© 2009 South-Western, a division of Cengage Learning 1 Chapter 6: BUSINESS FORMATION Choosing the Form that Fits

© 2009 South-Western, a division of Cengage Learning 2 CHOICES, CHOICES, CHOICES The form of ownership of a business is a big decision. Form of ownership affects: Operation Start-up Costs Profit Distribution Taxes The “Big Three” is Becoming the “Big Four”: Sole Proprietorship Partnership Corporation Limited Liability Company

© 2009 South-Western, a division of Cengage Learning 3 SOLE PROPRIETORSHIP: BUSINESS AT ITS MOST BASIC Advantages: –Ease of Formation –Retention of Control –Pride of Ownership –Retention of Profits –Possible Tax Advantages Disadvantages: –Limited Financial Resources –Unlimited Liability –Limited ability to attract and maintain talented employees –Lack of Permanence

© 2009 South-Western, a division of Cengage Learning 4 MOST COMMON TYPES OF SOLE PROPRIETORSHIPS CategoryExamplesNumber of Proprietorships (thousands) Professional, Technical, and Scientific Services Law firms, accountants, architects, computer system designers, consultants 2,752 ConstructionResidential construction, commercial construction, specialty contractors 2,491 Retail TradeCar dealerships, restaurants, clothing stores, home & garden stores 2,416 Other ServicesAutomobile repair and body shops, laundries, personal services 1,995 Health CarePhysicians, dentists, chiropractors, psychologists, psychiatrists 1,762 Source for Table: “Sole Proprietorship Returns”, by Kevin Pierce Statistics of Income Bulletin, Summer, 2005, Figure A, p.9; website: )

© 2009 South-Western, a division of Cengage Learning 5 BUSINESS FORMS: COMPARING THE NUMBERS Total Number of Businesses by Form of Ownership (Millions) Total Net Income by Form of Ownership ($Billions)

© 2009 South-Western, a division of Cengage Learning 6 PARTNERSHIPS: TWO HEADS CAN BE BETTER THAN ONE Advantages: –Pooled Financial Resources –Shared Responsibilities –Ease of Formation –Tax Advantages Disadvantages: –Unlimited Liability –Disagreements –Difficulty in withdrawing from agreement –Lack of Continuity

© 2009 South-Western, a division of Cengage Learning 7 LIMITED PARTNERSHIPS Limited Partnership – includes at least one general partner and at least one limited partner Limited Liability Partnership – All partners are actively involved but they have some form of limited liability. The amount of liability differs per state. Limited partners have limited liability.

© 2009 South-Western, a division of Cengage Learning 8 GENERAL VS LIMITED PARTNERSHIPS General Partnerships –All partners have the right to participate in the management of the firm and share in any profits/losses. Limited Partnerships –All partners contribute financially and share in the profits but the limited partner(s) cannot actively participate in management.

© 2009 South-Western, a division of Cengage Learning 9 CORPORATIONS: AN ARTIFICIAL REALITY A corporation is a legal entity, separate and distinct from its owners. Corporations are owned by stockholders. The Board of Directors establishes the mission and objectives. The Board is elected by the stockholders to represent their interests.

© 2009 South-Western, a division of Cengage Learning 10 CORPORATIONS Advantages: –Limited Liability –Permanence –Easy to Transfer Ownership –Ability to Raise Capital –Specialized Management Disadvantages: –Expense/complexity of formation and operation –Double Taxation –Paperwork and Regulation –Conflicts of Interest

Duties of the Board Provide continuity for the organization Select and appoint a chief executive Govern the organization by broad policies and objectives Acquire sufficient resources for the organization's operations Account to the public for the products and services of the organization and expenditures

Board FAQ’s The average size of boards is 16 Most boards pay members: –Stock options –Travel reimbursement –Cash stipends Directors of top 250 companies average $238,000 - $261,000 (over $1,000 per hour) Source: Steven Hall & Associates 2008 study

FAQ’s Most Boards organized into committees (i.e. compensation committee) Many Boards have term limits and evaluations of performance Boards generally meet every quarter

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© 2009 South-Western, a division of Cengage Learning 15 OTHER TYPES OF CORPORATIONS: SAME BUT DIFFERENT S Corporation Closed Corporation Non-profit Corporation

© 2009 South-Western, a division of Cengage Learning 16 COMPARING TYPES OF CORPORATIONS TYPE KEY ADVANTAGE LIMITATIONS S Corp.IRS does not tax earnings separately. Stockholders have limited liability. No more than 100 stockholders Stockholders must be US citizens or permanent residents Statutory Close Corp. Not require to have a board or hold annual meetings. Owners can participate in management while maintaining limited liability. Limited number of stockholders. Stockholders must offer shares to owner first before selling publicly Not all states allow this corporation type Nonprofit Corp. Earnings are exempt from federal and state income taxes. Members/directors have limited liability Contributions made by individuals are tax-deductible May have dues paying members but no stockholders. Can’t distribute dividends. Can’t make political donations. Must keep accurate records to document tax-exemption.

© 2009 South-Western, a division of Cengage Learning 17 LIMITED LIABILITY COMPANY: THE NEW KID ON THE BLOCK Advantages: –Limited Liability –Tax Pass-Through –Simplified Management and Operation –Flexible Ownership Disadvantages: –Franchise Taxes –Foreign Status in other States –State Law Differences –Limited to Select Industries

© 2009 South-Western, a division of Cengage Learning 18 COMPARING BUSINESS FORMS Sole Proprietorships Partnerships Corporations LOWHIGHDEGREE OF COMPLEXITY AND PERPETUITY HIGHLOWDEGREE OF PERSONAL LIABILITY

© 2009 South-Western, a division of Cengage Learning 19 CORPORATE RESTRUCTURING Corporations look for: –Growth opportunities –Operational efficiencies –Competitive advantages Mergers – two companies agree to a combination of equals. Acquisitions – when one firm buys another.

© 2009 South-Western, a division of Cengage Learning 20 TYPES OF MERGERS AND ACQUISITIONS Type of Merger DefinitionObjectiveExample HorizontalCombine firms in same industry. Increase size Increase market power Gain efficiency AT&T and SBC VerticalCombine companies with buyer-seller relationship. Provide tighter integration and increase control Time Warner and Turner Broadcasting ConglomerateCombination of unrelated companies. Increase company’s diversity. GE acquiring RCA

© 2009 South-Western, a division of Cengage Learning 21 FRANCHISING: PROVEN METHODS FOR A PRICE Not a form of ownership but an operation option. –Subway –Jiffy Lube –7-Eleven –McDonalds The franchisee uses the brand name, trademark and practices of the franchisor.

© 2009 South-Western, a division of Cengage Learning 22 FRANCHISING Advantages: –Less Risk –Training and Support –Brand Recognition –Access to Funding Disadvantages: –Costs –Lack of Control –Negative Halo Effect –Growth Challenges –Restriction on Sale –Poor Execution Ben & Jerry franchises its PartnerShops to non-profit corporations.

© 2009 South-Western, a division of Cengage Learning 23 LOOKING BACK What are the pros and cons of operating a business as a sole proprietorship? What are the basic features of general partnerships, limited partnerships, and limited liability partnerships? Why have corporations become the dominant form of business ownership? How do S corporations, statutory closed corporations and nonprofit corporations differ from general corporations, and from each other? How does a corporation restructure through mergers and acquisitions? Why have limited liability companies become increasingly popular? What are the advantages and disadvantages of franchising?