Lesson 2: ORGANIZING A BUSINESS; FORMS OF ORGANIZATION

Learning Objectives:

A. Define entrepreneurship, promotion, feasibility study, sole proprietorship, partnership,

corporation, pre-emptive right of stockholders, watered stock, common stock, preferred stock,
par value of stock, dividends, stock dividend, scrip dividend, liquidating dividend and other
terms given in the chapter.

B. Enumerate the following:

• The different activities involved in promotion
• Major parts of a feasibility study
• Advantages and disadvantages of a sole proprietorship, a partnership and a corporation
• Classes of partnerships and corporations
• Differences and similarities between partnerships and corporations

C. Compute for the following:

• the number of directors one can vote for based on the number of shares of stock owned
and vice-versa

• the effect on proportionate interest when pre-emptive right is exercised and when not
exercised

D. State the limitation to retention of corporate earnings as provided in the Corporation Code of
the Philippines

ORGANIZING A BUSINESS

Many individuals would want to go into business on their own but are hesitant to do so. Oftentimes,
they start small and gradually improve operations and consequently, their financial position. However,
the longer one engages in business, the more he realizes that there are greater opportunities for growth
and profit. They may be beyond his limitations so that he opts to modify the type of his organization.

Entrepreneurship

The term entrepreneurship refers to an individual's undertaking whereby he invests his money in a
business which he manages. When a man decides to go into business, it must be his ambition to be his
own master and employer. He must be willing to give up the complacency of an eight-to-five
employee who receives his paycheck regardless of typhoons, drought, etc. He must have sufficient
knowledge of management organization, finance and the related fields of study. He must have the
ability to take advantage of opportunities and the willingness to take risks. He must be innovative.

For an individual desirous of starting a business of his own, the following are some of the questions that
may guide him in his choice of activity:

o What goods and services are needed in the community? How can I make these goods and services
available?
o What sources of materials are available in the community that I can make use of in making the
goods and services available?
o What kind of labor do I need to make the goods and services available? Is the supply of required
labor sufficient?
o What financial resources do I have that I can make use of in this business?
o Am I willing to take risks? What are the risks involved?
o Am I willing to make sacrifices for the growth and stability of the business?
o Am I willing to work for longer hours?
o What governmental regulations must be observed in this kind of business?
o Where should my business be located?
o How much capital do I need to make the business viable?
o How much of this capital must be in working capital, plant, property and equipment?
o Are there competitors in the kind of business I have in mind? If so, what is their share of the market?
How can I improve on my competitors' practices?
o In case I need additional capital, what are my possible sources and the costs involved?
o How long would it take to recover my investment?
o What would be the rates of return on sales, on total assets, and on owner's equity?

There are so many business opportunities in a community but even if a person is willing to take risks, he
may not have sufficient capital. He may gradually save from his monthly pay, invest his savings in assets
that appreciate in value and dispose of the same afterwards. He may also start small by making use
of whatever his family has. Another alternative is to approach other parties with sufficient capital and
encourage them to finance the venture as creditors, as partners or as incorporators.

Promotion

The term promotion refers to the activities involved in making a business ready to operate. Individuals
who undertake the activities in organizing a business until it becomes operational are called promoters.

Discovery (or exploratory) stage refers to finding business opportunity and conducting investigation to
determine whether it should be undertaken or not. In other words, it refers to looking for business
prospects and making a study as to whether it would be worthwhile going into. The study so conducted
is generally called a feasibility study.

Financing. This stage of promotion refers to procurement of the initial capital that the proposed business
requires to be able to operate profitably. A sole proprietor may make use of his savings and/or borrow
from friends, relatives, and financing institutions. He may also invite other individuals to join him as
partners. For a corporation, the incorporators contribute funds and even promise additional
investments for future capital requirements.

The initial capital requirement is invariably for:

a). cost of organizing:
b). working capital
c). plant, property and equipment; and,
d). margin of safety to take care of possible changes in capital requirement.

Assembling. This stage is where all the factors required for viable business operations are made
available in their optimum combination. In other words, it is where actual organization takes place. The
business is registered with SEC (for partnerships and corporations) and the Department of Trade and
Industry. Municipal or city licenses and BIR permits are obtained, property and equipment are
acquired, personnel are hired, and their responsibilities are defined.

The effort expended in promoting a business varies with the nature of proposed operations and its type
of organization. A sari-sari store can be put up overnight. A grocery business would take a longer period
to promote but not as long as a manufacturing concern would require.

Project Feasibility Studies

A project feasibility study is a thorough and systematic analysis of all factors to ascertain the viability of
an undertaking. It gives a "capsule view of the whole project by presenting its highlights, descriptive
definition, long-range objectives, feasibility criteria, history, and basic assumptions. It contains the name
of the firm, location and size of its head office, plant site, comprehensive description of the business
and its operations, and the project lines.

Major Parts of the Feasibility Report

The major parts of a feasibility report are those on the following aspects:

a. Marketing
b. Organization and management
c. Technical
d. Taxation
 e. Legal Financing
f. Financial aspects
g. Social and economic benefits

The marketing aspects include the research made on actual and potential demand for the product,
competition, selling price and marketing plans. Organizing and management aspects cover the type
or form of business organization and division of functions within the organization. The technical aspects
should delve on the manufacturing process, operating requirements, plant capacity, plant layout, etc.
The project must also include the study on tax implications and tax saving measures. All applicable
taxes must be included in financial projections. The financing aspects include the determination of the
financing requirements, sources of financing, and cost of capital. The financial aspects cover the
presentation of the expected results of operations, their effects on the financial resources of the
company, and analysis thereof regarding profitability, liquid ity and stability,

The social and economic benefits of the project are presented to show the relevance of the project
under study in relation to the plans of the government in the particular region, the benefits that may
be derived directly or indirectly by the community and other business establishments, and the possible
effects on our national economy.

Financial Aspects of Project Feasibility Studies; Financial Managers' Role Therein

Finance managers are primarily involved in the financial aspects of a project feasibility study. The
financial aspects should include the following:

a) Statement of major assumptions

b) Projected financial statements and supporting computations
c) Analysis of financial statements

Valid and realistic assumptions must be made and stated in the study to provide a definite and specific
basis for financial projections. The statement of assumptions includes those on sales volume, plant
capacity, taxes, foreign exchange rate project timetable, and changes in the economic environment.
The projected financial statements may be in the form of:

o projected income statement.

o projected statement of financial position, and
o projected statement of cash flows.

Financial Projections

Whenever there is a proposed undertaking, the financial projections are made to provide answers to
questions such as the following

o How profitable can the project be?

o At what level should business activities be conducted to maximize rate of return considering the
limited resources of the company?
o What would be the effects thereon on the current business operations of the company?
o How much investment would be required to sustain operations of the company?
o How much investment would be required to sustain operations at the desired level and what is
the expected rate of return?

It is therefore imperative to determine the following:

• Expected value of sales estimates

• Breakeven point
• Expected value of annual cash returns
• Capital requirement
• Cost of capital
• Expected rate of return
In making financial projections, different techniques and concepts are used such as probability, cost-
volume-profit analysis, margin of safety, discounted cash flows, and analysis of financial statements.

Financial Projections Required by the BOI. The Board of Investments requires projected financial
statements for five years. Samples are shown on the following pages.

BOI: Sample Format of Projected Statements

Projected Income Statement

(In Thousand Pesos)
Year 1 Year 2 Year 3 Year 4 Year 5
Sales
Local (net of sales discount and sales returns)
Export
Less export tax
Net export sales
Total sales
Cost of sales
Gross profit on sales
Operating expenses
Net profit (loss) on operations
Less: Financial charges
Local
Foreign
Total financial charges
Net profit before income tax
Provision for income tax
Net profit after tax

Projected Cash Flow Statement

(In Thousand Pesos)
Pre- Year 1 Year 2 Year 3 Year 4 Year 5
operating
ESTIMATED CASH RECEIPTS
From Operation:
Net Profit after interest and tax
Add back:
Depreciation
Amortization of pre-operating expenses
Other noncash charges
Increase (decrease) in current liabilities
(excluding currently maturing portion of
long-term loans)
Decrease (increase) in noncash current assets
Total cash receipts from operations

From Other Sources:

Increase in capital stock
Preferred
Common
Total

Increase (decrease) in long-term loans

Local
Foreign
Total

Sale of non-current assets

Land
 Building
Machinery and equipment
Other non-current assets
Total
Total cash receipts from other sources
TOTAL ESTIMATED CASH RECEIPTS

ESTIMATED CASH DISBURSEMENTS:

Capital Expenditures
Land Improvements
Building
Machinery and equipment
Organizational and pre-operating expenses
Other non-current assets
Provision for contingencies
Total capital expenditures

Other disbursements
Amortization of long-term liabilities
Local
Foreign
Total

Reacquisition of capital stock

Redemption of preferred stock
Acquisition of treasury stock
Others
Total
Total other disbursements

TOTAL ESTIMATED CASH DISBURSEMENT

NET CASH INFLOW (OUTFLOW)

CASH BALANCE, BEGINNING

CASH BALANCE, END

Projected Balance Sheet

(In Thousand Pesos)
Pre- Year 1 Year 2 Year 3 Year 4 Year 5
operating
ASSETS
Current Assets
Cash
Marketable securities
Notes receivable
Accounts receivable
Inventories
Finished goods
Goods in process
Raw materials and supplies
Other current assets
Total current assets

Property, Plant and Equipment

Land and improvements
Leasehold improvements
Buildings
 Machinery and equipment
Transport equipment
Office equipment
Others (tools, etc.)
Less: Accumulated depreciation
and amortization
Total property, plant and equipment, net

Other assets

TOTAL ASSETS

LIABILITIES AND STOCKHOLDERS EQUITY

Liabilities
Current liabilities
Bank overdraft
Accounts payable
Income tax payable
Notes payable
Total current liabilities

Long-term liabilities
Development Bank of the Phil.
ABC Industrial Corp. (US)
Total long-term liabilities

Other liabilities

Total liabilities

Stockholders' Equity
Capital stock
Preferred stock
Common stock

Retained earnings
Balance, beginning
Net profit (loss)
Balance, end

Total stockholders' equity

TOTAL LIABILITIES & STOCKHOLDERS EQUITY

FORMS OF BUSINESS ORGANIZATIONS

A business organization may be in the form of sole proprietorship, partnership, or corporation.

A Sole proprietorship is a form of organization where there is only one owner, the proprietor.

A partnership is an association of two or more persons who bind themselves to contribute money,
property, or industry to a common fund, with the intention of dividing profits among themselves.

A corporation is an artificial being created by operation of law, having the right of succession and the
powers, attributes and properties expressly authorized by law or incident to its existence.

Sole Proprietorship

Many small businesses in the Philippines are started as sole proprietorships. This is often due to the desire
of an individual who is going into business for the first time, to do it on his own first while learning the
trade. After operating for some time, he invites or gets invited to form a partnership or a corporation.

Organizing a Sole Proprietorship

The following is the procedure followed in organizing a sole proprietorship:

➢ Register the business name with the Bureau of Domestic Trade.

➢ Pay the municipal licenses to the local government.
➢ Apply for VAT or non-Vat number.
➢ Register with the BIR the books of accounts (simplified bookkeeping records or journals and
ledger) and the business forms to be used (sales invoices, cash sales invoices, official receipts,
etc.)

It should be emphasized to anybody desirous of going into business that unless the business activities
he has in mind require an office or store, he can do business in his own residence.

Advantages and Disadvantages of a Sole Proprietorship

Each type of organization has its advantages and disadvantages. For a sole proprietorship, they are
as follows:

Advantages Disadvantages

1. It is easy to organize. The governmental 1. Limited ability to raise capital. The business
requirements for sole proprietorships are minimal. depends only on the financial resources that can
be procured by the sole owner.
2. Decisions can easily be made inasmuch as
they are made by the owner himself. 2. The sole proprietor has unlimited liability.
Business creditors can go after his personal assets
to satisfy their claims.
3. Financial operations are not complicated in
such as this type of organization is generally for
3. Limited ability to expand. This is due to its
small-scale business.
limited capital and in most cases, operations are
limited only to areas in which the sole proprietor
4. The owner is entitled to all the profits his
has expertise.
business realizes

4. Business is entirely a responsibility of the owner.

The owner has nobody to share with the burden
of decision making and losses he might incur.

5. Net income is subject to tax regardless of

whether it is withdrawn or not.
It may be noted that the disadvantage of having limited ability to expand (No. 3) arises from the limited
liability to raise capital (No. 1). For anyone intending to go into business, capitalize on the advantages
as listed and invest the minimum amount of capital required to make the business viable. The perennial
advice of not putting all your eggs in one basket" may be observed by channeling remaining resources
to other forms of investment to provide leverage.

Partnerships

Partnerships are governed by the provisions of the Civil Code, articles 1767 to 1867.

A partnership is defined as an association of two or more persons who bind themselves to contribute
money, property, or industry to a common fund with the intention of dividing the profits among
themselves. It begins to exist from the moment of the execution of the partnership contract, unless it is
otherwise stipulated.

Organization of Partnerships

A partnership, in its simplest form, is formed when an individual invites another to join him in business
and divide profits between themselves. In some cases, existing sole proprietorships combine their
businesses and even invite other individuals to a partnership.

As a general rule, no special form is required for the validity or existence of the partnership contract so
that it may be made orally or in writing regardless of the value of the contribution. When immovable
property or real properties are contributed, the contract must be in a public instrument.

Provisions of the Civil Code on Partnership Formation

Article 1771: A partnership may be constituted in any form except where immovable property or real
rights are contributed thereto, in which case a public instrument shall be necessary.

Article 1772: Every contract of partnership having a capital of three thousand pesos or more, in money
or property, shall appear in a public instrument, which must be recorded in the Office of the Securities
and Exchange Commission.

Failure to comply with the requirement of the preceding paragraph shall not affect the liability of the
partnership and the members thereof to third parties.

Although the Civil Code requires that every partnership contract with capital of P3,000 or more to be
in a public instrument and registered with the SEC, failure to comply with said requirement does not
affect its validity. However, the registration with the SEC Is a requirement for the issuance of licenses by
the municipal or city government.

The following is the procedure followed in organizing a partnership:

➢ Register the business name with the Bureau of Domestic Trade.
➢ Have the partnership agreement (articles of co-partnership) notarized.
➢ Obtain a tax account number for the partnership from the BIR.
➢ Have the partnership agreement (articles of co-partnership) notarized and then registered with
the SEC.
➢ Obtain the municipal licenses from the local government.
➢ Obtain the value added tax account number (VAT) or the NON-VAT, as the case may be.
➢ Register books of accounts Journals and general ledger) and business forms to be used (sales
invoice, official receipts, cash sales invoices, etc.) with the BIR

Partnership Contract

The contract between the partners is called the articles of co-partnership. It contains, among other
items, the following:

1. Name of the partnership

2. Names of the partners
3. Place of business.
4. Effective date of the partnership
5. Nature of business
6. Investment of each partner and corresponding capital credit
7. Duration of the contract
8. Rights, powers, and duties of the partners
9. Accounting period
10. Manner of dividing profits and losses
11. Liabilities of the partners for partnership debts
12. Compensation for services offered by partners
13. Treatment of partners' additional investments and withdrawals
14. Procedures for settlement of partner's interest upon dissolution of partnership
15. Provision for settlement of disputes.

Classification of Partnerships

Partnerships may be classified based on object or scope of subject matter and based on liability of
partners for partnership obligations.

Based on object or scope of subject matter:

a. Universal partnership. This may refer to the contribution by partner of all present property or of
all profits.
➢ Universal partnership of all present property. This may refer to all the properties that
actually belong to each of the partners at the time the partnership is formed, with the
intention of dividing the same among themselves as well as the profits that they may
acquire therewith.
➢ Universal partnership of all profits. This refers to all the profits that the partners may acquire
by their industry or work during the existence of the partnership.

b. Particular partnership. Its objects are determinate things, their use or fruits, or a specific
undertaking, or the exercise of a profession or vocation.

Based on liability of partners for partnership obligations:

a. General partnership. In this kind of partnership, all the partners are general partners (or partners
liable for partnership debts to the extent of their personal property after all the partnership assets
have been exhausted).
b. Limited partnership. This refers to partnership having one or more general partners and one or
more limited partners (or partners who are liable for partnership debts only to the extent of their
capital contributions).

Classes of Partners

Partners may be classified based on their contribution and based on their liability for partnership debts.

Based on their contribution:

a. Capitalist partner. He is a partner who contributes money or property to the capital of the
partnership.

b. Industrial partner. He is a partner who contributes his work, labor or industry to the partnership.

c. Capitalist-industrial partner. He is one who contributes money or property as well as his work or
industry to the capital of the partnership.

Based on their liability for partnership debts:

a. General partner. He is one who is liable for partnership debts to the extent of his personal property
after partnership assets are exhausted.

b. Limited partner. He is one whose liability for partnership debts is limited to his capital contribution.

Partnership as a Juridical Person

Per article 1768 of the Civil Code, a partnership has a juridical personality separate and distinct from
that of each of the partners even if the contract between the partners is not in a public instrument and
is not registered with the SEC. As such, the partnership can acquire and possess property of all kinds,
as well as incur obligations and bring civil or criminal actions in conformity with laws.

Responsibilities of Partners

Every partner is an agent of the partnership so that every act of his, including the execution of any
instrument in the partnership name, for apparently carrying partnership business in the usual way, binds
the partnership. An exception to this is when the partner so acting has in fact no authority to act for
the partnership in the particular matter and the person with whom he is dealing knows that he has no
such authority.

The relation between partners is essentially fiduciary involving trust and confidence so that each
partner is considered a confidential agent of the others. As such, it is his obligation to act for the
common benefit of all transactions relating to the partnership business or affairs.

Article 1768 of the Civil Code states:

The partnership has a juridical personality separate and distinct from that of each of the partner even
in case of failure to comply with the requirements of article 1772, first paragraph.

With respect to contribution of property, Article 1786 of the Civil Code states:

Every partner is debtor of the partnership for whatever he may have promised to contribute
thereto.

He shall also be bound for warranty in case of eviction with regard to specific and determinate
things which he may have con tribute to the partnership in the same cases and in the same manner as
the vendor is bound with respect to the vendee. He shall also be liable for the fruits thereof from the
time they should have been delivered without the need of any demand.

Manner of Dividing Profits and Losses

Partnership profits and losses are divided based on the agreement between themselves. In the
absence of stipulation in the partnership contract, the same shall be divided based on their capital
contributions. An industrial partner shares in profits based on what may be just and equitable under
the circumstances. He is given priority in the division of profits and he does not share in losses. If besides
his services, he contributes capital so that he in effect, is an industrial capitalist partner, he shall also
receive a share in the profits in proportion to his capital.

Liability of Incoming Partner for Existing Obligations

An incoming partner has limited liability for all obligations existing at the time of his admission to a
partnership. Article 1826 of the Civil Code states:

A person admitted as a partner into an existing partnership is liable for all the obligations of the
partnership arising before his admission as though he had been a partner when such obligations
were incurred, except that this liability shall be satisfied only out of partnership property, unless
there is a stipulation to the contrary.

Advantages and Disadvantages of Partnerships

The following are the advantages and disadvantages of partnerships:

Advantages Disadvantages

1. It is easy to form. This is because the partnership 1. Partners have unlimited liability for partnership
is subject to less legal requirements. debts.

2. Flexibility of operations. Its choice of activities is 2. It has limited life because it can easily be
not subject to so many restrictions. Inasmuch as dissolved. A partnership, being a contract
there generally are few owners in a partnership, between the partners, is dis solved based on their
an agreement among partners can be easily agreement, and upon the withdrawal,
arrived at without unnecessary delay. incapacity or death of a partner, etc.

3. It is expected to be operated more efficiently 3. Limited ability to raise capital. The amount of
when compared with a sole pro- proprietorship capital depends on how much can be
because of the presence of more owners. In contributed and/or procured by the partners.
other words, two heads are better than one"
 4. Partners are expected to have great interest in 4. Net income is subject to tax whether
the operations of the partnership because of distributed or not. All partnerships, except
their unlimited li ability for partnership debts aside general professional partner ships, are subject to
from their shares in profits. the corporate tax rate,

Organizational Setup in a Partnership

A partnership usually has a managing partner appointed in the articles of partnership. A managing
partner has all the powers of a general agent as well as all the incidental powers necessary to carry
out the object of the partnership in its operations. In case the partners fail to designate who among
them shall act as manager, all of them shall be considered as agents of the partnership,

Corporations

Private corporations are governed by the Revised Corporation Code of the Philippines, Republic Act
11232.

Corporation Defined

A corporation is an artificial being created by operation of law having the right of succession and the
powers, attributes and properties expressly authorized by law or incident to its existence.

As an artificial being, a corporation is a legal or juridical person with a personality separate from its
individual stockholders or members. Because of this legal concept of a corporation, it may acquire
and possess property of all kinds, incur obligations, and bring civil or criminal actions in the same
manner as a natural person does. Its juridical personality begins to exist from the date of the issuance
of Certificate of Incorporation by the Securities and Exchange Commission (SEC) under its official seal.

The Right of Succession

A corporation has the right to continuous existence irrespective of death, withdrawal, insolvency, or
incapacity of the individual members or stockholders and regardless of the transfer of their interests or
shares of stock. Perpetual existence unless its articles of incorporation provides for a specific term.

Classifications of Corporations

A. Based on the nature of capital

a. Stock Corporation. Capital is in the form of capital stock divided into shares. Corporate
earnings may be distributed to shareholders as dividends.
b. Non-stock Corporation. This refers to a not-for-profit organization and organized for the
benefit of its members or its intended beneficiaries. It is formed for educational, professional
charitable, religious, scientific, social, civic, fraternal or literary services or similar purposes
such as trade, industry or agricultural chambers or any combination thereof. It uses fund
accounting so that the balance sheet equation is: Assets Liabilities + Fund Balance

B. Based on ownership
a. Government owned or controlled corporation (GOCC). It is either owned or controlled by
the government.
b. Non-government Corporation.
i. Public company. The SEC's Code of Corporate Governance defines a public
company as any corporation with a class of equity securities listed in an Exchange or
with assets in excess of Fifty Million Pesos (P 50,000,000 and having two hundred (200)
or more stockholders each holding at least one hundred (100) shares of a class of its
securities,

(The term public corporations may also refer to Local Government Units (GLS). Their charters are
approved by Congress and are not included in these classification)

ii. Non-public Corporation. One that does not qualify as a public corporation per
requirements given in a above. (It may also be called private. However, all
companies registered with the SEC are private.)

C. Based on its relation to another corporation

a. Parent Corporation. It owns the controlling interest (more than 50%) in another corporation.
 b. Subsidiary. The investee corporation in which the investor corporation has controlling
interest. The controlled corporation is called a subsidiary.
c. Associate. The investee corporation in which the investor corporation has significant
influence (not controlling interest) In the absence of any evidence to the contrary, significant
influence is assumed to exist when there is ownership of 20% or more but not exceeding 50%
When the ownership exceeds 50%, it is already considered as controlling interest

D. Based on the country or by whose laws they have been created

a. Domestic Corporation. It was incorporated under Philippine laws.
b. Foreign Corporation. It was incorporated under the laws of a foreign country.

E. Based on who are accepted as shareholders or members

a. Close corporation. It is limited to selected persons or members of a family.
b. Open corporation. It is open to any person who may wish to become a shareholder or
member thereof.

Components of a Corporation

The following are the terms used for persons composing a corporation

Corporators. This term refers to all the persons composing a corporation whether they are stockholders
(in the case of stock corporations) or members in the case of non-stock corporations).

Incorporators. This refers to corporators who are mentioned in the articles of incorporation as originally
forming and composing the corporation and who executed and signed the articles of incorporation
as such. Sec. 10 of the Revised Corporation Code states:

Any person, partnership, association or corporation, singly or jointly with others but not more than
fifteen (15) in number, may organize a corporation for any lawful purpose or purposes: Provided, That
natural persons who are licensed to practice a profession, and partnerships or associations organized
for the purpose of practicing a profession, shall not be allowed to organize as a corporation unless
otherwise provided under special laws. Incorporators who are natural persons must be of legal age.

Each incorporator of a stock corporation must own or be a subscriber to at least one (1) share of the
capital stock.

A corporation with a single stockholder is considered a One Person Corporation as described in Title
XIII, Chapter III of this Code.

Stockholders. This term refers to natural or juridical persons who own at least one (1) share of the capital
stock of a corporation.

Member. They are the corporators in a non-stock corporation.

Board of Directors or Trustees. This is the governing body in a corporation. With the exception of some
powers reserved by law to stockholders (or members), the board of directors has the sole authority to
determine policy and conduct the ordinary business of the corporation within the scope of its charter.
A director must have at least one (1) share of capital stock registered in his name at the time of his
election (or required cut-off date) and during his term. For non-stock corporations, the body is usually
called the Board of Trustees.

Corporate Formation

Corporate formation requires all the activities that must be undertaken in preparing a business and in
complying with all the legal requirements for the entity to have its legal personality as a corporation
The promoters sell the idea of forming a corporation to other people who may agree to become
incorporators and/or provide capital, rights and property necessary to achieve the corporate purpose
or purposes. They have to open bank accounts, conduct regular meetings between the incorporators,
and contract people for services such as feasibility studies and preparation of legal documents,
particularly, those required by the Securities and Exchange Commission. The costs incurred in
corporate formation are charged to an account, Organization Costs.

Registration of Corporations

Registration of corporations involves the following procedure:

1. Verification of corporate name with SEC. This is to determine if the corporate name to be adopted
has already been adopted by any other firm whether partnership or corporation duly registered with
the SEC.

2. Drafting and execution of the articles of incorporation and By-laws

3. Deposit of cash received for subscribed shares of stocks in a banking institution in the name of the
temporary treasurer, in trust for and to the credit of the corporation

4. Filing of the articles of incorporation together with the following:

a). Treasurer's affidavit

b). Statement of assets and liabilities of the proposed corporation
c). Authority to verify bank deposits
d). Certificate of deposit of cash paid for subscription (no longer required)
e). Personal information sheet of the incorporators
f). Commitment to change corporate name if it is found similar to another corporate name

5. Payment of filing and publication fees

6. Issuance by SEC of the certificate of incorporation.
7. Registration of the corporate name with the Bureau of Domestic Trade
8. Obtaining municipal licenses from the local government (municipality or city)
9. Obtaining the VAT or Non-VAT account number from the BIR 10. Registration with BIR of books of
accounts and accountable forms

Contents of the Articles of Incorporation

Section 13 of the Revised Corporation Codes states:

All corporations shall file with the Commission articles of incorporation in any of the official languages, duly
signed and acknowledged or authenticated, in such form and manner as may be allowed by the
Commission, containing substantially the following matters, except as otherwise prescribed by this Code
or by special law:

(a) The name of corporation;

(b) The specific purpose or purposes for which the corporation is being formed. Where a
corporation has more than one stated purpose, the articles of incorporation hsall indicate the
primary purpose and the secondary purpose or purposes: Provided, That a nonstock corporation
may not include a purpose which would change or contradict its nature as such;

(c) The place where the principal office of the corporation is to be located, which must be within
the Philippines;

(d) The term for which the corporation is to exist, if the corporation has not elected perpetual
existence;

(e) The names, nationalities, and residence addresses of the incorporators;

(f) The number of directors, which shall not be more than fifteen (15) or the number of trustees
which may be more than fifteen (15);

(g) The names, nationalities, and residence addresses of persons who shall act as directors or
trustees until the first regular directors or trustees are duly elected and qualified in accordance with
this Code;

(h) If it be a stock corporation, the amount of its authorized capital stock, number of shares into
which it is divided, the par value of each, names, nationalities, and subscribers, amount subscribed
and paid by each on the subscription, and a statement that some or all of the shares are without
par value, if applicable;

(i) If it be a nonstock corporation, the amount of its capital, the names, nationalities, and residence
addresses of the contributors, and amount contributed by each; and

(j) Such other matters consistent with law and which the incorporators may deem necessary and
convenient.

An arbitration agreement may be provided in the articles of incorporation pursuant to Section 181 of this
Code. 1âwphi1
The Articles of incorporation and applications for amendments thereto may be filed with the Commission
in the form of an electronic document, in accordance with the Commission's rule and regulations on
electronic filing.

By Laws

By-laws may be defined as the rules of action for the internal government of a corporation and for the
government of its officers and stockholders or members. All corporations formed under the Corporation
Code of the Philippines are required to adopt a code of by-laws within one (1) month after receipt of
its corporate charter from the SEC. By-laws shall be effective only upon issuance by the SEC of a
certification that the by- laws are not inconsistent with the provisions of the Corporation Code. It may
provide for the following:

1. The time, place and manner of calling and conducting regular or special meetings of the directors
or trustees.
2. The time and manner of calling and conducting regular or special meetings of the stockholders or
members.
3. The required quorum in meetings of stockholders or members and the manner of voting therein.
4. The form of proxies of stockholders and members and the manner of voting therein.
5. The qualification, duties and compensation of directors or trustees and officers.
6. The time for holding the annual election of directors or trustees and the mode or manner of giving
notice thereof.
7. The manner of election or appointment and the term of office of all officers other than directors or
trustees.
8. In the case of stock corporations, the manner of issuing certificates.
9. The penalties for violation of the by-laws.
10. Other matters that may be necessary for the proper and convenient transaction of its corporate
business and affairs.

SEC Express Registration Services

The SEC provides express incorporation services whereby for a fee, an applicant is given a standard
set of incorporation papers to be filled up.

Rights of Stockholders

Stockholders, as owners of a corporation, have certain rights expressly recognized by the corporation
law. These may be summarized as follows:

1. Right to attend and vote in person or by proxy at stockholders' meetings.

2. Right to receive dividends when declared.
3. Right to inspect corporate books and records and to receive financial report of the corporation's
operations.
4. Right to pre-emption in the issue of shares.
5. Right elect remove directors.
6. Right to approve certain corporate acts.
7. Right to issuance of certificate of stock or other evidence of stock ownership and be registered as
shareholder.
8. Right to transfer of stock on the corporate books.
9. Right to participate in the distribution of corporate assets upon dissolution.
10. Right to adopt and amend or repeal the by-laws or adopt new by-laws.
11. Right to compel the calling of meeting of stockholders when for any cause there is no person
authorized to call a meeting.
12. Right to enter into a voting trust agreement
13. Right to recover stock unlawfully sold for delinquent.
14. Right to bring individual and representative or derivative suits.
15. Right to demand payment of the value of his shares and withdraw from the corporation in certain
cases.
16. Right to have the corporation voluntarily dissolved.

Pre-emptive Right of Stockholders

The pre-emptive right of a stockholder refers to his right to subscribe to all issues or disposition of shares
of any class, in proportion to his shareholdings subject to certain exceptions per Sec. 38 of the Revised
Corporation Code. This right aims to safeguard stockholders against unfairness in the issue of shares to
manipulate voting power of some stockholders and dilute the value of their proportionate interest.
Example: Clemence Santos owns 5,000 shares of the 25,000 outstanding shares of capital stock of AB
Mfg. Corp. The firm is issuing additional 15,000 shares to raise additional capital. If Clemence Santos is
not allowed to subscribe to the new issue in proportion to his shareholdings, his proportionate interest
would go down from 20% to 12,5%, computed as follows:

5,000 𝑠ℎ𝑎𝑟𝑒𝑠 𝑜𝑤𝑛𝑒𝑑

Proportionate interest at present = = 20%
25,000 𝑠ℎ𝑎𝑟𝑒𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔

5,000 𝑠ℎ𝑎𝑟𝑒𝑠 𝑜𝑤𝑛𝑒𝑑

Proportionate interest after the new issue = = 12.5%
40,000 𝑠ℎ𝑎𝑟𝑒𝑠 𝑜𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔

The adverse effect on the proportionate interest of C. Santos will be compounded if the additional
shares were to be issued at a price lower than the current book value per share. Assume that the
current book value per share is P150 and the new issue is to be issued to other stockholders at par value
of P100. The current book value of Clemence Santos' shareholdings of P750,000 would go down to
P656,250 or book value per share would go down from P150 to P131.25. The computations are as
follows:

Total stockholders' equity at present: P 3,750,000

(25,000 shares outstanding x P150 book value/share)
Add: New issue of 15,000 shares at P100 1,500,000
Total stockholders' equity after new issue 5,250,000
Divide by 40,000 shares outstanding 40,000 shares
Book value per share after new issue P 131.25
Book value of C. Santos' shareholdings
= 5,000 x P131.25 P 656,250
Decrease in book value of C. Santos' shareholdings
(5,000 shares at P150 or P750,000) - P656,250 P 93,750

Watered Stock

The Corporation Code prohibits the original issuance of stocks for a consideration less than par or issued
price thereof. Stocks issued for a consideration less than par or issued value are called watered stock.
Any director or officer of the corporation who approves the issuance of stocks at less than par or issued
value is solidarily liable with the stockholder concerned for the difference between the fair value of the
consideration at the time of issuance and the par or issued value of the stock.

Voting in a Stock Corporation

The manner of voting in a stock corporation is called cumulative voting. A stock holder is entitled to
cast votes equal to the number of shares he owns multiplied by the number of directors or trustees to
be elected. He may cast the said number of votes for only one candidate or divide the same among
the candidates he chooses.

Example: B. Acuña owns 7,000 shares of the 25,000 outstanding shares of the capital stock of B Corp.
There are seven seats in the board of directors. He can cast a total of 49,000 votes (that is, 7,000 x 7
seats). He may divide this total among the number of candidates he wishes to vote for. Should he
decide to vote for three candidates, he may divide the 49,000 votes in any manner he wants to among
the chosen three. In case he decides to vote for only one candidate, he may cast the total of 49,000
for the candidate of his choice.

Number Of Shares to Ensure Election to the Board of Directors. Oftentimes, a stockholder would want
to be represented or voted to the board of directors. To ensure his election to the board, he must have
sufficient number of votes based on shares owned and proxies obtained from other stockholders. The
formula used in determining the number of shares he must represent is as follows:

𝑇𝑜𝑡𝑎𝑙 𝑁𝑜.𝑖𝑓 𝑆ℎ𝑎𝑟𝑒𝑠 𝑂𝑢𝑡𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔 𝑥 𝐷𝑒𝑠𝑖𝑟𝑒𝑑 𝑁𝑜.𝑜𝑓 𝑆𝑒𝑎𝑡𝑠

No. of shares to ensure election = +1
𝑇𝑜𝑡𝑎𝑙 𝑁𝑜.𝑜𝑓 𝐷𝑖𝑟𝑒𝑐𝑡𝑜𝑟𝑠 𝑡𝑜 𝑏𝑒 𝐸𝑙𝑒𝑐𝑡𝑒𝑑𝑠+1
OR

𝑆𝑥𝐷
N= +1
𝑇+1
Example: John Lazaro would want to have three (3) seats in the board of directors of XYZ Corp. which
has 120,000 shares of capital stock outstanding and eleven (11) directors. The three seats in the board
of directors, the number of shares that John Lazaro must have or represent, is computed as follows:

120,000 𝑥 3
N= + 1 = 30,001 shares
11+1
The number of shares may also be arrived at follows:
 (𝑇+1 x S)+ 1 = ( x 120,000)+ 1 = 30,001
𝐷 3
N=
11+1

In a reverse case, the number of seats that a given number of shares can get is computed as follows:

𝑁𝑜.𝑜𝑓 𝐷𝑖𝑟𝑒𝑐𝑡𝑜𝑟𝑠 𝑡𝑜 𝑏𝑒 𝑒𝑙𝑒𝑐𝑡𝑒𝑑 + 1

No. of seats = Number of shares held – 1 x 𝑇𝑜𝑡𝑎𝑙 𝑛𝑢𝑚𝑏𝑒𝑟 𝑜𝑓 𝑆ℎ𝑎𝑟𝑒𝑠 𝑂𝑢𝑠𝑡𝑎𝑛𝑑𝑖𝑛𝑔

11+1
= 30,001 - 1 x = 3 seats
120,000

Voting in a Non-Stock Corporation

Every member of a non-stock corporation may cast as many votes as there are trustees to be elected
but may not cast more than one vote for one candidate unless cumulative voting is authorized in the
articles of incorporation.

Example: Julian Alarcon is a member of a professional organization in which ten (10) trustees are to be
elected. He may cast only one (1) vote for each of the candidates he chooses. If the articles of
incorporation authorizes the practice of cumulative voting, he may cast ten (10) votes for one
candidate or divide them between some of the candidates.

Classes of Shares of Stock

The shares of stock which a corporation can issue may be classified depending on voting power,
preferences, rights and restrictions as may be provided for in the articles of incorporation. They may be
grouped into:

(1) Common Stock and Preferred Stock

Common stock represents the basic issue of shares and has all the basic rights of a share of stock so
that it is often referred to as the basic ownership in a corporation. Common stockholders have the
same rights and privileges or they have no preferences over one another, thus, the term common. If a
corporation has only one class of capital stock, it must be classified as common stock.

Preferred stock is a class of stock having preferences over common stock. These preferences may be
in distribution of dividends and/or corporate assets upon dissolution of the corporation.

(2) Class "A" and Class "B" Shares

Stocks have been classified as Class "A" and Class "B" to keep track of Pilipino and foreign ownership in
a corporation. Class "A" shares are for Pilipino shareholders and Class "B" shares are for foreign investors.
Philippine citizens, however, are not prohibited from acquiring Class "B" shares.

(3) Par Value and No-Par Value Shares

Par Value shares refers to shares of capital stock that have been assigned a definite or fixed value in
the articles of incorporation so as to fix the minimum subscription or original issue price thereof.

No-par value shares are those that have not been assigned a definite or fixed value. They may be
assigned a stated value to serve as the minimum issue price.

(4) Founders' Shares

Founders shares are those classified as such in the articles of incorporation tion and may be given
certain rights and privileges not enjoyed by other stockholders.

Corporate Officers

A Corporation must have a president (who shall be a director), a treasurer (who may or may not be a
director), a secretary (who shall be a resident and citizen of the Philippines) and such other officers as
may be provided in the by-laws. Any two (2) or more positions may be held concurrently by the same
person, except that no one shall act as president and secretary or as president and treasurer at the
same time.

Distinctions between a Corporation and a Partnership

The distinctions between a corporation and a partnership may be summarized as follows:
Corporation Partnership
a. Governing laws
Revised Corporation Code Civil Code
b. Manner of creation.
It is created by law or operation of law. It can be created by mere agreement of the
parties.
c. Number of incorporators.
At least five (5) incorporators are required It may be organized by only two (2) persons.
- amended
d. Commencement of Juridical personality
It begins to have corporate existence and It commences to acquire juridical personality
juridical personality only from the date of the from the moment of the execution of the
insurance of the certificate of incorporation contract of partnership
by the Securities and Exchange Commission
(SEC) under official seal.
e. Powers
It can exercise only the powers expressly It may exercise any power authorized by the
granted by law or implied from those partner provided it is not contrary to law, morals,
granted or incident to its existence. good customs, public order or public policy.
f. Management
The power to do business and manage its When management is not agreed upon, every
affairs is vested in the board of directors or partner is an agent of the partnership
trustees.
g. Right of succession
It has the right of succession. It has no right of succession
h. Term of existence.
It may be formed for a term not louder It may be established for any period of time as
than 60 years subject to ex tension to not stipulated by the partners.
more than 50 years in any one instance.
- Amended (perpetuity)
i. Firm name.
It may adopt any firm name provided it is not In the case of a limited partnership, it is required
identical or deceptively similar to any by law to add the word Limited (Ltd.) to its name.
registered firm name, or contrary to existing
laws.
j. Transferability of interest.
A stockholder has the right to transfer his A partner cannot transfer his interest in the
shares without the prior consent of the other partnership without the consent of all the other
stockholders. existing partners.
k. Extent of liability to third parties.
Stockholders have limited liability, that is, Partners (except limited partners) have unlimited
they are liable only to the extent of their liability.
shareholdings.
l. Effect of mismanagement.
The corporation, as a juridical personality, A partner can sue a co-partner who
can sue or file a suit against a member of mismanages.
the board of directors or trustees who
mismanages.
m. Dissolution.
It can only be dissolved with the consent of It may be dissolved at any time by the will of any
the State. or all of the partners.

Similarities between a Corporation and a Partnership

The similarities between a corporation and a partnership may be summarized as follows:

a. Each of them has a juridical personality separate and distinct from those of the individuals
composing it.
b. They can be organized only where there is a law authorizing their organization.
c. They can act only through agents.
d. They are composed of an aggregate of individuals.
e. They distribute their profits to those who contribute capital (although in the case of a partnership,
the industrial partner also shares in partnership profits).
f. Both of them are subject to corporate professional partnerships).

Dividends; Cum-Dividend and Ex-Dividend Stocks

Dividend, in general, refers to items of value received by stockholders from an investee corporation
arising from the investor-investee relationship.

All assets and earnings of a corporation are owned by the corporation and not by its stockholders.
They may be transferred to stockholders upon declaration by the board of directors.

The board of directors is authorized by the Corporation Code of the Philippines to declare dividends
subject to approval by at least two-thirds (2/3) of the outstanding capital stock. The date of record
and date of payment are specified in the declaration.

Date of record. This refers to the date as of which, stockholders who appear on record as such, are
entitled to dividends. From the date of declaration to the date of record, the stocks are called cum
dividend. After this date, they are called ex-dividend, Cum-dividend stocks command higher prices as
compared to ex-dividend stocks.

Cut-off Date. In the absence of any other date given, the cut-off date must be the announced record
date. However, in the Philippines, although the date of record is set as of a given date, the cut-off date
may be earlier (especially for stocks that are heavily traded in the stock market) for the stock and
transfer office often requires a number of days for the recording process. In these cases, the cut-off
date refers to the actual date up to which stockholders are entitled to dividends after providing for the
time lag required by stock and transfer offices.

Date of payment. This refers to the date the stockholders are paid the dividends.

Example: On April 1, the board of directors of Alpa Mfg.Corp. declared a 10% cash dividend on its
capital stock (par value-P100) to stockholders on records as of May 1, payable on June 5. The stock
and transfer office requires seven (7) days as allowance for the updating of its records so that the real
cut-off date has been set at April 24.

In the given example, April 1st is the date of declaration, May 1st is the date of record, April 24th is the
cut-off date and June 5th, the date of payment. From April 1 to April 23, the stock of the corporation
are called cum-dividend. Thereafter, they are called ex-dividend.

Restriction to Retention of Corporate Earnings

The Corporation Code of the Philippines (Sec. 42) states, among others, the following:

Stock corporations are prohibited from restraining surplus profits in excess of one hundred percent
(100%} of their paid-in capital stock, except: (a) when justified by the definite corporate expansion
projects or programs approved by the board of directors; or (b) when the corporation is prohibited
under any loan agreement with financial institutions or creditors, whether local or foreign, from
declaring dividends without their consent, and such consent has not yet been secured; or (c) when
it can be clearly shown that such retention is necessary under special circumstances obtaining in
the corporation, such as when there is need for special reserve for probable contingencies.

The Bureau of Internal Revenue penalized corporations that violated this specific provisions but
refrained from doing so afterwards. At the time of their writing, it is the SEC that penalizes corporations
violating this provision.

Classification of Dividends; Effects on Corporate Accounts

Dividends may be classified as follows:

1. Cash dividend. This is paid in cash to the stockholders.

Effects on corporate accounts: Decrease in retained earnings and decrease in cash. If an entry
is made upon declaration, the immediate effects would be decrease in retained earnings and
increase in current liability (Dividends Payable).

2. Property dividend. This is in the form of noncash assets of a corporation. An example is X

Corporation (which has invested in the stocks of ABC, Inc.) which distributes the stocks of ABC, Inc.
to its own stockholders as dividend.
 Effects on corporate accounts: Decrease in retained earnings and de crease in assets (Investment)

3. Stock dividend. Dividend in the form of stocks of the issuing corporation Example: X Corp. (which
has 10,000 shares of its capital stock outstanding distributes a 15% stock dividend. This means that
it issues 1,500 shares of its own capital stock so that the total outstanding number of shares must
become 11,500.

Effects on corporate accounts: Decrease in retained earnings and increase in capital stock. If an
entry is made upon declaration, the immediate effects would be decrease in retained earnings
and increase in stockholders equity account Stock Dividend Distributable.

4. Scrip dividend. Dividend in the form of promissory notes indicating the kind of benefits the
stockholders shall be entitled to receive in the future (cash, noncash assets, stocks or some other
form of dividend).

Effects on corporate accounts: Decrease in retained earnings and either increase in current
liabilities, long-term liabilities, or stockholders' equity, depending on the nature of benefits to be
ultimately granted to stockholders.

5. Bond dividend. This is in the form of bonds of the company. Effects on corporate accounts:
Decrease in retained earnings and increase in liabilities.

6. Liquidating Dividend. This refers to return of capital by a corporation. In effect, it is a distribution of

the assets of the corporation upon its dissolution or cessation of its operations.

Effects on corporate accounts: Decrease in capital stock and premium on capital stock (or
additional paid-in capital) and decrease in assets.

Advantages and Disadvantages of a Corporation.

A corporate form of organization, just like sole proprietorships and partnerships, also has its advantages
and disadvantages. They may be summarized as follows:

Advantages Disadvantages
1. It Has a legal capacity to act as a legal unit. 1. It is subject to greater degree of governmental
control and supervision
2. It has continuity of existence.
2. Its cost of formation and operation is relatively
3. Management is centralized in the board of high
directors or trustees.
3. Its formation and management are relatively
4. The creation, organization, management and complicated.
dissolution processes are standardized because
they are governed by one general incorporation 4. Is subject to higher income tax rate. Corporate
law. income tax rate is 30% whereas for individuals,
the rates range from 1% to 35%.
5. Shareholders have limited liability.
5. It has limited powers. A corporation can do
6. Shareholders are not general agents of the only what is expressly or impliedly allowed by law
corporation or by its articles of incorporation. Other acts may
be considered ultra vires.
7. Shareholders can transfer their shareholdings
without the consent of other shareholders. 6. It is possible for the board of directors to abuse
its powers inasmuch as di rectors are usually the
8. It has the ability to raise more capital. Its credit majority stockholders.
is strengthened by its continuous existence and it
can issue additional shares of stock to a greater
number of people and to other corporations.

9. Its ability to raise more capital makes feasible

gigantic financial ventures.

10. Stockholders are taxed only on their shares of

distributed earnings.
ASSIGNMENT MATERIAL

Questions:

1. How would you go about in going into business for yourself?

2. Having In mind your family assets, what kind of business do you think you can easily go into? Why?

3. Going into business offers immeasurable rewards. However, it requires determination and sacrifices
on the part of an entrepreneur. Explain.

4. Differentiate sole proprietorship from a partnership. What are the advantages of the latter over the
former?

5. A corporation is an artificial being with almost perpetual existence. Explain.

6. A private corporation must have its own charter and by-laws. How are these acquired or how do
they become existent?