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Chapter 05 - How to Form a Business
5-46
critical thinking
exercise 5-3
CHOOSING A FORM OF BUSINESS
OWNERSHIP
This exercise presents eight types of businesses and asks the
student to consider which form of business ownership would
be right for each one. (See the complete exercise on page 5.74
of this manual.)
test
prep
PPT 5-54
Progress Assessment
TEST PREP
5-54
• What are some of the factors to consider before
buying a franchise?
• What opportunities are available for starting a
global franchise?
• What’s a cooperative?
Chapter 05 - How to Form a Business
5-47
PowerPoint slide notes
PPT 5-1
Chapter Title
CHAPTER 5
McGraw-Hill/Irwin Copyright © 2015 by the McGraw-Hill Companies, Inc. All rights reserved.
How to Form a
Business
PPT 5-2
Learning Objectives
LEARNING OBJECTIVES
5-2
1. Compare the advantages and disadvantages of sole
proprietorships.
2. Describe the differences between general and
limited partners, and compare the advantages and
disadvantages of partnerships.
3. Compare the advantages and disadvantages of
corporations and summarize the differences between
C corporations, S corporations and limited liability
companies.
PPT 5-3
Learning Objectives
LEARNING OBJECTIVES
5-3
4. Define and give examples of three types of corporate
mergers, and explain the role of leveraged buyouts
and taking a firm private.
5. Outline the advantages and disadvantages of
franchises, and discuss the opportunities for diversity
in franchising and the challenges of global
franchising.
6. Explain the role of cooperatives.
Chapter 05 - How to Form a Business
5-48
PPT 5-4
Anne Beiler
ANNE BEILER
Auntie Anne’s
5-4
• Started selling pretzels when
her family was living paycheck
to paycheck.
• Now Auntie Anne’s has over
1,200 locations and brings in
over $410 million!
• Beiler sold the company in
2005 to start focusing on
charity work.
PPT 5-5
Name That Company
NAME that COMPANY
5-5
In 2013, this company became the largest firm in
terms of revenue to be taken private through a
leveraged buyout. After closing the $25 million
deal, the founder now controls a 75% stake of
the company he started in his dorm room.
Name that company!
Company: Dell
PPT 5-6
Major Forms of Ownership
MAJOR FORMS of OWNERSHIP
5-6
• Sole Proprietorship -- A business owned, and
usually managed, by one person.
• Partnership -- Two or more people legally agree to
become co-owners of a business.
• Corporation -- A legal entity with authority to act
and have liability apart from its owners.
More than 600,000 businesses are started each year.
Chapter 05 - How to Form a Business
5-49
PPT 5-7
Forms of Business Ownership
FORMS of
BUSINESS OWNERSHIP
5-7
PPT 5-8
Ethnic Business Centers
Source:Forbes,www.forbes.com,accessedNovember2014.
ETHNIC BUSINESS CENTERS
Cities with the Most Minority-Run Firms
5-8
PhotoCredit:JamesRintamaki
1. Atlanta, GA
2. Baltimore, MD
3. Nashville, TN
4. Houston, TX
5. Miami - Ft.
Lauderdale, FL
1. This slide presents Forbes’ top 5 U.S. cities for minori-
ty-run businesses.
2. Most of these cities are situated in the South. Howev-
er, we tend to hear a lot about the high population
numbers of Asians in San Francisco or Hispanics in
Los Angeles.
3. Milwaukee, WI was listed last at #40 in ethnic popula-
tion growth.
4. To promote discussion, ask the students: Why do you
think these cities attract minority-run companies?
Don’t just focus on the businesses; also look at the to-
tal population and customer base.
PPT 5-9
Major Benefits of Sole Proprietorship
MAJOR BENEFITS of SOLE
PROPRIETORSHIP
5-9
LO 4-1
1) Ease of starting and
ending the business
2) Being your own boss
3) Pride of ownership
4) Leaving a legacy
5) Retention of company
profit
6) No special taxes
This slide helps students understand why sole proprietor-
ships account for the largest number of businesses in the
United States.
Chapter 05 - How to Form a Business
5-50
PPT 5-10
Disadvantages of Sole Proprietorships
DISADVANTAGES of SOLE
PROPRIETORSHIPS
5-10
LO 4-1
1) Unlimited Liability -- Any debts or damages
incurred by the business are your debts, even if it
means selling your home, car or anything else.
2) Limited financial resources
3) Management difficulties
4) Overwhelming time commitment
5) Few fringe benefits
6) Limited growth
7) Limited life span
Since the main advantage of sole proprietorships is the ease
by which they can be started, this slide gives students the
reason why this form of ownership only accounts for such a
small percentage of overall total revenue. Special emphasis
should be given to the disadvantage of unlimited liability
(personal assets at risk), and to the time commitment (24
hours, 7 days per week, and 365 days per year).
PPT 5-11
Work-Life Balancing Act
Source:Inc.,www.inc.com,accessedNovember2014.
WORK-LIFE BALANCING ACT
5-11
% of small business owners
Work over 80 hours per week Work over 40 hours per week
1. Many students are not aware of the effort it takes to be
a small business owner.
2. This slide shows us the amount of hours per week
some owners spend in their businesses.
3. To promote discussion, ask the students: How many
hours a week did you think owners spend at work? Do
many take holidays off? How much time would you
dedicate to your business?
PPT 5-12
Test Prep
TEST PREP
5-12
• Most people who start businesses in the U.S. are
sole proprietors. What are the advantages and
disadvantages of sole proprietorships?
• Why would unlimited liability be considered a
major drawback to sole proprietorships?
1. The primary advantages of sole proprietors are: 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 in-
clude: Unlimited liability, limited financial resources,
management difficulties, overwhelming time commit-
ment, few fringe benefits, limited growth, limited life
span.
2. With unlimited liability, the sole proprietor is liable for
all debts and obligations of the business and must pay
them even if it means selling your home, car, or what-
ever else you own.
Chapter 05 - How to Form a Business
5-51
PPT 5-13
Major Types of Partnerships
• General Partnership -- All owners share in
operating the business and in assuming liability for
the business
’
s debts.
MAJOR TYPES of PARTNERSHIPS
5-13
LO 4-2
• Limited Partnership --
A partnership with one or
more general partners and
one or more limited
partners.
Each type of partnership has advantages and disad-
vantages. In a general partnership resources are pooled and
liability is spread among all partners. However, in this type
of partnership there is the possibility for disagreement
and/or personality conflicts. A limited partnership is made
up of a mixture of general partners and limited partners.
Limited partners cannot actively take part in business deal-
ings.
PPT 5-14
Types of Partners
TYPES OF PARTNERS
5-14
LO 4-2
• General Partner -- An owner (partner) who has
unlimited liability and is active in managing the firm.
• Limited Partner -- An owner who invests money in
the business, but enjoys limited liability. Limited
Liability means that liability for the debts of the
business is limited to the amount the limited partner
puts into the company; personal assets are not at
risk.
The limited partner is not able to exercise any management
control over the partnership, but maintains limited liability.
A limited partner’s liability is limited to the amount invest-
ed in the partnership.
PPT 5-15
Other Forms of Partnerships
OTHER FORMS of
PARTNERSHIPS
5-15
LO 4-2
• Master Limited Partnership -- A partnership that
looks much like a corporation, but is taxed like a
partnership and thus avoids the corporate income
tax.
• Limited Liability Partnership -- Limits partners
’
risk of losing their personal assets to the outcomes of
only their own acts and omissions and those of
people under their supervision.
There are two less common forms of partnerships outlined
in this slide: master limited partnership and the limited lia-
bility partnership. The master limited partnership is unique
because it combines the tax benefits of a more traditional
partnership and the liquidity of a publicly traded security.
One example of a master limited partnership is Kinder
Morgan Energy Partners which is engaged in energy stor-
age and operates 75,000 miles of pipelines.
Chapter 05 - How to Form a Business
5-52
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
Partnerships have some distinct advantages. The key ad-
vantage is that partnerships have access to more resources,
such as financial resources, management skills and
knowledge.
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
Like the sole proprietorship, a partnership has some serious
disadvantages such as unlimited liability and division of
profits. One disadvantage that students might not consider
is disagreement among partners.
PPT 5-18
Picking Your Partner
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?
Successful partnerships start with a shared vision. In order to
develop a successful partnership all partners must be honest
with each other and bring a variety of different skills to the
partnership. Suggestions to discuss with students regarding
partnerships include:
• Partnership agreements must be in writing!
• Each individual’s responsibilities to the company
must be in writing and included as part of the con-
tract.
• Make certain that provisions are in place if one or
more partners want to terminate the agreement.
(Information outlining the terms and conditions of
terminating any agreement should be outlined in
the original contract.)
Chapter 05 - How to Form a Business
5-53
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:
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?
1. A general partner is an owner who has unlimited liabil-
ity and can be active in managing the firm. A limited
partner is an owner who invests money in the business,
but does not have any management responsibility or li-
ability for losses beyond his or her investment.
2. Some of the advantages of partnerships are: More fi-
nancial resources, shared management and
pooled/complementary skills and knowledge, longer
survival, no special taxes. Disadvantages of partner-
ships include: Unlimited liability (for general part-
ners), division of profits, disagreements among part-
ners, difficulty of termination.
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).
You don’t have to be big to incorporate. Incorporating may
be beneficial for small businesses as well.
Chapter 05 - How to Form a Business
5-54
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
1. The major advantage of corporate ownership is lim-
ited liability protection (personal assets are protected).
2. Interesting facts regarding incorporating a business:
the cost for a business to incorporate ranges from
about $50 to over $300, plus states’ fees. Over half of
Fortune 500 companies choose to incorporate in Del-
aware because the state’s laws make the process easi-
er than it is in other states.
PPT 5-23
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
1. This slide presents Fortune’s 2014 top 5 U.S. corpora-
tions.
2. Ask the students: Several of the companies in the top
five deal with similar products/services; how are the
products/services these companies sell similar? (Exxon
Mobil and Chevron are both oil companies.)
Chapter 05 - How to Form a Business
5-55
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
1. This slide presents America’s top 10 private compa-
nies in 2014.
2. Ask the students to debate why a company may want
to remain private. (Some of the reasons may be con-
trol, privacy, no external pressure, and preference.)
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
Double taxation is a major disadvantage of corporations. A
corporation is taxed on income earned, and then sharehold-
ers are taxed on any dividends the company may pay.
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
1. This slide presents examples of mistakes made by big
corporations.
2. Sometimes mistakes can be rectified (as in the case of
Coca-Cola withdrawing New Coke), but sometimes
they contribute to the company going out of business.
Chapter 05 - How to Form a Business
5-56
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.
Chapter 05 - How to Form a Business
5-57
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
1. A few facts you may wish to address with the stu-
dents are:
• JE Rhoads & Sons is the oldest company in
the United States and started off tanning
leather for Buggy Whips.
• Philadelphia Contributorship Insurance was
formed based on a suggestion by Benjamin
Franklin regarding the establishment of a
volunteer fire brigade, which eventually de-
veloped into an insurance company.
2. Environmental changes in the business world will
always happen; those companies that embrace
change and provide quality goods and services will
continue to profit.
3. Discuss with the students the significant amount of
commitment a company must be prepared to make
to stay in business. (Some areas that must continu-
ally be addressed are changes in societal culture,
competition, economy, laws/politics, and technolo-
gy changes.)
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.
An S corporation looks like a corporation, but is taxed like
a sole proprietorship or partnership. The primary advantage
of an S corporation is that it avoids the double taxation of a
C corporation. Approximately 3 million U.S. companies
operate as S corporations.
Chapter 05 - How to Form a Business
5-58
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.
Originally to qualify as an S Corporation, the number of
shareholders was limited to 75. This has now been amend-
ed to no more than 100.
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
The biggest advantages of LLCs are limited liability and
flexibility.
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
Primary disadvantages from entrepreneurs’ perspectives
would be limited life span and paperwork.
Chapter 05 - How to Form a Business
5-59
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?
1. Advantages of incorporating a business include: Lim-
ited liability, ability to raise more money for invest-
ment, size, perpetual life, ease of ownership change,
ease of attracting talented employees, separation of
ownership from management. Disadvantages of incor-
porating are: Initial cost, extensive paperwork, double
taxation, two tax returns, size, difficulty to terminate,
possible conflict with stockholders and board of direc-
tors.
2. Stockholders do not have to be employees of the cor-
poration. They are investors who have limited liability.
Stockholders elect the board of directors of a company
who select the management to control the company.
3. Stockholders in a corporation have limited liability
meaning as owners they are responsible for its losses
only up to the amount they invested. The corporation
could be sued and forced out-of-business but the
stockholder would only lose what he/she invested.
4. Limited liability companies have become a popular
way to form a business since all fifty states now rec-
ognize LLCs. Some of the advantages of LLCs are:
Limited liability, choice of taxation (can be taxed as a
partnership or corporation), flexible ownership rules,
flexible distribution of profit and losses, operating
flexibility.
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.
Chapter 05 - How to Form a Business
5-60
PPT 5-37
Types of Mergers
TYPES of MERGERS
5-37
LO 4-4
• Vertical Merger -- The joining of two firms in
different stages of related businesses.
• Horizontal Merger -- The joining of two firms in the
same.
• Conglomerate Merger -- The joining of firms in
completely unrelated industries.
There are three types of mergers. Horizontal mergers take
place in the same industry (i.e., one competitor merging
with another). An example of this would be Daimler Mer-
cedes Benz merging with Chrysler to create DaimlerChrys-
ler in the 1990s. Vertical merger takes place between com-
panies in a value chain, for example a supplier and a dis-
tributor merging. Conglomerate merger has no relationship
between companies; both Tyco and General Electric oper-
ate as conglomerates.
PPT 5-38
Leveraged Buyouts
LEVERAGED BUYOUTS
5-38
LO 4-4
• Leveraged Buyout (LBO) -- An attempt by
employees, management or a group of 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
businesses to giant corporations.
• In 2012, foreign investors poured $166 billion into
U.S. companies.
PPT 5-39
Franchising
FRANCHISING
5-39
LO 4-5
• Franchise Agreement -- An arrangement whereby
someone with a good idea for a business (franchisor)
sells the rights to use the business name and sell a
product or service (franchise) to others (franchisees)
in a given territory.
• More than 770,000 franchised businesses operate
in the U.S., employing approximately 8.5 million
people.
