Chapter 5: How to Form a Business

Basic Forms of Business Ownership

• Sole Proprietorship: A business owned and managed by one person.
• Partnership: A legal business form with two or more owners.
• Corporation: A legal entity with the authority to act and have liability separate from its owners.

Learning Objectives

• LO 5-1: Compare the advantages and disadvantages of sole proprietorships.
• LO 5-2: Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships.
• LO 5-3: Compare the advantages and disadvantages of corporations and summarize the differences between C corporations, S corporations, and limited liability companies.
• LO 5-4: Define and give examples of three types of corporate mergers, and explain the role of leveraged buyouts and taking a firm private.
• LO 5-5: Outline the advantages and disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising.
• LO 5-6: Explain the role of cooperatives.

Forms of Business Ownership - Statistics

• Percentage of Businesses:
  • Sole Proprietorships: 72%
  • Partnerships: 8%
  • Corporations: 20%
• Percentage of Total Receipts:
  • Sole Proprietorships: 6%
  • Partnerships: 13%
  • Corporations: 81%

Sole Proprietorships

Advantages

• Ease of starting and ending the business.
• Being your own boss.
• Pride of ownership.
• Leaving a legacy.
• Retention of company profits.
• No special taxes.

Disadvantages

• Unlimited liability: The responsibility of business owners for all debts of the business.
• Limited financial resources.
• Management difficulties.
• Overwhelming time commitment.
• Few fringe benefits.
• Limited growth.
• Limited life span.

Work-Life Balance

• Percentage of small business owners working over 50 hours per week.
• Percentage of small business owners working over 60 hours per week.

Partnerships

Major Types

• General Partnership: All owners share in operating the business and assuming liability for its debts.
• Limited Partnership: Includes one or more general partners and one or more limited partners.

Types of Partners

• General Partner: An owner with unlimited liability, active in managing the firm.
• Limited Partner: An owner who invests money but does not have management responsibility or liability beyond their investment.
• Limited Liability: The responsibility of a business’s owners for losses only up to the amount they invest; limited partners and shareholders have limited liability.

Advantages

• More financial resources.
• Shared management and pooled/complementary skills and knowledge.
• Longer survival.
• No special taxes.

Disadvantages

• Unlimited liability.
• Division of profits.
• Disagreements among partners.
• Difficulty of termination.

Questions to Ask When Choosing a Business Partner

• Do you share the same goals?
• Do you share the same vision for the company?
• What skills does the person have? Do they complement yours?
• What can the person bring to the business?
• What type of decision maker is the person?
• Do you trust each other?
• How does the person respond to adversity?
• Can the person accept constructive criticism?
• To what extent can you build excitement into the partnership?

Corporations

Conventional (C) Corporation

• A state-chartered legal entity with the authority to act and have liability separate from its owners (stockholders).

Corporate Types

• Alien Corporations: Do business in the U.S. but are chartered in another country.
• Domestic Corporations: Do business in the state in which they are chartered.
• Foreign Corporations: Do business in one state but are chartered in another.
• Closed (Private) Corporations: Stock is held by a few people and isn’t available to the general public.
• Open (Public) Corporations: Sell stock to the general public.
• Nonprofit (or Not-for-Profit) Corporations: Do not seek personal profit for their owners.
• Multinational Corporations: Operate in several countries.

Advantages

• Limited liability.
• Ability to raise more money for investment.
• Size.
• Perpetual life.
• Ease of ownership change.
• Ease of attracting talented employees.
• Separation of ownership from management.

Disadvantages

• Initial cost.
• Extensive paperwork.
• Double taxation.
• Size.
• Difficulty of termination.
• Possible conflict with stockholders and board of directors.

How Owners Affect Management

• Owners/stockholders elect the board of directors.
• The board of directors hires officers.
• Officers set corporate objectives and select managers.
• Managers supervise employees.

Individuals Can Incorporate

• Anyone (truckers, doctors, plumbers, athletes, small business owners) can incorporate.
• Stock is typically not issued to outsiders.
• Major advantages are limited liability.

Corporate Expansion: Mergers and Acquisitions

• Merger: The result of two firms forming one company.
• Acquisition: One company’s purchase of the property and obligations of another company.

Types of Mergers

• Vertical Merger: Joining of two companies in different stages of related businesses.
• Horizontal Merger: Joining of two firms in the same industry.
• Conglomerate Merger: Joining of firms in completely unrelated industries.

Examples of Mergers

• Horizontal Merger Example: Soft drink company buys another soft drink company.
• Vertical Merger Example: Soft drink company buys an artificial sweetener company.
• Conglomerate Merger Example: Soft drink company buys a snack food company.
• 2015 Heinz and Kraft merger valued at nearly 50 billion.

Corporate Expansion: Mergers and Acquisitions

• Leveraged Buyout (LBO): An attempt by employees, management, or a group of private investors to buy out the stockholders in a company.
• LBOs have ranged in size from 50 million to 34 billion and have involved everything from small family businesses to giant corporations.
• Business acquisitions are not limited to U.S. buyers.