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.

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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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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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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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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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

• Anyone can incorporte

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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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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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.

• Special qualifications for S Corporations

S CORPORATIONSLG3

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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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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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• 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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• 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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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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• 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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• Minority-Owned Franchises

• Home-Based Franchises

• eCommerce Franchising

• Online Franchising

• Global Franchising

TRENDS IN FRANCHISINGLG5

Disadvantages of Franchises

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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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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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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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