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 GOALS Chapter Five 5-2

4. Define and give examples of three types of corporate mergers. 5. Outline the advantages and disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising. LEARNING GOALS Chapter Five 5-3

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 Profile MARY ELLEN SHEETS Two Men and a Truck 5-4

Basic Forms of Business Ownership Sole Proprietorship -- A business owned, and usually managed, by one person. Generally the easiest to establish. 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 5-5

FORMS of BUSINESS OWNERSHIP Basic Forms of Business Ownership 5-6

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 – personal income MAJOR BENEFITS of SOLE PROPRIETORSHIP LG1 5-7

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 DISADVANTAGES of SOLE PROPRIETORSHIPS LG1 5-8

Partnerships General Partnership -- All owners share in operating the business and in assuming liability for the business’s debts. MAJOR TYPES of PARTNERSHIPS LG2 Limited Partnership -- A partnership with one or more general partners and one or more limited partners. 5-9

General Partner -- An owner (partner) who has unlimited liability and is active in managing the firm…partnerships must have at least one 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. Limited partner also means that the degree of profit is limited to the amount of investment. Based on partnership agreement TYPES OF PARTNERS LG2 Partnerships 5-10

Advantages & Disadvantages of Partnerships More financial resources Shared management and pooled/complementary skills and knowledge Longer survival No special taxes – taxed as personal income ADVANTAGES of PARTNERSHIPS LG Kate and Andy Spade

Unlimited liability Division of profits Disagreements among partners Difficult to terminate DISADVANTAGES of PARTNERSHIPS LG2 Advantages & Disadvantages of Partnerships 5-12

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 5-13

Corporations Conventional (C) Corporation -- A state- chartered legal entity with authority to act and have liability separate from its owners (its stockholders). CONVENTIONAL CORPORATIONS LG3 5-14

Advantages of Corporations Limited liability Ability to raise more money for investment –stock bonds Size Perpetual life – death of owners doesn’t terminate Ease of ownership change –sell stock Ease of attracting talented employees Separation of ownership from management ADVANTAGES of CORPORATIONS LG3 5-15

Source: Fortune, accessed June Walmart 2. Exxon Mobil 3. Chevron 4. ConocoPhillips 5. Fannie Mae The BIG BOYS of BUSINESS America’s Largest Corporations LG3 Advantages of Corporations Photo Courtesy of: Walmart Stores 5-16

Disadvantages of Corporations Initial cost Extensive paperwork Double taxation Two tax returns Size – inflexible to respond quickly Difficulty of termination Possible conflict with stockholders and board of directors DISADVANTAGES of CORPORATIONS LG3 5-17

Source: Bloomberg Businessweek, May 16, EVEN the BIG GUYS MAKE MISTAKES LG3 Disadvantages of Corporations 5-18

S Corporations S Corporation -- A unique government creation that looks like a corporation, but is taxed like sole proprietorships and partnerships. Approximately 3 million U.S. companies operate as S corporations. 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 CORPORATIONS LG3 5-19

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 (rents, royalties, interest). 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 5-20

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 – personal income or corporation income  Flexible ownership rules - not just individuals  Flexible distribution of profits and losses - not in proportion to personal investments LIMITED LIABILITY COMPANIES LG3 5-21

No stock, therefore ownership is nontransferable Limited life span – 30 years max – death of one partner dissolves Paperwork DISADVANTAGES of LLCs LG3 Limited Liability Companies 5-22

Progress Assessment What are the major advantages and disadvantages of incorporating a business? 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? PROGRESS ASSESSMENT 5-23

Corporate Expansion: Mergers and Acquisitions Merger -- The result of two firms joining to form one company. (Disney-Pixar, Sirius-XM) MERGERS and ACQUISITIONS LG4 Acquisition -- One company’s purchase of the property and obligations of another company. (Mars/Wrigley, HP/Compaq) 5-24

Vertical Merger -- Joins two firms in different stages of related businesses. soft drink/artificial sweetener Horizontal Merger -- Joins two firms in the same industry and allows them to diversify or expand their products. Soft drink/mineral water Conglomerate Merger -- Unites firms in completely unrelated industries in order to diversify business operations and investments. Soft drink/snack company TYPES of MERGERS LG4 Corporate Expansion: Mergers and Acquisitions 5-25

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. FRANCHISING LG5 5-26

Advantages of Franchises Management and marketing assistance Personal ownership Nationally recognized name Financial advice and assistance Lower failure rate ADVANTAGES of FRANCHISING LG5 5-27

Large start-up costs Shared profit Management regulation Coattail effects Restrictions on selling the franchise Fraudulent franchisors DISADVANTAGES of FRANCHISING LG5 Disadvantages of Franchises 5-28

Source: Entrepreneur, January Hampton Hotels 2. AMPM 3. McDonald’s 4. 7-Eleven 5. Supercuts 6. Days Inn 7. Vanguard Cleaning Systems 8. Servpro 9. Subway 10. Denny’s HIGH FLYERS Ten High-Performing Franchises LG5 Franchising in International Markets Photo Courtesy of: Innisfree Hotels 5-29

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. Common type is a farm cooperative. 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. COOPERATIVES LG6 5-30

Progress Assessment What are some of the factors to consider before buying a franchise? What are the benefits of franchising? What are the disadvantages? PROGRESS ASSESSMENT 5-31