CHAPTER 6

Forms of Business Ownership

and
Buying an Existing Business

Copyright © 2011 Pearson Education

Choosing a Form of Ownership

 There is no one “best” form of ownership.

 The best form of ownership depends on an entrepreneur’s
particular situation.
 Key: Understanding the characteristics of each form of
ownership and how well they match an entrepreneur’s
business and personal circumstances.
Factors Affecting the Choice
 Tax considerations
 Liability exposure
 Start-up and future capital requirements
 Control
 Managerial ability
 Business goals
 Management succession plans
 Cost of formation
Major Forms of Ownership
 Sole Proprietorship
 General Partnership
 Limited Partnership
 Corporation
 S Corporation
 Limited Liability Company
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Advantages of the Sole Proprietorship

 Simple to create
 Least costly form to begin
 Profit incentive
 Total decision making authority
 No special legal restrictions
 Easy to discontinue
Disadvantages of the Sole Proprietorship

 Unlimited personal liability

 Limited skills and capabilities
 Feelings of isolation
 Limited access to capital
 High percentage of Lack of continuity of the business

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1-9
Partnership

 An association of two or more people who co-own a

business for the purpose of making a profit.
 Always wise to create a partnership agreement states in
writing the terms under which the partners agree to
operate the partnership and that protects each
partner’s interests in the business.
 .The best partnerships are built on trust and respect.
Advantages of the Partnership

 Easy to establish
 Complementary skills of partners
 Division of profits
 Larger pool of capital
 Ability to attract limited partners
 Minimal government regulation
 Flexibility
 Taxation
 Types of Partners
 General partners
 Take an active role in managing a business.
 Have unlimited liability for the partnership’s debts.
 Every partnership must have at least one general partner.
 Limited partners
 Cannot participate in the day-to-day management of a company.
 Have limited liability for the partnership’s debts.
Types of Limited Partners

 Two types of limited partners:

1. Silent partners:
 Not active in a business but are generally known to be members of
the partnership
2. Dormant partners:
 Neither active nor generally known to be associated with the
business

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Liability Features of the Basic Forms of Ownership

Partnership

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Claims of Partnership’s Creditors

General Partnership’s
Partner’s Assets
Personal
Assets
Disadvantages of the Partnership

 Unlimited liability of at least one partner

 Capital accumulation
 Difficulty in disposing of partnership interest without dissolving the
partnership
 Lack of continuity in case of argument
 Potential for personality and authority conflicts

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Limited Partnership

 A partnership composed of at least one general partner

and one or more limited partners.

 A general partner in this partnership is treated exactly as

in a general partnership.

 A limited partner has limited liability and is treated as an

investor in the business.
Corporation
Types of corporations:

 Publicly held – a corporation that has a large number

of shareholders and whose stock usually is traded on
one of the large stock exchanges.

 Closely held – a corporation in which shares are

controlled by a relatively small number of people, often
family members, relatives, or friends.
Corporation
 A separate legal entity from its owners.
 Types of corporations:
 Domestic – a corporation doing business in the state in
which it is incorporated.
 Foreign – a corporation doing business in a state other
than the state in which it is incorporated.
 Alien – a corporation formed in another country but doing
business in another country.
Avoiding Legal Tangles
 Identify the company as a corporation by using “Inc.” or “Corporation” in the business
name.

 File all reports and pay all necessary fees required by the state in a timely manner.

 Hold annual meetings to elect officers and directors.

 Keep minutes of every meeting (formal and informal) of the officers and directors.

 Be sure that the corporation’s board makes all major decisions.

 Make it clear that the business is a corporation – officers should sign all documents in
the corporation’s name.

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Advantages of the Corporation

Ch, 5: Forms of Business Ownership

 Disadvantages of the Corporation

 Cost and time of incorporation process

 Potential for diminished managerial incentives
 Legal requirements and regulatory “red tape”
 Potential loss of control by founder(s)

 S- corporation removed

Ch, 5: Forms of Business Ownership

 Limited Liability Company (LLC)

 Resembles an S Corporation but is not subject to the same

restrictions.
 Two documents required:
 Articles of organization
 Operating agreement
Limited Liability Company (LLC)

 An LLC cannot have more than two of these four

corporate characteristics:
1. Limited liability
2. Continuity of life
3. Free transferability of interest
4. Centralized management
Liability Features of the Basic Forms of Ownership

Limited Liability Company - LLC

Claims of LLC’s Creditors

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LLC’s Assets

Member’s Member’s
Personal Assets Personal Assets
The Professional Corporation

 Designed for professions – lawyers, doctors,

dentists, accountants and other professionals
 Created in the same manner as a corporation
 Identified by the abbreviations:
 P.C. – Professional Corporation
 P.A. – Professional Association
 S.C. – Service Corporation

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The Joint Venture

Much like a partnership, but it:

 Is formed for a specific purpose
 Has a beginning and an end

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Conclusion
 The “right” choice of the form of ownership is unique to
every entrepreneur and their business.
 Each form has advantages and disadvantages.
 The entrepreneur must be thoughtful and strategic about
this important decision.

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Buying a Business
 Key Questions
to Consider Before Buying a Business

 Is the right type of business for sale in the market in which you want to
operate?
 What experience do you have in this particular business and the industry in
which it operates? How critical is experience in the business to your ultimate
success?
 What is the company’s potential for success?
 What changes will you have to make – and how extensive will they have to be
– to realize the business’s full potential?
Key Questions
to Consider Before Buying a Business

 What price and payment method are reasonable for you

and acceptable to the seller?
 Will the company generate sufficient cash to pay for itself
and leave you with a suitable rate of return on your
investment?
 Should you be starting a business and building it from the
ground up rather than buying an existing one?
Types of Business Buyers

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Ch. 6: Franchising and the Entrepreneur
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Advantages of Buying a Business

 It may continue to be successful

 It may already have the best location
 Employees and suppliers are established
 Equipment is already installed
 Inventory is in place and trade credit is established
Advantages of Buying a Business

(continued)

 New owners can “hit the ground running”

 New owners can use the previous owner’s experience
 Financing is easier to obtain
 It’s a bargain!
Disadvantages of Buying a Business
 It’s a “loser”
 Previous owner may have created ill will
 “Inherited” employees may be unsuitable
 The location may have become unsatisfactory
 Equipment and facilities may be obsolete or inefficient

 Change and innovation can be difficult to implement

 Inventory may be outdated or obsolete
 Accounts receivable may be worth less than face value
Acquiring a Business
 Study: 50 to 75% of all business sales that are initiated fall
through.
 The right way:
 Analyze your skills, abilities, and interests.
 Prepare a list of potential candidates.
 Investigate and evaluate candidate businesses and
select the best one.

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Acquiring a Business
(continued)

 Explore financing options.

 Potential source: the seller
 Ensure a smooth transition.
 Communicate with employees
 Be honest
 Listen
 Consider asking the seller to serve as a
consultant through the transition
Critical Areas for Analyzing an Existing Business

1. Why does the owner want to sell ... what is the real reason?
2. What is the physical condition of the business?
 Accounts receivable
 Lease arrangements
 Business records
 Intangible assets
 Location and appearance
3. What is the potential for the company's products or services?
 Product line status
 Potential for company’s products or services
 Customer characteristics and composition
 Competitor characteristics and composition
4. What legal aspects must I consider?
The Legal Aspects of Buying a Business

 Lien - creditors’ claims against an asset.

 Bulk transfer - protects business buyer from the claims
unpaid creditors might have against a company’s assets.
 Bulk Transfer
 Seller must give the buyer a sworn list of creditors.
 Buyer and seller must prepare a list of the property included in the sale.
 Buyer must keep the list of creditors and property for six months.
 Buyer must give written notice of the sale to each creditor at least ten days
before he takes possession of the goods or pays for them (whichever is
first).
 (continued)

The Legal Aspects of Buying a Business

• Lien - creditors’ claims against an asset.

• Bulk Transfer - protects business buyer from the claims unpaid creditors
might have against a company’s assets.
• Contract Assignment - buyer’s ability to assume rights under seller’s
existing contracts.
• Covenant not to compete (restrictive covenant or non compete
agreement) contract in which a business seller agrees not to compete
with the buyer within a specific time and geographic area.
• Ongoing legal liabilities - physical premises, product liability lawsuits,
and labor relations issues.

7 - 40 Ch. 7: Buying an Existing Business

Critical Areas for Analyzing an Existing Business

3. What is the potential for the company's products

or services?
 Product line status
 Potential for company’s products or services
 Customer characteristics and composition
 Competitor characteristics and composition
4. What legal aspects must I consider?
5. Is the business financially sound?

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The Acquisition Process

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FIGURE 7.2
Ch. 7: Buying an Existing Business
Sources: Adapted from Buying and Selling: A Company Handbook, Price Waterhouse,( New York: 1993) pp.38-42;Charles F. Claeys, “The Intent to Buy,” Small Business Reports, May 1994, pp.44-47.
Negotiating the Deal
Buyers seek to:
 Get the business at the lowest cost.
 Negotiate favorable payment terms.
 Get assurances that they are buying the business they are
getting.
 Avoid putting the seller in a position to open a competing
business.
 Minimize the amount of cash paid up front.

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Negotiating the Deal

Sellers seek to:

 Get the highest price possible
 Sever all responsibility for company liabilities
 Maximize the cash they receive
 Minimize the tax burden from the sale
 Make sure the buyer will be able to make all
future payments

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The Five Ps of Negotiating
In addition to the text

Preparation - Examine the needs Poise - Remain calm during the

of both parties and all of the
relevant external factors affecting
the negotiation before you sit
down to talk.
negotiation. Never raise your voice
or lose your temper, even if the
situation gets difficult or
emotional. It’s better to
walk away and calm
down than to blow

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Patience – up and blow
Don’t be in such the deal.
a hurry to close the deal that
you end up giving up much of what
you hoped to get. Impatience is
a major weakness in
a negotiation.

Persuasiveness - Know what Persistence - Don’t give in

your most important positions at the first sign of resistance to
are, articulate them, and offer your position, especially if it is
support for your position. an issue that ranks high in
your list of priorities.
Ch. 7: Buying an Existing Business
Conclusion

When buying an existing business:

 Assess the advantages and disadvantages
 Follow the steps to improve your chances of
success
 Determine the value of the business
 Appreciate the seller’s side
 Negotiate wisely

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 CHAPTER 7

Franchising and the

Entrepreneur

Copyright © 2011 Pearson Education

 The Franchising Boom
 About 3,000 franchisors operate more than 770,000
outlets in the United States.
 Franchises generate more than $800 billion in annual
sales and account for 4.1% of the U.S. GDP.
 Franchises employ 8.1 million workers in the United
States in more than 300 major industries.

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 The Franchising Boom

 Economic impact of franchising on the U.S. economy:

$2.3 trillion.
 A new franchise opens somewhere in the world every
8 minutes.

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Number of Franchised Outlets in
the United States

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Franchised Outlets by Industry

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 Franchising

A system in which 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.

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 The Franchising Relationship
Element The Franchiser The Franchisee
Site Selection Oversees and approves; may choose site Chooses site with franchiser’s approval

Design Provides prototype design Pays for and implements design

Employees Makes general recommendations and Hires, manages, and fires

training suggestions employees

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Products and Services Determines product or service line Modifies only with franchiser’s approval

Prices Can only recommend prices Sets final prices

Purchasing Establishes quality standards and Must meet quality standards and purchase
suppliers only from approved suppliers

Advertising Develops and coordinates national ad Pays for national ad campaign; complies
campaign; may require minimum level of with local advertising requirements; gets
spending on local advertising franchisor approval on local ads

Quality Control Sets quality standards and enforces them Maintains quality standards; trains
with inspections; trains franchisees employees to implement quality systems

Support Provides support through an established Operates business on a day-to-day basis

business system with franchiser’s support

FIGURE 6.1
Source: Adapted from Economic Impact of Franchised Businesses: A Study for the International Franchise
Association, National Economic Consulting Practice of PriceWaterhouseCoopers, (IFA Educational Foundation, New
York: 2004), pp. 3,5.
 Types of Franchising
 Trade-name:
 A franchisee purchases the right to use the franchisor’s
trade name without distributing particular products
exclusively under the franchisor’s name.
 Product distribution:
 A franchisor licenses a franchisee to sell its products under
the franchisor’s brand name and trademark through a
selective, limited distribution network.
 Pure:
 A franchisor sells a franchisee a complete business format
and system.

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Franchising Basics

 Franchisee gets the right to use all of the elements of a

fully integrated business operation.
 Essence of what franchisees purchase from the
franchisors: Experience.
 Key Question: “What can a franchise do for me that
I cannot do for myself?”

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 Benefits of Franchising

 A business system
 Management training and support
 Start-up
 Ongoing
 Brand name appeal
 “Cloning”
 Standardized quality of goods and services

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Benefits of Franchising

 National advertising programs

 Franchisees contribute 1% to 5% of sales
 Financial assistance
 Only 20% of franchisors offer direct financial
assistance to franchisees.
 Proven products and business formats

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Benefits of Franchising

 Centralized buying power

 Site selection and territorial protection
 Important issue:
Territorial encroachment
 Greater chance for success

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Drawbacks of Franchising

 Franchise fees and ongoing royalties

 Average upfront franchise fee = $25,147
 Royalties range from 1% to 11% of franchisees’ sales
 Average royalty = 6.7% of sales
 Strict adherence to standardized operations
 Restrictions on purchasing
 Approved suppliers only

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Drawbacks of Franchising
(continued)

 Limited product line

 Contract terms and renewal
 Average term = 10.3 years
 Unsatisfactory training programs
 Market saturation
 Less freedom –
 “No independence”
 “Happy prisoners”

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Ten Myths of Franchising
1. Franchising is the safest way to go into business because franchises
never fail.
2. I’ll be able to open my franchise for less money than the franchiser
estimates.
3. The bigger the franchise organization, the more successful I’ll be.
4. I’ll use 80 percent of the franchiser’s business system, but I’ll improve
upon by substituting my experience and know-how.
5. All franchises are the same.
6. I don’t have to be a hands-on manager, I can be an absentee owner and
still be very successful.
7. Anyone can be a satisfied, successful franchise owner.

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Ten Myths of Franchising (continued)

8. Franchising is the cheapest way to get into business for yourself.

9. The franchiser will solve my business problems for me; after all, that’s
why I pay an ongoing royalty fee.
10. Once I open my franchise, I’ll be able to run things the way I want to.

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Franchising and the Law

Franchise Disclosure Document (FDD)

 Established in 2008 to replace the Uniform Franchise
Offering Circular (UFOC)

 Requires franchisors to disclose to potential franchisees

information on 23 important topics

 Objective: To give franchisees the information they need

to protect themselves from dishonest franchisees and to
make good investment decisions

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Detecting Dishonest Franchisers
In addition to the text

 Claims that the contract is “standard; no need to read it.”

 Failure to provide a copy of the required disclosure documents.
 Marginally successful prototype or no prototype.
 Poorly prepared operations manual.
 Promises of future earnings with no documentation.
 High franchisee turnover or termination rate.
 Unusual amount of litigation by franchisees.

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Detecting Dishonest Franchisers (continued)
In addition to the text

 Attempts to discourage your attorney from evaluating the contract

before signing it.
 No written documentation.
 A high pressure sale.
 Claims to be exempt from federal disclosure laws.
 “Get rich quick” schemes, promising huge profits with minimal effort.
 Reluctance to provide a list of existing franchisees.
 Evasive, vague answers to your questions.

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The Right Way to Buy a Franchise
 Evaluate yourself - What do you like and dislike?
 Research your market.
 Consider your franchise options.
 Get a copy of the Franchisor’s FDD – and read it!
 Talk to existing franchisees.
 Ask the franchiser some tough questions.
 Make your choice.

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Factors That Make a Franchise Appealing

In addition to the text

 Unique concept or marketing approach
 Profitability
 Registered trademark
 Business system that works
 Solid training program
 Affordability
 Positive relationship with franchisees

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 Trends Shaping Franchising

 International opportunities
 Many franchises are focusing on international markets as a
source of growth.
 Yum! earns 75% of its revenues from international franchises.
 McDonald’s earns 70% of its sales internationally.

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 (continued)
Trends Shaping Franchising

 Smaller, nontraditional locations

 Intercept marketing: putting a franchise’s products or
services directly in the paths of potential consumers,
wherever they may be.
 Conversion franchising
 Owners of independent businesses become franchisees to
gain the advantage of name recognition.
 72% of North American franchisors use it as a growth
strategy.

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Trends Shaping Franchising

(continued)

 Refranchising
 Franchisors sell their company-owned outlets to franchisees.
 Multi-unit franchising
 IFA: 20% of franchise owners are multiple-unit owners.
 Typical multiple-unit franchises own five outlets.

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 Trends Shaping Franchising

(continued)
 Area development and master franchising
 Area development: the franchisee earns the exclusive right to
open multiple units in a specific territory in a specific time.
 Master franchise: franchisee has the right to create a semi-
independent organization in a particular territory to recruit, sell,
and support other franchisees.

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 Trends Shaping Franchising
(continued)

 Co-branding
 Aka piggyback or combination franchising:
 Two or more franchises team up to sell complementary products or
services under one roof.

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Conclusion
Franchising:
 Is a key part of the small business sector
 Increases the chance of business success for the
entrepreneur
 Growth continues

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