Forms of Business Ownership and Franchising Chapter 4

Factors Affecting the Choice l l l l Tax considerations Liability exposure Start-up capital requirements Control Business goals Management succession plans Cost of formation Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 2

Major Forms of Ownership l Sole Proprietorship l Partnership l Corporation l S Corporation l Limited Liability Company l Joint Venture Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 3

Source: Statistical Abstract of the United States, 2002, p. 471.

Advantages of the Sole Proprietorship l Simple to create l Least costly form to begin l Profit incentive l Total decision making authority l No special legal restrictions l Easy to discontinue Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 7

Disadvantages of the Sole Proprietorship l Unlimited personal liability l Limited skills and capabilities l Feelings of isolation l Limited access to capital l Lack of continuity Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 8

Advantages of the Partnership l l l Easy to establish Complementary skills of partners Division of profits Larger pool of capital Ability to attract limited partners Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 9

Types of Partners l General partners w Take an active role in managing a business. w Have unlimited liability for the partnership’s debts. l Limited partners w Cannot participate in the day-to-day management of a company. w Have limited liability for the partnership’s debts. Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 10

Advantages of the Partnership Easy to establish l Complementary skills of partners l Division of profits l Larger pool of capital l Ability to attract limited partners l Little government regulation l Flexibility l Taxation l Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 11

Disadvantages of the Partnership l Unlimited liability of at least one partner l Capital accumulation l Difficulty in disposing of partnership interest l Lack of continuity l Potential for personality and authority conflicts Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 12

Types of Corporations l Domestic – a corporation doing business in the state in which it is incorporated. l Foreign – a corporation doing business in a state other than the state in which it is incorporated. l Alien – a corporation formed in another country but doing business in the United States. Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 13

Advantages of the Corporation l Limited liability of stockholders l Ability to attract capital l Ability to continue indefinitely l Transferable ownership Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 14

Disadvantages of the Corporation l Cost and time of incorporating l Double taxation l Potential for diminished managerial incentives l Legal requirements and regulatory “red tape” l Potential loss of control by founder(s) Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 15

S Corporation l l l No different from any other corporation from a legal perspective. For tax purposes, however, an S corporation is taxed like a partnership, passing all of its profits (or losses) through to individual shareholders. To elect “S” status, all shareholders must consent, and the corporation must file with the IRS within the first 75 days of its tax year. Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 16

Limited Liability Company (LLC) l l l Resembles an S Corporation but is not subject to the same restrictions. Two documents required: the articles of organization and the operating agreement. An LLC cannot have more than two of these four corporate characteristics: w Limited liability w Continuity of life w Free transferability of interest w Centralized management Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 17

The Franchising Boom!!! l l Sales of $1 trillion in virtually every product or service imaginable. Boom! More than 4, 500 franchisers operating some 600, 000 outlets worldwide. Franchise sales account for 44% of total retail sales. A new franchise opens somewhere in the world every six-and-a-half minutes. Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 18

Types of Franchising l Trade-name l Product distribution l Pure (or Comprehensive or Business Format) Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 19

Benefits of Franchising l Management training and support l Brand name appeal l Standardized quality of goods and services l National advertising program l Financial assistance Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 20

Benefits of Franchising (continued) l Proven products and business formats l Centralized buying power l Site selection and territorial protection l Greater chance for success Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 21

Drawbacks of Franchising l l l l Franchise fees and profit sharing Strict adherence to standardized operations Restrictions on purchasing Limited product line Unsatisfactory training programs Market saturation Less freedom Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 22

Ten Myths of Franchising 1. Franchising is the safest way to go into business because franchises never fail. 2. I’ll be able to open my franchise for less money than the franchiser estimates. 3. The bigger the franchise organization, the more successful I’ll be. 4. I’ll use 80 percent of the franchiser’s business system, but I’ll improve upon by substituting my experience and know-how. Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 23

Ten Myths of Franchising (continued) 5. All franchises are the same. 6. I don’t have to be a hands-on manager. I can be an absentee owner and still be very successful. 7. Anyone can be a satisfied, successful franchise owner. Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 24

Ten Myths of Franchising (continued) 8. Franchising is the cheapest way to get into business for yourself. 9. The franchiser will solve my business problems for me; after all, that’s why I pay an ongoing royalty fee. 10. Once I open my franchise, I’ll be able to run things the way I want to. Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 25

Detecting Dishonest Franchisers l l l l Claims that the contract is “standard; no need to read it. ” Failure to provide a copy of the required disclosure documents. Marginally successful prototype or no prototype. Poorly prepared operations manual. Promises of future earnings with no documentation. High franchisee turnover or termination rate. Unusual amount of litigation by franchisees. Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 26

Detecting Dishonest Franchisers (continued) l l l l Attempts to discourage your attorney from evaluating the contract before signing it. No written documentation. A high pressure sale. Claims to be exempt from federal disclosure laws. “Get rich quick” schemes, promising huge profits with minimal effort. Reluctance to provide a list of existing franchisees. Evasive, vague answers to your questions. Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 27

The Right Way to Buy a Franchise l l l l Evaluate yourself - What do you like and dislike? Research your market. Consider your franchise options. Get a copy of the franchiser’s Uniform Franchise Offering Circular (UFOC) and read it. Talk to existing franchisees. Ask the franchiser some tough questions. Make your choice. Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 28

Factors That Make a Franchise Appealing l Unique concept or marketing approach l Profitability l Registered trademark l Business system that works l Solid training program l Affordability l Positive relationship with franchisees Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 29

Trends Shaping Franchising l l l l Changing face of franchisees International opportunities Smaller, nontraditional locations Conversion franchising Multiple-unit franchising Master franchising Piggybacking (Combination franchising) Serving baby boomers Chapter 4: Forms of Ownership & Franchising Copyright 2005 Prentice Hall Inc. A Pearson Education Company 30