6 BUSN Business Formation: Choosing the Form that Fits ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Business Formation: Choosing the Form that Fits • What are the four basic forms of business and their characteristics? • What are the advantages and disadvantages of a sole proprietorship? • What are the pros and cons of partnerships? • Why have corporations become the dominant form of business ownership? • Why are limited liability companies becoming increasingly popular? • What are the advantages and disadvantages of franchising? BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Business Formation: Choosing the Form that Fits Business Ownership Options: The Big Four Sole Proprietorship – the business is owned by a single individual Partnership – two or more people serve as co-owners of the business Corporation – the business is a separate legal entity Limited Liability Company – a hybrid with characteristics of both a corporation and partnership BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Business Formation: Choosing the Form that Fits Business Ownership Options: The Big Four Source: U.S Census Bureau, The 2009 Statistical Abstract, Table 722: Number of Tax Returns, Receipts, and Net Income by Type of Business: 1990-2005: http://www.census.gov/prod/2008pubs/09statab/business.pdf BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Business Formation: Choosing the Form that Fits Advantages and Disadvantages of Sole Proprietorships Advantages:  Ease of Formation  Retention of Control  Pride of Ownership  Retention of Profits  Possible Tax Advantages BUSN Disadvantages:  Limited Financial Resources  Unlimited Liability  Limited ability to attract and maintain talented employees  Lack of Permanence ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Business Formation: Choosing the Form that Fits Partnerships: Two Heads (and Bankrolls) Can Be Better Than One Advantages:  Pooled Financial Resources  Shared Responsibilities Disadvantages:  Unlimited Liability  Disagreements  Ease of Formation  Difficulty in withdrawing from agreement  Tax Advantages  Lack of Continuity BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 6 Business Formation: Choosing the Form that Fits Partnerships: General vs Limited General Partnerships All partners have the right to participate in the management of the firm and share in any profits/losses Limited Partnerships All partners contribute financially and share in the profits but the limited partner(s) cannot actively participate in management BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Business Formation: Choosing the Form that Fits Partnerships: Two Heads (and Bankrolls) Can Be Better Than One Limited Partnership – includes at least one general partner and at least one limited partner Limited partners have limited liability BUSN Limited Liability Partnership – all partners are actively involved but they have some form of limited liability The amount of liability differs per state ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Business Formation: Choosing the Form that Fits Keeping It All in The Family: Family Limited Partnerships (FLIPS) • Parents transfer assets to limited partners while still maintaining control, this strategy: • Reduces gift and inheritance taxes • Protects family assets from creditors and lawsuits • Parents as general partners • Children as limited partners • Watch out for the IRS – Family Limited Partnerships can attract tax auditors! BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part Business Formation: Choosing the Form that Fits Corporations: The Advantages and Disadvantages of Being an Artificial Person • A corporation is a legal entity, separate and distinct from its owners • Corporations are owned by stockholders • The Board of Directors establishes the mission and objectives • The Board is elected by the stockholders to represent their interests BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 10 Business Formation: Choosing the Form that Fits Other Types of Corporations: Same but Different • S Corporation • Closed Corporation • Nonprofit Corporation BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 13 Business Formation: Choosing the Form that Fits This TARP Has Executive Pay Covered • CEO pay of 12 major corporations totaled $1.26 billion while the firms lost $330 billion in shareholder value • Executive pay issues have been amplified as the economy spirals into recession • Government bailout (TARP) limits CEO compensation • Board of Directors are supposed to protect the interest of stockholders • But many of the CEOs have clauses that provide lucrative severance pay regardless of performance BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 14 Business Formation: Choosing the Form that Fits Corporations: Characteristics TYPE KEY ADVANTAGE S Corp Statutory Close Corp • IRS does not tax earnings separately • Stockholders have limited liability • No more than 100 stockholders • Stockholders must be U.S citizens or permanent residents • Not require to have a board or hold annual meetings • Owners can participate in management while maintaining limited liability • Limited number of stockholders • Stockholders must offer shares to owner first before selling publicly • Not all states allow this corporation type • Earnings are exempt from federal and state income taxes • Members/directors have limited liability Contributions made by individuals are tax-deductible â 2009 South-Western, a division of Cengage Learning Nonprofit Corp BUSN LIMITATIONS • May have dues paying members but no stockholders • Can’t distribute dividends • Can’t make political donations • Must keep accurate records to document 15 tax-exemption ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 15 Business Formation: Choosing the Form that Fits Corporate Restructuring: Mergers & Acquisitions Mergers – two companies agree to a combination of equals Acquisitions – when one firm buys another Corporations look for: • Growth opportunities • Operational efficiencies Competitive advantages BUSN â2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 16 Business Formation: Choosing the Form that Fits Types of Mergers & Acquisitions Type of Merger Definition Objective Example Horizontal Combine firms in same industry • Increase size • Increase market power • Gain efficiency AT&T and SBC Vertical Combine companies with buyer-seller relationship • Provide tighter integration and increase control Time Warner and Turner Broadcasting Conglomerate Combination of unrelated companies • Increase company’s diversity GE acquiring RCA BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 17 Business Formation: Choosing the Form that Fits Divestitures: When Less is More Divestitures allow the firm to streamline their operations and focus •Spin-off – setting up the division or part of the business as a separate company Sell stock to existing stockholders •Carve-out – setting up a separate business from an operation Sell stock to outside investors BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 18 Business Formation: Choosing the Form that Fits Breakin’ Up Is Hard to Do—Even in the Corporate World • The 1998 Daimler acquisition of Chrysler ended in 2007 • The strategy was to build a global automobile brand • But, the corporate cultures were not compatible and the product mix was not focused • Daimler had huge expenses • Daimler sold Chrysler and many analyst believe they paid to get rid of the company BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 19 Business Formation: Choosing the Form that Fits The Limited Liability Company: The New Kid on the Block Advantages: Disadvantages: • Limited Liability • Franchise Taxes • Tax Pass-Through • Foreign Status in other States • Flexible Ownership • Simplified Management and Operation BUSN • State Law Differences Limited to Select Industries â2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 20 Business Formation: Choosing the Form that Fits Franchising: Proven Methods for a Price • Not a form of ownership but an operation option • • • • Build-a-Bear Subway Jiffy Lube McDonald’s • The franchisee uses the brand name, trademark and practices of the franchisor BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 21 Business Formation: Choosing the Form that Fits Franchising: Proven Methods for a Price Advantages: Disadvantages:  Less Risk  Costs  Training and Support  Lack of Control  Brand Recognition  Negative Halo Effect  Access to Funding  Growth Challenges  Restriction on Sale  Poor Execution Ben & Jerry franchises its PartnerShops to nonprofit corporations BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 22 Business Formation: Choosing the Form that Fits Some Franchisees Are Quite Happy When They Don’t Earn Profit  Many customers like doing business with nonprofit franchisees  Nonprofit franchising is a good way for companies to be socially responsible and build goodwill  Nonprofits can boost their fundraising efforts BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 23 Business Formation: Choosing the Form that Fits Franchising in Today’s Economy • Franchising has been expanding into foreign markets • McDonald’s has slightly more franchises abroad than in the U.S • The number of women franchisees and franchisors is growing • Minority participation in franchising is low The International Franchising Association has launched an initiative to recruit minority franchisees BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 24 Business Formation: Choosing the Form that Fits Franchising in Today’s Economy Source: Individual franchise opportunity pages for each listed franchise on the Entrepreneur.com website, http://www.entrepreneur.com/franchiseopportunities/index.html, accessed February 1, 2009 BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 25 Business Formation: Choosing the Form that Fits Entering Into A Franchise Agreement • Know all the facts before signing the dotted line • Franchisors must provide a Franchise Disclosure Document (FDD) • The Federal Trace Commission (FTC) require:  The FDD Must be written in plain English  The franchisor must be give 14 days to review the FDD  The Franchisee should have a lawyer review the document BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 26 Looking Back • What are the four basic forms of business and their characteristics? • What are the advantages and disadvantages of a sole proprietorship? • What are the pros and cons of partnerships? • Why have corporations become the dominant form of business ownership? • Why are limited liability companies becoming increasingly popular? • What are the advantages and disadvantages of franchising? BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part 27 ... companies becoming increasingly popular? • What are the advantages and disadvantages of franchising? BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted... Limited Liability Company – a hybrid with characteristics of both a corporation and partnership BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted... Income by Type of Business: 1990-2005: http://www.census.gov/prod/2008pubs/09statab/business.pdf BUSN ©2011 Cengage Learning All Rights Reserved May not be scanned, copied or duplicated, or posted