ISSUES IN SELECTING A BUSINESS FORM
n Entrepreneur: Someone who initiates and
assumes the financial risk of a new enterprise.
n One or more entrepreneurs setting out to start a
business should consider the following four factors when deciding what form of
business to organize:
(1) ease and expense of creation,
(2) liability of the owner(s) for obligations of the entity,
(3) tax considerations, and
(4) the need to raise and
ability to raise capital.
TRADITIONAL BUSINESS FORMS
n Sole Proprietorship: A business owned by a single
person or family.
n Partnership: An agreement by two or more
persons to carry on, as co-owners, a business for profit.
n Corporation: A legal entity formed in
compliance with the statutory requirements of its state of incorporation, owned
by shareholders
whose liability is limited to their investment in the corporation, and managed
by (i) a board of directors elected by the shareholders and (ii) officers
employed by the board of directors.
SOLE PROPRIETORSHIP: PROS AND CONS
n Advantages:
n a proprietorship is easy and inexpensive to form;
n the proprietor receives all of the profits;
n the owner has the maximum degree of control over business decisions; and
n the proprietor may establish a tax-exempt retirement account.
n Disadvantages:
n the proprietor has unlimited liability for
any losses or liabilities incurred by the entity;
n the entity will
not survive the proprietor’s death, disability, or retirement; and
n the proprietor may only raise capital for the business out of his personal funds and from loans
others are willing to make based on his personal liability.
n Franchise: A relationship where the
owner of a trademark, trade name, or copyright (the franchisor) allows
another person or entity (the franchisee) to use that trademark,
trade name, or copyright, under specified conditions or subject to particular
limitations, in selling goods or services.
n Distributorship: A relationship where a
manufacturer (the franchisor) licenses one or more dealers (the franchisees) to
sell the manufacturer’s product. Often
a distributorship will cover an exclusive
territory.
n Chain Store: A relationship where the
franchisee operates under the franchisor’s trade name and is identified as a
member of a select group of dealers that engages in the franchisor’s business.
n Manufacturing or Processing
Plant: A
relationship where the franchisor transmits to the franchisee essential
ingredients or the specifications to make a particular product, which the
franchisee will then market at the wholesale or retail level in accordance with
the franchisor’s standards.
n Because a franchise relationship is primarily a
contractual relationship, state contract law governs most aspects of the franchise
relationship. In addition, federal
statutes govern particular types of franchises or aspects of franchising. For example:
n The Automobile
Dealers’ Franchise Act protects automobile dealership franchisees whose
franchisors impose unreasonable demands and then terminate the franchise
because of the dealer’s failure to satisfy them.
n The Petroleum
Marketing Practices Act prescribes the grounds and conditions under which a
franchisor may terminate or decline to renew a gas station’s franchise.
n More generally, the Federal Trade Commission requires franchisors to disclose material facts that a prospective
franchisee needs in order to make an informed decision whether to purchase a
franchise.
n Payment for the Franchise: The franchisee typically
pays an initial fee or a lump-sum price for the franchise license, separate and
apart from the cost of any equipment and products purchased by the franchisee
from the franchisor. In most cases, the
franchisee will also pay the franchisor a percentage of annual sales and, quite
often, will contribute to advertising and administrative costs of the
franchisor.
n Business Premises: The agreement should specify
whether the franchisee must lease or purchase its business premises.
n Location: Typically, the franchisor
determines the franchisee’s territory and whether it will be exclusive.
n Quality Controls: A franchisor may establish
and enforce certain quality standards in order to protect its reputation.
n Price Controls: A franchisor may suggest
the price at which its franchisees will sell its product; however, a franchisor
mandating price may run afoul of applicable antitrust laws.
n Termination: Most franchise agreements
provide that termination must be “for
cause” – e.g., death or
disability of franchisee, bankruptcy or insolvency of the franchisee, breach of
the franchise agreement – and must be preceded by notice to the franchisee.
n Wrongful Termination: Because the franchisee
makes a substantial investment to use, but not own, the franchisor’s trademark,
trade name, etc., both statutory and case law emphasize the franchisor’s duty
to act in good faith when terminating a franchisee.
n Notice: If the franchise agreement
does not set a minimum period for notice prior to termination, then the
franchisor must give the franchisee reasonable
notice of its intent to terminate the franchisee.