Chapter 5: Forms of Business Ownership
I. BASIC FORMS OF BUSINESS OWNERSHIP.
LEARNING GOAL 1
Compare the advantages and disadvantages of sole proprietorships.
A. About 800,000 new businesses are started in the U.S. each year.
B. How you form your business can make a difference in your long-term success.
C. The THREE MAJOR FORMS OF BUSINESS OWNERSHIP are:
1. A SOLE PROPRIETORSHIP is a business that is owned, and usually managed, by one person; it is the most common form.
2. A PARTNERSHIP is a legal form of business with two or more owners.
3. A CORPORATION is a legal entity with authority to act and have liability separate from its owners.
D. Each form of business ownership has its advantages and its disadvantages.
II. SOLE PROPRIETORSHIPS.
A. ADVANTAGES OF SOLE PROPRIETORSHIPS.
1. Ease of starting and ending the business. All you need is a permit from the local government.
2. Being your own boss. Working for yourself is exciting.
3. Pride of ownership. Sole proprietors have taken the risk and deserve the credit.
4. Leaving a legacy behind for future generations.
5. Retention of company profits. You don=t have to share profits with anyone.
6. No special taxes. Profits of the business are taxed as the personal income of the owner.
B. DISADVANTAGES OF SOLE PROPRIETORSHIPS.
1. UNLIMITED LIABILITY is the responsibility of business owners for all of the debts of the business.
2. Limited financial resources. Funds available are limited to the funds that the sole owner can gather.
3. Management difficulties. Many owners are not skilled at record keeping.
4. Overwhelming time commitment. The owner has no one with whom to share the burden.
5. Few fringe benefits. Fringe benefits can add up to 30% of a worker=s income.
6. Limited growth.
7. Limited life span. If the sole proprietor dies or leaves, the business ends.
LEARNING GOAL 2
Describe the differences between general and limited partnerships, and compare the advantages and disadvantages of partnerships.
A. A partnership is a legal form of business with two or more owners.
B. TYPES OF PARTNERSHIPS.
1. A GENERAL PARTNERSHIP is a partnership in which all owners share in operating the business and in assuming liability for the business=s debts.
2. A LIMITED PARTNERSHIP is a partnership with one or more general partners and one or more limited partners.
a. A GENERAL PARTNER is an owner (partner) who has unlimited liability and is active in managing the firm.
b. A LIMITED PARTNER is an owner who invests money in the business but does not have any management responsibility or liability for losses beyond the investment.
c. LIMITED LIABILITY is the responsibility of a businessí owners for losses only up to the amount they invest; limited partners and shareholders have limited liability.
3. MASTER LIMITED PARTNERSHIP (MLP) is a partnership that looks much like a corporation (in that it acts like a corporation and is traded on a stock exchange) but is taxed like a partnership and thus avoids the corporate income tax.
4. A LIMITED LIABILITY PARTNERSHIP (LLP) is a partnership that limits partners' risk of losing their personal assets to only their own acts and omissions and the acts and omissions of the people under their supervision.
5. UNIFORM PARTNERSHIP ACT (UPA).
a. All states except Louisiana have adopted the Uniform Partnership Act to replace laws relating to partnerships.
b. The UPA defines the THREE KEY ELEMENTS of any general partnership:
i. Common ownership.
ii. Shared profits and losses.
iii. The right to participate in managing the operations of the business.
C. ADVANTAGES OF PARTNERSHIPS.
1. More financial resources. Two or more people pool their money and credit.
2. Shared management and pooled/
complementary knowledge. Partners provide different skills and perspectives.
3. Longer survival. Partners are four times as likely to succeed as sole proprietorships.
4. No special taxes. All profits of partners are taxed as personal income of the owners.
D. DISADVANTAGES OF PARTNERSHIPS.
1. UNLIMITED LIABILITY.
a. Each general partner is liable for the debts of the firm, no matter who was responsible for causing those debts.
b. You are liable for your partners' mistakes as well as your own.
2. DIVISION OF PROFITS. Sharing profits can cause conflicts.
3. DISAGREEMENTS AMONG PARTNERS.
a. Disagreements can arise over division of authority, purchasing decisions, and so on.
b. Because of such potential conflicts, all terms of partnership should be spelled out IN WRITING to protect all parties.
4. DIFFICULT TO TERMINATE. For example: Who gets what and what happens next?
E. Many ventures avoid the disadvantages of these forms of ownership by forming corporations.
LEARNING GOAL 3
Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies.
A. A CONVENTIONAL (C) CORPORATION is a state-chartered legal entity with authority to act and have LIABILITY SEPARATE FROM ITS OWNERS.
1. The corporation=s owners (stockholders) are not liable for the debts of the corporation beyond the money they invest.
2. A corporation also enables many people to share in the ownership of a business without working there.
B. ADVANTAGES OF CORPORATIONS.
1. LIMITED LIABILITY.
a. Limited liability is probably the most significant advantage of corporations.
b. Limited liability means that the owners of a business are responsible for losses only up to the amount they invest.
2. MORE MONEY FOR INVESTMENT.
a. To raise money, a corporation sells ownership (stock) to anyone interested.
b. Corporations may also find it easier to obtain loans.
c. Corporations can also raise money from investors through issuing bonds.
a. Corporations have the ability to raise large amounts of money.
b. They can also hire experts in all areas of operation.
c. They can buy other corporations in other fields to diversity their risk.
d. Corporations have the size and resources to take advantage of opportunities anywhere in the world.
4. PERPETUAL LIFE: The death of one or more owners does not terminate the corporation.
5. EASE OF OWNERSHIP CHANGE. Selling stock changes ownership.
6. EASE OF DRAWING TALENTED EMPLOYEES. Corporations can offer benefits such as stock options.
7. SEPARATION OF OWNERSHIP FROM MANAGEMENT. Corporations can raise money from investors without getting them involved in management.
C. DISADVANTAGES OF CORPORATIONS.
1. EXTENSIVE PAPERWORK.
a. A corporation must prove all its expenses and deductions are legitimate.
b. A corporation must keep detailed records.
2. DOUBLE TAXATION.
a. Corporate income is taxed twice.
b. The corporation pays tax on income before it can distribute any to stockholders.
c. The stockholders pay tax on the income they receive from the corporation.
d. States often tax corporations more harshly than other enterprises.
3. TWO TAX RETURNS: A corporate owner must file both a corporate tax return and an individual tax return.
4. SIZE: Large corporations sometimes become inflexible and too tied down in red tape.
5. DIFFICULTY OF TERMINATION.
6. POSSIBLE CONFLICT WITH STOCKHOLDERS AND BOARD OF DIRECTORS. Since the board chooses the company=s officers, an entrepreneur can be forced out of the very company he or she founded.
7. INITIAL COST.
a. Incorporation may cost thousands of dollars and involve expensive lawyers and accountants.
b. There are less expensive ways of incorporating in certain states.
8. Many businesspeople feel the hassles of incorporation outweigh the advantages.
D. INDIVIDUALS CAN INCORPORATE.
1. By incorporating, individuals such as doctors and lawyers can save on taxes and receive other benefits of incorporation.
2. Small corporations do not share all the same advantages and disadvantages of large corporations.
3. It is usually wise to consult a lawyer when incorporating.
4. The average time needed to incorporate is approximately 30 days.
E. S CORPORATIONS.
1. An S CORPORATION is a unique government creation that looks like a corporation but is taxed like sole proprietorships and partnerships.
a. S corporations have shareholders, directors, and employees, but the profits are taxed as the personal income of the shareholders.
b. They also have the benefit of limited liability.
2. S CORPORATIONS MUST:
a. Have no more than 75 shareholders.
b. Have shareholders who are individuals or estates and are citizens or permanent residents of the U.S.
c. Have only one class of outstanding stock.
d. Not have more than 25% of income derived from passive sources (rents, royalties, interest, etc.)
3. The tax structure of an S corporation isn't attractive to all businesses.
a. The top personal income tax rate is almost four points higher than the highest corporation rate.
b. Fast-growing small businesses that don=t intend to pay dividends to owners often choose C corporation status to avoid the higher taxes.
c. Many slower-growing businesses have selected the S corporation form.
4. The benefits of S corporations change every time the tax rules change.
F. LIMITED LIABILITY COMPANIES.
1. A LIMITED‑LIABILITY COMPANY (LLC) is a company similar to an S corporation but without the special eligibility requirements.
2. The UNIFORM LIMITED LIABILITY COMPANY ACT was prepared for the National Conference of Commissioners on Uniform State Laws in an effort to provide uniform legislation regarding limited liability companies.
3. Advantages of LLCs:
a. Limited liability. Personal assets are protected.
b. Choice of taxation. LLCs can choose to be taxed as partnerships or as corporations.
c. Flexible ownership rules. LLCs do not have to comply with ownership restrictions as S corporations do.
d. Flexible distribution of profits and losses. Profit and losses donít have to be distributed in proportion to the money each person invests.
e. Operating flexibility. LLCs do not have the same reporting requirements as a corporation.
4. Disadvantages of LLCs: a. No stock. LLC ownership is nontransferable.
b. Limited life span. LLCs have to identify dissolution dates in the articles of organization.
c. Fewer incentives. LLCs canít deduct the cost of fringe benefits.
d. Taxes. LLC members must pay self-employment taxes on profits.
e. Paperwork. The paperwork required is more than what is required of sole proprietors.
5. The start-up cost for an LLC is approximately $2,500.
V. CORPORATION EXPANSION: MERGERS AND ACQUISITIONS.
LEARNING GOAL 4
Define and give examples of three types of corporate mergers, and explain the role of leveraged buyouts and taking a firm private.
A. The 1990s merger mania reached its peak in 2000.
1. In 1998 there was the $1.75 billion WorldCom/MCI merger.
2. The 1999 $75 billion Exxon/Mobil merger was topped by the $270 billion merger of AOL and Time Warner in 2000.
3. Most of the new deals involve companies trying to expand within their own fields.
4. A MERGER is the result of two firms forming one company.
5. An ACQUISITION is one companyís purchase of the property and obligations of another company.
B. three major types of corporate mergers.
1. VERTICAL MERGER is the joining of two companies involved in different stages of related businesses.
2. HORIZONTAL MERGER joins two firms in the same industry and allows them to diversify or expand their products.
3. CONGLOMERATE MERGER is the joining of firms incompletely unrelated industries thereby diversifying business operations.
C. Rather than merge or sell to another company, some corporations decide to maintain control of the firm internally.
1. Taking a firm private involves the efforts of a group of stockholders or management to obtain all the firm=s stock for themselves.
2. A LEVERAGED BUYOUT is an attempt by employees, management, or a group of investors to purchase an organization primarily through borrowing.
a. The funds borrowed are used to buy out the stockholders in the company.
b. Employees, managers, or group of investors then become the owners of the firm.
3. Merger mania has also involved foreign companies purchasing U.S. companies.
VI. SPECIAL FORMS OF BUSINESS OWNERSHIP.
In addition to the three basic forms of business ownership, the text discusses two special forms of ownership: franchises and cooperatives.
LEARNING GOAL 5
Outline the advantages and disadvantages of franchises and discuss the opportunities for diversity in franchising and the challenges of international franchising.
A. A FRANCHISE AGREEMENT is an arrangement whereby someone with a good idea for a business (the FRANCHISOR) sells the rights to use the business name and to sell a product or service (the FRANCHISE) to others (the FRANCHISEE) in a given territory.
1. Some people would like to own their own businesses but want more assurance of successC Franchising may be an alternative.
2. Franchising accounts for 50% of the national retail sales.
3. The most popular businesses for franchising are restaurants, retail stores, hotels and motels, and automotive parts and service centers.
B. ADVANTAGES OF FRANCHISES:
1. MANAGEMENT AND MARKETING ASSISTANCE, including an established product, help in choosing a location, and assistance in all phases of operation.
2. PERSONAL OWNERSHIP: You are still your own boss, although you must follow the rules, regulations, and procedures of the franchise.
3. NATIONALLY RECOGNIZED NAME: You get instant recognition and support.
4. FINANCIAL ADVICE AND ASSISTANCE.
a. Franchisees get assistance arranging financing and learning to keep records.
b. Some franchisors will even provide financing to potential franchisees.
5. LOWER FAILURE RATE.
a. Historically, the failure rate for franchises has been lower than that of other business ventures.
b. You should carefully research any franchise before investing.
C. DISADVANTAGES OF FRANCHISES.
1. LARGE START‑UP COSTS.
a. Most franchises will demand a fee to obtain the rights to the franchise.
b. Start-up costs can be as high as $2 million for a Krispy Kreme franchise.
2. SHARED PROFIT: The franchisor often demands a large share of the profits, or royalty, based on sales not profit.
3. MANAGEMENT REGULATION. a. Some franchisees may feel burdened by the company=s rules and regulations.
b. In recent years franchisees have been banding together to resolve their grievances with franchisors.
4. COATTAIL EFFECTS.
a. The actions of other franchisees have an impact on the franchise=s future growth and level of profitability, a phenomena known as a coattail effect.
b. Franchisees must also look out for competition from fellow franchisees.
5. RESTRICTIONS ON SELLING.
a. Many franchisees face restrictions in the reselling of their franchises.
b. Franchisors often insist on approving the new owner, who must meet their standards.
6. FRAUDULENT FRANCHISORS.
a. Most franchisors are not large systems; many are small, obscure companies.
b. There has been an increase in complaints to the FTC about franchisors that delivered little or nothing that they promised.
D. DIVERSITY IN FRANCHISING.
1. Only 24% of franchise owners are women.
2. The main factor restricting womenís ownership is money.
3. Some franchisors, such as Church=s Chicken, actively recruit women to be owners.
4. Women are becoming franchisors as well.
5. When women find it difficult to obtain financing to expanding their businesses, they often turn to finding franchisees to sidestep expansion costs.
6. Franchising opportunities fit the needs of many aspiring minority businesspersons.
7. Minority franchise ownership is not growing as fast as franchise ownership in general.
8. The Commerce Department=s Federal Minority Business Development Agency provides minorities with training in how to run franchises.
E. HOME‑BASED FRANCHISES.
1. Home-based businesses offer advantages but may leave owners with a feeling of isolation.
2. Home-based franchisees feel less isolated.
F. E-COMMERCE IN FRANCHISING.
1. Today Internet users worldwide are able to obtain franchises to open online retail stores.
2. Before signing up, however, you should check out the facts fully.
3. Many franchisees with existing brick-and-mortar stores are expanding online.
4. Many franchisors prohibit franchisee-sponsored websites, however, which can lead to conflicts between franchisors and franchisees. G. USING TECHNOLOGY IN FRANCHISING.
1. Franchisors are using technology to meet the needs of customers and franchisees.
2. Franchise websites can streamline communication with employees, customers, and vendors.
3. Using a website every franchisee has immediate access to every subject that involves the franchise operation.
H. FRANCHISING IN INTERNATIONAL MARKETS.
1. More than 450 of the 3,000 franchisors have outlets overseas. Canada is by far the most popular target because of proximity and language.
2. Franchisors find the costs of franchising high in these markets, but the costs are counterbalanced by less competition and rapidly expanding consumer base.
3. Newer, smaller franchises, such as Rug Doctor Pro and Merry Maid, are going international as well.
4. What makes international franchising successful are convenience and a predictable level of service and quality.
5. Franchisors must be careful to adapt to the region.
6. Foreign franchises are also expanding to the U.S.
LEARNING GOAL 6
Explain the role of cooperatives.
A. A COOPERATIVE is a business owned and controlled by the people who use itóproducers, consumers, or workers with similar needs who pool their resources for mutual gain.
1. There are 47,000 cooperatives in the U.S.
2. Members democratically control these businesses by electing a board of directors that hires professional management.
B. Some cooperatives are formed to give members MORE ECONOMIC POWER than they would have as individuals (i.e. farm cooperatives.)
1. The farm cooperative started with farmers joining together to get better prices for their food products.
2. The organizations expanded so that farm cooperatives now buy and sell other products needed on the farm.
3. In spite of debt and mergers, cooperatives are still a major force in agriculture today.
IX. WHICH FORM OF OWNERSHIP IS FOR YOU?
A. There are RISKS TO EVERY FORM of business ownership.
B. The miracle of free enterprise is that the freedom and incentives of capitalism make risks acceptable to many people.