*

* Chapter Five

How to Form

a Business

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

*

*

• Bought a used truck and started Rubbish Boys,

later changed the name to

http://www.1800gotjunk.com.

• $130 million in annual earnings from locations

across North America and Australia.

• Expanded through franchising.

Profile BRIAN SCUDAMORE 1-800-GOT-JUNK?

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

LG1

5-3

*

* Basic Forms of

Business

Ownership

LG1

FORMS of

BUSINESS OWNERSHIP

5-4

*

* 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

5-5

*

* 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

5-6

*

* Progress

Assessment

• Most people who start businesses in the United

States 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

5-7

*

* 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 PARTNERSHIPS LG2

5-8

*

* 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

5-9

*

* 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 PARTNERS LG2

5-10

*

* Advantages &

Disadvantages

of Partnerships

• More financial resources

• Shared management and

pooled skills and

knowledge

• Longer survival

• No special taxes

ADVANTAGES of

PARTNERSHIPS LG2

5-11

*

* Advantages &

Disadvantages

of Partnerships

• Unlimited liability

• Division of profits

• Difficult to terminate

• Disagreements among

partners

DISADVANTAGES of

PARTNERSHIPS LG2

5-12

*

*

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)

5-13

*

* 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

5-14

*

* 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

5-15

*

* 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

5-16

*

* Advantages of

Corporations

LG3

HOW OWNERS AFFECT

MANAGEMENT

5-17

*

*

Source: Fortune, www.fortune.com, April 2009.

1. Exxon Mobil

2. Wal-Mart

3. Chevron

4. ConocoPhillips

5. General Electric

Advantages of

Corporations The BIG BOYS of BUSINESS

America’s Largest Corporations LG3

6. General Motors

7. Ford

8. AT&T

9. Hewlett-Packard

10. Valero Energy

5-18

*

*

Source: Forbes, www.forbes.com, November 2008.

Advantages of

Corporations

Company State Industry

Cargill MN Farming

Koch Industries KS Chemicals

Chrysler MI Automobiles

GMAC Financial Services MI Financial

PricewaterhouseCoopers NY Business Services

Mars VA Food

Bechtel CA Construction

HCA TN Hospitals

Ernst & Young NY Business Services

Publix Supermarkets FL Grocery

PRIVACY PLEASE The Ten Largest Private Corporations in the U.S.

LG3

5-19

*

* 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

5-20

*

* Individuals Can

Incorporate

• Anyone - truckers, doctors, plumbers, athletes

and small business owners can incorporate.

• Normally, stock is not issued 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

5-21

*

* Individuals Can

Incorporate

Company Year Started Type of Company

J.E. Rhoads & Sons 1702 Conveyer Belts

Covenant Life Insurance 1717 Insurance

Philadelphia Insurance 1752 Insurance

Contributorship

Dexter 1767 Adhesives & Coatings

D. Landreth Seed 1784 Seeds

Bank of New York 1784 Banking

OLDIES BUT GOODIES America’s Oldest Corporations

LG3

5-22

*

* 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

5-23

*

* 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

5-24

*

* 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

5-25

*

* Limited Liability

Companies

• No stock, therefore ownership is nontransferable

• Limited life span

• Fewer incentives

• Taxes

• Paperwork

DISADVANTAGES of LLCs

LG3

5-26

*

*

• Since June 2008, Vermont allows a new kind of

LLC that exist 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.

VERMONT WANTS to be the HOME

of YOUR NEW VIRTUAL COMPANY (Legal Briefcase)

5-27

*

* 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

5-28

*

* 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

5-29

*

* Corporate

Expansion:

Mergers and

Acquisitions

• 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

5-30

*

* Corporate

Expansion:

Mergers and

Acquisitions

• 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

5-31

*

* 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

5-32

*

* Advantages &

Disadvantages

of Franchises

• Management and marketing

assistance

• Personal ownership

• Nationally recognized name

• Financial advice and

assistance

• Lower failure rate

ADVANTAGES of FRANCHISING

LG5

5-33

*

* Advantages &

Disadvantages

of Franchises

• Large start-up costs

• Shared profit

• Management regulation

• Coattail effects

• Restrictions on selling

• Fraudulent franchisors

DISADVANTAGES of

FRANCHISING LG5

5-34

*

* Diversity in

Franchising

• Women own about half of U.S. companies yet

receive less than 4% of venture capital.

• For the past 20 years, firms owned by women

have grown at twice the rate of all companies.

• More women are becoming franchisors. Auntie

Anne’s, Decorating Den, Jazzercise and Two

Men and a Truck are owned by women.

WOMEN in FRANCHISING

LG5

5-35

*

*

• The Nationals in D.C. have the first sports

stadium to earn the U.S. Green Building Council’s

Leadership in Energy and Environmental Design

(LEED) Rating.

• 95% of the stadium’s steel was recycled and low-

flow toilets save millions of gallons of water.

• New stadiums of the Mets and Twins also have

earned LEED certifications.

ROOT, ROOT, ROOT for the

GREEN TEAM (Thinking Green)

5-36

*

* Home-Based

Franchises

Advantages:

• Relief from commuting stress

• Extra family time

• Low overhead expenses

Main Disadvantage:

• Isolation

HOME-BASED FRANCHISES

LG5

5-37

*

* 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

5-38

*

*

Source: Richard Gibson, Wall Street Journal, www.wsj.com, February 12, 2008.

• 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.

Franchising in

International

Markets WHAT to CHOOSE?

Picking Franchises that May Survive a Recession LG5

5-39

*

*

Source: Wall Street Journal, www.wsj.com, February 12, 2008.

1. Arthur Murray Dance Studios

2. Banfield Pet Hospitals

3. Bojangles’ Famous Chicken ‘n

Biscuits

4. Denny’s

5. Friendly’s

6. The Melting Pot

7. Nathan’s Famous

8. Servpro

9. Stanley Steamer

10.Two Men and a Truck

Franchising in

International

Markets HIGH FLYERS

Ten High-Performing Franchises LG5

5-40

*

* 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

5-41

*

* 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

5-42