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Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.McGraw-Hill/Irwin

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CHAPTER 5 Small Business, Entrepreneurship, and Franchising

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CHAPTER 4 Options for Organizing Business

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Starting and Starting and GrowingGrowingA BusinessA Business

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Forms of Business OwnershipForms of Business OwnershipForms of Business OwnershipForms of Business Ownership

Sole proprietorship Partnership Corporation

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Comparing Forms of Business Comparing Forms of Business OwnershipOwnership

Comparing Forms of Business Comparing Forms of Business OwnershipOwnership

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Sole Sole ProprietorshipProprietorshipSole Sole ProprietorshipProprietorship

Businesses owned and operated by one individual; the most common form of business organization in the United States

15-20 million in the U.S.

Nearly three-quarters of all businesses

Men 2x more likely than women to start own business

o Restaurants

o Hair salons

o Flower shops

o Dog kennels

o Independent grocery stores

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AdvantagesAdvantages DisadvantagesDisadvantages

Ease and cost of formation Unlimited liability

Secrecy Limited sources of funds

Distribution and use of profits Limited skills

Flexibility and control of the business

Lack of continuity

Government regulation Lack of Qualified Employees

Taxation Taxation

Sole Sole ProprietorshipProprietorshipSole Sole ProprietorshipProprietorship

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PartnershipPartnershipPartnershipPartnership

A form of business organization defined by the Uniform Partnership Act as “an association of two or more persons who carry on as co-owners of a business profit”

General partnership

Limited partnership

Articles of Partnership• Legal documents that set forth the basic agreement between

partners

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Two Types of PartnershipsTwo Types of PartnershipsTwo Types of PartnershipsTwo Types of Partnerships

General PartnershipA partnership that involves a complete sharing in both the management and the liability of the business

Limited PartnershipA business organization that has at least one general partner, who assumes unlimited liability, and at least one limited partner whose liability is limited to his or her investment in the business

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Articles of PartnershipArticles of PartnershipArticles of PartnershipArticles of Partnership

Name, purpose, location

Duration of the agreement

Authority and responsibility of each partner

Character of partners (i.e., general or limited, active or silent)

Amount of contribution from each partner

Division of profits or losses

Salaries of each partner

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Articles of PartnershipArticles of PartnershipArticles of PartnershipArticles of Partnership

How much each partner is allowed to withdraw

Death of partner

Sale of partnership interest

Arbitration of disputes

Required and prohibited actions

Absence and disability

Restrictive covenants

Buying and selling agreements

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PartnershipsPartnershipsPartnershipsPartnerships

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Advantages Disadvantages

Ease of organization Unlimited liability

Capital & credit Business responsibility

Knowledge & skills Life of the partnership

Decision making Distribution of profits

Regulatory controls Limited sources of funds

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CorporationsCorporationsCorporationsCorporations

Legal entities created by the state whose assets and liabilities are separate from its ownersHave most of the rights of people

Typically owned by shareholders /stockholders

A corporation is created (incorporated) under the laws of the state in which it incorporates

The individuals creating the corporation are called incorporators

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Articles of IncorporationArticles of IncorporationArticles of IncorporationArticles of Incorporation

Legal documents filed with basic information about the business with the appropriate state office (often the Secretary of State)Common elements:

Name & address of corporation

Objectives of the corporation

Classes of stock (common, preferred, voting, nonvoting) and number of shares of each class of stock

Financial capital required at time of incorporation

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Articles of IncorporationArticles of IncorporationArticles of IncorporationArticles of Incorporation

Provisions for transferring shares of stock

Regulation of internal corporate affairs

Address of business office

Names and addresses of the initial board of directors

Names and addresses of the incorporators

The state issues a corporate charter based on the information in the articles of incorporation.

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Types of CorporationsTypes of CorporationsTypes of CorporationsTypes of Corporations

A corporation doing business in the state in which it is chartered is a domestic corporation.

When a corporation does business in other states, it is then referred to as a foreign corporation.

If a corporation does business outside the nation in which it is incorporated, it is termed an alien corporation.

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Types of CorporationsTypes of CorporationsTypes of CorporationsTypes of Corporations

Private CorporationA corporation owned by just one or a few people who are closely involved in managing the business

Public CorporationA corporation whose stock anyone may buy, sell, or trade

Initial Public OfferingA private corporation who wishes to go “public” to raise additional capital and expand. The IPO is selling a corporation’s stock on public markets for the first time

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Types of CorporationsTypes of CorporationsTypes of CorporationsTypes of Corporations

Quasi-Public CorporationCorporation owned and operated by the federal, state, or local government

NASA, U.S. Postal Service

Non-Profit CorporationFocuses on providing a service rather than earning a profit but is not owned by a government entity

Mercy Corps., The Conservation Fund

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Elements of a CorporationElements of a CorporationElements of a CorporationElements of a Corporation

Board of Directors: A group of individuals, elected by the stockholders to oversee the general operation of the corporation, who set the corporation’s long-range objectives.

Inside Directors Individuals who serve on a board and are employed by the

corporation (usually executives of the corporation)

Outside Directors Individuals who serve on a board who are not directly

affiliated with the corporation (usually executives of other corporations)

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Stock OwnershipStock OwnershipStock OwnershipStock Ownership

Preferred StockA special type of stock whose owners, though not generally having a say in running the company, have a claim to profits before other stockholders do.

Common StockStock whose owners have voting rights in the corporation, yet do not receive preferential treatment regarding dividends.

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CorporationsCorporationsCorporationsCorporations

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Advantages Disadvantages

Limited liability Double taxation

Transfer of ownership Forming a corporation

Perpetual life Disclosure of information

External sources of funds Employee-owner separation

Expansion potential

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Other Types of Other Types of Business OwnershipBusiness Ownership

Other Types of Other Types of Business OwnershipBusiness Ownership

Joint Venture A partnership established for a specific project or for a limited time

Control can be divided equally, or with one party taking more responsibility for decision making

S-Corporation (S-Corp)Corporation taxed as though it were a partnership (no double-taxation) with restrictions on shareholders.

Very popular with entrepreneurs

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Other Types of Business Other Types of Business Ownership: Ownership:

S-CorporationsS-Corporations

Other Types of Business Other Types of Business Ownership: Ownership:

S-CorporationsS-Corporations

Subchapter S-CorporationPopular because the form eliminates double-taxation

Combines the taxation structure of partnerships with legal environment of C-corporations

Qualifications:

• Only 1 class of stock

• Less than 100 shareholders

• Shareholders must be U.S. citizens or residents

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Other Types of Business Other Types of Business Ownership: Ownership:

Limited LiabilityLimited Liability

Other Types of Business Other Types of Business Ownership: Ownership:

Limited LiabilityLimited Liability

Limited Liability Company (LLC)Form of ownership that provides limited liability and taxation like a partnership but places fewer restrictions on members

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Other Types of Business Other Types of Business Ownership: Ownership: CooperativeCooperative

Other Types of Business Other Types of Business Ownership: Ownership: CooperativeCooperative

Cooperative (Co-Op)An organization composed of individuals or small businesses that have banded together to reap the benefits of belonging to a larger organization

Can take many different forms (retail, housing, social, worker)

Co-ops are increasingly popular with small farmers and artisans

Gives small producers more power as a group

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Trends in Business OwnershipTrends in Business OwnershipTrends in Business OwnershipTrends in Business Ownership

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MergerThe combination of two companies (usually corporations) to form a new company

Horizontal merger: When firms that make and sell similar products merge.

Vertical merger: When companies operating at different but related levels of an industry merge.

Conglomerate merger: When firms in unrelated industries merge.

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Trends in Business OwnershipTrends in Business OwnershipTrends in Business OwnershipTrends in Business Ownership

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AcquisitionThe purchase of one company by another, usually by buying its stock and/or assuming its debt.

Corporate raider: A company or individual who wants to acquire or take over another company and first offers to buy some or all of its stock at a premium in a tender offer.

Poison pill: The firm allows stockholders to buy more shares of a stock at lower prices than the current market value to head off a hostile takeover.

Shark repellant: Management requires a large majority of stockholders to approve a takeover.

White knight: A more acceptable firm that is willing to acquire a threatened company.

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Trends in Business OwnershipTrends in Business OwnershipTrends in Business OwnershipTrends in Business Ownership

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Leveraged Buyout (LBO)A purchase in which a group of investors borrows money from banks and other institutions to acquire a company (or a division of one), using the assets of the purchased company to guarantee repayment of the loan.

Mergers and acquisitions (particularly the merger mania in the late 20th century) have been criticized

Executives have to focus excessively on avoiding takeovers, not on managing the business

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CHAPTER 5 Small Business, Entrepreneurship, and Franchising

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CHAPTER 4 Options for Organizing Business

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Starting and Starting and GrowingGrowingA BusinessA Business

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EntrepreneurshipEntrepreneurship

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The process of creating and managing a business to

achieved desired objectives

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What is Small Business?What is Small Business?What is Small Business?What is Small Business?

“Smallness” is relative Small business is any independently owned

and operated business, not dominant in its competitive area

Employs less than 500 people

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Impact of Small BusinessesImpact of Small BusinessesImpact of Small BusinessesImpact of Small Businesses

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Small Businesses RepresentSmall Businesses RepresentSmall Businesses RepresentSmall Businesses Represent

64% of new net jobs, annually, created in the last 15 years

99.7% of all businesses employ fewer than 500 people

89% of businesses employ fewer than 19 people

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Small Business InnovationSmall Business InnovationSmall Business InnovationSmall Business Innovation

Small businesses represent 55% of all innovationsAirplane

Audio tape recorder

Double-knit fabric

Fiber-optic examining equipment

Heart valve

Optical scanner

Personal computer

Soft contact lenses

Zipper … and much more

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Traits of Successful Traits of Successful EntrepreneursEntrepreneurs

Traits of Successful Traits of Successful EntrepreneursEntrepreneurs

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Popular Industries for Popular Industries for Small BusinessSmall Business

Popular Industries for Popular Industries for Small BusinessSmall Business

Especially attractive industries to entrepreneurs:Retailing and wholesaling

Services

Manufacturing

High technology

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Retailing and WholesalingRetailing and WholesalingRetailing and WholesalingRetailing and Wholesaling

Selling directly to consumersMusic stores

Sporting-goods shops

Dry cleaners

Boutiques

Drugstores

Restaurants

Hardware stores

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Services and ManufacturingServices and ManufacturingServices and ManufacturingServices and Manufacturing

ServicesService sector is 80% of U.S. jobs

Attracts individuals whose skills are not required by large firms

ManufacturingSmall manufacturers excel at customization

The Malcolm Baldridge National Quality Award rewards innovative small manufacturing firms

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High TechnologyHigh TechnologyHigh TechnologyHigh Technology

Businesses that depend heavily on advanced scientific and engineering knowledge.40% of high-tech jobs are with small businesses

The government offers small business grants for high-tech companies

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Small Business OwnershipSmall Business OwnershipSmall Business OwnershipSmall Business Ownership

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Advantages Disadvantages

Independence High stress level

Costs High failure rate50% of all new businesses fail within the first 5 years

Flexibility UndercapitalizationLack of funds to operate normally

Focus Managerial inexperience or incompetence

Reputation Inability to cope with growth

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Starting a BusinessStarting a BusinessStarting a BusinessStarting a Business

Start with a concept or general idea Create a business plan Devise a strategy to guide planning &

development Make decisions

• Form of ownership

• Financing

• Acquire existing business or start new business?

• Buy a franchise

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The Business PlanThe Business PlanThe Business PlanThe Business Plan

A precise statement of the rationale for the business and a step-by-step explanation of how it will achieve its goals. Acts as a guide and reference document.Explanation of the business

Analysis of competition

Income/Expense estimates

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Forms of Business OwnershipForms of Business OwnershipForms of Business OwnershipForms of Business Ownership

Sole ProprietorshipPartnershipCorporation

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Financial ResourcesFinancial ResourcesFinancial ResourcesFinancial Resources

Provide your own personal capital Cash money

Obtain capital

Financing optionsLoans

Stocks

Equity financing

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Equity FinancingEquity FinancingEquity FinancingEquity Financing

Selling or borrowing against the value of an asset such as an (automobile,

insurance policy, savings account) to obtain funds to operate a business

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Venture CapitalistsVenture CapitalistsVenture CapitalistsVenture Capitalists

Persons/organizations that agree to provide funding for a new business in exchange for an ownership interest or stock. Usually requires a sharing of

ownership/control

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Debt FinancingDebt FinancingDebt FinancingDebt Financing

Borrowing financial resources typically from a bank or lending

institution– often collateral is needed

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Line of CreditLine of CreditLine of CreditLine of Credit

An agreement by which a financial institution promises to lend a

business a predetermined sum on demand

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Starting from Scratch vs. Starting from Scratch vs. Buying an Existing BusinessBuying an Existing BusinessStarting from Scratch vs. Starting from Scratch vs.

Buying an Existing BusinessBuying an Existing Business

Starting from scratch can be expensive and will require a lot of promotional efforts to familiarize customers with the businessExisting businesses have the advantage of a built-in network of customers, suppliers and distributors

Reduces guesswork

Involves taking on any problems the business already had

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FranchisingFranchisingFranchisingFranchising

A license to sell another’s products or to use another’s name in business, or bothFranchiser

The company that sells a franchise

Franchisee The purchaser of a franchise

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FranchisesFranchisesFranchisesFranchises

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Advantages DisadvantagesTraining & support Fees and profit sharing

Brand name appeal Standardized operations

National advertising Restrictions on purchasing

Financial assistance Limited product line

Proven products Possible market saturation

Greater chance for success Less freedom in decisions

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Help for Small Help for Small Business ManagersBusiness Managers

Help for Small Help for Small Business ManagersBusiness Managers

Organizations and programs exist to help small businesses

Small Business Administration Small Business Development Centers

Service Corps of Retired Executives

Active Corps of Executives

Small Business Institutes

U.S. and Local Departments of Commerce

Other small businesses

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The Future for Small BusinessThe Future for Small BusinessThe Future for Small BusinessThe Future for Small Business

Demographic TrendsThe Baby Boomers

Generation Y (Millennials)

Immigrants and shifting demographics

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The Future for Small BusinessThe Future for Small BusinessThe Future for Small BusinessThe Future for Small Business

Technological & Economic TrendsInternet usage continues to increase

Increase in service exports

Economic turbulence

Deregulation of the energy market & alternative fuels

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Big Businesses Acting SmallBig Businesses Acting SmallBig Businesses Acting SmallBig Businesses Acting Small

Common ApproachesLarge firms emulate smaller ones to improve bottom line

Downsizing (Rightsizing)• Acting small from inception – Southwest Airlines

Intrapreneurs• Individuals in large firms who take responsibility

for the development of innovations within the organization

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