Chapter 05 – How to Form a Business
Which of the following people would be most interested in participating in a business
organized as a cooperative?
A. Joe is intrigued by the idea of combining his time and resources with many other
people to operate a business providing a good or service that they all will use.
B. Joan wants to be an owner of a business and share in its profits, but has no desire to
take an active role in managing the company or participating in its daily operations.
C. Jeff wants to work for a government-owned business because he believes government
ownership ensures a more equitable distribution of income and wealth.
D. Jennifer prefers to work for a charitable organization that emphasizes helping people
who are less fortunate than she is.
Feedback: As its name implies, a cooperative emphasizes cooperation. A cooperative appeals
to people who dislike the notion of having owners, managers, workers, and customers as
separate groups with different goals. In a cooperative, the people who will use a product join
together and pool resources to operate the business for their mutual gain.
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1) They are relatively easy and inexpensive to set up.
2) The owner can be his or her own boss, which appeals to many entrepreneurs who want to
3) The owner can keep all of the profits (except the share the government takes in taxes).
4) Proprietors can take a great deal of pride in owning their own independent business and
5) The owner’s work establishes a legacy on which future generations may build.
6) There are no special taxes on proprietorships.
1) With only one owner, sole proprietorships have limited access to the financial capital
2) As the firm grows and becomes more complex, the owner may become overwhelmed with
3) Unfortunately, qualified professional workers are often reluctant to work in a sole
4) One of the biggest drawbacks for sole proprietorships is the unlimited liability of the
owner. This means that the owner can lose much more than the amount he or she initially
invested in the company (including personal property and savings) if the company gets into
severe financial trouble. In this respect, a sole proprietorship is a risky form of ownership.
Many growing companies decide to change their form of ownership to a corporation to
overcome these drawbacks.
Page: 116
AACSB: Reflective Thinking
Bloom’s: Application
Learning Goal: 05-1
Level of Difficulty 3: Application of principles
Topic: Sole Proprietorship
345.
Chapter 05 – How to Form a Business
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What is the difference between a general partner and a limited partner? Give an example
of a situation in which a person would want to be a limited partner.
1) Wealthy persons who want to invest in what they think could be a successful firm, but don’t
2) Persons who do not want the responsibility of managing a partnership.
3) Persons who are interested in a particular type of business but know nothing about the
field.
Page: 119
AACSB: Reflective Thinking
Bloom’s: Application
Learning Goal: 05-2
Level of Difficulty 3: Application of principles
Topic: Partnerships
346.
Chapter 05 – How to Form a Business
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What is a C corporation? What are the major advantages and disadvantages of this form of
business ownership?
1) More money for investment. A corporation can sell stock (shares of ownership) to large
numbers of interested investors. This enables corporations to finance growth, modernize
2) Limited liability. The personal assets of the stockholders are not at risk. This is a major
3) Perpetual life. Unlike a sole proprietorship or partnership, a corporation is separate from its
4) Ease of ownership change. Unlike the other major forms of business ownership,
5) Ability to attract talented employees. Because of their ability to grow and offer
opportunities for advancement, as well as the ability to offer fringe benefits (including stock
1) High initial cost of formation. It is generally more expensive and time consuming to form a
2) Increased regulation and paperwork. Corporations are subject to closer government
3) Possible conflicts between the corporation’s board of directors and management.
Stockholders elect the board of directors, and may choose members who are at odds with top
4) Double taxation. If a corporation pays dividends, its earnings are taxed both as income to
the corporation and as income to the stockholders. In other forms of ownership, earnings are
taxed only once.
Page: 123-126
AACSB: Reflective Thinking
Bloom’s: Application
Learning Goal: 05-3
Level of Difficulty 3: Application of principles
Topic: Corporations
347.
Chapter 05 – How to Form a Business
What is a limited liability company (LLC)? How does it compare to an S corporation?
What are the major advantages and disadvantages of an LLC?
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1) Vertical: a candy producer that merges with a sugar refiner.
2) Vertical: a swimming pool contractor that merges with a pool filter manufacturer to ensure
3) Horizontal: a publisher of business textbooks merges with a publisher that specializes in
4) Horizontal: a chain of donut shops merges with a company that operates a chain of shops
5) Conglomerate: an insurance company that merges with a magazine publisher.
6) Conglomerate: an auto parts manufacturer merges with a clothing store chain.
Page: 131
AACSB: Reflective Thinking
Bloom’s: Application
Learning Goal: 05-4
Level of Difficulty 3: Application of principles
Topic: Mergers and Acquisitions
349.
Chapter 05 – How to Form a Business
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Franchising has certainly become a key component of the U.S. economy. What are the
major advantages and disadvantages of franchising?
1) Management assistance: most franchisors offer franchisees advice and managerial
2) Personal ownership: the business is still owned by the franchisee.
3) Use of a nationally recognized name: Many franchises have established a national
4) Financial advice and assistance: Franchisors often provide franchisees with expert financial
5) Lower failure rate than that of other business ventures.
1) Large start-up costs to obtain the franchise.
2) Sharing profits with the franchisor, or paying commission based on sales to the franchisor.
3) Management regulations: franchisees have to follow rules and regulations set by the
franchisor that can limit their freedom. Thus, even though the franchisees own their business,
4) Negative coattail effects: the owners of a successful outlet can be adversely affected by the
5) Restrictions on selling: many franchisees face restrictions in the reselling of their
6) Fraudulent franchisors: many franchisors are small, rather obscure companies that
prospective franchisees may know little about. There has been an increase in complaints to the
Federal Trade Commission about franchisors that delivered little or nothing of what they
promised.
Page: 134-136
AACSB: Reflective Thinking
Bloom’s: Application
Learning Goal: 05-5
Level of Difficulty 3: Application of principles
Topic: Franchises
Chapter 05 – How to Form a Business
Multiple Choice Questions
Mini-Case
For as long as she could remember, Jenna Raiter’s passion was cars. As a teenager, she spent
hours with her dad tinkering with the family car, learning to change the oil and making minor
repairs. She got a job at a local garage while still in high school. A few years after graduating
from high school and completing the auto mechanics degree at a local community college,
Jenna decided she wanted to be her own boss. She quit her job, borrowed some money from
her dad, and began her own repair shop, the AutoMotion Garage. Jenna’s hard work gradually
attracted a loyal clientele of satisfied customers. Her success has her thinking about opening
garages in two other locations, but she lacks the financial resources needed for expansion.
Furthermore, the success of her business is forcing Jenna to spend more time managing the
business and less time doing the actual technical work she still enjoys. She wants to find
business partners who can help her with management and provide additional financial
resources. She has approached a couple of friends she met in high school: Al Ternator and
Lew Banfilter, to see if they would like to join the business.
350. Currently, AutoMotion Garage is operated as a(n):
A. Limited liability company.
B. Cooperative.
C. Sole proprietorship.
D. Solitary subsidiary.
Feedback: A business that is owned, and usually managed, by one person (such as Jenna) is a
sole proprietorship.
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