*

Chapter Five

*
How to Form a Business

McGraw-Hill/Irwin

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

BRIAN SCUDAMORE
1-800-GOT-JUNK?

*
Profile

Bought a used truck and started Rubbish Boys, later changed the name to 1-800-GOT-JUNK?. $130 million in annual earnings from locations across North America and Australia.

Expanded through franchising.

5-2

*
MAJOR FORMS of OWNERSHIP

Basic Forms of Business Ownership

LG1

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

FORMS of BUSINESS OWNERSHIP

Basic Forms of Business Ownership

LG1

5-4

MAJOR BENEFITS of SOLE PROPRIETORSHIP

Ease of starting and ending the business Being your own boss Pride of ownership

*Advantages of
Sole Proprietorships LG1

Leaving a legacy
Retention of company profit

No special taxes
5-5

DISADVANTAGES of SOLE PROPRIETORSHIPS

*Disadvantages
of Sole Proprietorships LG1

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

5-6

*
PROGRESS ASSESSMENT

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?

5-7

*
MAJOR TYPES of PARTNERSHIPS Partnerships
General Partnership -- All owners share in
LG2

operating the business and in assuming liability for the businesss debts.

Limited Partnership -- A partnership with one or

more general partners and one or more limited partners.

5-8

*
OTHER FORMS of PARTNERSHIPS
Partnerships LG2

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.

5-9

*
TYPES OF PARTNERS
Partnerships LG2

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.

5-10

ADVANTAGES of PARTNERSHIPS
More financial resources

Advantages & Disadvantages of Partnerships

LG2

Shared management and pooled skills and knowledge Longer survival

No special taxes

5-11

DISADVANTAGES of PARTNERSHIPS
Unlimited liability Division of profits Difficult to terminate

Advantages & Disadvantages of Partnerships

LG2

Disagreements among partners

5-12

*
PICK YOUR PARTNER WISELY
(Spotlight on Small Business)

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?
5-13

*
PROGRESS ASSESSMENT

Progress Assessment

*
Whats the difference between a limited partner and a general partner? What are some of the advantages and disadvantages of partnerships?

5-14

CONVENTIONAL CORPORATIONS
Conventional (C) Corporation -- A statechartered legal entity with authority to act and have liability separate from its owners (its stockholders).

*
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

HOW OWNERS AFFECT MANAGEMENT

*
Advantages of Corporations LG3

5-17

*
The BIG BOYS of BUSINESS
Americas Largest Corporations
Advantages of Corporations LG3

1.

Exxon Mobil

6.
7. 8. 9.

General Motors
Ford AT&T Hewlett-Packard

2.
3. 4. 5.

Wal-Mart
Chevron ConocoPhillips General Electric

10. Valero Energy

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

5-18

*
PRIVACY PLEASE
The Ten Largest Private Corporations in the U.S.
Company Cargill Koch Industries Chrysler GMAC Financial Services PricewaterhouseCoopers Mars Bechtel HCA Ernst & Young Publix Supermarkets
Source: Forbes, www.forbes.com, November 2008.

Advantages of Corporations LG3

State MN KS MI MI NY VA CA TN NY FL

Industry Farming Chemicals Automobiles Financial Business Services Food Construction Hospitals Business Services Grocery
5-19

*
DISADVANTAGES of CORPORATIONS
Initial cost
Disadvantages of Corporations LG3

Extensive paperwork
Double taxation Two tax returns Size Difficulty of termination Possible conflict with stockholders and board of directors

*
WHO CAN INCORPORATE?
Individuals Can Incorporate
LG3

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.

5-21

*
OLDIES BUT GOODIES
Americas Oldest Corporations
Individuals Can Incorporate
LG3

Company J.E. Rhoads & Sons Covenant Life Insurance Philadelphia Insurance Dexter D. Landreth Seed Bank of New York

Year Started 1702 1717 1752 1767 1784 1784

Type of Company Conveyer Belts Insurance Insurance Contributorship Adhesives & Coatings Seeds Banking

5-22

*
S CORPORATIONS
S Corporations LG3

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.

5-23

WHO CAN FORM S CORPORATIONS?

Qualifications for S Corporations:
-

*
S Corporations LG3

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.
5-24

*
LIMITED LIABILITY COMPANIES
Limited Liability Companies
LG3

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
5-25

*
DISADVANTAGES of LLCs
Limited Liability Companies
LG3

No stock, therefore ownership is nontransferable Limited life span

Fewer incentives
Taxes Paperwork

5-26

VERMONT WANTS to be the HOME of YOUR NEW VIRTUAL COMPANY

(Legal Briefcase)

* *

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.
5-27

*
PROGRESS ASSESSMENT

Progress Assessment

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

5-28

*
MERGERS and AQUISITIONS

Corporate Expansion: Mergers and Acquisitions

LG4

Merger -- The result of two firms joining to form one

company.

Acquisition -- One companys purchase of the

property and obligations of another company.

5-29

*
TYPES of MERGERS

Corporate Expansion: Mergers and Acquisitions

LG4

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.

5-30

*
LEVERAGED BUYOUTS

Corporate Expansion: Mergers and Acquisitions

LG4

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.
5-31

*
FRANCHISING
Franchises LG5

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.

5-32

ADVANTAGES of FRANCHISING

*Advantages &
Disadvantages of Franchises LG5

Management and marketing assistance Personal ownership Nationally recognized name Financial advice and assistance Lower failure rate

5-33

DISADVANTAGES of FRANCHISING
Large start-up costs
Shared profit Management regulation Coattail effects Restrictions on selling

*Advantages &
Disadvantages of Franchises LG5

Fraudulent franchisors

5-34

*
WOMEN in FRANCHISING
Diversity in Franchising
LG5

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 Annes, Decorating Den, Jazzercise and Two Men and a Truck are owned by women.

5-35

ROOT, ROOT, ROOT for the GREEN TEAM

(Thinking Green)

* *

The Nationals in D.C. have the first sports stadium to earn the U.S. Green Building Councils Leadership in Energy and Environmental Design (LEED) Rating. 95% of the stadiums steel was recycled and lowflow toilets save millions of gallons of water. New stadiums of the Mets and Twins also have earned LEED certifications.
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

GLOBAL FRANCHISING

*Franchising in
International Markets LG5

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.
5-38

WHAT to CHOOSE?
Picking Franchises that May Survive a Recession

*Franchising in
International Markets LG5

Focus on tried-and-true name brands. Stick to core goods and services.

Be choosy about the site.

Dont pinch pennies. Have a fallback choice. Dont assume the franchise will pay off.
Source: Richard Gibson, Wall Street Journal, www.wsj.com, February 12, 2008.

5-39

HIGH FLYERS
Ten High-Performing Franchises

*Franchising in
International Markets LG5

1. Arthur Murray Dance Studios 2. Banfield Pet Hospitals 3. Bojangles Famous Chicken n Biscuits 4. Dennys 5. Friendlys 6. The Melting Pot 7. Nathans Famous 8. Servpro 9. Stanley Steamer 10. Two Men and a Truck Source: Wall Street Journal, www.wsj.com, February 12, 2008.
5-40

*
COOPERATIVES
Cooperatives LG6

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.
5-41

*
PROGRESS ASSESSMENT

Progress Assessment

*
What are some of the factors to consider before buying a franchise? What opportunities are available for starting a global franchise? Whats a cooperative?

5-42