Business formation

Subject: Economics
Pages: 5
Word count: 1333
Save this page for later by
adding it to your bookmarks
Press Ctrl+D (Windows)
or Cmd+D (Mac OS)
Text
Sources

A partnership is a business agreement between two or more people or professionals to finance and operate a business. The partners basically work together in running the business and consequently share in the business profits and losses (Kimmel et al, 2011).

Partnership form of a business is basically of two types.

General partnership

This is an ownership entity whose all the members are general partners and hence have equal rights to share in the management duties and responsibilities unless the partners specifies otherwise in their partnership agreement.

Limited partnership

This on the other hand, is a legal ownership entity that is made up of at least one general partner and one or more limited partners.  Here, the partner is basically financially liable for its own investment only and will not be legally liable for the acts of other partners (Dlabay & Burrow, 2007).

Generally this form of a business has many advantages and disadvantages.

Advantages (Dlabay & Burrow, 2007)

  • Partnerships are relatively easy to form because it requires no costs or formalities particularly in the case of general partnership.
  • A partnership is a pass-through tax entity. The partners therefore reports information to tax authorities on the income for the partnership but however does not pay taxes. It files a tax return as a reporting function only hence all the losses and gains from the business’s operations are reported on the tax returns of the individual partners.
  • There is increased ability to raise funds because it has more than one partner who can contribute more funds and also through increased borrowing capacity because of many partners.
  • Coming together of two or more the partners provide them with wider pool knowledge, contacts and skills hence they benefit from the combination of these complimentary abilities.
  • It is cost-effective because different partner specializes in different aspects of the business.
  • Provides moral support hence allows for more creative brainstorming on the part of the partners.
  • Attracts prospective employees to the business if they are given the incentive to become partners too.
  • Minimal reporting requirements.
  • The partners shares in the staffing/management responsibilities.
  • Relatively easy to exit or dissolve and recover you shares, initial investment.
  • Partners share in the business losses.

Disadvantages (Pride et al, 2012)

  • The business profits are shared amongst the partners.
  • The sharing of the decisions may lead to disagreements.
  • The business partners are basically liable, both individually and jointly, for other partner’s actions. Further, they are liable in full for the partnership’s outstanding debts regardless of the amount they have invested in the business.
  • It has a finite or limited life because it can be dissolved any time upon the death or withdrawal of a partner.
  • There is delayed decision making because all the partners need to consult with each other.

Corporation

This is a type of business organization which is registered formally as a public owned hence it is basically recognized as a separate legal entity from the owners (Pride et al, 2012).

Advantages (Pride et al, 2012)

  • Raising additional capital is basically easy particularly through the stock market.
  • It is a separate legal entity hence has a perpetual existence.
  • The change of ownership or death cannot affect the company while it only dissolves when it is liquidated.
  • It has a limited liability; owner’s liabilities towards their creditors are only limited to their investment. In the liquidation and the assets of the company are not enough to meet the liabilities, owners are not required to contribute anything. It is only their contribution that is at stake and not their personal assets.
  • There is easy transfer of ownership because the share certificates are easily transferable.
  • It employs a qualified operational structure. Shareholders are just owners and not managers. They however, require a qualified staff to manage the business.
  • An owner who is employed in the business is given some reimbursement.

Disadvantages (Dlabay & Burrow, 2007)

  • Requires more legal formalities to form.
  • More expensive to form than the partnership.
  • Has no option of pass-through taxation. This leads to double-taxation because the corporate income is taxed and the dividend paid out to the shareholders is again taxed.
  • It has agency problem, the conflict of interest may exist between the shareholders and managers.
  • It has a complex establishment process and also requires registration basically with the central regulatory authority.
  • It has a number of requirements to comply with particularly for it to be listed on a stock exchange. These requirements relate to number of directors, amount of capital, to name just a few.
  • It leads to loss of control of the business because shareholders appoint a board of directors who then employee management.

Based on the above advantages and disadvantages of each form of a business, I would recommend the partnership form of a business ownership because it has more advantages than the corporation one.  In the case of partnership, the partners need not to register with the state and pay hefty fees unlike corporations that demands registration and have hefty fees in the form of attorney fees, various governmental fillings fees, franchise tax prepayment for the first year, and fees paid to file the articles of incorporation. Further, partnerships have an option pass-through taxation unlike corporations which lead to double taxation. However, the partners need to go into business with partners they can completely trust and prepare a binding partnership agreement to help so that the partners can act in a more responsible manner to reduce inherent liabilities (Kimmel et al, 2011).

Differences between debt and equity financing

Debt financing is a type of financing which involves borrowing of money by the business in the form of a loan from banks and other financial institutions while equity financing basically involve issuing of additional stock to investors to provide the needed capital in exchange for shares in the business ownership (Pride et al, 2012).

Debt financing allows the business to retain full ownership of the company while equity financing basically distribute ownership to the stockholders. Debt financing allows the company to repay the money plus the accrued interest while equity financing requires them to distribute part of the profit to the stockholders (Dlabay & Burrow, 2007).

Debt financing has a repayment obligation on the part of the company because they have to repay the interest costs hence face some degree of risk. Equity financing on the other hand, have no repayment obligations on the part of the company and hence the risks fall on the shareholders (Kimmel et al, 2011).

Because of the above, the partners should therefore opt for the debt financing option.  Firstly, dent financing will allow them to retain the control of the business basically because ownership stays on their hands.  Further, taking the loan builds the business credit which is basically good for the business future borrowing and for insurance rates. In addition, the paid interest is tax deductible which somewhat softens the blow of repayment. Finally, the lender has no say in the way the business is run.

Even though debt financing lowers net income and consequently earnings per share because of the interest expense (finance cost) paid, the partner’s tax will be reduced in return because interest expense is tax deductible.

Effects of debt and equity on net income, earnings per share and tax

Debt Equity
Interest paid=8.%% * 1400000= $119000 Number of shares=initial issue+new issue
(20000*3) +140000= 200000
EBIT 500000 EBIT 500000
Interest expense 119000 deduct: interest expense 0
profit before tax 381000 profit before tax 500000
Deduct: tax (34%) 129540 Deduct: tax (34%) 170000
net income 251460 net income 330000
EPS=251460/(20000*3)= 4.191 EPS= 330000/200000= 1.65

From the above computations, the effects of debt and equity on net income, tax and EPS are eminent. First, debt financing decreases net income, increases earnings per share (EPS) and lowers tax amount. However, equity financing, increases net income and tax and lowers EPS because the number of shares have increased despite the increase in net income.

They should therefore issue a debt to pay less tax and have high earnings per share (EPS).

Did you like this sample?
  1. Dlabay, L. R., & Burrow, J. (2007). Business finance. Mason, Ohio: South Western.
  2. Kimmel, P. D., Weygandt, J. J., & Kieso, D. E. (2011). Accounting: Tools for business decision making. Hoboken, N.J: Wiley.
  3. Pride, W. M., Hughes, R. J., & Kapoor, J. R. (2012). Business. Mason, OH: South-Western Cengage Learning.
  4. Willis, D. O. (2013). Business basics. Ames, Iowa: Wiley-Blackwell. (Pride et al, 2012).
Find more samples:
Related topics
More samples
Related Essays