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 owner’s 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 shareholder’s 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 member’s
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 entrepreneur’s 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 venture’s mission.
 Ability to understand the market environment.
 Ability to contribute important skills to the new
venture’s 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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