Current Events (none on Quiz/Test days):
The Ch. 2 Sec. 1 Quiz is today.
Clear your desk except for a pencil. Once everyone is quiet, and no talking during the Quiz, we can begin. Be sure to put your name on the Quiz and the Scantron. You may write on both the Quiz and the Scantron.
If you finish early, you may take out non-class materials; once everyone is finished, put away the non-class materials. Then, I will collect the Scantron first, and then I will collect the Quiz.
Be sure your name is on both the Scantron and the Quiz.
If your name is not on the Quiz it will not be returned.
If you have not taken the Chapter 1 Test Make-Up you should be sure to take it tomorrow.
The Ch. 2 Sec. 2 Quiz is on Friday (we do not meet on Thursday):
Want to start a model business? Here is a sample of combining your talent into a business:
The Global Economy and You, p. 58
Pirating Intellectual Property
Business Organizations, p. 60
Why It Matters
What are corporations? And what's the difference between a corporation and other types of businesses?
Once you master those basics, we can move on: What should you do if you want to buy stocks? If you start your own business, what type of business should you form?
What do corporations do for you?
* Provide employment: corporations provide the majority of American jobs
* Provide things you want and need: the vast majority of the things you consume are produced by corporations
Lots of people think corporations are defined by their size. They assume that they are gargantuan megabusinesses with thousands of employees and millions, maybe billions, in profits. But individuals can form corporations—your neighbor the accountant, your aunt the dentist, and your couldn’t-get-a-real job “life-coach” cousin Fred could all be incorporated. A corporation is just a type of business organization with specific legal and structural characteristics. Many corporations are among America’s largest businesses, but size is not a defining feature of the corporation.
So what are the defining features of the corporation? And what benefits do business people gain by incorporating? Perhaps most important—what’s in it for you? Read on and find out.
Meanwhile, lots of people think that the financial websites that track the stock market are a confusing batch of secret codes. They are intimidated by the jumble of numbers and symbols clearly meant for only the most sophisticated analysts. But most of these numbers are little more than price tags—today's price tags compared with old price tags—so that you can see how the market has changed. The stock market is complex, and money can be lost—but it’s not too complex for most savvy consumers to understand what's going on... and perhaps to profit.
So what do all those numbers about the stock market really mean? And what does all the jargon—margin, short, put call—really mean? Read on and find out.
The BIG Ideas
Section 1 Forms of Business Organization, p. 61
Most businesses operate in search of profits. Others are organized and operate like a business, although profits are not their primary concern. There are three main forms of business organization. The first is the sole proprietorship, which is a business owned and operated by one person. The second is the partnership, which is a business jointly owned by two or more persons. The third is the corporation, which is recognized as a separate entity having all the rights of an individual. The proprietorship is the most common and most profitable form of business organization. The corporation is the largest and most visible.
One is a sole proprietorship which one individual, the sole proprietor, exercises complete control over the business. Another is a partnership in which two or more individuals combine their efforts and share the profits of the business. Under both business forms, the business is an asset owned by the owner or owner, it has no existence separate from them, and any financial or legal problems encountered by the business are their responsibility. All of the owners’ assets, even those not involved in the business, are at risk. Liability is unlimited.
Chapter Three Spotlight Video, 3:21
What is her nickname? What industry did she start out in? How much did she invest? How much did she earn? How did McDonald's fit in? Did she expand her business? Does it take up a great deal of her time?
Guide to Reading
A type of business in which one individual, the sole proprietor, exercises complete control over the business and is legally and financially responsible for the activities of the business. The business is an asset owned by the owner, it has no existence separate from the owner, and any financial or legal problems encountered by the business are the legal responsibility of the owner. All of the owners’ assets, even those not involved in the business, are at risk. Liability is unlimited.
A type of business in which two or more individuals combine their efforts and share the profits of the business. The business is an asset owned by the owners, it has no existence separate from the owners, and any financial or legal problems encountered by the business are the legal responsibility of the owners. All of the owners’ assets, even those not involved in the business, are at risk. Liability is unlimited.
A corporation is type of business organization in which the business is legally separated from its owners. As distinct legal entities, corporations can buy and sell property, enter into contracts, sue, and be sued just like a person.
A state-issued license for a business to incorporate. Only this charter is what gives the business its status -- and rights and obligations -- as a corporation. Historically, charters were only granted to companies that performed some kind of socially useful purpose (running a ferry across a river crossing, for example). Nowadays, charters are available to any kind of business that wants to pay the fees to incorporate.
Corporations and Stocks Game
If you're like most students, you probably don't think much or at all about the stock market. But maybe you should.
Why does the stock market matter to you? Because the stock market – and the whole broader arena of financial investing, really – will almost certainly shape what kind of life you're going to be able to lead. Where you'll be able to live. What kind of lifestyle you'll be able to afford. When (and even whether) you'll be able to retire someday.
Investing matters because it's how the poor become rich and how the rich become richer; they stop working for their money and allow their savings to do their work for them. Big shifts in the overall American (and world) economy over the past generation or two have made it harder and harder to get ahead just by working hard; nowadays, if you don't make some smart investments, you're going to have an incredibly tough time living the kind of life you want to lead on the basis of your wages or salary alone.
Some people like schlepping bricks their whole life. If that's you, great. If it's not… well, listen up.
What Is "The Stock Market"?
Imagine yourself strolling down the aisles of Safeway, looking for bargains on your groceries. But imagine that the price of a bunch of bananas – and everything else – changes its price every second or less. Also, if you want you can sell back your bananas as well as buying more of them. That's basically how a stock brokerage works: the brokerage is the store and the shoppers trading bananas are the investors who buy and sell stocks. In practice, most of the investors trying to profit in the banana trade won't end up doing any better than the entire market performs… but a lot people like to go shopping anyways. And by the way, if you string together all the grocery stores in the world, they comprise the stock market.
There are several different kinds of financial products you can invest in through your brokerage: stocks, bonds, and mutual funds are probably the most important of these.
A mutual fund is just a fancy name for a bunch of stocks, grouped together into one package to make it easier to buy and sell. Imagine that we're still in the produce section; most folks want a balanced diet of investing but need fiber from all kinds of sources. Mutual funds are a way to buy fruit salad (a whole bunch of stocks bundled together) rather than just bananas (i.e., one individual stock).
For rich people, mutual funds are a simple convenience. In one shot, they can "buy exposure" to a wide range of securities. But for the average Joe, mutual funds provide a unique and irreplaceable service. To "buy diversity," most investors would need to purchase 75 to 200 different stocks. If they had to do that on their own, they'd have to buy $50-100,000 worth of securities at one time, or else pay a bunch of extra fees in "odd lot" penalties. (An odd lot is a purchase of securities smaller than some nice round number, usually 100 shares. The commission for a typical trade of 100 shares might be $50; to trade 4 shares also likely costs the same $50. The price per share of the commission on that odd lot trade will thus dwarf any investment gains the stock is likely to achieve over the next year or five.) Needless to say, most people don't have $50-100 grand lying around under the sofa cushions, so most people could never hope to build a diverse investment portfolio if they had to buy each stock one at a time.
Enter mutual funds. These aggregate large pools of investors' dollars to be able to buy a diverse basket of securities at "wholesale" prices. You can invest $1000 in a mutual fund and get the equivalent of fractional shares in hundreds of different stocks, all while paying relatively low fees.
For this reason, mutual funds are immensely popular. Most ordinary folks who invest a bit in the market – maybe in the form of a retirement account or college savings plan – will do so by buying mutual funds. So do your homework and invest wisely.
But maybe you're really into bananas. Fruit salad is great, but everybody is into fruit salad. Your investment in fruit salad will probably make you decent money, but it's not going to turn you into a millionaire by next year. But you just happen to have a hunch that papayas, in particular, are about to become the most profitable fruit in the produce section. So you might decide to buy shares in an individual stock in the papaya industry, hoping to beat the market – that is, to make more, faster, than you could by buying into the fruit salad of a mutual fund.
Now stocks, like the individual foods for sale at the grocery store, are not all created alike. You can eat a pound of watermelon and one thing is likely to happen; you can eat a pound of chocolate and another thing entirely is likely to happen; and you can eat a pound of prunes and a whole lot of something ugly is likely to happen.
So try not to put all your money in prunes.
Which stock is right for you depends on your appetite for risk and reward; the price of any particular stock at any particular time is set by our old friends supply and demand. Stocks which pay high dividends (that is, a promised payout in cash each quarter of the year) are generally considered lower-risk/lower-reward investments. They're thought to be a bit "safer," if probably less likely to explode in value. Meanwhile, stocks which trade at lofty multiples of earnings are regarded as "risky"; their value might continue shooting up, or it could come crashing back down.
So choose your investment in papayas carefully.
In addition to stocks, you can buy bonds. What's the difference?
Basically, a stock is a share of ownership in a company. You buy one share of Google, you just bought one tiny slice of the ownership of Google.
A bond, meanwhile, is basically a loan from you to whomever issued the bond – some private company or government entity, usually. The price of the bond is the amount of the loan you're giving them; they will then promise to pay you back regular interest payments, plus eventually the full value of the loan when the bond reaches "maturity."
That means that bonds, in general, are less risky but also have less upside than stocks. Unless the company (or government) that issued the bond goes bankrupt, of course. Then things start to get risky and you might just lose your shirt.
What Sets the Price of Securities?
What determines how much any stock or bond costs? You surely already know the answer to this, friend; it's the same thing that sets the price for everything: supply and demand.
A whole bunch of investors share your view that papayas are the next big thing and want to get into the same company you do: demand for that stock rises and so does the price.
Some kind of bad news on the papaya front – new scientific research proves that papayas make you fat, oh noes! – causes investors to want to flee that industry: demand for the stock falls and the price starts to plummet.
Same thing for bonds: if investors get scared off by volatility in the stock market and want a safe bet in some highly rated bond, demand will increase and the price will, too. But if investors worry that some bond issuer is about to go bankrupt, making the bonds worthless, demand (and prices) will fall.
Elementary, my dear Watson.
But what factors will influence investors' views on which securities will remain in demand, and which won't? There are a whole bunch of metrics to consider: The company's earnings and profit margins. The price-to-earnings ratio – that is, a comparison of the stock price to the size of the company's business. The size of the stock's dividend, if any. The future growth potential (or the opposite) in whatever industry the stock is in. (Is it a good time to invest in the growth potential of green technology? Maybe. Is it a good time to invest in the growth potential of print newspapers? Probably not.)
Some Real Examples
Let's pick on Google for a minute. Google is the King of Search. It has very high profit margins… and a huge load of cash sitting on its balance sheet. So how do we know what a fair price is to pay for GOOG?
Well, as we said, the market value of a company is… whatever the market forces of supply and demand say it is. GOOG has often traded at around $500 per share. The country has roughly 320 million shares outstanding, so if you do the math (320 million x $500) you see that the market has priced the company's total value at something like $160 billion. Whoa.
But Google has enormous profitability. The company has about $32 billion in cash lying around (as of 2010) and no debt on its balance sheet. And it generates almost a billion dollars a month in cash profits. So if you subtract the $32 billion from the $160 billion, you get an "equity capitalization" of a little under $130 billion. If the company will earn $12 billion in the next year, that means that GOOG is trading at a price-to-earnings ratio of about 11x earnings.
If the company continues to grow at anything like the pace it has grown in the past, that's likely "cheap" – even at $500 a share. But if the company's growth slows down, there's also a long way for that price to fall. So would you say GOOG is worth the risk?
What about the Un-Google? GOOG is a great company in a vibrant industry with great profit margins and "free cash flow dynamics" – that is, the company has relatively low costs in infrastructure or capital expenses. But what about a company facing almost the opposite situation; an easy target is the auto industry.
The industry is "enjoying" little or no growth in the United States. Running huge auto plants is enormously expensive in terms of capital expenditures – keeping all that heavy machinery running isn't cheap. Old union contracts have locked in high labor costs and reduced flexibility in the way management can use its workers. It's not an accident that companies like GM and Chrysler almost went out of business in 2009 and had to be bailed out by the government.
So, do you want to buy stock in GM? It certainly looks like a risky bet… and it is. But – remember the magic of supply and demand here – it's possible that demand for GM stock will fall so low that it might start to look to you like a stock with upside. In 2010, somebody bought Newsweek magazine – a firm in another deeply troubled industry – for one dollar. He'll probably lose a ton more money… but if he can somehow turn things around, his upside is huge. Do you have the taste for risk that would lead you to invest in a dodgy industry like autos or print media? Or would you rather stick to Google?
Finally, what about those super-trendy stocks that explode into popularity and trade at seemingly unbelievable valuations. That is, some given company – let's call it shmoop.com, just for fun – goes public at $30 a share, having earned 70 cents a share the year before and with Wall Street analysts projecting that it will earn a dollar a share in the next year.
By three days after the IPO, though, investors just can't get enough Shmoop; the price of the stock has zoomed to $100 a share and the Wall Street Journal writes, "ZOMG! Shmoop Trades at 100x Earnings."
What's going on here? Why would investors invest at such a high multiple? Nobody in his right mind would pay $100 per share for only $1 in earnings, right? But what's happened here is that the market is pricing in higher expectations of the future. The buying public has fallen so in love with the CEO of Shmoop and with the wily founder's creative vision that they believe the company will, in fact, earn $3 a share next year and $10 a share the year after that. So in the world they imagine, Shmoop will really be trading at 10x earnings rather than 100x, making it a fabulous growth stock. That's their dream, anyway; it will be up to their friends at Shmoop to make it actually happen. If it does, those investors will have made a mint. If it doesn't… oops.
Some Final Basics
If you’re hunting for an investment, remember that not all stock is the same. There are two basic types of stock: common and preferred. Common stock grants not just partial ownership in a corporation, but also voting rights. Each share of common stock carries a vote that its owner may cast in the elections that select the board of directors. A sizable bloc of stock confers significant power in choosing the people who will govern the company. Preferred stock does not confer voting rights, but it does guarantee some sort of dividend. Common stock holders may not receive a dividend if the board of directors decides to re-invest all of the profits. Preferred stock holders are also closer to the front of the line if the corporation goes out of business. If the company goes broke, creditors and bond holders have first claim on the company’s assets; preferred stock holders come next.
Next, investors have to know where to buy the stock that they are looking for. Not all stocks are sold in the same place or in the same way. For starters, you don’t buy stock from the company itself—you buy it from a current owner of the stock—and a stock broker facilitates the exchange. The exchange may take place in a physical stock market—America’s largest and oldest are the New York Stock Exchange and the American Stock Exchange. But the nation’s fastest growing exchange is the National Association of Securities Dealers Automated Quotations or Nasdaq. There are also regionial exchanges in several cities that handle the stock of corporations in their area.
Nowadays, though, as far as you're concerned, it's all about the internet. You don't really care where your stock is listed, and you can almost certainly do all your trading from your laptop while wearing your pajamas. But if you don't want to lose your shirt (like that mixed metaphor there?), you'll probably want to have a strong sense of whether the market as a whole is rising or falling.
A bull market is a market in which prices are rising. In a bear market prices are falling. Generally, investors favor bull markets because they are “long” in a stock—that is, stock investors buy a stock with the expectation that it will rise in value so they can sell it for a profit. But is it also possible to “go short” or “sell short” and make money on a falling stock. (If you have never been able to pick a winner this is the niche you’ve been looking for.) When you sell short you borrow the stock from your broker with the agreement that you will return the same number of shares at a later date. You then sell the stock while its price is relatively high, wait for the price to fall, and then buy the stock and return it to your broker. Your profit lies in the difference between the price you sold the borrowed stock for and the price you pay in buying the stock that you return to your broker. You can make a lot of money that way... or lose it all. Probably not a game to be played by amateurs, to be honest.
Brokers can help you out in other ways as well. When you buy stock on margin, your broker lends you a portion of the purchase price. For example, you may be asked only to pay 10% of the total purchase price. Of course, your broker charges you interest on the money he lends you. And if the stock you buy falls in value, placing the money he lent you at risk, he will issue a margin call demanding that you deposit more money or securities into your margin account to protect him from losses.
You should also understand the various ways that you can hedge your bets or reduce your risks in the market. Options, for example, give you the opportunity to buy or sell a stock at a specified price during a limited period of time. When you buy a put option, you are buying the option of purchasing stock at the strike price during an agreed upon period of time. When you purchase a call option, you are buying the option of selling stock at the strike price during an agreed upon period of time. An option allows you to hedge your bets—lock in a certain price before it changes to your disadvantage. But you pay for this certainty. Your final gain or loss will include the price you pay for the option.
You can also reduce your risk by placing stop orders. These are standing orders with your broker stating that he should buy or sell stocks when they reach a certain price. For example, when you are long in a stock you might place a sell stop order telling your broker to dump the stock if the price falls to a certain point. If you are short in a stock, you would place a buy stop order telling your broker to buy the stock if it climbs to a certain price, so that you can cover your short without losing any more money.
Why It Matters Today
Investor Warren Buffett, the richest person in the world, has been called "The Oracle of Omaha."
A mailman who was putting $1000 each year into savings once asked him how to become a billionaire. "Live to 5000," Buffett said.
That's funny, but it points to a deeper truth. Lottery winners excepted, it takes time to build wealth. Hopefully not 5000 years, but the miracle of compounding interest means that small investments can really add up over a long period of time. (Or "multiply up," really.)
Over the course of the last century, the stock market has grown by an average rate of about 9% per year. Looking forward, a more realistic bet is that the stock market will grow 5% per year. With the reinvestment of compounding interest, that means you'd have been about to double your money about every eight years. At that rate, if you'd invested $1000 back in 1930, your investment would have grown to be worth more than $1 million in 2008.
You’re just about ready to take a dip in the market... but do you know how to read Google Finance? A Schwab account?
Check out the stock data below. This is a snapshot (taken a while ago) of three important publicly-traded companies:
Ticker Symbol: Think of this as the company's nickname. GOOG = Google. BA = Boeing. GE = General Electric.
* Stock Tip: You can completely mess up if you don't pay attention. If you buy a share of HOG, you are buying a motorcycle company, not a pig.
Price: The last trade made for one share of this company.
* Stock Tip: If you're buying or selling shares, make sure to check whether the price quote you're looking at is real-time or not. Yahoo Finance and Google Finance offer real-time quotes. The price quotes on some websites and most TV stations may be delayed by 20 minutes or more.
* Stock Tip: Don't compare the price of company A and company B. Price = Market Cap / Shares Outstanding. So, if a company does a 2-for-1 split of its stock (doubles the number of Shares Outstanding), the Price would drop by half. The company is still worth the same amount. So, Price is not an indicator of the companies overall value.
Change: The amount the stock price has changed since it last closed (at the end of yesterday).
Percentage Change: Harken back to 4th grade math - this is percentage that the stock has changed since it last closed (at the end of yesterday).
Day Range: The day range shows the highest and lowest price that the stock had for the day. Ideally, buy low, sell high. The best investors (and we mean Warren Buffett) don't worry as much about a stock's daily price as its long-term prospects.
52 Week High and Low: This identifies the highest and the lowest price that this stock has sold for over the past 52 weeks. This information allows you to place its current price within a one-year context.
Market Capitalization: This is a measure of the total value of the company. Market Cap = Total Shares Outstanding x Current Price.
* Stock Tip: Market Cap often underestimates the true value of a company because it doesn't include (a) stock options held by employees and (b) privately-owned shares that are not reported, and (c) a pile of cash that the company has locked up in a vault (yep, most companies do this). On the flip side, the company likely has debt (loans) that would subtract from the overall value of the company. Debt isn't included in Market Cap, either.
Div is short for dividend. A dividend is the amount that the company will pay you (typically once per quarter) for each share of stock that you own. Some companies (like Google, in the above example) don't pay dividends.
Yield = dividend / price. This tells you what portion of the price you paid is "guaranteed" to be paid back to you each quarter. Companies can change their dividend at their own whim, so there really are no guarantees. When taxes on dividends are raised, or during tough times, companies often reduce their dividends.
P/E Ratio: The price-to-earnings ratio tells you "how many dollars today are you willing to pay for a dollar of earnings in the future?" In other words, this tells you how excited investors are about the companies growth prospects.
* Stock Tip: Expectations don't always match reality. Just because a company has a high P/E Ratio doesn't mean it will actually do well in the future. Sometimes, the better bet is a slower-growing company with a great management team who can beat expectations.
Volume: Nope, not the kind that you see in geometry. This simply tells you the number of shares that have traded that day.
Open: Stocks open and close. Open is how they begin the day. Close is how they end. Today's close = tomorrow's open.
Okay, team. If you think you've got it, then hop on over to our Corporations and Stocks game to see how you would have fared in the stock market over the past fifteen years.
Why It Matters Today
Think of the stock market as that moving-floor escalator thing you stand on in airports. As soon as you load a grand onto it, the money starts moving slowly forward, over time, at a clip of about 5% a year. Looking at the chart, you will see huge gyrations. You will likely experience some amazing boom times as well as some excrutiating lows. But unless you are really stupid or really lucky or both – or become a professional money manager – you’ll likely compound your savings at about that 5% clip, give or take (and likely take because most people give over a lot of profits to the tax man or to stock brokers by trying to beat the market via trading stocks they know little about... but that’s a different story).
Corporations and Stocks game
Corporations provide a different sort of benefit for their stockholders. Individuals can become partial owners in an enterprise without knowing a thing about business in general or about the specific service or product produced by the particular company. They become partial owners in a business that is professionally managed. Their personal assets are also shielded from any legal or financial liabilities taken on by the corporation. Like all of the corporation’s owners, they enjoy limited liability—only the money they paid for the stock is at risk. And their ownership is easily transferred. They can simply sell their stock and walk away from the business. They may not get as much as they paid for the stock, but that is all they lose in surrendering ownership.
Of course, there is a price for all of this. Since corporations are legally distinct entities, they must pay taxes like the rest of us. Corporate profits are taxed. And then, when those profits are divided up and paid out to shareholders in the form of dividends, shareholders pay income taxes on these profits once again. Shareholders must also pay taxes on any money they earn from the sale of their stock. If the selling price is greater than the purchase price, shareholders pay a tax on this difference or capital gain. But currently individuals pay a much lower tax on capital gains made on assets held for longer than one year than they do on income, shielding them from some of the pain of paying those taxes.
Over the course of the last several decades, stock ownership has become significantly more widespread. At the time of the great crash of 1929, which began the Great Depression, fewer than 1% of Americans owned any stock at all. Today, more than half of all households are invested in the stock market in some way, most commonly by owning mutual funds and 401(k) retirement plans.
The stock market -- the place where individuals can invest in corporations -- has thus become an important factor in many ordinary Americans' wellbeing.
At the same time, in recent decades returns on stock market investments have far outpaced returns on labor. In other words, it has become increasingly difficult (if not impossible) to earn a comfortable living or (especially) to enjoy a comfortable retirement on work wages or salary alone. If you're not earning investment income, you're going to have a really hard time making it in the 21st century.
So even if you don't own stocks yet, you should start figuring out how you're eventually going to buy into the market.
Quarterly distribution of corporate profits to shareholders. Not all stocks pay out dividends.
A type of corporate stock that confers voting rights but does not guarantee a dividend. Common stock holders participate in the election of the board of directors. The most common type of stock (hence the name, rimshot).
This is a definition of what is commonly labeled “double taxation,” corporate profits are taxed and then, if distributed in the form of dividends, these same profits are taxed again along with the rest of the shareholder’s income.
Student Web Activity "The Better Business Bureau"
The Better Business Bureau
* Click on "About Us" on your screen.
* Next click on "FAQ" and read through the questions and answers.
* Click back to the BBB homepage and click on "Business" under the "check it out:" tab. Explore the process of locating company reports.
You may need to try major firms and a more general search such as in all of the Commonwealth. Also, restaurants may be interesting for the information that the reports contain.
* Next, click on "File a Complaint" and explore the process of filing a complaint. Be sure to read the information in the "General Complaint" link at the left of your computer screen.
Companies in the News
Main types of business, 6:20
Types reviewed and advantages and disadvantages
Corporations are everywhere. You probably deal with thousands of them every day They're such a critical part of the American economy that you probably don't even notice or think about it.
But this wasn't always the case. When the United States was born, corporate charters were rarely granted. The benefits gained through incorporation were considered so great, they were offered only to businesses that served a broad public interest. A ferry company might receive a corporate charter, but an ordinary factory would not. If you proposed to build a canal that would link towns and expand trade, the state might grant you charter. But if you sought to incorporate your flour mill, you would probably be turned away.
Long story short: you could only incorporate if your business was going to do something very special to serve the public interest.
By the middle of the nineteenth century, however, these views had changed. Policymakers came to realize that the corporate form served all Americans by facilitating economic growth. For business owners, the corporation offered a way to increase both their capital and the stability of their businesses. For investors, the corporation offered a relatively risk-free way of taking part in emerging commercial opportunities.
Today, corporations bring in more than 80% of all dollars earned in America. Savvy stock investors participate in a global exchange worth more than $100 trillion. Corporations are here to stay, and they provide many of the best opportunities for individuals to get ahead in the world. Yet many people are left behind simply because they do not understand how to read a financial website. Are you one of them? Read on, and you won't be.
A trip through the local strip mall might suggest that corporations are taking over America—everywhere you look, you'll see Starbucks and Walmarts; the locally owned "mom and pop" business might start to seem like a dinosaur. But, as is often the case, the statistics tell a different story. The number of sole proprietorships and partnerships (based on the number of tax returns filed) increased by more than 53% between 1990 and 2006; the net income earned by this sector of the economy increased by almost 500%. In comparison, the number of corporations increased by 57%; their net income increased by 425%.
But corporate receipts accounted from more than 80% of all dollars earned in 2006.
Does that mean that America’s small business community is growing as fast as its corporate sector? Not exactly. Sole proprietorships, partnerships, and corporations are distinct forms of business organization—and size is not really the defining feature of any of them.
Ever think about starting your old small business? Maybe even something as simple as mowing lawns or babysitting neighborhood kids? If you wanted to set yourself up legit, you'd probably start with a sole proprietorship. It's simple, it's easy, and it's cheap.
Later, if your lawn-mowing or babysitting business really takes off, you may outgrow the basic structure of the sole proprietorship. Once you have employees, or grow large enough to fall under government regulation, or begin to worry about liability issues, it's probably time to incorporate.
Sole Proprietorship, p. 62
Forming a Proprietorship
Reading Check, p. 64
What are the major disadvantages of a sole proprietorship?
The most basic and fundamental type of business organization is the sole proprietorship. Within these types of businesses one individual, the sole proprietor, exercises complete control over the business and is legally and financially responsible for the activities of the business. If a customer trips and breaks a leg, the proprietor is sued; when it’s time to expand, the proprietor must secure the loan under his or her name.
A slightly more complex form of business organization is a partnership. Under this arrangement, two or more individuals combine their efforts and share the profits of the business. They also share all of the risks, as well as the financial and legal responsibilities. The details are generally spelled out in a letter of agreement between the partners.
Within a partnership, one individual is not held entirely responsible for the activities of the business. But for the most part, sole proprietorships and partnerships are very similar. The business is an asset owned by the owner or owners, it has no existence separate from the owners, and any financial or legal problems encountered by the business are the legal responsibility of the owners. All of the owners’ assets, even those not involved in the business, are at risk. Liability is unlimited.
That issue of liability is the single biggest reason why many businesses choose to incorporate; a corporate structure (read on to the next page for more) protects the business owner from individual liability if things go wrong with the business. Sales go in the toilet while costs shoot through the roof? Somebody wipe out on your sidewalk and sue you for millions of dollars worth of "pain and suffering"? If your business is a sole proprietorship or partnership, you might end up losing everything. But if you've incorporated, the business may be toast but you, as an individual, are protected.
Types of Partnerships
Forming a Partnership, p. 65
Introduction to Shark Tank, 3:49
Shark Tank - Season 1 Episode 1 Part 1/5, 9:49
Disadvantages, p. 66
What are the differences between a general partnership and a limited partnership?
Corporations, p. 67
What is a Corporation?, 7:15
Forming a Corporation
A corporation is a very different type of business organization. Most significantly, a corporation is a business entity legally separated from its owners. When business owners decide to incorporate they secure a charter from the state government. This charter is like a birth certificate, establishing the existence of a new and separate legal entity. Once incorporated, the corporation can buy and sell property, enter into contracts, sue, and be sued... just like a living, breathing person.
In fact, that's what a corporation is: a legal "person." (The word "incorporate" shares the same root as "corpse"; it means something like "to give it a body.") The idea is that the corporation is a fictitious person, with many of the same rights under the law as a real person.
For the sole proprietor turned corporation, there are several benefits. Most importantly, his personal assets (home, car, boat, iPod) are no longer at risk should the corporation have problems. If the corporation is sued, only its assets are at risk. If the corporation goes broke, its creditors can only go after the corporation’s assets. As there is a legal barrier separating the corporation and its owners, the owners enjoy limited liability.
There are other benefits as well. To finance expansion, corporations may sell stock. Most corporations, in fact, do not sell stock to the public; all of the stock is privately owned. But if a company decides to expand its capital base by “going public” it issues an initial public offering or IPO. People buying the stock acquire partial ownership in the corporation. And the more shares they buy, the larger percentage of the corporation they own. Of course, this also means that the original owners also have to share profits. These may be distributed to the shareholders quarterly in the form of dividends.
Corporations may also raise money by selling corporate bonds. Like governments, corporations may issue bonds that promise repayment over a specified period at a certain interest rate.
Another benefit of turning a sole proprietorship or partnership into a corporation is that the business becomes more durable—that is, it is no longer so tied to the health of the founder. If the founder dies, the corporation lives on. Similarly, a corporation is less dependent on the talents of its founders. As corporations grow, they are governed by a board of directors elected by the shareholders. This board selects a president or CEO (chief executive officer) to manage the corporation. A sole proprietorship may have a technically brilliant but, from a business point of view, inept founder. He may turn the business over to his even more incompetent children. But the governing structure of corporations allows management to be handed over to professionally trained executives.
Why It Matters Today
Are corporations people?
The common-sense answer is no. A corporation is not, to state the obvious, actually a living human being.
But in the eye of the law, the answer is essentially yes. A series of Supreme Court decisions in the 1800s expanded the rights of corporations, eventually extending to them the crucial rights to substantive due process included in the 14th Amendment. As recently as January 2010, the Court reaffirmed that corporations have most of the rights of real people, overturning a campaign finance law on the grounds that it violated corporations' (and unions') right to free speech.
In Motion Corporate Structure
Advantages, p. 68
Financially, corporations benefits from being allowed to raise capital by selling stock. In purchasing stock, stockholders become partial owners of the corporation and are entitled to a share of the profits. Corporations can also raise money by selling bonds like a government. Legally, corporations benefit from limited liability. Since the corporation is a legal entity separate from its owners, the owners’ personal assets are not placed at risk by any action taken by the corporation. Should the corporation be sued or have financial problems, only corporate assets can be seized.
Disadvantages, p. 69
Through what is commonly labeled “double taxation,” corporate profits are taxed and then, if distributed in the form of dividends, these same profits are taxed again along with the rest of the shareholder’s income.
Reading Check, p. 70
Why do many business owners prefer corporations over other forms of business organizations?
Entrepreneur, p. 71
Profiles in Economics
On Charlie Rose - Andrea Jung, 2:20
Forms of Business Organizations, Tax and Insurance Issues for Small Business, 9:56
Learn: * How to Choose a Form of Business * How it can maximize your protections and future growth potential * Characteristics of a sole proprietorship, general partnership, corporation, limited liability companies and limited liability partnerships * Whether S Corporation Tax election is right for you * What tax issues are important for small business and why * What insurance coverage every small business owner should consider
Larissa Buerano, Agent, State Farm Insurance
Rajeev Kaul, CPA, PC.
Joyce Moy, Executive Director, Asian American / Asian Research Institute - CUNY
My Own Business: A course on how to start a business
Chapter 3: Business Organizations
Show Business is the Federal Reserve Bank of Boston's learning activity on economics and the entertainment industry. The goal is to provide an additional tool for teaching and learning about basic economic concepts, with some economic history snuck in.
Test your skills running a business in this ultimate business simulation! As CEO, you will match wits in the competitive, technologically advanced industry of the Holo-Generator™.Cf. http://oldtitan.ja.org/home.php
Corporations and Stocks game
A music video from School House Rock on investing and Wall Street.
Ch. 3 Sec. 2 Business Growth and Expansion
Figure 3.4 Growth Through Reinvestment, p. 73
HW email to firstname.lastname@example.org or hand in hard copy.
Earning money plays a big part in why people decide to produce and sell goods and services.
1. What other reasons might people have for starting their own businesses?
Look for additional reasons throughout the Chapter.
Friday: Ch. 2 Sec. 2 Quiz (Study page posted)