Part I: Organization of a Business
Selecting a Form of
Business Ownership 2
Introduction to
Business
J eff Madura
3e
3e
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Learning Goals
• Explain how business owners select
a form of ownership.
• Explain how the potential return and
risk of a business are affected by its
form of ownership.
• Describe methods of owning
existing businesses.
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Business Ownership
Decisions
• Advantages and disadvantages of
each type of business ownership
• Impact of the form of business
ownership on return on investment
• Impact of the form of business
ownership on risk
• Methods to obtain ownership of
existing businesses
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Impact of Forms of
Ownership
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Forms of Business
Ownership
• Sole Proprietorship
– Owned by a single owner.
• Partnership
– Co-owned by two or more people.
– Co-owners must register with the state and
may need an occupational license.
• Corporation
– State chartered entity that pays taxes and is
legally distinct from its owners.
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Sole Proprietors
• Must be willing to accept full
responsibility for firm performance
• Business profits are not shared with
creditors
• Need strong leadership skills, must
be well organized, and communicate
well with employees
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Sole Proprietorship
• Advantages • Disadvantages
– All earnings go to – Sole proprietor
the sole proprietor incurs all losses
– Easy organization – Unlimited liability
– Complete control – Limited funds
– Lower taxes – Limited skills
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Types of Partnerships
• General Partnerships
– All partners have unlimited liability.
• Limited Partnerships
– Some partners have personal liability that is limited
to the cash or property they invested in the firm.
– One or more general partners who actively manage
the business, receive a salary, share in profits and
losses, have unlimited liability.
– Personal earnings received from the partnership are
subject to personal income taxes.
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Partnerships
• Advantages • Disadvantages
– Additional funding – Control is shared
– Losses are shared – Unlimited liability for
– More specialization general partners
– Profits are shared
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Other Business Forms
• S Corporation
– Firm has 75 or fewer employees.
– Owners have limited liability, but are taxed
as if the firm were a partnership.
• Limited Liability Corporation (LLC)
– Has all the favorable features of a general
partnership but also offers limited liability for
the partners.
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on
a Proprietorship versus a
Partnership
Copyright © 2004 South-Western. All rights reserved. Exhibit 2.1a 2–11
on
a Proprietorship versus a
Partnership
Copyright © 2004 South-Western. All rights reserved. Exhibit 2.1b 2–12
Relative Contributions to Business Revenue of
Sole Proprietorships, Partnerships, and
Corporations
Copyright © 2004 South-Western. All rights reserved. Exhibit 2.2 2–13
business online
e-business
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Corporations
• Individual or group must adopt
corporate charter and file it with the
state
– Describes name of the firm, stock issued,
firm’s operations
– Must also establish bylaws
– Shareholders have limited liability
– Shareholders elect members of board of
directors
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Stockholders
• Elect members of board of directors
who are responsible for establishing
general policies of the firm
– Elect president and other key officers who
run the business
• Earn return on investment in two
ways
– May receive dividends
– Stock may increase in value
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Corporations
• Advantages • Disadvantages
– Limited liability – High organizational
– Access to funds expense
– Transfer of – Financial disclosure
ownership – Agency problems
– High taxes
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Illustration of Double Taxation
Copyright © 2004 South-Western. All rights reserved. Exhibit 2.3 2–18
Comparison of Tax Effects on
Corporations and Sole Proprietorships
Copyright © 2004 South-Western. All rights reserved. Exhibit 2.4 2–19
Small Business Administration’s Home
Page
Copyright © 2004 South-Western. All rights reserved. Exhibit 2.5 2–20
List of SBA Publications on the Internet
Copyright © 2004 South-Western. All rights reserved. Exhibit 2.6 2–21
The Company Corporation Home Page
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Private Vs. Public
• Ownership of privately held
corporations is restricted to a small
group of investors.
• Publicly held shares can be easily
purchased or sold by investors.
– Act of initially selling stock is called “going
public.”
– Publicly held corporations obtain additional
funds by issuing new common stock.
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Impact of Ownership on
Return
• Return on Investment (ROI)
– After-tax earnings represent the return in
dollars to the business owners.
• Return on Equity (ROE)
– Reflects earnings as a proportion of the
firm’s equity
– Equity is the total investment by the firm’s
stockholders.
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Return on Equity for The Children’s Place
Copyright © 2004 South-Western. All rights reserved. Exhibit 2.8 2–25
Impact of Ownership on
Risk
• Risk represents uncertainty about
the firm’s future earnings
– Depends on future revenues and expenses
• Sole proprietorships tend to be
riskier than larger businesses, such
as partnerships and corporations.
– Limited funding restricts ability to diversify
and spread business risk
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Ownership of Existing
Business
• Assuming Ownership of a Family
Business
• Purchasing an Existing Business
– Assess expertise
– Compare expected benefits with initial outlay
– Be cautious about basing future earnings
expectations on historical data
• Franchising
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Franchising
• Business owner (franchisor) allows
another (the franchisee) to use its
trademark, trade name, or
copyright, under specified
conditions.
• Each franchise operates as an
independent business.
• Typically owned by a sole proprietor.
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Well Known Franchises
• McDonald’s
• Thrifty Rent-a-Car System
• Mail Boxes Etc.
• Dairy Queen
• Super 8 Motels Inc.
• TGI Fridays
• Pearle Vision Inc.
• Baskin-Robbins
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Types of Franchises
• Distributorship [Coca-Cola]
– Dealer is allowed to sell a product produced
by a manufacturer.
• Chain-Style Business [McDonald’s]
– Firm is allowed to use the trade name of a
company and follows guidelines related to
the pricing and sale of the product.
• Manufacturing Arrangement [ Pepsi
Co.]
– Firm is allowed to manufacture a product
using the formula provided by the franchisor.
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Franchises
• Advantages • Disadvantages
– Proven – Sharing profits
management style – Less control
– Name recognition
– Financial support
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B2B Franchises
• Franchises serving other businesses
that have grown substantially:
– Hiring services [Express Employment Professionals] -
[Pak: Rozee. pk]
– Consulting services [ActionCOACH]- [Pak:
Ascend Development Consulting]
– Training services – [Sandler Training] – [Pak:
Navitus]
• Require smaller initial investment bcoz they can
be operated by computer from a home office.
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Ownership of Foreign
Businesses
• Purchase a franchise created by a U.S.
firm in a foreign country
– Return may be higher than in U.S. if there is less
competition
• Purchase a business being sold by the
foreign government
– Reputation for inefficiency often leads to low prices
– Can be high risk due to instability of foreign
government
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Summary
• Entrepreneurs can select a form of ownership:
– Sole proprietorship
– Partnership
– Corporation
• Return and risk depend on form of business
ownership.
• Common methods for obtaining ownership of
existing businesses:
– Family business
– Purchase existing business
– Franchising
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