Assignment Instructions : Business Formation
Three (3) personal trainers at an upscale health spa / resort in Sedona, Arizona, want to start a health club that specializes in health plans for people in the 50+ age range. The trainers Donna Rinaldi, Rich Evans, and Tammy Booth are convinced that they can profitably operate their own club. They believe that the growing population in this age range, combined with strong consumer interest in the health benefits of physical activity, would support the new venture. In addition to many other decisions, they need to determine the type of business organization that they want to form: incorporate as a corporation or form a partnership. Rich believes there are more advantages to the corporate form than a partnership, but he has not convinced Donna and Tammy of this. The three (3) have come to you, a small-business consulting specialist, seeking information and advice regarding the appropriate choice of formation for their business. They are considering both the partnership and corporation formation options.
Assume the trainers determine that forming a corporation is the best option. Next, Donna, Rich, and Tammy need to decide on strategies geared toward obtaining financing for renovation and equipment. They have a grasp of the difference between equity securities and debt securities, but do not understand the tax, net income, and earnings per share consequences of equity versus debt financing on the future of their business. They have asked you, the CPA, for your opinion.
Write a two to three (2-3) page paper in which you:
- Provide a summary to the partners, outlining the advantages and disadvantages of forming the business as a partnership and the advantages and disadvantages of forming as a corporation. Recommend which option they should pursue. Justify your response.
- Explain the major differences between equity and debt financing, and discuss the primary ways in which each would affect the future of the partners’ business.
- Use at least two (2) quality academic resources in this assignment. Note: Wikipedia and other Websites do not qualify as academic resources.
Advantages and Disadvantages of Forming the Business as a Partnership
According to the provide case study, Donna, Tammy and Rich can opt for a general partnership form of business that contain two or more individuals organized to take part in business with intention of making profit. In this case, the partners live as co-owners with equal rights in business liability, management and operation (Miller, 2, p. 71). General partnership is said to have a great advantage over sole-proprietorship. Some of these advantages include higher borrowing capacity compared to sole-proprietorship and also partnership has more availability of capital for the business. In addition, there is a chance for splitting income, which is an advantage of specific significance due to subsequent tax savings. Business affairs of partnership are private unlike in corporation where business experience restricted external regulation, and it is considerably easy to change the business legal structure with change of circumstances later (Bevans, 1, p.72).
Business partnership also has a number of disadvantages. One of the main disadvantages include that the partners liability for the business debt is unlimited. This means that one can lose personal properties for a business debt. Every partner in partnership business is severally and jointly liable for the debt of the partnership such that, every partner is liable for personal share of the debts of the partnership and also on the debts of all. This means personal properties of one partner can be taken to settle debt share of the other partner in business Partnership also experiences a risk of friction and disagreement in management and among partners. In addition, every partner is a partnership agent and is liable for other partners’ actions, and in case a partner leaves or joins the partnership, valuing of all partnership assets may be needed which can be considerably expensive (Bevans, 1, p.72).
Advantages and Disadvantages of Forming as a Corporation
Donna, Tammy and Rich can also opt for corporation form of business. Corporation refers to an intangible, artificial being and only existing in the law contemplation. The corporation evolution is a direct outcome of business growth. Demands for accountability, capital, owners’ liability protection, and order prompt the growth and recognition of corporate formation (Miller, 2, p.76). The main advantage offered by a corporation over partnership is the liability protection. Corporation owners do not risk losing private assets due to the debts of the company since corporations are regarded as separate legal entities from individuals who own them. Another advantage is that corporations can raise business capital or funds more easily through sell of stocks. Their business can be funded by equity, debt or both, though funding by equity is considered easier and safer.
Corporation does not have life limit since the ownership transfer is considerably easy and thus the company can be easily passed to future generations (Miller, 2, p.77). Corporations also enjoy more tax benefits compared to partnerships since corporations are required to separately file taxes from the shareholders. Corporation owners pay taxes on any dividends, bonuses and salaries they make from the corporation. However, there are loopholes to ease weight of paying taxes as individual shareholders and as a corporation. A corporation is not needed to pay tax on revenues paid as shareholders or employees compensation, and it can subtract the payment as expense of a business. In addition, the tax rate of a corporate is normally lower compared to the tax rate of personal income. The partnership business owners pay income taxes using regular rates on the earned business profits (Bevans, 1, p.6).
The main disadvantages experienced by corporations include excessive paper work when it comes to taxation filing and financial reporting as dictated by the laws, especially in the USA. Corporation also works independent management such that with no clear majority interest the corporation management team can run the business without owners’ real oversight (Bevans, 1, p.6).
Recommendation on the Best Option
The presented business option for Donna, Tammy and Rich include corporation and partnership. The best option between the two is adopting a corporation form of business. This is because it is easy to raise capital for a corporation through equity or shares to other members of the public, thus taking debts would be necessary in this case. Moreover, corporation has limited liability, meaning shareholders can manage to protect their personal properties from business liabilities. In addition, the business can get independent management, working under the supervision of a board and hence limiting conflicts of interest and management conflicts. With this option, the shareholders can opt to employ qualified management personnel who ensure effective operation of business at ease. Corporation is also a recommended option since it has a long life and it is unlikely to be impacted by withdrawal of any of the three co-founders since one is just required to sell his shares to willing buyers to maintain the company foundation. Thus, this is the best option to consider.
The Major Differences between Equity and Debt Financing and How they Affect Future of the Partners’ Business
Corporation gives the business founder a chance to finance a business through equity, while partnership external source of funding can only be debt. The main difference is that equity is acquired by selling shares where buyers offer the company capital and the company gives them ownership worth their money. This makes it possible for the company to acquire capital without large cost of debt interest or owing others. The company also gets to share profit and liability with shareholders and hence making it easy for the company to survive in times of financial crisis.
However, where debt is the main source of financing a business, the business owners get to incur extra cost of debt interest. In addition, in case of financial crisis, the business assets are dissolved to pay the debt and sometimes even partners personal properties. Debt financing thus holds a higher business liability than equity. A business financed through debt is likely to fail during hard time compared with a business financed through equity.