Introduction to Business Dr. H. Ronald Moser Cumberland University McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

How to Form a Business Chapter 05 McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

MARY ELLEN SHEETS Two Men and a Truck PROFILE Bought an old truck and placed an ad in the local paper stating, “Two Men and a Truck.” Wanted her sons to have work during summer vacation. Now they earn $193.3 million annually. Expanded through franchising and are branching out to the UK. 5-3

Major Forms of Ownership BASIC FORMS OF BUSINESS OWNERSHIP Sole Proprietorship – Is a business with one owner who assumes unlimited liability. Sole proprietorships have single owners, or husband and wife teams It is the most common form of business ownership. Sole proprietorship are usually smaller then corporations. Partnership -- Two or more people legally agree to become co-owners of a business. Corporation -- A legal entity with authority to act and have liability apart from its owners. Typically a large firm where the officers are appointed by the board of director. See Learning Goal 1: Compare the advantages and disadvantages of sole proprietorships. 5-4 4

BASIC FORMS OF BUSINESS OWNERSHIP See Learning Goal 1: Compare the advantages and disadvantages of sole proprietorships. Although corporations make up only 20 percent of the total number of businesses, they make 81 percent of the total receipts. Sole proprietorships are the most common form (72 percent), but they earn only 6 percent of the receipts. Although corporations make up only 20% of the total number of business, they make 81% of the total receipts. Sole proprietorships are the most common form (72%), but they earn only 6% of the receipts. 5-5 5

Advantages of Sole Proprietorships Ease of starting and ending the business Being your own boss Pride of ownership Leaving a legacy Retention of company profit No special taxes See Learning Goal 1: Compare the advantages and disadvantages of sole proprietorships. This slide helps students understand why sole proprietorships account for the largest number of businesses in the United States. 5-6

Disadvantage of Sole Proprietorships Unlimited Liability -- Any debts or damages incurred by the business are your debts, even if it means selling your home, car or anything else. Limited financial resources - limited to what the one owner can gather. Management difficulties –Check out the Small business Administration. Overwhelming time commitment – 12 hours day at least six days a week. Few fringe benefits – There are none. Limited growth Limited life span – Retirement will come someday. See Learning Goal 1: Compare the advantages and disadvantages of sole proprietorships. Since the main advantage of sole proprietorships is the ease by which they can be started this slide gives students the reason why this form of ownership only accounts for such a small percentage of overall total revenue. 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). 5-7 7

Major types of Partnerships General Partnership -- All owners share in operating the business and in assuming liability for the business’s debts. Limited Partnership -- A partnership with one or more general partners and one or more limited partners. The limited partnership is an owner who invests money in the business but does not have any management responsibility or liability for losses beyond this or her investment. See Learning Goal 2: Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships. Each type of partnership has advantages and disadvantages. In a general partnership resources are pooled and liability is spread among all partners. However in this type of partnership there is the possibility for disagreement and/or personality conflicts. A limited partnership is made up of a mixture of general partners and limited partners. Limited partners cannot actively take part in business dealings. 5-8 8

Major types of Partnerships Limited Partnership – Greg’s band wants to form a partnership. General partners will include the drummer, two guitarists, one keyboardist, and one singer. Greg’s great-uncle, a musician in his own right plans to provide $30,000, but does not plan to participate in the gigs, only in the profits. The band will form a limited partnership. A Limited Partnership has one or more general partners and one or more limited partners. The general partners assume limited liability, while the limited partner is only liable for the money he/she invests in the business. The limited partner cannot be an active participant in the business, but may share in the profits. See Learning Goal 2: Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships. Each type of partnership has advantages and disadvantages. In a general partnership resources are pooled and liability is spread among all partners. However in this type of partnership there is the possibility for disagreement and/or personality conflicts. A limited partnership is made up of a mixture of general partners and limited partners. Limited partners cannot actively take part in business dealings. 5-9 9

Other Forms of Partnerships Master Limited Partnership -- A partnership that looks much like a corporation but is taxed like a partnership and thus avoids the corporate income tax. Limited Liability Partnership -- Limits partners’ risk of losing their personal assets to the outcomes of only their own acts and omissions and those of people under their supervision. See Learning Goal 2: Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships. There are two less common forms of partnerships outlined in this slide: master limited partnership and the limited liability partnership. The master limited partnership is unique because it combines the tax benefits of a more traditional partnership and the liquidity of a publicly traded security. One example of a master limited partnership is Kinder Morgan Energy Partners which is engaged in energy storage and operates 26,000 miles of pipelines. 5-10 10

Advantages of Partnerships More financial resources – When two or more people pool their money and credit, it is easier to pay the rent, utilities, and other bills incurred in the business. Shared management and pooled skills and knowledge – two heads are better than one. Longer survival – Partnerships are four times likely to succeed as a sole proprietorships. No special taxes – All profits are taxed as personal income. See Learning Goal 2: Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships. Partnerships have some distinct advantages. The key advantage is that partnerships have access to more resources such as financial, management and knowledge. 5-11 11

Disadvantage of Partnerships Unlimited liability – Each general partner is liable for the debts of the firm, no matter who was responsible for causing them. Division of profits – Sharing risk means sharing profits, and that can cause conflicts. There is no set system for dividing profits in a partnership, and they are not always divided evenly. Difficult to terminate – How do you get rid of a partner you don’t like. Disagreements among partners – Who has final authority over employees and who hire employees? Who works what hours? See Learning Goal 2: Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships. Like the sole proprietorship, a partnership has some serious disadvantages such as unlimited liability and division of profits. One disadvantage that students might not consider is disagreement among partners. 5-12 12

Pick Your Partner Wisely (Spotlight on Small Business) PARTNERSHIPS Pick Your Partner Wisely (Spotlight on Small Business) There is no such thing as a perfect partner but ask these questions when you try to find your best match: Do you share the same goals? Do you share the same vision for the company? What skills does he/she have? Are yours the same? What can he/she bring to the business? What type of decision maker is he/she? Do you trust each other? How does he/she problem solve? See Learning Goal 2: Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships. Successful partnerships start with a shared vision. In order to develop a successful partnership all partners must be honest with each other and bring a variety of different skills to the partnership. 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.) 5-13 13

Conventional Corporation CORPORATIONS Conventional (C) corporation -- A state-chartered legal entity with authority to act and have liability separate from its owners (its stockholders). Burton Baskin and Irvine Robbins ran their ice cream businesses separately for two years. Once they had succeeded apart, Baskin and Robbins became partners and were able to avoid many of the pitfalls of starting a new business from scratch. They flipped a coin to see whose name would come first. What factors besides the partners’ individual success do you think contributed to their long-lasting partnership? See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies. 5-14 14

Advantages of Corporations Limited liability – Means that the owners of a business are responsible for its losses only up to the amount they invest in it. Ability to raise more money for investment – To raise money, a corporation can sell shares of tock to anyone who is interested. Size – Is bigger better. More people mean more benefits the company is going to have to pay. Perpetual life – The death of one or more owner does not terminate the corporation. See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies. Identify that 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 about $50 to over $300, plus states fees. Over half of Fortune 500 companies choose to incorporate in Delaware because the state’s laws makes the process easier than it is in other states. “Continued” 5-15 15

Advantages of Corporations Ease of ownership change – It is easy to change the ownership of a corporation. Ease of attracting talented employees – Corporations can attract skilled employees by offering such benefits as stock options (the right to purchases shares of the corporation for a fixed price). Separation of ownership from management is most likely to occur in a corporation. A Corporation’s organization structure distinctly separates ownership form management. In large corporations, the stockholders (owners) elect the Board of Directors, The Board of Directors appoints the officers and/or management. Moser's See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies. Identify that 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 about $50 to over $300, plus states fees. Over half of Fortune 500 companies choose to incorporate in Delaware because the state’s laws makes the process easier than it is in other states. 5-16 16

Advantages of Corporations Jim and Sherry run Lawns for Less, inc,. A commercial lawn cutting services. The couple supplements their income with the rentals from a few apartment buildings that they own. The incorporated the lawn care business in order to keep it separate from their other income. As a C-corporation, if the business should fail, the couple would lose only the funds they originally invested in their company See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies. Identify that 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 about $50 to over $300, plus states fees. Over half of Fortune 500 companies choose to incorporate in Delaware because the state’s laws makes the process easier than it is in other states. By forming a corporation, Lawns for Less protects the personal assets of the owner. Corporation are costly to form but provide the owners/stockholders with limited liability. They are only liable for any funds, they have invested in the business. 5-17 17

How Owners Affect Management CORPORATIONS Owners have an influence on how business is managed by electing a board of directors. The board hires the top officers (and fires them it necessary). It also set the pay for those officers. The officers then select managers and employees with the help of the human resources department. See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies. 5-18 18

The Big Boys of Business America’s Largest Corporations Walmart Exxon Mobil Chevron ConocoPhillips Fannie Mae 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 Fortune’s 2008 top 10 U.S. corporations. Ask the students: Several of the companies in the top ten deal with similar products/services. How are the products/services these companies sell similar? (Exxon Mobil, Chevron, ConocoPhillips are all oil majors and Valero Energy is a processor of oil.) Source: Fortune, www.fortune.com, April 2009. 5-19 19

Disadvantages of Corporations Initial cost – Incorporation may cost thousands of dollars and require expensive lawyers and accountants. Extensive paperwork – A corporations must keep detailed financial records, the minutes of meeting, and more. Double taxation – When dividends are taxed after the corporation has already paid taxed on their profits. Two tax returns – An individual who incorporates must file both a corporate tax return and an individual tax return. “Continued” See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies. Double taxation is a major disadvantage of corporations. A corporation is taxed on income earned and then shareholders are taxed on any dividends the company may pay. 20

Disadvantages of Corporations Size – Large corporations sometimes become too inflexible and tied down in red tape to respond quickly to market changes, and their profitability can suffer. Difficulty of termination – Once a corporation has started, it’s relatively hard to end. Possible conflict with stockholders and board of directors – Conflict may brew it the stockholders elect a board of directors who disagree with management. See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies. Double taxation is a major disadvantage of corporations. A corporation is taxed on income earned and then shareholders are taxed on any dividends the company may pay. 21

Major advantages are limited liability and possible tax benefits. Individuals Can Incorporate CORPORATIONS Who Can Incorporate? Anyone - truckers, doctors, plumbers, athletes and small business owners can incorporate. Normally stock is not issued when individuals incorporate, so the advantages and disadvantages are not exactly the same as for large corporations. Major advantages are limited liability and possible tax benefits. See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies. 5-22 22

Profits are taxed only as the personal income of the shareholder. S Corporation CORPORATIONS S Corporation -- A unique government creation that looks like a corporation but is taxed like sole proprietorships and partnerships. S corporations have shareholders, directors and employees, plus the benefit of limited liability. Avoiding double taxation is reason enough for approximately 3 million U.S. companies to operate as S corporations. Profits are taxed only as the personal income of the shareholder. See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies. 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. 5-23 23

Who Can Form S Corporations Qualifications for S Corporations: Have no more than 100 shareholders. Have shareholders that are individuals or estates and are citizens or permanent residents of the U.S. Have only one class of stock. Derive no more than 25% of income from passive sources. If an S corporation loses its S status, it may not operate under it again for at least 5 years. United States “We only sell common stock” See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies. Originally to qualify as an S Corporation the number of shareholders was limited to 75; this has now been amended to no more than 100. 5-24 24

Limited Liability Companies CORPORATIONS Limited Liability Company (LLC) -- Similar to a S corporation but without the eligibility requirements. One reason limited liability companies have become so popular is that they can be taxed either as a corporation or a as a partnership. Owners can choose the tax treatment that is most advantageous for their situation. Limited liability – Personal assets are protected. Choice of taxation – LLC can choose to be taxed as partnership or a corporations. Flexible ownership rules – Owners can be a person, partnership or corporation. Flexible distribution of profit and losses Operating flexibility – LLC’s do have to submit articles of organization, but they are not required to keep minutes, file written resolutions, or hold annual meetings. Advantage of LLCs: See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies. Advantages and disadvantages of LLCs are listed in this slide. The biggest advantages that should be pointed out with LLCs are limited liability and flexibility. 5-25 25

No stock, therefore ownership is nontransferable. Limited life span. CORPORATIONS Limited Liability Companies Disadvantages of a Limited Liability Company (LLC) No stock, therefore ownership is nontransferable. Limited life span. Fewer incentives. Taxes – LLC members must pay self- employment taxes. Paperwork – While the paperwork required of LLCs is not as great as that required pf corporations, it is more than required of sole proprietors. See Learning Goal 3: Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies. Primary disadvantages from entrepreneurs perspectives would be limited life span and paperwork. 5-26 26

Mergers and Acquisitions CORPORATIONS EXPANSION: MERGERS AND ACQUISITIONS Mergers and Acquisitions Merger -- The result of two firms joining to form one company. When one firm buys the assets and liabilities of another firm. Acquisition -- One company’s purchase of the property and obligations of another company. See Learning Goal 4: Describe three types of corporate mergers, and explain the role of leveraged buyouts and taking a firm private. 5-27 27

CORPORATIONS EXPANSION: MERGERS AND ACQUISITIONS Types of Mergers Vertical Merger -- Joins two firms in different stages of related business. A merger between a soft drink company and an artificial sweetener maker Horizontal Merger -- Joins two firms in the same industry and allows them to diversify or expand their products. A soft drink company and a mineral water company that merge can now supply a variety of drinking products. Conglomerate Merger -- Unites firms in completely unrelated industries in order to diversify business operations and investments. See Learning Goal 4: Describe three types of corporate mergers, and explain the role of leveraged buyouts and taking a firm private. There are three types of mergers. Horizontal mergers take 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 in the 1990s. 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, both Tyco and General Electric operate as conglomerates. 5-28 28

CORPORATIONS EXPANSION: MERGERS AND ACQUISITIONS Types of Mergers Horizontal Merger – Trans Globe Airlines recently merged with Royal Blue Airlines, a financially troubled rival. The firms’ management believes the merger will create a stronger company that can offer travelers more flights to a wider variety of destinations. This proposed merger is an example of a Horizontal Merger. See Learning Goal 4: Describe three types of corporate mergers, and explain the role of leveraged buyouts and taking a firm private. There are three types of mergers. Horizontal mergers take 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 in the 1990s. 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, both Tyco and General Electric operate as conglomerates. 5-29 29

CORPORATIONS EXPANSION: MERGERS AND ACQUISITIONS Leveraged Buyouts Leveraged Buyout (LBO) -- An attempt by employees, management or other investors attempt to use borrowed funds to buy out the firm’s stockholders. Leveraged Buyout (LBO) have ranged in size from $50 million to $31 billion and have involved everything from small businesses to giant corporations. In 2007, foreign investors poured $414 billion into U.S. companies. See Learning Goal 4: Describe three types of corporate mergers, and explain the role of leveraged buyouts and taking a firm private. Moser’s Great! 5-30 30

FRANCHISING Franchise Agreement -- An arrangement whereby someone with a good idea for a business (franchisor) sells the rights to use the business name and sell a product or service (franchise) to others (franchisees) in a given territory. More than 900,000 franchised businesses operate in the U.S., employing approximately 10 million people. See Learning Goal 5: Outline the advantages and disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising. 5-31 31

FRANCHISING Franchise Agreement – Midas Muffler sells franchises to prospective business persons who want to use the Midas name and offer Midas products. In a franchise arrangement, Midas would be the franchisor, and the buyer of the franchise is the franchisee. See Learning Goal 5: Outline the advantages and disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising. 5-32 32

FRANCHISING Radio Shack Contractual System As a franchisor, Radio Shack would assist a franchisee in: Selecting the store location. Setting up the store. Advertising. Training Personnel. See Learning Goal 5: Outline the advantages and disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising. 5-33 33

Advantages of Franchising Management and marketing assistance. Personal ownership. Nationally recognized name. Financial advice and assistance. Lower failure rate. See Learning Goal 5: Outline the advantages and disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising. Franchising has a lower failure rate because the franchisee has support from the franchisor. This support can range from marketing to financial. An evaluation of franchising would conclude that this type of arrangement appeals to people who want to own a business, but are not comfortable starting a company from scratch. 5-34 34

Using Technology in Franchising Franchisors often use technology to meet the needs of both their customers and their franchisees. For example, U.S. Web Corporation set up it Web site to streamline communication for it employees, customers, and vendors. It built a computer network to allow communication among its 50 franchisee, almost eliminating paperwork. See Learning Goal 5: Outline the advantages and disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising. 5-35 35

Disadvantages of Franchising Large start-up costs. Shared profit. Management regulation. Coattail effects. Restrictions on selling. Fraudulent franchisors. See Learning Goal 5: Outline the advantages and disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising. 5-36 36

Firms owned by women have grown at twice the rate of all companies. FRANCHISING Diversity in Franchising Women in Franchising Women own about half of U.S. companies, yet ownership of franchises is about 25%. Firms owned by women have grown at twice the rate of all companies. More women are becoming franchisors. Auntie Anne’s and Jazzercise and are owned by women. See Learning Goal 5: Outline the advantages and disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising. 5-37

Over 20% of franchises are minority-owned. FRANCHISING Diversity in Franchising Minority-Owned Franchises MinorityFran is an initiative to build awareness of franchising opportunities within minority communities. Domino’s Pizza launched a minority franchise recruitment program called Delivering the Dream. Over 20% of franchises are minority-owned. See Learning Goal 5: Outline the advantages and disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising. Photo Courtesy of: Tom Magliery 5-38

Home-Based Franchises FRANCHISING Advantages: Relief from commuting stress Extra family time Low overhead expenses Main Disadvantages: Isolation Long hours See Learning Goal 5: Outline the advantages and disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising. Benefits of a Home-Based Franchise Home-based businesses are growing at an enormous rate. This slide helps clarify some of the reasons why. Share with the class some tips on getting started: Decide on business idea Set goals for the business How many hours do you want to work? How many employees do you want? How much money will you need to get started? Visit www.e-myth.com for more online information regarding start-ups. 5-39

E-Commerce in Franchising Most brick-and-mortar franchises have expanded to the Internet. Many franchisors prohibit franchisee- sponsored sites because conflicts can erupt. Sometimes “reverse royalties” are sent to franchisees who believe their sales were hurt by the franchisor’s site. Other franchises are solely based online. “I have had enough.” See Learning Goal 5: Outline the advantages and disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising. 5-40

Franchising in International Markets Global Franchising Franchising in International Markets Canada is the most popular target for U.S.- based franchises. China, South Africa, the Philippines and the Middle East are becoming popular despite high cost. Franchising is successful when the product is convenient, high quality, great service is included and the franchisee adapts to the region. International franchising goes both ways – some foreign franchises have come to the U.S. Canada China See Learning Goal 5: Outline the advantages and disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising. 5-41

Franchising in International Markets Business Qualifications Sought by McDonald’s for Potential Franchisees Can you count money? Experience Financial resources Growth capability Strong credit Ideal Franchisee Planning ability Customer and employee focus Ability to manage finances Willingness to complete training See Learning Goal 5: Outline the advantages and disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising. Zeal, determination and an understanding wife/husband. If you were activity in sports in high school or college—put that on your vita. Full-time commitment General Patton-”O how I love it so.” 5-42 42

COOPERATIVE Cooperatives -- Businesses owned and controlled by the people who use it – producers, consumers, or workers with similar needs who pool their resources for mutual gain. Worldwide, 750,000 cooperatives serve 730 million members – 120 million in the U.S. Members democratically control the business by electing a board of directors that hires professional management. See Learning Goal 6: Explain the role of cooperatives. United States 5-43 43

A retail firm owned by its customer members is a consumer cooperative. The growth of consumer cooperatives has developed because existing retail institution are inadequately fulfilling market needs. The growth of consumer cooperatives has been limited due to required consume/member initiative and drive. See Learning Goal 6: Explain the role of cooperatives. “My vote is for the Consumer Cooperative.” 5-44 44

The End! See Learning Goal 6: Discuss the changing landscape of the global market and the issue of offshore outsourcing. 3-45 45