Forms of Business Ownership Chapter 5 Chapter 5

Forms of Business Ownership Chapter 5

Chapter 5 Learning Goals 1. What are three main forms of business organization, and what factors should a company’s owners consider when selecting a form? 2. What are the advantages and disadvantages of sole proprietorships? 3. Why would a new business venture choose to operate as a partnership, and what downside would the partners face?

Chapter 5 Learning Goals (cont’d. ) 4. How does the corporate structure provide advantages and disadvantages to a company and what are the major types of corporations? 5. Does a company have any business organization options besides sole proprietorship, partnership, and corporation? 6. Why is franchising growing in importance? 7. Why would a company use mergers and acquisitions to grow? 8. What trends will affect business organization in the future?

Learning Goal 1 • What are three main forms of business organization, and what factors should a company’s owners consider when selecting a form? Sole proprietor • Partnership • Corporation – Choose a form of organization by evaluating: • • • Owner’s liability for firm’s debts The ease and cost of forming the business The ability to raise funds The taxes The degree of operating control the operator can retain The ability to attract employees

Comparisons of Forms of Business Organization Sole proprietorships Partnerships Corporations

Learning Goal 2 • What are the advantages and disadvantages W of sole proprietorships? • Advantages – Ease and low cost of formation – Owner’s rights to all profits – Owner’s control of the business – Relative freedom from government regulation – Absence of special taxes – Ease of dissolution • Disadvantages – Unlimited liability of the owner for debts – Difficulty in raising capital – Limited managerial expertise – Large personal time commitment – Unstable business life – Difficulty in attracting qualified employees – Owner’s personal absorption of all losses

1. Sole proprietorships Advantages Disadvantages • easy and inexpensive to form & dissolve • profits all go to owner • direct control of business • freedom from government regulations • no special taxation • hard to raise capital • unlimited liability & potential loss • limited expertise in all areas • trouble finding employees • large personal time commitment • unstable business life

Learning Goal 3 • Why W would a new business venture choose to operate as a partnership, and what downside would the partners face? • General Partnerships – Partners co-own assets and share profits – Each partner is individually liable for all debts and contracts of the partnership • Limited Partnerships – Controlled by one or more general partners who have unlimited liability – Partners’ liability is is limited to their investment – Do not participate in the firm’s operations

Learning Goal 3 (cont’d. ) • Why W would a new business venture choose to operate as a partnership, and what downside would the partners face? • Advantages of Partnerships • Disadvantages of Partnerships – Ease of formation – Availability of capital – Diversity of managerial expertise – Flexibility to respond to changing business conditions – Relative freedom from government control – Unlimited liability for general partners – Potential for conflict between partners – Limited life – Sharing of profits – Difficulty in leaving a partnership

2. Partnerships Advantages Disadvantages • easy and inexpensive to form • diverse skills and expertise • flexibility • relative freedom from government regulations • no special taxation • potential conflicts between partners • unlimited liability & potential loss • sharing profits • hard to leave or end partnership

Topics to Cover in a Partnership Agreement • • • Purpose & duration of partnership Roles, responsibilities, compensation Contributions Procedures for adding/removing partners Buy-out procedures Dispute resolution Financial arrangements Dissolving the partnership Valuation Source: American Express Small Business Exchange, home 3. americanexpress. com/smallbusiness

Learning Goal 4 • How does the corporate structure provide advantages and disadvantages to a company, and what are the major types of corporations? • Advantages of Corporations – Limited liability – Ease of transferring ownership – Stable business life – Ability to attract financing • Disadvantages of Corporations – Double taxation of profits – Cost of complexity of formation – Government restrictions

Learning Goal 4 (cont’d. ) • How does the corporate structure provide advantages and disadvantages to a company, and what are the major types of corporations? – Stockholders • Own the corporation • Can sell or transfer shares at any time • Entitled to receive profits in the form of dividends – Board of Directors • Elected by stockholders • Govern the firm – Officers • Carry out the goals and policies set by the board – C Corporations, S Corporations & Limited Liability Companies • Major types of corporations

Corporation: A legal entity with an existence and life separate from its owners, who therefore are not personally liable for its debts; it can own property, enter into contracts, sue and be sued, and operate under terms of its state charter.

3. Corporations Advantages Disadvantages • limited liability • easy to get financing • easy to transfer ownership • unlimited life-span • tax deductions • double taxation of profits • costly & complex to form • government restrictions

Steps of Forming a Corporation 1. Select company’s name 2. Write and file Articles of Incorporation paperwork 3. Pay fees and taxes 4. Hold organizational meeting 5. Adopt bylaws, elect directors, pass operating resolutions

Organizational Structure of Corporations Stockholders elect Directors elect Officers (Top Management) President Vice Treasurer Secretary President

Types of Hybrid Corporations 1. S corporations organized like a corporation, but avoids double taxation of profits by routing income and losses through stockholders 2. Limited liability companies (LLC) offers same limited liability as a corporation, but may be taxed as either a partnership or corporation

Some Pros and Cons of LLC’s Pros • Protection of personal assets • Avoid doubletaxation of profits • Flexible management & organization • Good foreign investors Cons • Often required to have a limited life (< 30 years) • Not corporations, so can not issue stock Source: The Company Corporation, www. incorporate. com

Learning Goal 5 • Does a company have any business organization options besides sole proprietorship, partnership, and corporation? – Limited Liability Company • Provides limited liability for its owners • Taxes like a partnership – Cooperatives • Collectively owned by individuals or businesses with similar interests • Combine to achieve more economic power – Joint venture • An alliance of two or more companies • Formed to undertake a special project – Franchises • Business arrangement between a franchisor and franchisee • Franchisee uses business name and logo of franchisor

Specialized Forms of Business Organization 1. Cooperatives 2. Joint ventures 3. Franchises

1. Cooperatives • Formed by people with similar interests, such as customers and suppliers ® lower costs ® increased economic power ® share in profits • Members/owners pay annual fees • Common in: – agriculture – hardware/lumber – grocery

2. Joint Ventures Joint Venture: 2 or more companies form an alliance to pursue a specific project, usually for a specific time period

Learning Goal 6 • Why is franchising growing in importance? – Business owner does not have to start from scratch – Buys a business concept with a proven product and operating methods – Franchisor provides: • Management training and assistance • Use of a recognized brand name, product, and operating concept • Financial assistance

3. Franchising: business organization in which a franchisor supplies the product concept to the franchisee, who sells the goods or services

Top 10 Franchises for 2000 • Ranking based on factors such as financial strength & stability, growth rate & size 1. Mc. Donald’s 2. Subway 3. Jackson Hewitt Tax Service 4. 7 -Eleven Convenience Stores 5. Jiffy Lube Int’l Inc. 6. Snap-on Tools 7. Mail Boxes Etc. 8. Radio Shack 9. Sonic Drive-In Restaurants Source: Entrepreneur, 10. GNC Franchising Inc. Jan. , 2000, p. 195.

Franchises Advantages Disadvantages • increased opportunity to • loss of control expand (franchisor) • recognized name, product, • costs of franchising and operating concept • restricted operating (franchisee) freedom (franchisee) • management training and assistance (franchisee) • financial assistance (franchisee)

Learning Goal 7 • Why would a company use mergers and acquisitions to grow? – Companies use mergers and acquisitions for strategic reasons such as • • Growth or diversification of product lines Increased market share Economies of scale Financial restructuring to increase company value to stockholders

Growth Through Mergers & Acquisitions Merger: The combination of 2 or more firms to form a new company, which often takes a new corporate identity Acquisition: The purchase of a corporation by another corporation or investment group

Benefits of Mergers Reduced: Increased: ¯ costs purchasing power ¯ overlap in operations market share ¯ competition

Types of Mergers 1. Horizontal mergers – same industry, same stage of production 2. Vertical mergers – same industry, different stages of production 3. Conglomerate mergers – different industries 4. Leveraged buyouts – corporate takeovers with borrowed money

Seagram’s Transformation • Since 1993, Seagram has changed from a beverage company with a large stake in Du. Pont with $10 billion in total assets. . . • To an entertainment conglomerate in 1998 with $35 billion in total assets, including Poly. Gram and a large stake in MCA Source: Fortune, Mar. 1, 1999, pp. 112 -124.

Learning Goal 8 • What trends will affect business organization in the future? – Service sector is growing to meet demand for convenience from working women and two-income families • Providing service for children and senior citizens • Resale shops and other specialty markets – Established franchisors are remaining competitive by • Offering multiple concepts • New types of outlets and expanded products

Trends Affecting Business Organization Increases in: Niche markets Variety in franchises - Expect more franchised goods & services that ease consumers’ busy lives (Source: Entrepreneur, Jan. 2000, p. 157) Consolidation through mergers & acquisitions Mergers across national borders