Chapter 3 Hospitality Operating Structures

Hospitality Operating Structures The Importance of Proper Organizational Structure Common Hospitality Organizational Structures The Hospitality Franchise

In This Chapter, You Will Learn: The various organizational business structures used in the hospitality industry. Some advantages and disadvantages of alternative organizational structures. The responsibilities and obligations created by an agency relationship. The unique business relationship involved in franchising. How franchise agreements affect the purchase, operation, and sale of a franchised hospitality operation.

The Importance of Proper Organizational Structure Ease of formation and maintenance Liability Taxation Terminating or selling the business

Common Hospitality Organizational Structures Sole proprietorship General partnership Limited partnership (LP) C corporation S corporation Limited liability company (LLC)

Common Hospitality Organizational Structures Legalese: Sole Proprietorship -A business organization in which one person owns and, often, operates the business.

Common Hospitality Organizational Structures Legalese: General Partnership - A business organization in which two or more owners agree to share the profits of the business, but are also jointly and severally liable for its debts.

Common Hospitality Organizational Structures Legalese: Limited Partnership - A business organization with two classes of owners. The limited partner invests in the business, but may not exercise control over its operation, in return for protection from liability. The general or managing partner assumes full control of the business operation, but can also be held liable for any debts the operation incurs.

Common Hospitality Organizational Structures Legalese: General Partner - The entity in a limited partnership relationship who makes the management decisions and can be held responsible for all debts and legal claims against the business.

Common Hospitality Organizational Structures Legalese: Limited Partner -The entity in a limited partnership relationship who is liable only to the extent of his or her investment. Limited partners have no right to manage the partnership.

Analyze the Situation 3.1 Nicholas Kostanty formed a limited partnership with his father-in-law, Ray Sweeney, to open an upscale French restaurant in a midwestern town. Mr. Kostanty was the general partner and owned 75 percent of the business. Mr. Sweeney, with 25 percent ownership, was the limited partner and invested $100,000. After one year, difficulties in the restaurant's operation caused business to drop off, and Mr. Kostanty called Mr. Sweeney for advice.

Analyze the Situation 3.1 After hearing of the difficulties, and concerned with the security of his investment, Mr. Sweeney traveled from Arizona to Indiana to visit the operation. Upon observing the operation for two days, the two partners decided to launch a large and expensive television ad campaign to increase flagging sales. Mr. Sweeney designed the campaign with the help of Seelhoff Advertising and Video, a local advertising agency specializing in television commercials.

Analyze the Situation 3.1 Despite an immediate increase in sales, volume continued to decline, and finally, three months after the ad campaign was launched, the restaurant closed its doors. Total debts at the time the restaurant closed equaled $400,000, with assets of the partnership only being $200,000. Included in the debt was $150,000 owed to the advertising agency. The agency sought payment directly from Mr. Sweeney.

Analyze the Situation 3.1 Mr. Sweeney claimed that his liability was limited to the $100,000 he had previously invested in the business, and refused to pay any additional money. The Seelhoff Advertising Agency sued the limited partnership, as well as Nicholas Kostanty and Ray Sweeney individually.

Analyze the Situation 3.1 By hiring the advertising agency, did Mr. Sweeney forfeit his limited partner status? Is Mr. Sweeney liable for the outstanding debts of the limited partnership?

Common Hospitality Organizational Structures Legalese: Corporation -A group of individuals granted a charter, legally recognizing them as a separate entity with rights and liabilities distinct from those of its members.

Common Hospitality Organizational Structures Legalese: Dividend - A portion of profits received by a shareholder, usually in relation to his or her ownership of a corporation.

Common Hospitality Organizational Structures Legalese: S Corporation - A type of business entity that offers liability protection to its owners, and is exempt from corporate taxation on its profits. Some restrictions limit the circumstances under which it can be formed.

Common Hospitality Organizational Structures Legalese: Limited Liability Company (LLC) - A type of business organization that protects the owners from liability for debts incurred by the business, without the need for some of the formal incorporation requirements. The federal government does not tax the profits of LLC’s; however, some states do while others do not.

Common Hospitality Organizational Structures Legalese: Agent - A person authorized to act for or to represent another, usually referred to as the principal.

Common Hospitality Organizational Structures Legalese: Respondeat Superior - Literally; “let the master respond,” a legal theory that holds the employer (master) responsible for the acts of the employee.

Common Hospitality Organizational Structures Legalese: Independent Contractor - A person or entity that contracts with another to perform a particular task, but whose work is not directed or controlled by the hiring party.

The Hospitality Franchise Legalese: Franchise - A contract between a parent company (franchisor) and an operating company (franchisee) to allow the franchisee to run a business with the brand name of the parent company, as long as the terms of the contract concerning methods of operation are followed.

Analyze the Situation 3.2 After five years of effort, you develop a unique style of roasting pork that is extremely popular in your hometown. You own and operate five units called Porkies that sell this product. Each unit costs $175,000 to develop. Total sales of each unit average $600,000, with a net profit margin of 10 percent per unit.

Analyze the Situation 3.2 A friend of yours discusses your success with you, and suggests the possibility of opening five new stores in his or her hometown. Your friend wants to know what you would charge to sell your recipe and your standard operating procedures (SOP) manual, as well as the use of the name Porkies.

Analyze the Situation 3.2 How would you determine a fair price for your experience? If your friend is successful, causing the name of Porkies to be even better known, thus resulting in greater demand for franchises, should your friend share in future revenue from franchise sales? What are the ethical issues at play here?

The Hospitality Franchise Legalese: License - Legal permission to do a certain thing or operate in a certain way.

The Hospitality Franchise Legalese: License Agreement - A legal document that details the specifics of a license.

The Hospitality Franchise Legalese: Licensor - One who grants a license.

The Hospitality Franchise Legalese: Licensee - One who is granted a license.

The Hospitality Franchise Legalese: Disclosure - To reveal fully and honestly.

Search the Web 3.1 Log on to the Internet and enter www.ftc.gov. Select: Business Guidance. Select: Franchise and Business Opportunities. Select: Franchise Rule Text. Read the entire FTC Franchise Rule (16 CFR Part 436), to familiarize yourself with its requirements, then write a one-page bulleted summary of the rule.

Franchise Rule Basic disclosures Earnings claims Advertised claims Franchise agreements Refunds Contradictory claims

Franchise Offering Circular Many states treat sales of franchises like securities. Must file circular of record before selling in the state.

Franchise Agreement Details the rights and responsibilities of the franchisor and the franchisee.

Operating a Franchise Encroachment / impact. Purchasing requirements. Operations manual changes. Renewal clauses. Noncompete clauses.

Analyze the Situation 3.3 In 2000, Robert Thornburg signs a franchise agreement with Starbelt Hotels to operate a full-service hotel under the Starbelt name. His franchise agreement includes a clause that prevents Starbelt from granting additional Starbelt franchises in Mr. Thornburg's market area without an impact study.

Analyze the Situation 3.3 In 2005, Starbelt develops a second hotel brand that targets upscale travelers who do not desire the meeting rooms, full-service restaurants, and indoor pools that define the Starbelt brand. The new hotels are called Moonbelts, and the franchisees who purchase this brand are connected to the same national reservation system as those franchisees in the Starbelt brand.

Analyze the Situation 3.3 Starbelt maintains a separate 800-number for each brand. However, a guest may book either hotel type with a call to either 800-number. The ADR (average daily rate) for a new Moonbelt hotel equals that of the older Starbelt hotels. In 2010, Mr. Thornburg finds that a franchisor-owned Moonbelt hotel is to be built across the street from his hotel.

Analyze the Situation 3.3 He protests that many of his customers will find the Moonbelt hotel desirable, and that his franchisor has violated the terms of the franchise agreement by erecting a competing hotel in his territory. Mr. Thornburg requests a copy of the impact study he feels should have been produced by the franchisor. Starbelt Hotels maintains that Mr. Thornburg has protection only against other Starbelt hotels, and since Moonbelt targets a different clientele, no protection exists, nor should an impact study have been performed.

Analyze the Situation 3.3 Has Starbelt violated the terms of the franchise agreement? What steps might Mr. Thornburg take to protect his business?

The Hospitality Franchise Legalese: Tying Arrangement - An agreement, often illegal, requiring that, as a precondition of purchasing or obtaining services, other services must be purchased and must be purchased through the seller.

The Hospitality Franchise Legalese: Noncompete Agreement - A contractual agreement between two parties in a business relationship in which one party, upon termination of the business relationship, agrees not to compete within a designated geographic area or for a designated period of time.

Analyze the Situation 3.4 Lo Vin Do was an immigrant from Southeast Asia. He spent 10 years in the United States operating a small restaurant that served lunches, dinners, and carryout baked goods. Later, he bought a franchise operation that sells European-style, fresh-baked breads.

Analyze the Situation 3.4 A clause in the franchise agreement signed by Mr. Do prohibited, “...the operation, by Mr. Do, of a similar business...,” within a 10-mile radius for a period of five years if the franchise agreement was terminated for any reason. Mr. Do established the franchise as a limited partnership. The business was marginally successful at first, but two years later declared bankruptcy.

Analyze the Situation 3.4 Mr. Do closed the operation and returned all confidential operating materials to the franchisor. Afterward, Mr. Do, operating as a sole proprietor, again opened a small, table service restaurant serving Vietnamese cuisine and French pastry products.

Analyze the Situation 3.4 This restaurant was located approximately three miles from his previous restaurant. The franchisor contacted Mr. Do stating that he must cease operation of the restaurant/bakery or face litigation.

Analyze the Situation 3.4 Did Mr. Do violate the terms of the franchise agreement?

The Hospitality Franchise Legalese: Right of First Refusal - A clause in a contractual agreement between two parties in a business relationship in which one party, upon termination of the business relationship, can exercise the right to buy the interest of the other party before those rights can be offered for sale to another.

What Would You Do? Assume you are responsible for approving commercial loans at a bank where you are the senior lending official. You are approached by two hospitality management college graduates, each with three years’ management experience acquired after they had completed their studies. They are seeking a loan slightly in excess of $1 million to establish a restaurant in the community. The funds will be used to lease land, facilities, and equipment, as well as for renovation, inventory, salaries, and other start-up costs.

What Would You Do? Will the organizational structure selected by the partners have an impact on your decision to extend the loan? What other factors would influence your decision? Would it make a difference to you if the partners were requesting the loan to complete a franchise agreement with an established and successful franchisor?

What Would You Do? Would you want to review the specifics of the franchise offering circular? Would you want to review the franchise agreement? What additional information might you request if the partners were seeking the loan to operate as an independent restaurant? Would it matter if the loan were for an existing restaurant, as opposed to a new start-up?

Rapid Review Identify those organizational structures that result in paying income taxes based on distributed, as compared to earned, profits. Explain the advantages of each approach. Explain the phrase respondeat superior, in terms of liability and organizational structure. Describe a real hospitality situation in which the phrase takes on meaning.

Rapid Review Compose a letter to a potential lender addressing only the issue of why the organizational structure you have selected for your new business group makes it advantageous for the lender to grant you the loan you have requested. State the defining characteristics of six types of organizational structures used in the hospitality industry as they relate to: Taxes Liability Financing Transfer of ownership

Rapid Review List six areas of disclosure addressed by the FTC Franchise Rule. Select one of these areas and explain why you think it is important. Using the World Wide Web, locate the case of a recent lawsuit pitting a franchisor against his or her franchise company. Discuss the merits of the lawsuit. (Hint: Try www.findlaw.com).

Rapid Review Contrast five advantages and five disadvantages of operating a restaurant or hotel as a franchisee, compared to operating as an independent. Assume you own a restaurant that is successful in part because of a signature menu item with a secret recipe. Prepare a noncompete agreement for a chef you are hiring that you feel would be fair to both of you.