How to Form a

Business

Chapter 05

McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

1. Compare the advantages and disadvantages of sole proprietorships.

2. Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships.

3. Compare the advantages and disadvantages of corporations and summarize the differences between C corporations, S corporations and limited liability companies.

LEARNING GOALSChapter Five

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4. Define and give examples of three types of corporate mergers, and explain the role of leveraged buyouts and taking a firm private.

5. Outline the advantages and disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising.

6. Explain the role of cooperatives.

LEARNING GOALSChapter Five

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• Bought an old truck and placed an ad in the local paper stating, “Two Men and a Truck.”

• Wanted her sons to have work during summer vacation. Now they earn $193.3 million annually.

• Expanded through franchising and are branching out to the UK.

Profile MARY ELLEN SHEETSTwo Men and a Truck

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Around April 15th every year, we are a very sought out company. With thousands of locations in the U.S. we make tax filing much easier. Most people are unaware that we are actually a Canadian franchise even though we have our headquarters in the U.S.

Name that company!

NAME that COMPANYChapter Five

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Basic Forms of Business Ownership

• Sole Proprietorship -- A business owned, and usually managed, by one person.

• Partnership -- Two or more people legally agree to become co-owners of a business.

• Corporation -- A legal entity with authority to act and have liability apart from its owners.

MAJOR FORMS of OWNERSHIP

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FORMS of BUSINESS OWNERSHIP

Basic Forms of Business Ownership

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Source: Forbes, April 11, 2011.

1. Atlanta, GA

2. Baltimore, MD

3. Nashville, TN

4. Houston, TX

5. Miami - Ft. Lauderdale, FL

ETHNIC BUSINESS CENTERSCities with the Most Minority-Run Firms

Basic Forms of Business Ownership

Photo Courtesy of: James Rintamaki

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Advantages of Sole Proprietorships

1) Ease of starting and ending the business

2) Being your own boss

3) Pride of ownership

4) Leaving a legacy

5) Retention of company profit

6) No special taxes

MAJOR BENEFITS of SOLE PROPRIETORSHIPLG1

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Disadvantages of Sole Proprietorships

1) Unlimited Liability -- Any debts or damages incurred by the business are your debts, even if it means selling your home, car or anything else.

2) Limited financial resources

3) Management difficulties

4) Overwhelming time commitment

5) Few fringe benefits

6) Limited growth

7) Limited life span

DISADVANTAGES of SOLE PROPRIETORSHIPSLG1

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Progress Assessment

• Most people who start businesses in the U.S. are sole proprietors. What are the advantages and disadvantages of sole proprietorships?

• Why would unlimited liability be considered a major drawback to sole proprietorships?

PROGRESS ASSESSMENT

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Partnerships

• General Partnership -- All owners share in operating the business and in assuming liability for the business’s debts.

MAJOR TYPES of PARTNERSHIPSLG2

• Limited Partnership -- A partnership with one or more general partners and one or more limited partners.

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• General Partner -- An owner (partner) who has unlimited liability and is active in managing the firm.

• Limited Partner -- An owner who invests money in the business, but enjoys limited liability. Limited Liability means that liability for the debts of the business is limited to the amount the limited partner puts into the company; personal assets are not at risk.

TYPES OF PARTNERSLG2

Partnerships

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• Master Limited Partnership -- A partnership that looks much like a corporation, but is taxed like a partnership and thus avoids the corporate income tax.

• Limited Liability Partnership -- Limits partners’ risk of losing their personal assets to the outcomes of only their own acts and omissions and those of people under their supervision.

OTHER FORMS of PARTNERSHIPSLG2

Partnerships

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Advantages & Disadvantages of Partnerships

• More financial resources

• Shared management and pooled/complementary skills and knowledge

• Longer survival

• No special taxes

ADVANTAGES of PARTNERSHIPSLG2

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• Unlimited liability• Division of profits• Disagreements among

partners• Difficult to terminate

DISADVANTAGES of PARTNERSHIPSLG2

Advantages & Disadvantages of Partnerships

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There is no such thing as a perfect partner but ask these questions when you try to find your best match:

• Do you share the same goals?• Do you share the same vision for the company?• What skills does he/she have? Are yours the same?• What can he/she bring to the business?• What type of decision maker is he/she?• Do you trust each other?• How does he/she problem solve?

The TIES that BIND(Spotlight on Small Business)

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Progress Assessment

• What’s the difference between a limited partner and a general partner?

• What are some of the advantages and disadvantages of partnerships?

PROGRESS ASSESSMENT

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Corporations

• Conventional (C) Corporation -- A state-chartered legal entity with authority to act and have liability separate from its owners (its stockholders).

CONVENTIONAL CORPORATIONSLG3

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Advantages of Corporations

• Limited liability

• Ability to raise more money for investment

• Size

• Perpetual life

• Ease of ownership change

• Ease of attracting talented employees

• Separation of ownership from management

ADVANTAGES of CORPORATIONSLG3

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HOW OWNERS AFFECT MANAGEMENTLG3

Advantages of Corporations

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Source: Fortune, www.fortune.com, accessed June 2011.

1. Walmart

2. Exxon Mobil

3. Chevron

4. ConocoPhillips

5. Fannie Mae

The BIG BOYS of BUSINESSAmerica’s Largest CorporationsLG3

Advantages of Corporations

Photo Courtesy of: Walmart Stores

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Source: Forbes, www.forbes.com, accessed June 2011.

PRIVACY PLEASEThe Ten Largest Private Corporations in the U.S.LG3

Advantages of Corporations

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Disadvantages of Corporations

• Initial cost

• Extensive paperwork

• Double taxation

• Two tax returns

• Size

• Difficulty of termination

• Possible conflict with stockholders and board of directors

DISADVANTAGES of CORPORATIONSLG3

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Source: Bloomberg Businessweek, May 16, 2011.

EVEN the BIG GUYS MAKE MISTAKESLG3

Disadvantages of Corporations

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Individuals Can Incorporate

• Anyone - truckers, doctors, plumbers, athletes and small business owners can incorporate.

• Normally stock is not issued to outsiders when individuals incorporate, so the advantages and disadvantages are not exactly the same as for large corporations.

• Major advantages are limited liability and possible tax benefits.

WHO CAN INCORPORATE?LG3

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OLDIES BUT GOODIESAmerica’s Oldest CorporationsLG3

Individuals Can Incorporate

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S Corporations

• S Corporation -- A unique government creation that looks like a corporation, but is taxed like sole proprietorships and partnerships.

• S corporations have shareholders, directors and employees, plus the benefit of limited liability.

• Profits are taxed only as the personal income of the shareholder.

S CORPORATIONSLG3

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• Qualifications for S Corporations:- Have no more than 100 shareholders.- Have shareholders that are individuals or estates and

are citizens or permanent residents of the U.S.- Have only one class of stock.- Derive no more than 25% of income from passive

sources.

• If an S corporation loses its S status, it may not operate under it again for at least 5 years.

WHO CAN FORM S CORPORATIONS?LG3

S Corporations

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Limited Liability Companies

• Limited Liability Company (LLC) -- Similar to an S corporation, but without the eligibility requirements.

• Advantages of LLCs:- Limited liability- Choice of taxation- Flexible ownership rules- Flexible distribution of profits and losses- Operating flexibility

LIMITED LIABILITY COMPANIESLG3

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• No stock, therefore ownership is nontransferable

• Limited life span

• Fewer incentives

• Taxes

• Paperwork

DISADVANTAGES

of

LLCs

LG3

Limited Liability Companies

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• Vermont allows a new kind of LLC that exists only online.

• Registration documents can be filed online, meetings can be held through online communication, and relationships can be established electronically.

• Virtual companies allow online contributors with different skills, availability and interest to interact and be successful.

VIRTUAL COMPANIES(Legal Briefcase)

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Progress Assessment

• What are the major advantages and disadvantages of incorporating a business?

• What’s the role of owners (stockholders) in the corporate hierarchy?

• If you buy stock in a corporation and someone gets injured by one of the corporation’s products, can you be sued? Why or why not?

• Why are so many new businesses choosing a limited liability company (LLC) form of ownership?

PROGRESS ASSESSMENT

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Corporate Expansion: Mergers and Acquisitions

• Merger -- The result of two firms joining to form one company.

MERGERS and ACQUISITIONSLG4

• Acquisition -- One company’s purchase of the property and obligations of another company.

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KEEP GROWING…Big Business‘ Acquisitions SpendingLG4

Corporate Expansion: Mergers and Acquisitions

Source: Bloomberg Businessweek, October 18, 2010.

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• Vertical Merger -- Joins two firms in different stages of related businesses.

• Horizontal Merger -- Joins two firms in the same industry and allows them to diversify or expand their products.

• Conglomerate Merger -- Unites firms in completely unrelated industries in order to diversify business operations and investments.

TYPES of MERGERSLG4

Corporate Expansion: Mergers and Acquisitions

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• Leveraged Buyout (LBO) -- An attempt by employees, management or a group of investors to buy out the stockholders in a company.

• LBOs have ranged in size from $50 million to $31 billion and have involved everything from small businesses to giant corporations.

• In 2010, foreign investors poured $300 billion into U.S. companies.

LEVERAGED BUYOUTSLG4

Corporate Expansion: Mergers and Acquisitions

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Franchises

• Franchise Agreement -- An arrangement whereby someone with a good idea for a business (franchisor) sells the rights to use the business name and sell a product or service (franchise) to others (franchisees) in a given territory.

• More than 825,000 franchised businesses operate in the U.S., employing approximately 17.5 million people.

FRANCHISINGLG5

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Source: Entrepreneur, March 2010.

MAKE WAY for the NEWBIESTop New Franchises

LG5

Franchises

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• The Nationals in D.C. have the first sports stadium to earn the Leadership in Energy and Environmental Design (LEED) Rating.

• 95% of the stadium’s steel was recycled and low-flow toilets save millions of gallons of water.

PLAY BALL but PLAY GREEN(Thinking Green)

• New York stadiums for the Mets, Giants and Jets have also earned green certifications.

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Advantages of Franchises

• Management and marketing assistance

• Personal ownership• Nationally recognized

name• Financial advice and

assistance• Lower failure rate

ADVANTAGES of FRANCHISINGLG5

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• Large start-up costs• Shared profit• Management regulation• Coattail effects• Restrictions on selling• Fraudulent franchisors

DISADVANTAGES of FRANCHISINGLG5

Disadvantages of Franchises

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Diversity in Franchising

• Women own about half of U.S. companies, yet ownership of franchises is about 25%.

• Firms owned by women have grown at twice the rate of all companies.

WOMEN in FRANCHISINGLG5

• More women are becoming franchisors. Auntie Anne’s and Jazzercise and are owned by women.

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Diversity in Franchising

• MinorityFran is an initiative to build awareness of franchising opportunities within minority communities.

• Domino’s Pizza launched a minority franchise recruitment program called Delivering the Dream.

• Over 20% of franchises are minority-owned.

MINORITY-OWNED FRANCHISESLG5

Photo Courtesy of: Tom Magliery

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Home-Based Franchises

Advantages:• Relief from

commuting stress• Extra family time• Low overhead

expenses

Main Disadvantages:• Isolation• Long hours

HOME-BASED FRANCHISESLG5

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Source: Neema P. Roshania, Kiplinger, January 2011.

HOME SWEET HOMETop Home-Based FranchisesLG5

Home-Based Franchises

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E-Commerce in Franchising

• Most brick-and-mortar franchises have expanded to the Internet.

• Many franchisors prohibit franchisee-sponsored sites because conflicts can erupt.

• Sometimes “reverse royalties” are sent to franchisees who believe their sales were hurt by the franchisor’s site.

• Other franchises are solely based online.

E-COMMERCE in FRANCHISHINGLG5

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• Many businesses use social media to communicate with potential investors and franchisees.

• Häagen-Dazs launched a simulation game called Ice Cream Boss on Facebook.

• The company hopes that players may move on to become franchisees of real Häagen-Dazs stores.

FRANCHISE EXPANSION on FACEBOOK(Social Media in Business)

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Franchising in International Markets

• Canada is the most popular target for U.S.-based franchises. China, South Africa, the Philippines and the Middle East are becoming popular despite high cost.

• Franchising is successful when the product is convenient, high quality, great service is included and the franchisee adapts to the region.

• International franchising goes both ways – some foreign franchises have come to the U.S.

GLOBAL FRANCHISINGLG5

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Source: Richard Gibson, Wall Street Journal, www.wsj.com, accessed June 2011.

• Focus on tried-and-true name brands.• Stick to core goods and services.• Be choosy about the site.• Don’t pinch pennies.• Have a fallback choice.• Don’t assume the franchise will pay off.

WHAT to CHOOSE?Picking Franchises that May Survive a RecessionLG5

Franchising in International Markets

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Source: Entrepreneur, January 2011.

1. Hampton Hotels2. AMPM3. McDonald’s4. 7-Eleven5. Supercuts6. Days Inn7. Vanguard Cleaning

Systems8. Servpro9. Subway10. Denny’s

HIGH FLYERSTen High-Performing FranchisesLG5

Franchising in International Markets

Photo Courtesy of: Innisfree Hotels

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Cooperatives

• Cooperatives -- Businesses owned and controlled by the people who use them– producers, consumers, or workers with similar needs who pool their resources for mutual gain.

• Worldwide, 750,000 co-ops serve 730 million members – 120 million in the U.S.

• Members democratically control the business by electing a board of directors that hires professional management.

COOPERATIVESLG6

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Progress Assessment

• What are some of the factors to consider before buying a franchise?

• What opportunities are available for starting a global franchise?

• What’s a cooperative?

PROGRESS ASSESSMENT

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