Chapter 6: BUSINESS FORMATION

1. Chapter 6: BUSINESS FORMATION Choosing the Form that Fits © 2009 South-Western, a division of Cengage Learning

2. LOOKING AHEAD • How are sole proprietorships and partnerships different? How are they different than corporations? • Why are corporations the most dominant form of business? • What are the different types of corporations and how are they different? • What are mergers & acquisitions? • What is the goal of mergers and acquisitions? • Why have limited liability companies become popular? • What are the advantages and disadvantages of franchising? © 2009 South-Western, a division of Cengage Learning

3. CHOICES, CHOICES, CHOICES • Form of ownership affects: • Operation • Start-up Costs • Profit Distribution • Taxes The form of ownership of a business is a big decision. • The “Big Three” is Becoming the “Big Four”: • Sole Proprietorship • Partnership • Corporation • Limited Liability Company © 2009 South-Western, a division of Cengage Learning

4. 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 SOLE PROPRIETORSHIP: BUSINESS AT ITS MOST BASIC © 2009 South-Western, a division of Cengage Learning

5. MOST COMMON TYPES OF SOLE PROPRIETORSHIPS © 2009 South-Western, a division of Cengage Learning Source for Table: “Sole Proprietorship Returns”, by Kevin Pierce Statistics of Income Bulletin, Summer, 2005, Figure A, p.9; website: http://www.irs.gov/pub/irs-soi/03solp.pdf )

6. BUSINESS FORMS: COMPARING THE NUMBERS Total Number of Businesses by Form of Ownership (Millions) Total Net Income by Form of Ownership ($Billions) © 2009 South-Western, a division of Cengage Learning

7. Advantages: Pooled Financial Resources Shared Responsibilities Ease of Formation Tax Advantages Disadvantages: Unlimited Liability Disagreements Difficulty in withdrawing from agreement Lack of Continuity PARTNERSHIPS: TWO HEADS CAN BE BETTER THAN ONE © 2009 South-Western, a division of Cengage Learning

8. LIMITED PARTNERSHIPS 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. © 2009 South-Western, a division of Cengage Learning

9. GENERAL VS LIMITED PARTNERSHIPS • 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. © 2009 South-Western, a division of Cengage Learning

10. FAMILY LIMITED PARTNERSHIPS • Parents as general partners • Children as limited partners • Parents transfer assets to limited partners while still maintaining control, this strategy: • Reduces gift and inheritance taxes • Protects family assets from creditors and lawsuits • But watch out for the IRS – Family Limited Partnerships can attract tax auditors! © 2009 South-Western, a division of Cengage Learning

11. CORPORATIONS: AN ARTIFICIAL REALITY • 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. © 2009 South-Western, a division of Cengage Learning

12. Advantages: Limited Liability Permanence Easy to Transfer Ownership Ability to Raise Capital Specialized Management Disadvantages: Expense/complexity of formation and operation Double Taxation Paperwork and Regulation Conflicts of Interest CORPORATIONS © 2009 South-Western, a division of Cengage Learning

13. OTHER TYPES OF CORPORATIONS: SAME BUT DIFFERENT • S Corporation • Closed Corporation • Non-profit Corporation © 2009 South-Western, a division of Cengage Learning

14. COMPARING TYPES OF CORPORATIONS © 2009 South-Western, a division of Cengage Learning

15. Advantages: Limited Liability Tax Pass-Through Simplified Management and Operation Flexible Ownership Disadvantages: Franchise Taxes Foreign Status in other States State Law Differences Limited to Select Industries LIMITED LIABILITY COMPANY: THE NEW KID ON THE BLOCK © 2009 South-Western, a division of Cengage Learning

16. COMPARING BUSINESS FORMS HIGH DEGREE OF PERSONAL LIABILITY LOW Sole Proprietorships Partnerships Corporations LOW DEGREE OF COMPLEXITY AND PERPETUITY HIGH © 2009 South-Western, a division of Cengage Learning

17. CORPORATE RESTRUCTURING Corporations look for: • Growth opportunities • Operational efficiencies • Competitive advantages Acquisitions – when one firm buys another. Mergers – two companies agree to a combination of equals. © 2009 South-Western, a division of Cengage Learning

18. TYPES OF MERGERS AND ACQUISITIONS © 2009 South-Western, a division of Cengage Learning

19. FRANCHISING: PROVEN METHODS FOR A PRICE • Not a form of ownership but an operation option. • Subway • Jiffy Lube • 7-Eleven • McDonalds • The franchisee uses the brand name, trademark and practices of the franchisor. © 2009 South-Western, a division of Cengage Learning

20. 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 FRANCHISING Ben & Jerry franchises its PartnerShops to non-profit corporations. © 2009 South-Western, a division of Cengage Learning

21. LOOKING BACK • What are the pros and cons of operating a business as a sole proprietorship? • What are the basic features of general partnerships, limited partnerships, and limited liability partnerships? • Why have corporations become the dominant form of business ownership? • How do S corporations, statutory closed corporations and nonprofit corporations differ from general corporations, and from each other? • How does a corporation restructure through mergers and acquisitions? • Why have limited liability companies become increasingly popular? • What are the advantages and disadvantages of franchising? © 2009 South-Western, a division of Cengage Learning