business formation: choosing the form that fits - … · 6 business formation: choosing the form...

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6 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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©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?

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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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Business Ownership Options: The Big Four

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(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)

http://www.census.gov/prod/2008pubs/09statab/business.pdf

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Advantages and Disadvantages of Sole Proprietorships

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Advantages:Ease of Formation

Retention of Control

Pride of Ownership

Retention of Profits

Possible Tax Advantages

Disadvantages:Limited Financial Resources

Unlimited Liability

Limited ability to attract and maintain talented employees

Lack of Permanence

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Partnerships: Two Heads (and Bankrolls) Can Be Better Than One

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Advantages:Pooled Financial Resources

Shared Responsibilities

Ease of Formation

Tax Advantages

Disadvantages:Unlimited Liability

Disagreements

Difficulty in withdrawing from agreement

Lack of Continuity

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Partnerships: General vs. Limited

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General PartnershipsAll partners have the right to participate in the management of the firm and share in any profits/losses.

Limited PartnershipsAll partners contribute financially and share in the profits but the limited partner(s) cannot actively participate in management.

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

• Limited partners have limited liability

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Corporations: The Advantages and Disadvantages of Being an Artificial Person

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• 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.

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Corporations: The Advantages and Disadvantages of Being an Artificial Person

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Disadvantages:• Expense/complexity of

formation and operation

• Double Taxation

• Paperwork and Regulation

• Conflicts of Interest

Advantages:• Limited Liability

• Permanence

• Easy to Transfer Ownership

• Ability to Raise Capital

• Specialized Management

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Corporations: The Role of Board of Directors

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• 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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Other Types of Corporations: Characteristics

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© 2009 South-Western, a division of Cengage Learning 12

TYPE KEY ADVANTAGE LIMITATIONS

S 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

Statutory Close Corp.

• 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

Nonprofit Corp.

• Earnings are exempt from federal and state income taxes

• Members/directors have limited liability

• Contributions made by individuals are tax-deductible

• May have dues paying members but no stockholders

• Can’t distribute dividends• Can’t make political donations• Must keep accurate records to document tax-exemption

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Corporate Restructuring: Mergers & Acquisitions

• Mergers – two companies agree to a combination of equals

• Acquisitions – when one firm buys another

• Corporations look for:

Growth opportunitiesOperational efficienciesCompetitive advantages

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Types of Mergers & Acquisitions

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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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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

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The Limited Liability Company: The New Kid on the Block

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Advantages:• Limited Liability

• Tax Pass-Through

• Flexible Ownership

• Simplified Management and Operation

Disadvantages:• Franchise Taxes

• Foreign Status in other States

• State Law Differences

• Limited to Select Industries

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Franchising: Proven Methods for a Price

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• Not a form of ownership but an operation option.

Build-a-BearSubwayJiffy LubeMcDonald’s

• The franchisee uses the brand name, trademark and practices of the franchisor.

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Franchising: Proven Methods for a Price

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Advantages:Less Risk

Training and Support

Brand Recognition

Access to Funding

Disadvantages:Costs

Lack of Control

Negative Halo Effect

Growth Challenges

Restriction on Sale

Poor Execution

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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.

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Franchising in Today’s Economy

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(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)

http://www.entrepreneur.com/franchiseopportunities/index.html

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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

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Looking Back

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• 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?

business formation: choosing the form that fits - … · 6 business formation: choosing the form...

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