Chapter 5

How to form a business

Peter Cancro, Founder of
Jersey Mike’s Subs

GETTING TO KNOW
 Chapter
Structure
1. Sole proprietorships
2. Partnerships
3. Corporations
4. Corporate Expansion: mergers and acquisitions
5. Franchises
6. Cooperatives
5.1. Sole proprietorships

Sole proprietorships
A business that is owned, and usually
managed, by one person
 A. The owner assumes all the profits and risks
from the business.
1. By taking all the risks, a sole proprietor
experiences unlimited liability.
Sole Proprietorship 2. This means that any debts that the business
owner owes can be collected from his/her
personal assets or belongings.
3. In other words, if the owner cannot pay
business-related debts, bill collectors can take
her/his car, boat, or home as payment.
 B. This form of ownership is often chosen for
businesses that can easily be managed by the
owner or by someone the owner hires.

Sole Proprietorship C. Sole proprietorships are often found in small,

local, and home-based businesses.
D. Most sole proprietors do not need to address
complicated legal issues within this form of
ownership.
E. Business and individual taxes are not
separated, and owners claim business taxes on
their personal income tax returns each year.
 5.1. Sole proprietorships

1. Ease of starting and

ending the business
2. Being your own boss 1. Unlimited liability – the
3. Pride of ownership risk of personal losses
4. Leaving a legacy Disadvantage
2. Limited financial
5. Retention of company Advantage
resources
profits 3. Management difficulties
6. No special taxes 4. Overwhelming time
commitment
5. Few fringe benefits
6. Limited growth
7. Limited life span
5.2. Partnerships

Partnerships
A partnerships is a legal form of business
with two or more owners.
A. Often, the purpose of forming a
partnership is to combine the capital
(money), experience, and abilities of the
individual owners.
B. In this form of ownership, the business
partners share both the chance for
profits and the risk of loss.
C. The partners decide what each owner
will contribute to the business and what
each will get out of it.
 5.2. Partnerships
A partnership with one or
more general partners and
one or more limited
partners. A partnership that looks much
like a corporation but is taxed
Limited like a partnership and thus
partnerships avoids the corporate income
Disadvantage tax
Advantage
General Master limited
partnerships partnerships
A partnership in which all
owners share in operating the
business and in assuming
liability for the business’s debts.
5.2. Partnerships

Limited Partnerships
a. For example, the amount of financial
responsibility could be limited to the
amount the partner invested.
b. If the partner invested $5,000 in a
business, that is all one would lose if the
company went out of business.
c. Setting up a limited partnership is a
little more complicated than establishing
a general partnership because the
government requires partners to comply
with a number of different rules and
restrictions.
 5.2. Partnerships

1. More financial resources

2. Shared management and
pooled/complementary
3. Longer survival
4. No special taxes Disadvantage
Advantage

1. Unlimited liability
2. Division of profits
3. Disagreements among
partners
4. Difficulty of termination
5.3. Corporations

Corporation
A state-chartered legal entity with
authority to act and have liability
separate from its owners.

The U.S. Supreme Court defines a

corporation as an “artificial being,
invisible, intangible, and existing only in
contemplation of the law.”
Corporation • As a business, a corporation functions
independently of its owners but is treated as a per-
son with legal rights, duties, and powers.
• Because the corporation is considered separate from
its owners, the owners are not liable for the
company’s actions, and their personal property
cannot be taken to pay outstanding debts.
• A corporation can:
1. Borrow and lend money
2. Buy and sell goods
3. Make contracts
4. Sue or be sued
5. Have an unlimited life span
Corporation
 To be an owner of a corporation, a person
purchases shares of stock and becomes a
stockholder (or shareholder).
 The more shares of stock a person owns, the
more control the person has over the business.
 The corporation form of ownership is suitable
for almost any type of business.
1. It is often used for businesses that require
large amounts of capital (e.g., airlines and
manufacturing).
2. Businesses with uncertain futures, such as
new magazine publishers or entertainment
ventures, are also well-suited for a
corporation business structure.
 5.3. Corporations

1. Limited liability
2. Ability to raise more 1. Initial cost
money for investment 2. Extensive paper work
3. Size 3. Double taxation
4. Perpetual life 4. Two tax returns
Disadvantage
5. Ease of ownership change 5. Size
Advantage
6. Ease of attracting talented 6. Difficulty of termination
employees 7. Possible conflict with
7. Separation of ownership stockholders and board of
from management. directors
 Types of corporation

Private S Corporation
corporation 01 02

03 Non-profit
C Corporation 04
corporation
Private Corporation

A private (or close) corporation does not

offer shares for sale to the general
public, meaning that it might have just a
few shareholders
Private Corporation
1. In many cases, the shareholders also operate
and manage the business.
2. A private corporation is usually not required
to make its financial activities public, but for
tax reasons, it must prepare reports for the
state in which it operates.
3. A private corporation is taxed by the
government in two ways.
4. First, it is taxed on the profits made by the
company itself.
5. Second, the shareholders are taxed on the
dividends they earn on their investments.
6. This is often called dual (or double) taxation.
 S Corporation

S Corporation is a unique
government creation that looks like
a private corporation but is taxed
like sole proprietorships and
partnerships.
 S Corporation

1. By taxing the corporation as if it were a

partnership, the “S” corporation avoids
dual taxation.
2. This saves the owners a lot of money in
taxes.
3. To qualify as an “S” corporation, the
company must have 100 or fewer
shareholders and adhere to a number
of other government policies.
 C Corporation

Known as a public corporation, can

sell millions of shares of stock
to the general public.
 C Corporation
Shareholders Annual report
Unlimited stockholders in just Mandate by law to provide
one company. financial information to public
and investors.

Laws and regulations

Taxation
Subject to more government
Like private corporations, public
regulation and taxation than
corporations are subject to dual
other forms of business
taxation
ownership
A nonprofit (or not-for-
profit) corporation operates
to accomplish a specific
mission—other than to make
a profit.
Because nonprofit
Generally, the purpose of the organizations are established
organization is to help to benefit society, they are
society, and income is used not generally taxed by the
to fund programs and cover federal government
operational expenses.

Non-Profit Corporation
Many nonprofits rely on
donations and grants for
funding
Corporations – LLP and LLC

Unique type of business ownership, a

hybrid structure, allows owners (or
members) to enjoy the advantages of
corporations and either sole
proprietorships or partnerships.
LLP - LLC
A company similar to an S corporation
but without the special eligibility
requirements.
 5.3. Corporations

1. Limited liability
2. Choice of taxation
3. Flexible ownership rules
4. Flexible distribution of
profit and losses Disadvantage
5. Operating flexibility Advantage 1. No stock
2. Limited life span
3. Fewer incentives
4. Taxes
5. Paperwork
Limited liability companies
 • Members determine how the company is
managed and how the profits are shared.
LLP & LLC • Characteristics of hybrid business structures
include:
1. Limited liability—Personal assets cannot be
taken to pay the company’s debts.
2. Limited life—Most states require that the
company dissolve after a certain amount of
time and/or upon the death, retirement, or
resignation of an owner.
3. Limited taxation—Taxes are claimed only on
individual members’ personal income tax
returns.
4. Unlimited owners/partners — Hybrid
structures can have as many members as
desired.
 • Many professional service businesses (e.g.,
doctors, attorneys, accountants) structure
LLP & LLC ownership as LLPs.
1. This form of ownership protects innocent
partners from the malpractice of other
partners.
2. For example, the LLP structure protects
partners in a doctor’s office if another
doctor in the practice is sued by a patient.
• Many states require that LLCs have at least two
owners, although some states require only one.
1. Like general partnerships, LLCs should
develop detailed agreements, known as
operating agreements, specifying each
member’s role in the company.
2. LLCs are suitable for most types of
businesses.
 Agent form
In other words, you’ll find many
ownership opportunities with
existing companies through
franchising, multi-level marketing,
licensing, and developing joint
ventures.

Agent of existing
company
 5.4. Corporate expansion: mergers and acquisitions

Conglomerate merger
The joining of firms in completely
unrelated industries

Merger Horizontal merger

The result of two firms The joining of two firms in the
forming one company same industry

Acquisition
Vertical merger
One company’s purchase of the
property and obligations of The joining of two companies
another company involved in different stages of
related businesses
 5.4. Corporate expansion: mergers and acquisitions

Types of mergers
5.5. Franchises

Franchises
A franchise agreement is an
arrangement whereby someone with a
good idea for a business (the franchisor)
sells the rights to use the business name
and sell a product or service (the
franchise) to others (the franchisees) in a
given territory.
Some definitions
• Franchisor: a company that develops a
product concept and sells others the rights
to make and sell the products.
• Franchise: the right to use a specific
business’s name and sell its products or
services in a given territory.
 5.5. Franchises
 To own a franchise, you must first sign a
franchise agreement and pay an initial
franchise fee.
 Sometimes, the franchisor establishes a
relationship with another person or firm,
known as a master licensee, who helps find
franchisees in a particular region or territory.
 Depending on the terms established with the
franchisor, the master licensee might pro-vide
support for franchises in the form of training or
warehousing.
 Land developers and other groups or individuals
often purchase franchise rights from a business and
open several outlets in a specific area.
 This type of multiple-unit business ownership is a
growing trend in the business world.
5.5. Franchises
 Business-format franchise
1. This franchise arrangement is usually available to anyone
who has the capital to invest.
2. It requires a close and continuous working relationship
between the franchisor and the franchisee.
3. Franchisors often provide training, financial guidance, and
supply channels for franchisees.
4. In turn, franchisees benefit from the franchisor’s national
advertising programs, since they operate under the same
trade name.
5. This reduces the franchisee’s risk of business failure.
5.5. Franchises
 Business-format franchise
6. On the flip side, franchisees are often limited to offering
specific goods and services, using certain vendors, operating
at certain hours, and presenting certain appearances.
7. Business-format franchises can be found in almost any
industry.
8. Within the business-format franchise, piggyback franchising
has become popular.
• This is a form of ownership in which a retail franchise
operates within the facilities of another store, often
referred to as the host.
• This arrangement benefits both the franchisee and the
host. The host increases its product line, while the
franchisee has access to the host store’s customers.
5.5. Franchises
 Product trade-name franchise
1. This is an independent sales relationship between a supplier
(franchisor) and a dealer (franchisee) to stock and sell a
specific or exclusive line of products.
2. Some of the major characteristics of a product trade-name
franchise include:
• Products are usually bought on consignment or straight from
the supplier/manufacturer.
• The name of the business is chosen by the franchisee.
• The franchisee usually must have a great deal of experience
and financial ability before the franchisor will agree to the
arrangement.
5.5. Franchises
 Product trade-name franchise
3. Product trade-name franchisees are commonly referred to as
dealerships or exclusive distributorships.
4. They are often used in the automobile, large appliance, soft-
drink, and petroleum-product industries.
 5.5. Franchises

1. Management and
marketing assistance
2. Personal ownership
3. Nationally recognized
1. Large start-up costs
name Disadvantage 2. Shared profit
4. Financial advice and Advantage 3. Management regulation
assistance
4. Coattail effects
5. Lower failure rate
5. Restrictions on selling
6. Fraudulent franchisors
 Multi level marketing

Multi-level marketing businesses pay

commissions on sales to people at two or more
levels
Multi level marketing
• The sales representatives (distributors)
usually work independently of the
company, not only selling products, but
trying to get others to sell them as well.
• The representatives receive payouts
from the sales of the people under them.
• Characteristics of legitimate multi-level
marketing businesses include the
following:
1. People become distributors because
they have used the product and
liked it.
Multi level marketing
2. Most distributors are home-based and offer flexible
scheduling.
3. Most distributors can get started for very little
money—this money is generally used to cover the
cost of instructions, samples, and promotional
materials.
4. Commission and bonus structures differ between
companies—some companies offer incentives or
prizes, such as cars, for attaining a set sales goal.
5. The representatives determine how much income
they generate by the amount of time and energy
they put into developing their business contacts.
The end …
How to form a business