Sole Proprietorship and Business Term Paper

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Knowledge Integration Project

1A) Business owners must take a number of different factors into account when determining the form of business. They have to consider the sources and types of risk that the business takes, if there will be employees, and considerations about raising capital or splitting ownership, which can be quite a complex issue depending on the business. In addition, whether there will be any employees matters. Each jurisdiction has its particular issues, so where the business is situated might be a role in the decision. Certainly, the tax implications of the decision are going to be relevant. In some cases, the cost and ease of setting the entity up might matter -- though such costs can easily be outweighed by liability risks for most businesses.

1B) A sole proprietorship is easy to start, which is its main advantage. Because of that it is mainly a suitable form for someone in business for themselves, with no employees, and with limited risk. The sole proprietorship has flow-through taxation, so is taxed at the personal rate, which can be good or bad depending on income and location. Further, if the business is a side business, it can be a write-off against the proprietor's other income while they are not earning in the early stages, so sole proprietorship's tax implications are advantageous.

Sole proprietorships have a high level of liability, however, and usually the proprietor will need to have insurance to cover this. It is difficult for a sole proprietorship to raise capital, so it most suitable for businesses that have no real possibility of expansion. For this reason a sole proprietorship is usually a one-person business, such as an artisan or tradesperson. Some sole proprietorships will eventually convert to another business form if the proprietor sees growth potential, but during the one-person stage the simplicity of the form is usually preferred.

Partnerships also have flow through taxation, the merits of which depend on the situation. Partnerships are able to be fairly flexible in how ownership is split, and terms can be customized in the partnership agreement. Partners also take on full legal risk of the entity. For some types of businesses, this ends up being a benefit -- for example at a law firm the partners are basically sharing risk associated with practice, which is beneficial to them, and one of the reasons they are selective about who is made partner. Partnerships do not necessarily limit growth -- they have difficulty raising capital, but partnerships are often unwound and reformed when partners leave or are added.

Corporations have the most flexibility. While they are the most complex and costly entity to establish, they have the benefit of having limited risk -- the liability for a corporation typically only extends as far as the investment a person makes in it. This form is a unique legal entity, and as such has the easiest time raising capital. The corporate form makes it easier to share ownership. Corporations are taxed on their earnings, which is usually at a lower rate than individual taxes, but this comes at a cost because any time dividends are paid or capital gains won, those are also taxed, so corporate earnings are taxed twice. There are different types of corporations, too, including those that have flow-through taxation (S corporations). The S. corporation form is for small, closely-held firms, and there are rules regarding what can and cannot be an S. corporation.

Limited liability forms are interesting. They have no tax implication at the federal level, so the business has to have some other form of organization (usually a corporation). But they do allow for limited liability. Legal firms tend to be legal liability partnerships (LLP), for example, where the liability is different than in a traditional partnership. A

1C) Collegiate Code is a classic example of a corporation. The business has scalable potential, which means that the benefits of incorporating are going to be needed. First, the company is going to want to hire people, which all but rules out the logic of a sole proprietorship. The partnership format makes governance more difficult because the partners each will have their degree of power-sharing. Further, as the business grows it might need to raise capital, and that will be much easier as a corporation. So the underlying logic is entirely that this company should be a corporation, to allow for easier scaling and the ability of the owners to have the right degree of control over the business.

There is no second-best here. I do not see S. corporation as viable here because of the need for Collegiate Code to have access to capital.

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That form of closely-held corporation with flow-through taxation is more appropriate for a small, stable, family-run business. Any company with strong upside potential will not be able to maintain S. corporation status for too long in its growth stage. Only if the company is not genuinely thinking growth beyond a few shareholders should it consider this form -- it is a poor second choice for Collegiate Code, in my opinion. The other forms, sole proprietorship and partnership, and entirely inappropriate.

I do not understand the question about constraints. There are no constraints to incorporating -- if they cannot afford to incorporate then they simply do not have enough money to start the business. The issues here are the ability to raise capital, which they need to maintain, and liability, which they need to minimize. Even if only one person owns Collegiate Code, incorporation is the only logical choice to minimize risk and gain access to capital in the future. I have no idea what inheriting the business has to do with anything -- when you're starting a business the first thought should probably be making sure it gets off the ground, not daydreaming about the day junior takes over. Putting the cart before the horse is not good business practice -- do what is right for the foreseeable future, build a viable business, and worry about succession planning later.

1D) The real life focus is on growing revenue. This is critical because revenue drives the business, and without sales, there is no business in the early stages. The company will become non-viable quickly. And that is regardless of what the business's cost structure is. Cutting costs is not necessarily part of the plan -- a lot of companies invest heavily without concern for costs because there is a business case for growing the business as rapidly as possible. Companies like Amazon or Tesla did not focus on cutting costs because of the need for first-mover advantage and the realization that building share in a new business is actually more important than turning a profit in the short run, because of how share influences long-run profit. But revenue -- that is important because that's what keeps the lights on.

It is important to gain a basic understanding of the choices of business organization, even before launching, because of the issues of capital and liability. Those are critical factors even for very young businesses, and should be resolved prior to launch ideally to protect the owner and to best position the entity for growth. There may be situations where a sole proprietorship or partnership is good initially, but once an idea proves viable and expansion beyond the initial proprietors is planned, the business should be incorporated so as to take advantages of the liability and capital benefits of the corporate form.

Question 2:

2A) The duties of a corporate officer in general are to increase shareholder value. How that is framed is up to the Board, for example to emphasize short-term or long-term returns. In general, long-run returns are preferred. Shkreli did not conform to those duties and obligations. Raising the price surely gave the company a short-term bump in profit, but also attracted the attention of regulators and garnered the company negative attention. Competitors might enter the market because the opportunity became well-publicized. Shkreli's actions did not conform to building long-run shareholder value, only short-run.

2B) The directors of the company are loyal to the shareholders. Their obligations are to ensure that management is acting in the best interests of the shareholders. This usually means focusing on building shareholder wealth, in particular earning returns that are positive on a risk-adjusted basis.

The Board of Valeant carried out their obligations by forcing the resignation of Pearson, but there's a caveat to that. If this was his standard operating procedure, then they should have hired him in the first place. However, the question was about his dismissal and that was the right move. Essentially, what Valeant did with Seconal was "common practice" but ultimately it was a move that could attract the attention of Congress. There are significant long-run risks of raising the ire of Congress, up to and including laws that curtail the ability of companies to do this in the future. Further, attracting public attention to a controversial issue like assisted death is not going to sit….....

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