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. LEARNING GOALS Chapter Five 5-2

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 5-3

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. Profile MARY ELLEN SHEETS Two Men and a Truck 5-4

Around April 15 th every year, we are a very sought out company. With thousands of locations in the U.S. we make tax filing much easier. Most people are unaware that we are actually a Canadian franchise even though we have our headquarters in the U.S. Name that company! NAME that COMPANY Chapter Five 5-5

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 5-6

FORMS of BUSINESS OWNERSHIP Basic Forms of Business Ownership 5-7

Source: Forbes, April 11, Atlanta, GA 2. Baltimore, MD 3. Nashville, TN 4. Houston, TX 5. Miami - Ft. Lauderdale, FL ETHNIC BUSINESS CENTERS Cities with the Most Minority-Run Firms Basic Forms of Business Ownership Photo Courtesy of: James Rintamaki 5-8

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 5-9

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 5-10

Progress Assessment 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? PROGRESS ASSESSMENT 5-11

Partnerships General Partnership -- All owners share in operating the business and in assuming liability for the business’s debts. MAJOR TYPES of PARTNERSHIPS LG2 Limited Partnership -- A partnership with one or more general partners and one or more limited partners. 5-12

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 5-13

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 5-14

Advantages & Disadvantages of Partnerships More financial resources Shared management and pooled/complementary skills and knowledge Longer survival No special taxes ADVANTAGES of PARTNERSHIPS LG2 5-15

Unlimited liability Division of profits Disagreements among partners Difficult to terminate DISADVANTAGES of PARTNERSHIPS LG2 Advantages & Disadvantages of Partnerships 5-16

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) 5-17

Progress Assessment What’s the difference between a limited partner and a general partner? What are some of the advantages and disadvantages of partnerships? PROGRESS ASSESSMENT 5-18

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 5-19

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 ADVANTAGES of CORPORATIONS LG3 5-20

HOW OWNERS AFFECT MANAGEMENT LG3 Advantages of Corporations 5-21

Source: Fortune, accessed June Walmart 2. Exxon Mobil 3. Chevron 4. ConocoPhillips 5. Fannie Mae The BIG BOYS of BUSINESS America’s Largest Corporations LG3 Advantages of Corporations Photo Courtesy of: Walmart Stores 5-22

Source: Forbes, accessed June PRIVACY PLEASE The Ten Largest Private Corporations in the U.S. LG3 Advantages of Corporations 5-23

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 5-24

Source: Bloomberg Businessweek, May 16, EVEN the BIG GUYS MAKE MISTAKES LG3 Disadvantages of Corporations 5-25

Individuals Can Incorporate 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. WHO CAN INCORPORATE? LG3 5-26

OLDIES BUT GOODIES America’s Oldest Corporations LG3 Individuals Can Incorporate 5-27

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. S CORPORATIONS LG3 5-28

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. WHO CAN FORM S CORPORATIONS? LG3 S Corporations 5-29

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 5-30

No stock, therefore ownership is nontransferable Limited life span Fewer incentives Taxes Paperwork DISADVANTAGES of LLCs LG3 Limited Liability Companies 5-31

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) 5-32

Progress Assessment 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? PROGRESS ASSESSMENT 5-33

Corporate Expansion: Mergers and Acquisitions Merger -- The result of two firms joining to form one company. MERGERS and ACQUISITIONS LG4 Acquisition -- One company’s purchase of the property and obligations of another company. 5-34

KEEP GROWING… Big Business‘ Acquisitions Spending LG4 Corporate Expansion: Mergers and Acquisitions Source: Bloomberg Businessweek, October 18,

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 5-36

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 5-37

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 5-38

Source: Entrepreneur, March MAKE WAY for the NEWBIES Top New Franchises LG5 Franchises 5-39

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 stadium’s 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 5-40

Advantages of Franchises Management and marketing assistance Personal ownership Nationally recognized name Financial advice and assistance Lower failure rate ADVANTAGES of FRANCHISING LG5 5-41

Large start-up costs Shared profit Management regulation Coattail effects Restrictions on selling Fraudulent franchisors DISADVANTAGES of FRANCHISING LG5 Disadvantages of Franchises 5-42

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 Anne’s and Jazzercise and are owned by women. Auntie Anne’s Jazzercise 5-43

Diversity in Franchising MinorityFran is an initiative to build awareness of franchising opportunities within minority communities.MinorityFran Domino’s Pizza launched a minority franchise recruitment program called Delivering the Dream.Domino’s Pizza Over 20% of franchises are minority-owned. MINORITY-OWNED FRANCHISES LG5 Photo Courtesy of: Tom Magliery 5-44

Home-Based Franchises Advantages: Relief from commuting stress Extra family time Low overhead expenses Main Disadvantages: Isolation Long hours HOME-BASED FRANCHISES LG5 5-45

Source: Neema P. Roshania, Kiplinger, January HOME SWEET HOME Top Home-Based Franchises LG5 Home-Based Franchises 5-46

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. E-COMMERCE in FRANCHISHING LG5 5-47

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) 5-48

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. GLOBAL FRANCHISING LG5 5-49

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. Don’t pinch pennies. Have a fallback choice. Don’t assume the franchise will pay off. WHAT to CHOOSE? Picking Franchises that May Survive a Recession LG5 Franchising in International Markets 5-50

Source: Entrepreneur, January Hampton Hotels 2. AMPM 3. McDonald’s 4. 7-Eleven 5. Supercuts 6. Days Inn 7. Vanguard Cleaning Systems 8. Servpro 9. Subway 10. Denny’s HIGH FLYERS Ten High-Performing Franchises LG5 Franchising in International Markets Photo Courtesy of: Innisfree Hotels 5-51

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 5-52

Progress Assessment What are some of the factors to consider before buying a franchise? What opportunities are available for starting a global franchise? What’s a cooperative? PROGRESS ASSESSMENT 5-53