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CHAPTER 5 How to Form a Business Mc. Graw-Hill/Irwin Copyright © 2015 by the CHAPTER 5 How to Form a Business Mc. Graw-Hill/Irwin Copyright © 2015 by the Mc. Graw-Hill Companies, Inc. All rights reserved.

LEARNING OBJECTIVES 1. Compare the advantages and disadvantages of sole proprietorships. 2. Describe the LEARNING OBJECTIVES 1. Compare the advantages and disadvantages of sole proprietorships. 2. Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships. 3. Compare the advantages and disadvantages of corporations and summarize the differences between C corporations, S corporations and limited liability companies. 5 -2

LEARNING OBJECTIVES 4. Define and give examples of three types of corporate mergers, and LEARNING OBJECTIVES 4. Define and give examples of three types of corporate mergers, and explain the role of leveraged buyouts and taking a firm private. 5. Outline the advantages and disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising. 6. Explain the role of cooperatives. 5 -3

ANNE BEILER Auntie Anne’s • Started selling pretzels when her family was living paycheck ANNE BEILER Auntie Anne’s • Started selling pretzels when her family was living paycheck to paycheck. • Now Auntie Anne’s has over 1, 200 locations and brings in over $410 million! • Beiler sold the company in 2005 to start focusing on charity work. 5 -4

NAME that COMPANY In 2013, this company became the largest firm in terms of NAME that COMPANY In 2013, this company became the largest firm in terms of revenue to be taken private through a leveraged buyout. After closing the $25 million deal, the founder now controls a 75% stake of the company he started in his dorm room. Name that company! 5 -5

MAJOR FORMS of OWNERSHIP • Sole Proprietorship -- A business owned, and usually managed, MAJOR FORMS of 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. 5 -6

FORMS of BUSINESS OWNERSHIP 5 -7 FORMS of BUSINESS OWNERSHIP 5 -7

ETHNIC BUSINESS CENTERS Cities with the Most Minority-Run Firms 1. Atlanta, GA 2. Baltimore, ETHNIC BUSINESS CENTERS Cities with the Most Minority-Run Firms 1. Atlanta, GA 2. Baltimore, MD 3. Nashville, TN 4. Houston, TX 5. Miami - Ft. Lauderdale, FL Source: Forbes, www. forbes. com, accessed November 2014. Photo Credit: James Rintamaki 5 -8

MAJOR BENEFITS of SOLE PROPRIETORSHIP LO 4 -1 1) Ease of starting and ending MAJOR BENEFITS of SOLE PROPRIETORSHIP LO 4 -1 1) Ease of starting and ending the business 2) Being your own boss 3) Pride of ownership 4) Leaving a legacy 5) Retention of company profit 6) No special taxes 5 -9

DISADVANTAGES of SOLE PROPRIETORSHIPS LO 4 -1 1) Unlimited Liability -- Any debts or DISADVANTAGES of SOLE PROPRIETORSHIPS LO 4 -1 1) Unlimited Liability -- Any debts or damages incurred by the business are your debts, even if it means selling your home, car or anything else. 2) Limited financial resources 3) Management difficulties 4) Overwhelming time commitment 5) Few fringe benefits 6) Limited growth 7) Limited life span 5 -10

WORK-LIFE BALANCING ACT % of small business owners Work over 80 hours per week WORK-LIFE BALANCING ACT % of small business owners Work over 80 hours per week Source: Inc. , www. inc. com, accessed November 2014. Work over 40 hours per week 5 -11

TEST PREP • Most people who start businesses in the U. S. are sole TEST PREP • Most people who start businesses in the U. S. 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 -12

MAJOR TYPES of PARTNERSHIPS LO 4 -2 • General Partnership -- All owners share MAJOR TYPES of PARTNERSHIPS LO 4 -2 • 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. 5 -13

TYPES OF PARTNERS LO 4 -2 • General Partner -- An owner (partner) who TYPES OF PARTNERS LO 4 -2 • 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 -14

OTHER FORMS of PARTNERSHIPS LO 4 -2 • Master Limited Partnership -- A partnership OTHER FORMS of PARTNERSHIPS LO 4 -2 • 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 -15

ADVANTAGES of PARTNERSHIPS LO 4 -2 • More financial resources • Shared management and ADVANTAGES of PARTNERSHIPS LO 4 -2 • More financial resources • Shared management and pooled/complementa ry skills and knowledge • Longer survival • No special taxes 5 -16

DISADVANTAGES of PARTNERSHIPS LO 4 -2 • Unlimited liability • Division of profits • DISADVANTAGES of PARTNERSHIPS LO 4 -2 • Unlimited liability • Division of profits • Disagreements among partners • Difficult to terminate 5 -17

PICKING YOUR PARTNER LO 4 -2 There is no such thing as a perfect PICKING YOUR PARTNER LO 4 -2 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 -18

GOOD BUSINESS, BAD KARMA? Imagine you and your partner own a construction company. You GOOD BUSINESS, BAD KARMA? Imagine you and your partner own a construction company. You receive a subcontractor’s bid you know is 20% too low. This could potentially put the subcontractor out of business. Accepting the bid will improve your chances of getting a big job. Your partner wants to take the bid: • What do you think you should do? • What will be the consequences of your decision? 5 -19

TEST PREP • What’s the difference between a limited partner and a general partner? TEST PREP • What’s the difference between a limited partner and a general partner? • What are some of the advantages and disadvantages of partnerships? 5 -20

CONVENTIONAL CORPORATIONS LO 4 -3 • Conventional (C) Corporation -- A statechartered legal entity CONVENTIONAL CORPORATIONS LO 4 -3 • Conventional (C) Corporation -- A statechartered legal entity with authority to act and have liability separate from its owners (its stockholders). 5 -21

ADVANTAGES of CORPORATIONS LO 4 -3 • Limited liability • Ability to raise more ADVANTAGES of CORPORATIONS LO 4 -3 • 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 5 -22

HOW OWNERS AFFECT MANAGEMENT LO 4 -3 5 -23 HOW OWNERS AFFECT MANAGEMENT LO 4 -3 5 -23

The BIG BOYS of BUSINESS LO 4 -3 America’s Largest Corporations 1. Walmart 2. The BIG BOYS of BUSINESS LO 4 -3 America’s Largest Corporations 1. Walmart 2. Exxon Mobil 3. Chevron 4. Berkshire Hathaway Photo Credit: Walmart Stores 5. Apple Source: Fortune, www. fortune. com, accessed November 2014. 5 -24

PRIVACY PLEASE LO 4 -3 The Ten Largest Private Corporations in the U. S. PRIVACY PLEASE LO 4 -3 The Ten Largest Private Corporations in the U. S. Company State Industry Cargill MN Farming Koch Industries KS Chemicals Dell TX Computers Bechtel CA Construction Pricewaterhouse. Coopers NY Business Services Mars VA Food Pilot Flying J TN Convenience Stores Publix Supermarkets FL Grocery Ernst & Young NY Business Services C&S Wholesale Grocers NH Food Wholesale Source: Forbes, www. forbes. com, accessed November 2014. 5 -25

DISADVANTAGES of CORPORATIONS LO 4 -3 • Initial cost • Extensive paperwork • Double DISADVANTAGES of CORPORATIONS LO 4 -3 • Initial cost • Extensive paperwork • Double taxation • Two tax returns • Size • Difficulty of termination • Possible conflict with stockholders and board of directors 5 -26

EVEN the BIG GUYS MAKE MISTAKES LO 4 -3 Company Bad Move Atari The EVEN the BIG GUYS MAKE MISTAKES LO 4 -3 Company Bad Move Atari The amount of surplus from a bad game was so big, the copies had to be buried in a New Mexican landfill. Blockbuster Passed on a partnership with Netflix and ended up going bankrupt in 2011. Coca-Cola New Coke lasted only 77 days because Coca-Cola received more than 1, 500 complaint calls a day. Pan American World Airways After the bombing of Flight 103, the airline blamed the government after the victims’ families filed a $300 million lawsuit. Pets. com Debuted with a $3 million Super Bowl ad and a Macy’s Thanksgiving Day Parade float. Nine months later, they went bankrupt. Source: Bloomberg Businessweek, www. businessweek. com, accessed November 2014. 5 -27

B CORPORATIONS LET SUSTAINABILITY SET SAIL • Michael Dimin saw tons of fish were B CORPORATIONS LET SUSTAINABILITY SET SAIL • Michael Dimin saw tons of fish were left to rot after fishermen caught too much. • Registered his company, Sea 2 Table as a benefit corporation. • B-corporations are judged on how they meet their own set of socially or environmentally beneficial goals. 5 -28

WHO CAN INCORPORATE? LO 4 -3 • Anyone - truckers, doctors, plumbers, athletes and WHO CAN INCORPORATE? LO 4 -3 • Anyone - truckers, doctors, plumbers, athletes and small business owners can incorporate. • Normally stock is not issued to outsiders 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 -29

OLDIES BUT GOODIES LO 4 -3 America’s Oldest Corporations Company Year Started Type of OLDIES BUT GOODIES LO 4 -3 America’s Oldest Corporations 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 5 -30

S CORPORATIONS LO 4 -3 • S Corporation -- A unique government creation that S CORPORATIONS LO 4 -3 • 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 -31

WHO CAN FORM S CORPORATIONS? LO 4 -3 • Qualifications for S Corporations: - WHO CAN FORM S CORPORATIONS? LO 4 -3 • 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. 5 -32

LIMITED LIABILITY COMPANIES LO 4 -3 • Limited Liability Company (LLC) -- Similar to LIMITED LIABILITY COMPANIES LO 4 -3 • Limited Liability Company (LLC) -- Similar to an S corporation, but without the eligibility requirements. • Advantages of LLCs: 1. Limited liability 2. Choice of taxation 3. Flexible ownership rules 4. Flexible distribution of profits and losses 5. Operating flexibility 5 -33

DISADVANTAGES of LLCs LO 4 -3 1. No stock, therefore ownership is nontransferable 2. DISADVANTAGES of LLCs LO 4 -3 1. No stock, therefore ownership is nontransferable 2. Limited life span 3. Fewer incentives 4. Taxes 5. Paperwork 5 -34

TEST PREP • What are the major advantages and disadvantages of incorporating a business? TEST PREP • 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? 5 -35

MERGERS and ACQUISITIONS LO 4 -4 • Merger -- The result of two firms MERGERS and ACQUISITIONS LO 4 -4 • Merger -- The result of two firms joining to form one company. • Acquisition -One company’s purchase of the property and obligations of another company. 5 -36

TYPES of MERGERS LO 4 -4 • Vertical Merger -- The joining of two TYPES of MERGERS LO 4 -4 • Vertical Merger -- The joining of two firms in different stages of related businesses. • Horizontal Merger -- The joining of two firms in the same. • Conglomerate Merger -- The joining of firms in completely unrelated industries. 5 -37

LEVERAGED BUYOUTS LO 4 -4 • Leveraged Buyout (LBO) -- An attempt by employees, LEVERAGED BUYOUTS LO 4 -4 • 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 $34 billion and have involved everything from small businesses to giant corporations. • In 2012, foreign investors poured $166 billion into U. S. companies. 5 -38

FRANCHISING LO 4 -5 • Franchise Agreement -- An arrangement whereby someone with a FRANCHISING LO 4 -5 • 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 770, 000 franchised businesses operate in the U. S. , employing approximately 8. 5 million people. 5 -39

MAKE WAY for the NEWBIES LO 4 -5 Top New Franchises Rank Company Industry MAKE WAY for the NEWBIES LO 4 -5 Top New Franchises Rank Company Industry 1 Mac Tools Automotive tools 2 Bricks 4 Kidz Toys 3 Orange Leaf Frozen Yogurt Frozen yogurt 4 Sears Hometown Appliances 5 Fitness Revolution Personal and group fitness 6 The Grounds Guys LLC Landscape management 7 Paul Davis Emergency Services Restoration 8 Doc Popcorn Food 9 Title Boxing Club Personal and group fitness 10 Fuzzy’s Taco Shop Food Source: Entrepreneur, www. entrepreneur. com, accessed November 2014. 5 -40

ADVANTAGES of FRANCHISING LO 4 -5 1. Management and marketing assistance 2. Personal ownership ADVANTAGES of FRANCHISING LO 4 -5 1. Management and marketing assistance 2. Personal ownership 3. Nationally recognized name 4. Financial advice and assistance 5. Lower failure rate 5 -41

DISADVANTAGES of FRANCHISING LO 4 -5 1. Large start-up costs 2. Shared profit 3. DISADVANTAGES of FRANCHISING LO 4 -5 1. Large start-up costs 2. Shared profit 3. Management regulation 4. Coattail effects 5. Restrictions on selling 6. Fraudulent franchisors 5 -42

THE BUILDING BLOCKS of FRANCHISING • Bricks 4 Kidz was created as a way THE BUILDING BLOCKS of FRANCHISING • Bricks 4 Kidz was created as a way to help kids understand engineering and construction. • Since the business was low cost and easily reproduced, this led to over 200 franchises in the U. S. and 11 other countries. 5 -43

WOMEN in FRANCHISING LO 4 -5 • Women own about half of U. S. WOMEN in FRANCHISING LO 4 -5 • Women own about half of U. S. companies, yet ownership of franchises is about 21%. • More women are becoming franchisors. Auntie Anne’s and Jazzercise and are owned by women. 5 -44

MINORITY-OWNED FRANCHISES LO 4 -5 • Diversity. Fran is an initiative to build awareness MINORITY-OWNED FRANCHISES LO 4 -5 • Diversity. Fran is an initiative to build awareness of franchising opportunities within minority communities. • Domino’s Pizza launched a minority franchise recruitment program called Delivering the Dream. Photo Credit: Tom Magliery • Over 20% of franchises are minority-owned. 5 -45

HOME-BASED FRANCHISES LO 4 -5 Advantages: • Relief from commuting stress • Extra family HOME-BASED FRANCHISES LO 4 -5 Advantages: • Relief from commuting stress • Extra family time • Low overhead expenses Main Disadvantages: • Isolation • Long hours 5 -46

HOME SWEET HOME LO 4 -5 Top Home-Based Franchises Rank Company Industry 1 Jan-Pro HOME SWEET HOME LO 4 -5 Top Home-Based Franchises Rank Company Industry 1 Jan-Pro Disaster Restoration 2 Cruise Planners Travel 3 Vanguard Cleaning Systems Commercial Cleaning 4 Snap-on Tools Professional Tools 5 Matco Tools Professional Tools 6 Jazzercise Fitness 7 Clean. Net USA Commercial Cleaning 8 Budget Blinds Home Décor 9 Coverall Health-Based Cleaning Commercial Cleaning 10 Chem-Dry Carpet & Upholstery Cleaning Commercial and Residential Cleaning Source: Entrepreneur, www. entrepreneur. com, accessed November 2014. 5 -47

E-COMMERCE in FRANCHISHING LO 4 -5 • Most brick-and-mortar franchises have expanded online. • E-COMMERCE in FRANCHISHING LO 4 -5 • Most brick-and-mortar franchises have expanded online. • Many franchisors prohibit franchisee-sponsored sites because conflicts can erupt. • Sometimes “reverse royalties” are sent to franchisees who believe their sales were hurt by the franchisor’s site. • Other franchises are solely based online. 5 -48

GIVING ENTREPRENEURS OPTIONS with DIGITAL FRANCHISING • Chris Jeffrey created Order. Up shortly after GIVING ENTREPRENEURS OPTIONS with DIGITAL FRANCHISING • Chris Jeffrey created Order. Up shortly after graduating college. • Order. Up links up restaurants with hungry patrons and allows people to order online while Order. Up takes a small commission. • For a startup fee of $42, 000 franchisees receive software and training to launch Order. Up in their area. 5 -49

GLOBAL FRANCHISING LO 4 -5 • Canada is the most popular target for U. GLOBAL FRANCHISING LO 4 -5 • Canada is the most popular target for U. S. -based franchises. • China, South Africa, the Philippines and the Middle East are becoming popular despite high cost. • International franchising goes both ways – some foreign franchises have come to the U. S. 5 -50

WHAT to CHOOSE? LO 4 -5 Picking Franchises that May Survive a Recession • WHAT to CHOOSE? LO 4 -5 Picking Franchises that May Survive a Recession • 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. Source: Richard Gibson, Wall Street Journal, www. wsj. com, accessed November 2014. 5 -51

HIGH FLYERS LO 4 -5 Ten High-Performing Franchises 1. Anytime Fitness 2. Hampton Hotels HIGH FLYERS LO 4 -5 Ten High-Performing Franchises 1. Anytime Fitness 2. Hampton Hotels 3. Subway 4. Supercuts 5. Jimmy John’s 6. 7 -Eleven 7. Servpro 8. Denny’s Photo Credit: Innisfree Hotels 9. Pizza Hut 10. Dunkin Donuts Source: Entrepreneur, www. entrepreneur, com, accessed November 2014. 5 -52

COOPERATIVES LO 4 -6 • Cooperatives -- Businesses owned and controlled by the people COOPERATIVES LO 4 -6 • Cooperatives -- Businesses owned and controlled by the people who use them– producers, consumers, or workers with similar needs who pool their resources for mutual gain. • Worldwide, co-ops serve one billion members! • Members democratically control the business by electing a board of directors that hires professional management. 5 -53

TEST PREP • What are some of the factors to consider before buying a TEST PREP • What are some of the factors to consider before buying a franchise? • What opportunities are available for starting a global franchise? • What is a cooperative? 5 -54