Busn 100 Chapter 05 Form of Businesses

Goals Forms of Businesses Advantages and Disadvantages of Sole Proprietorship Partnerships: General and Limited Partners Advantages and Disadvantages of Partnerships Corporations Advantages and Disadvantages of Corporations Types of Corporations C Corps S Corps Limited Liability Corporations (LLC)

Goals Define and give examples of three types of corporate mergers Leveraged Buyouts Taking a Firm Private Franchises Advantages and Disadvantages of Franchises Cooperatives

Forms of Businesses Sole Proprietorship A business that is owned, and usually managed, by one person Partnership A legal form of business with two or more owners Corporation A legal entity with authority to act and have liability separate from its owner

Basic Forms of Business Ownership Type of Ownership Number Sales Sole Proprietorship 72% 6% Partnership 8% 13% Corporation 20% 81% Also available on a Transparency Acetate See Learning Goal 1: Compare the advantages and disadvantages of sole proprietorships. See text pages: 118 See Learning Goal 2: Describe the differences between general limited partners, and compare the advantages and disadvantages of partnerships. See text pages: 121-124 See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, ad limited liability companies. See text pages: 124-131 Basic Forms of Ownership The rule of 80-20 applies to the forms of businesses as well. Although corporations make up only 20 percent of the total number of businesses, they generate about 81% of sales in the U.S. Ask the students, how many are interested in starting their own business? What form of ownership do they believe would they be starting their business with? (Many students may dream of having their own business but may not have thought through the process and what it takes to start a business. Majority should indicate that it would be a sole proprietorship. Some may suggest a partnership.) Source: US Internal Revenue Service

Terms Asset Liability Unlimited Liability Limited Liability Things like buildings, autos, cash Liability Debt = Owe Unlimited Liability With the business form, Sole Proprietorship, if the sole proprietor owes money, the creditor can take the business’s assets and the sole proprietor's assets Limited Liability With the business form, Corporation, if the Corporation owes money, the creditor can take the business’s assets but not the owners' assets Resources: Ability to get Capital (equity or debt)

Sole Proprietorship Advantages Disadvantages Ease of start/end Be your own boss Pride of ownership Leave a legacy Retain profit No special taxes, but you must pay payroll taxes Unlimited liability Limited financial resources Management difficulty HUGE Time commitment Few fringe benefits Limited growth Limited life span Also available on a Transparency Acetate See Learning Goal 1: Compare the advantages and disadvantages of sole proprietorships. See text pages: 119-120 Sole Proprietorship This slide identifies the advantages and disadvantages of a Sole Proprietorship form of business. Special emphasis should be given to the disadvantage of unlimited liability (Personal assets at risk), and to the time commitment (24 hours, 7 days per week, and 365 days per year). Special Note: It’s estimated that Small Business owners create 80% of new employment in this country; a major component of economic growth.

Types of Partnerships General Limited GP Passive Investor Passive Also available on a Transparency Acetate See Learning Goal 2: Describe the differences between general limited partners, and compare the advantages and disadvantages of partnerships. See text page: 121 Types of Partnership This slide presents basic types of partnerships: general and limited. In general partnership, all owners share in operating the business and assuming liability. A limited partnership: one or more general partner (unlimited liability and active in managing the firm) and one or more limited partner (invests money but no management responsibility and liability limited to the investment amount). GP GP GP GP Passive Investor

Partnerships General Partner Limited Partner General Partnerships An owner that has unlimited liability and is active in managing the firm Limited Partner An owner that invests money in the business buy does not have any management responsibility or liability for losses beyond the investment General Partnerships A partnership in which all the owners share in operating the business and in assuming liability for the business debts Limited Partnerships A partnership with one or more general partner and one or more limited partners

Mutual Agency (Advantage and Disadvantage) Agent One empowered to act for or represent another (http://www.answers.com/agent ) Someone who is supposed to act in the best interest of someone else Mutual Agency The ability of each partner to act as an agent of the firm, thereby committing the entire firm to a binding contract Each partner can enter into binding contracts in the name of the firm for the purchase or sale of goods or services within the normal scope of the firm’s business

Partnership Disadvantages Advantages Unlimited liability More financial resources Shared management Longer survival No special taxes, but you must pay payroll taxes Mutual Agency Unlimited liability Division of profits Disagreements among partners Difficult to terminate Mutual Agency Also available on a Transparency Acetate See Learning Goal 2: Describe the differences between general limited partners, and compare the advantages and disadvantages of partnerships. See text pages: 122-123 Partnership Partnerships as with all forms of ownership have advantages and disadvantages; so each member must choose carefully. Suggestions to discuss with students regarding partnerships: Partnership agreements must be in writing! Each individual’s responsibilities to the company must be in writing and included as part of the contract. Make certain that provisions are in place if one or more partners want to terminate the agreement. (Information outlining the terms and conditions of terminating any agreement, should be outlined in the original contract.) Do not add a partner unless that individual brings unique skills that add value to the business.

New Forms of Partnerships Master Limited Partnership (MLP) A partnership that looks much like a corporation (in that it acts like a corporation and is traded on a stock exchange) but is taxed like a partnership and thus avoids the corporate income tax Limited Liability Partnership (LLP) A partnership that limits partners’ risk of losing their personal assets to only their own acts and omissions and to the acts and omissions of people under their supervision See Learning Goal 2: Describe the differences between general limited partners, and compare the advantages and disadvantages of partnerships. See text pages: 121-122

New Forms of Partnerships Master Limited Partnership Traded Publicly Taxed As A Partnership Limited Liability Partnership An individual is responsible for their actions Solves the Mutual Agency problem See Learning Goal 2: Describe the differences between general limited partners, and compare the advantages and disadvantages of partnerships. See text pages: 121-122

Limited Liability Companies Types of Corporations Conventional ‘C’ S Corporation Limited Liability Companies See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies. See text pages: 124-131

Corporations Private: Not Traded on Any Stock Exchange Public: Shares are Traded on One or More Stock Exchanges Non-Profit: Performs Public Service, Has Special Tax Considerations to Encourage Formation See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies. See text pages: 124-131

Corporation Advantages Disadvantages Extensive paperwork Double taxation Two tax returns Size Termination difficult Conflict with Stockholder & Board Initial cost Separation of ownership/mgmt. Limited liability More money for investment Size Perpetual life Ease of ownership change Ease of drawing talented employees Separation of ownership/mgmt. Dividends paid in proportion to ownership Also available on a Transparency Acetate See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies. See text pages: 125-128 Corporation Identify the major advantage of corporate ownership is the limited liability protection. (Personal assets are protected) Interesting facts regarding incorporating a business: The cost for a business to Incorporate ranges from $100-$310, plus states fees. (This only includes the legal filing expenses) Connecticut has the highest state fees at $380, the state of Oregon has the lowest fees at $20. 3. Over half of the Fortune 500 companies choose to incorporate in Delaware for the following reasons: The cost to incorporate in Delaware is one of the lowest in the country ($89). There is no corporate income tax. Delaware maintains a separate corporate law court system, that does not use juries, but only use judges appointed for their knowledge of corporate laws.

How Owners Affect Management Also available on a Transparency Acetate See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies. See text pages: 124-131 How Owners Affect Management This acetate provides students with a visual example of how corporations are structured. Please note the importance of Stockholders as the owners of the company. Students should realize that the Board of Directors does not engage in daily operations, but rather they “oversee” the company’s operations. Board of Directors are responsible for the following: Set objectives Select Senior Executive Influence the company’s long-term strategic planning. Compensation for Board Members typically consist of an annual salary, plus expenses and additional compensations outlined in their contracts. (An example of compensation may be a $35,000 salary, plus $5,000 for every board meeting attended.)

World’s Largest Corporations 2008 Citigroup General Electric American Intl Group Bank of America HSBC Group ExxonMobil Royal Dutch/Shell BP ING Group Toyota Motor UBS Wal-Mart Stores Royal Bank of Scotland JP Morgan Chase Berkshire Hathaway BNP Paribas IBM Total Verizon Communication Chevron Texaco Also available on a Transparency Acetate See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies. World’s Largest Corporations This slide presents Forbes’ 2005 top 20 global corporations. Ask the students: How many of these top 20 are U.S. corporations? (11 out of 20) Ask the students: What is the home country of the rest of them? (Two are from France, two from the Netherlands, one from Japan, one from Switzerland, and rest are from U.K.) Source: Forbes, 2005

World’s Largest Corporations 2010 Also available on a Transparency Acetate See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies. World’s Largest Corporations This slide presents Forbes’ 2005 top 20 global corporations. Ask the students: How many of these top 20 are U.S. corporations? (11 out of 20) Ask the students: What is the home country of the rest of them? (Two are from France, two from the Netherlands, one from Japan, one from Switzerland, and rest are from U.K.)

America’s Largest Private Companies Cargill / agricultural commodities, food $66,669 Koch Industries / chemicals, energy, tech 60,000 Mars / candy, pet food electronics 19,100 PricewaterhouseCoopers / accounting 18,700 Publix Supermarket / supermarkets 18,686 Revenue 2004 (In Millions) Also available on a Transparency Acetate See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies. Largest Private Companies This slide presents America’s top 5 private companies in 2005. Ranked 6-10 were: Bechtel, Ernst & Young, C&S Wholesale Grocers, SEMGroup, and Meijer. Ask the students to debate why a company may want to remain private? (Some of the reasons may be control, privacy, no external pressure, and preference.) Source: Forbes, 2005

America’s Oldest Companies Company Year Started Type of Company J. E. Rhoads & Sons 1702 Conveyer Belts Covenant Life Ins. 1717 Insurance Philadelphia 1752 Insurance Contributorship Dexter 1767 Adhesives & Coatings D. Landreth Seed 1784 Seeds Bank of New York Banking Also available on a Transparency Acetate See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies. America’s Oldest Companies Interesting slide that identifies those companies that have been in business for over 200 years. A few facts you may wish to address with the students: JE Rhoads, is the oldest company in the U.S. and started off tanning leather for Buggy Whips. Philadelphia Contributorship Insurance, was formed based on a suggestion by Benjamin Franklin regarding the establishment of a volunteer fire brigade, which eventually developed into an insurance company. The Bank of New York, New York’s first bank, was opened for business in Lower Manhattan on June 9th, 1784, only a few months after the departure of British Troops from American soil. Environment changes in the business world will always happen; those companies who embrace change and provide quality goods and services, will continue to profit. Discuss with the students the significant amount of commitment a company must be prepared to do to stay in business. (Some areas that must continually be addressed are changes in societal culture, competition, economy, laws/politics, and technology changes.)

Formation of a Corporation A person or persons applies for a charter The appropriate state official issues the charter Charter Written permit, issued by a state government, for a corporation to exist State-approved articles of incorporation

Articles of Incorporation Application for a charter Include the following information: Name and address of the corporation Nature of the business Amount and description of the capital stock to be issued Name(s) of the promoter(s) or sole incorporator who will hold an initial meeting to elect an acting board of directors Become the governing instrument of the corporation Must be accompanied by a charter fee, which is based on the dollar amount of the maximum stock investment as specified in the charter

Initial Meeting Called by the promoters or sole incorporator to Elect an acting board of directors Formulate bylaws Charter and bylaws provide the basic rules for conducting the corporation's affairs

After Acceptance of Charter and Bylaws Directors meet to appoint officers to serve as active managers of the business Corporation issues capital stock to buyers of stock who have paid in full Stockholders elect a permanent board of directors

S Corp Small (less than 100 owners) corporation that is taxed like a sole proprietorship/partnership and has Limited Liability Benefits: Taxed Once Limited Liability

S Corporations No more than 100 shareholders Individual or Estates U.S. citizens or permanent residents 1 class of stock <25% of income can be passive Benefits change with new tax rules Also available on a Transparency Acetate See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies. See text page: 129 S Corporations An S corporation looks like a corporation but is taxed like a sole proprietorship or partnership. The primary advantage of an S corporation is that it avoids the double taxation of a C corporation. Approximately 3 million US companies operate as an S corporation.

Limited Liability Company (LLC) Similar to Corporations except: Taxed once (like Sole Proprietorships and Partnerships) Can share profits in whatever proportion they want (not like S or C corps) Less Required paperwork (no annual meetings, minutes, articles of organization, but does file written operating agreement) No stock (cannot transfer ownership) Must say when company will end

Limited Liability Companies Advantages Disadvantages Limited Liability Tax Choice Flexible Ownership Rules Flexible Profit & Loss Distribution Operating Flexibility No Stock Limited Life Span Fewer Incentives Paperwork Also available on a Transparency Acetate See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies. See text page: 130 Limited Liability Companies This slide presents the advantages and disadvantages of LLCs. Biggest advantages that should be pointed out with LLCs are limited liability and flexibility. Primary disadvantages from entrepreneurs perspectives would be limited life and paperwork.

Nolo Press This is a great place to find books about how to start and create any of the Business Forms discussed in the book http://www.nolo.com/all_books_cat.cfm

Define and give examples of three types of corporate mergers The result of two companies forming one company Acquisition One company’s purchase of the property and obligations of another company Vertical Merger The joining of two firms involved in different stages of related businesses Horizontal Merger The joining of two firms in the same industry Conglomerate Merger The joining of firms in completely unrelated industries

No Relationship between companies Types of Mergers Horizontal Also available on a Transparency Acetate See Learning Goal 4: Define and give examples of three types of corporate mergers, and explain the role of leveraged buyouts and taking a firm private. See text pages: 133 Types of Mergers This slide presents the three types of mergers. Horizontal merger takes place in the same industry, i.e., one competitor merging with another. An example of this would be Daimler Mercedes Benz merging with Chrysler to create DaimlerChrysler. Vertical merger takes place between companies in a value chain, for example a supplier and a distributor merging. Conglomerate merger has no relationship between companies. Vertical Conglomerate No Relationship between companies

Types of Mergers Conglomerate then Horizontal: Vertical: Horizontal During the 1960s, Shasta was purchased by the Sara Lee food company (then known as Consolidated Foods). In 1985, it was acquired by the National Beverage Corp., which also owns the popular Faygo line. http://en.wikipedia.org/wiki/Shasta_(soft_drink) Vertical: Cabinet manufacturer purchased wood producing factory Horizontal JPMorgan buys WaMu Wells Fargo buys Wachovia

Companies Overpay to Acquire Another Firm Why Mergers Don’t Work! Companies Overpay to Acquire Another Firm GM & Hummer www.gm.com/vehicles/ AOL & Time Warner (2002 $100 M write down) Acquiring Company Overestimates Cost Savings and Synergies The cultures of the two companies do not mix well 1998 Daimler-Benz AG & Chrysler Corporation Managers Disagree About Integrating Operations Obsession with Cost Cutting Hurts Business, Costing Top Employees & Customers See Learning Goal 4: Define and give examples of three types of corporate mergers, and explain the role of leveraged buyouts and taking a firm private. Why Mergers Don’t Work 1. A great topic for discussion in class, as mergers may effect many students in their future careers. 2. Several other reasons why mergers don’t work are: Mergers consolidate industries and reduce competition in free markets. Different Corporate Cultures make seamless merging very difficult. (Daimler – German Company / Chrysler – American Company) Extensive cost cutting leads to morale problems. Markets tend to overlap resulting in duplication of services and higher costs. Historically, the acquiring corporations experience a drop in market value.

Terms Leveraged Buyouts (LBO) Taking a Firm Private An attempt by employees, management, or a group of investors to purchase an organization primarily through borrowing Taking a Firm Private Individuals buying all public stock for themselves There are far fewer regulations and restrictions if the company is a “private corporation”

Franchise Franchisor Franchisee Franchise Agreement Franchise System The right to use a specific business’s name and sell its products or services in a given territory Franchisor The company that develops the product/service and sells the rights to use the product/service Franchisee The person who buys the franchise Franchise Agreement The contact between the franchisor and Franchisee See Learning Goal 5: Outline the advantages and the disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising. See text pages: 134-141

Branded Product/Service Franchise Contract Franchisor, Inc. Branded Product/Service Performance Monitoring See Learning Goal 5: Outline the advantages and the disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising. See text pages: 134-141 $$$$$ Franchisee

Provides Training/Support Franchisor Provides Training/Support Business Expansion Using O.P.M. Assigns Territory May Provide Financial Aid/Advice Offers Merchandise/ Supplies at Competitive Price See Learning Goal 5: Outline the advantages and the disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising. See text pages: 134-141

Franchisee Pays Up-Front Costs Makes Monthly Payment to Franchisor Runs Business by Franchisor’s Rules/Procedures Buys Materials from Franchisor/ Approved Supplier See Learning Goal 5: Outline the advantages and the disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising. See text pages: 134-141

Franchises Management & marketing assistance Personal ownership Advantages Disadvantages Management & marketing assistance Personal ownership Recognized name Financial advice & assistance Lower failure rate High start-up costs Shared Profit Management regulation Coattail effects Restrictions on selling Fraudulent franchisors Also available on a Transparency Acetate See Learning Goal 5: Outline the advantages and the disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising. See text pages: 135-137 Franchises This slide presents the advantages and disadvantages of franchising. Primary advantages are name, assistance, and lower failure rate. Primary disadvantages are high costs, shared profits, and restrictions.

Cost of Fast-Food Franchise Company Initial Fee Royalty Burger King $50,000 8.5% McDonald’s $45,000 8% Wendy’s $25,000 Domino’s None Subway $10,000 11.5% Krispy Kreme $40,000 5.5% See Learning Goal 5: Outline the advantages and the disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising. Cost of Fast-Food Franchise 1. This slide shows the initial purchase fee and the percentage of gross revenues charge to franchisers to operate. 2. Additional costs of startup include the following capital requirements: Royalty fees are traditionally based on gross sales minus sales tax. Advertising fees as high as 3.5% of sales Location acquisition Equipment ($40-$65,000) Leasehold Improvements ($20-$80,000) POS System (Point-of-Sale); minimum $4,500 Outside Signs ($3,500-$9,000) Opening Inventory ($3,000-$9,000)

Benefits of a Home-Based Franchise Terms Benefits of a Home-Based Franchise Flexible work hours Quality lifestyle Doing the work of your choice Opportunity to expand using technology Self-motivation Franchising & E-Commerce Technology- Faster Customer Service Access to International Markets

Cooperatives A business owned and controlled by the people who use it – producers, consumers, or workers with similar needs who pool their resources for mutual gain Examples: Grocery stores PCC http://www.pccnaturalmarkets.com/member/governance.html Electricity Childcare Financial services Farms

Goals Summarized Sole Proprietorship Partnerships Corporations Easy to start Taxed one time Unlimited Liability Partnerships More resources than Sole Proprietorship Corporations Limited Liability Easy to get resources (compared to SP and P) Perpetual life and easy to change owners

Goals Summarized Three types of corporate mergers Leveraged Buyouts Vertical Horizontal Conglomerate Leveraged Buyouts Lots of debt to take over ownership of firm Taking a Firm Private From Public Corp to Private Corp Franchises Large Start up cost, But you have a proven product/service Cooperatives A good business form for groups of people with similar interests