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Chapter 13

COMM200 Chapter 13.docx

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Queen's University
COMM 200
Gary J Bissonette

COMM200 Readings – Week Jan 20 Chapter 13 INTRODUCTION TO CAPITALAND FINANCIALMARKETS Business Ownership Options - Key initial decision in formation of business: type of legal structure utilized to commence business operations o Five main factors influence final outcome of this decision:  1) Ease of business set-up and operation • How easy it is to get a business up and running • Various government regulations and required “fillings” associated with a particular legal structure  2) Degree of control which an owner(s) desire(s) • The degree of ownership and level of decision-making authority which an individual, or individuals, desire within the business operation  3) Magnitude of risk an individual(s) is/are willing to take on • The level of financial, operational, and legal liability which an individual is willing to accept in owning and operating a business  4) Capacity of an individual(s) to provide the financial needs required • The financial resources which an individual(s) has access to in order to invest in commencing business operations and support ongoing cash requirements  5) The anticipated skills required for success • Arequired skills analysis evaluates the degree of expertise needed to successfully manage the business - Using these factors as a base for decision-making, individuals can form their business under one of three legal structures: o Sole Proprietorship o Partnership o Corporation - Commencing with one legal structure does not inhibit the ability of an individual to change the business structure in the future o As the needs of an organization change, or the level of risk magnifies, the need to adjust the business operation’s legal structure may be in the best interests of all those involved Sole Proprietorships - Sole Proprietorship: the commencement of a business by a single individual o No real creation of a separate legal business entity; the individual and the business are the same - COMMENCEMENT: o Generally takes place by registering your business and paying the required registration fee o Debts of business = debts of owner; income of business = personal income of owner - Key advantage: o The sole proprietor has 100% control of the business, with regards to ownership and in making decisions relating to the business - Key risk issue: o 1) Sole proprietor is 100% personally exposed to the liabilities incurred by the business organization o 2) The skill set of the business is limited to the skills possessed by the sole proprietor o 3) SP’s are limited to their own personal capacity to invest and/or borrow money - FACTORANALYSIS: o Ease of set-up: generally requires little more than registering business name; adv o Degree of control: 100% ownership and full-decision making control; adv o Magnitude of risk: unlimited personal liability for risks associated with business; con o Financial capacity: limited to financial resources of proprietor; con o Skills required: limited to skill set and business competencies of proprietor; con Partnerships - Partnership: a business organization formed by two or more individuals o don’t have to have a partnership agreement to commence a business partnership in CA o creating one, however, ensures that the expectations of each partner and the details of how the partnership is going to work, are fully understood by all partners involved o this PAoutlines the % of ownership attributed to each partner - Same with SP, partnerships aren’t separate legal entities when it comes to liability and taxation (and income) o Business income/losses pass through the Partnership and are reported on each partner’s personal income tax return; if can’t pay liabilities than becomes personal obligations o Joint and Several Liability: means each partner could be liable for the total debts of the Partnership if other partners are unable to pay their portion of the partnership’s obligation - ADVANTAGE: o Commencing in PAallows partners to jointly share risk and contribute dollars needed to fund the business = increased financial capacity; also combined skills and competencies - CONCERN: o Sharing of ownership and decision-making control; differences of opinion can occur  To protect from discord of this type, many PAinclude a buy-sell agreement - FACTORANALYSIS: o Ease of Set-up: easy to set up, but development of PA(highly recommended) may result in time delay and legal fees likely ensue; still ADV o Degree of Control: ownership and decision-making control divided among partners, in accordance with PA; CON o Magnitude of Risk: unlimited personal liability (joint and several) for risks associated with business; CON o Financial Capacity: capacity expanded to include capabilities of partners; ADV o Skills required: combined;ADV Limited Liability Partnership (LLP) - Apartnership made up of both general partners (at least one) and limited (passive) partners o Limited partners: individuals who contribute equity capital (money in exchange for % of ownership) to organization but are not actively involved in mgmt. of business operation and have minimal control over daily business decisions  The general partner(s) assume full liability exposure on behalf of the partnership Corporations - Corporations: creates a distinct legal entity separate from its owners; established through incorporation o Incorporation can be done provincially or federally allowing the business to legally operate respectively in a province or throughout Canada - INCORPORATING FEDERALLY: o Key advantage:  Able to use the same business name in all provinces o However, it is also more expensive to set up, requires additional paper work and there are requirements associated with corporate governance  Board of directors will need to be established, offices of the corporation elected, minutes of meetings kept, and resolutions associated with business decisions approved and documented - Why incorporate if it is much easier/cheaper to open a sole proprietorship or partnership? o 1) The liabilities of the corporation do not automatically transfer to the owners in the event that the corporation is unable to pay its bill o 2) Ownership rights are clearly defined and based on the percentage of stock owned by its owners o 3) The ability to issue shares of stock, as a means of raising additional cash (capital) for the business organization, is unique to the corporation o 4) Business organizations need to be incorporated in order to be eligible for many federal government programs and take advantage of tax incentives relating to capital gains exemptions and small business deductions o 5) Corporate tax rate may also result in a lower total tax obligation than for other structures - Disadvantages: o Incorporation requires filing of a tax return and then including income received from the corporation (dividends) by its owners on their personal income tax return where it could be subject to additional taxation - FACTORANALYSIS: o Ease of set-up: cumbersome to set-up; CON o Degree of control: ownership based on the percentage of shares in the corporation owned by an individual; CON o Magnitude of risk: As the corporation is a separate, legal entity, the liabilities of the corporation are limited to the corporation itself; ADV o Financial Capacity: Financial resource capacity is expanded; can issue shares of stock to raise capital; can also borrow money; ADV o Skills required: Skill set and business competencies expanded to include the capabilities of all shareholders, and/or a professional mgmt. team; ADV - TWO MAIN TYPES OF CORPORATIONS: o 1) Private Corporations  Business organizations whose ownership is privately held • Means the shares of the corporation aren’t publicly traded and aren’t available to the general public for purchase • As a private corporation, the selling of the shares would be a private transaction between the current owner of the shares and a potential purchaser • More difficult to establish a price for shares and the selling of these shares o 2) Public Corporations  Corporations whose shares of stock are initially issued via an Initial Public Offering (IPO) and whose shares of stock are then trade on at least one stock exchange or are publicly available in the over-the-counter market (OTC) • Issued shares are ‘publicly held’ • Share values are set as the result of daily trading activity by the public • PCs also have significantly more regulatory and periodic information filing requirements to abide by; these requirements are set by the securities commission overseeing the exchange which the company is trading its shares on Business Evolution - For many, commencing business operations is easiest via the establishment of a Sole Proprietorship - As the business grows, its cash requirements and potential liability exposure may necessitate a different legal structure - Thus, as business owners/managers, must continually be aware of the financial capacity of the business, the liability exposure, risks being incurred, and the skill sets necessary for success Funding the Organization - One of the core responsibilities of a manager: assess the financial resource requirements of an organization and determine how those needs are going to be met o Means managers need to:  review the capital structure of their organization  make financing decisions for operations  decide on the use of the difference sources of funds it has at its disposal - key component of this analysis: managing the debt/equity ratio Sources of Funds - 1) Funds derived from operations - 2) Funds obtained via credit facilities (Debt) - 3) Funds obtained via equity financing Funds Derived From Operations - Two internal sources of funds: o Current-Year Operating profits o Retained Earnings Current-Year Operating Profits - Current-year operating profits: The excess dollars which organizations have generated, and have at their disposal, during the current operating period as a result of their business activities after their current expense obligations have been paid o Total Revenue – Total Operating Expenses Retained Earnings - Retained Earnings: dollar amount of net earnings an organization has accumulated over the history of its operations and which it has chosen to hold within the organization (not pay out to investors/shareholders o This becomes a source of funds to draw upon in the event of operating losses during a given period or if additional investments need to be made into the organization (growth, R&D etc.) o Can also be used to compensate for operating losses occurring in a given year - CAUTION: o Although Retrained Earnings = source of capital, managers still need to view cash position of the company to be sure the dollar amount identified in retained earnings is still available to the organization in a liquid form Credit Facilities (Debt Financing) - Credit facilities: debt which an organization has taken on in support of its business activities o Essentially the organization borrows money or receives products/services on a credit basis from elsewhere - Characteristics: o There are repayment terms -> may include an obligation to pay interest on money borrowed - Two debt categories: o Short-term credit facilities o Long-term credit facilities Short-Term Credit Facilities - Refers to debt obligations which an organization takes on for a short period of time, generally one year or less o Typical categories include:  1) Trade credit [when the org. orders products or services from another organization, but payment is deferred (accounts payable)]  2) Borrowing against the organization’s future flow of accounts receivables/line of credit • Line of Credit: credit facility which gives the organization immediate access to a pre-determined sum of m
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