Business Structure
Background
Legal Framework
Changes in Legal Form
Managing Partners
Boards of Directors
Ownership
Locations
Business Hours
a. Days of the Week
b. Operating Hours
Managers and Functional Specialists
a. Managers
b. Functional Specialists
Final Comments
Background
The structure and organization of large businesses is an on-going and much discussed topic of interest to students of management and governance. Their focus is on operation of highly complex, developed organizations with public ownership, functioning boards of directors, layers of management, hundreds if not thousands of functionally specialized employees, written policies and procedures, and so forth. Small firms, in contrast, are much simpler organizations. They are not little big businesses if for no other reason than they are resource constrained. For example, the legal form of organization can be an issue for them. Ownership is almost always in private hands, though not necessarily in the hands of one individual or family, and generally illiquid. The smallest businesses have little if any management structure. The number of functionally specialized employees is limited. Many of these businesses, particularly the smallest, are located primarily in the home; comparatively few have multiple locations. So, how are small businesses organized? At what size do they start developing layers of management (beyond the owners)? When do administrative functions start being performed by in-house specialists? To answer these questions and many similar ones, this issue of the National Small Business Poll addresses Business Structure. One of the first organizational issues encountered when forming a business is its legal form. The legal form chosen has implications for taxes, liability, start-up costs, continuity, composition of ownership and other matters of concern to the business owner.
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Legal Framework
One of the first organizational issues encountered when forming a business is its legal form. The legal form chosen has implications for taxes, liability, start-up costs, continuity, and composition of ownership and other matters of concern to the business owner.
Though the overwhelming majority of tax returns with business income are Schedule Cs operating under the proprietary form of business, a majority of small employers are now corporations. The most common legal form of small (employing) business is the small-business corporation, better known as the Sub-Chapter S-corporation. Thirty-one (31) percent of all employing small businesses possess this legal form (Q#1) and that proportion has been growing over time. The second most common form of employing small business is the traditional corporation, the C-corporation (26%). Third is the proprietorship (21%), the one typically associated with small businesses, particularly very small and part-time operations. The limited liability corporation (LLC) (12%) follows, and lastly the partnership (6%). (The rapidly expanding LLC legal form resembles a partnership and is classified as such by the Internal Revenue Service.) The rest do not know or refused to answer.
Given the distribution of legal forms, the owners of approximately 70 percent of employing small businesses pay taxes as individuals, 26 percent as corporations, and the remaining 4 percent are undetermined. Multiple owners of individual businesses are more frequent in partnerships and Corporations than other legal forms. Nevertheless, if the form of taxpaying issue is framed to reflect the number of owners rather than the number of entities, the results are similar. Moreover, a large number of C-corporation owners legitimately zero-out corporate earnings (or almost do so) to avoid double taxation. It is, therefore, clear that the income tax most impacting small-business owners, even when including owners of C-corporations, is the personal income tax.
Another important consideration when selecting a legal form is liability. Some legal forms provide notably greater protection for personal assets in the event of a liability suit than others. A little over two-thirds (69%) have more protective forms, 27 percent less, and 4 percent are indeterminate. Since larger, small businesses use the corporate form in over 90 percent of cases contrasted to 65 percent of cases among the smaller, small businesses, those most in need of liability protection appear most likely to have it.
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Changes in Legal Form
Changes in the legal form of business occur infrequently. Only about 7 percent of businesses changed legal forms within the last three years (Q#4). Somewhat surprisingly, those changes were not highly correlated with business size.
The most frequent type of legal form from which owners moved was the proprietorship. Of those who changed, 57 percent moved from proprietorships to other forms (Q#4a). They typically fled from proprietorships to LLCs or Sub-chapter S-corporations. A few also left C-corporations for S-corporations. However, the number of cases from which these observations are made is small (n=51).
The most frequent purpose for the change was liability. Thirty-nine (39) percent of owners said that they changed legal status primarily for liability reasons (Q#4b). This rationale explains the large number leaving the proprietary form for other, liability protected legal forms. The second most frequent rationale for changing legal form was taxes (27%). A change in ownership collected 20 percent of respondents changing. The rest offered other reasons or were not certain why the change was made.
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Managing Partners
There were too few partnerships in the sample to determine the distribution between general and limited partnerships. However, it appears that owners of partnerships and S-corporations are far more likely to be managed on a day-to-day basis by one of the partners than by a professional manager. This seems true regardless of firm size. Seventy-three (73) percent of these businesses have a managing partner who operate the firm on a day-to-day basis compared to 13 percent who rest managerial responsibilities with a salaried manager (Q#2). The remainder did not respond to the question, implying its lack of clarity or the obvious nature of the answer. (Also, see Managers later in the text.)
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Boards of Directors
C-corporations are required by state law to have a board of directors. But the board serves different functions in publicly-held and privately-held companies. In the former, directors are supposed to represent the stockholders and are expected to provide oversight of the company’s management. In the latter, they are expected to provide counsel to owner/managers and may help cement important business relationships.
The evidence unfortunately shows that the board of directors is often a rubber stamp for management in publicly-held corporations and mere formalities in privately-held ones. For example, somewhat more than two-thirds (68%) of small employers, virtually all of whom are privately-held, say that their board exists primarily to fill legal requirements rather than to serve as an advisory body (27%) (Q#3c). There is a size effect. Owners of larger, small firms are more likely to use their boards for advisory purposes than are owners of smaller, small ones. Yet, owners of larger, small firms still are likely to use boards primarily in an advisory capacity in only 41 percent of cases.
Most small C-corporations have few members on their board (Q#3). The average number is 2.8 directors per firm with a median of three. The larger the firm is, the more directors who sit on the board. Companies employing 20 or more people average 3.5 board members compared to 1.5 for those employing nine or fewer.
Since a primary function of board members in smaller firms should be to provide counsel or insights, wise owners will ask people with experience to serve, particularly those with experience that is complementary to their own. Typically, board members currently own and operate their own businesses or have done so at some point in the past. Over 85 percent of companies have at least one person on the board with this type of experience (Q#3a). About 65 percent of all directors have a business ownership qualification.
Specific functional expertise also appears on most boards. For example, about one-third (33%) report at least one board member who has legal expertise (Q#3bA). Curiously, owners of the smallest are likely to have legal expertise more often than owners of the largest. This distribution suggests that incorporating owners may place their lawyers on their boards because they are ill-prepared to place anyone else on them, or they may do so as payment for legal fees (including a small share of the company stock).
Members of the board are considerably more likely to possess other types of expertise than legal. Seventy-three (73) percent reported at least one person on their board who has marketing or sales expertise (Q#3bC). Sixty-two (62) percent said that at least one board member has expertise in finance (Q#3bB). Fifty-eight (58) percent have two of these three types of expertise represented on the board and 28 percent have all three.
The anomaly of small-business boards of directors, therefore, is that despite having people with useful skills and experience serving on them, directors most often are names on a legal document rather than a useful advisory body.
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Ownership
An important characteristic of small businesses is that they are privately-held. The small firm that goes public is rare, so rare in fact that publicly traded small businesses number no more than one-tenth of 1 percent of small employers. Moreover, 59 percent of small (employing) businesses are owned by one individual (including his/her spouse if applicable) (Q#5). Twenty-seven (27) percent or over one in four have two owners. Another 14 percent have three or more. The average number is between two and three with a few outliers pushing the average up to the higher figure.
Ownership tends to be quite stable. Three (3) percent have increased the number of owners over the last three years (Q#5a); 4 percent have decreased the number; and 93 percent have not changed it. Of those who have not changed the number of owners, 96 percent say that the same people who owned the business three years ago own it today (Q#5b). Thus, 89 percent have not changed ownership in any way over the last three years.
Small employing businesses also tend to be independent in the sense of not being held, even partially, by another entity. Just 5 percent reported that another business or a non-profit organization owns some part of the firm (Q#5c).
Mergers, acquisitions and divestitures are not typically associated with small business activity. Yet, small-business owners do buy and sell portions of their businesses as circumstances dictate. For example, 4 percent report that over the last three years they divided their businesses into two or more businesses or sold a substantial share of it to someone else (Q#5d). Since those owners are still in business, they obviously did not sell-out entirely. During the same period of time, 8 percent purchased another business or a substantial part of another business and integrated it into their current firm (Q#5e).
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Locations
Over three-fourths (78%) of employing small businesses have a single business location (not counting work sites like a construction job site) (Q#6). Fourteen (14) percent have two locations and 8 percent have three or more. Of those with multiple locations, 72 percent have all of them in a single state (Q#6a). Five (5) percent of those with multiple locations have one or more locations outside the United States (Q#6b). That amounts to about 1 percent of all small employers.
Twenty-seven (27) percent of employing small businesses have their primary location in the home (Q#6c). The home for present purposes includes a basement, garage, annex, and so forth. Most of those lodge smaller businesses. Almost one-third (32%) of those employing nine or fewer people are located in the home. However, the figure falls to 7 percent among those employing 10 to 19 people.
Even if their businesses are not located in the home, many spend considerable time working there. Twenty-six (26) percent of owners whose businesses are not home-based or 18 percent of all small employers have a room set aside in their homes for the exclusive use as a business office (Q#6b1).
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Business Hours
The amount of time a firm is open for business depends on several factors including customer expectations, costs of being open, and so forth. Industry is an important factor in this regard. Still, employing businesses are open about 11 hours per day on average with a median of almost nine.
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a. Days of the Week
For years, local blue laws prohibited most businesses from being open on Sunday. That has changed. About one in four (26%) small employing businesses are now open every day of the week (Q#7). Still, 52 percent of small businesses are open five days a week, the most frequent number of days per week open. Another 19 percent are open six days a week. Virtually none (3%) are open less than five days a week.
The day most typically closed remains Sunday. Ninety-seven (97) percent of those not open seven days a week or about 72 percent of all small businesses close that day (Q#7c). Sixty-nine (69) percent close Saturdays. But relatively few close any other day of the week. Six (6) percent close on Mondays; 4 percent on Tuesdays, 3 percent on Wednesdays; 4 percent on Thursdays; and 3 percent on Fridays. The reason that businesses close week days was not determined.
One in five (20%) are open half-days (Q#7a). Typically, the half-day is Saturday (63%) (Q#7b). Another 15 percent open half-days on Sunday and 11 percent have business hours on multiple half-days. The smallest businesses are the most likely to close one or more half-days during the week.
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b. Operating Hours
Seven (7) percent of all businesses remain open 24 hours a day (Q#8). The most common starting times are between 7:00 am and 9:00 am. Seventy-eight (78) percent open in that time frame with 8:00 am the most frequent start time (34%). Larger, small firms usually open a half hour to an hour earlier than smaller, small firms.
Closing times are somewhat more broadly distributed, but 59 percent close between 5:00 pm and 6:00 pm (including 6:30) (Q#8a). Another 13 percent close in the evening between 7:00 pm and 9:30 pm. Another 9 percent close in the hour before 5:00 pm. Larger, small firms are likely to close earlier than smaller, small firms. Thus, size of firm appears unrelated to the number of operating hours, but related to when they occur. There is no obvious explanation for the difference. Most likely it is tied to industry and/or regional preferences.
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Managers and Functional Specialists
As organizations grow, people perform more specialized functions, one of which is management. Managers supervise and help plan the work performance of others. A variation on this theme is separation of ownership and management. In addition, as firms grow, they increasingly hire people whose only job is to perform increasingly specialized tasks.
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a. Managers
A little over one in three (35%) small businesses has at least one employee, not including the owner(s), whose principle job is to direct, manage, or supervise the work of others (Q#9). Small businesses employing more people are more likely to have at least one such person than are those employing fewer. In fact, 80 percent of small businesses employing 20 or more people have at least one of them. Just 25 percent of those employing nine or fewer do. It appears that the first supervisory employee (not including the owners) is typically hired when the firm is quite small. By the time a firm reaches 5 employees, there is about a 50-50 chance one of those employees will be a supervisor. The reason that small businesses take on their first managerial employee so quickly is likely associated with the owner’s preference for doing or selling rather than supervising people.
The number of employees whose primary job is to manage others also varies by firm size. Those employing more than 20 people have a single employee performing that function in only 7 percent of cases compared to five or more in 34 percent of cases (Q#9a). Owners employing nine or fewer people have one manager in 64 percent of cases where they have at least one, and only 1 percent have five or more. The latter number is possible if a firm hires several temporaries or subcontracts considerable work to other businesses.
Some employees perform managerial tasks from time-to-time, but it is not their principal job. For example, someone in an office may have authority over others when the owner leaves to make a sales call. Or, one employee may develop the work schedule, but otherwise performs non-supervisory tasks. Sixty-two (62) percent of small employers say that they have such people (Q#9b). The smallest are least likely to have them (58%). Once the firm grows to 10 employees, about four of five have at least one with the number increasing as the firm gets larger.
A characteristic of large businesses, typically not present in small ones, is the separation of ownership and management. In other words, the individual who owns the business does not operate the business. This separation happens in small businesses as well. For example, a mother could own a business and give its operation to a son; a semi-retired owner could elevate an employee to be a full-time manager; or an owner could be so involved in some technical aspect of the business, such as research and development of a product, that he or she could delegate day-to-day operations to a professional.
About 85 percent of small businesses are in control of owner/managers (Q#1D in the Demographics section). Size is an important factor in this regard. Eighty-seven (87) percent of those employing nine or fewer people have owner/managers while 77 percent of those employing 20 or more do. Little is known about the manager’s authority or what the owner is doing. The survey did determine, however, that the owner is present/available in about half those instances even if he/she does not actively manage the firm. In a disproportionately large share of those cases, the owner, non-manager was 65 years or older.
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b. Functional Specialists
As firms grow larger, their owners not only hire more managerial employees, they also hire employees to perform more specialized functional tasks. The most common of the four specialized tasks about which queries were made was in accounting, bookkeeping or finance. Thirty-six (36) percent of small employers have at least one employee whose only job is to work on these topics (Q#10D). The propensity to have such an employee is tied to firm size with larger firms more likely than smaller ones to engage such a person. Those employing more than 20 people have at least one in 63 percent of cases while those with nine or fewer have at least one less than half as often.
A person whose only job is in marketing and/or sales can be found in 20 percent of small employing businesses (Q#10B). Again, the propensity to have at least one such person varies by firm size. The largest size class is two to three times more likely to have at least one marketing/sales employee as the smallest.
Seventeen (17) percent have at least one employee whose exclusive task is to handle all government rules and regulations, licenses, and related paperwork (#10A). (Extrapolating that to 5.7 million small employers makes government generated paperwork a huge cost.) The largest class of small employers is twice as likely (30%) as the smallest to have such a person.
Personnel or human resources is the function least likely - of the four queried - to have at least one person whose sole job is devoted to a functional specialty. Just 12 percent have one (Q#10C). However, that figure rises to 31 percent in the largest size class, three times the frequency of the smallest size class.
No question was asked about production or doing, such as a barber or mechanic, due to the difficulty of the question in the time available to ask it. One assumes that jobs of this nature more typically are focused or functionally specific, though there is no direct evidence to support that view. However, it seems clear that employees in small businesses typically perform multi-functional tasks in their assigned duties. Even comparatively large firms ask this of many employees. No doubt some larger, small firms out-source the accounting/ bookkeeping function, for example, thereby reducing the opportunity to have an employee whose only job is performing a particular function. Still, outside production, functional specialization appears atypical in most small businesses.
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Final Comments
The foregoing primarily serves to put numbers on things we already know. It provides little information that should shock anyone or even raise eyebrows. Small businesses are privately-held organizations whose ownership and management is typically unified and that have an administratively simple structure. Even trappings of larger firms such as boards of directors more often seem a useless appendage than an integral part of the organization.
There is little doubt that the small business structure, on balance, becomes more complex as firms get larger. Virtually every piece of data captured here about the structure of small employing businesses has a size dimension. Firms with nine or fewer employees almost always differ notably from those with more than 20, even more than 10. So, businesses begin to become more complex and employee tasks more specialized very soon in the growth process.
But verifying these phenomena and putting numbers on their distributions serves important purposes. It allows us to recognize the exceptions (and their frequency), determine if exceptions make differences, and eventually determine whether things are changing and how. Not coincidentally, it helps us understand public policy impacts on small employers, most visibly with respect to tax and liability issues – among the issues of greatest interest to small employers.