1. Chapter 05
How to
Form a
Business
McGraw-Hill/Irwin Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.

2. Chapter Five
LEARNING GOALS
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.
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3. Chapter Five
LEARNING GOALS
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.
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4. Profile
MARY ELLEN SHEETS
Two Men and a Truck
• Bought an old truck and
placed an ad in the local
paper stating, “Two Men
and a Truck.”
• Wanted her sons to have
work during summer
vacation. Now they earn
$193.3 million annually.
• Expanded through
franchising and are
branching out to the UK.
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5. Chapter Five
NAME that COMPANY
Around April 15th every year, we are a very sought
out company. With thousands of locations in
the U.S. we make tax filing much easier. Most
people are unaware that we are actually a
Canadian franchise even though we have our
headquarters in the U.S.
Name that company!
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6. Basic Forms of
Business
Ownership MAJOR FORMS of OWNERSHIP
• 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.
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7. Basic Forms of
Business
Ownership
FORMS of
BUSINESS OWNERSHIP
5-7

8. Basic Forms of
Business
Ownership ETHNIC BUSINESS CENTERS
Cities with the Most Minority-Run Firms
1. Atlanta, GA
2. Baltimore, MD
3. Nashville, TN
4. Houston, TX
5. Miami - Ft.
Lauderdale, FL
Photo Courtesy of: James Rintamaki
Source: Forbes, April 11, 2011.
5-8

9. Advantages of
Sole
Proprietorships
MAJOR BENEFITS of SOLE
LG1 PROPRIETORSHIP
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
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10. Disadvantages
of Sole
Proprietorships
DISADVANTAGES of SOLE
LG1 PROPRIETORSHIPS
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
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11. Progress
Assessment PROGRESS ASSESSMENT
• 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?
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12. Partnerships
MAJOR TYPES of PARTNERSHIPS
LG2
• General Partnership -- All owners share in
operating the business and in assuming liability for
the business’s debts.
• Limited Partnership
-- A partnership with one
or more general partners
and one or more limited
partners.
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13. Partnerships
TYPES OF PARTNERS
LG2
• 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.
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14. Partnerships
OTHER FORMS of
LG2 PARTNERSHIPS
• 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.
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15. Advantages &
Disadvantages
of Partnerships ADVANTAGES of
LG2 PARTNERSHIPS
• More financial
resources
• Shared management
and
pooled/complementary
skills and knowledge
• Longer survival
• No special taxes
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16. Advantages &
Disadvantages
of Partnerships DISADVANTAGES of
LG2 PARTNERSHIPS
• Unlimited liability
• Division of profits
• Disagreements among
partners
• Difficult to terminate
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17. The TIES that BIND
(Spotlight on Small Business)
There is no such thing as a perfect partner but
ask these questions when you try to find your
best match:
• 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?
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18. Progress
Assessment PROGRESS ASSESSMENT
• What’s the difference between a limited partner
and a general partner?
• What are some of the advantages and
disadvantages of partnerships?
5-18

19. Corporations
CONVENTIONAL
LG3 CORPORATIONS
• Conventional (C)
Corporation -- A state-
chartered legal entity with
authority to act and have
liability separate from its
owners (its stockholders).
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20. Advantages of
Corporations
ADVANTAGES of
LG3 CORPORATIONS
• 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
5-20

21. Advantages of
Corporations
HOW OWNERS AFFECT
LG3 MANAGEMENT
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22. Advantages of
Corporations
The BIG BOYS of BUSINESS
LG3 America’s Largest Corporations
1. Walmart
2. Exxon Mobil
3. Chevron
4. ConocoPhillips
5. Fannie Mae Photo Courtesy of: Walmart Stores
Source: Fortune, www.fortune.com, accessed June 2011.
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23. Advantages of
Corporations
PRIVACY PLEASE
LG3 The Ten Largest Private Corporations in the U.S.
Source: Forbes, www.forbes.com, accessed June 2011.
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24. Disadvantages
of Corporations DISADVANTAGES of
LG3 CORPORATIONS
• Initial cost
• Extensive paperwork
• Double taxation
• Two tax returns
• Size
• Difficulty of termination
• Possible conflict with
stockholders and board
of directors
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25. Disadvantages
of Corporations EVEN the BIG GUYS
LG3 MAKE MISTAKES
Source: Bloomberg Businessweek, May 16, 2011.
5-25

26. Individuals Can
Incorporate WHO CAN INCORPORATE?
LG3
• 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.
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27. Individuals Can
Incorporate
OLDIES BUT GOODIES
LG3 America’s Oldest Corporations
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28. S Corporations
S CORPORATIONS
LG3
• 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.
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29. S Corporations
WHO CAN FORM
LG3 S CORPORATIONS?
• 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.
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30. Limited Liability
Companies LIMITED LIABILITY COMPANIES
LG3
• Limited Liability Company (LLC) -- Similar
to an S corporation, but without the eligibility
requirements.
• Advantages of LLCs:
- Limited liability
- Choice of taxation
- Flexible ownership rules
- Flexible distribution of profits and losses
- Operating flexibility
5-30

31. Limited Liability
Companies DISADVANTAGES of LLCs
LG3
• No stock, therefore
ownership is
nontransferable
• Limited life span
• Fewer incentives
• Taxes
• Paperwork
5-31

32. VIRTUAL COMPANIES
(Legal Briefcase)
• Vermont allows a new kind of LLC that exists only
online.
• Registration documents can be filed online,
meetings can be held through online
communication, and relationships can be
established electronically.
• Virtual companies allow online contributors with
different skills, availability and interest to interact
and be successful.
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33. Progress
Assessment PROGRESS ASSESSMENT
• 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?
5-33

34. Corporate
Expansion:
Mergers and MERGERS and ACQUISITIONS
Acquisitions
LG4
• Merger -- The result of two firms joining to form
one company.
• Acquisition --
One company’s
purchase of the
property and
obligations of
another company.
5-34

35. Corporate
Expansion:
Mergers and
Acquisitions
KEEP GROWING…
LG4 Big Business‘ Acquisitions Spending
Source: Bloomberg Businessweek, October 18, 2010.
5-35

36. Corporate
Expansion:
Mergers and TYPES of MERGERS
Acquisitions
LG4
• Vertical Merger -- Joins two firms in different
stages of related businesses.
• Horizontal Merger -- Joins two firms in the
same industry and allows them to diversify or expand
their products.
• Conglomerate Merger -- Unites firms in
completely unrelated industries in order to diversify
business operations and investments.
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37. Corporate
Expansion:
Mergers and LEVERAGED BUYOUTS
Acquisitions
LG4
• 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 $31
billion and have involved everything from small
businesses to giant corporations.
• In 2010, foreign investors poured $300 billion into
U.S. companies.
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38. Franchises
FRANCHISING
LG5
• 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 825,000 franchised businesses
operate in the U.S., employing approximately
17.5 million people.
5-38

39. Franchises
MAKE WAY for the NEWBIES
Top New Franchises
LG5
Source: Entrepreneur, March 2010.
5-39

40. PLAY BALL but PLAY GREEN
(Thinking Green)
• The Nationals in D.C. have the first sports
stadium to earn the Leadership in Energy and
Environmental Design (LEED) Rating.
• 95% of the stadium’s steel was recycled and low-
flow toilets save millions of gallons of water.
• New York stadiums
for the Mets, Giants
and Jets have also
earned green
certifications.
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41. Advantages of
Franchises
ADVANTAGES of FRANCHISING
LG5
• Management and
marketing assistance
• Personal ownership
• Nationally recognized
name
• Financial advice and
assistance
• Lower failure rate
5-41

42. Disadvantages
of Franchises DISADVANTAGES of
LG5 FRANCHISING
• Large start-up costs
• Shared profit
• Management regulation
• Coattail effects
• Restrictions on selling
• Fraudulent franchisors
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43. Diversity in
Franchising WOMEN in FRANCHISING
LG5
• Women own about half of U.S. companies, yet
ownership of franchises is about 25%.
• Firms owned by women have grown at twice the
rate of all companies.
• More women are
becoming franchisors.
Auntie Anne’s and
Jazzercise and are
owned by women.
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44. Diversity in
Franchising MINORITY-OWNED
LG5 FRANCHISES
• MinorityFran is an initiative to
build awareness of
franchising opportunities
within minority communities.
• Domino’s Pizza launched a
minority franchise recruitment
program called Delivering the
Dream.
Photo Courtesy of: Tom Magliery
• Over 20% of franchises are
minority-owned.
5-44

45. Home-Based
Franchises HOME-BASED FRANCHISES
LG5
Advantages:
• Relief from
commuting stress
• Extra family time
• Low overhead
expenses
Main Disadvantages:
• Isolation
• Long hours
5-45

46. Home-Based
Franchises
HOME SWEET HOME
LG5 Top Home-Based Franchises
Source: Neema P. Roshania, Kiplinger, January 2011.
5-46

47. E-Commerce in
Franchising E-COMMERCE
LG5
in FRANCHISHING
• Most brick-and-mortar franchises have expanded
to the Internet.
• Many franchisors prohibit franchisee-sponsored
sites because conflicts can erupt.
• Sometimes “reverse royalties” are sent to
franchisees who believe their sales were hurt by
the franchisor’s site.
• Other franchises are solely based online.
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48. FRANCHISE EXPANSION
on FACEBOOK
(Social Media in Business)
• Many businesses use social media
to communicate with potential
investors and franchisees.
• Hä agen-Dazs launched a
simulation game called Ice Cream
Boss on Facebook.
• The company hopes that players
may move on to become
franchisees of real Hä agen-Dazs
stores.
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49. Franchising in
International
Markets
GLOBAL FRANCHISING
LG5
• Canada is the most popular target for U.S.-based
franchises. China, South Africa, the Philippines
and the Middle East are becoming popular
despite high cost.
• Franchising is successful when the product is
convenient, high quality, great service is included
and the franchisee adapts to the region.
• International franchising goes both ways – some
foreign franchises have come to the U.S.
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50. Franchising in
International
Markets WHAT to CHOOSE?
LG5 Picking Franchises that May Survive a Recession
• Focus on tried-and-true name brands.
• Stick to core goods and services.
• Be choosy about the site.
• Don’t pinch pennies.
• Have a fallback choice.
• Don’t assume the franchise will pay off.
Source: Richard Gibson, Wall Street Journal, www.wsj.com, accessed June 2011.
5-50

51. Franchising in
International
Markets HIGH FLYERS
LG5 Ten High-Performing Franchises
1. Hampton Hotels
2. AMPM
3. McDonald’s
4. 7-Eleven
5. Supercuts
6. Days Inn
7. Vanguard Cleaning
Systems
8. Servpro Photo Courtesy of: Innisfree Hotels
9. Subway
10. Denny’s
Source: Entrepreneur, January 2011.
5-51

52. Cooperatives
COOPERATIVES
LG6
• Cooperatives -- Businesses owned and
controlled by the people who use them– producers,
consumers, or workers with similar needs who pool
their resources for mutual gain.
• Worldwide, 750,000 co-ops serve 730 million
members – 120 million in the U.S.
• Members democratically control the business by
electing a board of directors that hires
professional management.
5-52

53. Progress
Assessment PROGRESS ASSESSMENT
• 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?
5-53