An introduction to the fundamentals of dynamic business law and business ethics chap020

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?
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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 Wedding bells have been replaced by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?”
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Major Forms of Business
Organizations
• Sole Proprietorship
• General Partnership
• Limited Partnership
• Corporation
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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
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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
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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

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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
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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

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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
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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
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“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

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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

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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

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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)
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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
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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
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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
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Top Ten Global Franchises (2011)
• Subway

• Snap-On Tools

• McDonald’s

• Pizza Hut

• KFC

• Wyndham Hotel Group

• 7-Eleven

• ServiceMaster

• Burger King

• Choice Hotels

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