Chapter 20 Forms of Business Organization McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc All rights reserved Chapter 20 Ethical Dilemma As this chapter indicates, a corporation is a legal construct with an identity separate and apart from its owner(s) The primary legal advantage to converting one’s business from an unincorporated enterprise to the corporate form is the ability to avoid personal liability for the business’s financial obligations Since the corporation is distinguishable from its owner, the owner’s personal assets cannot be seized to satisfy business indebtedness This effectively means that an owner can “crash and burn” a corporation financially, bankrupt the business, and walk away from the “flaming wreckage” of the corporation without personal obligation for business debts Is it ethical for an owner to use the corporate entity to avoid personal obligation for business debts? 20-2 Chapter 20 Case Hypothetical Allison Seizer has a very wealthy father, entrepreneur Warren Seizer of “Chimichonga Chime” restaurant fame, although her family pedigree was not what attracted Blake Patterson to his girlfriend of three years; instead, it was “love at first sight.” Blake proposes to Allison, and the two are married with the blessing of Warren Seizer Warren wants the best for his daughter and son-in-law, so he offers a “Chimichonga Chime” franchise to Blake, with a prime location in the center of the Elmwood business district After one year, it is clear that the newest “Chimichonga Chime” is and will be a tremendous business success In fact, sales, revenue and profit goals for the restaurant are shattered in its first year of operation, and Blake would like to think that his “hands-on” ownership and operation of the restaurant was an important part of the store’s success   Unfortunately, the couple’s relationship has suffered over the year, and the term “irreconcilable differences” creeps into marriage conversations Blake asks for his freedom, and Allison obliges Wedding bells have been replaced by divorce attorneys Warren Seizer is furious He is firmly convinced that Blake Patterson is to blame for the marriage’s dissolution, because there is no conceivable way (at least in his mind) that his “darling angel,” his “precious daughter,” could be responsible for the divorce The creative genius behind “Chimichonga Chime” plots justice for his daughter and himself, although some may call it revenge On September 1, Warren Seizer personally delivers a Notice of Termination of Franchise to Blake Patterson The document states that Patterson’s franchise agreement has been terminated for cause, and that he must either close the restaurant, or cease and desist from using the name “Chimichonga Chime,” advertising the franchise chime logo, and selling all franchise-related products, within 30 days Who wins: The “ex-father-in-law,” or the “ex-son-in-law?” 20-3 Major Forms of Business Organizations • Sole Proprietorship • General Partnership • Limited Partnership • Corporation 20-4 Sole Proprietorship • Definition: Unincorporated business owned by one person • Owner has total control • Owner has unlimited liability • Profits taxed directly as income to sole proprietor 20-5 Advantages and Disadvantages of Sole Proprietorship • Advantages -Ease of creation (“start-up”) -Owner has total managerial control -Owner retains profits • Disadvantages -Personal liability for all business debts/obligations/losses -Funding limited to personal funds and loans 20-6 General Partnership • Definition: Unincorporated business owned and operated by two or more persons • Each partner has equal control of business • Each partner has unlimited, personal liability for business debts/obligations/losses • Profits taxed as income to partners 20-7 Advantages and Disadvantages of Partnership • Advantages -Ease of creation (“start-up”) -Partnership income is partner income -Business losses qualify for tax deduction • Disadvantages -Personal liability for all business debts/obligations/losses, including those incurred by other partners on behalf of partnership 20-8 Limited Partnership • Definition: Unincorporated business with at least one general partner, and one limited partner • General partner in limited partnership has managerial/operational control over business • Limited partner’s liability limited to extent of his/her capital contributions • Limited partner has no managerial/operational control over business 20-9 Corporation • Definition: State-sanctioned business with legal identity separate and apart from its owners (shareholders) • Owners’ (shareholders’) liability limited to amount of investment in corporation • Profits taxed as income to corporation, plus income to owners/shareholders (“doubletaxation”) • “S” Corporation can avoid double-taxation 20-10 Advantages and Disadvantages of Corporation • Advantages -Limited liability for shareholders -Ease of raising capital by issuing (selling) stock -Profits taxed as income to shareholders (not partners) • Disadvantages -“Double-taxation” -Formalities required in establishing and maintaining corporate existence 20-11 “S” Corporation • Definition: Business organization formed under federal tax law that is considered corporation, yet taxed like a partnership • Formed under federal law • No more than one hundred shareholders • Shareholders must report income on their personal income tax forms 20-12 Limited Liability Company (LLC) • Definition: Business organization with limited liability of a corporation, yet taxed like partnership • Formed under state law • Owners of LLC (“members”) pay personal income taxes on shares they report • No limitation on number of owners permitted in LLC 20-13 Specialized Forms of Business Organizations • Cooperative—Organization formed by individuals to market products • Joint stock company—Partnership agreement in which company members hold transferable shares, while all company goods are held in names of partners • Business Trust—Business organization governed by group of trustees, who operate trust for beneficiaries 20-14 Specialized Forms of Business Organizations (Continued) • Syndicate—Investment group that forms for purpose of financing specific large project • Joint Venture—Relationship between two or more persons/corporations created for specific business undertaking • Franchise—Agreement between “franchisor” (owner of trade name/trademark) and “franchisee” (person who, by specific terms of agreement, sells goods/services under trade name/trademark) 20-15 Advantages and Disadvantages of Franchise (To Franchisee) • Advantages -Assistance from franchisor in starting franchise -Trade name/trademark recognition -Franchisor advertising • Disadvantages -Must meet contractual requirements, or possibly lose franchise -Little/no creative control over business 20-16 Advantages and Disadvantages of Franchise (To Franchisor) • Advantages -Low risk in starting franchise -Increased income from franchises • Disadvantages -Little control (except contractually) over individual franchise -Can become liable for franchise, if franchisor exerts too much control 20-17 Types of Franchises • “Chain-Style” Business Operation -Franchisor helps franchisee establish a business (using franchisor’s business name, and franchisor’s standard “methods and practices”) • Distributorship -Franchisor licenses franchisee to sell franchisor’s product in specific area • Manufacturing Arrangement -Franchisor provides franchisee with technical knowledge to manufacture franchisor’s product 20-18 Top Ten Global Franchises (2011) • Subway • Snap-On Tools • McDonald’s • Pizza Hut • KFC • Wyndham Hotel Group • 7-Eleven • ServiceMaster • Burger King • Choice Hotels 20-19 ... first year of operation, and Blake would like to think that his “hands-on” ownership and operation of the restaurant was an important part of the store’s success   Unfortunately, the couple’s... Operation -Franchisor helps franchisee establish a business (using franchisor’s business name, and franchisor’s standard “methods and practices”) • Distributorship -Franchisor licenses franchisee to sell... effectively means that an owner can “crash and burn” a corporation financially, bankrupt the business, and walk away from the “flaming wreckage” of the corporation without personal obligation for business