Question

Jeff Blake is an entrepreneur and owner of Wood Creations, a sole proprietorship. The business, which manufactures tables, chairs, cabinets and other furniture, is growing, and Jeff is exploring the idea of purchasing a brand new manufacturing facility. Because he does not have the money to do so, he believes his options are to borrow the money or to convert the business to a corporation and sell stock.

Describe the which option you believe Jeff should pursue. Make sure to explain the advantages and disadvantages of the course of action that you choose.

Answer 1

If Jeff opts to borrow the money:

In this case, the borrower would have the right over the security Jeff keeps at the time of borrowing. The Borrower is entitled with regular interest payments. Jeff could get tax advantage on interest. Since interest expense is allowed in calculating net income as per taxes, interest expense reduces the taxes of Jeff. Jeff can continue being sole proprietor and not bound to restrictions of SEC or some of the stringent laws of corporations.

If Jeff opts to convert the business to a corporation and sell stock:

In this case, Jeff is converting his sole-proprietorship into corporation. This implies that the people who purchase the stock becomes the owner and Jeff loses his 100% control over his business. Jeff becomes responsible for the deeds of business to the potential owners. Jeff needs to follow SEC rules, taxes would be more for corporation. Profits earned in the business are to be shared with the potential owners as dividends.

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Depending upon sharing the ownership, regulations, taxes it is better for Jeff to borrow money rather than converting into a corporation.