Section II - Building the Business Plan: Beginning Considerations
Chapter 4
Forms of Business Ownership and Franchising (PPT 4.1 thru 4.6)
Part One: Learning Objectives
1.Explain the advantages and the disadvantages of the three major forms of ownership: the sole proprietorship, the partnership, and the corporation.
2.Discuss the advantages and the disadvantages of the S corporation, the Limited Liability Company, the professional corporation, and the joint venture.
3.Describe the three types of franchising: trade name, product distribution, and pure.
4.Explain the benefits and the drawbacks of buying a franchise.
5.Understand the laws covering franchise purchases.
6.Discuss the right way to buy a franchise.
7.Outline the major trends shaping franchising.
Part Two: Lesson Plan
I.The Sole Proprietorship (PPT 4.7, 4.8)
The sole proprietorship is the most popular type of ownership, defined as business owned and managed by one individual.
A.Advantages
1.Simple to create
2.Least costly form of ownership to begin
3.Profit incentive
4.Total decision-making authority
5.No special legal restrictions
6.Easy to discontinue
B.Disadvantages
1.Unlimited personal liability
2.Limited skills and capabilities
3.Feelings of isolation
4.Limited access to capital
5.Lack of continuity for the business
YOU BE THE CONSULTANT - Where do Small Business Owners Turn for Advice…It’s All in the Family
A national survey revealed that small business owners tend to seek advice from family members.
Q1. Who else could provide a business owner with objective advice?
Q2. Is who you ask for advice a source of potential problems? Explain.
A1. A partial list includes: bankers, suppliers, attorneys, accountants, employees and other business owners.
A2. Anyone’s advice is a source of potential problems since no one can predict the future. The astute business owner seeks advice from a variety and wide range of people in order to gather a full perspective on the given situation.
II.The Partnership (PPT 4.9 thru 4.12)
A partnership is an association of two or more people who co-own a business for the purpose of making a profit.
A.The partnership agreement
B.The Uniform Partnership Act (UPA)
C.Advantages
1.Easy to establish
2.Complementary skills
3.Division of profits
4.Larger pool of capital
5.Ability to attract limited partners
6.Little governmental regulation
7.Flexibility
8.Taxation
D.Disadvantages
1.Unlimited liability of at least one partner
2.Capital accumulation
3.Difficulty in disposing of partnership interest without dissolving the partnership
4.Lack of continuity
5.Potential for personality and authority conflicts
E.Types of partnership
- Limited Partnership
- Limited Liability Partnership
- Master Limited Partnership
YOU BE THE CONSULTANT – How Will the Assets of the Business be Valued for Dissolution?
Partnerships, Death and Feuds
The death of a partner often results in conflict among family members as to the disposition of assets.
Q1. What provisions of a partnership agreement could eliminate this and other problems?
A1. All partnerships should establish legally binding agreements that strive to answer every possible
“what-if” question (what if-- someone dies, someone wants to sell, we do not agree, and so on).
YOU BE THE CONSULTANT – Rosabeth Moss Kanter on Partnerships
The Howard Professor and Chairholder offers six guidelines for partners to consider.
Q1. If you were asked to add a “seventh rule,” what would it be?
A1. Students will generate ideas as they think about the best and most solid partnership agreement.
III.Corporations (PPT 4.13 thru 4.15)
The corporation is a separate entity apart from its owners, and may engage in business, make contracts, sue and be sued, and pay taxes. It is the most complex form of business ownership.
A."C Corporations" are creations of the state.
1.Domestic corporation
2.Foreign corporation
3.Alien corporation
B.Incorporation
1.Certificate of Incorporation
2.Bylaws
C.Advantages
1.Limited liability of stockholders
2.Ability to attract capital
3.Ability to continue indefinitely
4.Transferable ownership
D.Disadvantages
1.Cost and time involved in the incorporation process
2.Double taxation
3.Potential for diminished managerial incentives
4.Legal requirements and regulatory red tape
5.Potential loss of control by the founder(s)
IV.Other Forms of Ownership (PPT 4.16, 4.17)
A."S" Corporation: An "S" corporation is the same as any other corporation, except that a distinction is made for federal income tax purposes.
1.Criteria for businesses seeking "S" status
2.Advantages
a.Retains all of the advantages of regular corporations
b.Passes all profits/losses through to individual shareholders
c.Avoids double taxation
- Avoids taxes paid on assets that have appreciated in value
and are sold
3.Disadvantages
a.Increase in individual tax rates above maximum corporate
tax rate
b. Many fringe benefits cannot be deductible business expenses
4.Choosing an "S" Corporation wisely
B.The Limited Liability Company (LLC): The limited liability company is a cross between a partnership and a corporation, but is not subject to many of the restrictions incurred by "S" Corporations.
- Articles of organization
- Operating agreement
- Limited to no more than two of the following corporate concepts:
a.Limited liability
b.Continuity of life
c.Free transferability of interest
d.Centralized management
C.The Professional Corporation: Professional corporations are designed to offer professional - lawyers, doctors, dentists, accountants, and others - the advantages of the corporate form of ownership.
- The Joint Venture: A joint venture is much like a partnership, except it is formed for a specific, limited purpose.
YOU BE THE CONSULTANT SUMMARY – Which Form Is Best?
Watoma Kinsey and her daughter Katrina are about to launch a business that specializes in children's parties. The Kinseys have leased a large building and have renovated it to include many features designed to appeal to kids.
Watoma and Katrina have invested $45,000 each, developed a business plan and have negotiated a $40,000 bank loan. The Kinseys want to minimize their exposure to potential legal and financial problems so a large portion of their startup costs went to purchase a liability insurance policy to cover the Kinseys in case a child is injured at a party. If their business plan is accurate, the Kinseys will earn a small profit in their first year (about $1,500), and a more attractive profit of $16,000 in their second year of operation. Within five years, they expect their company to generate as much as 50,000 in profits. The Kinseys have agreed to split the profits and the workload equally.
The Kinseys believe their business will be successful and eventually want to franchise their company. For now, they want to perfect their business system and prove that it can be profitable before they try to duplicate it in the form of franchises. As they move closer to the launch date for their business, the Kinseys are reviewing the different forms of ownership.
Q1. Which form(s) of ownership would you recommend to the Kinseys? Explain.
Q2. Which form(s) of ownership would you recommend the Kinseys avoid? Explain.
Q3. What factors should the Kinseys consider as they try to choose the form of ownership that is best for them?
A1. Due to the Kinsey's desire to minimize their exposure to potential legal and financial problems, their choice of ownership should be a corporation.
A2. Any form of partnership should be avoided due to the issue of liability. Students should discuss the issue of liability.
A3. Students should list and briefly discuss the factors that every entrepreneur should consider prior to making a final decision on the form of ownership (taxes, liability, capital, business goals, management succession and so on).
YOU BE THE CONSULTANT – Tallman’s of Savannah
Louise Tallman spent much of her childhood playing and working in her mother and aunt’s antique shop. Her interest, involvement and love of antiques led her to attend a school of art and design. Upon graduation, Louise decided to start her own antique shop and is in the process of completing her business plan.
Q1. What are the questions that you would pose to Louise in order to help her select the form of ownership for her antique shop? Please explain the relevance of each question and answer, to determination of the suggested form of ownership.
A1. Louise’s current financial (asset) position and her short- and long-term personal and business goals must be known in order to properly answer the question. Students should be encouraged to make assumptions that will position them to offer good advice.
V.Franchising (PPT 4.18)
In franchising, semi-independent business owners (franchisees) pay fees and royalties to a parent company (franchiser) in return for the right to become identified with its trademark, to sell its products or services, and often to use its business format and system.
VI.Types of Franchises (PPT 4.19)
A.Tradename franchising
B.Product distribution franchising
C.Pure (or comprehensive or business format) franchising
VII.The Benefits of Buying a Franchise (PPT 4.20, 21)
A.Management training and support
B.Brand name appeal
C.Standardized quality of goods and services
D.National advertising programs
E.Financial assistance
- Proven products and business formats
- Centralized Buying Power
H.Site Selection and Territorial Protection
I.Greater chance for success
VIII.The Drawbacks of Buying a Franchise (PPT 4.22 thru 4.25)
A.Franchise fees and profit sharing
B.Strict adherence to standardized operations
C.Restrictions on purchasing
D.Limited product line
E.Unsatisfactory training programs
F.Market saturation
G.Less freedom
IX.Franchising and the Law (PPT 4.26, 4.27)
In response to problems that occurred in the 1950's to the franchising boom and the associated franchisers who defrauded their franchisees, laws have been enacted to prevent such behavior.
Uniform Franchise Offering Circular (UFOC): franchisers must register a UFOC and deliver a copy to the prospective franchisees before any offer or sale of a franchise. It establishes full disclosure and guidelines for the franchising company. It contains 23 rules, the franchise agreement, and any contracts accompanying it.
Trade Regulation Rule: enacted by the Federal Trade Commission (FTC) requiring all franchisers to disclose detailed information on their operations at the first personal meeting or at least ten days before a franchise contract is signed, or before any money is paid. In this section, the twenty-three major topics required by the Trade Regulation Rule are discussed as well.
X.The Right Way to Buy a Franchise (PPT 4.28)
A.Evaluate yourself
B.Research your market
C.Consider your franchise options
D.Get a copy of the franchiser's UFOC
E.Talk to existing franchisees
F.Ask the franchiser some tough questions
G.Make your choice
(PPT 4.29)
YOU BE THE CONSULTANT SUMMARY – The Opportunity of a Lifetime
Joe Willingham, a 51 year-old victim of downsizing is overly excited and anxious to spend all of his available cash on a franchise that he knows very little about. He is being pressured by both the salesman (who claims to have another buyer in waiting) and his soon to end severance package.
Q1. What advice would you offer Joe about investing in this franchise?
Q2. Map out a plan for Joe to use in finding the right franchise for him. What can Joe do to protect himself from making a bad franchise investment?
Q3. Summarize the advantages and disadvantages Joe can expect if he buys a franchise.
A1. Joe is in no position to invest in this franchise-- he needs to take a step back and properly assess the opportunity.
A2. Joe should begin with a “self-assessment” analysis in order to determine what he really wants to do with his future. If a franchise is the answer, Joe needs to learn all that he can about franchises in general and then compare and contrast his options through the business planning process.
A3. Students should list and discuss the list of advantages and disadvantages presented in the text.
XI.Trends Shaping Franchising (PPT 4.30)
A.The changing face of franchisees
B.International Opportunities
C.Smaller, non-traditional locations
D.Conversion franchising
E.Multiple-unit franchising
F.Master franchising
G.Piggybacking
Part Three: Suggested Answers to Discussion Questions
1.What factors should an entrepreneur consider before choosing a form of ownership?
Factors to be considered before choosing a form of ownership include:
- Tax considerations – calculate the firm's tax bill under each form of ownership.
- Liability exposure - how much personal liability is involved in the ownership form?
- Start-up capital required - how much capital does the entrepreneur have and how much will he need?
- Control - how much control is involved for each type of business organization? How much is the entrepreneur willing to give up?
- Business goals - how large and profitable does the entrepreneur expect the business to be?
- Management succession plans - consider smooth transition when passing company to the next generation of buyers.
- Cost of formation - some forms are more costly to create.
2.Why are sole proprietorships so popular as a form of ownership?
Sole proprietorships are a popular form of ownership for several reasons. First, they are simple to create. Anyone wanting to start a business can do so by obtaining the necessary licenses from state, county, and/or local governments. Also, this form is normally the least expensive. In addition, the owner has the total decision making-authority, can keep all profits remaining after expenses are paid, and may discontinue the sole proprietorship fairly easily if he wishes.
3.How does personal conflict affect partnerships?
The success/failure of a partnership depends on the cohesiveness of its partners. In the beginning, there is an "emotional high" when the startup of the business begins. Partners are so busy creating strategies and focusing on the new business, that they often do not consider the idea of future conflict with other partners. If this conflict does occur, the partnership may suffer. The mutual goals and general business philosophies may not be shared among the partners at this time. Thus, the demise of many partnerships can often be traced to interpersonal conflict if there are no procedures in place to resolve these problems.
4.What issues should the articles of partnership address? Why are the articles important to a successful partnership?
The major provisions of a partnership agreement include the following:
a.The name of the partnership
b.The purpose of the business
c.The domicile of the business
d.The duration of the partnership
e.The partners and their legal addresses
f.The contribution of each partner to the business
g.An agreement on how the profits (or losses) of the partnership will be distributed
h.An agreement on salaries or drawing rights against profits for each partner
i.The procedure to be followed in the event that the partnership wishes to expand through the addition of a new partner
j.How assets of the partnership will be distributed if the partners voluntarily dissolve the partnership
k.Sale of partnership interest
l.Absence or disability of one of the partners
m.Provisions for alteration or modification of the partnership agreement
5.Can one partner commit another to a business deal without the other’s consent? Why?
Yes, if the partner was exercising good faith and reasonable care in the performance of his duties, the law of agency holds that the actions of a general partner binds the other partners to a business deal made in the name of the partnership, without the other's consent.
6.What issues should the Certificate of Incorporation cover?
A Certificate of Incorporation normally will include the following:
a.The name of the corporation
b.A statement of the purpose of the corporation
c.The time horizon of the corporation
d.The names and addresses of the corporation
e.Place of business
f.Capital stock authorization
g.Capital required at the time of incorporation
h.Provisions for preemptive rights
i.Restrictions on transferring shares
j.Names and addresses of the initial officers
k.The bylaws by which the corporation will operate
7.How does an S Corporation differ from a regular corporation?
An S Corporation offers many of the same advantages of a corporation--limited liability, capital formation, and others--while being taxed as a partnership. Thus, the S Corporation avoids the corporate disadvantage of double taxation.
8.What role do limited partners play in a partnership? What happens if a partner takes an active role in managing the business?
The limited partner is treated, under the law, exactly as in a general partnership. The limited partner(s) is treated more as an investor in the business venture; limited partners have limited liability, and can only lose the amount invested in the business. If the limited partner does take an active part in managing the business, a limited partner may actually forfeit limited liability, taking on the liability status of a general partner.
9.What advantages does a Limited Liability Company offer over an S Corporation? A partnership?
An LLC eliminates many restrictions imposed by an S corporation such as: a maximum of thirty-five shareholders, none of whom can be foreigners or corporations; a limitation to one class of stock; restriction on members' ability to become involved in managing the company; and limited personal liability with imposed requirements. The LLC is not subject to such restrictions.
There are two advantages an LLC has over a C corporation. First, an LLC offers limited liability and a C corporation does not. Also, an LLC does not pay income tax and avoids the double taxation of C corporations.
10.How is an LLC created? What criteria must an LLC meet to avoid double taxation?
Creating an LLC is much like creating a corporation. Two documents are required to be filed: the articles of organization and the operating agreement. The articles of organization establish the company's name, its method of management, its duration, and the names and addresses of each organizer. The operating agreement outlines the provisions governing the business’ conduct.
11.Briefly outline the advantages and disadvantages of the major forms of ownership.
Sole proprietorship – least costly to start, total control, typically favorable tax considerations.
Partnership – typically favorable tax considerations, however, unlimited liability for general partner(s). Several other forms which may be costly to establish but limit liability.
Corporation – least favorable tax considerations, costly to establish, however, limited liability for owners.
Sub-S corporation and LLC’s combine the more favorable characteristics of both a sole proprietorship and corporation.
12.What is franchising?
In franchising, semi-independent business owners (franchisees) pay fees and royalties to a parent company (franchiser) in return for the right to sell its products or services and often to use its business format and system.