Chapter 6 Business formation Learning Outcomes: List and Describe the four basic forms of business ownership Discuss the advantages and disadvantages of each business forms Identify and explain which form of business that dominate in the U.S. Market Define Merger, Acquisition, and Franchising and list their advantages and disadvantages Chapter 6 Business formation

Peter J. Patsula, Author of Successful Business Planning in 30 Days Quote of the Day “The primary advantage of [a partnership] business formation is the pooling of talent, experience, and capital. However, dual or multiple ownership structures can lead to serious complications if the relationships between individuals break down. Quite often, the pool becomes a drain.” Peter J. Patsula, Author of Successful Business Planning in 30 Days Peter J. Patsula, Ph.D founded Patsula Media in 1997, an Internet company dedicated to providing usable, inspirational, and educational media.

How do I make my choice of business ownership???? The initial cost for setting up the business Ways the profits are distributed Type of taxes business must pay Type of regulations Personal liability on owners (Debt & Resources)

Types of Business Ownership Sole Proprietorship A business that is owned and managed by a single individual. Most common. (23 Million, 1.32 Trillion in Revenue, 72% of total business enterprise) Earnings are income of the owner Company’s debt is the owner’s personal liability

Sole Proprietorship, Continue Advantages Disadvantages Ease of Formation: Less paperwork & Cost Retention of Control: “Be your own boss” Pride of ownership: Personal satisfaction from owning and running own business Retention of Profits. Tax on profit Possible Tax Advantage: Earnings taxed as income. No double taxation. Limited Financial Resources: Depend on own wealth Unlimited Liability: Any business debt is considered personal debt (Personal possessions at risk!) Limited Ability to attract and maintain talented employees Heavy Workload & Responsibilities: Many hours & a lot of stress, lack of expertise in certain areas Lack of Permanence: When owner dies, the company legally ceases to exist Sole Proprietorship, Continue

2. Partnership A voluntary agreement under which two or more people act as co-owners of a business for profit. (Verbal Agreement: YES, but NO)

Partnership, Cont. Types of Partnership: General Partnership: All partners can take an active role in managing the business & have unlimited liability for any claims against the firm. Limited Partnership: A partnership agreement that has a general partner & at least one limited partner: Both contribute financially to the company & share profit. General partner has full rights to manage the company & assume full liability for debts. Limited partner can’t participate in management, but have the protection of limited liability. Limited Liability Partnership: All partners participate in management and have limited liability.

Partnership, Cont. Ability to pool financial resources Advantages Disadvantages Ability to pool financial resources Ability to share responsibilities & skills Ease of formation (Partnership Agreement???) Possible tax advantages: Earnings are taxed only as the partners’ personal income to avoid double taxation Unlimited liability: All partners are responsible for mistakes, liabilities, and loans. Personal assets are at risk if business assets aren't’ enough Potential for disagreements: Partnership agreements should specify how to resolve disputes (Result in friction and hard feeling) Lack of continuity: If one leaves, the relationship among partners changes & may end the partnership Difficulty withdrawing from the partnership: debts, personal liabilities, etc… Partnership, Cont.

3. Corporation A business entity created by filing a form called the ‘Articles of Incorporation’ with the appropriate state agency. Includes fees and meeting requirements. A legal entity that is separate from its owners (Artificial Person) Can enter into binding contracts, own property, pay taxes, and initiate legal actions (lawsuits) in its own name Owners have limited liability. No personal responsibility for debts and obligations More expensive and more complex for form Vary from state to state Can be publically traded

Forms of corporations C Corporation: Most common type. A legal business entity that offers limited liability to all of its owners, who are called Stockholders. Stockholders: An owner of a corporation (Stocks owners: Common with rights to vote, and Preferred with no rights to vote. Corporate Bylaws: Detailed rules that govern the way the corporation is organized and managed. Board of Directors: Individuals who are elcted by stockholders of a corporation to represent their interests: Establish the Corp. Mission & Objectives, and have role in day-to-day management, such as the CEO.

Forms of Corporations, Cont. S Corporation: A form of Corporation that avoids double taxation by having its income taxed as if it were a partnership.

Advantages disadvantages Limited liability: No personal liability for debt Permanence: continuous operation Ease of transfer of ownership: sell shares of stocks Ability to raise large amount of financial capital by issuing shares & selling corporation funds Ability to make use of specialized management: hiring highly qualified professional managers (Better salaries, benefits, growth opportunities, and career advancement) Expense & complexity of formation and operation. (Regular meetings, keeping minutes, etc.) Complications when operating in more than one state: Domestic vs. Foreign corporations, and may include more fees and taxes in other states Double taxation More paperwork, more regulations, and less secrecy Possible conflict of interest Corporations, Cont.

4. Limited liability company (llc) A form of business (legal entity) ownership that offers both limited liability to its owners and flexible tax treatment. Can combine Corp. with Partnership Owners select tax treatment (Corp or Partnership) May require filling “Certificate of Organization or Article of Organization” & pay filling fees Draft operating agreement Owners called members or partners who manage the LLC

Limited liability company, cont. Advantages disadvantages Limited liability Tax Pass-Through: Either as Corp., Partnership, or Sole Proprietorship (Owned by one). Taxed once as income of the owners Simplicity and flexibility in management and operation: No meetings required. Flexible ownership: Can have many owners. Can include foreign investors and other corporations (different in some states) Complexity of formation: Takes time and effort Annual franchise tax: many states require LLC to pay an annual franchise tax Foreign status in other states: more paperwork, fees and taxes Limits on types of firms that can form LLC. (Ex. Banks, Insurance Companies & Nonprofit Corporations) Differences in state laws Limited liability company, cont.

Mergers & acquisitions A corporate restructuring that occurs when two formerly independent business entities combine to form a new business. Ex: United Airlines & Continental Airlines, Google & Motorola Mobile Occurs when one firm buys another firm Acquiring firm Acquired firm “Hostile Take-over”: When the acquiring firm buys the target firm despite the opposition of the target firm’s board and management Mergers & acquisitions

Franchising A licensing agreement under which one party (Franchisor) allows another party (Franchisee) to use its name, trademark, patents, copyrights, business methods, and other property in exchange for monetary payments and other considerations. Very popular Important source of employment and income Dominates certain markets: food, auto dealerships, convenience stores

Types of franchise arrangements Distributorships: a type of franchising arrangement in which the franchisor makes a product and licenses the franchisee to sell it. Ex: New Umbrella Business Format Franchise: A broad franchise agreement in which the franchisee pays for the right to use the name, trademark, and business and production methods of the franchisor. Ex: Automakers and Dealerships. Franchise Agreements Provide services such as, site selection, training, obtaining financing, follow industry guidelines. Ex: Wendy’s, Burger King, etc.

Franchising, Cont. Less risk Training & support Brand recognition advantages disadvantages Less risk Training & support Brand recognition Easier access to funding Cost Lack of control Negative Halo Effect: The effect of irresponsible and incompetent behavior of a few franchisees create negative perception Growth challenges Restrictions on sale Poor execution Franchising, Cont.

Franchise Agreement The contractual arrangement between a franchisor and franchisee that sells out the duties and responsibilities of both parties. Key items covered in the agreement: Terms and conditions Fees and other payments Training and support Specific operational requirements Conflict resolution Assigned territory

Recollection of Knowledge In groups of four: Answer the following: List three different types of business ownership. Sole Proprietorship, Partnership, Corporation , Limited Liability Corporation Describe advantages and disadvantages of a sole proprietorship Advantages: 1. Ease of formation. 2. Retention of Control. 3. Pride of Ownership. 4. Retention of Profits. 5. Possible Tax Advantage. Disadvantages: 1. Limited Financial Resources. 2. Unlimited Liability. 3. Limited Ability to Attract and Maintain Talented Employees. 4. Heavy Workload and Responsibilities. Lack of Permanence. Describe advantages and disadvantages of a partnership Advantages: 1. Ability to Pool Financial Resources. 2. Ability to Share Responsibilities and Skills. 3. Ease of Formation. 4. Possible Tax Advantage. Disadvantages: 1. Unlimited Liability. 2. Potential for Disagreements. 3. Lack of Continuity. 4. Difficulty in Withdrawing from a Partnership. Describe advantages and disadvantages of a corporation Advantages: 1. Limited Liability. 2. Permanence. 3. Ease of Transfer of Ownership. 4. Ability to Raise Large Amounts of Financial Capital. 5. Ability to Make Use of Specialized Management. Disadvantages: 1. Expense and Complexity of Formation and Operation. 2. Complications when Operating in more than one State. 3. Double Taxation of Earnings. 4. More Paperwork, More Regulation, and Less Secrecy. 5. Possible Conflicts of Interest. Describe advantages and disadvantages of a Limited Liability Advantages: 1. Limited Liability. 2. Tax Pass-Through. 3. Simplicity and Flexibility in Management. 4. Flexible Ownership. Disadvantages: 1. Complexity of Formation. 2. Annual Franchise Tax. 3. Foreign Status in Other States. 4. Limits on types of Firms that can Form LLCs. 5. Differences in State Laws. Define and give examples of franchises : A licensing arrangement under which one party allows another party to use its name, trademark, patents, copyrights, business methods, and other property in exchange for monetary payments. Ex: Subway, Wendy’s, etc…