Chapter 05 – How to Form a Business
5-16
PPT 5-16
Advantages of Partnerships
ADVANTAGES of
PARTNERSHIPS
5-16
LO 4-2
• More financial
resources
• Shared
management and
pooled/
complementary skills
and knowledge
• Longer survival
• No special taxes
TEXT FIGURE 5.2
Questions to Ask When Choosing a
Business Partner
This text figure gives some suggestions for questions potential
partners should ask each other before entering a business
agreement.
critical thinking
exercise 5-1
PICKING PARTNERS
This exercise explores the personal skills and capital that can
be obtained for a business by adding a partner. (See the com-
plete exercise on page 5.72 of this manual.)
PPT 5-17
Disadvantages of Partnerships
DISADVANTAGES of
PARTNERSHIPS
5-17
LO 4-2
• Unlimited liability
• Division of profits
• Disagreements among
partners
• Difficult to terminate
Chapter 05 – How to Form a Business
5-17
a. Disagreements can arise over division of
authority, purchasing decisions, and so on.
b. Because of potential conflicts, all terms of
partnership should be spelled out IN WRIT-
ING to protect all parties.
4. DIFFICULTY OF TERMINATION
a. It is not easy to get out of a partnership.
b. For example: Who gets what and what
happens next?
c. It is best to make these decisions at the
beginning.
E. Many ventures avoid the disadvantages of these
forms of ownership by forming corporations.
LEARNING OBJECTIVE 3
Compare the advantages and disadvantages of corporations, and summarize
the differences between C corporations, S corporations, and limited liability compa-
nies.
IV. CORPORATIONS
A. A CONVENTIONAL (C) CORPORATION is a
state-chartered legal entity with authority to act and
have liability separate from its owners.
1. Businesses do not have to be big to incorpo-
rate.
2. The corporation’s owners (STOCKHOLDERS)
are not liable for the debts of the corporation
beyond the money they invest.
3. Many people can share in the ownership of a
business without working there.
4. Corporations can choose to offer ownership to
Chapter 05 – How to Form a Business
5-18
PPT 5-18
Picking Your Partner
TEXT FIGURE 5.3
How to Form a Partnership
There is no such thing as a perfect partner but
ask these questions when you try to find your
best match:
PICKING YOUR PARTNER
5-18
LO 4-2
• Do you share the same goals?
• Do you share the same vision for the company?
• What skills does he/she have? Are yours the same?
• What can he/she bring to the business?
• What type of decision maker is he/she?
• Do you trust each other?
• How does he/she problem solve?
MAKING
ethical
decisions
PPT 5-19
Good Business,
Bad Karma?
• What do you think you should do?
• What will be the consequences of your decision?
GOOD BUSINESS,
BAD KARMA?
5-19
Imagine you and your partner own a construction
company. You receive a subcontractor’s bid you
know is 20% too low. This could potentially put the
subcontractor out of business. Accepting the bid
will improve your chances of getting a big job.
Your partner wants to take the bid:
lecture enhancer 5-3
THE DEVELOPMENT OF SEARS,
ROEBUCK, AND COMPANY
Sears started out as a sole proprietorship, became a partner-
ship, then formed a corporation. (See the complete lecture en-
hancer on page 5.68 of this manual.)
test
prep
PPT 5-20
Test Prep
TEST PREP
5-20
• What’s the difference between a limited partner
and a general partner?
• What are some of the advantages and
disadvantages of partnerships?
TEXT FIGURE 5.4
Corporate Types
This text figure identifies several different types of corpora-
tions.
PPT 5-21
Conventional Corporations
CONVENTIONAL
CORPORATIONS
5-21
LO 4-3
• Conventional (C)
Corporation — A state-
chartered legal entity with
authority to act and have
liability separate from its
owners (its stockholders).
Chapter 05 – How to Form a Business
5-19
outsiders or remain private.
B. ADVANTAGES OF CORPORATIONS
1. LIMITED LIABILITY
a. Limited liability is probably the MOST SIG-
NIFICANT ADVANTAGE of corporations.
b. The owners of a business are responsible
for losses only up to the amount they invest.
2. ABILITY TO RAISE MORE MONEY FOR IN-
VESTMENT
a. To raise money, a corporation sells OWN-
ERSHIP (STOCK) to anyone interested.
b. It is also easier for corporations to obtain
loans.
c. Corporations can also borrow money from
investors by issuing BONDS.
3. SIZE
a. Because corporations can raise large
amounts of money, they can build modern
facilities.
b. They can also hire experts in all areas of op-
eration.
c. They can buy other corporations in other
fields to diversify their risk.
d. Corporations have the size and resources to
take advantage of opportunities anywhere in
the world.
e. Corporations do not have to be large to have
these benefits.
Chapter 05 – How to Form a Business
5-20
PPT 5-22
Advantages of Corporations
ADVANTAGES of
CORPORATIONS
5-22
LO 4-3
• 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
lecture enhancer 5-4
FORTUNE 500 LARGEST
CORPORATIONS
Fortune magazine also publishes a listing of the largest U.S.
companies ranked by annual revenue. For 2012, ExxonMobil
topped the list. (See the complete lecture enhancer on page
5.69 of this manual.)
PPT 5-23
How Owners Affect Management
TEXT FIGURE 5.5
How Owners Affect Management
HOW OWNERS AFFECT
MANAGEMENT
5-23
LO 4-3
PPT 5-24
The Big Boys of Business
Source:Fortune,www.fortune.com,accessedNovember2014.
The BIG BOYS of BUSINESS
America’s Largest Corporations
5-24
PhotoC redit:WalmartStores
LO 4-3
1. Walmart
2. Exxon Mobil
3. Chevron
4. Berkshire
Hathaway
5. Apple
Chapter 05 – How to Form a Business
5-21
4. PERPETUAL LIFE: The death of one or more
owners does not terminate the corporation.
5. EASE OF OWNERSHIP CHANGE: Selling
stock to someone else changes ownership.
6. EASE OF DRAWING TALENTED EMPLOY-
EES: Corporations can offer benefits such as
STOCK OPTIONS—the right to purchase
shares of the corporation for a fixed price.
7. SEPARATION OF OWNERSHIP FROM
MANAGEMENT: Corporations can raise mon-
ey from investors without having them involved
in management.
C. DISADVANTAGES OF CORPORATIONS
1. INITIAL COST
a. Incorporation may cost thousands of dollars
and involve lawyers and accountants.
b. There are less expensive ways of incorpo-
rating in certain states.
2. EXTENSIVE PAPERWORK
a. A corporation must keep detailed records.
b. Many firms incorporate in Delaware and
Nevada because favorable laws make the
process easier.
3. DOUBLE TAXATION: Corporate income is
taxed twice.
a. The CORPORATION PAYS TAX on in-
come before it can distribute any dividends
to stockholders.
b. The STOCKHOLDERS PAY TAX on the
Chapter 05 – How to Form a Business
5-22
PPT 5-25
Privacy Please
Source:Forbes,www.forbes.com,accessedNovember2014.
PRIVACY PLEASE
The Ten Largest Private Corporations in the U.S.
Company State Industry
Cargill MN Farming
Koch Industries KS Chemicals
Dell TX Computers
Bechtel CA Construction
PricewaterhouseCoopers NY Business Services
Mars VA Food
Pilot Flying J TN Convenience Stores
Publix Supermarkets FL Grocery
Ernst & Young NY Business Services
C&S Wholesale Grocers NH Food Wholesale
5-25
LO 4-3
PPT 5-26
Disadvantages of Corporations
DISADVANTAGES of
CORPORATIONS
5-26
LO 4-3
• Initial cost
• Extensive paperwork
• Double taxation
• Two tax returns
• Size
• Difficulty of termination
• Possible conflict with
stockholders and board of
directors
PPT 5-27
Even the Big Guys Make Mistakes
Source:BloombergBusinessweek,www.businessweek.com,accessedNovember2014.
EVEN the BIG GUYS
MAKE MISTAKES
Company Bad Move
Atari
The amount of surplus from a bad game was so big,
the copies had to be buried in a New Mexican
landfill.
Blockbuster Passed on a partnership with Netflix and ended up
going bankrupt in 2011.
Coca-Cola New Coke lasted only 77 days because Coca-Cola
received more than 1,500 complaint calls a day.
Pan American World
Airways
After the bombing of Flight 103, the airline blamed
the government after the victims’ families filed a
$300 million lawsuit.
Pets.com
Debuted with a $3 million Super Bowl ad and a
Macy’s Thanksgiving Day Parade float. Nine months
later, they went bankrupt.
5-27
LO 4-3
Chapter 05 – How to Form a Business
5-23
income they receive from the corporation.
c. States often tax corporations more harshly
than other enterprises.
4. TWO TAX RETURNS: A corporate owner
must file both a corporate tax return and an
individual tax return.
5. SIZE: Large corporations sometimes become
inflexible and too tied down in red tape.
6. DIFFICULTY OF TERMINATION: A corpora-
tion is relatively difficult to end.
7. POSSIBLE CONFLICT WITH STOCK-
HOLDERS AND BOARD OF DIRECTORS.
a. The board chooses the company’s offic-
ers.
b. An entrepreneur can be forced out of the
very company he or she founded.
8. Many people feel the hassles of incorporation
outweigh the advantages.
D. 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 usually do not issue stock
to outsiders, so they don’t have all the same
advantages and disadvantages of large cor-
porations.
3. It is wise to consult a lawyer when incorporat-
ing.
Chapter 05 – How to Form a Business
5-24
critical thinking
exercise 5-2
INDEPENDENT RESEARCH: SMALL–
BUSINESS OWNERSHIP
This exercise asks students to select a local businessperson
and interview that individual about his or her business struc-
ture. (See the complete exercise on page 5.73 of this manual.)
lecture enhancer 5-5
BENEFIT CORPORATIONS REDE-
FINE BOTTOM LINE
Benefit corporations have been recognized by a handful of
states. Here’s a look at one possible addition. (See the com-
plete lecture enhancer on page 5.70 of this manual.)
SEEKING
sustainability
PPT 5-28
B Corporations Let Sustainability
Set Sail
B CORPORATIONS LET
SUSTAINABILITY SET SAIL
5-28
• Michael Dimin saw tons of
fish were left to rot after
fishermen caught too much.
• Registered his company,
Sea2Table as a benefit
corporation.
• B-corporations are judged on
how they meet their own set
of socially or environmentally
beneficial goals.
PPT 5-29
Who Can Incorporate?
WHO CAN INCORPORATE?
5-29
LO 4-3
• Anyone – truckers, doctors, plumbers, athletes
and small business owners can incorporate.
• Normally stock is not issued to outsiders when
individuals incorporate, so the advantages and
disadvantages are not exactly the same as for
large corporations.
• Major advantages are limited liability and possible
tax benefits.
TEXT FIGURE 5.6
How to Incorporate
This text figure lists some common items included in the arti-
cles of incorporation.
Chapter 05 – How to Form a Business
5-25
4. It takes, on average, about 30 days to incor-
porate.
E. S CORPORATIONS
1. An S CORPORATION is a unique govern-
ment creation that looks like a corporation
but is taxed like sole proprietorships and
partnerships.
a. S corporations have shareholders, direc-
tors, and employees.
b. However, the profits are taxed as the
personal income of the shareholders.
c. They also have the benefit of limited lia-
bility.
2. S CORPORATIONS MUST:
a. Have no more than 100 shareholders
b. Have shareholders who are individuals
or estates and are citizens or permanent
residents of the U.S.
c. Have only one class of stock
d. Not have more than 25% of income de-
rived from passive sources (rents, royal-
ties, interest, etc.)
3. The TAX STRUCTURE of an S corporation
isn’t attractive to all businesses.
4. The benefits of S corporations change every
time the tax rules change.
F. LIMITED LIABILITY COMPANIES
1. A LIMITED LIABILITY COMPANY (LLC) is
Chapter 05 – How to Form a Business
5-26
PPT 5-30
Oldies but Goodies
OLDIES BUT GOODIES
America’s Oldest Corporations
Company Year Started Type of Company
J.E. Rhoads & Sons 1702 Conveyer Belts
Covenant Life
Insurance 1717 Insurance
Philadelphia
Insurance 1752 Insurance
Contributorship
Dexter 1767 Adhesives & Coatings
D. Landreth Seed 1784 Seeds
Bank of New York 1784 Banking
5-30
LO 4-3
PPT 5-31
S Corporations
S CORPORATIONS
5-31
LO 4-3
• S Corporation — A unique government creation that
looks like a corporation, but is taxed like sole
proprietorships and partnerships.
• S corporations have shareholders, directors and
employees, plus the benefit of limited liability.
• Profits are taxed only as the personal income of
the shareholder.
PPT 5-32
Who Can Form S Corporations?
WHO CAN FORM
S CORPORATIONS?
5-32
LO 4-3
• Qualifications for S Corporations:
– Have no more than 100 shareholders.
– Have shareholders that are individuals or estates and
are citizens or permanent residents of the U.S.
– Have only one class of stock.
– Derive no more than 25% of income from passive
sources.
• If an S corporation loses its S status, it may not
operate under it again for at least 5 years.
Chapter 05 – How to Form a Business
5-27
a company similar to an S corporation but
without the special eligibility requirements.
a. LLCs were introduced in Wyoming in
1977.
b. By 1996, all 50 states recognized LLCs.
c. More than half of new business registra-
tions in some states today are LLCs.
2. ADVANTAGES OF LLCs:
a. LIMITED LIABILITY: Personal assets are
protected.
b. CHOICE OF TAXATION: LLCs can
choose to be taxed as partnerships or as
corporations.
c. FLEXIBLE OWNERSHIP RULES: LLCs
do not have to comply with ownership re-
strictions as S corporations do.
d. FLEXIBLE DISTRIBUTION OF PROFITS
AND LOSSES: Profit and losses don’t
have to be distributed in proportion to the
money each person invests.
e. OPERATING FLEXIBILITY: Reporting
requirements are less than for a corpora-
tion.
3. DISADVANTAGES OF LLCs:
a. NO STOCK
i. LLC ownership is nontransferable.
ii. LLC members need the approval of
the other members in order to sell
Chapter 05 – How to Form a Business
5-28
PPT 5-33
Limited Liability Companies
LIMITED LIABILITY COMPANIES
5-33
LO 4-3
• Limited Liability Company (LLC) — Similar to an
S corporation, but without the eligibility requirements.
• Advantages of LLCs:
1. Limited liability
2. Choice of taxation
3. Flexible ownership rules
4. Flexible distribution of profits and losses
5. Operating flexibility
Chapter 05 – How to Form a Business
5-29
their interest.
b. LIMITED LIFE SPAN: LLCs have to identify
dissolution dates in the articles of organiza-
tion.
c. FEWER INCENTIVES: LLCs can’t deduct
the cost of fringe benefits or use stock op-
tions.
d. TAXES: LLC members must pay self-
employment taxes on profits.
e. PAPERWORK: More paperwork is required
than for sole proprietors.
4. The start-up cost for an LLC varies.
learning objective 4
Define and give examples of three types of corporate mergers, and explain the
role of leveraged buyouts and taking a firm private.
V. CORPORATION EXPANSION: MERGERS AND
ACQUISITIONS
A. The 1990s merger mania reached its peak in 2000.
1. Most of the deals involved companies trying to
expand within their own fields or enter a new
market.
2. Two-thirds of the mergers of the late 1990s
failed to meet their goals.
3. A MERGER is the result of two firms forming
one company.
4. An ACQUISITION is one company’s purchase of
the property and obligations of another compa-
ny.
Chapter 05 – How to Form a Business
5-30
PPT 5-34
Disadvantages of LLCs
DISADVANTAGES of LLCs
5-34
LO 4-3
1. No stock, therefore
ownership is
nontransferable
2. Limited life span
3. Fewer incentives
4. Taxes
5. Paperwork
TEXT FIGURE 5.7
Comparison of Forms of Business
Ownership
This text figure presents the advantages and disadvantages of
the major forms of business ownership.
test
prep
PPT 5-35
Test Prep
TEST PREP
5-35
• What are the major advantages and disadvantages
of incorporating a business?
• What’s the role of owners (stockholders) in the
corporate hierarchy?
• If you buy stock in a corporation and someone gets
injured by one of the corporation’s products, can
you be sued? Why or why not?
• Why are so many new businesses choosing a
limited liability company (LLC) form of ownership?
PPT 5-36
Mergers and Acquisitions
• Merger — The result of two firms joining to form one
company.
MERGERS and ACQUISITIONS
5-36
LO 4-4
• Acquisition —
One company
’
s
purchase of the
property and
obligations of
another company.