarterly earnings. To show short-term profits, they avoid investing in future growth. To develop new products, buy new equipment or expand geographically, an enterprise has to spend money -- on marketing research, product design, prototype development, legal expenses associated with patents, lining up contractors and so on... Rather than incur such expenses, companies increasingly prefer to pay their executives exorbitant bonuses, or issue special dividends to shareholders, or engage in purely financial speculation. But this means they also short-circuit a major driver of economic growth.
Are Profits Hurting Capitalism? NYT, 7/6/2010
Kevin McGovern Cornell Entrepreneur of the Year 2007
Kevin McGovern Cornell Entrepreneur of the Year 2007
The fact of the matter is the better the agreement is up front the higher the probability of a successful relationship long term. The agreement should be in writing and you should iron out -- a shareholders agreement is a good, again, exercise in thinking through the issues, just like a business plan. What happens if somebody dies? What happens if somebody becomes disabled? What happens if they simply want to leave the business? Can they just leave and keep their shares? Is there a right of first refusal back for those shares? If somebody dies should the family continue to own the shares? Or should you buy back some part of it? All of those considerations are very important up front. Resolve them. A good lawyer, what he'll do is he'll give you his form so that you can think through it. There'll be no cost in the form. You can think through those issues, read through them, then come back to his office after you've thought it through as a team. Again, it's a good exercise in how you get along as partners, and you tell him how you want to modify his form. I mean that's a good way of doing it. But very important. Then there is the consideration of what kind of structure do you have initially, okay? And I'm a big proponent, you have to have a business entity. There are many different business entities: corporation, limited partnership, limited liability corporation. Why do you have to have one? Because all of those give you the benefit of insulating you from personal liability. And it's an insurance plan that's relatively inexpensive. To incorporate should be only hundreds of dollars, maybe a thousand dollars total legal fees etcetera and that's an insurance policy you have for the rest of your business career that you will not lose your home over this particular business venture. There are only a few ways that the law can pierce through that corporate veil and go after you personally and that's if you've been fraudulent, you set up that company just to not pay debts, or if you have a situation where it's the IRS or tax liability the government goes right through your corporation. So on that subject I must tell you, may sure you pay your withholding taxes for a corporation. Now you're paying payroll there's something you leave out, the 7%. If you're not paying that on a monthly basis to the IRS they will go after you personally. So you never, ever keep that money. You always pay that in. But back to legal structure. Once I've convinced you now you have to have a business structure the decision as to whether you want to be a normal corporation, which is known as a C corporation, a subchapter S corporation, which is basically an equivalent to a partnership because all the investors do not pay corporate tax, they only pay individual tax and all the income is allocated out to the partners or whether you do a limited liability company depends on a lot of tax issues and structuring issues which you don't want me to go through in this particular session. But yes, one of those forms. Limited liability corp., C corp. or subchapter S. Not a partnership. Where there's a partnership you have total liability in partnership. Not a proprietorship, that's where you've an individual. But in a partnership all the partners have individual liability and creditors can go right after you. A limited partnership has insulation. So it's a limited partnership, limited liability corporation, subchapter S or C corporation.
Partnership Corporation Hybrids
Limited Partnerships
A partnership with general partners (partners that contribute money and management, and are fully liable) and limited partners (partners that only contribute money and run only the risk of that investment); A corporate-like ownership structure that avoids double taxation; Partnership-like ownership structure that avoids unlimited and liability double taxation; Partnership-like ownership structure that avoids unlimited liability.
S Corporations
Limited Liability Companies
Limited Liability Partnership
Advantages and Disadvantages of LLCs
Advantages Limited liability Tax Pass-Through Simplicity and Flexibility in Management and Operation
No regular board meetings, less paperwork Any number of owners from anywhere
Disadvantages Medium Complexity of Formation Annual Franchise Fee Interstate heterogeneity Limits on Types of Firms That Can Form LLCs
Flexible Ownership
Franchises
+ Management & marketing ass't + Personal ownership + Recognized name + Financial advice & ass't + Lower failure rate - High start-up costs - Shared Profit - Management regulation - Coattail effects - Restrictions on selling - Fraudulent franchisors
Earl Blanks - PartyCity
Earl Blanks - PartyCity
I think that franchising is a strategy that is not looked at enough by people who are seeking to get into business for the first time, especially. A little history on franchising. About 42 percent of our retail sales in this country are generated through franchises. They employ over 10 million people. That is about 10 times the number of employees of Wal-Mart, which is our biggest retailer. So they are very important in the landscape. One of the big benefits I believe they give to people who are starting business for the first time, and maybe minority-owned businesses, is that they give them a proven format for entering the market. One of the things I discovered at Procter & Gamble as we talked earlier, and one of the reasons for their tremendous success is that they understand their markets. They research their markets. They test things in market. And this requires a lot of time and effort to build a brand. To build awareness. In a franchise, you are buying that already. You're going with something that has already been tested because if they had not had some experience with it in some part of the country, they would not be selling it to someone to - as a franchise. So you have the opportunity to go and understand how that business has worked. And it comes out in the numbers. The numbers indicate that 94 percent of franchises are in existence five years after they have been started. That compares with only 18 percent of businesses that are started from scratch. So it's a wonderful opportunity to get in a market and to build value and ownership of a business, of an asset. In addition to being able to hire employees. I think it's a wonderful strategy for minority owned businesses. And for small businesses.
Criticisms of the Corporate Form
"...the corporation is a psychopath. Like all psychopaths, the firm is singularly self-interested: its purpose is to create wealth for its shareholders. And, like all psychopaths, the firm is irresponsible, because it puts others at risk to satisfy its profit-maximising goal, harming employees and customers, and damaging the environment. The corporation manipulates everything. It is grandiose, always insisting that it is the best, or number one. It has no empathy, refuses to accept responsibility for its actions and feels no remorse. It relates to others only superficially, via make-believe versions of itself manufactured by public-relations consultants and marketing men. In short, if the metaphor of the firm as person is a valid one, then the corporation is clinically insane... Through their psychopathic pursuit of profit, (corporations) make good people do bad things."
Review of the documentary "The Corporation", The Economist, 5/6/2004
CORPORATION, n. An ingenious device for obtaining individual profit without individual responsibility.
Ambrose Bierce's Devil's Dictionary
Business Stakeholders
Stockholders Bankers Suppliers Government Employees Dealers and retailers Activists and environmentalists Community Customers Etc, etc, etc
Sustainability
Meeting the needs of the present generation without compromising the ability of future generations to meet their own needs. Brundtland Commission, 1987.
Corporate social responsibility
Refers to the comprehensive approach that a corporation takes to meet or exceed stakeholder expectations beyond measures of revenue, profit and legal obligation.
community investment, human rights and employee relations, environmental practices ethical conduct. Profits Environmental sustainability Social responsibility But, can it all be measured? And is the economy really so static?
The Triple Bottom Line
The B-Corporation
Operating as a Benefit Corporation Makes Room for Other Priorities
What is a 'benefit corporation'? A company whose charter allows the board to consider social or environmental objectives ahead of profits. What is the advantage? Protection from investor allegations of not maximizing shareholder value. Does that make it a nonprofit? No, a benefit corporation isn't a nonprofit nor is it tax exempt. How many states allow it? Seven. With bills introduced in four additional states. What are the downsides? 'For an investor, this is a terrible idea' due to lack of accountability, says Charles Elson, who teaches corporate governance at the University of Delaware. If management makes a bad decision, 'there's very little you can do about it as a shareholder.'
States Open Doors to 'Benefit' Firms
Benefit corporation laws passed
Maryland effective Oct. 1, 2010 Vermont effective July 1, 2011 New Jersey effective March 7, 2011 Virginia effective July 1, 2011 Hawaii effective July 8, 2011 California effective Jan. 1, 2012 New York effective Feb. 10, 2012
Benefit corporation bills introduced
Colorado Jan. 13, 2011 North Carolina Feb. 1, 2011 Pennsylvania Feb. 11, 2011 Michigan May 4, 2011
Source: B Lab and WSJ research
Cooperatives
A business owned and controlled by the people who use it producers, consumers, or workers with similar needs who pool their resources for mutual gain;
Eg. Greenstar Markets.
Over 100 million people are members of over 47,000 cooperatives in the U.S.A. Avoid
Uncommitted directors; "Dead-weight" members Lack of transparency Lack of enough capital
"Not-for-profit" organizations
Organization whose primary objective is to support some issue or matter of private interest or public concern for non-commercial purposes; Main characteristics (US)
No profits, profit distribution or stock issuance; Does not pay taxes; Monetary contributions to not for profit organizations are not included in taxable income.
501-c3 section of the US tax code.
The Stakeholder Corporation and CSR: a critique
There is one and only one social responsibility of business-to use its resources and engage in activities designed to increase its profits so long as it stays within the rules of the game, which is to say, engages in open and free competition, without deception or fraud.
Milton Friedman Nobel laureate
Take Aways
There are many ways to organize a business. In terms of flexibility and ability to grow, the corporation form is the most successful form of organization in the U.S. economy. The corporate form of organization creates conflicts of agency and social allocation of resources. Business obtains resources and legitimacy from society, and it is therefore responsible to it.