Business Chapter 5: How to Form a Business

Corporations₂

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. Disadvantages of Corporations: • Initial cost. • Extensive paperwork. • Double taxation. • Two tax returns. • Size. • Difficulty of termination. • Possible conflict with stockholders and board of directors.

Franchises₂

Advantages of Franchises: 1. Management and marketing assistance. 2. Personal ownership. 3. Nationally recognized name. 4. Financial advice and assistance. 5. Lower failure rate. Disadvantages of Franchises 1. Large start-up costs. 2. Shared profit. 3. Management regulation. 4. Coattail effects. 5. Restrictions on selling. 6. Fraudulent franchisors.

Partnerships₄

Advantages of Partnerships: • More financial resources. • Shared management and pooled/complementary skills and knowledge. • Longer survival. • No special taxes. Disadvantages of Partnerships • Unlimited liability. • Division of profits. • Disagreements among partners. • Difficulty of termination.

Sole Proprietorships

Advantages: 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 profits. 6. No special taxes. Disadvantages: 1. Unlimited liability — The responsibility of business owners for all debts of the business. 2. Limited financial resources. 3. Management difficulties. 4. Overwhelming time commitment. 5. Few fringe benefits. 6. Limited growth. 7. Limited life span.

Figure 5.1 Forms of Business Ownership

Although corporations make up only 20 percent of the total number of businesses, they earn 81 percent of the total receipts. Sole proprietorships are the most common form (72 percent), but they earn only 6 percent of the receipts.

Corporations₁

Conventional (C) Corporation • A state-chartered legal entity with authority to act and have liability separate from its owners (its stockholders). • Enables many people to share in ownership.

Cooperatives

Cooperative (Co-Op) • A business owned and controlled by the people who use it—producers, consumers, or workers with similar needs who pool their resources for mutual gain. • Serve one billion members worldwide. • Members democratically control the business by electing a board of directors that hires professional management. • Other cooperatives are formed to give members more economic power as a group than they have as individuals, such as a farm cooperative.

Franchises₃

Diversity in Franchising • Women own about half of U.S. companies, yet ownership of franchises is about 35 percent. • More women are becoming franchisors, such as those who started Auntie Anne's, Decorating Den, and Build-a-Bear Workshops. • Minorities own less than 19 percent of businesses, yet over 30 percent of franchises are minority-owned. • DiversityFran and Federal Minority Business Development Agency build awareness of franchising opportunities within minority communities and provide training and support.

Franchises₅

E-commerce in Franchising • 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.

Franchises₁

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. • Can be formed as a sole proprietorship, a partnership, or a corporation. • More than 733,000 franchised businesses operate in the U.S., creating 7.6 million jobs.

Franchises₇

Franchising in Global Markets • Even smaller franchises are going global. • Canada is the most popular target for U.S.-based franchises, but so is China, South Africa, the Philippines, and the Middle East. • They offer the same advantages as in the U.S.: convenience and a predictable level of service and quality. • Adapting products and brand names to different countries creates challenges. • Foreign franchises also come to the U.S.

Franchises₄

Home-Based Franchises • Advantages: • Relief from commuting stress. • Extra family time. • Low overhead expenses. • Disadvantages: • Isolation. • Long hours.

Corporations₃

Individuals Can Incorporate • Anyone—truckers, doctors, plumbers, athletes, and small business owners—can incorporate. • Stock is normally not issued to outsiders when individuals incorporate, so they do not share the advantages and disadvantages of large corporations. • Major advantages are limited liability and possible tax benefits.

Corporations₅

Limited Liability Companies • LLCs are similar to an S corporation but without the special eligibility requirements. • Advantages of LLCs: 1. Limited liability. 2. Choice of taxation. 3. Flexible ownership rules. 4. Flexible distribution of profits and losses. 5. Operating flexibility. • Disadvantages of LLCs: 1. No stock; ownership is nontransferable. 2. Fewer incentives. 3. Taxes. 4. Paperwork.

Partnerships₁

Major Types of Partnerships • General partnership — A partnership in which 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.

Partnerships₃

Other Forms of Partnerships • Master limited partnership (MLP) — A partnership that looks much like a corporation (in that it acts like a corporation and is traded on a stock exchange) but is taxed like a partnership and thus avoids the corporate income tax. • Limited liability partnership (LLP) — A partnership that limits partners' risk of losing their personal assets to only their own acts and omissions and to the acts and omissions of people under their supervision.

Corporate Expansion: Mergers and Acquisitions₃

Other Types of Expansion • Take a firm private — Management or a group of stockholders take control by obtaining all the firm's stock. • Leveraged buyout (LBO) — An attempt by employees, management, or a group of private investors to buy out the stockholders in a company. • Range in size from $50 million to $34 billion and involve everything from small family businesses to giant corporations. • Business acquisitions are not limited to U.S. buyers.

Figure 5.5 How Owners Affect Management

Owners have an influence on how a business is managed by electing a board of directors. The board hires the top officers (and fires them if necessary). It also sets the pay for those officers. The officers then select managers and employees with the help of the human resource department.

Corporations₄

S Corporations • A unique government creation that looks like a corporation but is taxed like sole proprietorships and partnerships. • Have shareholders, directors, and employees, plus the benefit of limited liability. • Profits are taxed only as the personal income of the shareholders. • If an S corporation loses its S status, it may not operate under it again for at least 5 years.

Basic Forms of Business Ownership

Three Major Forms • Sole proprietorship — A business owned, and usually managed, by one person. • Partnership — A legal form of business with two or more owners. • Corporation — A legal entity with authority to act and have liability separate from its owners.

Corporate Expansion: Mergers and Acquisitions₁

Types of Expansion • Merger — The result of two firms forming one company. • Acquisition — One company's purchase of the property and obligations of another company.

Corporate Expansion: Mergers and Acquisitions₂

Types of Mergers • Vertical merger — The joining of two companies in different stages of related businesses. • Horizontal merger — The joining of two firms in the same industry. • Mergers between competitors must prove to the Federal Trade Commission (FTC) that the new combined company does not limit competition unfairly. • Conglomerate merger — The joining of firms in completely unrelated industries.

Partnerships₂

Types of Partners • 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 does not have any management responsibility or liability for losses beyond the investment. • Limited liability — The responsibility of a business's owners for losses only up to the amount they invest; limited partners and shareholders have limited liability.

Franchises₆

Using Technology in Franchising • Franchisors use technology, including social media, to: • Extend their brands. • Meet the needs of both customers and their franchisees.

Figure 5.4 Corporate Types

You may find some confusing types of corporations when reading about them. Here are a few of the more widely used terms: Alien corporations do business in the United States but are chartered (incorporated) in another country. Domestic corporations do business in the state in which they are chartered (incorporated). Foreign corporations do business in one state but are chartered in another. About one-third of all corporations are chartered in Delaware because of its relatively attractive rules for incorporation. A foreign corporation must register in states where it operates. Closed (private) corporations have stock that is held by a few people and isn't available to the general public. Open (public) corporations sell stock to the general public. Quasi-public corporations are chartered by the government as an approved monopoly to perform services to the general public. Professional corporations are owned by those who offer professional services. Nonprofit (or not-for-profit) corporations don't seek personal profit for their owners.