McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved. Chapter 20 Forms of Business Organization

20-2 Chapter 20 Ethical Dilemma As this chapter indicates, a corporation is a legal construct with an identity separate and apart from its owner(s). The primary legal advantage to converting one’s business from an unincorporated enterprise to the corporate form is the ability to avoid personal liability for the business’s financial obligations. Since the corporation is distinguishable from its owner, the owner’s personal assets cannot be seized to satisfy business indebtedness. This effectively means that an owner can “crash and burn” a corporation financially, bankrupt the business, and walk away from the “flaming wreckage” of the corporation without personal obligation for business debts. Is it ethical for an owner to use the corporate entity to avoid personal obligation for business debts?

20-3 Chapter 20 Case Hypothetical Allison Seizer has a very wealthy father, entrepreneur Warren Seizer of “Chimichonga Chime” restaurant fame, although her family pedigree was not what attracted Blake Patterson to his girlfriend of three years; instead, it was “love at first sight.” Blake proposes to Allison, and the two are married with the blessing of Warren Seizer. Warren wants the best for his daughter and son-in-law, so he offers a “Chimichonga Chime” franchise to Blake, with a prime location in the center of the Elmwood business district. After one year, it is clear that the newest “Chimichonga Chime” is and will be a tremendous business success. In fact, sales, revenue and profit goals for the restaurant are shattered in its first year of operation, and Blake would like to think that his “hands-on” ownership and operation of the restaurant was an important part of the store’s success. Unfortunately, the couple’s relationship has suffered over the year, and the term “irreconcilable differences” creeps into marriage conversations. Blake asks for his freedom, and Allison obliges. Wedding bells have been replaced by divorce attorneys. Warren Seizer is furious. He is firmly convinced that Blake Patterson is to blame for the marriage’s dissolution, because there is no conceivable way (at least in his mind) that his “darling angel,” his “precious daughter,” could be responsible for the divorce. The creative genius behind “Chimichonga Chime” plots justice for his daughter and himself, although some may call it revenge. On September 1, Warren Seizer personally delivers a Notice of Termination of Franchise to Blake Patterson. The document states that Patterson’s franchise agreement has been terminated for cause, and that he must either close the restaurant, or cease and desist from using the name “Chimichonga Chime,” advertising the franchise chime logo, and selling all franchise-related products, within 30 days. Who wins: The “ex-father-in-law,” or the “ex-son-in-law?”

20-4 Major Forms of Business Organizations Sole Proprietorship General Partnership Limited Partnership Corporation

20-5 Sole Proprietorship Definition: Unincorporated business owned by one person Owner has total control Owner has unlimited liability Profits taxed directly as income to sole proprietor

20-6 Advantages and Disadvantages of Sole Proprietorship Advantages -Ease of creation (“start-up”) -Owner has total managerial control -Owner retains profits Disadvantages -Personal liability for all business debts/obligations/losses -Funding limited to personal funds and loans

20-7 General Partnership Definition: Unincorporated business owned and operated by two or more persons Each partner has equal control of business Each partner has unlimited, personal liability for business debts/obligations/losses Profits taxed as income to partners

20-8 Advantages and Disadvantages of Partnership Advantages -Ease of creation (“start-up”) -Partnership income is partner income -Business losses qualify for tax deduction Disadvantages -Personal liability for all business debts/obligations/losses, including those incurred by other partners on behalf of partnership

20-9 Limited Partnership Definition: Unincorporated business with at least one general partner, and one limited partner General partner in limited partnership has managerial/operational control over business Limited partner’s liability limited to extent of his/her capital contributions Limited partner has no managerial/operational control over business

20-10 Corporation Definition: State-sanctioned business with legal identity separate and apart from its owners (shareholders) Owners’ (shareholders’) liability limited to amount of investment in corporation Profits taxed as income to corporation, plus income to owners/shareholders (“double- taxation”) “S” Corporation can avoid double-taxation

20-11 Advantages and Disadvantages of Corporation Advantages -Limited liability for shareholders -Ease of raising capital by issuing (selling) stock -Profits taxed as income to shareholders (not partners) Disadvantages -“Double-taxation” -Formalities required in establishing and maintaining corporate existence

20-12 “S” Corporation Definition: Business organization formed under federal tax law that is considered corporation, yet taxed like a partnership Formed under federal law No more than one hundred shareholders Shareholders must report income on their personal income tax forms

20-13 Limited Liability Company (LLC) Definition: Business organization with limited liability of a corporation, yet taxed like partnership Formed under state law Owners of LLC (“members”) pay personal income taxes on shares they report No limitation on number of owners permitted in LLC

20-14 Specialized Forms of Business Organizations Cooperative—Organization formed by individuals to market products Joint stock company—Partnership agreement in which company members hold transferable shares, while all company goods are held in names of partners Business Trust—Business organization governed by group of trustees, who operate trust for beneficiaries

20-15 Specialized Forms of Business Organizations (Continued) Syndicate—Investment group that forms for purpose of financing specific large project Joint Venture—Relationship between two or more persons/corporations created for specific business undertaking Franchise—Agreement between “franchisor” (owner of trade name/trademark) and “franchisee” (person who, by specific terms of agreement, sells goods/services under trade name/trademark)

20-16 Advantages and Disadvantages of Franchise (To Franchisee) Advantages -Assistance from franchisor in starting franchise -Trade name/trademark recognition -Franchisor advertising Disadvantages -Must meet contractual requirements, or possibly lose franchise -Little/no creative control over business

20-17 Advantages and Disadvantages of Franchise (To Franchisor) Advantages -Low risk in starting franchise -Increased income from franchises Disadvantages -Little control (except contractually) over individual franchise -Can become liable for franchise, if franchisor exerts too much control

20-18 Types of Franchises “Chain-Style” Business Operation -Franchisor helps franchisee establish a business (using franchisor’s business name, and franchisor’s standard “methods and practices”) Distributorship -Franchisor licenses franchisee to sell franchisor’s product in specific area Manufacturing Arrangement -Franchisor provides franchisee with technical knowledge to manufacture franchisor’s product

20-19 Top Ten Global Franchises (2011) Subway McDonald’s KFC 7-Eleven Burger King Snap-On Tools Pizza Hut Wyndham Hotel Group ServiceMaster Choice Hotels