CHAPTER 5 McGraw-Hill/Irwin Copyright © 2015 by the McGraw-Hill Companies, Inc. All rights reserved. How to Form a Business

MAJOR FORMS of OWNERSHIP 5-2 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.

5-3 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Three Basic Forms of Business Ownership Sole ProprietorshipsSole Proprietorships PartnershipsPartnerships CorporationsCorporations

5-4 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Three Basic Forms of Business Ownership Sole ProprietorshipsSole Proprietorships PartnershipsPartnerships CorporationsCorporations

5-5 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. What to Look For How they are started / endedHow they are started / ended Liability of ownersLiability of owners How owners are taxedHow owners are taxed Advantages / DisadvantagesAdvantages / Disadvantages

5-6 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Unlimited Liability -- Any debts or damages incurred by the business are the owner’s debts, even if it means selling their home, car or anything else. Limited Liability means that liability for the debts of the business is limited to the amount the owner puts into the company; personal assets are not at risk. TYPES OF LIABILITY 5-6

5-7 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. SOLE PROPRIETORSHIPS

5-8 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. SOLE PROPRIETORSHIP Owned, usually managed, by one person Most common

Source: Forbes, accessed November ETHNIC BUSINESS CENTERS Cities with the Most Minority-Run Firms 5-9 Photo Credit: James Rintamaki 1. Atlanta, GA 2. Baltimore, MD 3. Nashville, TN 4. Houston, TX 5. Miami - Ft. Lauderdale, FL

MAJOR BENEFITS of SOLE PROPRIETORSHIP 5-10 LO 4-1 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

DISADVANTAGES of SOLE PROPRIETORSHIPS 5-11 LO 4-1 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

TEST PREP 5-12 Most people who start businesses in the U.S. are sole proprietors. What are the advantages and disadvantages of sole proprietorships? Why would unlimited liability be considered a major drawback to sole proprietorships?

5-13 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. PARTNERSHIPS

5-14 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. PARTNERSHIP Two or more owners

TYPES OF PARTNERS 5-15 LO 4-2 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.

General Partnership -- All owners share in operating the business and in assuming liability for the business’s debts. MAJOR TYPES of PARTNERSHIPS 5-16 LO 4-2 Limited Partnership -- A partnership with one or more general partners and one or more limited partners.

5-17 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Types of Partnerships General GP GP GP GP Limited GP LimitedPartner LimitedPartner LimitedPartner All Partners share in operation Limited Partners do not share in operation

5-18 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. General Partnership Three key elements of any GP – –Common ownership – –Shared profits and losses – –Right to participate in managing operations

5-19 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Limited Partnership Three key elements of any LP – –Common ownership – –Shared profits and losses – –Limited partners do not participate in managing operations

OTHER FORMS of PARTNERSHIPS 5-20 LO 4-2 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.

ADVANTAGES of PARTNERSHIPS 5-21 LO 4-2 More financial resources Shared management and pooled/complement ary skills and knowledge Longer survival No special taxes

DISADVANTAGES of PARTNERSHIPS 5-22 LO 4-2 Unlimited liability Division of profits Disagreements among partners Difficult to terminate

PARTNERSHIP AGREEMENT

TEST PREP 5-24 What’s the difference between a limited partner and a general partner? What are some of the advantages and disadvantages of partnerships?

5-25 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. CORPORATIONS

5-26 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Types of Corporations  Regular “C”  “S” Corporation  Limited Liability Company

5-27 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. “C” Corporations

CONVENTIONAL CORPORATIONS 5-28 LO 4-3 Conventional (C) Corporation -- A state- chartered legal entity with authority to act and have liability separate from its owners (its stockholders).

ADVANTAGES of CORPORATIONS 5-29 LO 4-3 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

HOW OWNERS AFFECT MANAGEMENT 5-30 LO 4-3

DISADVANTAGES of CORPORATIONS 5-31 LO 4-3 Initial cost Extensive paperwork Double taxation Two tax returns Size Difficulty of termination Possible conflict with stockholders and board of directors

WHO CAN INCORPORATE? 5-32 LO 4-3 Anyone - truckers, doctors, plumbers, athletes and small business owners can incorporate. Normally stock is not issued to outsiders 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.

INCORPORATION

Source: Fortune, accessed November The BIG BOYS of BUSINESS America’s Largest Corporations 5-34 Photo Credit: Walmart Stores LO Walmart 2. Exxon Mobil 3. Chevron 4. Berkshire Hathaway 5. Apple

Source: Bloomberg Businessweek, accessed November EVEN the BIG GUYS MAKE MISTAKES 5-35 LO 4-3

Source: Forbes, accessed November PRIVACY PLEASE The Ten Largest Private Corporations in the U.S LO 4-3

OLDIES BUT GOODIES America’s Oldest Corporations 5-37 LO 4-3

S CORPORATIONS 5-38 LO 4-3 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.

WHO CAN FORM S CORPORATIONS? 5-39 LO 4-3 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.

5-40 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Limited Liability Companies

5-41 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Limited Liability Companies Similar to “S” corporation without special eligibility requirementsSimilar to “S” corporation without special eligibility requirements May be taxed as partnership or corporationMay be taxed as partnership or corporation Uniform Limited Liability Company Act provides uniform legislation regarding limited liability companiesUniform Limited Liability Company Act provides uniform legislation regarding limited liability companies

ADVANTAGES of LLCs 5-42 LO Limited liability 2. Choice of taxation 3. Flexible ownership rules 4. Flexible distribution of profits and losses 5. Operating flexibility

DISADVANTAGES of LLCs No stock, therefore ownership is nontransferable 2. Limited life span 3. Fewer incentives 4. Taxes 5. Paperwork

FORMS of BUSINESS OWNERSHIP 5-44

TEST PREP 5-45 What are the major advantages and disadvantages of incorporating a business? What’s the role of owners (stockholders) in the corporate hierarchy? If you buy stock in a corporation and someone gets injured by one of the corporation’s products, can you be sued? Why or why not? Why are so many new businesses choosing a limited liability company (LLC) form of ownership?

5-46 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Mergers and Acquisitions

Merger -- The result of two firms joining to form one company. MERGERS and ACQUISITIONS 5-47 LO 4-4 Acquisition -- One company’s purchase of the property and obligations of another company.

TYPES of MERGERS 5-48 LO 4-4 Vertical Merger -- The joining of two firms in different stages of related businesses. Horizontal Merger -- The joining of two firms in the same. Conglomerate Merger -- The joining of firms in completely unrelated industries.

5-49 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Leveraged Buyout

LEVERAGED BUYOUTS 5-50 LO 4-4 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 $34 billion and have involved everything from small businesses to giant corporations. In 2012, foreign investors poured $166 billion into U.S. companies.

5-51 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Leveraged Buyout Individual + Loan= Purchase of Company Purchase Loan:Company = Collateral

5-52 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. America’s Oldest Companies J. E. Rhoads & Sons1702 Conveyer Belts Covenant Life Ins Insurance Philadelphia Contributorship 1752 Insurance Dexter1767 Adhesives & Coatings D. Landreth Seed1784 Seeds Bank of New York1784 Banking

5-53 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. FRANCHISES

5-54 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Franchise System 1. 1.Franchise Agreement 2. 2.Franchisor 3. 3.Franchisee

5-55 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Franchise System Franchise Agreement An agreement between a firm (franchisor) and another party (franchisee) in which the firm provides the other party with the right to use the firm's name and to sell or rent its products.

5-56 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Franchisor Assigns Territory May Provide Financial Aid/Advice Offers Merchandise/ Supplies at Competitive Price Provides Training/Support Business Expansion Using O.P.M.

5-57 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Franchisee Pays Up-Front Costs Makes Monthly Payment to Franchisor Runs Business by Franchisor’s Rules/Procedures Buys Materials from Franchisor/ Approved Supplier

Source: Entrepreneur, accessed November MAKE WAY for the NEWBIES Top New Franchises 5-58 LO 4-5

ADVANTAGES of FRANCHISING 5-59 LO Management and marketing assistance 2. Personal ownership 3. Nationally recognized name 4. Financial advice and assistance 5. Lower failure rate

DISADVANTAGES of FRANCHISING 5-60 LO Large start-up costs 2. Shared profit 3. Management regulation 4. Coattail effects 5. Restrictions on selling 6. Fraudulent franchisors

5-61 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Cost of Fast-Food Franchise Company Initial Fee Royalty Burger King $50,0008.5% McDonald’s$45,0008% Wendy’s$25,0008% Domino’sNone8.5% Subway$15, % Krispy Kreme $40,0005.5%

Women own about half of U.S. companies, yet ownership of franchises is about 21%. WOMEN in FRANCHISING 5-62 LO 4-5 More women are becoming franchisors. Auntie Anne’s and Jazzercise and are owned by women.Auntie Anne’s Jazzercise

E-COMMERCE in FRANCHISHING 5-63 LO 4-5 Most brick-and-mortar franchises have expanded online. 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.

FRANCHISING 5-64 SUBWAY The initial franchise fee is $15,000. If qualified to purchase additional locations, the franchise fee is $7,500. What is the term of a SUBWAY® franchise? The $15,000 franchise fee purchases a franchise honored for twenty years.

FRANCHISING 5-65 McDONALD’S Most McDonald's owner/operators have entered the corporation by purchasing an existing restaurant. To open a McDonald's franchise, however, requires a total investment of $1.06 million-$1.9 million, with liquid capital available of $500,000. The franchise fee is $45,000.

GIVING ENTREPRENEURS OPTIONS with DIGITAL FRANCHISING 5-66 Chris Jeffrey created OrderUp shortly after graduating college. OrderUp links up restaurants with hungry patrons and allows people to order online while OrderUp takes a small commission. For a startup fee of $42,000 franchisees receive software and training to launch OrderUp in their area.

Source: Richard Gibson, Wall Street Journal, accessed November WHAT to CHOOSE? Picking Franchises that May Survive a Recession 5-67 Focus on tried-and-true name brands. Stick to core goods and services. Be choosy about the site. Don’t pinch pennies. Have a fallback choice. Don’t assume the franchise will pay off.

Source: Richard Gibson, Wall Street Journal, accessed November WHAT to CHOOSE? How to Avoid a Franchise Lemon 5-68 Research officers & their business experience Get summary of any bankruptcy & litigation Estimate all costs to set up franchise Review franchise contract & three most recent financial statements

Source: Entrepreneur, accessed November HIGH FLYERS Ten High-Performing Franchises 5-69 Photo Credit: Innisfree Hotels LO Anytime Fitness 2. Hampton Hotels 3. Subway 4. Supercuts 5. Jimmy John’s 6. 7-Eleven 7. Servpro 8. Denny’s 9. Pizza Hut 10. Dunkin Donuts

5-70 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. Franchise Information Franchise.com FranchiseLife.com FranchiseSolutions.com FranchiseAdvantage.com BizBuySell.com FranchiseAmerica.com Franchise-Zone.com International Franchise Association

FRANCHISING 5-71 About

5-72 McGraw-Hill/Irwin Understanding Business, 7/e © 2005 The McGraw-Hill Companies, Inc., All Rights Reserved. CO-OPERATIVES

COOPERATIVES 5-73 LO 4-6 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, co-ops serve one billion members! Members democratically control the business by electing a board of directors that hires professional management.

TEST PREP 5-74 What are some of the factors to consider before buying a franchise? What opportunities are available for starting a global franchise? What is a cooperative?