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Understanding Business, 6/e
William G. Nickels
James M. McHugh
Susan M. McHugh
Chapter 5: Forms of Business Ownership
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eLearning Session

The PROFILE at the beginning of this chapter is "Getting to Know RACHEL BELL and SARA SUTTON of JOBDIRECT.COM." Bell and Sutton’s firm developed from a partnership into a growing corporation by taking advantage of the Internet.

  1. BASIC FORMS OF BUSINESS OWNERSHIPPower Point Presentation.

    2. Compare the advantages and disadvantages of sole proprietorships.

    1. How you form your business can make a difference in your long-term success.
    2. The THREE MAJOR FORMS OF BUSINESS OWNERSHIP are:
      1. A SOLE PROPRIETORSHIP is an organization that is owned, and usually managed, by one person; it is the most common form.
      2. A PARTNERSHIP is a legal form of business co-owned by two or more owners.
      3. A CORPORATION is a legal entity with authority to act and have liability separate from its owners.
    3. Each form of business ownership has its advantages and its disadvantages. Concept Check CONCEPT CHECK
  2. SOLE PROPRIETORSHIPS.
    1. ADVANTAGES OF SOLE PROPRIETORSHIPSKey Term .
      1. Ease of starting and ending the business.
      2. Being your own boss.
      3. Pride of ownership
      4. Leaving a legacy.
      5. Retention of profit.
      6. No special taxes.
    2. DISADVANTAGES OF SOLE PROPRIETORSHIPS.
      1. UNLIMITED LIABILITY means that any debts or damages incurred by the business are your debts and you must pay them.
      2. Limited financial resources.
      3. Management difficulties.
      4. Overwhelming time commitment.
      5. Few fringe benefits.
      6. Limited growth.
      7. Limited life span.
  3. PARTNERSHIPSPower Point Presentation.

    4. Describe the differences between general and limited partnerships and compare the advantages and disadvantages of partnerships.

    1. A partnership is a legal form of business with two or more owners.
    2. TYPES OF PARTNERSHIPS.
      1. GENERAL PARTNERSHIP: a partnership in which all owners share in operating the business and in assuming liability for the business’s debts.
      2. LIMITED PARTNERSHIP: a partnership with one or more general partners and one or more limited partners.
        1. A GENERAL PARTNER is an owner who has unlimited liability and is active in managing the firm.
        2. A LIMITED PARTNER risks an investment in the firm, but enjoys limited liability and cannot legally help manage the company.
        3. LIMITED LIABILITY means that limited partners are not responsible for the debts of the business beyond the amount of their investment. Concept Check CONCEPT CHECK
      3. MASTER LIMITED PARTNERSHIP is a new form of partnership that acts like a corporation and is traded on the stock exchange, but is taxed like a partnership avoiding the corporate income tax.
    3. UNIFORM PARTNERSHIP ACT (UPA).
      1. All states except Louisiana have adopted the Uniform Partnership Act to replace laws relating to partnerships.
      2. The UPA defines the THREE KEY ELEMENTS of any general partnership:
        1. Common ownership.
        2. Shared profits and losses.
        3. The right to participate in managing the operations of the business.
    4. ADVANTAGES OF PARTNERSHIPS.
      1. More financial resources.
      2. Shared management and pooled knowledge.
      3. Longer survival.
    5. DISADVANTAGES OF PARTNERSHIPS.
      1. UNLIMITED LIABILITY.
        1. Each general partner is liable for the debts of the firm, no matter who was responsible for causing those debts.
        2. You are liable for your partners’ mistakes as well as your own.
        3. A LIMITED LIABILITY PARTNERSHIP (LLP) limits partners’ risk to only their own acts and omissions and those of the people under their supervision.
      2. DIVISION OF PROFITS.
      3. DISAGREEMENTS AMONG PARTNERS.
        1. Disagreements can arise over division of authority, purchasing decisions, and division of profit.
        2. Because of such potential conflicts, all terms of partnership should be spelled out IN WRITING to protect all parties.
      4. DIFFICULT TO TERMINATEConcept Check CONCEPT CHECK .
    6. Many businesspeople try to avoid the disadvantages of the sole proprietorship and partnership by forming corporations.
  4. CORPORATIONSPower Point Presentation.

    5. Compare the advantages and disadvantages of corporations and summarize the differences between C corporations, S corporations, and limited liability companies.

    1. 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.
    2. ADVANTAGES OF CORPORATIONS.
      1. MORE MONEY FOR INVESTMENT.
        1. To raise money, a corporation sells ownership (stock) to anyone interested.
        2. Corporations may also find it easier to obtain loans.
      2. LIMITED LIABILITY.
        1. Limited liability is probably the most significant advantage of corporations.
        2. Limited liability means that the owners of a business are responsible for losses only up to the amount they invest.
      3. SIZE.
        1. Corporations have the ability to raise large amounts of money.
        2. They can also hire experts in all areas of operation.
        3. They can buy other corporations in other fields to diversity their risk.
        4. 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.
      6. EASE OF DRAWING TALENTED EMPLOYEES.
      7. SEPARATION OF OWNERSHIP FROM MANAGEMENT.
        1. Owners/shareholders are separate from the managers and employers.
        2. The owners thus have some say in who runs the corporation, but no control.
    3. DISADVANTAGES OF CORPORATIONS.
      1. INITIAL COST.
        1. Incorporation may cost thousands of dollars and involve expensive lawyers and accountants.
        2. There are less expensive ways of incorporating in certain states.
      2. EXTENSIVE PAPERWORK.
        1. A corporation must prove all its expenses and deductions are legitimate.
        2. A corporation must keep detailed records.
      3. TWO TAX RETURNS—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. DOUBLE TAXATION.
        1. Corporate income is taxed twice.
        2. The corporation pays tax on income before it can distribute any to stockholders.
        3. The stockholders pay tax on the income they receive from the corporation.
        4. States often tax corporations more harshly than other enterprises.
      7. POSSIBLE CONFLICT WITH BOARD OF DIRECTORS.
        1. Since the board chooses the company’s officers, an entrepreneur can be forced out of the very company he founded.
        2. Many businesspeople feel the hassles of incorporation outweigh the advantages.
    4. 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.
    5. S CORPORATIONSPower Point Presentation.
      1. An S CORPORATION is a unique government creation that looks like a corporation, but is taxed like sole proprietorships and partnerships.
        1. S corporations have shareholders, directors, and employees, but the profits are taxed as the personal income of the shareholders.
        2. They also have the benefit of limited liability. Key Term
      2. S CORPORATIONS MUST:
        1. Have no more than 75 shareholders.
        2. Have shareholders who are individuals or estates and are citizens or permanent residents of the U.S.
        3. Have only one class of outstanding stock.
        4. Not have more than 25% of income derived from passive sources (rents, royalties, interest, etc.)
      3. The tax structure of S corporations isn’t attractive to all businesses.
        1. The top tax rate for S corporations is almost five points higher than the highest corporation rate.
        2. Fast-growing small businesses that don’t intend to pay dividends to owners often choose C corporation status to avoid the higher taxes.
        3. Many slower-growing businesses have selected the S corporation form.
      4. The benefits of S corporation
    6. LIMITED LIABILITY COMPANIES.
      1. A LIMITED-LIABILITY COMPANY is similar to an S corporation 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. LLCs are best for many new businesses for the following reasons:
        1. Personal-asset protection.
        2. Choice to be taxed as partnership or as corporation.
        3. Flexible ownership rules.
  5. CORPORATION EXPANSION: MERGERS AND ACQUISITIONSPower Point Presentation.

    6. Define and give examples of three types of corporate mergers and explain the role of leveraged buyouts and taking a firm private.

    1. In the 1990s merger mania in the U.S. continued at a fever pitch.
      1. Nine of the ten largest merger transactions of all time occurred in 1998.
      2. Most of the new deals involve companies trying to expand within their own fields.
      3. A MERGER is the result of two firms forming one company.
      4. An ACQUISITION is when one company buys another company.
    2. There are three major types of corporate mergers: vertical, horizontal, and conglomerate.
      1. VERTICAL MERGER is the joining of two firms involved in different stages of related businesses.
      2. HORIZONTAL MERGER Key Term joins two firms in the same industry and allows them to diversify or expand their products.
      3. CONGLOMERATE MERGER unites completely unrelated firms, diversifying business operations.
    3. 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.
        1. The funds borrowed are used to buy out the stockholders in the company.
        2. Employees, managers, or group of investors now become the owners of the firm.
      3. Merger mania has also involved foreign companies purchasing U.S. companies.
  6. SPECIAL FORMS OF BUSINESS OWNERSHIP.

    7. In addition to the three basic forms of business ownership, we shall discuss two special forms of ownership: franchises and cooperatives.

  7. FRANCHISESConcept Check CONCEPT CHECK

    8. Outline the advantages and disadvantages of franchises and discuss the opportunities for diversity in franchising and the challenges of international franchising.Power Point Presentation

    1. 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.
    2. Some people would like to own their own businesses but want more assurance of success— Franchising may be an alternative for such people.
      1. Franchising accounts for 40% of the national retail sales.
      2. The most popular businesses for franchising are restaurants, retail stores, hotels and motels, and automotive parts and service centers.
      3. Some entrepreneurs have had great success taking American franchises overseas.
    3. 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.
        1. Franchisees get assistance arranging financing and learning to keep records.
        2. Some franchisors will even provide financing to potential franchisees.
      5. LOWER FAILURE RATE.
        1. Historically, the failure rate for franchises has been lower than that of other business ventures.
        2. Studies show that you should carefully research any franchise before buying
    4. DISADVANTAGES OF FRANCHISES.
      1. LARGE START-UP COSTS.
        1. Most franchises will demand a fee to obtain the rights to the franchise.
        2. Start-up costs can be as high as $4 million for a Holiday Inn franchise.
      2. MANAGEMENT REGULATION
      3. SHARED PROFIT—The franchisor often demands a large share of the profits, or royalty, based on sales not profit.
        1. Some franchisees may feel burdened by the company’s rules and regulations.
      4. COATTAIL EFFECTS.
        1. The actions of other franchisees have an impact on the franchise’s future growth and level of profitability.
        2. Franchisees must also look out for competition from fellow franchisees.
      5. RESTRICTIONS ON SELLING.
        1. Many franchisees face restrictions in the reselling of their franchises.
        2. Franchisors often insist on approving the new owner, who must meet their standards.
      6. FRAUDULENT FRANCHISORS.
        1. Most franchisors are not large systems.
        2. There has been an increase in complaints to the FTC about franchisors that delivered little or nothing that they promised.
    5. DIVERSITY IN FRANCHISING.
      1. Only 24% of franchise owners are women.
      2. Some franchisors, such as Church’s Chicken, actively recruit women to be owners.
      3. Women are becoming franchisors as well.
      4. When women find it difficult to obtain financing to expanding their businesses, they often turn to finding franchisees to sidestep expansion costs.
      5. Franchising opportunities fit the needs of many aspiring minority businesspersons.
      6. The Commerce Department’s Federal Minority Business Development Agency provides minorities with training in how to run franchises.
    6. HOME-BASED FRANCHISES.
      1. Home-based businesses offer advantages but may leave owners with a feeling of isolations.
      2. Home-based franchisees feel less isolated.
    7. 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.
    8. USING TECHNOLOGY IN FRANCHISING.
      1. Franchisors are using technology to meet the needs of customers and franchisees.
      2. Franchise Web sites can streamline communication with employees, customers, and vendors.
      3. Using the Internet every franchisee has immediate access to every subject that involves the franchise operation.
    9. 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 is convenience and a predictable level of service and quality.
      5. Franchisors must be careful to adapt to the region.
  8. COOPERATIVES. Concept Check CONCEPT CHECK

    9. Explain the role of cooperatives.

    1. COOPERATIVES are organizations that are owned by members/customers who pay an annual membership fee and share in any profit-making organization.
      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.
    2. Some cooperatives give the group 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.
  9. WHICH FORM OF OWNERSHIP IS FOR YOU? Concept Check CONCEPT CHECK
    1. There are RISKS TO EVERY FORM of business ownership.
    2. The miracle of free enterprise is that the freedom and incentives of capitalism make risks acceptable to many people.




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