BUSN11 KellyWilliams Ch06

Chapter 6 – Business Formation:
Choosing the Form that Fits
6
Business
Formation:
Choosing the
Form That Fits
Copyright ©2019 Cengage Learning. All Rights Reserved. May
not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part.
Learning Outcomes
LEARNING OUTCOMES
1. Describe the characteristics of the four basic forms

of business ownership
2. Discuss the advantages and disadvantages of a sole
proprietorship
3. Evaluate the pros and cons of the partnership as a
form of business ownership
Copyright ©2019 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly
accessible website, in whole or in part. BUSN11 | CH6 2
Learning
LEARNINGOutcomes (continued)
OUTCOMES (continued)
4. Explain why corporations have become the

dominant form of business ownership
5. Explain why limited liability companies are
becoming an increasingly popular form of business
ownership
6. Evaluate the advantages and disadvantages of
franchising
LO 1
Forms of Business Ownership
• Sole proprietorship: Single owner who

manages the company
• Partnership: Voluntary agreement between
two or more co-owners of a business for
profit
➖ Take an active role in managing the business

• General partnership: All partners:
➖ Have unlimited liability for claims against the

firm
LO 1
Forms of Business Ownership (continued 1)
• Corporation: Business is considered a legal

entity that is separate and distinct from its
owners
• Created by filing the articles of incorporation
and paying a fee of incorporation to the
appropriate state agency
• Owners of a corporation have limited liability
LO 1
Forms of Business Ownership (continued 2)
• Limited liability company (LLC)

• Offers limited liability to owners and flexible tax
treatment
LO 2
Advantages and Disadvantages of Sole

Proprietorship
Advantages Disadvantages
• Ease of formation • Limited financial resources

• Retention of control • Unlimited liability
• Pride of ownership • Limited ability to attract
• Retention of profits and maintain talented
• Possible tax advantage employees
• Heavy workload and
responsibilities
• Lack of permanence
LO 2
General Partnership
• No limit on the number of partners

• Partnership agreement should entail details
regarding:
• Initial financial contributions
• Specific duties and responsibilities
• Sharing profits (and losses)
• Settling disagreements
• Death or withdrawal of a partner
LO 3
Advantages and Disadvantages of

Partnerships
• Ability to pool financial • Unlimited liability

resources • Potential for disagreements
• Ability to share • Lack of continuity
responsibilities and • Difficulty in withdrawing
capitalize on from a partnership
complementary skills
• Ease of formation
• Possible tax advantages
LO 3
Limited Partnership and Limited Liability Partnership

(LLP)
• Limited partnership: Includes at least one

general partner who actively manages the
company and accepts unlimited liability
• Other partner gives up the right to actively
manage the company in exchange for limited
liability
• LLP: All partners have the right to
participate in the management and have
limited liability for company debts
LO 4
C Corporation
• Offers limited liability to all its

stockholders
• Formation of a corporation requires filing
articles of incorporation, paying filing fees, and
adopting corporate bylaws
• Stockholders can be institutional investors
• Institutional investor: Organization that pools
contributions from investors, clients, or
depositors
LO 4
C Corporation (continued)
➖ Uses pooled funds to buy stocks and securities

• Issues common stock as the basic ownership
interest
• Some corporations issue preferred stock as well
LO 4
Board of Directors
• Elected by stockholders to represent their

interests
• Oversee the operation of their company and
protect their interests
• Appoint a chief executive officer (CEO) and
other corporate officers to manage the
company on a daily basis
LO 4
Advantages of C Corporations
• Limited liability
• Permanence
• Ease of transfer of ownership
• Ability to raise financial capital
• Ability to make use of specialized
management
LO 4
Disadvantages of C Corporations
• Expense and complexity of formation and

operation
• Complications when operating in multiple
states
• Double taxation of earnings and additional
taxes
• More paperwork and regulation and less
secrecy
• Possible conflicts of interest
LO 4
Exhibit 6.5 Characteristics of S, Statutory Close,

and Nonprofit Corporations
Type Advantages Disadvantages
S • Internal Revenue Service does • Can have only 100 stockholders

Corporation not tax earnings of S • With only rare exceptions, each
Corporations separately stockholder must be a U.S.
• Stockholders have limited citizen or permanent resident of
liability the United States
Statutory • Operates under simple • Limited number of stockholders

Close arrangements than conventional • Not all states allow formation of
(or Closed) corporations this type of corporation
Corporation • Owners can participate in • Stockholders normally can’t sell
management while still having their shares to the public
limited liability without first offering the shares
to existing owners
LO 4
Exhibit 6.5 Characteristics of S, Statutory Close, and

Nonprofit Corporations (continued)
Type Advantages Disadvantages

Nonprofit (or Not-for- • Earnings are exempt • Cannot have
profit) Corporation from federal and state stockholders
income taxes • Cannot distribute
• Members and dividends to members
directors have limited • Cannot contribute
liability funds to a political
• Individuals who campaign
contribute money or • Must keep accurate
property to the records and file
nonprofit can take a paperwork to
tax deduction document tax-exempt
status
LO 4
Corporate Restructuring
• Acquisition: One firm buys another firm

• Merger: Two formerly independent
business entities combine to form a new
organization
• Types - Horizontal merger, vertical merger, and
conglomerate merger
• Divestiture: Transfer of total or partial
ownership of some of a firm’s operations to
investors or to another company
LO 4
Forming and Managing an LLC
• Created by filing a document and paying

filing fees in the state where the business is
organized
• Organizers draft an operating agreement, which
is similar to the bylaws of a corporation
• LLCs are neither partnerships nor
corporations
• Owners are known as members rather than
stockholders or partners
LO 5
Advantages and Disadvantages of Limited

Liability Companies (LLCs)
• Limited liability • Complexity of formation
• Tax pass-through • Annual franchise tax
• Simplicity and flexibility • Foreign status in other
in management and states
operation • Limits on firms that can
• Flexible ownership form LLCs
• Differences in state laws
LO 6
Franchise
• Licensing arrangement under which a

franchisor allows franchisees to use its
name, trademark, products, and business
methods
• Arrangement is in exchange for monetary
payments
LO 6
Franchise (continued)
• Types of arrangements
• Distributorship: Franchisor makes a product
and licenses the franchisees to sell it
• Business format franchise: Franchisee pays for
the right to use the name, trademark, and
business and production methods of the
franchisor
LO 6
Franchising in Today's Economy
• Expansion into foreign markets is greater

because competition is less intense and less
saturated
• Business methods must be adjusted because
of differences in culture and other factors
• Women own about 45 percent of all
franchises
• Minority participation in franchises has
been relatively low
LO 6
Advantages and Disadvantages of Franchising
• Less risk • Costs
• Training and support • Lack of control
• Brand recognition • Negative halo effect
• Easier access to • Growth challenges
funding • Restrictions on sale
• Poor execution
LO 6
Franchise Agreement
• Contractual arrangement between a

franchisor and franchisee
• Spells out the duties and responsibilities of both
parties
• Franchise Disclosure Document (FDD):
Description of all aspects of a franchise that the
➖ Should be provided at least 14 calendar days

franchisor must provide to the franchisee
before the franchise agreement is signed
LO 6
Terms Included under Franchise Agreements
Terms and conditions

• Rights to use a franchisor’s trademarks, patents, and signage,
and any restrictions on those rights
Fees and other payments

• Fees that a franchisee must pay for the right to use a
franchisor’s products and methods
Training and support

• Training that should be provided by the franchisor to the
franchisee
LO 6
Terms Included under Franchise Agreements

(continued)
Specific operational requirements
• Methods and standards that a franchisee is required to follow
Conflict resolution
• Manner in which a franchisor and franchisee handle their

disputes
Assigned territory
• Geographic area in which a franchisee will operate and

exclusivity of the rights to that area
Key Terms
KEY TERMS
• Sole proprietorship • Limited partnership

• Partnership • Limited liability
• General partnership partnership (LLP)
• Corporation • C corporation
• Articles of • Corporate bylaws
incorporation • Stockholder
• Limited liability • Institutional investor
• Limited liability • Board of directors
company (LLC) • S corporation
BUSN11 | CH6 28
Key Terms
KEY TERMS
(continued)
• Statutory close (or • Divestiture
closed) corporation • Franchise
• Nonprofit • Franchisor
corporation • Franchisee
• Acquisition • Distributorship
• Horizontal merger • Business format
• Vertical merger franchise
• Conglomerate • Franchise agreement
merger • Franchise Disclosure
• Merger Document (FDD)
BUSN11 | CH6 29
Summary
SUMMARY
• Basic forms of business ownership are sole

proprietorship, partnership, corporation, and
LLC
• Corporations are dominant forms of business
ownership because they are legal entities that
stand apart from the owners
• Limited liability companies are popular forms
of business ownership as they are simple and
flexible to manage
• Franchising is a well-established method of
operating a business
Copyright ©2016 Cengage Learning. All Rights Reserved. May not be scanned, copied or duplicated, or posted to a publicly accessible website, in whole or in part. BUSN11
HIST4 | CH6 30
End of Chapter

BUSN11 KellyWilliams Ch06

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Chapter 6 – Business Formation:

Choosing the Form that Fits

1. Describe the characteristics of the four basic forms

4. Explain why corporations have become the

Forms of Business Ownership

• Sole proprietorship: Single owner who

➖ Take an active role in managing the business

➖ Have unlimited liability for claims against the

Forms of Business Ownership (continued 1)

• Corporation: Business is considered a legal

Forms of Business Ownership (continued 2)

• Limited liability company (LLC)

Advantages and Disadvantages of Sole

• Ease of formation • Limited financial resources

• No limit on the number of partners

Advantages and Disadvantages of

• Ability to pool financial • Unlimited liability

Limited Partnership and Limited Liability Partnership

• Limited partnership: Includes at least one

• Offers limited liability to all its

➖ Uses pooled funds to buy stocks and securities

• Elected by stockholders to represent their

• Expense and complexity of formation and

Exhibit 6.5 Characteristics of S, Statutory Close,

Type Advantages Disadvantages

S • Internal Revenue Service does • Can have only 100 stockholders

Statutory • Operates under simple • Limited number of stockholders

Exhibit 6.5 Characteristics of S, Statutory Close, and

Type Advantages Disadvantages

• Acquisition: One firm buys another firm

Forming and Managing an LLC

• Created by filing a document and paying

Advantages and Disadvantages of Limited

• Licensing arrangement under which a

Franchising in Today's Economy

• Expansion into foreign markets is greater

Advantages and Disadvantages of Franchising

• Contractual arrangement between a

➖ Should be provided at least 14 calendar days

before the franchise agreement is signed

Terms Included under Franchise Agreements

Terms and conditions

Fees and other payments

Training and support

Terms Included under Franchise Agreements

Specific operational requirements

• Methods and standards that a franchisee is required to follow

• Manner in which a franchisor and franchisee handle their

• Geographic area in which a franchisee will operate and

• Sole proprietorship • Limited partnership

• Basic forms of business ownership are sole

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