FBP C5 - Forms of ownership

Question 1

Three major forms of business ownership:

Answer 1

1. Sole proprietorships
2. Partnerships
3. Corporations

Just because a business starts in one form of ownership doesn’t mean they have to stay in it, they can change…

Question 2

Sole proprietorships

Answer 2

a business owned and managed by one person

Question 3

Advantages and Disadvantages of Sole proprietorships

Answer 3

Advantages:
Easy to start and end this business - all you need is to buy/ lease the equipment and announce you’re as business
Ability to be your own boss - setting your own hours, more freedom
Pride of ownership - increases motivation
You can leave a legacy - owners can leave an ongoing business for future generations
Retention of company profits - owners keep all the profits
No special taxes, all profits are taxed as the personal income of the owner

Disadvantages:
Unlimited liability – the risk of an owners personal loses
Limited financial resources – funds are limited to what the owner can gather. Harder to raise finance the smaller the business.
Management difficulties – hard to attract qualified employees as they can’t compete with salaries and benefits of larger companies.
Overwhelming time commitment - a lot of time, money and desire to run your own business
Few fringe benefits – no paid insurance, no paid disability insurance, no paid pension plan, no sick leave or vacation pay.
Limited growth – less people = slower growth
Limited life span – if the owner dies the business will no longer exist

Question 4

Partnership

Answer 4

when two or more people legally agree to become co-owners of a business

Question 5

The key elements of a general partnerships:

Answer 5

• Common ownership
• Shared profits and losses
• The right to participate in managing the operations of the business

Question 6

There are several types of partnerships:

Answer 6

1. General partnerships
2. Limited partnerships
3. Master limited partnerships
4. Limited liability partnership

Question 7

General partnerships

Answer 7

all owners share in operating the business and in assuming liability for the business’ debts.

Question 8

Limited partnerships

Answer 8

Has one or more general partners and one or more limited partners.

Question 9

General partner

Answer 9

is an owner (partner) who has unlimited liability (must pay debts) and is active in managing the firm. Every partnership must have at least one general partner.

Question 10

Limited partner

Answer 10

is an owner who invests money in the business but does not have any management responsibilities or liabilities for losses beyond his or her investment.

Question 11

Limited liability

Answer 11

means that the limited partner’s liability for the debts of the business is limited to the money they put into the company: personal assets are not at risk.

Question 12

Unlimited liability

Answer 12

Owners must pay all debt of the business, even with their own personal assets.

Question 13

Master limited partnership (MLP)

Answer 13

very much like a corporation. It acts like a corporation and is traded on the stock exchange like a corporation. Yet, it is taxed like a partnership and avoids cooperate income tax. Master limited partnerships are limited to oil, real estate and gas industries

Question 14

Limited liability partnership

Answer 14

limits someone risk of losing their personal assets to the outcomes of only their own acts and omissions and those of people under their supervision.

Question 15

Advantages and Disadvantages of Partnerships

Answer 15

Advantages:
More financial resources – More people = more resources
Shared management and pooled / complementary skills and knowledge
Longer survival – partnerships are more likely to succeed than sole proprietorships because being watched by a partner can help a businessperson become more disciplined.
No special taxes – all profits of a partnership are taxed as personal income of the owners

Disadvantages

Unlimited liability – each general partner are liable for the debts of the firm no matter who’s responsible for causing them. They can lose their personal assets.
Division of profits – sharing risks mean sharing profits, yet they are not always divided evenly.
Disagreements among partners
Difficulty of termination – hard to get out of a partnership once you are in it

Question 16

Corporation

Answer 16

a legal entity with authority to act and have liability apart from its owners – it’s stockholders. Stockholders are not liable for the debts or problems of the corporation beyond the money they invest in it buy buying ownership, shares and stock.

Question 17

Why do people incorporate:

Answer 17

• Special tax advantage

- Limited liability

Question 18

Types of corporations: (extra)

Answer 18

1. Multinational companies – operate in several countries
2. Open corporations – sells stock to the general public
3. Closed corporations – have stock that is held by a few people and isn’t available to the general public.
4. Domestic corporations – do business in the state in which they are chartered

Question 19

Advantages and Disadvantages of Corporations

Answer 19

Advantages:
Limited liability – only lose the amount they invest
Ability to raise more money for investment – can sell shares on the stock to anyone. They can also borrow money from financial institutions. They can also borrow from individual investors by issuing bonds which involves paying interest until bonds are repaid.
Size – Large corporations with numerous resources can take advantage of opportunities anywhere in the world but corporations do not have to be large to enjoy the benefits or incorporating.
Perpetual life – the death of an owner does not affect the businesses survival
Ease of ownership change – easy to change owners of a corporation
Ease of attracting talented employees – corporations can attract skilled employees by offering benefits
Separation of ownership from management – corporations are able to raise money from different owners / stockholders without getting them involved in management.

Disadvantages:
Initial costs – may cost thousands of dollars and require lawyers and accountants.
Extensive paperwork – must keep constant detailed financial reports
Double taxation - Corporate income is taxed twice. First the corporation pays tax on its income before it can distribute any dividends to stockholders. Then the stockholders pay income tax on the dividends they receive.
Two tax returns – incorporates must file 2 tax returns (corporate and individual tax return). It can take time, be complex and may require assistance.
Size – Large incorparations may be too inflexible and tied down in red tape to respond quickly to market changes, and their profitability can suffer.
Difficulty of termination – once started, it’s difficult to end.
Possible conflict with stockholders and board of directors – conflict may happen is the stockholders elect a board of directors that who disagree with management.

Question 20

Leveraged buyouts

Answer 20

attempts by managers and employees to borrow money and purchase the company.

Question 21

S corporation

Answer 21

unique government creation that looks like a corporation but is taxed like a sole proprietorship and partnerships.

• The paperwork of an S corporation is like a C corporation.
• Limited liability
• Avoids double taxation

Question 22

Limited liability company (LLC)

Answer 22

Limited liability company is like an S corporation but without the special eligibility

Question 23

Advantages and Disadvantages of Limited liability company (LLC)

Answer 23

Advantages:

• Limited liability (personal assets are protected)
• Choice of taxation – they can choose how to be taxed, like a partnership or a corporation.
• Flexible ownership rules – Owners can be a person, partnership or corporation. Don’t have to comply with owner restrictions like S corporations.
• Flexible distribution of profit and losses – LLC members agree o the percentage distributed to each member
• Operating flexibility – LLCs do have to submit articles of organization but aren’t required to keep very detailed constant notes (keep minutes), hold annual meetings and file written solutions

Disadvantages:

• No stock – LLC ownership is nontransferable. LLC members need the approval of the other members in order to sell their interests in the company but S corporations stockholde3rs sell their shares as they wish.
• Fewer incentives – unlike corporations, LLCs can’t deduct the cost of fringe benefits for member owning 2% or more in the company. And since there’s no stock they can’t use stock options as incentives.
• Taxes – LLC members must pay self employed taxes. S corporations pay self-employment tax on owners’ salaries but not on the entire profit.
• Paperwork – Paperwork is required in LLCs but not as much as corporations

Question 24

A merger

Answer 24

two firms joining to form one company

Question 25

Acquisition

Answer 25

one companies purchase of the property and obligations or another company.

Question 26

There are three major types of cooperate mergers:

Answer 26

1. Vertical
2. Horizontal
3. Conglomerate

Rather than sell or merge with another company, some corporations decide to maintain or regain control of a firm internally. This happens when you take a firm private.

Question 27

vertical merger

Answer 27

joins two firms operating in different stages of related business.

Example:
A merger between a soft drink company and an artificial sweetener would ensure the merged firm with a constant supply of an ingredient the soft drink manufacture needs.

Question 28

Horizontal merger

Answer 28

two firms join in the same industry and allow them to diversify or expand their products.

Example:
A soft drink company and slushie company merge so they can supply a greater amount of products.

Question 29

Conglomerate merger

Answer 29

unites firms in completely unrelated industries in order to diversify business operations and investments.
Example:
A soft drink company and a snack food company would form a conglomerate merger.

Question 30

In addition to these three basic forms of ownership (Sole proprietorships, Partnerships, Corporations), there are two special forms:

Answer 30

1. Franchise

2. Cooperatives

Question 31

A franchise agreement

Answer 31

is an agreement whereby someone with a good idea for a business (the franchisor) sells the rights to use the business name and sell the product or service (the franchise) to others (the franchisees).

Question 32

Franchise

Answer 32

the right to use a specific business’s name and sell its products or services in each territory

Question 33

Franchisee

Answer 33

a person who buys a franchise

Question 34

Franchisor

Answer 34

a company that develops concept and sells others the rights to make and sell the products

Question 35

Royalty payment

Answer 35

is an amount paid by the third party to an owner of a product or patent for the use of that product or patent.

Question 36

Advantages and disadvantages of franchises

Answer 36

Advantages of a franchise:
Management and marketing assistance – You have help and guidance with everything as well as an established product to sell. Franchisors usually provide intensive training.
Personal ownership – It is your business, and you enjoy the incentives and profit a sole proprietorship would but there is a set of rules and regulations you must follow.
Nationally recognized name – with an already established franchise, you get instant recognition and support from a product group with established customers around the world
Financial advice and assistance – Franchisees often get valuable assistance and periodic advice from people with expertise in areas harder things for people to do: learning to keep records, arranging finance.
Lower failure rate – than other types of ownerships

Disadvantages of franchises
Large startup costs – fee for the rights to the franchise
Shared profit – franchisor often demands either a large share of profits in addition to the startup fees or a percentage commission based on sales. This share is called royalty.
Management regulations – management “assistance” has a way of becoming managerial orders, directives, and limitations. Franchisees feeling burdened by the companies rules and regulations may lose drive to run their own business.
Coattail effects – you could be forced out of business even if your franchise has been profitable. The actions of other franchises have an impact on your future growth and profitability.
Restrictions on selling – franchisees face restrictions on the resale of their franchises. To control quality, franchisors often insist on approving the new owner who must meet their standard.
Fraudulent franchisors – some franchises grow to quickly and aren’t controlled so they collapse.

Question 37

Diversity in franchising

Answer 37

Women own half of US companies yet their ownership of franchises is only 35% but this number has grown a lot from previous years.

Question 38

Home based franchises

Answer 38

Relief from stress of commuting
Extra time for family activities
Low overhead expenses
Feeling isolated

Question 39

What is the major challenge to global franchise?

Answer 39

• It is often difficult to transfer an idea or product that worked well in the US to another culture.

Question 40

A cooperative

Answer 40

is owned and controlled by people who use it – producers, consumers or workers with similar needs who pool their resources for mutual gain. People centered enterprises.

Some people form cooperatives to acquire more economic power than they would have as individuals.

Question 41

A corporation has _ and _ which describe how the firm is to be operated from both legal and managerial points of view .

Answer 41

• bylaws

- articles of incorporation

Question 42

termination of a partnership is difficult without a _ agreement.

Answer 42

partnership agreement

Question 43

The actions of a fellow franchisee will affect your franchise. This is known as:

Answer 43

coattail effect

Question 44

LLCs do have to submit articles of organization and an operating agreement but do not have to:

Answer 44

• file written solutions
• keep minutes
• hold annual meetings

Question 45

_ owned businesses are growing at more than the national rate.

Answer 45

minority

Question 46

Many brick and motar franchisees are using _ to expand their businesses online to lower costs and better meet the needs of their customers

Answer 46

• technology
• websites
• e commerce

Question 47

A business owned and controlled through pooled resources by the people who use it is a

Answer 47

cooperative

Question 48

Accounts payable

Answer 48

is the amount of money that is owed to the company from clients

Question 49

Accounts receivable

Answer 49

is the amount of money that the company owes suppliers plus other operating expenses such as payroll, rent ect

Question 50

The difference between and entrepreneur and sole proprietor

Answer 50

Sole proprietor – wants to build a business that can sustain their financial interests. Often the costs of running the business preclude rapid expansion. (family business kind that’s main focus is to over costs not to be a big business)

Entrepreneur – wants to build a business that is easily scalable and can be transformed with financing into a business enterprise. (wants to do more than just cover cost, create a big business)

• Both the entrepreneurs and sole proprietors / partnerships utilize financing
• When the sole proprietor / partnership ventures beyond an outside loan financing to angel or vc financing they are then considered entrepreneurs

Question 51

Stages of financing a business

There are 4 distinct stages:

Answer 51

1. Friends and family
2. Angel financing
3. Venture capital financing
4. Mature financing

Question 52

1. Friends and family

Answer 52

1. Friends and family – the first stage of financing a new business is to use personal money or borrow the money from friends and family.
   - Startup money
   - And then…
   - outside loan financing can come from several sources (bank loans, government grant, small business association). These loans are usually short term and need repayment in 2/3 years. Outside loan financing = they have full ownership still.

Loan – a two-way financial agreement where one party agree to give money to another party. The lender gives money to the borrower and the borrower agrees to pay back the money with an interest over a period of time.

The ultimate goal of every entrepreneur is to create a business that can go public, selling shares of their business to the public. The alternative goal is to have your company bought out by another company.

Question 53

2. Angel financing

Answer 53

when an angel investor helps with financing, they are individuals who provide capital and advice in exchange for owners’ equity (20/30%). They provide seed money.

Question 54

3. Venture capital financing

Answer 54

If a company is success, they move to venture capitalists are private equity investors that provide capital to companies in exchange for equity stake. They take significant ownership of the company.

• Round one – used to develop sales and manufacturing
• Round two – used for marketing, advertising and product distribution
• Round three (Mezzanine financing) – is for expansion after initial profitability
• Round four – (Bridge financing) – is used to prepare for the IPO and the final exist strategy which is to sell once the stock goes public to merge the company with another company.

Question 55

Loan

Answer 55

a two-way financial agreement where one party agree to give money to another party. The lender gives money to the borrower and the borrower agrees to pay back the money with an interest over a period of time.

The ultimate goal of every entrepreneur is to create a business that can go public, selling shares of their business to the public. The alternative goal is to have your company bought out by another company.

Question 56

Venture capitalists

Answer 56

are employees of risk capital companies who invest other persons money in companies, happen later.

Question 57

Angel investors

Answer 57

rick persons who invest their own money in companies, happen earlier.