CHAPTER 5

How to
Form a
Business

McGraw-Hill/Irwin Copyright © 2015 by the McGraw-Hill Companies, Inc. All rights reserved.
 LEARNING OBJECTIVES

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 5-2
 LEARNING OBJECTIVES

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.

5-3
 Exercise 1

Choose the correct word to complete each sentence:

1.The amount of money a company receives from sales in a particular period is called its …………
2.The money a company makes after taking away its costs and tax is its …………
3.A company which is more than 50% owned by parent company is called a …………
4.The employees in a particular country or business are called the …………
5.The percentage of sales a company has in a particular market is its ………… Profit

6.The main building or location of a large organisation is its …………

7.The cost of a company's shares is its ………… Subsidiar
y
Personnel
Marke
Department Exclusive
t
Share Distribut
Head- or
Share office
price Share Turn-
Organization
Stakehold holde over
al chart
er r

6
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1
 Exercise 2

Complete the extract from a company report with appropriate words in the box.

Share price Workforce Subsidiary

Profit Turnover
Market share Head office

I am pleased to say the company has continued its excellent performance. We are changing, growing and doing
well at a difficult time for the industry. ………… (1) was €57.2 million, an increase of 15% on last year, and
………… (2) rose by 5% to €6.4 million. We are a highly competitive business. We have increased our
………… (3) to 20%. Consequently our ………… (4) has risen and is now at an all-time high of €9.6. Increased
production and strong demand have had a positive effect on our cash flow, so we are able to finance a number of
new projects. We have successfully moved to our new ………… (5) in central London. We are now planning to start
full production at the recently opened Spanish ………… (6) in October. Finally, thanks once again to our loyal and
dedicated ………… (7). Our employees will always be our most valuable asset.

7
v1.002110320
1
 PART 1. STARTING UP

Be everywhere, do everything, and Never

fail to astonish the customer

A company cannot be existed if it fails to

communicate to customers!

I’d like to work for my own

company because I love to
manage others. That’s why I’m
studying business management 1. a family If you have already got
at my university … owned a job, you can also talk
company about your career
Q1: Which of these companies 2. a multinational ambition in 5 or 10 years.
would you like to work for? company
Why? Don’t forget to give
3. your own reasons for your option.
company

v1.002110320
1
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.

5-9
 FORMS of
BUSINESS OWNERSHIP

5-10
 MAJOR BENEFITS of SOLE LO 4-1

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 5-12
 DISADVANTAGES of SOLE LO 4-1

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
5-13
 TEST PREP

• 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?

5-15
 LO 4-2
MAJOR TYPES of PARTNERSHIPS

• 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.
5-16
 LO 4-2
TYPES OF PARTNERS

• 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.
5-17
 OTHER FORMS of LO 4-2

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.

5-18
 ADVANTAGES of LO 4-2

PARTNERSHIPS

• More financial
resources

• Shared
management
and
pooled/complem
entary skills and
knowledge

• Longer survival
5-19
•
 DISADVANTAGES of LO 4-2

PARTNERSHIPS

• Unlimited liability
• Division of profits
• Disagreements
among partners
• Difficult to
terminate

5-20
 PICKING YOUR PARTNER
LO 4-2

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?
5-21
• How does he/she problem solve?
 GOOD BUSINESS,
BAD KARMA?

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
What do wants
• partner you think
toyou should
take thedo?
bid:
• What will be the consequences of your
decision?

5-22
 TEST PREP

• What’s the difference between a limited

partner and a general partner?

• What are some of the advantages and

disadvantages of partnerships?

5-23
 CONVENTIONAL LO 4-3

CORPORATIONS

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

5-24
 ADVANTAGES of LO 4-3

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
5-25
HOW OWNERS AFFECT LO 4-3

MANAGEMENT

5-26
 PRIVACY PLEASE LO 4-3

The Ten Largest Private Corporations in the U.S.

Source: Forbes, www.forbes.com, accessed November 2014. 5-28

 DISADVANTAGES of LO 4-3

CORPORATIONS

• Initial cost
• Extensive
paperwork
• Double taxation
• Two tax returns
• Size
• Difficulty of
termination
• Possible conflict 5-29
 B CORPORATIONS LET
SUSTAINABILITY SET SAIL

• 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 5-31
 LO 4-3
WHO CAN INCORPORATE?

• 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. 5-32
 LO 4-3
S CORPORATIONS

• 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.
5-34
 WHO CAN FORM LO 4-3

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.
5-35
 LO 4-3
LIMITED LIABILITY COMPANIES

• 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
5-36
 LO 4-3

1. No stock, therefore
ownership is
nontransferable
2. Limited life span
3. Fewer incentives
4. Taxes
5. Paperwork

5-37
 TEST PREP

• 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 5-38

 LO 4-4
MERGERS and ACQUISITIONS

• Merger -- The result of two firms joining to

form one company.
• Acquisition --
One company’s
purchase of the
property and
obligations of
another
company.

5-39
 LO 4-4
TYPES of MERGERS

• 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.

5-40
 LEVERAGED BUYOUTS
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 5-41

 LO 4-5
FRANCHISING

• 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. 5-42
 LO 4-5
ADVANTAGES of FRANCHISING

1. Management and
marketing assistance
2. Personal ownership
3. Nationally recognized
name
4. Financial advice and
assistance
5. Lower failure rate

5-44
 DISADVANTAGES of LO 4-5

FRANCHISING

1. Large start-up costs

2. Shared profit
3. Management
regulation
4. Coattail effects
5. Restrictions on
selling
6. Fraudulent
franchisors 5-45
 THE BUILDING BLOCKS of
FRANCHISING

• Bricks 4 Kidz was

created as a way to
help kids understand
engineering and
construction.

• Since the business was

low cost and easily
reproduced, this led to
over 200 franchises in
the U.S. and 11 other
5-46
countries.
 LO 4-5
WOMEN in FRANCHISING

• Women own about half of U.S.

companies, yet ownership of franchises
is about 21%.
• More women are
becoming
franchisors.
Auntie Anne’s
and Jazzercise
and are owned
by women.
5-47
 MINORITY-OWNED LO 4-5

FRANCHISES

• DiversityFran is an
initiative to build
awareness of
franchising
opportunities within
minority communities.
• Domino’s Pizza
launched a minority
franchise recruitment
Photo Credit: Tom Magliery

program called
Delivering the Dream. 5-48
 LO 4-5
HOME-BASED FRANCHISES

Advantages:
• Relief from
commuting
stress
• Extra family
time
• Low overhead
expenses

Main Disadvantages:
• Isolation 5-49
 E-COMMERCE LO 4-5

in FRANCHISHING

• Most brick-and-mortar franchises have

expanded online.

• 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 5-51

 GIVING ENTREPRENEURS
OPTIONS with DIGITAL
FRANCHISING
• Chris Jeffrey created OrderUp shortly
after graduating college.
• OrderUp links up restaurants with
hungry patrons and allows people to
order online while OrderUp takes a
small commission.
• For a startup fee of
$42,000 franchisees
receive software and
training to launch
OrderUp in their area.
5-52
 LO 4-5
GLOBAL FRANCHISING

• 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.

• International franchising goes both

ways – some foreign franchises have
come to the U.S.

5-53
 COOPERATIVES
LO 4-6

• 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, co-ops serve one billion

members!

• Members democratically control the

business by electing a board of
directors that hires professional
5-56
management.
 TEST PREP

• What are some of the factors to

consider before buying a franchise?

• What opportunities are available for

starting a global franchise?

• What is a cooperative?

5-57
CASE – STUDY
Valentino Chocolate …

v1.0021103201 58
 CASE – STUDY (cont…)
Valentino Chocolate …
Reasons for falling profits

Prices Higher than competitors’ prices to price-cutting

Production Delays due to old machinery breaking down

Demand Falling demand or new products (Buiscuits and cakes) and

Classic Bar
Staff Sales team and production staff demotivated
morale
CASE – STUDY (cont…)
Valentino Chocolate …
 CASE – STUDY (cont…)
Valentino Chocolate …

You are directors of Valentino. Meet to discuss your investment plan.

1.Work in pairs. Decide how to spend the €1.5million. Prepare a
presentation of your investment plan, with reasons for your choices.
2.Meet as one group and present your ideas.
3.As one group, agree on a final investment plan.

TIPS to do TASK:
1.Find a group to do task with you.
2.Make sure you understand the background information and task well.
3.You should outline or writing down your ideas before discussing.