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CHAPTER

8 The Organizational Plan: Teams, Legal

Structures, Alliances, and Directors

LEARNING OBJECTIVES

By studying this chapter, you should be able to… 8-1 Describe the characteristics and value of a strong management

team. 8-2 Explain the common legal forms of organization used by small

businesses. 8-3 Identify factors to consider in choosing among the primary legal

forms of organization. 8-4 Discuss the unique features and restrictions of six specialized

organizational forms. 8-5 Understand the nature of strategic alliances and their uses in

small businesses. 8-6 Describe the effective use of boards of directors and advisory

boards.

8-1 BUILDING A MANAGEMENT TEAM (slide 1 of 2)

• Management team – Managers and other key persons who give a company its general direction. • In general, the management team consists of individuals with

supervisory responsibilities, as well as nonsupervisory personnel who play key roles in the business.

• Investors consider the quality of a new venture’s management to be one of the most important factors in decisions to invest.

• One reason that a management team often can bring greater strength to a venture than an individual entrepreneur can is that a team can provide a diversity of talent to meet various managerial needs.

• In addition, a team can provide greater assurance of continuity, since the departure of one member of a team is less devastating to a business than the departure of a single owner.

• The competence required in a management team depends on the type of venture and the nature of its operations.

8-1 BUILDING A MANAGEMENT TEAM (slide 2 of 2)

• In many cases, a startup owner stacks the management team with family and friends, rather than seeking balanced expertise. • The upside to this is that:

• The owner knows these people well and trusts them. • They often work for less compensation. • They are more likely to make personal sacrifices to keep the

business alive. • The downside to this is that:

• The team can quickly become very homogeneous. • The team lacks complementary strengths. • The team entertains feelings of entitlement. • The team carries the baggage of family dysfunction into the

enterprise.

8-1a Achieving Balance

• Not all members of a management team need competence in all areas—the key is balance. • Example: If one member has expertise in finance, another

should have an adequate marketing background. • A diversity in perspectives and work styles enables the

completion of complex tasks. • A functionally diverse and balanced team will be more

likely to cover all the business bases, giving the company a competitive edge.

• A small firm can enhance its management by drawing on the expertise of competent insiders and outside specialists.

8-1b The Solo Startup Is Still an Option

• Despite the advantages of forming a team to start a business, The Wall Street Journal has reported that the number of small business owners who are choosing to go it alone is increasing significantly. • Research shows that 44 percent of successfully

funded startups are run by a single entrepreneur. • Emerging technologies make this option

increasingly manageable today.

8-1c Expanding Social Networks (slide 1 of 2)

• Management team members can connect the enterprise with a social network that provides access to a wide range of resources beyond the reach of individual team members. • Social network – An interconnected system of relationships

with other people. • Small business owners in the process of launching a

startup use their networks: • To access information or get advice. • To gain introductions to other people. • To obtain money, business services, physical facilities and

equipment, help with personal needs, and other forms of assistance.

8-1c Expanding Social Networks (slide 2 of 2)

• Social media tools can be very helpful in attracting customers, connecting with peers, and sharing advice about common problems.

• Small business owners are finding that they can use social media tools to build an active and robust social network to increase their social capital. • Social capital – The advantage created by an individual’s

connections within a social network. • The principle of reciprocation can be extremely helpful

in adding to whatever social capital you already have. • Reciprocation – A powerful sense of obligation to repay in

kind what another has done for or provided to us.

8-2 COMMON LEGAL FORMS OF ORGANIZATION

• The most basic forms of organization used by small businesses are the: • Sole proprietorship. • Partnership. • C corporation.

8.1 Forms of Legal Organization for Small Businesses

8.2 Percentage of Small Businesses by Legal Form of Organization

8-2a The Sole Proprietorship Option (slide 1 of 2)

• Sole proprietorship – A business owned by one person, who bears unlimited liability for the enterprise.

• Advantages: • An individual proprietor has title to all business assets. • He or she receives all of the firm’s profits. • Forming a sole proprietorship is the simplest and cheapest

way to start operation. • The owner holds title to all of the firm’s assets. • The owner is free from interference by partners, stakeholders,

and directors.

8-2a The Sole Proprietorship Option (slide 2 of 2)

• Disadvantages: • An individual proprietor is subject to the claims of creditors. • He or she must assume all losses, bear all risks, and pay all

debts. • The owner bears unlimited liability.

• Unlimited liability – Liability on the part of an owner that extends beyond the owner’s investment in the business.

• A sole proprietor is not an employee of the business and cannot benefit from the advantage of many tax-free fringe benefits, such as insurance and hospitalization plans.

• The death of the owner terminates the legal existence of the business.

8-2b The Partnership Option (slide 1 of 6)

• Partnership – A legal entity formed by two or more co-owners to operate a business for profit.

• Benefits: • Owners can set it up quickly, avoiding many of the legal requirements

involved in creating a corporation. • The workload, as well as the emotional and financial burdens of the

enterprise, are shared. • Management talent that might otherwise break the budget is gained. • Companionship is added to life in a small business.

• Potential problems: • The owners share unlimited liability. • Personal conflicts are common. • Decision making is more complicated because leadership is shared. • The owners must share their equity position in the business, which

dilutes the control of each partner.

8-2b The Partnership Option (slide 2 of 6)

CHOOSING A PARTNER • Any person capable of contracting may legally become

a business partner. • Individuals may become partners without contributing

capital or having a claim to assets if the decision is made to close the business down. • Such persons are partners only with regard to management

and profits. • Forming a partnership involves consideration not only of

legal issues but also of personal and managerial factors. • A strong partnership requires partners who are honest,

healthy, capable, and compatible.

8-2b The Partnership Option (slide 3 of 6)

• The following are suggestions for forming a partnership: • Choose your partner carefully.

• Goals, values, and work habits must be compatible, and skills should be complementary before committing to the deal.

• Team up with a person you can trust. • Be open, but cautious, about partnerships with friends. • Test-drive the relationship, if possible.

• Try more limited forms of business collaboration first. • Create a shared vision for the business.

• Before joining forces, discuss the expectations of all partners, planned division of work, anticipated vacation time, and the sharing of profits and losses.

• Prepare for the worst. • From the beginning, have an exit strategy.

8-2b The Partnership Option (slide 4 of 6)

RIGHTS AND DUTIES OF PARTNERS • A written partnership agreement should be drawn up before the

venture is launched. • Partnership agreement – A document that states explicitly the rights

and duties of partners. • Unless the articles of the partnership agreement specify

otherwise, a partner is generally recognized as having certain implicit rights. • Partners share profits or losses equally, unless they have agreed to a

different ratio. • These rights are also balanced against serious liabilities, such as

joint and several liability. • Joint and several liability – The liability of each partner resulting

from any one partner’s ability to legally bind the other partners.

8-2b The Partnership Option (slide 5 of 6)

TERMINATION OF A PARTNERSHIP • Death, incapacity, or withdrawal of a partner

ends a partnership and requires liquidation or reorganization of the business. • Liquidation often results in substantial losses to all

partners. • When one partner dies, loss due to liquidation may be

avoided if the partnership agreement stipulates that surviving partners can continue the business after buying the decedent’s interest.

• This option can be facilitated by having each partner carry life insurance that names the other partners as beneficiaries.

8-2b The Partnership Option (slide 6 of 6)

• When a partner decides to leave the business, the other partners should take several measures as part of a sound response plan: • Cut off the departing partner’s access to bank

accounts, physical facilities, and company assets to avoid loss or damage to equipment critical to the business.

• Quickly assess that partner’s role in the enterprise, and take steps to fill his or her shoes to get the business back to normal as soon as possible.

• Once these very pressing matters are under control, sort out any legal issues that remain.

8-2c The C Corporation Option (slide 1 of 6)

• Corporation – A business organization that exists as a legal entity and provides limited liability to its owners. • Legal entity – A business organization that is

recognized by the law as having a separate legal existence.

• This means that the corporation can file suit and be sued, hold and sell property, and engage in business operations that are stipulated in the corporate charter.

• In other words, a corporation is a separate entity from the individuals who own it, which means that the corporation, not its owners, is liable for the debts of the business.

8-2c The C Corporation Option (slide 2 of 6)

• C corporation – An ordinary corporation, taxed by the federal government as a separate legal entity.

THE CORPORATE CHARTER • To form a corporation, one or more persons must apply to the

secretary of state (at the state level) for permission to incorporate. • After completing preliminary steps, including payment of an

incorporation fee, the written application is approved by the secretary of state and becomes the corporate charter. • Corporate charter – A document that establishes a corporation’s

existence.

8-2c The C Corporation Option (slide 3 of 6)

• A corporation’s charter should be brief, in accordance with state law, and broad in its statement of the firm’s power.

• Details should be left to the corporate bylaws, which outline the basic rules for ongoing formalities and decisions of corporate life, including the following: • The size of the board of directors. • The duties and responsibilities of directors and officers. • The scheduling of regular meetings of the directors and shareholders. • The means of calling for a special meeting of these groups. • Procedures for exercising voting rights. • Restrictions on the transfer of corporate stock.

8-2c The C Corporation Option (slide 4 of 6)

RIGHTS AND STATUS OF STOCKHOLDERS • Ownership in a corporation is evidenced by shares of

stock owned by a stockholder. • An ownership interest does not confer a legal right to act for

the firm or to share in its management. • It does, however, provide the stockholder with the right to

receive dividends in proportion to the shares of stock owned, but only when the dividends are properly declared by the firm.

• Ownership of stock typically carries a preemptive right. • Preemptive right – The right of stockholders to buy new shares

of stock before they are offered to the public.

8-2c The C Corporation Option (slide 5 of 6)

LIMITED LIABILITY OF STOCKHOLDERS • Stockholders’ financial liability is restricted to the amount of

money they invest in the business. • Creditors cannot require them to sell personal assets to pay the

corporation’s debts.

DEATH OR WITHDRAWAL OF STOCKHOLDERS • Unlike a partnership interest, ownership in a corporation is readily

transferable. • An exchange of shares of stock is sufficient to transfer an ownership

interest to a different individual. • To prevent any negative repercussions from the death of a

majority stockholder, legal arrangements should be made at the outset to provide for management continuity by surviving stockholders and fair treatment of a stockholder’s heirs.

8-2c The C Corporation Option (slide 6 of 6)

MAINTAINING CORPORATE STATUS • To retain its standing as a separate entity, a

corporation must: • Hold annual meetings of both the shareholders and the board

of directors. • Keep minutes to document the major decisions of

shareholders and directors. • Maintain bank accounts that are separate from owners’ bank

accounts. • File a separate income tax return for the business.

8-3 CONSIDERATIONS IN CHOOSING AN ORGANIZATIONAL FORM

• The key factors in choosing an organization are: • The initial organizational requirements and costs. • The liability of the owners.

• Piercing the corporate veil – A situation in which a court concludes that incorporation has been used to perpetuate a fraud, skirt a law, or commit some wrongful act, and it removes liability protection from the corporate entity.

• The continuity of the business. • The transferability of ownership. • Management control. • Its attractiveness for raising capital. • Income tax considerations.

8.3 Comparison of Basic Legal Forms of Organization (slide 1 of 2)

8.3 Comparison of Basic Legal Forms of Organization (slide 2 of 2)

8-4 SPECIALIZED LEGAL FORMS OF ORGANIZATION

• The majority of small businesses use one of the three major ownership structures—the sole proprietorship, partnership, or C corporation.

• However, other specialized forms of organization are also used by small firms, including: • The limited partnership. • The S corporation. • The limited liability company. • The professional corporation. • The nonprofit corporation. • The B corporation.

8-4a The Limited Partnership

• Limited partnership – A partnership with at least one general partner and one or more limited partners. • General partner – A partner in a limited partnership who has

unlimited personal liability. • Limited partners – A partner in a limited partnership who is not

active in its management and whose liability is limited to his or her investment.

• If a limited partner becomes active in management, however, his or her limited liability is lost.

• To form a limited partnership, partners must file a certificate of limited partnership with the proper state office, as state law governs this form of organization.

8-4b The S Corporation

• S corporation (subchapter S corporation) – A corporation that offers limited liability to its owners and passes taxable income or losses on to stockholders.

• To obtain S corporation status, a corporation must meet certain requirements, including the following: • The corporation must be domestic. • The corporation can have no more than 100 stockholders. • All stockholders must be individuals or certain qualifying estates and

trusts. • Only one class of stock can be outstanding. • It must not be an ineligible corporation.

• Because an S corporation does not pay income taxes but instead passes taxable income or losses on to the stockholders, this allows stockholders to receive dividends from the corporation without double taxation on the firm’s profit.

8-4c The Limited Liability Company

• Limited liability company – A form of organization in which owners have limited liability but pay personal income taxes on business profits.

• A limited liability company can have an unlimited number of owners, or “members,” and these may include other limited liability companies and non-U.S. entities.

• This form differs from the C corporation in that it avoids double taxation. • Like S corporations, limited liability companies are not taxed but simply

pass their income on to their owners, who pay taxes on it as part of their personal income.

• Compared to most other forms of organization, the limited liability company is easier to set up, is more flexible, and offers some significant tax advantages. • Thus, according to many attorneys, the limited liability company is

usually the best choice for new businesses.

8-4d The Professional Company

• Professional corporation – A form of corporation that shields owners from one another’s liability and is set up for individuals in certain professional practices. • The term professional usually applies to those

individuals whose professions require that they obtain a license before they can practice.

• Examples: Doctors, chiropractors, lawyers, accountants, engineers, and architects.

8-4e The Nonprofit Corporation

• Nonprofit corporation – A form of corporation for enterprises established to serve civic, educational, charitable, or religious purposes; not for generation of profits.

• The IRS will not grant this option to a sole proprietorship or partnership.

• In the application process, the officers need to submit articles of organization that spell out and limit the range of activities of the enterprise.

• For a tax exemption to be granted, the organization must pass the organizational test. • Organizational test – Verification of whether a nonprofit organization

is staying true to its stated purpose. • A nonprofit corporation must establish a board of directors or

trustees to oversee its operations, and if it should dissolve, it is required to transfer its assets to another nonprofit corporation.

8-4f The B Corporation

• B corporation – A form of corporation that creates a positive social or environmental impact while maintaining high standards of transparency and accountability.

8-5 FORMING STRATEGIC ALLIANCES

• Strategic alliance – An organizational relationship that links two or more independent business entities in a common endeavor.

• Without affecting the independent legal status of the participating business partners, a strategic alliance provides a way for companies to improve their individual effectiveness by sharing certain resources.

• Alliances can take many forms. • Alliances provide a way for small businesses to become more

competitive: • By accessing another firm’s first-rate resources. • By expanding the market range for products or services offered. • By combining advertising efforts. • By reaching crucial economies of scale. • By sharing risks that might prove crippling if borne by a single small

company.

8.4 Most Popular Small Business Alliances by Type

8-5a Strategic Alliances with Large Companies

• Benefits: • The complementary skills and expertise of the partnered firms

can promote the competitive edge of both (or all) parties. • Forming an alliance with a large company may offer a boost to

status and market access. • Risks:

• The small company may be squeezed financially. • Partnering with a large firm may result in smothering

bureaucratic complications. • The parties’ strategic priorities may not mesh. • Large companies can wield enormous power over small

companies. • Some large firms have a track record of misbehavior as

partners.

8-5b Strategic Alliances with Small Companies

• About half of all small businesses maintain one or more strategic alliances with companies that are smaller or equal in size. • These partnerships have been found to be more

flexible, dedicated, creative, and understanding of the needs of small businesses.

8-5c Setting Up and Maintaining Successful Strategic Alliances (slide 1 of 2)

• An alliance strategy can be powerful for growing companies. • It spreads the risk of entering new markets. • It helps small players with unattractive balance sheets appear

stable to the end buyer. • It can provide a fast track to reaching the critical mass required

for pre-sale and post-sale support. • Working closely with other companies can also

introduce significant hazards. • Because alliance partners are in a unique position to learn

about your strategy and customer base, they can become competitors overnight.

• Thus, it is crucial to select partners with care and include an “easy out” clause in the contract, in case the alliance does not go well.

8-5c Setting Up and Maintaining Successful Strategic Alliances (slide 2 of 2)

• While strategic alliances often are not easy to set up, they can be even more difficult to maintain. • Entrepreneurs can improve their chances of

creating and maintaining a successful alliance by: • Establishing productive connections. • Identifying the best person to contact. • Being prepared to confirm the long-term benefits of the

alliance. • Learning to speak the partner’s “language.” • Ensuring a win-win arrangement. • Monitoring the progress of the alliance and making any

necessary changes.

8-6 MAKING THE MOST OF A BOARD OF DIRECTORS

• Board of directors – The governing body of a corporation, elected by the stockholders. • In entrepreneurial firms, the board of directors tends to be

small (usually five or fewer members). • The board chooses the firm’s officers, sets or approves

management policies, considers reports on operating results from the officers, and declares any dividends.

• Corporations are required by law to have a board of directors. • Research shows that smaller companies that appoint

entrepreneurs to their boards experience increased performance along multiple dimensions.

8-6a Selection of Directors

• An entrepreneur who is attempting to assemble a cooperative and experienced group of directors needs to consider the value of an outside board. • Objectivity is a valuable contribution of outside directors.

• They can look at issues more dispassionately than can insiders who are involved in daily decision making.

• The nature and needs of a business help determine the qualifications required in its directors.

• After deciding on the qualifications to look for, a business owner must seek suitable candidates as board members. • Effective directors are honest and accountable, offer valuable

insights based on business experience, and enhance the company’s credibility with its stakeholders.

8-6b Contributions of Directors

• Boards of directors can assist small businesses by offering objective counsel and assistance to their chief executives.

• Directors can fill gaps in the expertise of a management team and monitor its activities.

• An active board of directors serves management by: • Reviewing major policy decisions. • Advising on external business conditions and on proper

reaction to the business cycle. • Providing informal advice from time to time on specific

problems that arise. • Offering access to important personal contacts.

8-6c Compensation of Directors

• The compensation paid to board members varies greatly, and some small firms pay no fees at all.

• If compensation is provided, it is usually offered in the form of an annual retainer, board meeting fees, and pay for committee work (evaluating executive compensation, nominating new board members, and overseeing the work of the company’s auditors). • Annual retainers for board work typically range from $5,000 to $10,000,

and board meeting fees can run from $500 to $2,000 per meeting. • These costs are usually in addition to reimbursements for travel

expenses related to board meetings and the financial burden of providing directors and officers liability insurance, which protects board members if they should be sued in the course of carrying out their duties as directors.

• Sometimes, board members are also given a small percentage of the company’s profits as a bonus for their participation.

8-6d An Alternative: An Advisory Board

• Some individuals are reluctant to join a board of directors because outside directors may be held responsible for harmful or illegal company actions, even though they are not directly involved in wrongdoing. • Thus, many small companies use an advisory board

as an alternative to a board of directors. • Advisory board – A group that serves as an alternative to

a board of directors, acting only in an advisory capacity. • In other words, it has no legal authority over the owner or the

company.

Key Terms advisory board B corporation board of directors C corporation corporate charter corporation general partner joint and several liability legal entity limited liability company limited partners limited partnership management team nonprofit corporation

organizational test partnership partnership agreement piercing the corporate veil preemptive right professional corporation reciprocation S corporation (Subchapter S

corporation) social capital social network sole proprietorship strategic alliance unlimited liability

�CHAPTER�8��The Organizational Plan: Teams, Legal Structures, Alliances, and Directors
LEARNING OBJECTIVES
8-1 BUILDING A �MANAGEMENT TEAM (slide 1 of 2)
8-1 BUILDING A �MANAGEMENT TEAM (slide 2 of 2)
8-1a Achieving Balance
8-1b The Solo Startup �Is Still an Option
8-1c Expanding Social Networks (slide 1 of 2)
8-1c Expanding Social Networks (slide 2 of 2)
8-2 COMMON LEGAL �FORMS OF ORGANIZATION
8.1 Forms of Legal Organization for Small Businesses
8.2 Percentage of Small Businesses by Legal Form of Organization
8-2a The Sole Proprietorship Option (slide 1 of 2)
8-2a The Sole Proprietorship Option (slide 2 of 2)
8-2b The Partnership Option (slide 1 of 6)
8-2b The Partnership Option (slide 2 of 6)
8-2b The Partnership Option (slide 3 of 6)
8-2b The Partnership Option (slide 4 of 6)
8-2b The Partnership Option (slide 5 of 6)
8-2b The Partnership Option (slide 6 of 6)
8-2c The C Corporation Option �(slide 1 of 6)
8-2c The C Corporation Option �(slide 2 of 6)
8-2c The C Corporation Option �(slide 3 of 6)
8-2c The C Corporation Option �(slide 4 of 6)
8-2c The C Corporation Option �(slide 5 of 6)
8-2c The C Corporation Option �(slide 6 of 6)
8-3 CONSIDERATIONS IN CHOOSING AN ORGANIZATIONAL FORM
8.3 Comparison of Basic Legal Forms of Organization (slide 1 of 2)
8.3 Comparison of Basic Legal Forms of Organization (slide 2 of 2)
8-4 SPECIALIZED LEGAL �FORMS OF ORGANIZATION
8-4a The Limited Partnership
8-4b The S Corporation
8-4c The Limited �Liability Company
8-4d The Professional Company
8-4e The Nonprofit Corporation
8-4f The B Corporation
8-5 FORMING STRATEGIC ALLIANCES
8.4 Most Popular Small Business Alliances by Type
8-5a Strategic Alliances �with Large Companies
8-5b Strategic Alliances �with Small Companies
8-5c Setting Up and Maintaining Successful Strategic Alliances (slide 1 of 2)
8-5c Setting Up and Maintaining Successful Strategic Alliances (slide 2 of 2)
8-6 MAKING THE MOST OF A BOARD OF DIRECTORS
8-6a Selection of Directors
8-6b Contributions of Directors
8-6c Compensation of Directors
8-6d An Alternative: �An Advisory Board
Key Terms