Running head: M1A1 MINI CASE: THE MCGEE CAKE COMPANY 1

M1A1 Mini Case: The McGee Cake Company

Josh Hamilton

Excelsior College
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Like many people do, Doc and Lynn McGee decided to start a small business that they

could undertake in their spare time with the idea they could create more income to their

household. They started the McGee Cake Company, a sole proprietorship, which would become

very successful. A sole proprietorship is a personal and private business endeavor that is owned

by only one person. Most people start their small businesses as a sole proprietorship because it is

easy to get started and there is very little red tape or regulation to hinder them from getting their

startup off the ground. In fact, it is the simplistic process that is probably the reason

proprietorships outnumber any other types of business. Couple that with the fact that the owner

keeps all the profits and it is easy to understand why (Ross, Westerfield, & Jordan, 2013).

With that said, there are certainly some disadvantages to this form of business

organization. Owners of a proprietorship are held liable for business debts. This is called

unlimited liability and it means that creditors can legally take action against not only business

assets, but personal assets as well in order to collect debt. Another drawback to this type of

business is that business earnings and personal income are not distinguished as separate revenues

in regards to tax laws. Business income is taxed as personal income. Also, a proprietor’s ability

to expand is very dependent on that income. It can be hard for a proprietor to expand as they are

limited to their personal assets and wealth as capital for expansion. Additionally, it can be very

difficult to transfer a proprietorship as the entire business must be sold as a whole, so an owner

must find someone willing to buy it, and this can often be a long and arduous process.

Nonetheless, there are options that can impede some of these disadvantages. With the

recent success of the McGee Cake Company, Doc and Lynn have recognized the need to take

their business in a new direction, but this will require a change of business organization. In order
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to circumvent some of these handicaps of proprietorship, they are exploring the options of

becoming a limited liability company (LLC) or a Corporation.

For legal purposes a corporation is considered a single entity. It is a “person” if you will,

and as its own entity. It is separate from its owners. It has many of the same privileges as a

person does as it can “borrow money and own property, can sue and be sued, and can enter into

contracts” (Ross et al., 2013). While corporations have owners, usually by means of stock

shares, it is the management that makes financial management decisions and directs the day to

day operations. Having shareholders allows for less complex transferability of the company as it

can be sold through means of stock shares. Another advantage to the corporate form is that

corporations are considered “limited liability” (Ross et al., 2013) which means owners can rest

easier knowing that their personal assets are not at risk if the company goes into debt or fails.

Maybe the biggest advantage and the advantage that applies most directly with the McGee’s

situation is that the corporate format is built for the ability to raise capital which is required for

the growth of their business. Available shares in a successful business will often attract new

investors willing to invest the capital needed in order to expand. The McGee’s are in a situation

where capital may not be readily available, but if they want to move forward with the lucrative

options that have been presented to them, going corporate can help with that.

Although, there are many advantages to going corporate, it is important to remember that

starting a corporation can be a lot more complex than that of a small business. There is a lot of

red tape and paperwork required to start. A charter (or articles of incorporation) must be drafted

along with a set of bylaws. It can also be an expensive process. You are required to apply with

your state and the application process often consists of state application fees and taxes as well as

other government fees. While not required, most corporations choose to procure legal
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representation which is another added cost. Maybe the most significant disadvantage is that

because a corporation is considered a legal “person”, it is susceptible to personal taxation just as

a person is, so when revenue is earned it is taxed but, the taxes don’t end there. When dividends

are paid to stock holders, this cash flow is taxed again meaning corporate profits are in the

scenario of double taxation. “Once when they are earned, and again when they are paid out”

(Ross et al., 2013).

While going corporate may be advantageous, it may also seem like a huge undertaking.

There is another option the McGee’s can consider. Limited Liability Companies (or LLC’s)

have become a popular option for many small business owners. This form of business

organization aims to give owners the advantage of limited liability without the burdensome

double taxation that occurs with corporations. It is the best of both worlds although it is

important for the LLC to act in more of a partnership manner as the IRS will tax an LLC as a

corporation if it deems the LLC is too “corporation like” (Ross et al., 2013). This might seem

like a very attractive option for the McGee’s but I don’t think it provides the solution to the

biggest issue they face with expansion and that is generating the working capital needed to grow.

In all this, I feel starting a corporation is the most sensible and effective way to create the

capital needed to grow, especially considering the immensity of the proposals the McGee’s have

been offered. Going corporate would allow Doc and Lynn to sell shares in the company giving

them the capital to go national. Add the fact that their personal assets would be protected

through limited liability and I believe this form of business organization is the best fit for the

McGee’s situation and this would be my recommendation.

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References

Ross, S. A., Westerfield, R. W., & Jordan, B. D. (2013).Fundamentals of corporate finance.

New York, NY: McGraw-Hill Education