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

1. Compare the advantages and disadvantages of sole proprietorships. 2. Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships. 3. Compare the advantages and disadvantages of corporations and summarize the differences between C corporations, S corporations and limited liability companies. 4. Define and give examples of three types of corporate mergers, and explain the role of leveraged buyouts and taking a firm private. 5. Outline the advantages and disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising. 6. Explain the role of cooperatives. LEARNING GOALS Chapter Five 5-2

Basic Forms of Business Ownership Sole Proprietorship -- A business owned, and usually managed, by one person. 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. MAJOR FORMS of OWNERSHIP 5-3

FORMS of BUSINESS OWNERSHIP Basic Forms of Business Ownership 5-4

Advantages of Sole Proprietorships 1) Ease of starting and ending the business 2) Being your own boss 3) Pride of ownership 4) Leaving a legacy 5) Retention of company profit 6) No special taxes MAJOR BENEFITS of SOLE PROPRIETORSHIP LG1 5-5

Disadvantages of Sole Proprietorships 1) Unlimited Liability -- Any debts or damages incurred by the business are your debts, even if it means selling your home, car or anything else. 2) Limited financial resources 3) Management difficulties 4) Overwhelming time commitment 5) Few fringe benefits 6) Limited growth 7) Limited life span DISADVANTAGES of SOLE PROPRIETORSHIPS LG1 5-6

Partnerships General Partnership -- All owners share in operating the business and in assuming liability for the businesss debts. MAJOR TYPES of PARTNERSHIPS LG2 Limited Partnership -- A partnership with one or more general partners and one or more limited partners. 5-7

General Partner -- An owner (partner) who has unlimited liability and is active in managing the firm. Limited Partner -- An owner who invests money in the business, but enjoys limited liability. Limited Liability means that liability for the debts of the business is limited to the amount the limited partner puts into the company; personal assets are not at risk. TYPES OF PARTNERS LG2 Partnerships 5-8

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. OTHER FORMS of PARTNERSHIPS LG2 Partnerships 5-9

Advantages & Disadvantages of Partnerships More financial resources Shared management and pooled/complementary skills and knowledge Longer survival No special taxes ADVANTAGES of PARTNERSHIPS LG2 5-10

Unlimited liability Division of profits Disagreements among partners Difficult to terminate DISADVANTAGES of PARTNERSHIPS LG2 Advantages & Disadvantages of Partnerships 5-11

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? The TIES that BIND (Spotlight on Small Business) 5-12

Corporations Conventional (C) Corporation -- A state- chartered legal entity with authority to act and have liability separate from its owners (its stockholders). CONVENTIONAL CORPORATIONS LG3 5-13

Advantages of Corporations Limited liability Ability to raise more money for investment Size Perpetual life Ease of ownership change Ease of attracting talented employees Separation of ownership from management Anyone can incorporte ADVANTAGES of CORPORATIONS LG3 5-14

HOW OWNERS AFFECT MANAGEMENT LG3 Advantages of Corporations 5-15

Source: Fortune, accessed June Walmart 2. Exxon Mobil 3. Chevron 4. ConocoPhillips 5. Fannie Mae The BIG BOYS of BUSINESS Americas Largest Corporations LG3 Advantages of Corporations Photo Courtesy of: Walmart Stores 5-16

Disadvantages of Corporations Initial cost Extensive paperwork Double taxation Two tax returns Size Difficulty of termination Possible conflict with stockholders and board of directors DISADVANTAGES of CORPORATIONS LG3 5-17

S 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. Profits are taxed only as the personal income of the shareholder. Special qualifications for S Corporations S CORPORATIONS LG3 5-18

Limited Liability Companies Limited Liability Company (LLC) -- Similar to an S corporation, but without the eligibility requirements. Advantages of LLCs: Limited liability Choice of taxation Flexible ownership rules Flexible distribution of profits and losses Operating flexibility LIMITED LIABILITY COMPANIES LG3 5-19

No stock, therefore ownership is nontransferable Limited life span Fewer incentives Taxes Paperwork DISADVANTAGES of LLCs LG3 Limited Liability Companies 5-20

Vermont allows a new kind of LLC that exists only online. Registration documents can be filed online, meetings can be held through online communication, and relationships can be established electronically. Virtual companies allow online contributors with different skills, availability and interest to interact and be successful. VIRTUAL COMPANIES (Legal Briefcase) 5-21

Corporate Expansion: Mergers and Acquisitions Merger -- The result of two firms joining to form one company. MERGERS and ACQUISITIONS LG4 Acquisition -- One companys purchase of the property and obligations of another company. 5-22

Vertical Merger -- Joins two firms in different stages of related businesses. Horizontal Merger -- Joins two firms in the same industry and allows them to diversify or expand their products. Conglomerate Merger -- Unites firms in completely unrelated industries in order to diversify business operations and investments. TYPES of MERGERS LG4 Corporate Expansion: Mergers and Acquisitions 5-23

Leveraged Buyout (LBO) -- An attempt by employees, management or a group of investors to buy out the stockholders in a company. LBOs have ranged in size from $50 million to $31 billion and have involved everything from small businesses to giant corporations. In 2010, foreign investors poured $300 billion into U.S. companies. LEVERAGED BUYOUTS LG4 Corporate Expansion: Mergers and Acquisitions 5-24

Franchises 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 825,000 franchised businesses operate in the U.S., employing approximately 17.5 million people. FRANCHISING LG5 5-25

The Nationals in D.C. have the first sports stadium to earn the Leadership in Energy and Environmental Design (LEED) Rating.Nationals 95% of the stadiums steel was recycled and low- flow toilets save millions of gallons of water. PLAY BALL but PLAY GREEN (Thinking Green) New York stadiums for the Mets, Giants and Jets have also earned green certifications.Mets 5-26

Advantages of Franchises Management and marketing assistance Personal ownership Nationally recognized name Financial advice and assistance Lower failure rate ADVANTAGES of FRANCHISING LG5 5-27

Diversity 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. WOMEN in FRANCHISING LG5 More women are becoming franchisors. Auntie Annes and Jazzercise and are owned by women. Auntie Annes Jazzercise 5-28

Large start-up costs Shared profit Management regulation Coattail effects Restrictions on selling Fraudulent franchisors DISADVANTAGES of FRANCHISING LG5 Disadvantages of Franchises 5-29

Minority-Owned Franchises Home-Based Franchises eCommerce Franchising Online Franchising Global Franchising TRENDS IN FRANCHISING LG5 Disadvantages of Franchises 5-30

Many businesses use social media to communicate with potential investors and franchisees. Häagen-Dazs launched a simulation game called Ice Cream Boss on Facebook. The company hopes that players may move on to become franchisees of real Häagen-Dazs stores. FRANCHISE EXPANSION on FACEBOOK (Social Media in Business) 5-31

Source: Richard Gibson, Wall Street Journal, accessed June Focus on tried-and-true name brands. Stick to core goods and services. Be choosy about the site. Dont pinch pennies. Have a fallback choice. Dont assume the franchise will pay off. WHAT to CHOOSE? Picking Franchises that May Survive a Recession LG5 Franchising in International Markets 5-32

Cooperatives Cooperatives -- Businesses owned and controlled by the people who use them– producers, consumers, or workers with similar needs who pool their resources for mutual gain. Worldwide, 750,000 co-ops 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. COOPERATIVES LG6 5-33