BUSN 3rd kelly mcgowen chapter6

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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.


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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?
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©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.

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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

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©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.

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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:

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©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.

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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

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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.

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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

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©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.

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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.

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©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.

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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.

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Limited Liability Partnership –
all partners are actively
involved but they have some
form of limited liability. The
amount of liability differs
per state.

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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.

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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.

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Business Formation: Choosing the Form that Fits

Corporations: The Advantages and Disadvantages of
Being an Artificial Person

Advantages:
• Limited Liability
• Permanence

• Easy to Transfer Ownership
• Ability to Raise Capital
• Specialized Management

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Disadvantages:
• Expense/complexity of
formation and operation
• Double Taxation
• Paperwork and Regulation
• Conflicts of Interest

©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.

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Business Formation: Choosing the Form that Fits

Corporations: The Role of Board of Directors

• Oversee the operation of corporation and protect investors’
interest
• Establish mission and set objectives
• Rarely get involved in day-to-day management
• Responsible for monitoring the performance of the corporate
officers

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©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.

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Business Formation: Choosing the Form that Fits

Other Types of Corporations: Same but Different

• S Corporation
• Closed Corporation
• Nonprofit Corporation

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©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.

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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

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©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.

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Business Formation: Choosing the Form that Fits

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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

© 2009 South-Western,
a division of Cengage Learning
Nonprofit
Corp.

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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.

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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

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©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.

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Business Formation: Choosing the Form that Fits

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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

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©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.

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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.

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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.

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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

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• State Law Differences
• Limited to Select
Industries

©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.

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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.

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©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.

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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.
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©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.

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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.

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©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.

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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.

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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, accessed
February 1, 2009

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©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.

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