Dynamic business law 4e kubasek 4e CH35

Chapter 35
Forms of Business Organization

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Overview

• LO35-1: What are the major forms of business organization, and what are
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the differences among them?
LO35-2: What are the specialized forms of business organization?
LO35-3: What is a franchise?

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Chapter 35 Hypothetical Case 1
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According to the United States Small Business Administration (SBA), over 70 percent of U.S. businesses are owned and operated by sole proprietors.
As this chapter indicates, a sole proprietorship is an unincorporated business owned by one person. A sole proprietor's potential liabilities are
significant. Since there is no legal distinction between a sole proprietor as an individual and his or her business, all business debts and obligations,
including contract and tort liabilities, are the owner's responsibility. A sole proprietor does not have a legal shield to protect himself, as the owner of
a corporation or a member of a limited liability company (LLC) does.

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Given the potential personal liabilities of sole proprietors, what accounts for the fact that over 70 percent of U.S. businesses are operated as sole

proprietorships?

Note: Supporting research information for this issue, including the 70 percent statistic, can be located at the following web site:
Sole Proprietorship—Is this Popular Business Structure Right for You?

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Chapter 35 Hypothetical Case 2
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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.

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Is it ethical for an owner to use the corporate entity to avoid personal obligation for business debts?

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Major Forms of Business Organizations

• Sole proprietorship
• General partnership
• Limited partnership

• Corporation

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Sole Proprietorship
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Definition: Unincorporated business owned by one person
Owner has total control
Owner has unlimited liability
Profits taxed directly as income to sole proprietor
Advantages

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Ease of creation (start-up)
Owner has total managerial control
Owner retains profits

Disadvantages

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Personal liability for all business debts/obligations
Funding limited to personal contributions and loans
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General Partnership
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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
Profits taxed as income to partners
Advantages

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Ease of creation (start-up)
Partnership income is partner income
Business losses qualify for tax deduction

Disadvantages

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Personal liability for all business debts/obligations, including those incurred by other partners on behalf of
partnership

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Limited Partnership
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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
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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 (double taxation)
S Corporation can avoid double taxation
Advantages

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Limited liability for shareholders
Ease of raising capital by issuing (selling) stock

Disadvantages

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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
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corporation, yet taxed like a partnership
Formed under federal law
No more than 100 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
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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
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Cooperative: Organization formed by individuals to market products

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Business trust: Business organization governed by group of trustees, who operate trust for beneficiaries

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Joint stock company: Partnership agreement in which company members hold transferable shares, while all
company goods are held in names of partners
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
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Assistance from franchisor in starting franchise
Trade name/trademark recognition
Franchisor advertising

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Must meet contractual requirements or possibly lose franchise
Little/no creative control over business

• Disadvantages

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Advantages and Disadvantages of Franchise to Franchisor

• Advantages
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Low risk in starting franchise
Increased income from franchises

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Little control (except contractually) over individual franchise
Can become liable for franchise, if franchisor exerts too much control

• Disadvantages

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Types of Franchises
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Chain-style business operation

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Franchisor helps franchisee establish a business (using franchisor's business name and franchisor's standard
methods and practices)

Distributorship

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Franchisor licenses franchisee to sell franchisor's product in specific area

Manufacturing arrangement

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Franchisor provides franchisee with technical knowledge to manufacture franchisor's product

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Chapter 35 Hypothetical Case 3

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Allison Seizer's very wealthy father, entrepreneur Warren Seizer of Chimichonga Chime restaurant fame, was not what attracted
Blake Patterson to her. It was love at first sight, and the two were married two years ago.

Seizer wanted the best for his daughter and son-in-law, so he offered Patterson a Chimichonga Chime franchise with a prime
location in the center of the Elmwood business district. After a year under Patterson's ownership, it became clear that the newest
Chimichonga Chime was a tremendous business success. In fact, sales, revenue, and profit goals for the restaurant were shattered
in its first year of operation. Patterson believes 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 time, and the term "irreconcilable differences" has been frequently
mentioned in their conversations. Patterson asks for a divorce, and his wife obliges.

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Chapter 35 Hypothetical Case 3 (cont'd)
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Seizer is furious. He is firmly convinced that 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. 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 he must either close the restaurant or cease and desist
from using the name Chimichonga Chime and the company's logo and from selling all franchise-related products within 30 days.

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Who wins: The ex-father-in-law or the ex-son-in-law?

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Chapter 35 Hypothetical Case 4
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Tailoring experts Frieda Oglesby, Rena Fitts, and Will Bertrand decide to go into business together. Their business, FitzWellby, is a
business that provides in-home measuring and fittings and even on-site stitching, for busy executives who don't have time to take
their clothing to tailor shops.

Since all three have the same skills, they plan to share the profits of the business equally. At first, Oglesby believes that their
business is unlikely to be sued for any reason—after all, they're just providing in-home services. Fitts points out that one of the
three could accidentally damage a client's personal property, or more likely, an expensive piece of clothing. Oglesby is quickly
convinced.

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Which type of partnership would be right for FitzWellby: general, limited, limited liability, cooperative, or joint venture? Explain
your response.

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