FUNDAMENTAL OF BUSINESS

CHAPTER : 5 - HOW TO FORM A BUSINESS

➢ What are the advantages and disadvantages of Sole

proprietorship?

Ans: Sole proprietorship is a popular form of business ownership. Here are the
advantages and disadvantages associated with it:

Advantages:

✓ Simplicity: Setting up a sole proprietorship is usually straightforward and

involves minimal legal formalities. This simplicity makes it an attractive option
for small businesses and solo entrepreneurs.
✓ Full Control: The owner has completed control over all business decisions,
allowing for quick and decisive actions.
✓ Pride of Ownership: People who own and manage their own businesses and
rightfully proud of their work. They deserve all the credit for taking the risks and
providing needed goods or services.
✓ Direct Profits: All profits belong to the owner, and there is no need to share
them with partners or shareholders.
✓ Tax Benefits: Sole proprietors may get benefit from tax advantages, such as
the ability to report business income and expenses on their personal tax
returns, potentially leading to lower tax rates.
✓ Flexibility: The owner has the freedom to change the business's direction,
products, or services without seeking approval from partners or a board of
directors.
Disadvantages:

✓ Unlimited Liability: One significant drawback is that the owner has

unlimited personal liability for business debts and legal issues. This means
personal assets may be at risk to satisfy business debts and obligations.
✓ Limited Resources: Sole proprietors often have limited access to financial
resources, making it difficult to expand or invest in the business.
✓ Limited Expertise: As a single individual, the owner may have limited
expertise in all areas of the business, which can hinder growth and decision-
making.
✓ Limited Capital: Raising capital can be challenging since the owner must
rely on personal savings, loans, or contributions from family and friends.
✓ Continuity: The business's continuity is heavily reliant on the owner, making
it vulnerable to disruptions due to illness, death, or personal circumstances.
✓ Difficulty in Attracting Talent: It can be challenging to attract and retain
skilled employees due to the limited resources available for competitive
salaries and benefits.

In summary, sole proprietorship offers simplicity and control but comes with the risk
of unlimited personal liability and limited resources. It is an ideal choice for small
businesses where the owner can manage most aspects of the operation effectively.
However, for larger enterprises or those seeking significant investment and protection
against personal liability, other business structures like partnerships or corporations
may be more appropriate.
➢ What are the main differences between general and
limited partnership ?

Ans: General partners and limited partners are two distinct roles within
a partnership business structure. Here are the main differences
between them:

➢ General Partners:

✓ Management and Control: General partners have the authority and

responsibility for the day-to-day management and decision-making of the
partnership. They are actively involved in the business operations.
✓ Unlimited Liability: General partners have unlimited personal liability
for the partnership's debts and legal obligations. This means that their
personal assets can be used to satisfy business debts and legal claims.
✓ Investment and Capital Contribution: General partners
typically contribute capital to the partnership and may also invest their time,
skills, and expertise in running the business.
✓ Profit Sharing: General partners share in the profits and losses of the
partnership based on their ownership or agreed-upon share of the business.
✓ Taxation: General partners report their share of the partnership's income
on their personal tax returns. The partnership itself does not pay taxes;
instead, income "passes through" to the partners.
✓ Liability for Partnership Actions: General partners can bind the
partnership to contracts and other legal obligations without needing the
consent of other partners. They have the authority to make decisions on
behalf of the partnership.
➢ Limited Partners:

✓ Limited Involvement in Management: Limited partners are passive

investors in the partnership. They do not have the same level of involvement in
day-to-day operations and management as general partners.
✓ Limited Liability: Limited partners have limited personal liability. Their
liability is typically restricted to the amount of their capital contribution to the
partnership. Their personal assets are generally protected from business debts
and liabilities.
✓ Investment and Capital Contribution: Limited partners primarily
contribute capital to the partnership. They are not expected to participate in
running the business on a daily basis.
✓ Profit Sharing: Limited partners share in the profits and losses of the
partnership based on their ownership or agreed-upon share of the business,
similar to general partners.
✓ Taxation: Like general partners, limited partners report their share of
partnership income on their personal tax returns. The partnership itself is a
pass-through entity for tax purposes.
✓ Limited Authority: Limited partners typically have limited authority to
make decisions for the partnership. They may not bind the partnership to
contracts or make major business decisions without the consent of general
partners.

In summary, the key distinctions between general and limited partners lie in their
roles, management involvement, liability, and authority within the partnership. General
partners have active management responsibilities and unlimited personal liability,
while limited partners are passive investors with limited liability and limited
involvement in daily operations. These roles are often defined in a partnership
agreement, which outlines the specific rights and responsibilities of each partner.
➢ What are the advantages and disadvantages of
partnership Business?

ANS: Partnership businesses offer various advantages and

disadvantages, which can make them a suitable choice for some
entrepreneurs and less so for others. Here are the key advantages and
disadvantages of partnership businesses:

Advantages:

✓ Ease of Formation: Partnerships are relatively easy to establish. They

typically involve fewer legal formalities and costs compared to corporations.
✓ Diverse Skills and Expertise: Partnerships allow individuals with different
skills and expertise to come together, which can lead to well-rounded decision-
making and business operations.
✓ Shared Financial Burden: Partners can pool their financial resources,
making it easier to raise capital for the business. This can lead to a stronger
financial foundation.
✓ Shared Responsibilities: Partners can share the responsibilities of running
the business, reducing the workload and stress on each individual partner.
✓ Tax Benefits: Most partnerships are pass-through entities for tax purposes.
This means that business income is "passed through" to the individual
partners, who report it on their personal tax returns, potentially resulting in
lower tax rates.
✓ Flexibility: Partnerships are often more flexible than corporations in terms of
management and decision-making. The partners can set their own rules and
operating agreements.
Disadvantages:

✓ Unlimited Liability: General partners in a general partnership have

unlimited personal liability for business debts and legal obligations. This means
personal assets can be used to satisfy business debts, and partners can be held
personally responsible for the actions of other partners.
✓ Conflict and Disagreements: Partnerships can be prone to conflicts and
disagreements among partners, which can impede decision-making and
potentially harm the business.
✓ Shared Profits: Partners must share the profits with each other based on
their agreed-upon sharing ratio. This may not always be equitable, leading to
dissatisfaction among partners.
✓ Limited Capital: Partnerships may still face challenges in raising capital,
especially if individual partners have limited financial resources.
✓ Risk of Partner Withdrawal: If a partner decides to leave the partnership, it
can disrupt the business's continuity, as the departure may require the
dissolution of the partnership or a significant adjustment in ownership and
operations.
✓ Lack of Public Funding: Unlike corporations, partnerships cannot access
public financial markets for capital, limiting their ability to raise funds from a
broad range of investors.
✓ Complex Decision-Making: In larger partnerships, decision-making can
become more complex as the number of partners increases, potentially leading
to inefficiencies.
✓ Shared Profits and Losses: Partners must also share losses, and if the
business incurs losses, each partner's personal finances may be affected.
➢ What are advantages of S Corporations?
ANS: S Corporations (S Corps) offer several advantages, making
them an attractive business structure for many entrepreneurs and
small business owners. Some of the key advantages of S
Corporations include:

✓ Pass-Through Taxation: One of the primary advantages of S Corps is

pass-through taxation. The business itself does not pay federal income taxes.
Instead, the profits and losses "pass through" to the individual shareholders,
who report them on their personal tax returns. This can lead to potential tax
savings, as S Corp income is typically taxed at the individual tax rate, which can
be lower than corporate tax rates.
✓ Limited Liability: Shareholders in an S Corporation enjoy limited liability,
which means their personal assets are generally protected from business
debts and legal liabilities. In most cases, shareholders are not personally
responsible for the corporation's debts or legal obligations.
✓ Ease of Ownership Transfer: S Corporations make it relatively easy to
transfer ownership interests. Shares of an S Corp can be bought and sold, and
ownership changes do not require significant paperwork or restructuring.
✓ Attractive to Investors: The pass-through taxation of S Corps can be
appealing to investors, as they receive their share of profits directly and can
offset these with any business losses on their personal tax returns.
✓ Professional Credibility: S Corporations often carry a higher degree of
professionalism and credibility in the eyes of clients, customers, and partners
compared to sole proprietorships or general partnerships.
✓ Perpetual Existence: An S Corporation can continue to exist even if one
or more shareholders leave or sell their shares. Its existence is not tied to the
life of any one individual.
 ✓ Deductible Business Expenses: S Corp shareholders may be able to
deduct certain business expenses, including health insurance premiums, on
their personal tax returns.
✓ Flexibility in Compensation: S Corp owners can receive income in the
form of both salary and dividends, potentially reducing their overall tax liability.
✓ Eligibility for Retirement Plans: S Corp shareholders can participate
in retirement plans and enjoy potential tax benefits associated with these
plans.
✓ Estate Planning: S Corps can facilitate estate planning by allowing for the
transfer of ownership shares to heirs or beneficiaries without triggering
immediate tax consequences.

➢ What is Merger?
Ans: A merger is a corporate transaction in which two or more companies combine
to form a single, new entity or when one company absorbs another.

➢ What are the benefits and drawbacks of being a

franchisee?
Ans:
Being a franchisee offers several benefits and drawbacks that individuals
should consider when deciding whether to invest in a franchise business.
These advantages and disadvantages can vary depending on the specific
franchise system and the industry it operates in. Here are some of the key
benefits and drawbacks of being a franchisee:
➢ Benefits of Being a Franchisee:

✓ Proven Business Model: Franchises typically come with a well-

established and proven business model. This can reduce the risk
associated with starting a new business from scratch.
✓ Brand Recognition: Franchisees benefit from the established brand
name and reputation of the franchisor. This can lead to increased customer
trust and loyalty
✓ Training and Support: Franchisors often provide comprehensive
training programs and ongoing support to franchisees, helping them
understand and operate the business successfully.
✓ Marketing and Advertising: Franchise systems usually have
marketing and advertising programs in place, which can lead to increased
visibility and customer acquisition.
✓ Bulk Purchasing Power: Franchisees often benefit from bulk
purchasing power, allowing them to secure supplies and inventory at lower
costs.
✓ Easier Access to Financing: Banks and lenders are often more
willing to provide financing to franchisees due to the established track
record of successful franchise systems.
✓ Network and Peer Support: Franchisees can tap into a network of
other franchisees, providing a support system for sharing experiences and
best practices.
✓ Exclusive Territory: Many franchises offer exclusive territories,
reducing competition from other franchise locations of the same brand.

➢ Drawbacks of Being a Franchisee:

✓ Franchise Fees and Royalties: Franchisees must pay initial
franchise fees, ongoing royalties, and other fees to the franchisor. These
costs can impact profitability.
✓ Limited Independence: Franchisees must adhere to the franchisor's
guidelines, standards, and operational procedures, which can limit
entrepreneurial freedom.
✓ High Initial Investment: Starting a franchise can require a significant
initial investment, including franchise fees, real estate costs, and inventory
purchases.
✓ Revenue Sharing: Franchisees must share a portion of their revenues
with the franchisor, reducing potential profits.
✓ Market Saturation: In some cases, certain franchise markets may
become oversaturated, leading to increased competition among
franchisees
✓ Renewal Terms and Conditions: Franchise agreements typically
have renewal terms and conditions that may change, affecting the
franchisee's ability to continue operating the business
✓ Limited Product or Service Offerings: Franchisees may have
limited control over the products or services they offer, which may not align
with local market preferences.
✓ Risk of Brand Damage: Negative events or actions by other
franchisees or the franchisor can affect the brand's reputation and,
subsequently, a franchisee's business.