Part I: Organization of a Business Introduction to Business 3e 2 Copyright © 2004 South-Western. All rights reserved. Selecting a Form of Business Ownership

Copyright © 2004 South-Western. All rights reserved.2–2 Learning Goals Explain how business owners select a form of ownership. Explain how the potential return and risk of a business are affected by its form of ownership. Describe methods of owning existing businesses.

Copyright © 2004 South-Western. All rights reserved.2–3 Business Ownership Decisions Advantages and disadvantages of each type of business ownership Impact of the form of business ownership on return on investment Impact of the form of business ownership on risk Methods to obtain ownership of existing businesses

Copyright © 2004 South-Western. All rights reserved.2–4 Impact of Forms of Ownership

Copyright © 2004 South-Western. All rights reserved.2–5 Forms of Business Ownership Sole Proprietorship –Owned by a single owner. Partnership –Co-owned by two or more people. –Co-owners must register with the state and may need an occupational license. Corporation –State chartered entity that pays taxes and is legally distinct from its owners.

Copyright © 2004 South-Western. All rights reserved.2–6 Sole Proprietors Must be willing to accept full responsibility for firm performance Business profits are not shared with creditors Need strong leadership skills, must be well organized, and communicate well with employees

Copyright © 2004 South-Western. All rights reserved.2–7 Sole Proprietorship Advantages –All earnings go to the sole proprietor –Easy organization –Complete control –Lower taxes Disadvantages –Sole proprietor incurs all losses –Unlimited liability –Limited funds –Limited skills

Copyright © 2004 South-Western. All rights reserved.2–8 Types of Partnerships General Partnerships –All partners have unlimited liability. Limited Partnerships –Some partners have personal liability that is limited to the cash or property they invested in the firm. –One or more general partners who actively manage the business, receive a salary, share in profits and losses, have unlimited liability. –Personal earnings received from the partnership are subject to personal income taxes.

Copyright © 2004 South-Western. All rights reserved.2–9 Partnerships Advantages –Additional funding –Losses are shared –More specialization Disadvantages –Control is shared –Unlimited liability for general partners –Profits are shared

Copyright © 2004 South-Western. All rights reserved.2–10 Other Business Forms S Corporation –Firm has 75 or fewer employees. –Owners have limited liability, but are taxed as if the firm were a partnership. Limited Liability Corporation (LLC) –Has all the favorable features of a general partnership but also offers limited liability for the partners.

Copyright © 2004 South-Western. All rights reserved.2–11 Your Portion of Earnings (or Losses) on a Proprietorship versus a Partnership Exhibit 2.1a

Copyright © 2004 South-Western. All rights reserved.2–12 Your Portion of Earnings (or Losses) on a Proprietorship versus a Partnership Exhibit 2.1b

Copyright © 2004 South-Western. All rights reserved.2–13 Relative Contributions to Business Revenue of Sole Proprietorships, Partnerships, and Corporations Exhibit 2.2

Copyright © 2004 South-Western. All rights reserved.2–14 business online

Copyright © 2004 South-Western. All rights reserved.2–15 Corporations Individual or group must adopt corporate charter and file it with the state –Describes name of the firm, stock issued, firm’s operations –Must also establish bylaws –Shareholders have limited liability –Shareholders elect members of board of directors

Copyright © 2004 South-Western. All rights reserved.2–16 Stockholders Elect members of board of directors who are responsible for establishing general policies of the firm –Elect president and other key officers who run the business Earn return on investment in two ways –May receive dividends –Stock may increase in value

Copyright © 2004 South-Western. All rights reserved.2–17 Corporations Advantages –Limited liability –Access to funds –Transfer of ownership Disadvantages –High organizational expense –Financial disclosure –Agency problems –High taxes

Copyright © 2004 South-Western. All rights reserved.2–18 Illustration of Double Taxation Exhibit 2.3

Copyright © 2004 South-Western. All rights reserved.2–19 Comparison of Tax Effects on Corporations and Sole Proprietorships Exhibit 2.4

Copyright © 2004 South-Western. All rights reserved.2–20 Small Business Administration’s Home Page Exhibit 2.5

Copyright © 2004 South-Western. All rights reserved.2–21 List of SBA Publications on the Internet Exhibit 2.6

Copyright © 2004 South-Western. All rights reserved.2–22 The Company Corporation Home Page Exhibit 2.7

Copyright © 2004 South-Western. All rights reserved.2–23 Private Vs. Public Ownership of privately held corporations is restricted to a small group of investors. Publicly held shares can be easily purchased or sold by investors. –Act of initially selling stock is called “going public.” –Publicly held corporations obtain additional funds by issuing new common stock.

Copyright © 2004 South-Western. All rights reserved.2–24 Impact of Ownership on Return Return on Investment (ROI) –After-tax earnings represent the return in dollars to the business owners. Return on Equity (ROE) –Reflects earnings as a proportion of the firm’s equity –Equity is the total investment by the firm’s stockholders.

Copyright © 2004 South-Western. All rights reserved.2–25 Return on Equity for The Children’s Place Exhibit 2.8

Copyright © 2004 South-Western. All rights reserved.2–26 Impact of Ownership on Risk Risk represents uncertainty about the firm’s future earnings –Depends on future revenues and expenses Sole proprietorships tend to be riskier than larger businesses, such as partnerships and corporations. –Limited funding restricts ability to diversify and spread business risk

Copyright © 2004 South-Western. All rights reserved.2–27 Ownership of Existing Business Assuming Ownership of a Family Business Purchasing an Existing Business –Assess expertise –Compare expected benefits with initial outlay –Be cautious about basing future earnings expectations on historical data Franchising

Copyright © 2004 South-Western. All rights reserved.2–28

Copyright © 2004 South-Western. All rights reserved.2–29 Franchising Business owner (franchisor) allows another (the franchisee) to use its trademark, trade name, or copyright, under specified conditions. Each franchise operates as an independent business. Typically owned by a sole proprietor.

Copyright © 2004 South-Western. All rights reserved.2–30 Well Known Franchises McDonald’s Thrifty Rent-a-Car System Mail Boxes Etc. Dairy Queen Super 8 Motels Inc. TGI Fridays Pearle Vision Inc. Baskin-Robbins

Copyright © 2004 South-Western. All rights reserved.2–31 Types of Franchises Distributorship –Dealer is allowed to sell a product produced by a manufacturer. Chain-Style Business –Firm is allowed to use the trade name of a company and follows guidelines related to the pricing and sale of the product. Manufacturing Arrangement –Firm is allowed to manufacture a product using the formula provided by the franchisor.

Copyright © 2004 South-Western. All rights reserved.2–32 Franchises Advantages –Proven management style –Name recognition –Financial support Disadvantages –Sharing profits –Less control

Copyright © 2004 South-Western. All rights reserved.2–33 B2B Franchises Franchises serving other businesses that have grown substantially: –Hiring services –Consulting services –Training services Require smaller initial investment because they can be operated by computer from a home office.

Copyright © 2004 South-Western. All rights reserved.2–34 Ownership of Foreign Businesses Purchase a franchise created by a U.S. firm in a foreign country –Return may be higher than in U.S. if there is less competition Purchase a business being sold by the foreign government –Reputation for inefficiency often leads to low prices –Can be high risk due to instability of foreign government

Copyright © 2004 South-Western. All rights reserved.2–35 Summary Entrepreneurs can select a form of ownership: –Sole proprietorship –Partnership –Corporation Return and risk depend on form of business ownership. Common methods for obtaining ownership of existing businesses: –Family business –Purchase existing business –Franchising