Chapter 25 - Business Organization

Overview:

This chapter introduces the business organization chart, board of advisors, legal business structures (sole proprietorship, partnership, general and limited partners, limited liability partnership, subchapter-C corporation, subchapter-S corporation, limited liability company, joint ventures, cooperatives) and some legal and tax implications.

Objectives:

After completing this chapter, you will be able to:

• Describe how a farm is organized in terms of who is responsible for what and who reports to whom
• Understand the alternative legal forms of business organization and when each is appropriate

Key Points:

• The complexity of the farm business and the number of people involved increase the need for a formal description of how the farm and the people involved are organized and work together.
• A board of advisors can be a valuable management tool for a manager facing an increasingly complex business environment.
• Three common legal forms of business organization are the sole proprietorship, partnership, and corporation, with the sole proprietorship being the most common among farms in the United States.
• Other legal forms also used by some farmers include limited partnerships, subchapter-S corporations, and limited liability companies.
• Each legal form has different benefits and requirements and is appropriate in different situations.

Key Terms:

• Board of advisors: A group of people who offer advice to the management of a farm, but who do not directly benefit from the success or suffer from the loss of the farm.
• Business organization: Both (1) how a business is organized in terms of how owners, managers, and workers relate to each other and (2) the legal form of organization (i.e., sole proprietorship, partnership, corporation, or cooperative)
• Cooperative: An enterprise collectively owned and operated for mutual benefit.
• Corporation: A group of persons granted a charter to form a separate entity having its own rights, privileges, and liabilities, a corporation is usually formed to operate a business.
• Organization chart: A diagram showing how owners, managers, and workers relate to each other within an organization.
• Partnership: Two or more parties who have joined to operate a business.
• Sole proprietorship: A business owned by one owner.
  

Study Notes:

Let’s consider business organization in two ways. First in how the business is organized and the relationships involved. That is, who does what and who is responsible for what. Second, how is the business organized from a legal viewpoint: sole proprietorship, partnership, corporation, or cooperative.

ORGANIZATIONAL STRUCTURE

Rather than just assuming work will be done in an efficient, profitable manner, managers need to answer several questions, including the following: Who’s in charge? Is one person in charge or is a committee? How much responsibility and authority does each person have? To whom does each worker report? For a single person business, these are easy questions. For a multi-operator business, even a family business, these questions can be very involved and contentious. The answers determine the structure and relationships between the owners, managers, partners, employees, and other stakeholders in the farm. The structure can be seen easily in what is called an organizational chart.

A single farmer with only one employee has a very simple structure and may not need an extensive chart. Even if the employee is in charge of the equipment and the repair shop, both the farmer and the employee probably know who is in charge of the whole operation.

A farm that has several strategic parts and several people involved will have a more complicated chart and require more time to develop and communicate these relationships and the resulting structure of the business. Drawing an organizational chart (such as Figure 25.1 in the text) will help all the people involved better understand who is responsible for what and who reports to whom.

BOARD OF ADVISORS

Major corporations and organizations have a board of directors that bring an external view to the organization and act as a sounding board for management’s ideas.

Why shouldn’t a farm benefit from this idea of an external view and a sounding board?

There is no reason why farmers can’t have these benefits.

Unless a farm is incorporated, it is not required to have a board of directors. But a farm can benefit from a board of advisors. While these advisors would not have the power of a corporation’s board of directors, they would still bring an external view to the farm. An astute manager will realize the value of a well selected board of advisors and their wisdom and experience. They will bring a seasoned voice to the ideas and direction of management for operating in a complicated, connected world.

A board of advisors can help a farmer overcome several of the potential problems mentioned in Chapter 9, Crafting Strategy. These problems include planning under uncertainty, ivory tower planning, planning for the present, and manager’s biases.

LEGAL FORMS OF BUSINESS ORGANIZATION

There are three basic legal forms of business organization widely used in farming: sole proprietorship, partnership, and corporation. These are discussed briefly here. More detailed information and a tabular summary (Table 25.1) is in the text.

Sole Proprietorship

A sole proprietorship is owned solely by one person. It’s main advantage is simplicity of formation and governance. The owner bears personal liability for all debts of the business as well as any other liabilities. All business income is passed directly to the owner and taxed as part of the individual’s earned income. The sole proprietorship business ceases to exist upon death of the owner.

General Partnership

A general partnership consists of two or more partners who have joined to operate a business. Each partner is personally liable for all debts incurred by any of the other partners in the operation of the business. A general partnership is very easy flexible and fairly easy to form, but forms do have to be filed with the government. In the U.S., a partnership does not pay income taxes and passes all income and deductions to the partners as individuals. A general partnership ceases to exist when the partners dissolve the partnership, but not necessarily when one partner dies. A general partnership is a quasi-person in U.S. law. Partnerships can allow people to pool their financial, management, and other resources to create, hopefully, a better advantage in the marketplace compared to the partners having their own sole proprietorships.

Limited Partnership

A limited partnership is similar to a general partnership with at least one general partner and at least one partner limited in liability and in ability to directly participate in the management of the business. The advantage of the limited partnership is its ability to attract outside capital from individuals who are willing to put their investment at risk, but do not want to become personally liable for all debts of the partnership. The disadvantage to the general partner(s) is their unlimited liability to the debts of a larger business.

Corporation

Corporations are separate entities that, once formed, have unlimited legal life. One or more stockholders own stock in the corporation and their liability is limited to their investment. Shares are easily transferable. Owners are not personally liable for debts of the corporation — unless they also sign as individuals and not just as officers of the corporation. The initial cost of forming a corporation is greater than a partnership or a sole proprietorship; taxation rules and forms are more involved; and the business must be run more formally.

The most common legal form of a corporation in general business is called the Sub Chapter-C corporation due to the section of the law that allows their creation in the U.S. Corporations can be either publically traded or privately held. There is no limit on the number of shares, types of shareholders, or the number of owners of Sub Chapter-C corporations. Sub Chapter-C corporations pay taxes on corporation income at corporate tax rates before they pay dividends to the owners as shareholders. The disadvantage is that the shareholders then pay taxes on the dividends as income to them as individuals. The complaint is the double taxation on corporate income. However, Sub Chapter-C corporations do have some tax advantages (such as the deductibility of manager’s salaries, some insurance costs, and retirement programs) not available to sole proprietors and partnerships.

Another form of the corporation is known as the Sub Chapter-S Corporation. They are limited in the number and type of shareholders who are limited in their liability. Income from a Sub Chapter-S corporation is not taxed, but passed through to the owners — like a partnership.

Limited Liability Companies

Limited liability companies (under U.S. law) have the tax benefits of a partnership (that is, no double taxation) and the limited liability of a corporation. Income from limited liability companies is not taxed but passed through to the owners who then pay income taxes as individuals. The disadvantage of the limited liability company is the complexity and organizational cost. It also can’t fully utilize all fringe and retirement benefits. Ownership is not transferred as easily as shares in a corporation.

This chapter has covered the basic ideas of how to organize a farm (1) in terms of how people relate to each other and (2) as a legal organization.

Worksheet(s):

None for this chapter.

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