Chap005

*

*Chapter Five

How to Form a Business

Copyright © 2010 by the McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

*

*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

LG1

5-2

*

*Basic Forms of Business Ownership

LG1

FORMS of BUSINESS OWNERSHIP

5-3

*

*Advantages of Sole Proprietorships

• Ease of starting and ending the business

• Being your own boss

• Pride of ownership

• Leaving a legacy

• Retention of company profit

• No special taxes

MAJOR BENEFITS of SOLE PROPRIETORSHIP

LG1

5-4

*

*Disadvantages of Sole Proprietorships

• Unlimited Liability -- Any debts or damages incurred by the business are your debts, even if it means selling your home, car or anything else.

• Limited financial resources

• Management difficulties

• Overwhelming time commitment

• Few fringe benefits

• Limited growth

• Limited life span

DISADVANTAGES of SOLE PROPRIETORSHIPS

LG1

5-5

*

*Partnerships

• General Partnership -- 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.

MAJOR TYPES of PARTNERSHIPSLG2

5-6

*

*Partnerships

• 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

5-7

*

*Partnerships

• 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 PARTNERSLG2

5-8

*

*Advantages & Disadvantages of Partnerships

• More financial resources

• Shared management and pooled skills and knowledge

• Longer survival

• No special taxes

ADVANTAGES of PARTNERSHIPS

LG2

5-9

*

*Advantages & Disadvantages of Partnerships

• Unlimited liability

• Division of profits

• Difficult to terminate

• Disagreements among partners

DISADVANTAGES of PARTNERSHIPS

LG2

5-10

*

*

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?

PICK YOUR PARTNER WISELY(Spotlight on Small Business)

5-11

*

*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

5-12

*

*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

5-13

*

*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

5-14

*

*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

5-15

*

*S Corporations

• 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

5-16

*

*Limited Liability Companies

• Limited Liability Company (LLC) -- Similar to a S corporation but without the eligibility requirements.

• Advantages of LLCs:- Limited liability- Choice of taxation- Flexible ownership rules- Flexible distribution of profit and losses- Operating flexibility

LIMITED LIABILITY COMPANIES

LG3

5-17

*

*Limited Liability Companies

• No stock, therefore ownership is nontransferable

• Limited life span

• Fewer incentives

• Taxes

• Paperwork

DISADVANTAGES

of

LLCs

LG3

5-18

*

*Corporate Expansion: Mergers and Acquisitions

• Merger -- The result of two firms joining to form one company.

• Acquisition -- One company’s purchase of the property and obligations of another company.

MERGERS and AQUISITIONS

LG4

5-19

*


• Vertical Merger -- Joins two firms in different stages of related business.

• 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

5-20

*


• 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 2007, foreign investors poured $414 billion into U.S. companies.

LEVERAGED BUYOUTS

LG4

5-21

*

*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 900,000 franchised businesses operate in the U.S., employing approximately 10 million people.

FRANCHISING

LG5

5-22

*

*Advantages & Disadvantages of Franchises

• Management and marketing assistance

• Personal ownership

• Nationally recognized name

• Financial advice and assistance

• Lower failure rate

ADVANTAGES of FRANCHISING

LG5

5-23

*

*Advantages & Disadvantages of Franchises

• Large start-up costs

• Shared profit

• Management regulation

• Coattail effects

• Restrictions on selling

• Fraudulent franchisors

DISADVANTAGES of FRANCHISING

LG5

5-24

*

*Home-Based Franchises

Advantages:• Relief from commuting stress• Extra family time• Low overhead expenses

Main Disadvantage:• Isolation

HOME-BASED FRANCHISES

LG5

5-25

*

*Franchising in International Markets

• Canada is the most popular target for U.S. based franchises; South Africa and the Philippines 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

5-26

*

*Cooperatives

• Cooperatives -- Businesses owned and controlled by the people who use it – producers, consumers, or workers with similar needs who pool their resources for mutual gain.

• Worldwide, 750,000 cooperatives 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

5-27