chapter 3 hospitalityoperatingstructures. © 2005 stephen c. barth p.c. and john wiley & sons,...

Chapter 3Chapter 3

HospitalityHospitality

OperatingOperating

StructuresStructures

© 2005 Stephen C. Barth P.C. and John Wiley & Sons, Inc.All Rights Reserved

Hospitality Operating StructuresHospitality Operating Structures

The Importance of Proper The Importance of Proper Organizational StructureOrganizational Structure

Common Hospitality Organizational Common Hospitality Organizational StructuresStructures

The Hospitality FranchiseThe Hospitality Franchise


In This Chapter, You Will Learn:In This Chapter, You Will Learn:

1.1. The various organizational business The various organizational business structures used in the hospitality industry.structures used in the hospitality industry.

2.2. Some advantages and disadvantages of Some advantages and disadvantages of alternative organizational structures.alternative organizational structures.

3.3. The responsibilities and obligations created The responsibilities and obligations created by an agency relationship.by an agency relationship.

4.4. The unique business relationship involved in The unique business relationship involved in franchising.franchising.

5.5. How franchise agreements affect the How franchise agreements affect the purchase, operation, and sale of a franchised purchase, operation, and sale of a franchised hospitality operation. hospitality operation.


The Importance of Proper The Importance of Proper Organizational StructureOrganizational Structure

Ease of formation and maintenanceEase of formation and maintenance LiabilityLiability TaxationTaxation Terminating or selling the businessTerminating or selling the business


Common Hospitality Common Hospitality Organizational StructuresOrganizational Structures

Sole proprietorshipSole proprietorship General partnershipGeneral partnership Limited partnership (LP)Limited partnership (LP) C corporationC corporation S corporationS corporation Limited liability company (LLC)Limited liability company (LLC)



Legalese:Legalese:

Sole Proprietorship Sole Proprietorship -A business -A business organization in which one person organization in which one person owns owns and, often, operates the and, often, operates the business.business.



Legalese:Legalese:

General Partnership General Partnership - A business - A business organization in which two or more organization in which two or more owners agree to share the profits of owners agree to share the profits of

the business, but are also jointly the business, but are also jointly and and severally liable for its debts.severally liable for its debts.



Legalese:Legalese:

Limited Partnership Limited Partnership - A business - A business organization organization with two classes of owners. with two classes of owners. The limited The limited partner invests in the partner invests in the business, but may not business, but may not exercise control exercise control over its operation, in return over its operation, in return for protection for protection from liability. The general or from liability. The general or managing managing partner assumes full control of the partner assumes full control of the business business operation, but can also be held operation, but can also be held liable for liable for any debts the operation incurs.any debts the operation incurs.



Legalese:Legalese:

General Partner General Partner - The entity in a - The entity in a limited limited partnership relationship who partnership relationship who makes the makes the management decisions management decisions and can be held and can be held responsible for all responsible for all debts and legal debts and legal claims against the claims against the business. business.



Legalese:Legalese:

Limited Partner Limited Partner -The entity in a -The entity in a limited limited partnership relationship who partnership relationship who is liable is liable only to the extent of his or only to the extent of his or her her investment. Limited partners investment. Limited partners have no have no right to manage the right to manage the partnership. partnership.


Analyze the Situation 3.1Analyze the Situation 3.1

Nicholas Kostanty formed a limited Nicholas Kostanty formed a limited partnership with his father-in-law, Ray partnership with his father-in-law, Ray Sweeney, to open an upscale French Sweeney, to open an upscale French restaurant in a midwestern town. Mr. restaurant in a midwestern town. Mr. Kostanty was the general partner and Kostanty was the general partner and owned 75 percent of the business. Mr. owned 75 percent of the business. Mr. Sweeney, with 25 percent ownership, was Sweeney, with 25 percent ownership, was the limited partner and invested $100,000. the limited partner and invested $100,000. After one year, difficulties in the After one year, difficulties in the restaurant's operation caused business to restaurant's operation caused business to drop off, and Mr. Kostanty called Mr. drop off, and Mr. Kostanty called Mr. Sweeney for advice.Sweeney for advice.



After hearing of the difficulties, and After hearing of the difficulties, and concerned with the security of his concerned with the security of his investment, Mr. Sweeney traveled from investment, Mr. Sweeney traveled from Arizona to Indiana to visit the operation. Arizona to Indiana to visit the operation. Upon observing the operation for two Upon observing the operation for two days, the two partners decided to launch a days, the two partners decided to launch a large and expensive television ad large and expensive television ad campaign to increase flagging sales. Mr. campaign to increase flagging sales. Mr. Sweeney designed the campaign with the Sweeney designed the campaign with the help of Seelhoff Advertising and Video, a help of Seelhoff Advertising and Video, a local advertising agency specializing in local advertising agency specializing in television commercials.television commercials.



Despite an immediate increase in Despite an immediate increase in sales, volume continued to decline, and sales, volume continued to decline, and finally, three months after the ad campaign finally, three months after the ad campaign was launched, the restaurant closed its was launched, the restaurant closed its doors. Total debts at the time the restaurant doors. Total debts at the time the restaurant closed equaled $400,000, with assets of the closed equaled $400,000, with assets of the partnership only being $200,000. Included partnership only being $200,000. Included in the debt was $150,000 owed to the in the debt was $150,000 owed to the advertising agency. The agency sought advertising agency. The agency sought payment directly from Mr. Sweeney.payment directly from Mr. Sweeney.



Mr. Sweeney claimed that his Mr. Sweeney claimed that his liability was limited to the liability was limited to the $100,000 he had previously $100,000 he had previously invested in the business, and invested in the business, and refused to pay any additional refused to pay any additional money. The Seelhoff Advertising money. The Seelhoff Advertising Agency sued the limited Agency sued the limited partnership, as well as Nicholas partnership, as well as Nicholas Kostanty and Ray Sweeney Kostanty and Ray Sweeney individually.individually.



1.1. By hiring the advertising agency, By hiring the advertising agency, did Mr. Sweeney forfeit his limited did Mr. Sweeney forfeit his limited partner status?partner status?

2.2. Is Mr. Sweeney liable for the Is Mr. Sweeney liable for the outstanding debts of the limited outstanding debts of the limited partnership?partnership?



Legalese:Legalese:

Corporation Corporation -A group of individuals -A group of individuals granted a charter, legally recognizing granted a charter, legally recognizing

them as a separate entity with them as a separate entity with rights rights and liabilities distinct from and liabilities distinct from those of its those of its members. members.



Legalese:Legalese:

Dividend Dividend - A portion of profits - A portion of profits received by received by a shareholder, usually a shareholder, usually in relation to his in relation to his or her ownership of or her ownership of a corporation.a corporation.



Legalese:Legalese:

S Corporation S Corporation - A type of business - A type of business entity entity that offers liability that offers liability protection to its protection to its owners, and is owners, and is exempt from corporate exempt from corporate taxation taxation on its profits. Some on its profits. Some restrictions restrictions limit the circumstances limit the circumstances under under which it can be formed.which it can be formed.



Legalese:Legalese:

Limited Liability Company (LLC) Limited Liability Company (LLC) - A type of - A type of business organization that protects business organization that protects

the the owners from liability for debts owners from liability for debts incurred by incurred by the business, without the the business, without the need for some of need for some of the formal the formal incorporation requirements. The incorporation requirements. The federal federal government does not tax the profits government does not tax the profits of of LLC’s; however, some states do while LLC’s; however, some states do while others do not.others do not.



Legalese:Legalese:

Agent Agent - A person authorized to act for - A person authorized to act for or or to represent another, usually to represent another, usually referred referred to as the principal.to as the principal.



Legalese:Legalese:

Respondeat Superior Respondeat Superior - Literally; “let - Literally; “let the the master respond,” a legal theory master respond,” a legal theory that that holds the employer (master) holds the employer (master)

responsible for the acts of the responsible for the acts of the employee.employee.



Legalese:Legalese:

Independent Contractor Independent Contractor - A person or - A person or entity that contracts with entity that contracts with

another toanother to perform a particular perform a particular task, but whose task, but whose work is not directed work is not directed or controlled by or controlled by the hiring party. the hiring party.



Legalese:Legalese:

Franchise Franchise - A contract between a parent - A contract between a parent company (franchisor) and an operating company (franchisor) and an operating company (franchisee) to allow the company (franchisee) to allow the franchisee franchisee to run a business with the to run a business with the brand name of the brand name of the parent company, as parent company, as long as the terms of the long as the terms of the contract contract concerning methods of operation concerning methods of operation are are followed.followed.



After five years of effort, you After five years of effort, you develop a unique style of roasting pork develop a unique style of roasting pork that is extremely popular in your that is extremely popular in your hometown. You own and operate five hometown. You own and operate five units called Porkies that sell this units called Porkies that sell this product. Each unit costs $175,000 to product. Each unit costs $175,000 to develop. Total sales of each unit develop. Total sales of each unit average $600,000, with a net profit average $600,000, with a net profit margin of 10 percent per unit. margin of 10 percent per unit.



A friend of yours discusses your A friend of yours discusses your success with you, and suggests the success with you, and suggests the possibility of opening five new stores in possibility of opening five new stores in his or her hometown. Your friend wants his or her hometown. Your friend wants to know what you would charge to sell to know what you would charge to sell your recipe and your standard your recipe and your standard operating procedures (SOP) manual, as operating procedures (SOP) manual, as well as the use of the name Porkies.well as the use of the name Porkies.



1.1. How would you determine a fair price How would you determine a fair price for your experience?for your experience?

2.2. If your friend is successful, causing the If your friend is successful, causing the name of Porkies to be even better name of Porkies to be even better known, thus resulting in greater demand known, thus resulting in greater demand for franchises, should your friend share for franchises, should your friend share in future revenue from franchise sales?in future revenue from franchise sales?

3.3. What are the ethical issues at play What are the ethical issues at play here?here?



Legalese:Legalese:

License License - Legal permission to do a - Legal permission to do a certain certain thing or operate in a certain thing or operate in a certain way.way.



Legalese:Legalese:

License Agreement License Agreement - A legal - A legal document document that details the that details the specifics of a license.specifics of a license.



Legalese:Legalese:

Licensor Licensor - One who grants a license.- One who grants a license.



Legalese:Legalese:

Licensee Licensee - One who is granted a - One who is granted a license.license.



Legalese:Legalese:

Disclosure Disclosure - To reveal fully and - To reveal fully and honestly.honestly.


Search the Web 3.1Search the Web 3.1

Log on to the Internet and enter Log on to the Internet and enter www.ftc.govwww.ftc.gov..

1.1. Select: Business Guidance.Select: Business Guidance.

2.2. Select: Franchise and Business Select: Franchise and Business Opportunities.Opportunities.

3.3. Select: Franchise Rule Text.Select: Franchise Rule Text.

4.4. Read the entire FTC Franchise Rule (16 Read the entire FTC Franchise Rule (16 CFR Part 436), to familiarize yourself with CFR Part 436), to familiarize yourself with its requirements, then write a one-page its requirements, then write a one-page bulleted summary of the rule.bulleted summary of the rule.


Franchise RuleFranchise Rule

Basic disclosuresBasic disclosures Earnings claimsEarnings claims Advertised claimsAdvertised claims Franchise agreementsFranchise agreements RefundsRefunds Contradictory claimsContradictory claims


Franchise Offering CircularFranchise Offering Circular

Many states treat sales of franchises Many states treat sales of franchises like securities.like securities.

Must file circular of record before Must file circular of record before selling in the state.selling in the state.


Franchise AgreementFranchise Agreement

Details the rights and responsibilities Details the rights and responsibilities of the franchisor and the franchisee.of the franchisor and the franchisee.


Operating a FranchiseOperating a Franchise

Encroachment / impact.Encroachment / impact. Purchasing requirements.Purchasing requirements. Operations manual changes.Operations manual changes. Renewal clauses.Renewal clauses. Noncompete clauses.Noncompete clauses.



In 2000, Robert Thornburg signs In 2000, Robert Thornburg signs a franchise agreement with Starbelt a franchise agreement with Starbelt Hotels to operate a full-service hotel Hotels to operate a full-service hotel under the Starbelt name. His under the Starbelt name. His franchise agreement includes a franchise agreement includes a clause that prevents Starbelt from clause that prevents Starbelt from granting additional Starbelt granting additional Starbelt franchises in Mr. Thornburg's market franchises in Mr. Thornburg's market area without an impact study. area without an impact study.



In 2005, Starbelt develops a In 2005, Starbelt develops a second hotel brand that targets upscale second hotel brand that targets upscale travelers who do not desire the meeting travelers who do not desire the meeting rooms, full-service restaurants, and rooms, full-service restaurants, and indoor pools that define the Starbelt indoor pools that define the Starbelt brand. The new hotels are called brand. The new hotels are called Moonbelts, and the franchisees who Moonbelts, and the franchisees who purchase this brand are connected to purchase this brand are connected to the same national reservation system the same national reservation system as those franchisees in the Starbelt as those franchisees in the Starbelt brand. brand.



Starbelt maintains a separate 800-Starbelt maintains a separate 800-number for each brand. However, a number for each brand. However, a guest may book either hotel type with a guest may book either hotel type with a call to either 800-number. The ADR call to either 800-number. The ADR (average daily rate) for a new Moonbelt (average daily rate) for a new Moonbelt hotel equals that of the older Starbelt hotel equals that of the older Starbelt hotels. hotels.

In 2010, Mr. Thornburg finds that a In 2010, Mr. Thornburg finds that a franchisor-owned Moonbelt hotel is to franchisor-owned Moonbelt hotel is to be built across the street from his hotel. be built across the street from his hotel.


Analyze the Situation 3.3Analyze the Situation 3.3 He protests that many of his customers will He protests that many of his customers will

find the Moonbelt hotel desirable, and that his find the Moonbelt hotel desirable, and that his franchisor has violated the terms of the franchisor has violated the terms of the franchise agreement by erecting a competing franchise agreement by erecting a competing hotel in his territory. Mr. Thornburg requests a hotel in his territory. Mr. Thornburg requests a copy of the impact study he feels should have copy of the impact study he feels should have been produced by the franchisor. Starbelt been produced by the franchisor. Starbelt Hotels maintains that Mr. Thornburg has Hotels maintains that Mr. Thornburg has protection only against other Starbelt hotels, protection only against other Starbelt hotels, and since Moonbelt targets a different clientele, and since Moonbelt targets a different clientele, no protection exists, nor should an impact no protection exists, nor should an impact study have been performed.study have been performed.



1.1. Has Starbelt violated the terms of Has Starbelt violated the terms of the franchise agreement?the franchise agreement?

2.2. What steps might Mr. Thornburg What steps might Mr. Thornburg take to protect his business?take to protect his business?



Legalese:Legalese:

Tying Arrangement Tying Arrangement - An agreement, - An agreement, often often illegal, requiring that, as a illegal, requiring that, as a precondition precondition of purchasing or of purchasing or obtaining services, obtaining services, other services other services must be purchased and must be purchased and must be must be purchased through the seller.purchased through the seller.



Legalese:Legalese:

Noncompete Agreement Noncompete Agreement - A contractual - A contractual agreement between two parties in agreement between two parties in

a a business relationship in which one business relationship in which one party, party, upon termination of the upon termination of the business business relationship, agrees not to relationship, agrees not to compete within compete within a designated a designated geographic area or for a geographic area or for a designated designated period of time.period of time.



Lo Vin Do was an immigrant Lo Vin Do was an immigrant from Southeast Asia. He spent 10 from Southeast Asia. He spent 10 years in the United States operating years in the United States operating a small restaurant that served a small restaurant that served lunches, dinners, and carryout lunches, dinners, and carryout baked goods. Later, he bought a baked goods. Later, he bought a franchise operation that sells franchise operation that sells European-style, fresh-baked breads. European-style, fresh-baked breads.



A clause in the franchise agreement A clause in the franchise agreement signed by Mr. Do prohibited, “...the signed by Mr. Do prohibited, “...the operation, by Mr. Do, of a similar operation, by Mr. Do, of a similar business...,” within a 10-mile radius for a business...,” within a 10-mile radius for a period of five years if the franchise period of five years if the franchise agreement was terminated for any agreement was terminated for any reason. reason.

Mr. Do established the franchise as Mr. Do established the franchise as a limited partnership. The business was a limited partnership. The business was marginally successful at first, but two marginally successful at first, but two years later declared bankruptcy. years later declared bankruptcy.



Mr. Do closed the operation and Mr. Do closed the operation and returned all confidential operating returned all confidential operating materials to the franchisor. materials to the franchisor.

Afterward, Mr. Do, operating Afterward, Mr. Do, operating as a sole proprietor, again opened as a sole proprietor, again opened a small, table service restaurant a small, table service restaurant serving Vietnamese cuisine and serving Vietnamese cuisine and French pastry products. French pastry products.



This restaurant was located This restaurant was located approximately three miles from his approximately three miles from his previous restaurant. The franchisor previous restaurant. The franchisor contacted Mr. Do stating that he contacted Mr. Do stating that he must cease operation of the must cease operation of the restaurant/bakery or face restaurant/bakery or face litigation.litigation.



1.1. Did Mr. Do violate the terms of the Did Mr. Do violate the terms of the franchise agreement?franchise agreement?



Legalese:Legalese:

Right of First Refusal Right of First Refusal - A clause in a - A clause in a contractual agreement between two contractual agreement between two parties in a business relationship in parties in a business relationship in which which one party, upon termination of one party, upon termination of the the business relationship, can exercise business relationship, can exercise the the right to buy the interest of the right to buy the interest of the other party other party before those rights can before those rights can be offered for salebe offered for sale to another.to another.


What Would You Do?What Would You Do?Assume you are responsible for approving Assume you are responsible for approving commercial loans at a bank where you are the commercial loans at a bank where you are the senior lending official. You are approached by senior lending official. You are approached by two hospitality management college graduates, two hospitality management college graduates, each with three years’ management experience each with three years’ management experience acquired after they had completed their acquired after they had completed their studies. They are seeking a loan slightly in studies. They are seeking a loan slightly in excess of $1 million to establish a restaurant in excess of $1 million to establish a restaurant in the community. The funds will be used to lease the community. The funds will be used to lease land, facilities, and equipment, as well as for land, facilities, and equipment, as well as for renovation, inventory, salaries, and other start-renovation, inventory, salaries, and other start-up costs.up costs.


What Would You Do?What Would You Do?

1.1. Will the organizational structure Will the organizational structure selected by the partners have an selected by the partners have an impact on your decision to extend the impact on your decision to extend the loan?loan?

2.2. What other factors would influence What other factors would influence your decision?your decision?

3.3. Would it make a difference to you if the Would it make a difference to you if the partners were requesting the loan to partners were requesting the loan to complete a franchise agreement with complete a franchise agreement with an established and successful an established and successful franchisor?franchisor?


What Would You Do?What Would You Do?

4.4. Would you want to review the Would you want to review the specifics of the franchise offering specifics of the franchise offering circular? Would you want to review circular? Would you want to review the franchise agreement?the franchise agreement?

5.5. What additional information might you What additional information might you request if the partners were seeking request if the partners were seeking the loan to operate as an independent the loan to operate as an independent restaurant? Would it matter if the loan restaurant? Would it matter if the loan were for an existing restaurant, as were for an existing restaurant, as opposed to a new start-up?opposed to a new start-up?


Rapid ReviewRapid Review

1.1. Identify those organizational Identify those organizational structures that result in paying income structures that result in paying income taxes based on distributed, as taxes based on distributed, as compared to earned, profits. Explain compared to earned, profits. Explain the advantages of each approach.the advantages of each approach.

2.2. Explain the phrase Explain the phrase respondeat respondeat superiorsuperior, in terms of liability and , in terms of liability and organizational structure. Describe a organizational structure. Describe a real hospitality situation in which the real hospitality situation in which the phrase takes on meaning.phrase takes on meaning.



3.3. Compose a letter to a potential lender addressing Compose a letter to a potential lender addressing only the issue of why the organizational structure only the issue of why the organizational structure you have selected for your new business group you have selected for your new business group makes it advantageous for the lender to grant makes it advantageous for the lender to grant you the loan you have requested.you the loan you have requested.

4.4. State the defining characteristics of six types of State the defining characteristics of six types of organizational structures used in the hospitality organizational structures used in the hospitality industry as they relate to:industry as they relate to:

TaxesTaxes LiabilityLiability FinancingFinancing Transfer of ownershipTransfer of ownership



5.5. List six areas of disclosure addressed List six areas of disclosure addressed by the FTC Franchise Rule. Select one by the FTC Franchise Rule. Select one of these areas and explain why you of these areas and explain why you think it is important.think it is important.

6.6. Using the World Wide Web, locate the Using the World Wide Web, locate the case of a recent lawsuit pitting a case of a recent lawsuit pitting a franchisor against his or her franchise franchisor against his or her franchise company. Discuss the merits of the company. Discuss the merits of the lawsuit. (Hint: Try www.findlaw.com).lawsuit. (Hint: Try www.findlaw.com).



7.7. Contrast five advantages and five Contrast five advantages and five disadvantages of operating a restaurant disadvantages of operating a restaurant or hotel as a franchisee, compared to or hotel as a franchisee, compared to operating as an independent.operating as an independent.

8.8. Assume you own a restaurant that is Assume you own a restaurant that is successful in part because of a signature successful in part because of a signature menu item with a secret recipe. Prepare menu item with a secret recipe. Prepare a noncompete agreement for a chef you a noncompete agreement for a chef you are hiring that you feel would be fair to are hiring that you feel would be fair to both of you.both of you.

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