Chapter 05
How to
Form a
Business
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
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.
5-2
Basic Forms of
Business
Ownership
FORMS of
BUSINESS OWNERSHIP
5-3
Advantages of
Sole
Proprietorships
LG1
MAJOR BENEFITS of SOLE
PROPRIETORSHIP
1) Comparative 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**
5-4
Disadvantages
of Sole
Proprietorships
LG1
DISADVANTAGES of SOLE
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
5-5
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.
5-6
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.
5-7
Advantages &
Disadvantages
of Partnerships
LG2
ADVANTAGES of
PARTNERSHIPS
• More financial
resources
• Shared management
and
pooled/complementary
skills and knowledge
• Longer survival
• No special taxes
5-8
Advantages &
Disadvantages
of Partnerships
LG2
DISADVANTAGES of
PARTNERSHIPS
• Unlimited liability
• Division of profits
• Disagreements among
partners
• Difficult to terminate
5-9
Corporations
LG3
CONVENTIONAL
CORPORATIONS
• Conventional (C)
Corporation -- A statechartered legal entity with
authority to act and have
liability separate from its
owners (its stockholders).
5-10
Advantages of
Corporations
LG3
ADVANTAGES of
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
5-11
Advantages of
Corporations
LG3
HOW OWNERS AFFECT
MANAGEMENT
5-12
Disadvantages
of Corporations
LG3
DISADVANTAGES of
CORPORATIONS
• Initial cost
• Extensive paperwork
• Double taxation (w dividends)
• Two tax returns
• Size
• Difficulty of termination
• Possible conflict with
stockholders and board of
directors
5-13
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.
5-14
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.
5-15
S Corporations
LG3
WHO CAN FORM
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.
5-16
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
5-17
Limited Liability
Companies
DISADVANTAGES of LLCs
LG3
• No stock, therefore
ownership is
nontransferable
• Limited life span
• Fewer incentives
• Taxes
• Paperwork
5-18
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.
5-19
Advantages of
Franchises
ADVANTAGES of FRANCHISING
LG5
• Management and
marketing assistance
• Personal ownership
• Nationally recognized
name
• Financial advice and
assistance
• Lower failure rate
5-20
Disadvantages
of Franchises
LG5
DISADVANTAGES of
FRANCHISING
• Large start-up costs
• Shared profit
• Management regulation
• Coattail effects
• Restrictions on selling
• Fraudulent franchisors
5-21
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.
5-22
Chapter 06
Entrepreneurship
and Starting a
Small Business
McGraw-Hill/Irwin
Copyright © 2013 by The McGraw-Hill Companies, Inc. All rights reserved.
The Age of the
Entrepreneur
WHAT is ENTREPRENEURSHIP?
• Entrepreneurship -Accepting the risk of
starting and running a
business.
6-24
Why People
Take the
Entrepreneurial
Challenge
WHY TAKE the RISK?
LG1
• Opportunity
• Profit
• Independence
• Challenge
6-25
Why People
Take the
Entrepreneurial
Challenge
LG1
WHAT DOES IT TAKE to be an
ENTREPRENEUR?
• Self-directed
• Self-nurturing
• Action-oriented
• Highly energetic
• Tolerant of uncertainty
6-26
Turning Your
Passion and
Problems into
Opportunities
LG1
An IDEA is a
GOOD OPPORTUNITY IF…
• It fills customers’ needs.
• You have the skills and resources to start a
business.
• You can sell the product or service at a
reasonable price and still profit.
• You can get your product or service to customers
before the window of opportunity closes.
• You can keep the business going.
6-27
Entrepreneurial
Teams
ENTREPRENEURIAL TEAMS
LG1
• Entrepreneurial team -- A
group of experienced people
from different areas of
business who join to form a
managerial team with the skills
to develop, make and market a
new product.
• An entrepreneurial team
(Steve Jobs, Steve Wozniak
and Mike Markkula) was key
to Apple’s success.
6-28
Entrepreneurship
Within Firms
INTRAPRENEURS
LG1
• Intrapreneur -- A creative person who works as an
entrepreneur within a corporation.
• Intrapreneurs use a company’s existing
resources to launch new products for the
company.
• Art Fry of 3M developed
Post-Its when he was
trying to mark pages of
his hymnal without
damage.
6-29
Small Business
Success &
Failure
THEY DID WHAT?
LG2
Famous Business Failures
• Tommy Hilfiger – First store went bankrupt
• Milton Hershey – First confectionery failed
• H.J. Heinz – Company went bankrupt six years after
start
• Walt Disney – First film company
went bankrupt
• Henry Ford – First two car
companies failed
• L.L. Bean – Almost went bankrupt
in first year
Source: World Features Syndicate.
6-30
Learning About
Small Business
Operations
LG3
LEARNING ABOUT
SMALL BUSINESS
• Learn from Others – Investigate your local
colleges for classes on small business and
entrepreneurship; talk to and work for successful
local entrepreneurs.
• Get Some Experience – Gain three years
experience in the field; then start a part-time small
business.
• Take Over a Successful Firm – Serve as an
apprentice and eventually take over once the owner
steps down.
6-31
Begin with
Planning
BUSINESS PLANS
LG4
• Business Plan -- A detailed written statement that
describes the nature of the business, the target
market, the advantages the business will have
over competition, and the resources and owners’
qualifications.
• A business plan forces potential owners to be
specific about what they will offer.
• A business plan is mandatory for talking with
bankers or investors.
6-32
Writing a
Business Plan
WRITING a BUSINESS PLAN
LG4
• A good plan takes a long time to prepare.
• A good executive summary catches interest and
tempts potential investors to read on.
• Getting the plan into
the right hands is
almost as important
as getting the right
information in it.
6-33
Getting Money
to Fund a Small
Business
SOURCES of CAPITAL
LG4
• Personal savings
• Relatives
• Former employers
• Banks & finance companies
• Government agencies
• Angel investors
• Venture capitalists -- Individuals or companies
that invest in new businesses in exchange for
partial ownership.
6-34
Getting Money
to Fund a Small
Business
LG4
FUNDING YOUR DREAM
Getting Cash When Financing Isn’t an Option
1. Get close to your customers.
2. Make clients pay upfront.
3. Outsource tasks on the
cheap.
4. Get in front of customers
quickly.
5. Become an expert.
6. Ask for help.
7. Be patient.
Source: Inc., October 2010.
6-35
SOCIAL LENDING
(Social Media in Business)
• Kickstarter and Lending
Club connect loan
seekers to potential
lenders.
• Administrators assign
interest rates between
6.78% and 24.95%
based on their credit
history, how much money
is needed, and what the
person is using it for.
6-36
The Small
Business
Administration
LG4
The SMALL BUSINESS
ADMINISTRATION
• Small Business Administration (SBA) -- A
U.S. government agency that advises and assists
small businesses by providing management training
and financial advice.
• SBA started a microloan program in 1991 that
provides very small loans to small business
owners.
• Program judges worthiness based on the
borrowers’ integrity and soundness of their
business ideas.
6-37
The Small
Business
Administration
LG4
HELP PLEASE!
More SBA Resources and Other Helpful Groups
•
Small Business
Investment Companies
•
The Office of
Innovation &
Entrepreneurship
•
SCORE
•
Entrepreneurship.org
Source: Inc., October 2010.
6-38
Looking for Help
MARKETING RESEARCH
LG4
• Marketing decisions need to be made long before
introducing a product or opening a store.
• A marketing research study can help you:
-
Determine where to locate.
Whom to select as your target market.
What is an effective strategy for reaching the
market.
6-39
Looking for Help
OTHER FORMS OF HELP
LG4
• A commercial loan officer can help:
-
Design an acceptable business plan.
Give financial advice.
Lend money.
• An insurance agent can help you:
-
Know the risks associated with the business.
How to cover risks with insurance.
How to prevent risks with safety devices.
• Service Corps of Retired Executives
-
More than 10,500 volunteers from industry, trade
associations, and education who counsel small
business at no cost.
6-40
Entrepreneurship
and
Wealth Building
LG1
BUSINESS and
ENTREPRENEURSHIP
• Business -- Any activity that seeks to provide
goods and services to others while operating at a
profit.
• Entrepreneur -- A person who risks time and
money to start and manage a business.
• Success in business is often based on the
strategy of finding a need and filling it.
1-41
Matching Risk
with Profit
RISK
LG1
• Risk -- The chance an
entrepreneur takes of losing time
and money on a business that
may not prove profitable.
• Not all businesses make the
same amount of profit.
• Businesses take risks, but with
great risks could come great
profit.
1-42
Responding to the
Various Business
Stakeholders
STAKEHOLDERS
LG1
• Stakeholders -- All the people who stand to gain
or lose by the policies and activities of a business
and whose concerns the businesses need to
address.
• Who are Stakeholders?
- Customers
- Community Members
-
-
Employees
Stockholders
Suppliers
Dealers
Media
Elected Officials
Bankers
Environmentalists
1-43
Responding to the
Various Business
Stakeholders
LG1
OUTSOURCING
and INSOURCING
• Outsourcing -- Contracting with other companies
(often in other countries) to do some of the firm’s
functions, like production or accounting.
• Insourcing -- Foreign companies opening offices
and factories in the United States.
1-44
Entrepreneurship
Versus Working for
Others
LG2
THE UPS and DOWNS
of ENTREPRENEURSHIP
The UPS
The DOWNS
The freedom to succeed.
The freedom to fail.
Make your own decisions.
No paid vacations.
High possibility of wealth.
No health insurance.
Hire your own staff.
No daycare.
1-45
The Importance
of Entrepreneurs
to the Creation
of Wealth
FIVE FACTORS of PRODUCTION
LG2
1.
2.
3.
4.
5.
Land
Labor
Capital
Entrepreneurship
Knowledge
• Entrepreneurs use what they’ve learned to
grow their businesses and increase wealth.
1-46
The Economic
and Legal
Environment
CORRUPTION WORLDWIDE
LG3
Least Corrupt
1.Denmark
2.New Zealand
3.Singapore
4.Finland
5.Sweden
Most Corrupt
1.Somalia
2.Myanmar
3.Afghanistan
4.Iraq
5.Uzbekistan
Source: Transparency International, June 2011.
1-47
ETHICS BEGINS with YOU
(Making Ethical Decisions)
The number of employees calling in sick has
reached a five-year high. 3/5 of all callers were
not even sick. Others conduct personal business
at work, play video games and check their
Facebook pages while at work.
What is the problem with this situation?
What are the alternatives?
What are the consequences of each alternative?
What path would you choose?
Is it ethical?
1-48
The Global
Environment
LG7
IMPORTANT CHANGES to the
GLOBAL ENVIRONMENT
1. Growth of global competition.
2. Increase of free trade among nations.
3. Development
of efficient
distribution
systems.
4. Advances in
communication
systems.
1-49
The Evolution of
U.S. Business
The EVOLUTION of BUSINESS
LG8
Agriculture Era
Manufacturing Era
Service Era
Information-Based Era
1-50
Progress in the
Agricultural
Industry
The AGRICULTURAL ERA
LG8
•
In the 1800s, the
agricultural industry led
economic development.
•
Technology, like the
harvester and cotton gin,
changed the farming
industry making it more
efficient.
•
This led to fewer farmers
with larger farms.
1-51
Progress in the
Manufacturing
Industry
The MANUFACTURING ERA
LG8
•
Industrialization in the 19th and 20th centuries
moved jobs from farms to factories.
• As technology
improved
productivity, fewer
workers were
needed in factories.
1-52
Progress in the
Service Industry
The SERVICE ERA
LG8
• Make up about 70% of the
U.S. economy.
• Since the mid-1980s, the
service industry generated
almost all the increases in
employment.
• More high-paying jobs in
service industries.
1-53
Your Future in
Business
LG8
•
The INFORMATION
TECHNOLOGY ERA
IT affects:
- Agriculture
- Industry
- Service
1-54