Although most new firms start out as sole proprietorships, few large firms are organized this way. Why is the sole proprietorship such a popular form of ownership for new firms? What features of the sole proprietorship make it unattractive to growing firms? What is the difference between a general partner and a limited partner? Give an example of a situation in which a person would want to be a limited partner. What is a C corporation? What are the major advantages and disadvantages of this form of business ownership?
Chapter 05 - How to Form a Business Test Planning Table for Chapter Learning Objective LL:1 Knows Basic Terms and Facts LL:2 Understands Concepts and Principles LL:3 Applies Principles Compare the advantages and disadvantages of sole proprietorships 1,2,3,4,5,6,7,8,9,10,11,12, 13,14,15,16,17, 189,190,191,192,193,194, 195,196,197,198,199 18,19,20,21, 200,201,202,203,204, 205 Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships 25,26,27,28,29,30,31,32, 33,34,35,36,37,38,39,40, 41,42,43,44,45, 213,214,215,216,217,218, 219,220,221 46,47,48,49,50,51, 222,223,224,225,226, 227,228 Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies 60,61,62,63,64,65,66,67, 68,69,70,71,72,73,74,75, 76,77,78,79,80,81,82,83, 84,85,86,87,88,89,90,91, 92,93,94,95,96,97,98,99, 100, 239,240,241,242,243,244, 245,246,247,248,249,250, 251,252,253,254,255,256 101,102,103,104,105, 106,107,108,109,110, 257,258,259,260,261, 262,263,264,265 111,112,113,114,115, 116,117,118,119, 266,267,268,269,270, 271,272,273,274,275, 338,339, 345* Define and give examples of three types of corporate mergers, and explain the role of leveraged buyouts and taking a firm private Outline the advantages and disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising 120,121,122,123,124,125, 126,127,128,129,130,131, 276,277,278,279,280,281, 282,283,284,285,286 132,133,134,135,136, 137, 287,288,289,290,291, 292 138,139,140,141,142, 293,294,295,296,297, 298,299, 340 143,144,145,146,147,148, 149,150,151,152,153,154, 155,156,157,158,159,160, 161, 300,301,302,303,304,305, 306,307,308,309,310,311, 312 162,163,164,165,166, 167,168,169~,170~, 313,314,315,316,317 171,172,173,174,175, 176,177,178, 318,319,320,321,322,3 23,324,325, 341, 346*,347* Explain the role of cooperatives 179,180,181,182,183,184, 326,327,328,329,330 185,186, 331,332,333 187,188, 334,335 Total number of test items: 347 True/false questions are in plain text Multiple choice questions are in bold text Questions on boxed material are in bold text with a tilde~ Essay questions are in bold underlined text Minicase questions are in bold with an asterisk* 5-1 22,23,24, 206,207,208,209,210, 211,212, 336, 342* 52,53,54,55,56,57,58, 59, 229,230,231,232,233, 234,235,236,237,238, 337, 343*,344* Chapter 05 - How to Form a Business Chapter 05 How to Form a Business Answer Key True / False Questions The corporation is the most common form of business ownership Answer: False AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Easy Topic: The Importance of Small Business Ownership to the U.S Economy The three major forms of business ownership in the U.S are sole proprietorships, partnerships, and corporations Answer: True AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Easy Topic: The Importance of Small Business Ownership to the U.S Economy Few people today start their own business Answer: False AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Easy Topic: The Importance of Small Business Ownership to the U.S Economy Once a business is established, it's almost impossible to change from one form of business ownership to another Answer: False AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Easy Topic: The Importance of Small Business Ownership to the U.S Economy When two or more people legally agree to become co-owners of a business, the form of business is called a partnership Answer: True 5-2 Chapter 05 - How to Form a Business AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Easy Topic: The Importance of Small Business Ownership to the U.S Economy A legal entity with authority to act and have liability separate from its owners is called a partnership Answer: False AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Easy Topic: The Importance of Small Business Ownership to the U.S Economy Corporations represent 20 percent of all the businesses in the U.S and earn 81 percent of the total U.S business receipts Answer: True AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Easy Topic: The Importance of Small Business Ownership to the U.S Economy A comparison of the three major forms of business ownership shows that sole proprietorships are usually the most difficult type of business to establish Answer: False AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Easy Topic: The Importance of Small Business Ownership to the U.S Economy The first step in starting a sole proprietorship is to fill out a proprietorship charter application form and file it with the state government Answer: False AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Easy Topic: Sole Proprietorships 10 It is usually easy to start and end a sole proprietorship Answer: True 5-3 Chapter 05 - How to Form a Business AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Easy Topic: Sole Proprietorships 11 The profits of a sole proprietorship are taxed as the personal income of the owner Answer: True AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Easy Topic: Sole Proprietorships 12 The sole proprietorship form of ownership tends to be attractive to people who want to invest in a company without taking an active role in management Answer: False AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Easy Topic: Sole Proprietorships 13 A major advantage of sole proprietorships is that an owner has limited liability for the debts of his or her business Answer: False AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Easy Topic: Sole Proprietorships 14 One of the strengths of the sole proprietorship is its ability to sustain rapid growth by raising large amounts of financial resources Answer: False AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Easy Topic: Sole Proprietorships 15 The debts of a business operated as a sole proprietorship are considered to be the personal debts of the owner of the business Answer: True 5-4 Chapter 05 - How to Form a Business AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Easy Topic: Sole Proprietorships 16 A drawback of sole proprietorships is that they usually have limited access to additional financial resources Answer: True AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Easy Topic: Sole Proprietorships 17 An advantage of forming a sole proprietorship is that it allows the owner to have more time for leisure activities Answer: False AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Easy Topic: Sole Proprietorships 18 If a sole proprietorship fails, the owner may lose whatever was invested in the business; however, the owner's personal assets are not at risk Feedback: Sole proprietors have unlimited liability for the debts of their business This means that if their business gets into financial trouble they can lose their personal assets Answer: False AACSB: Reflective Thinking Bloom’s: Understand Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Medium Topic: Sole Proprietorships 19 If the business is designated a sole proprietorship, profits are passed along to the owner For tax purposes, these profits are accounted for with any other personal income the owner may have accumulated and taxed at the owner's personal income tax rate Feedback: The profits of a sole proprietorship are passed through to the owner, and taxed at the owner's personal tax rate However, owners have to pay self employment tax (for Social Security and Medicare) By law, sole proprietors are required to estimate their taxes and make quarterly payments to the government or suffer penalties for nonpayment Answer: True 5-5 Chapter 05 - How to Form a Business AACSB: Reflective Thinking Bloom’s: Understand Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Medium Topic: Sole Proprietorships 20 A difficulty that sole proprietors try to overcome is the fact that they have trouble competing with large firms for expert talent Large firms can usually pay better and offer fringe benefits that are unaffordable to the sole proprietor Feedback: Sole proprietors often find it difficult to attract qualified employees to help run the business because often they cannot compete with the salary and benefits offered by larger companies Answer: True AACSB: Reflective Thinking Bloom’s: Understand Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Medium Topic: Sole Proprietorships 21 Unlike partnerships, if sole proprietorships find themselves in bankruptcy, they need not worry about a court of law requiring them to sell off personal assets to pay for the debts of the firm Feedback: Sole proprietorships have unlimited liability This means that the proprietor is financially responsible for all debts incurred by the company In a court of law, a judge could require the owner/proprietor to liquidate personal assets to pay the debts of the business Answer: False AACSB: Reflective Thinking Bloom’s: Understand Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Medium Topic: Sole Proprietorships 5-6 Chapter 05 - How to Form a Business 22 Eric wants to start a business He is attracted to the idea of being his own boss, and wants to get started with a minimum of expense and hassle He is confident in his abilities, and the market he can draw from, so he is not particularly worried about financial risks All of these factors suggest that Eric may favor starting his business as a sole proprietorship Feedback: People who want to be their own boss often prefer to operate their business, at least initially, as a sole proprietorship An advantage of the sole proprietorship is that it is a relatively easy and inexpensive form of business to set up One drawback of a sole proprietorship is that the owner has unlimited liability However, at this time, Eric is not worried about risk The unlimited liability factor does not appear to be a problem for him Answer: True AACSB: Knowledge Application Bloom’s: Apply Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Hard Topic: Sole Proprietorships 23 Sandy Beech, a talented fashion designer who wants to start her own women's swimwear and beach towel line, is trying to decide which form of business ownership is right for her As a young mother who aspires to send her children to college some day, she does not want to jeopardize her savings account in any way In order to overcome these risks, Sandy should start her business as a sole proprietorship Feedback: Sandy is concerned about the risk of losing personal assets if her business does not succeed Although the sole proprietorship is easy to set up, it may not be the best form of business ownership for Sandy due to her need to protect personal assets She may want to consider a form of ownership that provides limited liability Answer: False AACSB: Knowledge Application Bloom’s: Apply Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Hard Topic: Sole Proprietorships 24 Rocky Rhodes is convinced that he has a great idea for a new business Unfortunately, the type of business he wants to start would require a fairly high initial investment and Rocky has a poor credit rating and very little personal wealth Rocky would be unlikely to find success if he organized his business as a sole proprietorship Feedback: Funds available to sole proprietorships are often limited to the amount the owner can raise Thus, Rocky's business would probably have a hard time raising enough money if he organized it as a sole proprietorship Answer: True 5-7 Chapter 05 - How to Form a Business AACSB: Knowledge Application Bloom’s: Apply Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Hard Topic: Sole Proprietorships 25 A general partner takes an active role in the management of the business Answer: True AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-02 Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships Level of Difficulty: Easy Topic: Partnerships 26 All partners in a general partnership have limited liability for the debts of their firm Answer: False AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-02 Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships Level of Difficulty: Easy Topic: Partnerships 27 In a general partnership, all partners share in management of the business and in the liability for the firm's debts Answer: True AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-02 Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships Level of Difficulty: Easy Topic: Partnerships 28 In a general partnership, all partners are entitled to an equal share of the firm's profits Answer: False AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-02 Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships Level of Difficulty: Easy Topic: Partnerships 29 Limited partnerships are just like general partnerships, except that they are partners for a limited time period Answer: False 5-8 Chapter 05 - How to Form a Business AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-02 Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships Level of Difficulty: Easy Topic: Partnerships 30 A limited partner is an owner who assumes no management responsibility and has no liability for losses beyond the amount invested Answer: True AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-02 Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships Level of Difficulty: Easy Topic: Partnerships 31 A limited partnership consists of one or more general partners and one or more limited partners Answer: True AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-02 Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships Level of Difficulty: Easy Topic: Partnerships 32 Although shares of master limited partnerships can be purchased on one of the national stock exchanges, these companies are taxed like partnerships Answer: True AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-02 Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships Level of Difficulty: Easy Topic: Partnerships 33 The Uniform Partnership Act is law in every state except Louisiana Answer: True AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-02 Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships Level of Difficulty: Easy Topic: Partnerships 5-9 Chapter 05 - How to Form a Business 34 According to the Uniform Partnership Act, the three key elements of any general partnership are (1) shares of stock to represent ownership, (2) limited liability, and (3) ease of ownership transfer Answer: False AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-02 Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships Level of Difficulty: Easy Topic: Partnerships 35 According to the Uniform Partnership Act, the three key elements of any general partnership are (1) common ownership, (2) shared profits and losses, and (3) the right to participate in managing the operations of the business Answer: True AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-02 Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships Level of Difficulty: Easy Topic: Partnerships 36 A recent study showed that partnerships are more likely to fail than sole proprietorships Answer: False AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-02 Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships Level of Difficulty: Easy Topic: Advantages of Partnerships 37 A major objective of limited liability partnerships (LLPs) is to limit each partner's personal liability to the consequences of their own acts and those of people under their supervision Answer: True AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-02 Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships Level of Difficulty: Easy Topic: Partnerships 5-10 Chapter 05 - How to Form a Business 325 Greg plans to open up three Hottie Pata′ tee franchises in the greater Denver area He just informed you that he plans to negotiate with the franchisor to eliminate the Big Potato Head that graces the roof of these restaurants Greg is likely to learn that: A the parent company will give him a start-up cost break for the same amount that it would have to pay for three of these signs B he is making a smart decision because it is not the sign that will bring customers to his potato bar It is the wide-selection of toppings and six different ways he will cook potatoes C it is nonnegotiable due to company rules D his failure rate will not increase or decrease because franchises traditionally have low failure rates Feedback: Franchisors quite often require franchisees to adhere to strict rules when it comes to the design of their buildings, the signs that they use, and other mandates The proven business model usually has centralized regulations that franchisees must follow Answer: C AACSB: Knowledge Application Bloom’s: Apply Learning Objective: 05-05 Outline the advantages and disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising Level of Difficulty: Hard Topic: Franchising 326 A _ is an organization that is owned and controlled by the people who use it—producers, consumers and workers with similar needs pool their resources for mutual gain A corporation B limited partnership C mutual fund D cooperative Answer: D AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-06 Explain the role of cooperatives Level of Difficulty: Easy Topic: Cooperatives 327 In rural areas electrical power is often sold by that take advantage of the government's policy to sell them electricity at wholesale rates A franchises B limited partnerships C mutual funds D cooperatives Answer: D 5-110 Chapter 05 - How to Form a Business AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-06 Explain the role of cooperatives Level of Difficulty: Easy Topic: Cooperatives 328 Some ask members/customers to work at the organization for a number of hours a month as part of their duties A franchises B limited partnerships C mutual funds D cooperatives Answer: D AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-06 Explain the role of cooperatives Level of Difficulty: Easy Topic: Cooperatives 329 The purpose of a farm cooperative is to: A give members more economic power as a group than they would have as individuals B give each farm an equal share in the running of the cooperative C equalize the members' standard of living D allow socialism a foothold in the U.S Answer: A AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-06 Explain the role of cooperatives Level of Difficulty: Easy Topic: Cooperatives 330 In a cooperative, members/customers: A democratically control their businesses by electing a board of directors B are known as limited partners C each have unlimited liability for the debts of the firm D take turns serving on the board that manages the company Answer: A AACSB: Reflective Thinking Bloom’s: Remember Learning Objective: 05-06 Explain the role of cooperatives Level of Difficulty: Easy Topic: Cooperatives 5-111 Chapter 05 - How to Form a Business 331 People who form cooperatives: A believe the government should play a larger role in the economy B dislike the notion of having owners, managers, and customers as separate individuals with separate goals C see competitive behavior as the key to ensuring rapid economic growth D want to find a way to supply basic necessities free of charge to everyone Feedback: People who form cooperatives dislike the notion of separating owners, managers, and customers into separate groups with separate goals They tend to favor more cooperation and a more equal distribution of wealth Answer: B AACSB: Reflective Thinking Bloom’s: Understand Learning Objective: 05-06 Explain the role of cooperatives Level of Difficulty: Medium Topic: Cooperatives 332 A distinguishing feature of a cooperative is that it: A maintains a distinct separation between ownership and management B is only intended to operate for a limited period of time C is owned and operated by the people who use it D can have no more than 75 owners, all of whom must be citizens of the United States Feedback: A cooperative is an organization that is owned and operated by the people who use it—producers, consumers and workers with similar needs who pool their resources for mutual gain Answer: C AACSB: Reflective Thinking Bloom’s: Understand Learning Objective: 05-06 Explain the role of cooperatives Level of Difficulty: Medium Topic: Cooperatives 5-112 Chapter 05 - How to Form a Business 333 Which of the following statements about farm cooperatives is most accurate? Farm cooperatives have: A declined in importance in recent years B become a major force in American agriculture C run afoul of U.S antitrust laws in recent years D increased in number, but decreased in size in recent years Feedback: Statistics and examples cited in the text clearly indicate that farm cooperatives, such as Sunkist, Land O'Lakes, Blue Diamond, and Ocean Spray, are a major force in U.S agriculture Answer: B AACSB: Reflective Thinking Bloom’s: Understand Learning Objective: 05-06 Explain the role of cooperatives Level of Difficulty: Medium Topic: Cooperatives 334 Which of the following people would be most interested in participating in a business organized as a cooperative? A Joe is intrigued by the idea of combining his time and resources with many other people to operate a business providing a good or service that they all will use B Joan wants to be an owner of a business and share in its profits, but has no desire to take an active role in managing the company or participating in its daily operations C Jeff wants to work for a government-owned business because he believes government ownership ensures a more equitable distribution of income and wealth D Jennifer prefers to work for a charitable organization that emphasizes helping people who are less fortunate than she is Feedback: As its name implies, a cooperative emphasizes cooperation A cooperative appeals to people who dislike the notion of having owners, managers, workers, and customers as separate groups with different goals In a cooperative, the people who will use a product join together and pool resources to operate the business for their mutual gain Answer: A AACSB: Analytical Thinking Bloom’s: Analyze Learning Objective: 05-06 Explain the role of cooperatives Level of Difficulty: Hard Topic: Cooperatives 5-113 Chapter 05 - How to Form a Business 335 Twenty-six years ago, several small vineyard owners in California joined voluntarily to market their grapes and wine in an attempt to get better prices Over the years they expanded the organization to include other services such as buying and selling farm supplies and equipment and providing financial and technical services The arrangement established by these vineyard owners is an example of a(n): A closed corporation B joint venture C limited agricultural partnership D farm cooperative Feedback: A farm cooperative is an organization of farmers who have joined to gain more economic power than they would have as individuals These organizations often buy and sell supplies and equipment, provide warehouses, offer insurance and financial and technical services, and even operate manufacturing facilities Answer: D AACSB: Knowledge Application Bloom’s: Apply Learning Objective: 05-06 Explain the role of cooperatives Level of Difficulty: Hard Topic: Cooperatives 5-114 Chapter 05 - How to Form a Business Essay Questions 336 Although most new firms start out as sole proprietorships, few large firms are organized this way Why is the sole proprietorship such a popular form of ownership for new firms? What features of the sole proprietorship make it unattractive to growing firms? Answer: Sole proprietorships have many features which are attractive to people starting a new business, including the following: They are relatively easy and inexpensive to set up The owner can be his or her own boss, which appeals to many entrepreneurs who want to things their own way, without the need to consult others The owner can keep all of the profits (except the share the government takes in taxes) Proprietors can take a great deal of pride in owning their own independent business and running it as they see fit The owner's work establishes a legacy on which future generations may build There are no special taxes on proprietorships However, sole proprietorships also have some disadvantages that limit their growth potential: With only one owner, sole proprietorships have limited access to the financial capital needed by rapidly growing firms As the firm grows and becomes more complex, the owner may become overwhelmed with the tasks of running the firm and need to attract qualified help Unfortunately, qualified professional workers are often reluctant to work in a sole proprietorship One of the biggest drawbacks for sole proprietorships is the unlimited liability of the owner This means that the owner can lose much more than the amount he or she initially invested in the company (including personal property and savings) if the company gets into severe financial trouble In this respect, a sole proprietorship is a risky form of ownership Many growing companies decide to change their form of ownership to a corporation to overcome these drawbacks AACSB: Knowledge Application Bloom’s: Apply Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Hard Topic: Sole Proprietorship 5-115 Chapter 05 - How to Form a Business 337 What is the difference between a general partner and a limited partner? Give an example of a situation in which a person would want to be a limited partner Answer: A general partner is an owner (partner) who has unlimited liability and is active in managing the firm A limited partner invests money in the business and shares in the profits, but has limited liability and cannot legally assume any management responsibility Students could offer any number of examples Among them might be: Wealthy persons who want to invest in what they think could be a successful firm, but don't want to risk their personal assets Persons who not want the responsibility of managing a partnership Persons who are interested in a particular type of business but know nothing about the field AACSB: Knowledge Application Bloom’s: Apply Learning Objective: 05-02 Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships Level of Difficulty: Hard Topic: Partnerships 5-116 Chapter 05 - How to Form a Business 338 What is a C corporation? What are the major advantages and disadvantages of this form of business ownership? Answer: The C corporation is a state-chartered legal entity with authority to act and have liability separate from its owners The text identifies many advantages of corporations Among the major advantages are: More money for investment A corporation can sell stock (shares of ownership) to large numbers of interested investors This enables corporations to finance growth, modernize facilities and invest in the latest technologies Limited liability The personal assets of the stockholders are not at risk This is a major advantage to investors who want to invest in a company but want to limit potential losses Perpetual life Unlike a sole proprietorship or partnership, a corporation is separate from its owners, so its existence is not threatened by the death of an owner Ease of ownership change Unlike the other major forms of business ownership, stockholders in corporations can easily transfer ownership by simply selling their stock Ability to attract talented employees Because of their ability to grow and offer opportunities for advancement, as well as the ability to offer fringe benefits (including stock options), corporations often can attract talented and highly qualified employees The text also mentions disadvantages of becoming a C corporation, including: High initial cost of formation It is generally more expensive and time consuming to form a corporation than to form a sole proprietorship or partnership Increased regulation and paperwork Corporations are subject to closer government regulation than other forms of ownership, and must keep detailed records Possible conflicts between the corporation's board of directors and management Stockholders elect the board of directors, and may choose members who are at odds with top management As the text points out, this can result in an entrepreneur being forced out of the very company he or she founded Double taxation If a corporation pays dividends, its earnings are taxed both as income to the corporation and as income to the stockholders In other forms of ownership, earnings are taxed only once AACSB: Knowledge Application Bloom’s: Apply Learning Objective: 05-03 Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies Level of Difficulty: Hard Topic: Corporations 5-117 Chapter 05 - How to Form a Business 339 What is a limited liability company (LLC)? How does it compare to an S corporation? What are the major advantages and disadvantages of an LLC? Answer: A limited liability company (LLC) is a relatively new form of business organization that has been called the "business entity of the future." LLCs have some similarities to S corporations Both of these forms of ownership have the advantage of providing limited liability for their owners while allowing the earnings of the company to be taxed as a partnership, thus avoiding the problem of double taxation that is a disadvantage of the conventional (or C) corporation S corporations must meet certain eligibility requirements For example, they can have no more than 100 stockholders (entire families are considered one stockholder), and all of the stockholders must be either individuals or estates and the individuals must be citizens or permanent residents of the United States LLCs avoid these special eligibility requirements Moreover, LLCs offer even more flexibility than S corporations in the choice of taxation methods and they provide a great deal of flexibility in the way they are operated, and in the way profits and losses are distributed For all of these reasons, LLCs have quickly become a very popular form of ownership However, LLCs also have some disadvantages For example, shares of ownership in LLCs are not transferable without the approval of other owners In addition, LLCs have a limited life, and members of LLCs must pay self-employment taxes on profits (In contrast, owners of S corporations pay self-employment taxes only on salary, not on the entire profits of their company.) LLCs cannot deduct the cost of fringe benefits as an expense, and there is more paperwork for an LLC than there is for a sole proprietorship Thus, though LLCs offer many attractive benefits, they are not the best choice in all situations AACSB: Knowledge Application Bloom’s: Apply Learning Objective: 05-03 Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies Level of Difficulty: Hard Topic: Corporations 5-118 Chapter 05 - How to Form a Business 340 Describe and differentiate between the three types of corporate mergers Give an example of each type Answer: A vertical merger is the joining of two firms involved in different stages of related businesses A horizontal merger joins two firms in the same industry and allows them to expand their product offerings and/or achieve efficiencies in production and distribution A conglomerate merger unites completely unrelated firms for the purpose of diversifying operations and investments Students could come up with many different examples here Probably most will draw from the examples in the chapter but other examples could include: Vertical: a candy producer that merges with a sugar refiner Vertical: a swimming pool contractor that merges with a pool filter manufacturer to ensure a constant supply of filters Horizontal: a publisher of business textbooks merges with a publisher that specializes in legal and political texts Horizontal: a chain of donut shops merges with a company that operates a chain of shops selling fresh baked cookies and candy in shopping malls Conglomerate: an insurance company that merges with a magazine publisher Conglomerate: an auto parts manufacturer merges with a clothing store chain AACSB: Knowledge Application Bloom’s: Apply Learning Objective: 05-04 Define and give examples of three types of corporate mergers, and explain the role of leveraged buyouts and taking a firm private Level of Difficulty: Hard Topic: Mergers and Acquisitions 5-119 Chapter 05 - How to Form a Business 341 Franchising has certainly become a key component of the U.S economy What are the major advantages and disadvantages of franchising? Answer: Students should be able to identify and discuss several of the following advantages: Management assistance: most franchisors offer franchisees advice and managerial assistance Personal ownership: the business is still owned by the franchisee Use of a nationally recognized name: Many franchises have established a national reputation Financial advice and assistance: Franchisors often provide franchisees with expert financial advice and may even be willing to provide financing to franchisees Lower failure rate than that of other business ventures Again, students can select from several disadvantages cited in the text Among them are: Large start-up costs to obtain the franchise Sharing profits with the franchisor, or paying a royalty based on sales to the franchisor Management regulations: franchisees have to follow rules and regulations set by the franchisor that can limit their freedom Thus, even though the franchisees own their business, they not have as much control as owners of independent small businesses Negative coattail effects: the owners of a successful outlet can be adversely affected by the problems and poor performance of less successful franchisees in the same franchise Restrictions on selling: many franchisees face restrictions in the reselling of their franchises Fraudulent franchisors: many franchisors are small, rather obscure companies that prospective franchisees may know little about There has been an increase in complaints to the Federal Trade Commission about franchisors that delivered little or nothing of what they promised AACSB: Knowledge Application Bloom’s: Apply Learning Objective: 05-05 Outline the advantages and disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising Level of Difficulty: Hard Topic: Franchising 5-120 Chapter 05 - How to Form a Business Multiple Choice Questions Mini-Case For as long as she could remember, Jenna Raiter's passion was cars As a teenager, she spent hours with her dad tinkering with the family car, learning to change the oil and making minor repairs She got a job at a local garage while still in high school A few years after graduating from high school and completing the auto mechanics degree at a local community college, Jenna decided she wanted to be her own boss She quit her job, borrowed some money from her dad, and began her own repair shop, the AutoMotion Garage Jenna's hard work gradually attracted a loyal clientele of satisfied customers Her success has her thinking about opening garages in two other locations, but she lacks the financial resources needed for expansion Furthermore, the success of her business is forcing Jenna to spend more time managing the business and less time doing the actual technical work she still enjoys She wants to find business partners who can help her with management and provide additional financial resources She has approached a couple of friends she met in high school: Al Ternator and Lew Banfilter, to see if they would like to join the business 342 Currently, AutoMotion Garage is operated as a(n): A limited liability company B cooperative C sole proprietorship D solitary subsidiary Feedback: A business that is owned, and usually managed, by one person (such as Jenna) is a sole proprietorship AACSB: Analytical Thinking Bloom’s: Analyze Learning Objective: 05-01 Compare the advantages and disadvantages of sole proprietorships Level of Difficulty: Hard Topic: Sole Proprietorship 5-121 Chapter 05 - How to Form a Business 343 Jenna approached Al Ternator about joining the business as an owner She proposed that she continue to provide the technical expertise and deal directly with customers, while Al, who has a college degree in finance, handles many of the financial aspects of running AutoMotion In addition, Jenna wants Al to contribute some much-needed money for expansion Under Jenna's proposal, she and Al would operate the business together as: A limited partners B general partners C majority shareholders D business consultants Feedback: Since both partners are taking an active role in the business, they would be considered general partners Answer: B AACSB: Analytical Thinking Bloom’s: Analyze Learning Objective: 05-02 Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships Level of Difficulty: Hard Topic: Partnerships 344 Although Lew Banfilter, now a young attorney, is impressed with AutoMotion and believes it could be a place to invest money, he informed Jenna that his professional position at a law firm prevents him from taking an active role in the business He is also concerned about accepting more risk since he has a young family He mentioned a preference for unlimited liability If Lew joined Jenna and Al, the three might consider forming a(n): A limited partnership B general partnership C sole proprietorship D Master Limited Partnership Feedback: A limited partner invests in the business and shares in the profits, but has limited liability and does not take an active role in the management of the company This type of arrangement would meet Lew's goals of investing without incurring unlimited liability Answer: A AACSB: Analytical Thinking Bloom’s: Analyze Learning Objective: 05-02 Describe the differences between general and limited partners, and compare the advantages and disadvantages of partnerships Level of Difficulty: Hard Topic: Partnerships 5-122 Chapter 05 - How to Form a Business 345 When Jenna confided in Lew and Al that she too was concerned about adding additional risk, Lew suggested that they explore the possibility of one of the newest forms of business ownership, a(n) , which has very flexible ownership rules and would give them more choices in how the company's earnings are taxed while still protecting all owners from high levels of risk A alien corporation B master limited partnership C limited partnership D limited liability company Feedback: Limited liability companies offer the protection of limited liability, but allow the company a great deal of flexibility in how the earnings of the business are taxed In many cases, the company will choose to have its earnings taxed as if it were a partnership, thus avoiding the problem of double taxation However, the company can also choose to have its earnings taxed as a corporation if that is more advantageous Answer: D AACSB: Analytical Thinking Bloom’s: Analyze Learning Objective: 05-03 Compare the advantages and disadvantages of corporations, and summarize the differences between C corporations, S corporations, and limited liability companies Level of Difficulty: Hard Topic: Corporations 346 Al also suggested another way Jenna could finance her expansion He described setting up a chain of AutoMotion Garages by selling the rights to use AutoMotion's name, business model, garage design and service ideas to others who would like to own a similar shop These individuals would pay AutoMotion an initial fee and monthly royalties based on earnings Al is suggesting that Jenna set up a: A joint venture B franchise arrangement C C corporation D master limited partnership Feedback: A franchise arrangement exists when someone with an idea for a business (the franchisor) sells the right to use the business name and to sell a product or a service (the franchise) to others (the franchisees) in a given territory Franchisees usually pay the franchisor an initial fee and royalties Many women have turned to franchising as a means of financing an expansion of their business Answer: B AACSB: Analytical Thinking Bloom’s: Analyze Learning Objective: 05-05 Outline the advantages and disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising Level of Difficulty: Hard Topic: Franchising 5-123 Chapter 05 - How to Form a Business 347 With all these choice, Jenna's head is swirling with ideas She knows that Al and Lew have expertise in business and management, but she also knows that she will need to read on her own for more information Referring back to a textbook she had in her Introduction to Business class in college, she comes upon the following statement: A All forms of business ownership ultimately offer the same liability protection B An S corporation is a suitable form of business ownership for all businesses, while an LLC is limited to ownership by U.S citizens C Even if you sell the rights to others to own a similar business, you still need to commit to a form of business ownership D The least risky form of business ownership is still the sole proprietorship, and that is precisely the reason that so many are formed each year Feedback: A franchised business is an arrangement It is not a form of business ownership If Jenna agrees to become a franchisor, she is still required by law to commit to a form of business ownership Answer: C AACSB: Analytical Thinking Bloom’s: Analyze Learning Objective: 05-05 Outline the advantages and disadvantages of franchises, and discuss the opportunities for diversity in franchising and the challenges of global franchising Level of Difficulty: Hard Topic: Franchising 5-124 ... general and limited partners, and compare the advantages and disadvantages of partnerships Level of Difficulty: Hard Topic: Partnerships 5- 1 7 Chapter 05 - How to Form a Business 59 Last night as... Board of Directors of a corporation The Board of Directors appoints the management The management operates separately from stockholders Answer: False 5- 2 6 Chapter 05 - How to Form a Business AACSB:... penalties for nonpayment Answer: True 5- 5 Chapter 05 - How to Form a Business AACSB: Reflective Thinking Bloom’s: Understand Learning Objective: 0 5- 0 1 Compare the advantages and disadvantages