Chapter 9

The Organizational Plan

Hisrich
Peters

McGraw-Hill/Irwin Copyright 2010 by The McGraw-Hill Companies, Inc. All rights reserved. Shepherd
Developing the Management Team
Investors demand that the management
team not operate the business as a part-
time venture.
It is assumed that the management team is
prepared to operate the business full time
and at a modest salary.
An attempt to draw a large salary out of the
new venture may be perceived as a lack of
commitment to the business.

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Legal Forms of Business

Three basic legal forms of business:

Proprietorship - Single owner, unlimited liability,
controls all decisions, and receives all profits.
Partnership - Two or more individuals having
unlimited liability who have pooled resources to
own a business.
Corporation (C corporation) - Most common
form of corporation; regulated by statute;
treated as a separate legal entity for liability and
tax purposes.

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Legal Forms of Business (cont.)

New forms of business formations:

Limited liability company (LLC).
Limited liability partnership (LLP).
S corporation.

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Table 9.1 - Three Forms of
Business Formation

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Table 9.1 - Three Forms of
Business Formation (cont.)

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Table 9.1 - Three Forms of
Business Formation (cont.)

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Tax Attributes of Forms of Business

Tax Issues for Proprietorship

IRS treats business as the individual owner; not
regarded as a separate tax entity.
All income appears on owners return as
personal income.
Tax advantages:
No double tax when profits are distributed to owner.
No capital stock tax or penalty for retained earnings.
Tax Issues for Partnership (general)
Tax advantages and disadvantages similar sole
proprietorship.
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Tax Attributes of Forms of Business
(cont.)

Tax Issues for Partnership (limited)

Has the advantage of limited liability.
Treated the same as the LLC for tax purposes.
Tax Issues for Corporation:
Can take many deductions and expenses not
available to proprietorship or partnership.
Distribution of dividends is taxed twice.
Double taxation can be avoided if income is
distributed to entrepreneur(s) in the form of
salary.

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Table 9.2 - Tax Attributes of
Various Legal Forms of Business

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Table 9.2 - Tax Attributes of
Various Legal Forms of Business (cont.)

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Table 9.2 - Tax Attributes of
Various Legal Forms of Business (cont.)

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The Limited Liability Company
Versus S Corporation
Venture capitalists prefer LLCs as a form of
business entity.
A new regulation allows LLCs to be taxed as
a partnership.
The S corporation was the most popular
choice of organization structure by new
ventures and small businesses.
Growth rate of S corporations has leveled
off mainly because of the wide acceptance
of LLCs.
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S Corporation

A special type of corporation where profits are

distributed to stockholders and taxed as
personal income.
The Small Business Protection Act of 1996
reduced some restrictions.
In 2004, Congress responded to criticisms of
the restrictions on S corporations as compared
to LLCs.
Intent was to make the S corporation as
advantageous as the LLC.
Status of the S corporation must be monitored
and maintained.
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S Corporation (cont.)

Advantages of an S Corporation
Capital gains or losses are treated as personal
income or losses.
Limited liability protection.
Not subject to a minimum tax.
Transfer of stock to low-income-bracket family
members
Stock may be voting or nonvoting.
Cash method of accounting.
Corporate long-term capital gains and losses are
deductible directly by the shareholders.
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S Corporation (cont.)

Disadvantages of an S Corporation
Some restrictions for qualification.
Potential tax disadvantages.
Most fringe benefits not deductible for
shareholders.
Must have a calendar year for tax purposes.
Only one class of stock is permitted.
Net loss is limited to shareholders stock plus
loans to business.
No more than 100 shareholders.

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The Limited Liability Company

A partnership/corporation hybrid.
Laws governing its formation differ from
state to state.
LLC has members.
No shares issued; each member owns an
interest as designated by the articles of
organization.
Liability does not extend beyond members
capital contribution.

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The Limited Liability Company (cont.)

Transfer of interest requires unanimous

consent.
It is taxed as a partnership.
Standard acceptable term is 30 years;
continuity restricted.

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The Limited Liability Company (cont.)

Advantages of LLC
Partners can add their proportionate shares of
the LLC liabilities to their partnership interests.
Most states do not tax LLCs.
One or more (without limit) individuals,
corporations, partnerships, trusts, or other
entities form an LLC.
Members share income, profit, expense,
deduction, loss and credit, and equity of the LLC
among themselves.

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Designing the Organization

This is the entrepreneurs formal and

explicit indication to the members of the
organization as to what is expected of
them; expectations can be grouped into:
Organization structure.
Planning, measurement, and evaluation
schemes.
Rewards.
Selection criteria.
Training.

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Figure 9.1 - Stages in
Organizational Design

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Building the Management Team and a
Successful Organization Culture
A management team must be able to
accomplish three functions:
Execute the business plan.
Identify fundamental changes in the business as
they occur.
Make adjustments to the plan based on changes
in the environment and market that will
maintain profitability.

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Building the Management Team and a
Successful Organization Culture (cont.)
Important factors in establishing an effective
team:
Desired culture must match business strategy
outlined in the business plan.
Employees must be motivated and rewarded for
good work.
Entrepreneur should be flexible to try different
things.
Spend extra time in the hiring process.
Core values and appropriate tools must be provided
for employees to effectively complete their jobs.

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The Role of a Board of Directors

Functions of the board of directors:

Reviewing operating and capital budgets.
Developing longer-term strategic plans for
growth and expansion.
Supporting day-to-day activities.
Resolving conflicts among owners or
shareholders.
Ensuring the proper use of assets.
Developing a network of information sources for
the entrepreneurs.

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The Role of a Board of Directors
(cont.)

They meet the requirements of the

Sarbanes-Oxley Act and the following
criteria:
Ability to work with a diverse group and commit
to the ventures mission.
Ability to understand the market environment.
Ability to contribute important skills to the new
ventures achievement of planning goals.
Ability to show good judgment in business
decision making.

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The Board of Advisors

They serve only in an advisory capacity.

No legal status; not subject to regulations
stipulated in the Sarbanes-Oxley Act.
Likely to meet less frequently.
Useful in a family business.
Selection process is similar to the process
for selecting a board of directors.
Advisors may be compensated on a per-
meeting basis or with stock or stock options.

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The Organization and Use of
Advisors
Outside advisors are usually used on an as-
needed basis.
They can become a part of the organization
and need to be managed.
The relationship between the entrepreneur
and outside advisors can be enhanced by
involving them thoroughly and at an early
stage.
Even after hiring advisors, the entrepreneur
should question their advice.
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