Chapter 5

Which form of business organization best suites the needs of your particular business?

To choose wisely, you must ask several key questions: Do you want to own the business alone or with other participants? How much operating control do the owners want? Who will be liable for the firm’s debts and taxes? Can the firm attract employees? What costs are associated with the chosen ownership structure? How easy will it be to find financing? How will the business be taxed? The answers determine the legal ownership structure you will select.

Most businesses fall into one of three major ownership categories: sole proprietorships, partnerships, or corporations. As Exhibit 5-1, page 139, illustrates, sole proprietorships are the most popular form of business ownership. They account for 73 percent of all businesses, compared to 20 percent for corporations and 7 percent for partnerships. Most sole proprietorships and partnerships remain small, however, so corporations generate about 90 percent of total business sales and 71 percent of profits.

Each form of business has advantages and disadvantages. As we’ll discover in the following sections, the form that offers the most advantages in the early stages of a company’s life may no longer meets its needs as it grows.

…A sole proprietorship is a business that is established, owned, operated, and often financed by one person. Your neighborhood florist, shoe repair shop, construction company, and hair salon are usually sole proprietorships. Small service businesses, such as lawyers, accountants, consultants, landscapers, and real estate agents, often operate as sole proprietorships. In fact, almost half of all sole proprietorships offer services.

Along with the freedom to operate the business as they wish, sole proprietorships face several disadvantages.

The sole proprietorship may be a suitable choice for a one-person start-up operation that has no employees and little risk of liability exposure. For many sole proprietors, however, this is a temporary choice. As the business grows, the owner may not have the managerial and financial resources to operate alone. At this point she or he may decide to go into partnership with one or more co-owners.

A partnership is an association of two or more persons who agree to operate a business together for profit. Some professional service firms—for example, law firms, accounting firms investment banks, stock brokerages, and real estate companies—are set up as partnerships.

Forming a partnership is simple. The parties agree, either orally or in writing, to share in the profits and losses of a joint enterprise. Written partnership agreements that spell out the terms and conditions of the partnership can prevent later conflicts between the partners. Those agreements typically include the name and purpose of the partnership, contributions of each partner (financial, talent, equipment, etc.), management responsibilities and duties of each partner, compensation arrangements (salaries and shares of profits), provisions concerning the addition of new partners and sale of partnership interests, and procedures for resolving conflicts, dissolving the business, and distributing assets.

There are two basic types of partnerships: general and limited. In a general partnership, all partners share in the management and profits. They co-own assets, and each can act on behalf of the firm.

A limited partnership has two types of partners: one or more general partners, who have unlimited liability, and one or more limited partners, whose liability is limited to the amount of their investment. In return for limited liability, limited partners agree not to take part in the day-to-day management of the firm. They help to finance the business, but the general partners maintain operational control.

You can see why business partnerships are often compared to marriages. As with marriage, choosing the right partner is critical. If you’re considering forming a partnership, allow plenty of time to evaluate both your own and your potential partner’s goals, personalities, business values, and work habits. You might even decide to go into partnership with your spouse.

A corporation is a legal entity with an existence and life separate from its owners. Because of this separation, the owners are not personally liable for the corporation’s debts. A corporation is subject to the laws of the state in which it is formed. The state issues a charter that gives the corporation the right to operate as a business and specifies its business goals. A corporation can own property, enter into contracts, sue and be sued, and engage in business operations under the terms of its charter. Unlike sole proprietorships and partnerships corporations are taxable entities.

Corporations play an important role in the U.S. economy. As we saw in Exhibit 5-1, page 139, corporations account for only 20 percent of all businesses but generate about 90 percent of the profits. …In 1999, the top 500 industrial and service corporations, as ranked by Fortune, accounted for over 6.3 trillion in sales and $410 billion in profits. Yet many individuals and small businesses also incorporate to benefit from the advantages of this form of business organization. Over 70 percent of all corporations have sales under $500,000.

Setting up a corporation is more complex than starting a sole proprietorship or a partnership. Most states base their laws for chartering corporations on the Model Business Corporation Act of the American Bar Association. Nevertheless, registration procedures, fees, taxes, and laws regulating corporations do vary from state to state.

A firm doesn’t have to incorporate in the state where it is based. It may benefit by comparing the rules in several states before choosing a state of incorporation. Although it is a small state with few corporations actually based there, Delaware’s pro-corporation policies have made it the state of incorporation for many companies including about half of the Fortune 500.

Articles of incorporation are prepared on a form authorized or supplied by the state of incorporation. Although they may vary slightly from state to state, all articles of incorporation include the following key items.

-Name of corporation -Methods of transferring shares

-The company’s goals of stock

-Types of stock and number of -Address of corporate office

shares of each type to issue -Names and addresses of the

-Life of the corporation (usually first board of directors

“perpetual,” meaning with no -Names and addresses of the

time limit) incorporators

-Minimum investment by owners -Other public information the

incorporators with to include

As exhibit 5-5, on page 147, shows, corporations have their own organizational structure with three important components: stockholders, directors, and officers.

The owners of the corporation are its stockholders, or shareholders, who hold shares of stock that provide certain rights. They may receive a share of the corporation’s profits in the form of dividends, and they can sell or transfer their ownership in the corporation (the shares of stock) at any time. Stockholders can attend annual meetings, elect the board of directors, and vote on matters that affect the corporation, as the charter and bylaws specify. they generally have one vote for each share of stock they own.

Stockholders elect a board of directors to govern the corporation. The directors handle overall management of the corporation. They set major corporate goals and policies, hire corporate officers, and oversee the firm’s operations and finances. Small firms may have as few as 3 directors, whereas larger corporations usually have 15 to 25. Large corporations typically include both corporate executives and outside directors (not employed by the organization) chosen for their professional and personal expertise. Because they are independent of the firm, outside directors can bring a fresh view to the corporation.

The officers of a corporation are its top management. Hired by the board, they include the president and chief executive officer (CEO), vice-presidents, treasurer, and secretary are responsible for achieving corporate goals and policies. Officers may also be board members and stockholders.

Certain features enable corporations to merge financial and human resources into enterprises with great potential for growth and profits:

Although corporations offer businesses many benefits, they also have several disadvantages:

Three types of corporate business organizations provide limited liability. The “basic” corporate form of organization is the conventional, or C, corporation. Small businesses can also achieve limited liability through two other options: the S corporation and the limited liability company.

Double taxation of corporate profits is a major disadvantage for some small corporations. To avoid this problem, firms that meet certain size and ownership constraints can organize as S corporations. An S corporation is a hybrid entity that is organized like a corporation, with stock holders, directors, and officers, but taxed like a partnership. Income and losses flow through to the stockholders and are taxed as the personal income of the stockholders. S corporations can have only 75 qualifying shareholders and one class of stock. The owners of an S corporation are not personally liable for the debts of the corporation. About 2.2 million U.S. businesses enjoy the benefits of limited liability and special tax treatment that S corporations offer.

A newer type of business entity, the limited liability company (LLC) is also a hybrid organization. Although LLCs are not corporations, like S corporations they appeal to small businesses. LLCs are easy to set up and are not subject to many restrictions. LLCs provide the same liability protection as corporations but offer the option of being taxed as either a partnership or a corporation. First authorized by Wyoming in 1977, LLCs became popular after a 1988 tax ruling that treats them like partnerships for tax purposes. Today, all states allow the formulation of LLCs.

Exhibit 5-6 summarizes the advantage and disadvantages of each form of business ownership.

Sole Proprietorship Partnership Corporation

Advantages

Owner receives all profits. More expertise and Limited liability

managerial skill protects owners from

available losing more than they

invest.

Low organizational costs Relatively low Can achieve large size

organizational costs due to marketability

of stock (ownership)

Income taxed as personal Income taxed as Ownership is readily

income of proprietor. personal income transferable.

partners.

Independence Fund-raising ability Long life of firm (not

is enhanced by more affected by death of

owners owners)

Secrecy Can attract employees

with specialized skills

Ease of dissolution Greater access to

financial resources

allows growth.

Receives certain tax

advantages

Disadvantages

Owner receives all losses Owners have Double taxation

unlimited liability; because both

may have to cover corporate profits and

debts of other, less dividends paid to

financially sound owners are taxed.

partners.

Owner has unlimited Dissolves or must More expensive and

liability; total wealth can reorganize when complex to form.

be taken to satisfy business partner dies.

debts.

Limited fund-raising Difficult to liquidate Subject to more

ability can inhibit growth. or terminate. government

regulation.

Proprietor may have Potential for Financial reporting

limited skills and conflicts between requirements make

management expertise. partners. operations public.

In addition to the three main forms, several specialized types of business organization play a role in our economy. We’ll look at cooperatives and joint ventures in this section and take a more detailed look at franchising in the following section.

Have you ever eaten a Sunkist orange or spread Land O’ Lakes butter on your toast? If so, you’ve used items produced by cooperatives. Cooperatives are typically formed by people with similar interests, such as customers or suppliers, to reduce costs and gain economic power. The member-owners pay annual fees and share in any profits. Cooperatives may be organized to provide just about any good or service, such as business services, child care, financial services, food, health care, marketing of agricultural and other products, and utilities and cable television. Today, over 100 million people are members of 48,000 U.S. cooperatives with revenues of over $120 billion. The top 100 cooperatives, led by the agriculture, grocery, and hardware/lumber industries, typically generate over $4 billion in revenues.

A cooperative is a legal entity with several corporate features, such as limited liability, an unlimited life span, and elected board of directors, and an administrative staff. Cooperatives distribute all profits to the members in proportion to their contributions. Because they do not keep any profits, cooperatives do not pay taxes.

There are two types of cooperatives. Seller cooperatives are popular in agriculture. Individual producers join to compete more effectively with large producers. Member dues support market development, national advertising, and other business activities. In addition to Sunkist and Land O’ Lakes, other familiar cooperatives are Calvo (avocados), Ocean Spray (cranberries and juices), and Blue Diamond (nuts). Farmland Industries, the largest cooperative in the United States, sells feed, fertilizer, petroleum, and grain.

Buyer cooperatives combine members’ purchasing power. Buying in volume results in lower prices. Food cooperatives are one example. College bookstores may operate as buyer cooperatives. At the end of the year, members get shares of the profits based on how much they bought.

By forming cooperatives to obtain discounts, small companies can lower costs, increase their efficiency, and compete with larger corporations. Many independent hardware store owners belong to True Value, Doing it Best, or Ace cooperatives. Robin Bryant, owner of a Doing It Best hardware store in Burlington, North Carolina, paid $2,700 to joint that cooperative. In return, she received training in store management, as well as support from the cooperative. “They always get the answers I need quickly,” she says. “They work with owners like myself because they really want us to succeed. For Bryant, the cooperative route was the only way to survive against chain discounters like Home Depot and Low’s. Among the benefits are lower prices and greater merchandise variety she gets by ordering from the cooperative’s centralized purchasing system.

In a joint venture (defined in Chapter 3), two or more companies form an alliance to pursue a specific project, usually for a specified time period. There are many reasons for joint ventures. The project may be too large for one party to handle on its own. By forming joint ventures, companies can gain access to new markets, products, or technology. Both large and small companies benefit from joint ventures. Software giant Microsoft Corp. teamed up with Citibank and other partners for its TransPoint joint venture to offer nationwide online billing and bill-paying services. Young technology companies often form joint ventures with more established players to wider distribution for their products. The joint venture brings the larger company access to the latest technology.

Franchising, one of the fastest growing segments of the economy, provides a way to own a business without starting it from scratch. Franchising is a from of business organization that involves a business arrangement between a franchisor, the company that supplies the product concept, and the franchisee, the individual or company that sells the goods or services in a certain geographic area. With a franchise, the business owner buys a package; a proven product, proven operating methods, and training in managing the business.

The franchise agreement is a contract allowing the franchisee to use the franchisor’s business name and its trademark and logo. The agreement outlines the rules for running the franchise, the services provided by the franchise, and the financial terms. The franchisee agrees to keep inventory at certain levels, buy a standard equipment package, keep up sales and service levels, follow the franchisor’s operating rules, take part in the franchisor’s promotions, and maintain a relationship with the franchisor. In return, the franchisor generally provides the use of a proven company name and symbols, building plans and help finding a site, guidance training, management assistance, managerial and accounting procedures, employee training, wholesale prices on supplies and financial assistance.

Like other forms of business organization, franchising offers some distinct advantages.

Many of today’s major names in franchising, such as McDonald’s and Kentucky Fried Chicken, started in the 1950s. Franchising grew rapidly in th e1960s and 1970s as more types of businesses—clothing, business services, convenience stores, and many others—used franchising to distribute their goods and services. The popularity of franchising to continued as more business owners turned to franchising as a way to expand operations quickly and in new geographic areas, with limited capital investment.

…Today, there are more than 2,100 franchise systems in the United States and Canada. The more than 500,000 business units in the United States employ over 8 million people and generate revenues of $800 billion. Franchisers account for an estimated 50 percent of U.S. retail sales. Fast food is the industry with the largest number of franchises.

Like other areas of business, franchising is part of the global marketplace. Most franchise systems either operate units internationally already or plan to expand overseas as the demand for all types of goods and services grows. “Our research has shown us that this is an ideal time to move into the Korean market,” says Doug Dwyer, president of Worldwide Refinishing Systems, a bath and kitchen remodeling franchise. “Because the average living standard now is fairly high in Korea, people not only desire but also can afford a better living environment that refinishing and restoring can provide.” Currently among the most popular types of international franchises are restaurants, hotels, business services, educational products, car rentals, and nonfood retail stores.

As the 20^th century came to a close, corporations continued to merge at record levels. In 1999 alone, the worldwide total was $3.4 trillion, including over 10,800 acquisition announcements totaling $1.7 trillion for U.S. companies.

A merger occurs when two or more firms combine to form one new company, which often takes on a new corporate identity.

In an acquisition, a corporation or an investor group buys a corporation, and the identity of the acquired company may be lost. ( A company can also acquire divisions or subsidiaries of another firm.) In Pfizer’s 1999 $87 billion acquisition of Warner-Lambert, Pfizer was the acquirer and Warner-Lambert was the target. Normally an acquiring company finds a target company and, after analyzing the target carefully, negotiates with its management or stockholders.

Although headlines tend to focus on mega-mergers, the current “merger mania” affects small companies as well. The motives for undertaking mergers and acquisitions are similar regardless of the size. Often the goal is strategic: improving the overall performance of the merged firms through cost savings, elimination of overlapping operations, improved purchasing power, increased market share, or reduced competition. Growth, widening of product lines, and the ability to quickly acquire technology or management skill are other motives. Acquiring a company is often faster, less risky, and less costly than developing products internally or expanding internationally.

…Another motive for acquisitions is financial restructuring—cutting costs, selling of units, laying off employees, refinancing the company—to increase the value of the company to its stockholders. Financially motivated mergers are based not on the potential to achieve economies of scale, but rather on the acquirer’s belief that the target has hidden value that can be unlocked through restructuring. Most financially motivated mergers involve larger companies.

The three main types of mergers are horizontal, vertical, and conglomerate. In a horizontal merger, companies at the same stage in the same industry merge to reduce costs, expand product offerings, or reduce competition. Many of the large mergers in the late 1990s were horizontal mergers to achieve economies of scale. For example, in 1999, Qwest acquired former regional Bell operating company U.S. West. Quest’s goal was to create a larger company to dominate the newly deregulated telecommunications industry.

In a vertical merger, a company buys a firm in its same industry that is involved in an earlier or a later stage of the production or sales process. Buying a supplier of raw materials, a distribution company, or a customer gives the acquiring firm more control. America Online (AOL), Inc. acquires companies that address different Internet-related markets and capabilities. In 1999 AOL completed its $4.2 billion acquisition of Netscape Communications Corp. AOL had focused on the consumer market, while Netscape had a strong presence in the corporate market. AOL gained Netscape’s software technology, including powerful website browser software and the behind-the-scenes software to run Web sites and conduct electronic commerce.

A conglomerate merger brings together companies in unrelated businesses to reduce risk. Combining with a company whose products have a different seasonal pattern or that respond differently to the business cycle can result in a more stable sales pattern. GE Capital Corp., the financial unit of General Electric Co., targets acquisitions that balance each other: risky companies whose performance fluctuates with changing financial markets and companies that perform consistently regardless of market conditions. GE Capital has 28 separate business lines in five major product groups: specialty insurance; consumer services such as credit card operations and auto and home financing; equipment leasing, ranging from aircraft to satellites to portable toilets; commercial financing; and financing for smaller businesses. Recently, it entered the rapidly growing information technology services market as well.

A specialized financially motivated type of merger, the leveraged buyout (LBO), became popular in the 1980s but is less common today. LBOs are corporate takeovers financed by large amounts of borrowed money—as much as 90 percent of the purchase price. LBOs can be started by outside investors or the corporation’s management. Believing that the company is worth more than the value of all the stock, they buy the stock and take the company private. The purchasers expect to generate cash flow by improving operating efficiency or by selling off some units for cash that can be used to pay the debt. Although some LBOs did improve efficiency, many did not live up to investment expectations or generate enough cash to pay the debt.

As we learned in Chapter 1, an awareness of trends in the business environment is a critical component of business success. Many of the social, demographic, and technology trends described in that chapter affect how businesses organize. When studying options for organizing a business or choosing a career path, consider the following trends in franchising and mergers and acquisitions.

More franchisers are catering to niche markets. For example, former Denver dentist Scott Menough now operates two Colorado Wild Birds Unlimited, Inc. franchises. Started by Jim Carpenter in 1981, this franchise system now has more than 250 units around the United States. Used goods are another growing segment of the retail market. GrowBiz offers franchisees resale outlets in six concepts: Once Upon a Child, Computer Renaissance, It’s About Games, Play it Again Sports, Music Go Round (instruments), and ReTool. Within 10 years the company opened 1,200 outlets. At its 700 play It Again Sports stores, used items sell so quickly that the units now carry new items as well, amounting to about 60 percent of inventory.

As more franchise systems crowd into growing industry categories, established franchises must find ways to differentiate themselves.

As noted earlier, consolidation to achieve economies of scale is driving strategic mergers in industries such as automobiles, defense, oil, telecommunications, utilities, and financial services. These and other industries overexpanded due to an abundance of investment capital, globalization, better information and technology, deregulation, and privatization. The result was fierce price competition and a search for other ways to improve financial performance. Consolidation is affecting companies of all sizes, from small businesses to industry leaders like Mobil and Citicorp, which surprised many when they became targets.

Because size is also an advantage when competing in the global marketplace, cross-boarder mergers are also on the rise. In particular, U.S. and European companies want new markets around the world. German automaker Daimler-Benz’s 1998 acquisition of Chrysler, the number three U.S. automaker, created the world’s largest auto manufacturer based on revenues. Other trans-Atlantic acquisitions in recent years include the 2000 acquisition of Bestfoods by British-Dutch consumer firm Unilever for $20 billion an the $56 billion 1999 merger between Britain’s Vodaphone Group and its joint venture partner Air Touch Communications to create the world’s largest cellular phone company.

…Cross-boarder mergers present special challenges for the combined entity. It must contend with differences in language and social and workplace cultures in addition to the usual complexities of merging two companies. Regulatory considerations also increase

A sole proprietorship is a business owned and operated by an individual. A partnership is an association of two or more people who operate a business as co-owners. A corporation is a legal entity with an existence separate from its owners. When choosing a form of organization for a business, evaluate the owner’s liability for the firm’s debts, the ease and cost of forming the business, the ability to raise funds, the taxes, the degree of operating control the operator can retain, and the ability to attract employees.

The advantages of sole proprietorships include ease and low cost of formation, the owner’s rights to all profits, the owner’s control of the business, relative freedom from government regulation, absence of special taxes, and the ease of dissolution. Disadvantages include unlimited liability of the owner for debts, difficulty in raising capital, limited managerial expertise, large personal time commitment, unstable business life, difficulty in attracting qualified employees, and the owner’s personal absorption of all losses.

Partnerships can be formed as either general partnerships or limited partnerships. In a general partnership, the partners co-own the assets and share in the profits. Each partner is individually liable for all debts and contracts of the partnership. The operations of a limited partnership are controlled by one or more general partners, who have unlimited liability. Limited partners are financial partners whose liability is limited to their investment; they do not participate in the firm’s operations. The advantages of partnerships include ease of formation, availability of capital, diversity of managerial expertise, flexibility to respond to changing business conditions, and relative freedom from government control. Disadvantages include unlimited liability for general partners, potential for conflict between partners, limited life, sharing of profits, and difficulty in leaving a partnership.

A corporation is a legal entity chartered by the state. Its organizational structure includes stockholders, who own the corporation; the board of directors, who are elected by the stockholders and govern the firm; and officers who carry out the goals and policies set by the board. Stockholders can sell or transfer their shares at anytime and are entitled to receive profits in the form of dividends.

Advantages of corporations include limited liability, ease of transferring ownership, stable business life, and ability to attract financing. Disadvantages are double taxation of profits, the cost and complexity of formation, and government restrictions.

Businesses can also organize as limited liability companies, cooperatives, joint ventures, and franchises. A limited liability company (LLC) provides limited liability for its owners but is taxed like a partnership. These two features make LLCs an attractive form of business organization for many small firms.

Cooperatives are collectively owned by individuals or businesses with similar interests that combine to achieve more economic power. Cooperatives distribute all profits to their members. Two types of cooperatives are buyer and seller cooperatives.

A joint venture is an alliance of two or more companies formed to undertake a special project. Joint ventures can be set up in various ways, such as through partnerships or special-purpose corporations. By sharing management expertise, technology, products, and financial and operational resources, companies can reduce the risk of new enterprises.

Franchising is one of the fastest growing forms of business ownership. It involves an agreement between a franchisor, the supplier of goods or services, and a franchisee, the individual or company that buys the right to sell the franchisor’s products in a specific area. With a franchise, the business owner does not have to start from scratch but buys a business concept with a proven product and operating methods. The franchisor provides the management training and assistance; use of recognized brand name, product, and operating concept; and financial assistance. Franchises can be costly to start, however, and restrict operating freedom because the franchisee must conform to the franchisor’s standard procedures.

In a merger, two companies combine to form one company; in an acquisition, one company or investor group buys another. Companies merge for strategic reasons, such as growth, diversification of product lines, increased market share, and economies of scale. The other main motive for merging is financial restructuring—cutting costs, selling off units, laying off employees, refinancing the company—to increase the value of the company to its shareholders.

There are three types of mergers. In a horizontal merger, companies at the same stage in the same industry combine to have more economic power, to diversify, or to win greater market share. A vertical merger involves the acquisition of a firm that serves an earlier or later stage of the production or sales cycle, such as a supplier or sales outlet. In a conglomerate merger, unrelated businesses come together to reduce risk through diversification.

Americans continue to open new businesses, from sole proprietorships to multi-unit franchise operations, at record rates. The service sector is growing fastest to meet the increased demand for convenience from working women and two-income families. Good franchise opportunities include those providing services for children and senior citizens, as well as resale shops and other specialty markets. To remain competitive, established franchisors are offering multiple concepts, new types of outlets, and expanded products. Key merger trends include increasing numbers of mergers between companies that wish to consolidate to achieve economies of scale and cross-boarder mergers.

The entrepreneurial spirit is capturing the interest of people from all backgrounds and age groups. Teenagers are starting fashion clothing and high-tech companies. Recent college graduates like Tom Scott and Tom First shun the “jacket and tie” corporate world to make it on their own. Downsized employees and midcareer executives form another large group of small business owners. Retirees who worked for others all their lives may form the company they always wanted to own.

…You may be one of the millions of Americans who’s considering joining the ranks of the business owners. As you read this chapter, you’ll get the information and tools you need to help you decide whether owning your own company is the right career for you. You’ll discover why entrepreneurship continues to be one of the hottest areas of business activity, as well as the characteristics you need to become a successful entrepreneur. then we’ll look at the importance of small businesses in the economy, their advantages and disadvantages, and the role of the Small Business Administration. Next, the chapter offers guidelines for starting and managing a small business. Finally, it explores the trends that will shape entrepreneurship and small business ownership in the 21^st century.

…The United States is blessed with a wealth of entrepreneurs like Schulz, According to the research by the Small Business Administration, 16 million Americans—about 13 percent of all nonagricultural workers—are involved in either full or part-time entrepreneurial activities. And their ranks continue to swell as up-and-coming entrepreneurs aspire to become the next Bill Gates or Marc Andreessen (co-founder of Netscape).

Why has entrepreneurship remained a strong part of the foundation of the U.S. business system for so many years? Today’s global economy rewards innovative, flexible companies that respond quickly to changes in the business environment. These companies are started by entrepreneurs, people with vision, drive, and creativity who are willing to take the risk of starting and managing a business to make a profit.

While entrepreneurs may be small business owners, not all small business owners are entrepreneurs. They are managers or people with technical expertise who started a business or bought an existing business and made a conscious decision to stay small. For example, the proprietor of your local independent bookstore is a small business owner. Jeff Bezos, founder of Amazon.com, also sells books. But Bezos is an entrepreneur: he developed a new model—a Web based book retailer—that revolutionized the world of book selling.

Entrepreneurs fall into several categories: classic entrepreneurs, multipreneurs, and intrapreneurs.

Classic entrepreneurs are risk takers who start their own companies based on innovative ideas.

Some classic entrepreneurs are micropreneurs who start small and plan to stay small. They often start businesses just for personal satisfaction and the lifestyle.

In contrast, growth-oriented entrepreneurs want their businesses to grow into major corporations. Most high-tech companies are formed by growth-oriented entrepreneurs. Jeff Bezos’s recognized that with Internet technology he could compete with large chains of traditional book retailers. Bezos’ goal was to build his company into a high-growth enterprise—and he even chose a name that reflected this strategy: Amazon.com. Now he’s moved beyond books to sell CDs, toys, and other products in an effort to make his company a one-stop shopping site.

Then there are multipreneurs, entrepreneurs who start a series of companies. Jim Clark is the quintessential multipreneurs, starting three high-tech companies with market values of more than $1 billion each. A former Stanford professor, Clark founded Silicon Graphics, Inc., which makes powerful high-end graphics computers, in 1982. His next venture, Internet pioneer Netscape, was formed in 1994 and went public in 1995. While Clark was still Netscape’s chairman, he shifted his attention to his newest company, Healtheon, which he founded in 1996 and took public in early 1999. Healtheon provides online medical data for physicians, insurers, and hospitals.

Some entrepreneurs don’t own their own companies but apply their creativity, vision, and risk taking within a large corporation. Called intrapreneurs, these employees enjoy the freedom to nurture their ideas and develop new products, while their employers provide regular salaries and financial backing. Intrapreneurs have a high-degree of autonomy to run their own mini-companies within the larger enterprise. They share many of the same personality traits as classic entrepreneurs but take less personal risk.

As the examples in this chapter show, entrepreneurs are found in all industries and have different motives for starting companies. The most common reason cited by CEOs of the Inc. 500, the magazine’s annual list of fasted growing private companies, is the desire to control their own destiny. Related to this is a desire for job security now that large corporations regularly down-size staff and streamline operations. Other reasons, as Exhibit 6-1 shows, include making money and building a new company. Two other important basic motives mentioned in other surveys are feeling personal satisfaction with your work and creating the lifestyle that you prefer.

…Being an entrepreneur requires special drive, perseverance, passion, and a spirit of adventure in addition to managerial and technical ability. Having a great concept is not enough. An entrepreneur must also be able to develop and manage the company that implements the idea. In addition, entrepreneurs are the company; they cannot leave problems at the office at the end of the day.

Many of the studies of the entrepreneurial personality have found similar traits. In general entrepreneurs are:

A person with all the characteristics of an entrepreneur might still lack the business skills to run a successful business. As we’ll discuss later in this chapter, entrepreneurs believe they can learn many of these technical skills. Entrepreneurs need managerial ability to organize a company, develop operating strategies, obtain financing, and manage day-to-day activities. Good interpersonal and communication skills are also essential in dealing with employees, customers, and other business people, such as bankers, accountants, and attorneys. They also need the technical knowledge to carry out their ideas.

…Working on the business often requires entrepreneurs to take Jim Clark’s approach: focus on what they do best and hire others to do the rest. As Lillian Vernon, founder of the successful mail-order business that bears her name, explains, “My biggest mistake was trying to do it all. As the business grew, I had a hard time relinquishing responsibility. I finally realized the only healthy way to grow a business is with a qualified, dedicated management team.

Although large corporations dominated the business scene for many decades, in recent years small businesses have once again come to the forefront of the U.S. economy. Ninety-nine percent of the businesses in the United States have less than 100 employees and nearly three-quarters of all U.S. businesses are owned by self-employed people who have no other employees. By some estimates, U.S. small businesses in the aggregate would rank third among the world’s economic powers based on the total value of goods and services they provide.

Let’s look at some of the main reasons behind the increase in small business formation:

How many small businesses are there it the United States? Estimates range from over 5 million to almost 20 million, depending on how government agencies and other groups define a business and the size limits they use. The data base of the federal Small Business Administration, which uses the number of business enterprises, lists about 5.4 million firms with fewer than 500 employees as of 1995. The Bureau of Labor and Statistics estimates that another 10.5 million individuals are self-employed.

So what makes a business “small”? As we have seen, there are different interpretations, and the range is extremely broad. Generally, though, a small business has the following characteristics.

Exhibit 6-2 shows some of the characteristics of the typical American small business.

Small businesses in the United States can be found in almost every industry group, as shown in Exhibit 6-3.

Services. Service firms are the most popular category of small businesses because they are easy and low cost to start. They are often small; very few service-oriented companies are national in scope. They include repair services, restaurants, specialized software companies, accountants, travel agencies, management consultants, and temporary help agencies.

Wholesale and retail trade. Retailers sell goods or services directly to the end user. Wholesalers link manufacturers and retailers or industrial buyers; they assemble store, and distribute products ranging from heavy machinery to produce. About 85 percent of all wholesale firms have fewer than 20 employees. Most retailers also qualify as small business, whether they operate one store or a small chain.

Manufacturing. This category is dominated by large companies, but many small businesses produce goods. Machine shops, printing firms, clothing manufacturers, beverage bottlers, electronic equipment manufacturers and furniture makers are often small manufacturers. In some industries, small manufacturing businesses have an advantage because they can focus on customized products that would not be profitable for larger manufacturers.

Construction. Firms employing under 20 people account for about 90 percent of the nation’s construction companies. They include independent builders of industrial and residential properties and thousands of contractors in trades as plumbing, electrical, roofing, and painting.

Agriculture. Small businesses dominate agriculture-related industry, including forestry and fisheries. The Small Business Administration estimates that 99 percent of all agricultural firms have fewer than 100 employees.

wide variety of skills they need to respond quickly to change. As noted earlier, they often lack knowledge in areas like finance, marketing, taxation, and business law. They may have experience in one area of business but not in the specific type of business they choose to start. Other’s have technical skills but not the management ability.

is obtaining adequate financing. Small firms must compete with larger, more established firms for the same pool of investment funds. Getting loans can be difficult because new businesses are obviously more risky than established ones.

state, and local regulations creates more compliance and reporting requirements for small businesses. Expanded federal, state, and local environmental regulations on water pollution and toxic wastes are especially burdensome.

managing a small business requires a major commitment by the owner. According to Dun & Bradstreet’s 17^th Annual Small Business Survey, more than half of all entrepreneurs work more than 51 hours a week, and 26 percent work over 60 hours a week.

Many small business owners turn to the Small Business Administration (SBA) for assistance. The SBA’s mission is to help people start and manage small businesses, help them win federal contracts, and speak on behalf of small business. Through its national network of local offices, the SBA advises and helps small businesses in the areas of finance and management.

The SBA offers financial assistance to qualified small businesses that cannot obtain financing on reasonable terms through normal lending channels. This assistance takes the form of guarantees on loans made by private lenders. (The SBA no longer provides direct loans.) These loans can be used for most business purposes, including purchasing real estate, equipment, and materials.

More than 300 SBA Small Business Investment Companies (SBICs) provided long-term financing for small businesses. These privately owned and managed investment companies hope to earn a substantial return on their investments as the small businesses grow.

The SBA also provides a wide variety of management advice. It’s Business Development Library has publications on most business topics. It’s “Starting Out” series offers more than 30 brochures on how to start a business in different fields.

The Office of Business Development and local Small Business Development Centers offer advice, training, and educational programs. Business development officers council small businesses owners. The SBA also offers free management consulting through two volunteer groups, the Service Corps of Retired Executives (SCORE) and the Active Corps of Executives (ACE). Executives in these programs use their business background to help small business owners.

The first step in starting your own business is a self-assessment to determine whether you have the personal traits you need to succeed and, if so, what type of business would be best for you.

Entrepreneurs get ideas for their businesses from many sources. Its not surprising that 60 percent of Inc. 500 executives got the idea for their company while working in the same industry. Starting a firm in a field where you have experience improves you chances of success. Other sources of inspiration are hobbies and personal interests; suggestions from customers, family and friends; and college courses or other education.

Ideas are all around you. Do you have a problem that you need to solve or a product that doesn’t work as well as you’d like? Maybe one of your coworkers has a complaint. Raising questions about the way things are done is a great way to generate ideas.

Another key decision for a person starting a new business is whether it will be a sole proprietorship, partnership, corporation, or a limited liability company. As discussed in Chapter 5, each type of business organization has advantages and disadvantages. The choice depends on the type of business, number of employees, capital requirements, tax considerations, and level of risk involved.

Once you have the basic concept for a product, you must develop a plan to create the business. The planning process is one of the most important steps in starting a business and helps minimize the risks involved. A good business plan can be a critical determinant of whether a firm succeeds or fails. It has been pointed out that two thirds of all businesses fail in the first five years, because people haven’t educated themselves as to what it takes to run a business.

One of the best ways to get that education is by preparing a formal, written business plan that describes in detail the idea for the new business and how it will be carried out. A well-prepared, comprehensive business plan helps business owners take an objective and critical look at their business venture and set goals that will help them manage the business and monitor its growth and performance.

Key features of a business plan are a general description of the company, the qualifications of the owner(s), a description of the product or service, an analysis of the market (demand, customers, competition), and a financial plan. It should focus on the uniqueness of the business and explain why customers will be attracted to it. Exhibit 6-4 is a brief outline of what a business plan should include.

Title page: Provides names, addresses, and phone numbers of the venture and its owners and management personnel; date prepared; copy number; and contact person.

Table of contents: Provides page numbers of the key sections of the business plan.

Executive summary: Provides a one- to three-page overview of the total business plan. Written after the other sections are completed, it highlights their significant points and, ideally, creates enough excitement to motivate the reader to continue reading.

Vision and mission statement: Concisely describes the intended strategy and business philosophy for making the vision happen.

Company overview: Explains the type of company, such as manufacturing, retail, or service; provides background information on the company if it already exists; describes the proposed form of organization—sole proprietorship, partnership, or corporation. This section should be organized as follows: company name and location, company objectives, nature and primary product or services of the business, current status (startup, buyout, or expansion) and history (if applicable), and legal form of organization.

Product and/or service plan: Describes the product an/or service and points out any unique features; explains why people will buy the product or service. This section should offer the following descriptions: product and/or service; features of the product or service providing competitive advantage; available legal protection—patents, copyrights, trademarks—and dangers of technical or style obsolescence.

Marketing plan: Shows who the firm’s customers will be and what type of competition it will face; outlines the marketing strategy and specifies the firm’s competitive edge. This section should offer the following descriptions: analysis of target market and profile of target customer; methods of identifying and attracting customers; selling approach, type os sales force, and distribution channels; types of sales promotions and advertising; and credit and pricing policies.

Management plan: Identifies the key players—active investors, management team, and directors—citing the experience and competence they posses. This section should offer the following descriptions: management team, outside investors, and/or directors and their qualifications, outside resource people and their qualifications, and plans for recruiting and training employees.

Operating plan: Explains the type of manufacturing or operating system to be used; describes the facilities, labor, raw materials, and product processing requirements. This section should offer the following descriptions: operating or manufacturing methods, operating facilities (location, space, and equipment), quality-control methods, procedures to control inventory and operations, sources of supply, and purchasing procedures.

Financial plan: Specifies financial needs and contemplated sources of financing; presents projections of revenues, costs, and profits. This section should offer the following descriptions: historical financial statements for the last three to five years or as available; pro forma financial statements for three to five years, including income statements, balance sheets, cash flow statement, and cash budgets (monthly for first year and quarterly for second year); break-even analysis of profits and cash flows; and planned sources of financing.

Appendix of supporting documents: Provides materials supplementary to the plan. This section should offer following the descriptions: management team biographies, any other important data that support the information in the business plan, and the firm’s ethics code.

Writing a good business plan may take many months. Many businesspeople, in their eagerness to begin doing business, neglect planning. They immediately get caught up in day-to-day operations and have little time for planning. But taking the time to develop a good business plan pays off. Writing the plan forces you to analyze your concept carefully and make decisions about marketing, production, staffing, and financing. A venture that seems sound at the idea stage my not look so good after a closer analysis. The business plan also serves as the first operating plan for the business.

The most common use of business plans it so persuade lenders and investors to finance the venture. The detailed information in the business plan helps them decide whether to invest. Even though the business plan may have taken months to write, it must capture the potential investor’s interest in only a few minutes. For that reason, the basic business plan should be written with a particular reader in mind; it should be tailored to the type of investor you plan to approach and his or her investment goals.

The business plan should not be set aside once financing is obtained and the company is operational. Entrepreneurs who think the business plan is only for raising money make a huge mistake. Owners should review the plan on a regular basis—monthly, quarterly, or annually, depending on how fast their particular industry changes.

Once the business plan is complete, the next step is to get the financing to set up the business. The amount required depends on the type of business and the entrepreneur’s planed investment. Businesses started by lifestyle entrepreneurs require less financing that growth-oriented businesses. The National Federation of Independent Businesses estimates that about half of all small business owners started their companies with less than $20,000, and 37 percent of the 1998 Inc. 500 were started with $10,000 or less. Of course, manufacturing and high-tech companies generally require a larger initial investment.

The two forms of business financing are debt, borrowed from funds that must be repaid with interest over a stated period of time,

…and equity, funds raised through the sale of stock in the business. Those who provide equity funds get a share of the profits. Lenders usually limit debt financing to no more than a quarter to a third of the firm’s total needs. Thus equity financing usually amounts to about 65 to 75 percent of the total start-up financing.

Two sources of equity financing for young companies are angel investors and venture capital firms.

Angle investors are individual investors or groups of experienced investors who provide funding for start-up businesses. Angels often get involved with companies at a very early stage.

Venture capital is financing obtained from investment firms that specialize in financing small, high-growth companies and receive an ownership interest and a voice in management in return for their money. They typically invest at a later stage than angle investors.

Who provides the start-up funding, whether debt or equity, for small companies? Almost 80 percent of all business owners contribute personal savings to their new companies.

Another route to small business ownership is buying an existing business. Although this approach is less risky, it still requires careful and thorough analysis. Several important questions must be answered: Why is the owner selling? Does he or she want to retire or move to another challenge, or are there some problems with the business? Is the business operating at a profit? If not, can the problems be corrected? What are the owner’s plans after selling the company? Depending on the type of business, customers may be more loyal to the owner than to the product or service. They could leave the firm if the current owner decides to open another business. To protect against this situation, a “noncompete clause” can be included in the contract of sale.

Running your own business may not be as easy as it sounds. Despite the many advantages of being your own boss, the risks are great as well. Many business fail each year. The SBA estimates that about a quarter of all new businesses fail after two years, half after three years, and almost two out of every three by the end of the sixth year.

Many of the causes of business failure are interrelated. For example, low sales and high expenses are often directly related to poor management.

Inadequate planning is often the core of business problems. As described earlier, a thorough feasibility analysis, from market assessment to financial plan, is critical to business success.

Whether you start a business from scratch or buy an existing one, you must be able to keep it going. The main job of the small business owner is to carry out the business plan through all areas of the business—from personnel to production and maintenance. The small business owner must be ready to solve problems as they arise and move quickly when market conditions change. Hiring, training, and managing employees is another crucial responsibility. Clearly, managing a small business is quite a challenge.

Over time, the owner’s role will change. As the company grows, others will make many of the day-to-day decisions while the owner focuses on managing employees and making plans for the firm’s long-term success.

One way to ease the burden of managing a business is to hire outside consultants. Nearly all small businesses need a good certified public accountant (CPA) who can help with financial record keeping, tax planning, and decision making. An accountant who works closely with the owner to help the business grow is a valuable asset. An attorney who knows about small business law can provide legal advice and draw up essential documents. Consultants in other areas, such as marketing, employee benefits, and insurance, can be hired as needed. Outside directors with business experience are another way for small companies to get advice. Resources like these free the small business owner to concentrate on planning and day-to-day operations.

Small companies may have to be creative to find new employees and to convince applicants to join their firm.

…Attracting good employees can be hard for a small firm, which may not be able to match the salaries, benefits, and advancement potential offered to larger firms. Compounding the problem is the general labor shortage.

More and more small businesses are discovering the benefits of looking beyond the United States for markets. As we learned in Chapter 3, the global marketplace represents a huge opportunity for U.S. businesses, both large and small. About 40 percent of the Inc. 500 companies do business overseas, and more companies are joining their ranks each year. According to the Department of Commerce (DOC), 60 percent of American firms that export have fewer than 100 employees. Small businesses decide to export because of foreign competition in the United States, new markets in growing economies, economic conditions (such as recession) in the United States, and the need for increased sale and higher profits.

Many small businesses hire international trade specialists to get started selling overseas. They have the time, knowledge, and resources that most small business lack. Export trading companies buy goods at discount from small businesses and resell them abroad.

Export management companies (EMCs) act on a company’s behalf. For fees of 5 to 15 percent of gross sales and multi-year contracts, they handle all aspects of exporting, including finding customers, billing, shipping, and helping the company comply with foreign regulations.

Social and demographic trends, combined with the challenges of operating in the fast-paced technology-dominated business climate of the 1990s, have changed the face of entrepreneurship and small business ownership. About two-thirds of all new business owners launch their ventures from home. New ownership trends are emerging as well as more young people choose entrepreneurship over traditional career paths. The number of women and minority business owners continues to grow. Finally the Internet is creating numerous opportunities for new types of small business.

For an increasing number of business owners, their daily commute is a walk down the hall to their home office. Home-based business make up 52 percent of all businesses and contribute about $314 billion to the U.S. economy each year. Although most home-based businesses are small, with average revenues of $40,000 a year, more than 55,000 home-based businesses report annual sales of $1 million or more.

…Two trends that contribute to the rising popularity of working at home are the availability of low-cost technology—from voice mail to powerful computers and the Internet—and the large number of former corporate executives who consult or start businesses from home.

At one time, most entrepreneurs were career changers starting second or third careers and corporate executives deciding to go out on their own. Today many young people are choosing entrepreneurship as their first career.

…A Wells Fargo Bank-National Federation of Independent Business (NFIB) study showed that Generation X-ers are among the most entrepreneurial of all age groups.

Women start businesses at a rate twice the national average, making them one of the most dynamic small business segments. The SBA Office of Advocacy estimates that about 9.1 million American women own businesses that generate 3.6 trillion in revenue and employ almost 27.5 million workers.

…The passage of NAFTA has opened doors for Hispanic entrepreneurs in particular. Their bilingual and bicultural skills help them form stronger trade relationships with Mexico.

…African Americans are less likely than other minorities to own their own enterprises. Although self-employment has been a route to advancement for other minority groups in the United States, the rate of self-employment for blacks is one-third that of whites. African-owned businesses also tend to have lower revenues than other businesses, averaging $70,000 a year. A major obstacle for African American business owners is poor access to financing.

…Advances in technology make it easier than ever to start a company and develop a loyal customer following. The Internet has opened new opportunities for small businesses, and research shows that small businesses are taking advantage of its benefits. …Small businesses use the internet for email, to purchase goods and services, to conduct business research, and, of course, to sell their products and communicate with customers. Thirty-eight percent of small business owners reported they have a Web site and 38 percent of those sites transact business directly over the internet. About 8 percent of small business revenues currently come through electronic commerce-enabled web sites.

>lg 1. Why do people become entrepreneurs, and what are the different types of entrepreneurs?

Entrepreneurship involves taking the risk of starting and managing a business to make a profit. Entrepreneurs are innovators who start firms either to have a certain lifestyle or to develop a company that will grow into a major corporation. People become entrepreneurs for four main reasons: the opportunity for profit, Independence, personal satisfaction, and lifestyle. Classic entrepreneurs may be micropreneurs, who plan to keep their businesses small, or growth-oriented entrepreneurs. Multipreneurs start multiple companies while intrapreneurs work within large corporations.

Successful entrepreneurs are ambitious, independent, self-confident, creative, energetic, passionate, and committed. They have a high need for achievement and a willingness to take moderate risks. They have good interpersonal and communications skills. Managerial skills and technical knowledge are also important for entrepreneurial success.

A small business is independently owned and operated, has a local base of operations, and is not dominant in its field. The Small Business Administration further defines small business by size, according to the industry. Small businesses play an important role in the economy. About 98 percent of U.S. businesses have fewer than 100 employees. Small business are found in every field, but they dominate the construction, wholesale, and retail categories. Most new private-sector jobs created in the United States over the past decade were in small firms. Small businesses also create about twice as many new goods and services than larger firms.

Small businesses have flexibility to respond to changing market conditions. Because of their streamlined staffing and structure, they can be efficiently operated. Small firms can serve specialized markets more profitably than large firms and provide a higher level of personal service. Disadvantages include limited managerial skill, difficulty in raising the capital needed for start-up and expansion, the burden of complying with increasing levels of government regulation, and the major personal commitment required on the part of the owner.

The Small Business Association is the main federal agency serving small businesses. It provides guarantees of private lender loans for small businesses. The SBA also offers a wide range of management assistance services, including courses, publications, and consulting. It has special programs for veterans, minorities, and women.

After finding out an idea that satisfies a market need, the small business owner should choose a form of business organization. The process of developing a formal business plan helps the business owner to analyze the feasibility of his or her idea. This written plan describes in detail the idea for the business and how it will be implemented. The plan also helps the owner obtain both debt and equity financing for the new business.

At first, small business owners are involved in all aspects of the firm’s operations. Wise use of outside consultants can free up the owner’s time to focus on planning and strategy in addition to day-to-day operations. Other key management responsibilities are finding and retaining good employees and monitoring market trends.

Women are starting businesses at a faster rate than any other group. Currently, they own about 30 percent of all businesses. Women often choose self employment for lifestyle reasons and to overcome limited opportunities in large firms. Minority-owned businesses are another high-growth category. Minorities view business ownership as a way to overcome racial discrimination and economic hardship. Both men and minorities have made strides in overcoming barriers to entrepreneurship, such as discrimination, lack of formal business education, and limited experience. Special training programs and financial assistance have helped increase business ownership among women and minorities. The Internet is also fueling small business growth by making it easier to open Web-based businesses.