Scary stuff, right?
First-off: The role of the firm.
In economics, we define a firm as any self-contained, profit maximizing entity that produces and sells goods or services (or both)
A firm is an economic construct, and may not necessarily be exactly the same as a "business". There are three main kinds of firms in the economic universe: Single Proprietorships, Partnerships, and Corporations.
Single (Sole) Proprietorship:
In this type of firm, the owner IS the business. For an example, Mr. Wong owns Mr. Wong's Confectionary, so Mr. Wong IS Mr. Wong's Confectionary! What this means is that Mr. Wong is personally liable for all damage done by his business, and will be accordingly held responsible. For an example, if I ate a pie from Mr. Wong's Confectionary and it made me sick, I could sue Mr. Wong's Confectionary for damages and uncleanliness. If I won, Mr. Wong would have to pay me out of his own pocket.
Some other characteristics of proprietorships:
-There is only one owner
-Unlimited liability
-There are obvious incentives for the owner to get the firm to generate profit
-They can be difficult to finance (because the burden of financing proprietorships falls on one individual)
-Transfering ownership is difficult (selling your business can be hard)
-Owners are taxed at the personal rate
Partnership:
In this type of firm, two or more individuals who perform the same kind of work (for an exampple, two laser hair removal specialists) join together under a contract in order to make PROFIT! This partnership is legal and binding. What it entails is that all of the individuals who have entered the partnership are jointly liable for all damage their business causes. For an example if I get laser hair removal from doctor A, and the procedures somehow gives me skin cancer, I can sue A & B hair removal and force Doctor B to pay me for damages out of his own pocket, even though he had nothing to do with me contracting skin cancer. For this reason, it is important to REALLY TRUST anyone you enter a partnership with.
Some other characteristics of partnerships:
-2 or more owners
-Unlimited shared liability
-They can be difficult to finance (because the burden of financing proprietorships falls on only a few individual)
-Transfering ownership is difficult (selling your small business can be hard, especially if you are a group of specialized professionals and there is no one with a similar skill set who is willing to take over your business)
-Owners are taxed at the personal rate
Both of these types of firms can be very risky to own, due to the unlimited liability imposed on all owners. SO, laws were invented to pave the way for...
THE CORPORATION:
These have lots of different names (company, ltd, inc)
http://en.wikipedia.org/wiki/Salomon_v_A_Salomon_&_Co_Ltd
Basically, the corporation is treated as a separate legal entity. Each shareholder (owner) has limited liability equal only to the dollar amount of the company which they own as shares
-Corporations are easier to finance (many different people can become part owners and finance corporations as shareholders without having to assume liability)
-Shareholders can easily buy and sell their partial ownership (this is what trading stocks and selling shares is all about)
-Usually, the shareholders elect a board of directors, who in turn hire the top-ranking employees (the CEO, CFO, and VPs)
-Corporations are taxed twice: once for corporate profits and once for shareholder dividends.
There are also a few hybrid firms, which combine aspects of several different kinds of firms.
A limited partnership is a cross-breed between a partnership and a company. In a limited partnership, there is at least one general partner with unlimited liability. There can be other limited partners, however, who own limited shares of the business, but aren't involved in running it (kind of like shareholders). Limited partnerships are used to get around security legislation and gives limited partners the chance to invest in riskier operations without being held liable for shortcomings
A limited liability partnership is only available for professionals. It is very similar to a limited partnership, but the limited partners can be involved in the business.
A crown corporation is a company in which the controlling shareholder is the government. The business may function as an entity independent from the government, but often they act as a sounding board for government policy (ie CBC).
Not For Profit Corporations try to just break even, not making any excess profit.
TransNational Corporations (TNGs) are the big boys. THINK McDonalds and Wal-Mart
Proprietorship Partnership Corp
Ownership Easy Easy Easy
Liability Unlimited Unlimited Limited (but with conditions)
Transfer Difficult P-ship Agmnt Easy
Finance Difficult Difficult Easier
Mgmt Easy Tough Separate
Taxes Tough Tough Excruciating
3 problems which small businesses face:
- Government Regulation and payroll taxes (Canada Pension Plan, Unemployment Insurance, Workers Compensation Board)
-Financing Problems
-A lack of Qualified Labor
Canadian Federation of Independent Business is a lobby group for small businesses.
A shelf company is just a piece of paper created by company lawyers. After it is created, a firm needs to raise financial capital (money) to carry on their business.
There are 2 ways most firms do this:
1: Equity Financing: Firms grant others a share of control of their company in return for a gift of money. Investor, however, expect a divident- a return on their investment. It should be noted that this return is completely DISCRETIONARY (firms can withhold it). Capital gain is an increase in the market value of the share (the share becomes more valuable, eg: a stock goes from $12 to $16). If a company pumps profits back into the company instead of distributing them to the shareholders, this is called undistributed profit.
2: Debt Financing: Firms borrow money from external lenders (usually banks)
Debtor = Borrower
Creditor = Lender
Principal = Originally Borrowed Amount
Interest = Extra money paid as a return on the loan
Redemption Date = The date the loan must be repaid
Term = The period between the date of the loan and the redemption date.
There are 3 Kinds of debt instruments!
1: Loans
-Short Terms
-Principal must be repaid
-Interest must be paid
2: Bill and Notes (ie you loan $90 and expect $100 back)
-Short Term
-Principal Guaranteed
-No interest, but sold by debtors to creditors for less than their real worth
3: Bonds and Debentures
-Long term
-Principal must be paid
-Interest payments must be made
Debentures:
If they are unsecured, there is no charge on specific assets
If they are secured all assets which are no specifically secured can be charged
Assets are taken by the creditor in the case of bankruptcies
This lets you use your assets as a credit (ie- you can use your house as a line of credit if it is paid for)
BIG IDEA: We assume that firms want to maximize profit!
This may not happen in corporations where management is hired by the owners. Management may be more focused on increasing their own salaries in this case. Here, they will maximize sales sometimes at the expense of profit.
There IS a range of profit which companies can work within which can be adjusted for different situations while still keeping the owners reasonably happy.
In the end, the companies that make profits are the one which survive. it's evolutionary.
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