SECTION-I

Definition of Entrepreneurship Entrepreneurship can be described as a process of action an entrepreneur undertakes to establish his enterprise. Entrepreneurship is a creative activity. It is the ability to create and build something from practically nothing. It is a knack of sensing opportunity where others see chaos, contradiction and confusion. Entrepreneurship is the attitude of mind to seek opportunities, take calculated risks and derive benefits by setting up a venture. It comprises of numerous activities involved in conception, creation and running an enterprise. According to Peter Drucker Entrepreneurship is defined as a systematic innovation, which consists in the purposeful and organized search for changes, and it is the systematic analysis of the opportunities such changes might offer for economic and social innovation. A conceptual Model of Entrepreneurship Entrepreneurship can be described as a process of action an entrepreneur undertakes to establish his enterprise. Entrepreneurship is a creative activity. It is the ability to create and build something from practically nothing. It is a knack of sensing opportunity where others see chaos, contradiction and confusion. Entrepreneurship is the attitude of mind to seek opportunities, take calculated risks and derive benefits by setting up a venture. It comprises of numerous activities involved in conception, creation and running an enterprise. Entrepreneurship is a discipline with a knowledge base theory. It is an outcome of complex socio-economic, psychological, technological, legal and other factors. It is a dynamic and risky process. It involves a fusion of capital, technology and human talent. Entrepreneurship is equally applicable to big and small businesses, to economic and non-economic activities. Different entrepreneurs might have some common traits but all of them will have some different and unique features. If we just concentrate on the entrepreneurs then there will be as many models as there are ventures and we will not be able to predict or plan, how and where, and when these entrepreneurs will start their ventures. Entrepreneurship is a process. It is not a combination of some stray incidents. It is the purposeful and organized search for change, conducted after systematic analysis of opportunities in the environment. Entrepreneurship is a philosophy- it is the way one thinks, one acts and therefore it can exist in any situation be it business or government or in the field of education, science and technology or poverty alleviation or any others. Schumpeters View OF Entrepreneurship Joseph Alois Schumpeter (8 February 1883 8 January 1950) [1] was an Austrian American economist and political scientist. He briefly served asFinance Minister of Austria in 1919. One of the most influential economists of the 20th century, Schumpeter popularized the term "creative destruction" in economics.Austrian economist joseph Schumpeters definition of enterpreneurships plance an emphasis on innovation, such as: New Products New Production Methods New Markets New Form of Organization Weath is created when such innovation results in new demand. From this viewpoint once can define the function of the entrepreneur as once of combining various input factors in an innovative manner to generate value to the customer with the hope that this values will exceed the cost of the input factors, thus generating superior returns that results in the creation of wealth. Walkers View Organizer and coordinator Different degrees of organizational skill and coordinating capacity. True entrepreneurs are limited. Druckers View Entrepreneur is one who always searches for change, responds to it and exploits it as an opportunity Purposeful an systematic innovation Behavior rather than personality trait.

Entrepreneurship Culture Culture is a hot buzzword among corporate and entrepreneurial companies alike. It's what everyone is striving for, what brings on the loyalty, what attracts and keeps the really awesome employees. If done right, it seems so simple. Good corporate culture, in its purest sense, and at its most successful, has the look and feel of something organic and uncontrived, something that just exists. But alas, there's the rub, and at once the wonderful twist: Corporate culture cannot, does not and never will exist "just because." Culture is a balancing act between many elements of a company and requires careful execution at each level. This is especially true for entrepreneurial companies, where what's going on is the building of a business as well as a culture. Corporate culture must be led, nurtured, constantly monitored and adjusted. Much like a "culture" in a petri dish, it requires that you combine the right ingredients, in the right way, to ensure that what you grow is not an aberration of your intentions. Laying the Groundwork When I founded Net Daemons, my computer consulting company, I had very definite ideas of what I wanted to provide for our future employees, a safe and comfortable environment, which enabled people to learn, grow and, at the same time, focus on their day-to-day work. From early on, I felt it was important to treat every employee with trust and respect. That meant assuming automatically that each was an honest, hard-working, reliable and dependable individual. Rather than requiring all employees show up at nine and leave at five, for example, I expected each person to do the job assigned, and to apply the right amount of time and quality of skills toward the accomplishment of each task. While I wasn't aware, back then, that I was creating what is now considered "corporate culture," I knew I was looking to create a place of employment where employees were at once valued for who they were and what they brought to the table. This was critical for our business, which sold knowledge and a system of collaboration between some 45 engineers providing networkadministration and internet-development solutions. If a team isn't in sync, you can't sell a team approach, and you're no better than the single consultant. What Makes a Culture Entrepreneurial? As one of our engineers once put it, in an entrepreneurial culture, work is more than a job, it's a lifestyle. Employees are more like a team than in most companies, and in some cases, we're even like a family. What also evolved was a set of rules for creating and maintaining NDA's petri dish. In creating your own, consider these rules: Treat people with respect. This is a very simple premise, which threads through each and every complicated issue that can arise within a company. Respect and trust provide the necessary base for a vibrant and sustainable corporate culture. Help employees stay healthy. When employees get sick, they miss work, so it makes sense to offer health insurance as a benefit. We covered 100% of employee health plans. I never want an employee to experience a catastrophic illness and not be covered by insurance. We also offered unlimited sick time. While I had seen this type of policy backfire elsewhere, it nonetheless allowed people to be sick when they really were sick, and not feel obligated to gobble up each "allotted" sick day. You may also want to add a wellness allowance for health-club membership. Open doors to communication create an environment where people can interact with each other, support each other and recognize each other's efforts and achievements. Provide positive rewards for positive behavior. Share information, so that employees are aware of the direction of the company and are involved in it. Use all-hands meetings for financial and operational information, team-building and social events. Offer incentive programs to reward effort and improve quality of life. Build camaraderie. Make time for people to get to know each other and the company. We held an annual off-site meeting to build team spirit and discuss where the company was going. At such events you can also distribute and share your business plan and discuss issues and ideas raised by your strategies. Maintaining Entrepreneurial Culture Once you have healthy, trusted and informed employees, don't let the culture that's evolving just be. It needs to be watched so that it grows as you intended. The trick is standing back, but not too

far back. In maintaining your culture, consider these rules. Let the team build itself. Within that safe, comfortable, open environment, let employees grow together without being made to. Participate without controlling. Let the culture thrive, without your either meddling with it or ignoring it. Don't forget the little things. Culture is made up of many small actions that, when put together, create something larger than the sum of the parts. There are many things a CEO can do to make employees feel a part of the company. Some are just common courtesies: hallway conversations, saying "hello" in the morning, opening doors, asking after people's families and partners. Others are little extras, such as flowers to say thank you and happy-birthday e-mail messages. Eating lunch with employees, helping spouses find jobs and participating in team events show that you, the CEO, are involved with your employees. Treating employees with respect helps enable them to do their jobs to the best of their abilities. If you challenge people to raise their bars, provide fun activities, keep people informed and humanize your management, you get culture. From these basics, you will grow in your petri dish a strong, healthy culture that will allow you, your company and your employees to flourish Trail of a True Entrepreneur Most scholars state that in order to become a successful in any undertaking, you must have the right attitude, discipline, good knowledge, passion and motivation. This is also true with an entrepreneur. However, not everyone is born an entrepreneur but you can become one. Who is an entrepreneur? An entrepreneur is someone who undertakes a commercial venture with the chance of great profit or loss. If you too would want to become a businessperson, think twice, examine yourself and if you find that you possess the following characteristics of an entrepreneur, then you will make it and grow your business. 1. You must be willing to take risks Successful entrepreneurs take risks in any business they venture in. There are two things that may happen. The investment may pay off, thereby increase its power and growth. On the other hand, things may not work as expected and lose money. A true entrepreneur may see this as a learning curve and get more experience so that next time he or she is more careful. So, In any business, you will encounter a lot of obstacles and challenges which you need to be aware of as part of your development. We learn more from our past mistakes than from our good choices. Therefore risk taking is good for development in the long term. Do not mourn over the lost dollar; it will pay you off in the long run. 2. You must be smart and intelligent To work smart is to be knowledgeable, continue learning new skills and take advantage of new and better entrepreneur environment. There are many entrepreneurs scattered all over the planet where one can tap experiences and knowledge. Gone are the days when you were confined to your physical environment. With advanced technology, you can define your community among entrepreneurs who have more experiences, skills and share similar interest that will enhance your entrepreneurial skills to manage your products/services and clients more effectively. You must be able to identify needs and problems of your customers in order to change their situation and give them the right solution. This will help you gain respect and trust from your customers and clients. You will instantly earn their attention and their unwavering devotion. They can buy what ever you are offering at any cost. 3. Must be a leader Leadership is an attribute that is hard to find among individuals. Not many individuals have the nerve to take the lead any organization. To become a good entrepreneur, you must be a leader. Some say that this is a born characteristic but if you don't possess it, you can also learn to become a leader. In fact literature states that leaders are not born, but they are made. The most powerful attributes of a leader include: A person who does not compromise on matters of principle and standards Some one who has a vision for the future and communicates this vision in a simple way for others to understand Someone who does not give up and leads by example Some one who can set high standards and not afraid to confront even enormous problem despite the risks involved Some one, who accepts blame for any failure, instead gives credit of success to followers Some one who has integrity and courage. As a leader, you should be able to guide, influence, and direct people. This way, you can handle all your business activities with ease and fewer worries. 4. Have an inner passion for

business another important attribute that many entrepreneur lacks is having the right passion for business. Without passion, you will never fulfill your desires. Passion is the fuel that drives you to get what you want to achieve. Do you have the passion for your business? Passion leads to productivity that is taking action to produce results for your business. Passion does not entertain laziness. You have to maintain your enthusiasm and interest in the business. You must put all your soul into it; have a firm belief in what you do. The truth of the matter is that the more passion you put into your efforts every day, the more you will achieve your dreams in real life. This will give you drive to run the business despite the ups and downs. 5. Be honest and trustworthy Being honest with your self is the hardest thing in life, but this is vital to the success of your business. Customers would like to deal with honest people and any mistrust will create a bad reputation and that will lead to the down fall of your company. These days most of entrepreneur's time is dedicated to pooling and attracting customers. You must have the ability to build relationships with everybody knowing that you are building your personal wealth, if you have earned their trust. This may be true because without the customers, the business will not exist. You have to be honest and trustworthy so that you can develop good will. 6. Be ready to adapt new skills To stay at the top of other competitors, you must have the ability to adapt to new skills or technology. In other words, you must possess the ability to learn new things every day- which is the most important skill for an entrepreneur in this changing economy. 7. Improve speed of communication To be a successful entrepreneur, you must use the right technology to find new products and that are in great demand, then communicate andeducate your customers about the products and services and emphasize the importance of improving their lives in a simplest and fastest way possible that they for them to understand and buy from you without hesitation. Entrepreneur and a Manager The terms Entrepreneur and Manager are considered one and the same. But the two terms have different meanings. The following are some of the differences between a manager and an entrepreneur. The main reason for an entrepreneur to start a business enterprise is because he comprehends the venture for his individual satisfaction and has personal stake in it where as a manager provides his services in an enterprise established by someone. An entrepreneur and a manager differ in their standing, an entrepreneur is the owner of the organization and he bears all the risk and uncertainties involved in running an organization where as a manager is an employee and does not accept any risk. An entrepreneur and a manager differ in their objectives. Entrepreneurs objective is to innovate and create and he acts as a change agent where as a managers objective is to supervise and create routines. He implements the entrepreneurs plans and ideas. An entrepreneur is faced with more income uncertainties as his income is contingent on the performance of the firm where as a managers compensation is less dependent on the performance of the organization. An entrepreneur is not induced to involve in fraudulent behavior where as a manger does. A manager may cheat by not working hard because his income is not tied up to the performance of the organization. Entrepreneur is required to have certain qualifications and qualities like high accomplishment motive, innovative thinking, forethought, risk-bearing ability etc. Conversely its mandatory for a manager to be educated in the fields of management theories and practices. An entrepreneur deals with faults and failures as a part of learning experience where as a manager make every effort to avoid mistakes and he postpones failure. An entrepreneur could be a manager but a manager cannot be an entrepreneur. An entrepreneur is intensely dedicated to develop business through constant innovation. He may employ a manager in order to perform some of his functions such as setting objectives, policies, rules etc. A manager cannot replace an entrepreneur in spite of performing the allotted duties because a manager has to work as per the guidelines laid down by the entrepreneur.

On the downside, typical manager brings professionalism into working of an organization. They bring fresh perspectives, ideas and approach to trouble shooting which can be invaluable. Lately there has been convergence of the entrepreneur and the manager in certain sectors like software. An employee is being given highly valuable stock options, which make a typical manager a part owner. When you compare managers and entrepreneurs you need to first look at the definitions of both titles. A manager is someone who directs a team and an entrepreneur is someone who organizes, manages, and assumes the risks of a business or enterprise. With these definitions you can surmise that an entrepreneur can be a manager but a manager cannot be an entrepreneur. The reasons for this are plentiful, but it basically comes down to the type of person you are. If you like to control all aspects of a situation then you are generally a manager, but if you are someone who works through problems with people then you are more likely an entrepreneur. A manager is someone who is what is known as a micro-manager. They like to control all aspects of their workplace. Each person is given their assigned tasks and a manager will look over your shoulder until you finish it. They do not like to give up control enough to find out if you could do it on your own because they think if you make a mistake that it will come down on them. Unfortunately, with this attitude the people who work for a manager are less likely to grow in their career and will either stagnate or leave the company or position quickly. This will help to perpetuate the feelings of the manager that no one can measure of to him in their skill levels. This type of demeanor works well when you have a person that needs to be consistently supervised. Someone who can't take a task and see if through on their own, they need to have it explained to them step by step. An entrepreneur is generally considered a leader versus a manager. They will give people tasks and a deadline and generally leave them alone until it is completed. They will trust people to get the job done without having to constantly look over their shoulder. When they hire someone they believe that they have hired someone who is qualified to handle the tasks before them, so they don't think they should have to ask for status reports on an hourly basis. The people who work for them are normally intelligent individuals who will move up quickly in the company, because their boss has helped to build their confidence and it will be noticed by not only their boss but other people within the company. This type of manager believes that it is important to have people with varied skill sets because it will only enhance his own skills and abilities. Of the two different types of managers mentioned, it is normally more productive to work for a leader versus a manager. You will be able to improve your skill set and to move up within the company because you have learned good managerial skills from a true leader. Learning how this type of person manages an office will help you to be able to become a leader within the company and it will help you in all facets of your life. Entrepreneurial Motivation Entrepreneurial Motivation is the drive of an entrepreneur to maintain an entrepreneurial spirit in all their actions. Entrepreneurial Motivation Factor Educational background Occupational Experience Desire to work independently Desire to branch out to manufacturing Family background Assistance from Government Assistance from financial institution Availability of technology/raw material Profit margin Desire for taking personal responsibility Anticipation of future possibilities Success stories of entrepreneurs To gain social prestige Heavy Demand Technical knowledge Entrepreneurial ambitions Compelling factors, facilitating factors, Achievement motivation theory The Achievement motivation theory relates personal characteristics and background to a need for achievement and the associated competitive drive to meet standards of excellence. According to theoretical research by Murray (1938), McClelland, Atkinson, Clark, and Lowel (1953), and McClelland (1961), achievement motivation or need for achievement is influenced by a

combination of internal factors including personal drives and external or environmental factors including pressures and expectations of relevant organizations and society. Related to an individuals need for achievement and overall motivation is the individuals need for power and need for affiliation. Understanding and explaining individuals achievement motivation is important within organizations where such characteristics are strongly associated with ongoing organizational success, most notably in the sales function. Staffing the organization with individuals having backgrounds and personal characteristics that are suggestive of a high need for achievement becomes an important consideration. While many factors are potentially influential and interact, e.g. an individuals values (e.g. valuing the accomplishment of tasks over personal relationships), culture and educational background, providing appropriate external support in the form of organizational systems, structures, and culture (e.g. including opportunities for promotion, recognizing and rewarding successes, ensuring performance feedback, and matching individual control with role responsibilities and role importance) becomes just as important as the organizations assessing and nurturing an individuals personal drives. Kakinada Experiment Establishing Idea Performance of Entrepreneurship Development Programmes (EDPs) in India has not been very exciting. Starting 1971, India embarked on a massive programme of entrepreneurship development. Since then, there is no looking back. As of now, more than 700 state levels financial institutions, public sector banks and other agencies across India, have been conducting thousands of EDPs every year. This is similar to 'Senior Achievement Programme' based on the principle of 'Catch them young' in the USA; and 'Young Enterprises Programme' in the UK (Khanka, 2005). Well known behavioural scientist David McClelland at HarvardUniversity made an interesting investigation into why certain societies displayed great creative powers at particulars periods of their history? What was the cause of these creative bursts of energy? He found that the need for achievement (nach factor) was the answer to his question (McClelland, 1961). It was 'need to achieve' that motivated people to work hard. According to him, money making was incidental. It was only a measure of achievement, not its motivation. In order to answer the next question whether this needfor achievement could be induced, he conducted a five-year experimental study in one of the prosperous district of Andhra Pradesh in India in collaboration with Small Industries Extension and Training Institute (SIET), Hyderabad. This experiment is popularly known as Kakinada Experiment. As a part of this experiment, young persons were selected and put through a three month training programme and motivated to seek fresh goals. One of the significant conclusions of the experiment was that the traditional beliefs did not seem to inhibit an entrepreneur and that the suitable training can provide the necessary motivation to the entrepreneurs (McClelland and Winter, 1969). The achievement motivation has positive impact on the performance of entrepreneurs. The Kakinada Experiment could be treated as a precursor to the present day EDP input on behavioral aspects. In fact, it was the Kakinada Experiment that made people appreciates the need for and importance of the entrepreneurial training, now popularly known as EDP, to induce motivation and competence among the young prospective entrepreneurs. Evaluation of EDPs Developing entrepreneurship has become a movement in India in the recent years. EDPs have been considered as an effective instrument for entrepreneurship in the countryside. Hundreds of EDPs are conducted by more than 700 organizations to impart entrepreneurial training to participants in thousands (Gupta, 1990). The main objective of these EDPs is to train enterprise creators. Having spent lot of public money and effort for organising EDPs it was also necessary to evaluate whether the objectives of EDPs are fulfilled or not. In simple words, there is a need to have a data as to how many participants of these EDPs have actually started their own enterprises after completing the training. With this feedback evaluation of EDPs was imminent. So far some 16 evaluation studies have been conducted by various

organizations and individual researchers. No doubt, these studies vary in their objectives, coverage and content. But, one common thread in all of them is the assessment of effectiveness or impact of EDPs, howsoever, loosely defined. One of the earliest attempts in this direction was made by a team of researchers and experts appointed by the Gujarat Corporations to evaluate the effectiveness of EDPs (Gaikwad, et al,1974). One of the most comprehensive evaluation studies on EDPs was one carried out by the Entrepreneurship Development Institute of India, Ahmedabad (Awasthi and Sebastian, 1996). It was observed that one out of every four trainees (26per cent) actually started his/her enterprise after undergoing entrepreneurial training. However, the expected final start-up rate was slightly higher around 32 per cent. About 10 per cent trainees are found blocked due to various reasons at various stages in the process of setting up their enterprises. If not helped effectively, they may join the category of those 29 per cent trainees who have already given up the idea of launching their ventures. According to the secondary sources, viz., family, friends and neighbours, out of 430 trainees who could not be contacted personally during this field survey, 17 per cent have given up the idea of venture launching as they are engaged in other activities. According to Awasthi and Sebastian (1996), the performance of EDPs across the states and across the ED organization has not been uniform. The actual startup rates are observed to be oscillating between 9 per cent and 56 per cent, bringing down the overall national start-up rate to about 26 per cent. This by any count cannot be considered as impressive performance. And in this non impressive performance lies the need for looking at the problems and constraints of EDPs Measuring Performance It is clear that the problems are not with the strategy but with its implementation. One way of evaluating the EDPs is to assess their effectiveness in developing need for achievement among the entrepreneurs. This is also called the qualitative evaluation of EDPs. McClelland and Winter (1969) used the following criteria to assess the effectiveness of EDPs in motivating the entrepreneurs- (i) activity level of the respondents; (ii) new enterprise established; (iii) total investments made; (iv) investments in fixed assets made; (v) number of people employed; (vi) number of jobs created; (vii) increase in profit; (viii) increase in sales; (ix) quality of product/service improved; and (x) Quicker repayment of loans. In other behavioural experiments (Sah, et al, 1974) the impact of EDPs is measured with the help of indices relating to the entrepreneurial behaviour. The entrepreneurial behaviour is measured on the following four dimensions - (a) planning orientation, (b) achievement orientation, (c) expansion orientation,and (d) management orientation. Technology ventures: from idea to enterprise Technology Ventures is the first textbook to thoroughly examine a global phenomenon known as technology entrepreneurship. Entrepreneurship represents a vital source of change in all facets of society, empowering individuals to seek opportunity where others see insurmountable problems. Technology entrepreneurship is a style of business leadership that involves identifying highpotential, technology-intensive commercial opportunities, gathering resources such as talent and capital, and managing rapid growth and significant risks using principled decision-making skills. The book integrates the most valuable entrepreneurship and technology management theories from some of the worlds leading scholars and educators. It provides an action-oriented approach through the use of examples, exercises, cases, sample business plans, and recommended sources for more information. This comprehensive collection of concepts and applications provides both students and professionals with the tools necessary for success in starting and growing a technology enterprise. Technology Ventures details the critical differences between scientific ideas and true business opportunities. Sommaire de Technology ventures: from idea to enterprise Section I 1 Capitalism and the Technology Entrepreneur 2 The Opportunity, the Entrepreneur, and the Business Summary 3 Building Competitive Advantage 4 Creating Strategy 5 Technology, Innovation, and Timing Section II 6 Risk, Return, and Product Design 7 Corporate Technology Ventures 8 Creating New Ventures and the Business Plan 9 Building Knowledge and Learning in a

New Enterprise 10 Name, Legal Formation, and Intellectual Property Section III 11 The Marketing and Sales Plan 12 The New Enterprise Organization 13 Acquiring, Organizing, and Managing Resources 14 Acquisitions, Mergers, and Global Business 15 The Management of Operations Section IV 16 The Profit and Harvest Plan 17 The Financial Plan 18 Sources of Capital 19 Presenting the Plan and Negotiating the Deal 20 Leading the New Technology Venture to Success Appendix A Business Plans Appendix B Cases Appendix C Glossary Appendix D Information on the Internet ABSTRACT. Creative destruction is a central element of the competitive dynamic of capitalism. This phenomenon assumes concrete form in relation to specic geographical and historical conditions. One such set of conditions is investigated here under the rubric of the creative eld, i.e. the locationally-dierentiated web of production activities and associated social relationships that shapes patterns of entrepreneurship and innovation in the new economy. The creative eld operates at many dierent levels of scale, but I argue that the urban and regional scale is of special interest and signicance. Accordingly, I go on to describe how the creative eld functions as a site of (a) entrepreneurial behavior and new rm formation, (b)technical and organizational change, and (c) the symbolic elaboration and re-elaboration of cultural products. All of these activities are deeply structured by relations of spatial-cum-organizational proximity and separation in the system of production. The creative eld, however, is far from being a fully selforganizing entity, and it is susceptible to various kinds of breakdowns and distortions. Several policy issues raised by these problems are examined. The paper ends by addressing the question as to whether industrial agglomeration is an eect of producers search for creative synergies, or whether such synergies are themselves simply a contingent outcome of agglomeration. 1. Introductory Remarks Throughout his voluminous writings, Marx insisted on the notion of capitalism as a turbulent scene of production and exchange, gripped by the forces of competition in an endless process of self-transformation. In these circumstances, every rm faces a stark choice between the continual need to upgrade its process and product congurations or eventually going out of business. The result is what Schumpeter (1942), in an explicit invocation of Marx, called creative destruction, i.e. the periodic abandonment of old equipment, production methods, and product designs in favor of newer and more economically performative assets. At the same time, as both Marx and Schumpeter recognized, creative destruction is inscribed within an everexpanding sphere of economic activity due to the growth of existing rms, the extension of entrepreneurship, and the appearance of new products on nal markets. Capitalism, in brief, is a complex eld of forces spurring constant qualitative and quantitative readjustments across all its multiple dimensions of operation (see also Baumol, 2002). Sometimes these readjustments are of cataclysmic proportions, as when steam replaced water-power in the nineteenth century; more often than not, as Rosenberg (1982) points out, they take the form of small, incremental steps, many of which may be minuscule, but which collectively produce the incessant turbulence descried by Marx. Of late years, there has been a considerable outpouring of literature devoted to these matters, much of it partaking of institutionalist and evolutionary economic theory (e.g. Archibugi et al., 1999; Arthur, 1990; David, 1985; Edquist, 1997; Foray and Lundvall, 1996; Freeman, 1995; Lundvall and Johnson, 1994; Nelson, 1993; Von Hippel, 1988). An important aspect of this literature is the emphasis that much of it assigns to geography and above all to the region as an active force in molding industrial performance qua new rm formation, learning, invention, and growth (cf. Acs, et al., 2002; Antonelli, 2003; Audretsch and Feldman, 1996; Cooke and Morgan, 1994; Feldman, 1994; Howells, 1999; Maskell and Malmberg, 1999; Oinas and Malecki, 1999; Simmie, 2003; Storper, 1995). This expanding interest in the geographic foundations of industrial performance can no doubt in large degree be ascribed to the emergence of a dominant post-fordist (or more simply new) economy since the late 1970s and early 1980s, and to the concomitant transformations, often quite radical, of the industrial landscape that have

ensued. For the rst three-quarters of the 20th century, the leading edges of economic expansion in the advanced capitalist societies were constituted mainly by fordist mass-production sectors (steel, cars, petroleum products, food processing, and so on). Schumpeter himself, or more accurately, the later Schumpeter, identied sectors like these, with their substantial research budgets and central R&D laboratories, as the principal foci of innovative activity and technical change in the capitalism of that period. Observers of technological change in the post-War decades, such as Manseld (1968), made much of the distinction between basic and applied research, almost always with the further observation that the latter is in important ways pulled along by the former as engineers and other technical workers translate theoretical ideas into practical blueprints for industrial application. A complementary view of processes of innovation and change in this period of economic history is encapsulated in the so-called product-cycle model (Vernon, 1966). Here, the analysis turns on the notion that sectors of production and/or systems of applied technology go through a predictable series of evolutionary changes from their moment of inception to their nal expression in the form of mature mass production. The model recognizes three main stages of development in any sector, i.e. (a) a period of infancy and experimentation as new technologies and products make their appearance and as small entrepreneurial rms spring into existence in order to exploit them; (b) a period of growth, based on research intensive process and product development, accompanied by the shakeout of underperforming assets; (c) a period of maturity or oligopoly in which just a few very large rms making standardized products dominate the entire sector, and in which technological change has radically slowed down. Several attempts were made to incorporate a theory of industrial location into the product cycle model, as expressed in a composite story to the eect that new industries originate in agglomerated incubators and then steadily disperse outward as they develop, until in the nal stages of maturity, virtually all production has decentralized to cheap-labor locations (Norton and Rees, 1979; Struyk and James, 1975). In spite of its many over-simplications and oversights, this vision of technological change and entrepreneurship can be taken as an approximate description as to how at least some massproduction sectors evolved in the post-War decades. Even in the context of fordist massproduction, however, the product-cycle model fails to provide a really adequate account of technological trajectories and the evolution of the rm (Storper, 1985). As the new leading edges of capitalist development today such as high-technology manufacturing, neo-artisanal industry, business and nancial services, the media, and so on have come to the fore, the deciencies of the theory have grown yet more apparent, above all in view of the circumstance that one of the dening features of the so-called new economy is its persistent postponement of anything like the stage of maturity. New-economy sectors are endemically given to continuous learning and hyper innovation in all phases of their growth, not only in so far as tangible technologies are concerned but intangible capital of all kinds as well (Amable et al., 1997; David and Foray, 2002)..

Section II
Policy incentive for entrepreneurial Growth
1. Introduction The papers in this special issue focus on the relationship between entrepreneurship, economic growth and public policy. This question has been a core component of the economics literature as far back as Adam Smith. A related question how does public policy vary with the stage of economic development? has been examined more recently in the economic development literature (Lucas, 1993), the regional science literature (Acs and Storey, 2004) and the entrepreneurship literature (Acs, 2006). There is empirical evidence that entrepreneurial activity varies across stages of economic development, indicated by a U-shaped relationship between level of development and the rate of entrepreneurship. A positive eect of entrepreneurial activity on economic growth is found for highly developed countries; a negative eect is found for developing nations (van Stel et al., 2005; Wennekers et al., 2005; Acs and Varga, 2005). It is this policy interaction that motivated the second Global Entrepreneurship Monitor (GEM) Research Conference, in Budapest, Hungary from May 25 to 27, 2005. While economic growth and regional eects (agglomeration, networking, clustering) dominated in the rst GEM research conference (Sternberg and Wennekers, 2005), this special issue largely addresses the development questions: the inuence of government regulation on new rm startups, perceptual issues; international issues include immigration and access to foreign technology. Two strong sub-themes emerge in these papers: Cross-country comparisons and a special focus on Central European economies. Altogether, there were 116 special guests, GEM members, experts, researchers and politicians in attendance. The purpose of this conference was to present an overview of stateof-the-art, current research on entrepreneurial activity in countries and regions covered by GEM. Since 1999, close to 40 national teams and 120 consortium participants have contributed to the GEM program. By 2004, the number of interviewed individuals exceeded 500,000 and more than 6,000 national entrepreneurship Final version accepted on October 2006. Zoltan J. Acs School of Public Policy George Mason University Fairfax, VA, 22030, USA E-mail: zacs@gmu.edu Laszlo Szerb Faculty of Business and Economics University of Pecs Pecs, 7601, Hungary Small Business Economics (2007) 28:109122 Springer 2006 DOI 10.1007/s11187-006-9012-3experts were asked their opinion about the entrepreneurial framework conditions. Therefore, a wide variety of research opportunities can come out of the GEM data (Reynolds et al., 2005). Initially 27 abstracts were submitted, of which 19 were accepted and 18 papers were ultimately presented in six sessions. Two papers were presented in one of the two roundtables. Finally, 10 papers were invited for publication consideration and 8 were selected for this special issue after the referee process. In order to put the papers into historical perspective, the following section describes the emergence of entrepreneurial capitalism through the end of the last century. Section 3 provides structure to this analysis by categorizing a range of policies in an entrepreneurial economy: policies with eects on individual decisions to become an entrepreneur, national policies that aect the overall entrepreneurial environment, policies directed mainly at international commercial activity and regional policies. Section 4 describes the papers in this issue and discusses key ndings from the conference. The nal section examines specic policy implications for Central Europe. 2. Entrepreneurial capitalism The U.S. economy has enjoyed remarkable economic success during the past decade, as indicated by the most important economic statistic: Rate of productivity growth. Over the long run, this determines the rate of advance in average living standards. After surging to 2.6% annually from 1950 to 1973, productivity growth dropped to 1.4% in the period from 1973 through 1995. Although this 1.4 percentage point annual decline may seem trivial, it has enormous consequences over time. At the earlier rate of 2.6%, living standards double every 28 years

whereas at the rate of 1.4%, this doubling would take more than 50 years. What accounts for this good fortune so far? Conventional economic wisdom has converged on the opinion that the information technology (IT) revolution especially rapidly falling prices of computer chips and their dependent products has been critical. When measured by conventional statistics, there seems to be much truth in this (Oliner and Sichel, 2002). However, a deeper change in the structure of the American economy itself a decades-long transition from managerial to entrepreneurial capitalism also seems to have played an important role in the acceleration of productivity growth (Acs and Armington, 2006; Audretsch et al., 2006; Baumol et al., 2007, among others). Acs rst articulated that markets, new technology and entrepreneurship are at the heart of the transition from managerial to entrepreneurial capitalism, in The Changing Structure of the U.S. Economy (1984). Three distinct features of this increasingly entrepreneurial capitalism are noteworthy: Firm structure is more dynamic. After World War II, large rms, often in oligopolies, dominated the U.S. economy. Turnover among the largest rms was minimal and new rms played a minor role. This has changed dramatically in the last several decades. New rms oering new products and services (in IT, biotechnology and retail) and foreign entrants in traditional industries (such as automobiles and steel) have been major drivers, if not the main driver, of economic growth. Markets and individual rms are replacing bureaucracies (inside and outside the private sector). A hallmark of entrepreneurial rms is relatively at management structures with rapid responsiveness to market demands, whereas large rms host more bureaucratic, hierarchal management and thus, decisionmaking takes longer. In the managerial economy, there was an implicit compact between big labor, big business and big government. (Galbraith, 1967). That compact, if it ever existed, is now clearly gone. Labor s share of the workforce has fallen dramatically, big business is in ux (with constant changes in the rankings of America s leading rms) and government functions at all sectors are increasingly being contracted out to the private sector. Innovation is very dierent in managerial and entrepreneurial settings. Led by risk-taking entrepreneurs, new rms are disproportionately responsible for radical or breakthrough technologies, although larger 110 Zoltan J. Acs and Laszlo Szerbmanagerial rms are typically needed to re- ne, mass-produce and market these technologies (Baumol, 1993). The innovations that now characterize modern life the automobile, telephone, airplane, air conditioning, personal computer, most software and Internet search engines were all developed and commercialized by entrepreneurs. Radical innovations tend to lead to faster overall growth than do incremental improvements. It is not a coincidence that the IT revolution which has statistically accounted for the signicant acceleration in US productivity growth over the last decade was sparked largely by entrepreneurial companies (Acs and Audretsch, 1989). How did this transformation occur? A brief discussion of historical context is useful. The interaction between economic growth and public policy dates back to the Mercantilist debates in the 17th century, but the introduction of entrepreneurship into this relationship is a relatively new topic (Acs et al., 2005; Autio, 2005). At the very least, any society interested in encouraging entrepreneurship must make it rewarding and easy to do. For the most part, the U.S has developed laws and institutions over time to eectively do that: A legal system protects rights of contract and property (including intellectual property), state and local registration systems make it easy to form a business, the tax system has evolved towards lower marginal tax rates, and laws support a nancial system that generally favors the formation and growth of new ventures (Schramm, 2004). Several federal policy initiatives were adopted during Democratic and Republican administrations over the past three decades, which have supported the shift from a managerial to an entrepreneurial economy (Acs, 1984). These include:

 The removal of legal barriers to entry and price controls in a number of key industries, specically transportation and communications Successive Executive Orders requiring executive branch agencies to at least study the costs and benets of introducing new regulations before adopting them, as well as legislation requiring agencies to tailor regulations to the size and the resources of the aected business (with special regulatory exibility for small businesses seeking to raise capital) Various tax reforms that have had the eect of enhancing rewards from entrepreneurship, including cuts in the capital gains tax rate (from 49% prior to 1977 to a current rate of 15%) and reductions in the top individual marginal tax rate (from 70% prior to 1981 to a current rate of approximately 38%) Legal changes that have allowed pension funds to nance the formation and growth of new rms, by investing in venture capital partnerships; and Federal legislation aimed at accelerating the commercialization of innovations in universities (through the Bayh-Dole Act of 1980, which granted universities exclusive control over inventions funded by the federal government) and in small business (by earmarking 1.25% of federal R&D funds for small business, under the Small Business Innovation Development Act of 1982) For these reasons, policy makers across all levels of government should not only have a strong interest in promoting entrepreneurship directly, but should also consider the impact their decisions on a range of issues are likely to have on entrepreneurial activity. In eect, we are interested in two dierent but related questions: What should entrepreneurship policy look like? and What does policy look like in an entrepreneurial economy? In the managerial economy, governments primarily tried to support the small and medium sector of the economy. However, much of this was to promote democracy and not eciency. According to John Hancock, one of the signers of the Declaration of Independence, The more people who own little businesses of their own, the safer our country well be, for the people who have a stake in their country and their community are its best citizens. In other words, SME policy was less about productivity growth and more about political pluralism (Acs and Entrepreneurship, Economic Growth and Public Policy 111Audretsch, 2002; see Storey, 2003 for a full discussion). A string of initiatives in the 1990s started to focus attention on individuals instead of rms. The rst careful treatment of the distinction between SME policy and entrepreneurship policy was done by Lundstrom and Stevenson (2005). However, much of this was directed at disadvantaged individuals, so in eect, the result was more of the same: Bringing the disenfranchised into the economic mainstream. However, it was also recognized that much of the entrepreneurial activity that aected productivity growth was carried out by the best and the brightest. Hart (2003) addresses this from a regional high-technology perspective and HoltzEakin and Rosen (2004) present a broad view of this relationship. However, all of these approaches miss the essential point: That there is no such thing as entrepreneurship policy per se only policy in an entrepreneurial economy. Acs and Armington (2006, chapter 7) lay out, for the rst time, a policy formulation for an entrepreneurial economy and examine the question as it relates to the making of economic society. This overarching perspective is now the subject of a Kauman Foundation policy paper Roadmap for an Entrepreneurial Economy (Kauman, 2006). A key question is: How can policy makers maintain and ideally accelerate the continuing transition toward a more entrepreneurial economy? We now address this question. 3. A policy framework for an entrepreneurial economy: the papers An entrepreneurial economy is dierent from a managed economy because of the way in which it used entrepreneurs to facilitate knowledge spillovers (Acs et al., 2006). In the managed economy the organization exists exogenously and endogenously engages in the creation of new knowledge through investment in research and development. However, as Arrow (1962) pointed out investment in new knowledge is not straightforward.

Organization inertia may result in new ideas not being commercialized either by the incumbent rm or by other rms. The spillover of knowledge that exists by assumption in the Griliches (1992), Romer (1990) models may not be automatic but may be impeded by a lter, or what Acs et al. (2004) refer to as the knowledge lter. The knowledge lter serves to impede, if not preempt the spillover and commercialization of knowledge. Entrepreneurship can contribute to economic growth by serving as a mechanism that permeates the knowledge lter. It is a virtual consensus that entrepreneurship revolves around the recognition of opportunities along with the cognitive decision to commercialize those opportunities by starting a new rm. Thus, according to the Knowledge Spillover Theory of Entrepreneurship, by serving as a conduit for knowledge spillovers that might otherwise not exist, entrepreneurship permeates the knowledge lter and provides the missing link to economic growth. According to evidence provided by Acs and Armington (2006) and Audretsch et al. (2006) entrepreneurship makes a unique contribution to economic growth by permeating the knowledge lter and commercializing ideas that would otherwise remain uncommercialized. This leads to the question What is policy in an entrepreneurial economy? Entrepreneurship policy is dierent from traditional business policy that tried to constrain the corporation. A new policy approach is emerging that focuses on enabling the creation and commercialization of knowledge. The policy also diers from small business policy that tried to confront the cost disadvantage of small rm due to scale economies. In contrast, entrepreneurship policy has a much broader focus. Entrepreneurship policy encompasses those measures that intend to directly inuence the level of entrepreneurial activity in a country or region and the consequences of that action for society (Lundstrom and Stevenson, 2005). This policy framework is written from the perspective of the US economy, which has emerged as the leading entrepreneurial economy in the world (Schramm, 2006). This is a useful background against which we may evaluate policy in other countries, both high- and middleincome. The papers in this special issue are interpreted from this policy framework. In essence, we are able to take an integrated approach to understanding how other countries 112 Zoltan J. Acs and Laszlo Szerbt into this framework and how GEM research can make an important contribution to this understanding. 3.1. Policies relating to the global economy It has become cliche to say that American rms and workers live in a global economy, but it is true nonetheless. As a result, entrepreneurs that ignore the global market do so at their peril when designing and implementing business plans. The implication for policy makers at all levels of government likewise is very clear: If they want to promote entrepreneurship, they must think globally rather than locally or even nationally. The Kauman framework nds that this manifests in at least the following policy arenas: Trade (including policies of o- shoring), immigration, technology and foreign policy. Trade Policy: Capitalist economies rest on a fundamental principle: The freedom of individuals and rms to contract with each other. It is through this freedom of exchange that economies realize the benets of specialization, economies of scale and comparative advantage, which together maximize economic welfare. Exchanges of goods, services and capital across countries magnify the benets of exchanges. This, in essence, is the classic case for free trade. Entrepreneurs and established rms alike cannot succeed in an increasingly global environment without the ability to move quickly and contract for the least cost, highest quality inputs, wherever they may be found. They also need to sell to purchasers wherever they may be located. This is not possible if governments maintain articial barriers to impede the movement of goods, services, capital and ideas across national borders (Brainard et al., 2005). Immigration Policy: In the wake of 9/11, U.S. immigration authorities have tightened legal immigration in the name of national security. More recently, Congressional proposals to criminalize and deport millions of illegal immigrants have generated vigorous debate in Washington, along with mass protests throughout the nation. An entrepreneurial perspective leads to several policy approaches with respect to legal and illegal immigrants. The

implication for legal immigration policy is clear: Place more emphasis on educational background of potential immigrants, while maintaining proper deference to the needs of national security (i.e. prevent the entry of individuals with criminal backgrounds and those whose past activities and associations pose a real threat). Future advances in American living standards require the commercial application of continued improvements in technology. In the past, immigrants have made huge contributions and will continue to do so if policies permit. Access to Foreign Technology: One of the worst economic mistakes any business or country can make is to adopt the not invented here syndrome: The refusal to embrace something developed and used elsewhere. Certainly, this is not the case for many countries that have licensed or used American technology and in the process, have improved economic welfare. In some cases, this has occurred at a faster pace, though from a lower starting level, than in the U.S. Likewise, the U.S has beneted from investment by foreign companies especially those in the manufacturing sector that have enabled technology transfer and introduce foreign products to the domestic market. For example, where would the American manufacturing sector be without Just In Time production systems or quality circles that were pioneered in Japan? The U.S., and its entrepreneurs, could do even better if government took a more active role in facilitating awareness of foreign technologies (Brezneitz, 2007). Two issues stand out in the papers that address entrepreneurship in the global context: Access to foreign technology and immigration. Foreign Direct Investment (FDI) plays an important role in economic development policy. Since the late 1960s, Ireland has focused mainly on FDI-based industrial development policies. In the rst paper, Acs-O Gorman-Szerb-Terjesen builds on internationalization theory to answer the question: Could the Irish miracle be repeated in Hungary? This is important, as the potential for replication within Central Europe has not been examined. This paper uses GEM data to explore if, and how, the policy of attracting inward FDI from multinational Entrepreneurship, Economic Growth and Public Policy 113enterprises impacts indigenous entrepreneurial activity. Internationalization theory suggests that entrepreneurs in Ireland and Hungary will dier in terms of type of person and the nature of opportunities pursued. They nd signicant dierences for both. Ethnic minority entrepreneurship has attracted considerable attention from sociologists and others. In the second paper, Immigration Inmigration, Ethnicity and Entrepreneurship in the United Kingdom, Levie develops and tests hypotheses concerning the eect of migrant status and ethnicity on propensity to engage in new business formation at the individual level in the U.K. The large-scale empirical approach used by Levie enables estimation of the relative contribution of life-long residents, in-migrants and immigrants of dierent ethnicities to new business activity. The data suggests that controlling for basic demographic variables and dierences in opportunity perception, risk propensity and experience being a migrant has a signicant positive eect on propensity to engage in new business activity. Migration increases the chance of new business startups, although in-migration plays a more important role than immigration. The independent eect of ethnicity is only marginal. Overall, ethnic minorities as a group do not have a higher propensity to engage in new business activity, if one controls for dierences in average age, gender, education and working status. 3.2. Taking entrepreneurship into account in setting national policies Policymakers constantly confront a series of decisions that aect the economy. Many factors aect how these decisions are made. Given the presumptive causal link between long-term economic growth and entrepreneurial activity, it behooves policy makers to take into account the impact of their decisions on entrepreneurship. There are several essential points to consider in this regard: The Fiscal Challenge: While the long-term budget outlook imperils the future economic welfare of all Americans, it poses particularly signicant challenges to entrepreneurs, who face the greatest economic risks in the economy. Growing scal imbalances create additional uncertainties, which

make it more dicult to raise capital from investors and may discourage some individuals who might otherwise pursue an entrepreneurial path from acting. Fortunately, concerns about the growing federal budget problem are beginning to surface. The Comptroller General of the U.S. (who heads the federal government s ocial auditor, the General Accountability Oce), various think tanks spanning the political spectrum and other organizations are beginning to sound the alarm for federal policymakers to address the scal crisis before it is too late. This framework recognizes that the likely solution will consist of a combination of measures to increase revenues and reduce future spending, especially on entitlement programs where costs are projected to increase most rapidly. Education: Although not a guarantee of economic success, a strong educational system (primary, secondary, tertiary and higher) is clearly a prerequisite for continued economic growth. Provided the right incentives are in place to reward innovation, the greater the proportion of highly educated people, the more likely it is that some will generate and commercialize the breakthroughs that generategrowth in incomes and living standards for allresidents (and for many around the world as well). Innovations, even by a relative few, require many skilled workers to rene, produce, market and distribute the resulting products and services. America owes much of its economic success to its enviable record in providing universal primary and secondary education to its citizens. Science and Technology Policy: Productivity improvements come about through technical change, which requires both the discovery of new ideas and their commercialization by entrepreneurs and existing rms. New ideas, in turn, are the product of research and development, which span the range from basic research (such as the discovery of new scientic laws or improvements in our understanding of basic science) to development activities (the embodiment of new ideas in products, services or production techniques). It is now well understood that because the benets of basic research 114 Zoltan J. Acs and Laszlo Szerbcannot be fully captured by those who pursue it, society will be better o if government funds it and either pursues it directly or contracts it to universities and private sector research organizations. Litigation and Regulation: It is important not only for government to facilitate the formation of new businesses but also to encourage their growth or at the very least, not to penalize it. In this respect, it is vital that all levels of government remain committed to analyzing the costs and benets of new regulations before adopting them and where possible, create appropriate allowances for streamlined procedures for new businesses. Particular attention should be paid to regulations that have the eect of deterring entry by new businesses, which typically do not have the resources or capability of complying to the same degree as more mature rms. At the same time, existing regulatory regimes bear further examination and some may need modication (the Sarbanes-Oxley Act is a prime example) (Kamara et al., 2005). Litigation can also have the same eect as regulation, resulting in verdicts that set norms for behavior by rms and individuals in specic industries or across many, or all, sectors of the economy. An inherent diculty with regulation-by-litigation, however, is that the rules that emerge from individual, fact-specic litigated cases are decided by randomly chosen juries, in cases across the country. It is somewhat anomalous that a jury in one particular place can have the eect of setting national norms, especially if that place is suciently important to a national manufacturer so that it must do business in that state. In the process, therefore, the most restrictive state can have the eect of setting the national norm. As the abovementioned considerations indicate, the national level addresses policies that aect the economy as a whole. The papers by van Stel-Storey-Thurik and Ho-Wong both use World Bank data to examine the impact of regulation on startups for GEM countries. The rst paper is concerned with Europe and the second paper with Asia. The van StelStoreyThurik paper nds that entry regulations requirements have only had a small and indirect impact on the actual entrepreneurship rate, and that the impact of labor market regulations and

nancial requirements is more important. Dierences between determinants of opportunity and necessity entrepreneurship emerge in both papers for regulatory costs. This has a negative eect on the nascent entrepreneurship rate across countries. The Ho-Wong paper nds that informal capital is important in overcoming liquidity constraints, in addition to showing that regulatory costs deter opportunity entrepreneurship. 3.3. Regional policies to promote entrepreneurship Like politics, entrepreneurship is local. If successful, individuals expand their enterprises into other locations. Still, all new rms must start somewhere, even if the business is conducted largely or exclusively on the Internet (Acs and Armington, 2006). Policymakers likewise are increasingly recognizing entrepreneurship as the key to building and sustaining economic growth. Historically, much of the thinking and policy has focused on trying to attract existing rms from somewhere else, either to relocate or to build new facilities in a particular area. Such smokestack chasing has degenerated into what is essentially a zero-sum game for the national economy as a whole. When one city or state oers tax breaks or other nancial inducements to encourage rms to locate new plants or headquarters, some alternate city or state loses that economic activity. However, the idea of economic development centered around entrepreneurship is a fundamentally dierent approach. The formation and growth of new rms, wherever this occurs, is clearly a positive sum game not just for the locality, but for the nation as a whole. A brief look at various high-tech clusters around the country from Silicon Valley, to Austin, Research Triangle Park (North Carolina), San Diego, Boise, Denver, Madison, Route 128 around Boston, Northern Virginia, to name just a few demonstrates the overall positive eects of development around entrepreneurship. The United States economy has clearly beneted, as a whole, from the innovative products and services that have emerged from these clusters. The same can be said for Entrepreneurship, Economic Growth and Public Policy 115other countries as well. High-tech, high-growth clusters in India, China, Taiwan, Ireland and Israel to name a few are powering economic growth far beyond these countries. Some clusters host rms that have become essential within a worldwide supply chain. Others are becoming leaders in new product and services development. Still others are doing both. In the Bergmann-Sternberg paper, the authors address regions and individual characteristics related to entrepreneurship. They focus on policies that may be used to increase the number of startups in Germany. They conclude that these policies have made starting a business more attractive for unemployed people in Germany, while at the same time becoming more restrictive in unemployment benets. The results show that individual and regional variables have an inuence on the decision to become self-employed and for the most part, the results of opportunity startups are in line with theoretical predictions. The factors inuencing necessity startups, on the other hand, are far more dicult to determine. Necessity startups due to a lack of employment are predominantly launched independently of age, gender, education and regional inuences, due to individual perception of economic need. 3.4. Policies that primarily aect entrepreneurs There are policies directed at entrepreneurs themselves within any entrepreneurial framework. These aect individual decisions to take a job or make a job that is, to work for someone else or to make the riskier, but potentially more protable, choice and launch an enterprise. Easing Business Formation: Entrepreneurs cannot be expected to take the plunge unless it is easy and inexpensive to form their businesses. The U.S. government has done this well at all levels, a judgment conrmed by the World Bank. Still, there is room for improvement, particularly at the state and local levels, where businesses actually register and must acquire various permits. For example, there is the possibility to make it easier for new and existing rms to obtain and submit requisite forms on the Internet. This is likely to be cheaper and more quickly accomplished than building new (or retrotting existing) physical facilities such as one-stop shops. Some cities already have done this, and other cities and states may wish to consider doing so in conjunction

with an active Web-based initiative. Ensuring Access to Finance: Virtually all-new business ventures require some initial amount of capital and often more as they grow. The U.S. has been able to create a nancial system conducive to business formation and growth. The democratization of credit markets, whether through credit card or mortgage lending, has enabled many entrepreneurs without personal, family or friends wealth to get started (Blanchower et al., 2003). In the past several decades, a vibrant venture capital industry has developed to fund the relatively small but vital number of technologically sophisticated or capital-intensive start-ups. In recent years, angel investors wealthy individuals or groups of such individuals have become an increasingly important source of early-stage equity capital as well (by some accounts, angel investors may now be more important than venture capital, especially since the Internet stock bubble burst in 2000). As for debt nance, banks and nance companies have been the traditional sources of funds. However, both types of lenders are facing increasingly sti competition from securities markets that are nancing a growing share of debt taken on by larger entrepreneurial rms that have gone public. Appropriate Protection of Intellectual Property: One of the ways entrepreneurial economies motivate people to become entrepreneurs is by giving their ideas legal protection. This is accomplished with intellectual property laws such as patents, copyrights and trademarks. There is a complicated tradeo involved when providing exclusive property protection to inventors or creators (Merrill et al., 2004). If protection is granted for too long or is excessively easy to obtain, then government is essentially permitting monopolies and public returns are limited. On the other hand, if protection of intellectual property is too weak, or if legal protections can be easily circumvented through technological means, then inventors and creators may have insucient incentives to bring their ideas to market. 116 Zoltan J. Acs and Laszlo SzerbTax Policy: Rewards for entrepreneurial activity, as for any other economic activity, are reduced by taxes on earnings. At the same time, tax revenue collected by income and other taxes funds public goods such as the physical and legal infrastructure, education, defense and crime detection, punishment and prevention without which entrepreneurs (and all citizens) could not pursue their endeavors. A central challenge for policy makers at all levels of government is to undertake public measures whose benets outweigh costs, and to implement and fund them to least distort economic activity (Gentry and Hubbard, 2004). Taxes are and should certainly be determined with more than entrepreneurship in mind. Considerations of revenue adequacy, simplicity and fairness also play an important role. The next section includes a discussion of a broad direction for future tax policy that is likely to be consistent with promoting, or at least not discouraging, entrepreneurial activities while, at the same time, adequately funding government programs and promises. The Minniti-Nardone paper contributes to the research on entrepreneurlevel factors. Gender dierences in entrepreneurship have typically been attributed to dierences in human and social capital, dierences in risk tolerance and management styles, and to women being more sensitive than men to non-monetary factors. On the other hand, research has shown that men and women tend to react to the same set of incentives and much of the dierence across genders disappears after correcting for some socio-economic conditions. The purpose of the paper is to investigate what variables cause gender dierences in entrepreneurship and whether they are independent from country eects. It is clearly possible for these dierences not to depend on work conditions but rather to be the eect of factors that co-vary systematically with gender. The analysis shows that although work status and education have some minor gender specic impact, the relationships between the likelihood of starting a business and age, household income, work status and education do not depend on gender. The results support the conclusion that perceptual variables play a crucial role in explaining entrepreneurial dierences across genders. Overall, the ndings conrm the importance of cognitive processes within the context of specic market

processes. This means that entrepreneurial discovery is not a pure bolt but is based on the ability to perceive and act upon an unexploited opportunity. The subjective perception of possessing skills is the most important variable, while opportunity recognition and fear of failing oer less explanatory power. There are no real socioeconomic or contextual based dierences between male and female entrepreneurs. Szerb-Rappai-Makra-Terjesen focus on informal investment in Croatia, Hungary and Slovenia. This Central European focus is welcome because much less is known about entrepreneurship in middle-income countries. What is the reason for the low level of entrepreneurial activity in Central European countries? While it is generally believed that nancial constraints are particularly important, the presence and reason for the existence of the nance gap should be examined further. If informal investors are vital for opportunity-oriented new rm startups (Bygrave and Hunt, 2004), then the lack of these sources may explain the low levels of entrepreneurial activity found across middleincome countries, including those in Central Europe. The authors investigate the factors driving investor decisions and nd that dierences in the informal investor ratio can be explained mainly by perceptual variables and less by limited entrepreneurial activity. Unfamiliarity with start-ups, limited business leadership skills, little opportunity perception and more generally, inexperience in market economies explain the low level of informal investment and amounts of investments in transition economies. However, it is unclear that the level of entrepreneurship in these middle-income countries is too low, and that more informal investors would actually make a dierence. The Tominic-Rebernik paper explores whether signicantly dierent growth aspirations of early stage entrepreneurs in Slovenia, compared to those in Hungary and Croatia, are also accompanied by signicantly dierent opportunity recognition, cultural support for entrepreneurship and self-ecacy. Despite similar history and socio-economic conditions, there are Entrepreneurship, Economic Growth and Public Policy 117dierences in the growth aspirations of earlyphase entrepreneurs in these countries. The results suggest that a higher degree of alertness to unexploited opportunities, along with cultural support for entrepreneurial motivation, may be the reason for higher growth aspirations of Slovenian early stage entrepreneurs. Self-ecacy with regard to entrepreneurial skills, knowledge and experience was not found to be crucial. Incentive and Subsidise Role 1. Introduction Does clustered entrepreneurial activity contribute to development more than non-clustered? Defining entrepreneurship as the creation of new organisations (Gartner, 1989, p. 62) and cluster as a geographically proximate group of firms and associated institutions in related industries, linked by economic and social interdependences (adapted from Porter, 1998), this research question arises for several reasons. 1 Firstly, it targets one of the most important challenges and contributions of the entrepreneurship field, i.e. the role of new enterprises in furthering economic progress (Low and MacMillan, 1988). Secondly, both clusters and entrepreneurship face high visibility among academics and policymakers, given their common historical resurgence and potential to retain and increase employment after the drastic changes in the economic, institutional, and technological environments since the 1970s (Birch, 1981; OECD, 1996a, 1999, 2000, 2001; Arzeni and Pellegrin, 1997; Porter, 1998; Bergman and Feser, 1999; Reynolds et al., 2001). In effect, the intrinsic rigidity of the independent large firmbased system was incompatible with the fast pace of change in the environment resulting in an increase of unemployment. Consequently, a shift of emphasis from mass to flexible production, from independent firm-based to regional networkbased system, and from established firms to new firms emerged as part of the solution (Piore and Sabel, 1984; Saxenian, 1994; Nohria, 1992, 1996; Castells, 2000). Finally, from a public policy standpoint, several authors highlight the importance of the entrepreneurial climate in fostering economic development through the creation of new companies (Malecki, 1994; Reynolds et al., 2001). Given the spatial variations of entrepreneurial activity across regions (Reynolds et al.,

1994), it is worth studying how clusters, a special regional context, moderate the relationship between entrepreneurship and development. Although all of these reasons invite to analyse the moderating effect of clusters on the relationship between entrepreneurship and development, there are no studies on this cluster moderating Final version accepted on October 9, 2002 London Business School Regents Park London NW1 4SA United Kingdom E-mail: hrocha@london.edu effect. Researchers have studied specific kinds of clusters, such as industrial districts (Visser, 1999; Fabiani et al., 2000) and scientific parks (Westhead and Storey, 1994), using as unit of analysis established small and medium sized companies (focus on size) rather than entrepreneurship (focus on new firms). Those studying founding and failure rates (Hannan and Freeman, 1989; Baum and Mezias, 1992; Lomi, 2000; Sorenson and Audia, 2000) have focused on only one industry and one dimension of clusters i.e. agglomeration of economic activity, without analysing societal level outcomes of the entrepreneurial activity. Given this research need, the main thrust of this paper is to explore, from a literature review standpoint, whether clustered entrepreneurial activity generates more development than non-clustered. However, any answer to this question will depend on how development, entrepreneurship, and clusters are defined and measured. Also, in order to identify the potential causes of the moderating effect of clusters on the relationship between entrepreneurship and development, it is necessary to isolate three different impacts: entrepreneurship on development, clusters on development, and clusters on entrepreneurship. Therefore, the aim of this paper is threefold: to review the conceptual and operational definitions of entrepreneurship, clusters and development; to review the literature on the impact of entrepreneurship on development as well as that on the impact of clusters on development and entrepreneurship; and to put forward suggestions for future research. These aims set the scope of the paper (Figure 1). The focus is to analyse whether entrepreneurial activity develops its potential contribution to development better inside clusters rather than outside them (discontinuous line in Figure 1). To address this research need, this paper analyses the relationships indicated with a continuous line in Figure 1. Given the focus on clusters, other interesting relationships such as the impact of development on entrepreneurship and the effect of entrepreneurship on clusters are out of the papers scope. 2 Theories behind each concept are explained briefly and representative bibliography is given in the appropriate place. The most extensive analysis will be that devoted to clusters, on which subject there is neither consensus nor available data to accomplish cross-sectoral and longitudinal research as there is in the cases of entrepreneurship and development. Given this focus, the paper brings together relevant literature from the development, entrepreneurship and cluster fields. The link between concepts was derived from combined keyword searches in several search engines and specialised journals. Additionally, due to the policy nature of the topic, there was a search of publications and websites of multilateral organisations. Appendix A shows the sources of information analysed during the literature review. The findings of the paper are threefold. First,entrepreneurship is positively associated with economic growth. Given the importance of entrepreneurship in changing the economic and social structure of the economy, more research on the impact of entrepreneurship on development i.e. focus on capabilities rather than on output is 364 Hector O. Rocha Figure 1. Research focus.needed. Second, it is difficult to reach empirical generalisations on the impact of clusters on development and entrepreneurship given conceptual and methodological constraints. Both positive results and caveats are found at different levels of analysis and at different stages of development of a cluster. Finally, given the previous finding, it is difficult to generalise on the impact of clusters on the association between entrepreneurship and development. Consensus on and validity between conceptual and operational definitions of clusters; consideration of context as well as process and, therefore, quantitative and qualitative methods; and differentiation between levels of analysis controlling for cluster stage and strength are the main criteria for future studies to consider to disentangle the impact of clusters on entrepreneurship, development and the association between

entrepreneurship and development. This paper is organized as follows: the next section reviews the concept of development and its operational definition in the entrepreneurship field; section three and four review the concepts and measures of entrepreneurship and clusters, respectively, as well as their impact on development. Section five reviews the impact of clusters on entrepreneurship. Section six concludes. 2. Development conceptual definition and 2. measurement Several books have undertaken the task of classifying and explaining the theories of development. 3 A review of the literature reveals that there is a great deal of variation in the way development is defined and measured. One reason for this is that the term development has strong policy implications for society as a whole. Therefore, different stakeholders with different views (economists, business leaders, labour leaders, and public officials) intervene in its conceptualisation and measurement. However, the historical evolution of the concept shows three main conceptualisations: economic growth, economic development, and development (Allen and Thomas, 2000; UNPD, 1992; Sen, 1990). Table I shows different definitions and their associated measures according to the literature. Two main distinctions are in order. The first one is between economic growth (Table I reference 1) and economic development (Table I references 2 and 3). While economic growth is a quantitative change in the scale of the economy in terms of investment, output, consumption, and income, economic development is a qualitative change, which entails changes in the structure of the economy including innovations in institutions, behaviour, and technology (U.S. Department of Commerce, 2000). The second important distinction is between traditional economic development definitions and measures (Table I references 1 to 3) and the new view of development (Table I references 4 to 6). The traditional view understands development as the capacity of a national economy to generate and sustain an annual increase in its gross national product (GNP) and/or income per capita. This view prevailed until the 1970s and defined development as an economic phenomenon in which rapid gains in overall and per capita GNP growth would either trickle down to the masses in the form of jobs and other economic opportunities or create the necessary conditions for the wider distribution of the economic and social benefits of growth (Todaro, 2000, p. 14). The new view of development emerged during the 1970s when many underdeveloped countries had realised their economic growth-targets during the 1960s but the levels of living of the masses of people remained unchanged. The situation worsened during the 1980s, when the distribution of the benefits of development was concentrated in the richer scale both within and across countries (PNUD, 1992; Todaro, 2000). Thus, economic development was redefined as reduction of poverty, inequality, and unemployment within the context of a growing economy. 4 The literature uses the previous conceptualisation and measures of development at both national and regional levels. However, regional economics focuses on explaining how regional disparities, especially in unemployment rates, arise and why they persist over time. This focus has been the centre of regional policy since the 1950s and will continue to dominate discussion of regional policy issues in the future (Armstrong and Taylor, 2000, p. 3). The literature on entrepreneurship and development takes GNP/capita and job creation as indicators by which to measure economic develEntrepreneurship and Development: The Role of Clusters 365opment (Birch, 1981; Brock and Evans, 1989; OECD, 1996b; Arzeni, 1998; Reynolds and White, 1997; Reynolds, 1999; Reynolds et al., 2001). Strictly speaking, the first indicator is a measure of economic growth while the second one is an indicator more related to the new view of development given the human, social, and economic implications of getting a job. The validity of job creation as a measure of development increases if it is related to both outputs in order to measure economic productivity and quality jobs in order to include the human and social dimensions of development. Quality jobs encompass not only economic (wage level, pension provision, car allowances) and social (holiday entitlements, sick pay, safety and health, working hours, security of 366 Hector O. Rocha TABLE I Alternative definitions of development Reference Term Definition Measurement 1 Allen and Economic A continued

increase in the size of an Variation in GDP Thomas, 2000 growth economy, i.e. a sustained increase in output over a period 2 U.S. Economic Economic development is (. . .) about GNP Department of development enhancing the factors of productive Job creation Commerce, capacity land, labour, capital, and 2000: 1 technology of a national, state or local economy 3 Bernstein, Economic Raising the productive capacities Raising in the 1983 (cited in development of societies, in terms of their productivity of labour Allen and technologies (more efficient tools Thomas, 2000) and machines), technical cultures (knowledge of nature, research and capacity to develop improved technologies), and the physical, technical and organisational capacities and skills of those engaged in production. 4 Sen, 1990, Development Expansion of human freedom to live Literacy rate 1997, 1999 the kind of lives that people have Life expectancy rate reason to value (Sen, 1997: 21). This Health rate freedom is achieved by the expansion Agricultural expansion of people capabilities Industrial development Peoples political participation Real income per capita 5 United Nations Human The purpose of development is to Human Development Index Development development create an environment in which all (HDI): a weighted index that Programme, 1992 people can expand their capabilities, combines three indicators: and opportunities can be enlarged for life expectancy at birth, both present and future generations educationalattainment, and per capita income 6 UK Department Sustainable Ensuring a better quality of life for Three broad themes: of the Environment, development everyone, now and for generations Environment (ex. Transport, and the to come local air quality) Regions, 1997 Society (ex. road traffic accident/1000) The economy (ex. rate of long term unemployment)employment, child care) benefits but also morale and job satisfaction (OECD, 1996b). Future research can benefit from this simpler measure as opposed to the more complex ones suggested by the new view of development. 5 3. Entrepreneurship definition, 2. measurement, and impact on development 3.1. Defining and measuring entrepreneurship Entrepreneurship as a field of study is relatively young (Cooper et al., 1997). 6 The definition of entrepreneurship has evolved from a trait or supply side (who is the entrepreneur) to a context or demand side approach (the influence of firms and markets on how, where, and why new enterprises are founded) (Thornton, 1999). The literature on entrepreneurship and development defines entrepreneurship as either the creation of new economic activity (Low and MacMillan, 1988; Shane and Venkataraman, 2000), often resulting in the creation of new organisations (Schumpeter, 1934, p. 66; Gartner, 1989; Reynolds, 1999), or the pursuit of innovation (Schumpeter, 1934; for a review, see Wennekers and Thurik, 1999; Davidsson et al., 2001). From the work of Birch (1981), entrepreneurship was measured in terms of size i.e., small and medium sized enterprises (SMEs). Yet, if entrepreneurship is the creation of new organisations, it is not consistent to measure it in terms of existing firms. Now the focus is on the phenomenon itself given data availability not only on new firms creation (Reynolds et al., 2001) but also on the entrepreneurial process i.e. the gestation, birth, and growth of firms 7 (Reynolds, 2000). 3.2. Entrepreneurship and development The link between entrepreneurship and development has been approached mainly from an economic standpoint, theoretically as well as empirically, focussing on economic growth rather than on development. From the theoretical standpoint, Todaro analyses five leading theories of economic development, named stages of growth, structural patterns of development, dependence, neoclassical, and new endogenous growth theory (Todaro, 2000, p. 78). Entrepreneurship falls in the latter, which includes technological innovation as well as human capital as endogenous variables in the model that explains economic growth (Morris, 1998, p. 38; Wennekers and Thurik, 1999, p. 36; Todaro, 2000, p. 101; Porter et al., 2000, p. 14). Endogenous growth theory emerged to overcome the shortcomings of the traditional neo-classical theory. This theory attributes economic growth to labour and capital, but leaves unexplained 50% of historical growth in the industrialised nations, which is called Solow residual. Therefore, neoclassical theory credits the bulk of economic growth to an exogenous or completely independent process of

technological process (Todaro, 2000, p. 99). The origin of the new endogenous growth theory can be traced to the work of Schumpeter, who introduced the idea that changes in technology introduced by entrepreneurs contribute to development (Schumpeter, 1934), through a process of creative destruction. Baumol, based on Solows finding that gross output per man-hour variation was due to technical change (Solow, 1957), was one of the first to argue that despite the role of the entrepreneur in fostering innovations that drive technical change, the economic formal models are entrepreneurless (Baumol, 1968, p. 51). He concluded that to promote economic growth it is key to examine the determinants of the payoff to entrepreneurial activity and to encourage it. In a later work he concludes that the entrepreneur acts according to the prevailing rules of the game the reward structure in the economy , and that these rules undergo significant changes from one period to another and help to dictate the effect on the economy via the allocation of entrepreneurial resources (Baumol, 1990, p. 25). This line of reasoning is endorsed by Kent (1982) and Kirzner (1982), who view economic development not as an increase in the per capita production of goods and services but rather as a change in the total economic and social structure in a populations standard of living. Kent summarises the role of the entrepreneur in economic development through not only his influence on both the supply and demand sides of the growth equation but also on the phases of the stage theories. Kirzner concludes that entrepreneurship will most thrive where rewards are paid to those with sufficient insight to exploit opportunity Entrepreneurship and Development: The Role of Clusters 367(Kirzner, 1982). Reynolds and White (1997) and Reynolds et al. (2001) build a bridge between the previous theoretical arguments and their empirical demonstration. Reynolds and White (1997) back the argument that entrepreneurial activity is generally not included in formal economic models, refusing empirically each of the assumptions on which they are built. The explicit inclusion of entrepreneurship in a formal model to explain economic growth takes place in the GEM model (Reynolds et al., 1999).From the empirical standpoint, the link between entrepreneurship and economic growth has been explored and demonstrated since the pioneering work of Birch, in which he showed, through a longitudinal analysis, that SMEs were the main factor of job creation in the U.S.A. Small business in Entrepreneurship No one should start a business thinking that they are going to fail. However, it is important to know what may go wrong. It's important to learn about these potential drawbacks ahead of time, but it is also good to consider the benefits of entrepreneurship. Uncertainty of Income There are no guarantees that an entrepreneur will make enough money to survive. Some small businesses barely make enough to pay the owner-manager with adequate income. The median income of small business owners is $30,000, which is about the same as wage and salary workers. However, business owners are more likely to earn higher incomes than wage and salary workers. In the start-up phase a business often cannot provide an attractive salary for the owner and cover its financial obligations. This means that the entrepreneur may have to live on savings for a little while.The owner is the last one paid, so there is no regularity of income. Risk of Losing Invested Capital Starting a business is all about risk. And the small business failure rate is relatively high. According to a study by the National Federation of Independent Businesses (NFIB), 35% of businesses fail within two years, 54% fail within four years and 64% of new businesses fail after six years. When a business fails it can be financially and emotionally devastating. People contemplating entrepreneurship should decide how much they are willing to risk. Long Hours and Hard Work The average small business owner works 52 hours per week. In many start-up business, 10 - 12 hour work days on 6 - 7 days of the week with no paid vacations is the norm. Because owners must often do everything themselves, they experience long, intense, draining work days. Lower Quality of Life Until the Business is Established Long hours and hard work can effect the entrepreneur's outside life. Business owners often put their role as company founder ahead of their role as husband, wife, or parent. Marriages and friendships are some unfortunate casualties of entrepreneurship. Part of the problem is that most people launch new

businesses between the ages of 25 and 34, just when they start their families. High Levels of Stress Most entrepreneurs make significant investments in their companies; they leave behind a steady paycheck, and mortgage everything to get into business. Failure can mean total financial failure as well as a psychological blow. This creates high levels of stress and anxiety. Complete Responsibility Entrepreneurship is highly rewarding, but many entrepreneurs find that they must make decisions on issues they are not very knowledgeable about. When there is no one to ask for answers, the pressure can build quickly. The knowledge that these decisions could decide the success or failure of a business can have a devastating effect on the business owner. Discouragement Launching a business requires much dedication, tenacity and discipline. Entrepreneurs may run into many obstacles, some may even appear to be insurmountable. Disillusionment and discouragement can set in, but successful entrepreneurs know that every new business encounters rough patches and that perseverance is required to get through them. What constitutes a small business varies widely around the world. Small businesses are normally privately owned corporations, partnerships, or sole proprietorships. What constitutes "small" in terms of government support and tax policy varies by country and by industry, ranging from fewer than 15 employees under the Australian Fair Work Act 2009, 50 employees according to the definition used by the European Union, and fewer than 500 employees to qualify for many U.S. Small Business Administration programs, although in 2006 there were over 18,000 "small businesses" with over 500 employees that accounted for half of all the employees employed by all "small business ". [1] [2] Small businesses can also be classified according to other methods such as sales, assets, or net profits. Small businesses are common in many countries, depending on the economic system in operation. Typical examples include: convenience stores, other small shops (such as a bakery or delicatessen), hairdressers, tradesmen, lawyers, accountants, restaurants, guest houses, photographers, small-scale manufacturing, and online business, such as web design and programming, etc. Contents [hide] 1 Characteristics of small businesses 1.1 Size definitions 1.2 Demographics 1.3 Franchise businesses 2 Advantages of small business 3 Problems faced by small businesses 3.1 Small business bankruptcy 3.2 Social Responsibility 3.3 Job Quality 4 Benefits of Supporting Local Business 5 Marketing the small business 6 Contribution to the economy 7 Sources of funding 8 Business Networks and Advocacy Groups 9 See also 10 References 11 External links Characteristics of small businesses Size definitions The legal definition of "small" varies by country and by industry. In the United States the Small Business Administration establishes small business size standards on an industry-by-industry basis, but generally specifies a small business as having fewer than 500 employees for manufacturing businesses and less than $7 million in annual receipts for most non-manufacturing businesses.[2] The definition can vary by circumstance dash; for example, a small business having fewer than 25 full-time equivalent employees with average annual wages below $50,000 qualifies for a tax credit under the health care reform bill Patient Protection and Affordable Care Act.[3] The European Union generally defines a small business as one that has fewer than 50 employees. However, in Australia, a small business is defined by the Fair Work Act 2009 as one with fewer than 15 employees. By comparison, a medium sized business or mid-sized business has under 500 employees in the US, and fewer than 200 in Australia. In addition to number of employees, other methods used to classify small companies include annual sales (turnover), value of assets and net profit (balance sheet), alone or in a mixed definition. These criteria are followed by the European Union, for instance (headcount, turnover and balance sheet totals). Small businesses are usually not dominant in their field of operation. The table below serves as a useful guide to business size nomenclature. Business Size definitions AUS US EU Minute/Micro 1-2 1-6 <10

Small <15 <250 <50 Medium <200 <500 <250 Large <500 <1000 <1000 Enterprise >500 >1000 >1000 Most cells reflect size not defined in relevant legislation Some definitions are multi-parameter, e.g., by industry, revenue, market share Demographics According to a survey run in the United States among businesses having <500 employees in late 2010, about 50% of minute/micro-businesses are owned by women.[4] Franchise businesses Franchising is a way for small business owners to benefit from the economies of scale of the big corporation (franchiser). McDonald's restaurants, TrueValue hardware stores, and NAPA Auto Parts stores are examples of a franchise. The small business owner can leverage a strong brand name and purchasing power of the larger company while keeping their own investment affordable. However, some franchisees conclude that they suffer the "worst of both worlds" feeling they are too restricted by corporate mandates and lack true independence. However, in some chains, such as the aforementioned TrueValue and NAPA, franchises may have their own name alongside the franchise's name. Advantages of small business A small business can be started at a very low cost and on a part-time basis. Small business is also well suited to internet marketing because it can easily serve specialized niches, something that would have been more difficult prior to the internet revolution which began in the late 1990s. Adapting to change is crucial in business and particularly small business; not being tied to anybureaucratic inertia, it is typically easier to respond to the marketplace quickly. Small business proprietors tend to be intimate with their customers and clients which results in greater accountability and maturity. Independence is another advantage of owning a small business. One survey of small business owners showed that 38% of those who left their jobs at other companies said their main reason for leaving was that they wanted to be their own bosses.[citation needed] Freedom to operate independently is a reward for small business owners. In addition, many people desire to make their own decisions, take their own risks, and reap the rewards of their efforts. Small business owners have the satisfaction of making their own decisions within the constraints imposed by economic and other environmental factors.[5] However, entrepreneurs have to work for very long hours and understand that ultimately their customers are their bosses. Several organizations, in the United States, also provide help for the small business sector, such as the Internal Revenue Service's Small Business and Self-Employed One-Stop Resource.[6] Problems faced by small businesses Small businesses often face a variety of problems related to their size. A frequent cause of bankruptcy is undercapitalization. This is often a result of poor planning rather than economic conditions - it is common rule of thumb that the entrepreneur should have access to a sum of money at least equal to the projected revenue for the first year of business in addition to his anticipated expenses. For example, if the prospective owner thinks that he will generate $100,000 in revenues in the first year with $150,000 in start-up expenses, then he should have not less than $250,000 available. Failure to provide this level of funding for the company could leave the owner liable for all of the company's debt should he end up in bankruptcy court, under the theory ofundercapitalization. In addition to ensuring that the business has enough capital, the small business owner must also be mindful of contribution margin (sales minus variable costs). To break even, the business must be able to reach a level of sales where the contribution margin equals fixed costs. When they first start out, many small business owners underprice their products to a point where even at their maximum capacity, it would be impossible to break even. Cost controls or price increases often resolve this problem. In the United States, some of the largest concerns of small business owners are insurance costs (such as liability and health), rising energy costs, taxes and tax compliance.[7] In the United Kingdom and Australia, small business owners tend to be more concerned with excessive governmental red tape.[8] Another problem for many small businesses is termed the 'Entrepreneurial Myth' or E-

Myth. The mythic assumption is that an expert in a given technical field will also be expert at running that kind of business. Additional business management skills are needed to keep a business running smoothly. Still another problem for many small businesses is the capacity of much larger businesses to influence or sometimes determine their chances for success. Small business bankruptcy When small business fails, the owner may file bankruptcy. In most cases this can be handled through a personal bankruptcy filing.[citation needed] Corporations can file bankruptcy, but if it is out of business and valuable corporate assets are likely to be repossessed by secured creditors there is little advantage to going to the expense of a corporate bankruptcy.[citation needed] Many states offer exemptions for small business assets so they can continue to operate during and after personal bankruptcy.[citation needed] However, corporate assets are normally not exempt, hence it may be more difficult to continue operating an incorporated business if the owner files bankruptcy.[citation needed] Social Responsibility Small businesses can encounter several problems related to Corporate social responsibility due to characteristics inherent in their construction. Owners of small businesses often participate heavily in the day-to-day operations of their companies. This results in a lack of time for the owner to coordinate socially responsible efforts. [9] Additionally, a small business owner's expertise often falls outside the realm of socially responsible practices contributing to a lack of participation. Small businesses also face a form of peer pressure from larger forces in their respective industries making it difficult to oppose and work against industry expectations. [10] Furthermore, small businesses undergo stress from shareholder expectations. Because small businesses have more personal relationships with their patrons and local shareholders they must also be prepared to withstand closer scrutiny if they want to share in the benefits of committing to socially responsible practices or not. [11] Job Quality While small businesses employ over half the workforce [12] and have been established as a main driving force behind job creation [13] the quality of the jobs these businesses create has been called into question. Small businesses generally employ individuals from the Secondary labor market. As a result, in the U.S. wages are 49% higher for employees of large firms.[14] Additionally, many small businesses struggle or are unable to provide employees with benefits they would be given at larger firms. Research from the U.S. Small Business Administration indicates that employees of large firms are 17% more likely to receive benefits including salary, paid leave, paid holidays, bonuses, insurance, and retirement plans.[15] Both lower wages and fewer benefits combine to create a job turnover rate among U.S. small businesses that is 3 times higher than large firms.[16] Employees of small businesses also must adapt to the higher failure rate of small firms. In the U.S. 69% last at least 2 years, but this percentage drops to 51% for firms reaching 5 years in operation.[17] Benefits of Supporting Local Business By opening up new national level chain stores, the profits of locally owned businesses greatly decrease and many businesses end up failing and having to close. This creates an exponential effect. When one store closes, people lose their jobs, other businesses lose business from the failed business and so on. In many cases large firms displace just as many jobs as they create.[18] Not only that but it also increases the costs of taxes. Instead of increasing a communitys revenue, big businesses actually shift money away from the community. Independent businesses depend on the many resources that a community can supply. They hire architects, contractors, hardware stores, interior designers, local advertisement agencies, accountants, business attorneys, and insurance companies. Local businesses also are more likely to supply locally produced products than chains, ultimately benefiting their community. Large corporations on the other hand eliminate the need for local goods and services. >. [Milchen] A lack of diversity can decrease the revenues in a community. When towns are interesting, they attract people from out of town. More personality and individuality can lead to more tourists, which, in turn leads to money placed directly into the community [Santa Fe Independent Business Report] ). The diversity of businesses is also important to the individuality of consumers. Oftentimes, independent retailers can adjust the products that

they sell in order to fit the needs of their consumers and the unique tastes of their community. Local businesses are also more likely to support unique, new, and/or controversial products. Local bookstores can provide controversial books and can support small authors or local authors. The same idea helps out with local art and music. Bookstores and music shops are more likely to support local art and music than the mainstream stuff that large corporations provide.[Mitchell] Business chains decrease a communitys individuality because they ultimately choose what products reach their customers. This greatly narrows what products are available and shrinks diversity What constitutes a small business varies widely around the world. Small businesses are normally privately owned corporations, partnerships, or sole proprietorships. What constitutes "small" in terms of government support and tax policy varies by country and by industry, ranging from fewer than 15 employees under the Australian Fair Work Act 2009, 50 employees according to the definition used by the European Union, and fewer than 500 employees to qualify for many U.S. Small Business Administration programs, although in 2006 there were over 18,000 "small businesses" with over 500 employees that accounted for half of all the employees employed by all "small business ". [1] [2] Small businesses can also be classified according to other methods such as sales, assets, or net profits. Small businesses are common in many countries, depending on the economic system in operation. Typical examples include: convenience stores, other small shops (such as a bakery or delicatessen), hairdressers, tradesmen, lawyers, accountants, restaurants, guest houses, photographers, small-scale manufacturing, and online business, such as web design and programming, etc. Contents [hide] 1 Characteristics of small businesses 1.1 Size definitions 1.2 Demographics 1.3 Franchise businesses 2 Advantages of small business 3 Problems faced by small businesses 3.1 Small business bankruptcy 3.2 Social Responsibility 3.3 Job Quality 4 Benefits of Supporting Local Business 5 Marketing the small business 6 Contribution to the economy 7 Sources of funding 8 Business Networks and Advocacy Groups 9 See also 10 References 11 External links Characteristics of small businesses Size definitions The legal definition of "small" varies by country and by industry. In the United States the Small Business Administration establishes small business size standards on an industry-by-industry basis, but generally specifies a small business as having fewer than 500 employees for manufacturing businesses and less than $7 million in annual receipts for most non-manufacturing businesses.[2] The definition can vary by circumstance dash; for example, a small business having fewer than 25 full-time equivalent employees with average annual wages below $50,000 qualifies for a tax credit under the health care reform bill Patient Protection and Affordable Care Act.[3] The European Union generally defines a small business as one that has fewer than 50 employees. However, in Australia, a small business is defined by the Fair Work Act 2009 as one with fewer than 15 employees. By comparison, a medium sized business or mid-sized business has under 500 employees in the US, and fewer than 200 in Australia. In addition to number of employees, other methods used to classify small companies include annual sales (turnover), value of assets and net profit (balance sheet), alone or in a mixed definition. These criteria are followed by the European Union, for instance (headcount, turnover and balance sheet totals). Small businesses are usually not dominant in their field of operation. The table below serves as a useful guide to business size nomenclature. Business Size definitions AUS US EU Minute/Micro 1-2 1-6 <10 Small <15 <250 <50 Medium <200 <500 <250 Large <500 <1000 <1000 Enterprise >500 >1000 >1000 Most cells reflect size not defined in relevant legislation

Some definitions are multi-parameter, e.g., by industry, revenue, market share Demographics According to a survey run in the United States among businesses having <500 employees in late 2010, about 50% of minute/micro-businesses are owned by women.[4] Franchise businesses Franchising is a way for small business owners to benefit from the economies of scale of the big corporation (franchiser). McDonald's restaurants, TrueValue hardware stores, and NAPA Auto Parts stores are examples of a franchise. The small business owner can leverage a strong brand name and purchasing power of the larger company while keeping their own investment affordable. However, some franchisees conclude that they suffer the "worst of both worlds" feeling they are too restricted by corporate mandates and lack true independence. However, in some chains, such as the aforementioned TrueValue and NAPA, franchises may have their own name alongside the franchise's name. Advantages of small business A small business can be started at a very low cost and on a part-time basis. Small business is also well suited to internet marketing because it can easily serve specialized niches, something that would have been more difficult prior to the internet revolution which began in the late 1990s. Adapting to change is crucial in business and particularly small business; not being tied to anybureaucratic inertia, it is typically easier to respond to the marketplace quickly. Small business proprietors tend to be intimate with their customers and clients which results in greater accountability and maturity. Independence is another advantage of owning a small business. One survey of small business owners showed that 38% of those who left their jobs at other companies said their main reason for leaving was that they wanted to be their own bosses.[citation needed] Freedom to operate independently is a reward for small business owners. In addition, many people desire to make their own decisions, take their own risks, and reap the rewards of their efforts. Small business owners have the satisfaction of making their own decisions within the constraints imposed by economic and other environmental factors.[5] However, entrepreneurs have to work for very long hours and understand that ultimately their customers are their bosses. Several organizations, in the United States, also provide help for the small business sector, such as the Internal Revenue Service's Small Business and Self-Employed One-Stop Resource.[6] Problems faced by small businesses Small businesses often face a variety of problems related to their size. A frequent cause of bankruptcy is undercapitalization. This is often a result of poor planning rather than economic conditions - it is common rule of thumb that the entrepreneur should have access to a sum of money at least equal to the projected revenue for the first year of business in addition to his anticipated expenses. For example, if the prospective owner thinks that he will generate $100,000 in revenues in the first year with $150,000 in start-up expenses, then he should have not less than $250,000 available. Failure to provide this level of funding for the company could leave the owner liable for all of the company's debt should he end up in bankruptcy court, under the theory ofundercapitalization. In addition to ensuring that the business has enough capital, the small business owner must also be mindful of contribution margin (sales minus variable costs). To break even, the business must be able to reach a level of sales where the contribution margin equals fixed costs. When they first start out, many small business owners underprice their products to a point where even at their maximum capacity, it would be impossible to break even. Cost controls or price increases often resolve this problem. In the United States, some of the largest concerns of small business owners are insurance costs (such as liability and health), rising energy costs, taxes and tax compliance.[7] In the United Kingdom and Australia, small business owners tend to be more concerned with excessive governmental red tape.[8] Another problem for many small businesses is termed the 'Entrepreneurial Myth' or EMyth. The mythic assumption is that an expert in a given technical field will also be expert at running that kind of business. Additional business management skills are needed to keep a business running smoothly. Still another problem for many small businesses is the capacity of much larger businesses to influence or sometimes determine their chances for success. Small business bankruptcy When small business fails, the owner may file bankruptcy. In most cases this

can be handled through a personal bankruptcy filing.[citation needed] Corporations can file bankruptcy, but if it is out of business and valuable corporate assets are likely to be repossessed by secured creditors there is little advantage to going to the expense of a corporate bankruptcy.[citation needed] Many states offer exemptions for small business assets so they can continue to operate during and after personal bankruptcy.[citation needed] However, corporate assets are normally not exempt, hence it may be more difficult to continue operating an incorporated business if the owner files bankruptcy.[citation needed] Social Responsibility Small businesses can encounter several problems related to Corporate social responsibility due to characteristics inherent in their construction. Owners of small businesses often participate heavily in the day-to-day operations of their companies. This results in a lack of time for the owner to coordinate socially responsible efforts. [9] Additionally, a small business owner's expertise often falls outside the realm of socially responsible practices contributing to a lack of participation. Small businesses also face a form of peer pressure from larger forces in their respective industries making it difficult to oppose and work against industry expectations. [10] Furthermore, small businesses undergo stress from shareholder expectations. Because small businesses have more personal relationships with their patrons and local shareholders they must also be prepared to withstand closer scrutiny if they want to share in the benefits of committing to socially responsible practices or not. [11] Job Quality While small businesses employ over half the workforce [12] and have been established as a main driving force behind job creation [13] the quality of the jobs these businesses create has been called into question. Small businesses generally employ individuals from the Secondary labor market. As a result, in the U.S. wages are 49% higher for employees of large firms.[14] Additionally, many small businesses struggle or are unable to provide employees with benefits they would be given at larger firms. Research from the U.S. Small Business Administration indicates that employees of large firms are 17% more likely to receive benefits including salary, paid leave, paid holidays, bonuses, insurance, and retirement plans.[15] Both lower wages and fewer benefits combine to create a job turnover rate among U.S. small businesses that is 3 times higher than large firms.[16] Employees of small businesses also must adapt to the higher failure rate of small firms. In the U.S. 69% last at least 2 years, but this percentage drops to 51% for firms reaching 5 years in operation.[17] Benefits of Supporting Local Business By opening up new national level chain stores, the profits of locally owned businesses greatly decrease and many businesses end up failing and having to close. This creates an exponential effect. When one store closes, people lose their jobs, other businesses lose business from the failed business and so on. In many cases large firms displace just as many jobs as they create.[18] Not only that but it also increases the costs of taxes. Instead of increasing a communitys revenue, big businesses actually shift money away from the community. Independent businesses depend on the many resources that a community can supply. They hire architects, contractors, hardware stores, interior designers, local advertisement agencies, accountants, business attorneys, and insurance companies. Local businesses also are more likely to supply locally produced products than chains, ultimately benefiting their community. Large corporations on the other hand eliminate the need for local goods and services. >. [Milchen] A lack of diversity can decrease the revenues in a community. When towns are interesting, they attract people from out of town. More personality and individuality can lead to more tourists, which, in turn leads to money placed directly into the community [Santa Fe Independent Business Report] ). The diversity of businesses is also important to the individuality of consumers. Oftentimes, independent retailers can adjust the products that they sell in order to fit the needs of their consumers and the unique tastes of their community. Local businesses are also more likely to support unique, new, and/or controversial products. Local bookstores can provide controversial books and can support small authors or local authors. The same idea helps out with local art and music. Bookstores and music shops are more likely to support local art and music than the mainstream stuff that large corporations provide.[Mitchell]

Business chains decrease a communitys individuality because they ultimately choose what products reach their customers. This greatly narrows what products are available and shrinks diversity.

Section III
The Definition of Small Business Management Entrepreneurship

By Audra Bianca, howContributor A business requires constant oversight of operations and financial activities. An entrepreneur is a person who owns a small business and staffs it as needed to meet customer needs. Entrepreneurship means that a business owner will focus on creating a market for his/her products or services based on a business plan. This focus on testing a business idea requires an entrepreneur to decide early on if he will assume the role of small business manager or hire another person to oversee daily operations. Other People Are Reading The Relationship Between Corporate Entrepreneurship & Strategic Management.

The Differences between Small Business Management & Entrepreneurship

If your talent lies in working with customers or developing your products, that's where you invest your time. A big part of small business management is creating policies and procedures to guide daily operations. Some small-business managers shape these protocols based on prior experience and education. Also, studying your instincts. Understanding the specific market you have chosen for your products or services will help you adjust policies and procedures and business strategy. Bearing Risk Small business managers help entrepreneurs bear the risk inherent in experimenting with a business idea. An entrepreneur opens an existing business concept in a new location or sector of the market, or she tries to take some market share away from competitors. Alternatively, she creates a new market with a novel business idea. Small-business management requires knowledge of how to develop the market by marketing one or more products to customers and convincing them that your company gives these products value. Both entrepreneurs and small business managers must bear the uncertainty of consumer demand for product and service offerings because business sales can be feast or famine. rganization Managing a small business requires choosing the right organization for business operations. A tax adviser suggests what type of corporation, sole proprietorship or limited liability company to form. Organization concerns how to develop infrastructure to support production and distribution. A manager consults with a business owner about which human resources, technology, financial resources and physical resources to invest in. A good manager handles the details of organizing resources on a daily basis to keep costs low and maximize high-quality outputs for customers. Planning Small-business management requires planning. Some entrepreneurs take advantage of resources at a smallbusiness development center. At a minimum, becoming an entrepreneur should include consulting a business checklist. If you write a business plan that addresses all or most of the questions in a checklist, you have a better chance of success. If you decide to delegate the management of small business operations, you can trust your manager to implement the specific details of the business plan in an incremental way, building infrastructure with available resources. Small Business: A small business is a business that is privately owned and operated, with a small number of employees and relatively low volume of sales. Small businesses are normally privately owned corporations, partnerships, or sole proprietorships. The legal definition of small varies by country and by industry, ranging from fewer than 15 employees under the Australian Fair Work Act 2009, 50 employees in the European Union, and fewer than 500 employees to qualify for many U.S. Small Business Administration programs. Small businesses can also be classified according to other methods such as sales, assets, or net profits. Me: In my mind, small businesses are those boutiques, hair salons, yoga studios, etc. you walk by downtown. Small business to me connotes a brick-and-mortar location. Employees are a must, even if its your wife and daughter. Small businesses may use more old school forms of marketing, like print ads or television commercials, rather than social media and the internet. You might have a small business if Youre a member of your Chamber of Commerce. You have a family business passed down

through generations. You work 100 percent (or 150 percent) at your small business (its your fulltime job). You sell or manufacture a product. Entrepreneur Wikipedia: An entrepreneur is a person who has possession of a new enterprise, venture or idea and is accountable for the inherent risks and the outcome. The term was originally from the French and was first defined by the IrishFrench economist Richard Cantillon. Entrepreneur in English is a term applied to a person who is willing to launch a new venture or enterprise and accept full responsibility for the outcome. JeanBaptiste Say, a French economist, is believed to have coined the word entrepreneur in the 19th century he defined an entrepreneur as one who undertakes an enterprise, especially a contractor, acting as intermediatory between capital and labour. Me: This is the one I most identify with. Entrepreneurs may have employees, but often go it alone as solopreneurs. Theyre willing to take risks for the reward (though maybe not as much as a startup). Entrepreneurs are all about social media, at least the ones I know. You might be an entrepreneur if The idea of failure doesnt scare youtoo much. You use social media to market your businessand do it all yourself. You tend to do all the work and have trouble delegating You have started more than one business (successfully or not). Startup Wikipedia: A startup company or startup is a company with a limited operating history. These companies, generally newly created, are in a phase of development and research for markets. The term became popular internationally during the dot-com bubble when a great number of dot-com companies were founded. A high tech startup company is a startup company specialized in a high tech industry. Me: I definitely think of tech companies when I think of startups, although I see non-tech companies claim the title. To me, startups are like fuses: They light brightly very quickly, but the fuse is short. At the end of it, the startup turns to another form, like part of a corporation that buys it, or it becomes a small business. Also, I tend to associate getting funded or working with angel investors with startups only. You might be an startup if Youre starting your company while working 40 hours a week at a day job. You fly to Silicon Valley at the drop of a hat to meet someone with deep pockets and good contacts. You know what a term sheet is. I realize this post will incite some aggressive great dialogue around the definitions Ive laid out here, and I welcome it. After all, its all subjective, isnt it? Small business From Wikipedia, the free encyclopedia This article has multiple issues. Please help improve it or discuss these issues on the talk page. This article needs additional citations for verification. (December 2008) This article may contain original research. (January 2009) Small businesses on Dalrymple Street inGreenock, ScotlandWhat constitutes a small business varies widely around the world. Small businesses are normally privately owned corporations, partnerships, or sole proprietorships. What constitutes "small" in terms of government support and tax policy varies by country and by industry, ranging from fewer than 15 employees under the Australian Fair Work Act 2009, 50 employees according to the definition used by the European Union, and fewer than 500 employees to qualify for many U.S. Small Business Administration programs, although in 2006 there were over 18,000 "small businesses" with over 500 employees that accounted for half of all the employees employed by all "small business ". [1] [2] Small businesses can also be classified according to other methods such as sales, assets, or net profits. Small businesses are common in many countries, depending on the economic system in operation. Typical examples include: convenience stores, other small shops (such as a bakery or delicatessen), hairdressers, tradesmen, lawyers, accountants, restaurants, guest houses, photographers, small-scale manufacturing, and online business, such as web design and programming, etc.

Contents [hide] 1 Characteristics of small businesses 1.1 Size definitions 1.2 Demographics 1.3 Franchise businesses 2 Advantages of small business 3 Problems faced by small businesses 3.1 Small business bankruptcy 3.2 Social Responsibility 3.3 Job Quality 4 Benefits of Supporting Local Business 5 Marketing the small business 6 Contribution to the economy 7 Sources of funding 8 Business Networks and Advocacy Groups 9 See also 10 References 11 External links Characteristics of small businesses Size definitions The legal definition of "small" varies by country and by industry. In the United States the Small Business Administration establishes small business size standards on an industry-by-industry basis, but generally specifies a small business as having fewer than 500 employees for manufacturing businesses and less than $7 million in annual receipts for most non-manufacturing businesses.[2] The definition can vary by circumstance dash; for example, a small business having fewer than 25 full-time equivalent employees with average annual wages below $50,000 qualifies for a tax credit under the health care reform bill Patient Protection and Affordable Care Act.[3] The European Union generally defines a small business as one that has fewer than 50 employees. However, in Australia, a small business is defined by the Fair Work Act 2009 as one with fewer than 15 employees. By comparison, a medium sized business or mid-sized business has under 500 employees in the US, and fewer than 200 in Australia. In addition to number of employees, other methods used to classify small companies include annual sales (turnover), value of assets and net profit (balance sheet), alone or in a mixed definition. These criteria are followed by the European Union, for instance (headcount, turnover and balance sheet totals). Small businesses are usually not dominant in their field of operation. The table below serves as a useful guide to business size nomenclature. Business Size definitions AUS US EU Minute/Micro 1-2 1-6 <10 Small <15 <250 <50 Medium <200 <500 <250 Large <500 <1000 <1000 Enterprise >500 >1000 >1000 Most cells reflect size not defined in relevant legislation Some definitions are multi-parameter, e.g., by industry, revenue, market share Demographics According to a survey run in the United States among businesses having <500 employees in late 2010, about 50% of minute/microbusinesses are owned by women.[4] Franchise businesses Franchising is a way for small business owners to benefit from the economies of scale of the big corporation (franchiser). McDonald's restaurants, TrueValue hardware stores, and NAPA Auto Parts stores are examples of a franchise. The small business owner can leverage a strong brand name and purchasing power of the larger company while keeping their own investment affordable. However, some franchisees conclude that they suffer the "worst of both worlds" feeling they are too restricted by corporate mandates and lack true independence. However, in some chains, such as the aforementioned TrueValue and NAPA, franchises may have their own name alongside the franchise's name. Advantages of small business A small business can be started at a very low cost and on a part-time basis. Small business is also well suited to internet marketing because it can easily serve specialized niches, something that would have been more difficult prior to the internet revolution which began in the late 1990s. Adapting to change is crucial in business and particularly small business; not being tied to anybureaucratic inertia, it is typically easier to respond to the marketplace quickly. Small business proprietors tend to be intimate with their customers and clients which results in greater accountability and maturity. Independence is another advantage of owning a small business. One survey of small business owners showed that 38% of those who left their jobs at other companies said their main reason for leaving was that they wanted to be their own bosses.[citation needed] Freedom to operate independently is a reward for small business owners. In addition, many people

desire to make their own decisions, take their own risks, and reap the rewards of their efforts. Small business owners have the satisfaction of making their own decisions within the constraints imposed by economic and other environmental factors.[5] However, entrepreneurs have to work for very long hours and understand that ultimately their customers are their bosses. Several organizations, in the United States, also provide help for the small business sector, such as the Internal Revenue Service's Small Business and Self-Employed One-Stop Resource.[6] Problems faced by small businesses Small businesses often face a variety of problems related to their size. A frequent cause of bankruptcy is undercapitalization. This is often a result of poor planning rather than economic conditions - it is common rule of thumb that the entrepreneur should have access to a sum of money at least equal to the projected revenue for the first year of business in addition to his anticipated expenses. For example, if the prospective owner thinks that he will generate $100,000 in revenues in the first year with $150,000 in start-up expenses, then he should have not less than $250,000 available. Failure to provide this level of funding for the company could leave the owner liable for all of the company's debt should he end up in bankruptcy court, under the theory ofundercapitalization. In addition to ensuring that the business has enough capital, the small business owner must also be mindful of contribution margin (sales minus variable costs). To break even, the business must be able to reach a level of sales where the contribution margin equals fixed costs. When they first start out, many small business owners underprice their products to a point where even at their maximum capacity, it would be impossible to break even. Cost controls or price increases often resolve this problem. In the United States, some of the largest concerns of small business owners are insurance costs (such as liability and health), rising energy costs, taxes and tax compliance.[7] In the United Kingdom and Australia, small business owners tend to be more concerned with excessive governmental red tape.[8] Another problem for many small businesses is termed the 'Entrepreneurial Myth' or E-Myth. The mythic assumption is that an expert in a given technical field will also be expert at running that kind of business. Additional business management skills are needed to keep a business running smoothly. Still another problem for many small businesses is the capacity of much larger businesses to influence or sometimes determine their chances for success. Small business bankruptcy When small business fails, the owner may file bankruptcy. In most cases this can be handled through a personal bankruptcy filing.[citation needed] Corporations can file bankruptcy, but if it is out of business and valuable corporate assets are likely to be repossessed by secured creditors there is little advantage to going to the expense of a corporate bankruptcy.[citation needed] Many states offer exemptions for small business assets so they can continue to operate during and after personal bankruptcy.[citation needed] However, corporate assets are normally not exempt, hence it may be more difficult to continue operating an incorporated business if the owner files bankruptcy.[citation needed] Social Responsibility Small businesses can encounter several problems related to Corporate social responsibility due to characteristics inherent in their construction. Owners of small businesses often participate heavily in the day-to-day operations of their companies. This results in a lack of time for the owner to coordinate socially responsible efforts. [9] Additionally, a small business owner's expertise often falls outside the realm of socially responsible practices contributing to a lack of participation. Small businesses also face a form of peer pressure from larger forces in their respective industries making it difficult to oppose and work against industry expectations. [10] Furthermore, small businesses undergo stress from shareholder expectations. Because small businesses have more personal relationships with their patrons and local shareholders they must also be prepared to withstand closer scrutiny if they want to share in the benefits of committing to socially responsible practices or not. [11] Job Quality While small businesses employ over half the workforce [12] and have been established as a main driving force behind job creation [13] the quality of the jobs these businesses create has been called into question. Small businesses generally employ individuals from the Secondary labor market. As a result, in the U.S. wages are 49%

higher for employees of large firms.[14] Additionally, many small businesses struggle or are unable to provide employees with benefits they would be given at larger firms. Research from the U.S. Small Business Administration indicates that employees of large firms are 17% more likely to receive benefits including salary, paid leave, paid holidays, bonuses, insurance, and retirement plans.[15] Both lower wages and fewer benefits combine to create a job turnover rate among U.S. small businesses that is 3 times higher than large firms.[16] Employees of small businesses also must adapt to the higher failure rate of small firms. In the U.S. 69% last at least 2 years, but this percentage drops to 51% for firms reaching 5 years in operation.[17] Benefits of Supporting Local Business By opening up new national level chain stores, the profits of locally owned businesses greatly decrease and many businesses end up failing and having to close. This creates an exponential effect. When one store closes, people lose their jobs, other businesses lose business from the failed business and so on. In many cases large firms displace just as many jobs as they create.[18] Not only that but it also increases the costs of taxes. Instead of increasing a communitys revenue, big businesses actually shift money away from the community. Independent businesses depend on the many resources that a community can supply. They hire architects, contractors, hardware stores, interior designers, local advertisement agencies, accountants, business attorneys, and insurance companies. Local businesses also are more likely to supply locally produced products than chains, ultimately benefiting their community. Large corporations on the other hand eliminate the need for local goods and services. >. [Milchen] A lack of diversity can decrease the revenues in a community. When towns are interesting, they attract people from out of town. More personality and individuality can lead to more tourists, which, in turn leads to money placed directly into the community [Santa Fe Independent Business Report] ). The diversity of businesses is also important to the individuality of consumers. Oftentimes, independent retailers can adjust the products that they sell in order to fit the needs of their consumers and the unique tastes of their community. Local businesses are also more likely to support unique, new, and/or controversial products. Local bookstores can provide controversial books and can support small authors or local authors. The same idea helps out with local art and music. Bookstores and music shops are more likely to support local art and music than the mainstream stuff that large corporations provide.[Mitchell] Business chains decrease a communitys individuality because they ultimately choose what products reach their customers. This greatly narrows what products are available and shrinks diversity. Marketing the small business This section does not cite anyreferences or sources.(November 2010) Finding new customers is the major challenge for Small business owners. Small businesses typically find themselves strapped for time but in order to create a continual stream of new business, they must work on marketing their business every day. Common marketing techniques for small business include networking, word of mouth, customer referrals, yellow pages directories, television, radio, outdoor (roadside billboards), print, email marketing, and internet. Electronic media like TV can be quite expensive and is normally intended to create awareness of a product or service. Another means by which small businesses can advertise is through the use of deal of the day websites such as Groupon and Living Social. These Internet deals encourage new visitors to small businesses. Example of keyword analysis based on market competition. Many small business owners find internet marketing more affordable. Google AdWords and Yahoo! Search Marketing are two popular options of getting small business products or services in front of motivated Web searchers. Successful online small business marketers are also adept at utilizing the most relevant keywords in their site content. Advertising on niche sites can also be effective, but with the long tail of the internet, it can be time intensive to advertise on enough sites to garner an effective reach. Creating a business Web site has become increasingly affordable with many do-ityourself programs now available for beginners. A Web site can provide significant marketing

exposure for small businesses when marketed through the Internet and other channels. Some popular services areWordPress, Joomla and Squarespace. Social media has proven to be very useful in gaining additional exposure for many small businesses. Many small business owners use Facebook and Twitter as a way to reach out to their loyal customers to give them news about specials of the day or special coupons and generate repeat business. The relational nature of social media, along with its immediacy and 24-hour presence lend intimacy to the relationship small businesses can have with their customers, while making it more efficient for them to communicate with greater numbers. Facebook ads are also a very cost-effective way for small businesses to reach a targeted audience with a very specific message. In addition to the social networking sites, blogs have become a highly effective way for small businesses to position themselves as experts on issues that are important to their customers. This can be done with a proprietary blog and/or by using a backlink strategy wherein the marketer comments on other blogs and leaves a link to the small business' own Web site. A solid public relations strategy that utilizes speaking engagements, press releases, feature stories, events and sponsorships can also be a very cost-effective way to build a loyal following for a small business. Designing a Marketing Plan for Small Businesses Market Research To produce a marketing plan for Small businesses, research needs to be done on similar businesses which should include desk and field research. This gives an insight in the target groups behaviour and shopping patterns. Analysing the competitors marketing strategies makes it easier for Small business to gain market share. Marketing mix[19] Marketing mix is a crucial factor for any business to be successful. Especially for a Small business, competitors marketing mix can be very helpful. An appropriate market mix helps boost sales. Product Life Cycle[20] After launch of the business, crucial points of focus should be increasing growth phase and delaying maturity phase. Once the business reaches maturity stage, an extension strategy should be in place. Re-launching is also an option at this stage. Pricing strategy should be flexible and based on the different stages of the PLC. Promotion Techniques Its preferable to keep promotion expenses as low as possible. Word of mouth, Email marketing, Print-ads in local newspapers etc. can be effective. Channels of Distribution Selecting an effective channel of distribution may reduce the promotional expenses as well as overall expenses for a Small business. Contribution to the economy In the US, small business (less than 500 employees) accounts for more than half the nonfarm, private GDP and around half the private sector employment. [21] Regarding small business, the top job provider is those with fewer than 10 employees, and those with 10 or more but fewer than 20 employees comes in as the second, and those with 20 or more but fewer than 100 employeescomes in as the third (interpolation of data from the following references).[22] The most recent data shows firms with less than 20 employees account for slightly more than 18% of the employment.[23] According to The Family Business Review, There are approximately 17 million sole-proprietorships in the US. It can be argued that a sole-proprietorship (an unincorporated business owned by a single person) is a type of family business and there are 22 million small businesses (less than 500 employees) in the US and approximately 14,000 big businesses. Also, it has been found that small businesses created the most new jobs in communities, In 1979, David Birch published the first empirical evidence that small firms (fewer than 100 employees) created the most new jobs and Edmiston claimed that perhaps the greatest generator of interest in entrepreneurship and small business is the widely held belief that small businesses in the United States create most new jobs. The evidence suggests that small businesses indeed create a substantial majority of net new jobs in an average year. Local businesses provide competition to each other and also challenge corporate giants. Of the 5,369,068 employer firms in 1995, 78.8 percent had fewer than 10 employees, and 99.7 percent had fewer than 500 employees.[24] Sources of funding Small businesses in Biloela, Central Queensland, Australia, 1949 Small businesses use several sources available for start-up capital:[25] Self-financing by the owner through cash, equity loan on his or her home, and or other assets. Loans from friends or

relatives Grants from private foundations Personal savings Private stock issue Forming partnerships Angel investors Banks SME finance, including Collateral based lending and Venture capital, given sufficiently sound business venture plans Some small businesses are further financed through credit card debtusually a poor choice, given that the interest rate on credit cards is often several times the rate that would be paid on a line of credit or bank loan. Recent research suggests that the use of credit scores in small business lending by community banks is surprisingly widespread. Moreover, the scores employed tend to be the consumer credit scores of the small business owners rather than the more encompassing small business credit scores that include data on the firms as well as on the owners.[26] Many owners seek a bank loan in the name of their business, however banks will usually insist on a personal guarantee by the business owner. In the United States, the Small Business Administration (SBA) runs several loan programs that may help a small business secure loans. In these programs, the SBA guarantees a portion of the loan to the issuing bank and thus relieves the bank of some of the risk of extending the loan to a small business. The SBA also requires business owners to pledge personal assets and sign as a personal guarantee for the loan. The 8(a) Business Development Program assists in the development of small businesses owned and operated by African Americans, Hispanics, and Asians.[27] Canadian small businesses can take advantage of federally funded programs and services. See Federal financing for small businesses in Canada (grants and loans). Relation between Small Business and Entrepreneurship The lens mentions the relation between small business and entrepreneurship. Furthermore, the point here is to look for is the advantages and disadvantages of having small business entrepreneurs. New RSS: Add Your Own Feed Add any RSS feed to your Lens. Just edit this module, and set the Feed URL. Then, Bam! You'll be syndicating your content on Squidoo. Cool, huh? Small Business owner to a Successful Entrepreneurship Where does an Entrepreneur come from ? Can we say it is a small business owner who could take his business to the next level? Entrepreneurs are not necessarily big, it ranges in scale from solo projects to major undertakings creating huge job opportunity. A small business owner is often satisfied in his small craftsmanship. However, an entrepreneur exploits his talent and has constant urge to evolve his business, keeping aside the monetary interest remains constant while the business grows. A small business owner needs to be inspired and have the constant drive to grow himself into an entrepreneur. Running a one-person business is a creative, flexible and challenging way to become your own boss and chart your own future. It is about creating a life, as it is about making a living. It takes courage, determination and foresight to decide to become an entrepreneur. From the relatively safe cocoon of the corporate world, where pay checks arrive regularly, an entrepreneur ventures into the unchartered territories of business. Here are a few points which shows the connection between small business andentrepreneurship. Lets first know what these two terms mean. Small business is a business with comprises of few number of employees. For a company to be termed as a small business depends in different countries. For example, in United States a company is generally under 100 employees and in Australia it should be under 20 employees. These businesses are generally privately owned soleproprietorships, corporations or partnership. On the other hand, entrepreneurshipmeans starting new organizations or revitalizing mature organizations, particularly new businesses generally in response to identify opportunities. It's a difficult undertaking, because most of these businesses fail at a very early stage. In the beginning of the business the term "Small Business Owner" and "Entrepreneur" are interchangeable. Advantages

Every business has its own advantages and disadvantages. As for talking about small business, it requires less initial capital to start the business. Its sources of funding can be self-financing, loans from friends and relatives, private stock issue, forming partnerships and SME finance which includes collateral based funding or venture capital . The owner can keep a close check on the accounts and books. Also, a small business owner can build intimate relations with his clients which results in better creditability and responsiveness. For a Entrepreneur, has the inclination to grow his business to the highest level, which in turns leads to high quality products and better job opportunity. As a bigger organization, it encourages use of modern technology with research activity for quality improvement. Innovative and strategic ideas are developed to enhance product quality. Contributes to theeconomy by giving better quality products for export. Healthy competition lets the entrepreneur work towards better quality services constantly. Disadvantages The typical entrepreneurship is a small business. The success of any business is measured by its financial growth. This also applies to large businesses who wish to start up a new business within the current corporate framework. Small business often faces problems related to their size like these businesses fail because of undercapitalization. The owner, before starting the business, needs to make sure he has access to enough capital to support his project for at least one year, anticipating his expenses. Another problem that is often realized in small business is the "Entrepreneurial Myth", which means any person who is technically trained in any field, has a myth he can run the business efficiently. However, additional management skills are required to run the business. A small business owner, who wants to survive in the competition, not only needs to take care of the above listed issues but also what a bigger entrepreneur would face. An entrepreneur needs to carry total load of debts, long works hours are required to keep up with no additional overtime or holiday pay which affects an individuals personal and social life. Apart from these an entrepreneur also needs to assume all risks from start up through operations and customer satisfaction, he also needs to maintain and improve his expertise for continues growth for which business concepts and marketing strategies are required. Needs to anticipate competition and have strategies ready to face them. Small Business owner to a Successful Entrepreneurship First of all a small business owner needs to have a vision and passion to succeed. There are several points that needs to be kept in mind to drive a small business to the heights of roaring success. Starting with having the right attitude, an entrepreneur needs to be optimistic, open to new ideas and be willing to research , ask questions and reflect on mistakes to learn better. Secondly, Customer Focus. Study the market your business is catering to. Learn their demands, the quality they are looking for and monitor the customer traffic. Thirdly, getting feedback. This is one important tool which helps you measure your standing with the customer. An entrepreneur should keep in contact with an expert for constant feedback on what is going right or what needs to be done improve a particular section. Not only this, customer feedback also needs to be in the limelight, which helps an entrepreneur use innovative ideas, for his product according to the demand. Fourthly, Networking. In business you are judged by the company you keep. Small businesses always need assistance. It is important to cash every opportunity. An entrepreneur can make contact through the business meetings or parties which lets you meet important people from different aspects of business who can help a business grow.

Concluding the discussion. For an entrepreneurship his business is a vehicle for discovering and expressing his unique talent and his passion to succeed. For a small business owner needs more drive and a successful entrepreneur to have the constant determination to achieve success for his business. The Future of Small Business Entrepreneurship: Jobs Generator for the U.S. Economy Email Share inShare StumbleUpon Print Policy Brief #175 As the nation strives to recover from the Great Recession, job creation remains one of the biggest challenges to renewed prosperity. Small businesses have been among the most powerful generators of new jobs historically, suggesting the value of a stronger focus on supporting small businessesespecially high-growth firmsand encouraging entrepreneurship. Choosing the right policies will require public and private decision-makers to establish clear goals, such as increasing employment, raising the overall return on investment, and generating innovations with broader benefits for society. Good mechanisms will also be needed for gauging their progress and ultimate success. This brief examines policy recommendations to strengthen the small business sector and provide a platform for effective programs. These recommendations draw heavily from ideas discussed at a conference held at the Brookings Institution with academic experts, successful private-sector entrepreneurs, and government policymakers, including leaders from the Small Business Administration. The gathering was intended to spur the development of creative solutions in the private and public sectors to foster lasting economic growth. RECOMMENDATIONS What incentives and assistance could be made available to gazelles and to small business more generally? What policies are likely to work most effectively? In the near term, government policies aimed at bolstering the recovery and further strengthening the financial system will help small businesses that have been hard hit by the economic downturn. Spurred by the interchange of ideas at a Brookings forum on small businesses, we have identified the following more targeted ideas for fostering the health and growth of small businesses (and, in many cases, larger businesses) over the longer run: Improve access to public and private capital. Reexamine corporate tax policy with an eye toward whether provisions of our tax code are discouraging small business development. Promote education to help businesses struggling with shortages of workers with particular skills, and promote research to spur innovation. Rethink immigration policy, as current policy may be contributing to shortages of key workers and deterring entrepreneurs who wish to start promising businesses in our country. Explore ways to foster innovation-friendly environments, such as regional cluster initiatives. Strengthen government counseling programs. The term small business applies to many different types of firms. To begin, the small business community encompasses an enormous range of Main Street stores and services we use every day, such as restaurants, dry cleaners, card shops and lawn care providers. When such a business fails, it is often replaced by a similar firm. The small business community also includes somewhat bigger firmsin industries such as manufacturing, consulting, advertising and auto salesthat may have more staying power than Main Street businesses, but still tend to stay relatively small, with under 250 employees. While these two kinds of small businesses contribute relatively little to overall employment growth, they are a steady source of mainstream employment. If economic conditions do not support the formation of new businesses to replace the ones that fail, there would be a significant net destruction of jobs and harm to local communities. Yet another type of small business has an explicit ambition for rapid growth. These high-growth companies are sometimes known as gazelles. According to the Small Business Administration,

small businesses account for two-thirds of new jobs, and the gazelles account for much of this job creation. The most striking examplessuch as Google and eBayhave tended to be in high-tech industries and were gazelles for a significant time before they graduated to be very large businesses. However, gazelles exist in all industry types and in all regions of the country, and the large majority are not grazing in the nations technology-dominated SiliconValleys. According to one expert, the three largest industry categories for high-growth companies are restaurant chains, administrative services and health care companies. One non-high-tech example is Potbelly Sandwiches, a restaurant chain that began in Chicago. Another is the San Francisco-based Gymboree Corporation, a provider of child development programs and childrens clothing. Fostering the Development of High-Growth Companies High-growth small businesses represent only about 5 percent of total startups, making it important to determine how to spot and foster them. A key common characteristic is that growth is critically dependent on the entrepreneurs who start these companies; they are people on a mission, charismatic leaders who can inspire creativity and commitment from their staffs. The age of these firms is highly correlated with when their growth is highest. Generally, the most dramatic growth occurs after at least four years of existenceand coincidentally lasts about four yearsbefore it slows again to a more typical pace for small businesses. Of course, some firms such as Google defy this pattern and continue to experience high growth for many years. Although dynamic small businesses can be found nearly everywhere and in many industries, some regions spawn more of them than others. These regions may have especially supportive features, such as a critical mass of potential workers with relevant skills, a social climate and network that encourage idea generation, locally available venture capital, or some combination of these factors. Unfortunately, attempts to anticipate which companies or even industries are likely to produce gazelles are prone to error. Thus, excessive emphasis on national industrial policies that favor specific industries are likely misplaced. Without knowing how to target assistance precisely, broad strategies, such as assistance with funding, knowledge, contacts and other essential resources, may be the best approach to fostering high-growth businesses. Such support has the added value of also aiding Main Street businesses. Many of the most promising policies focus on removing obstacles that hinder entrepreneurs with solid business plans from launching and expanding their businesses. Funding As a result of the burst of the dot.com bubble in early 2000 and the recent financial crisis, small businesses have found the availability of venture capital funds drastically diminished. The crisis has also made it more difficult to obtain funding from banks and other conventional means. These trends particularly affect the missing middle of small businessesroughly, those with between 10 and 100 employees. The venture capital market. Historically, venture capital has financed only a relatively small portion of small businesses, but those financed have tended to be the ones with the greatest growth potential. In recent years, firms that eventually grew to where they could issue initial public stock offerings generally relied more heavily on venture capital financing than the average small business.

The dollar value of venture capital deals funded today is only about one-fifth the size it reached at its peak. While the peak amount may have been too large, todays value is probably too small. With their capital heavily invested in a small range of industries and locales, it seems likely that venture capital firms have missed a high proportion of potential investment opportunities. Further, once burned, twice shy funders have increasingly focused on larger, later-stage ventures. Consequently, mezzanine financing, which new companies need to survive and thrive in the critical early stages, is scarce. The funding problems partly stem from venture capital firms today having less money to invest. Some investors who formerly contributed to such firms have become more risk-averse, and worse performance figures have discouraged new investors. Lack of venture capital affects some industries more than others, and even some green energy companiesviewed by some as one of the nations more promising industry sectorshave moved to China, where financial support is more readily available. Bank lending. In contrast to large businesses, which can turn to capital markets for funding, many small businesses are dependent on banks for financing. Although the worst of the 200809 credit crunch is behind us, many small businesses still find it difficult to obtain bank loans. Community banks, a key source of small business financing, have been hard hit by losses in commercial real estate, which have limited their lending capacity. Further, many small business owners who historically would have used real estate assets as collateral for expansion loans can no longer do so because of declines in real estate prices. In addition, small businesses that have, in the past, used credit cards to purchase equipment and supplies have been hindered by reductions in credit limits. Overall economic conditions The high degree of uncertainty currently surrounding the economic and financing climate may have prompted many entrepreneurs and would-be entrepreneurs to hold off on growth plans. Despite their reputation as high-flying risk-takers, good entrepreneurs take only calculated risks, where the benefits outweigh the dangers. Uncertainties about the future trajectory of the economy merely increase risk without raising potential rewards. Government policies Government policies affect the climate for small businesses in many ways. For example, small businesses face substantial hurdles when entering the complicated world of federal grants and contracts. At the state level, severe budget shortfalls mean that even well-designed initiatives to boost small businesses may founder. The Small Business Administration (SBA) assists the full continuum of small businesses through a variety of means. These include: an $80 billion loan guarantee portfolio; specialized counseling and training centers; specialized business development programs targeting the socially and economically disadvantaged; oversight to ensure that at least 23 percent of federal government contracts go to small businesses (with certain preferences for minority and women-owned businesses); and the Small Business Innovation Research and Small Business Investment Companies programs. The Obama administration is attempting to broaden support for small businesses by bringing the SBA into multi-agency initiatives that tackle common problems. For example, the Departments of

Energy, Commerce, Housing and Urban Development, Education, and Labor, along with the National Science Foundation and the SBA, are supporting a five-year, nearly $130 million Energy Regional Innovation Cluster. Strength of social capital Through the 1990s, the United States was a worldwide leader in fostering innovation and entrepreneurship and reaped the reward of employment growth. Current international comparisons suggest that we are now closer to tenth place among some 70 nations in our ability to support innovation. Much of what has kept our nation from remaining in the top spot appears to relate to insufficient cultural support for entrepreneurship. Strong social networks in specific geographic regions appear to substantially bolster the growth of innovative businesses. These networks are built around entrepreneurial dealmakers who serve as the nodes of the network, forming connections among researchers, entrepreneurs and investors. Unfortunately, many regions and industries lack strong networks. Access to decision-making information. Entrepreneurs need an array of information and advice about how to tackle the problems that arise at different stages in business development. The SBA reports that companies that have taken advantage of their long-term counseling programs, for example, have higher growth than companies that have not. Opportunity for all. Social networks are self-selecting, and some people have to work extra hard to gain entry to a regions network of entrepreneurs. While various organizations exist to help women and people of color access entrepreneurial skills and information, these efforts may not suffice. Under-representation of any group presumably would filter out a number of potential high-growth companies. Workforce issues A long-time strength of the American workforce, worker mobility has declined. This trend has been attributed in part to an aging population and in part to the current difficulty people have in selling their homes. Businesses report difficulty finding employees with the right training, especially at the technician level, where straightforward vocational training could help. Global competition Increasing global competition for good projects, entrepreneurs and capital is a positive trend from an international perspective, but runs counter to the national goal of promoting rapid growth in U.S. industry and employment. Today, many entrepreneurs can choose among starting a business here, in their home country, or even in a third, more hospitable nation. At the same time, current U.S. immigration policy hinders entrepreneurs from coming here to launch their companies. A recent report from The Brookings- Duke Immigration Policy Roundtable concluded that educated workers with the knowledge and skills to innovate are critical to the United States and recommended increasing the annual number of skilled visas. Policy Goals for Small Business Measuring Results More work is needed to identify key policy goals and priorities related to small business success. Critically, what would constitute improvement in public policy regarding small business

employment, and how would we measure it? Clearly, increasing the total number of jobs created each year (by both small and large businesses, net of job destruction) would be a positive outcome, all else being equal. Another potential goal would be improving the quality of the jobs created, as measured by average compensation or by job creation in new industries or geographic areas where unemployment is high. Creating good jobs that bring generous compensation would seem to be always desirable, but this outcome could conflict with other social goals, for example, if the jobs created required skills out of the reach of groups that are traditionally difficult to employ. Slowing job destruction could be as important as increasing the creation of new jobs, but discouraging layoffs without increasing performance would do more harm than good. The trick is to raise the quality of marginal firms so that their improved performance allows them to retain employees they would otherwise have to let go. A final key factor in setting policy goals that would support small businesses is measuring the cost to taxpayers of the initiatives that flow from the goals. This includes the subsidy cost contained in the federal budget, as well as costs and tradeoffs in society at large. Changing Key Policies Small businesses face both short-run and long-run challenges. With regard to the former, many small businesses have been hard hit by the recession and appear to be lagging behind larger businesses in their recovery. The cyclical struggles of this sector in part reflect the dependence of many small firms on the still-strained banking system for their financing; they also reflect the high toll that our extremely soft labor markets have taken on demand for Main Street goods and services. Thus, government policies aimed at broadly bolstering the recovery and further strengthening the financial system will yield important benefits to small businesses. The government, in conjunction with the private sector, can also take steps that will foster an economic environment that is supportive of entrepreneurship and economic growth over the long run. Specific policy steps that might help small businesses (and, in many cases, large businesses) include: Improve access to public and private capital. Implementing serious financial reform will reduce the likelihood that we will see a repeat of the recent credit cycle that has been so problematic for the small business sector. When credit market disruptions do occur, policymakers should be attentive to whether temporary expansions of the SBA loan guarantee program are needed to sustain lending to creditworthy borrowers. The SBA should also consider expanding the points of access to its loan programs through an expansion of its lending partners. Finally, the SBA (or a similar entity) might encourage venture capital funds to broaden their investments beyond familiar areas by systematically bringing these investors together with entrepreneurs from neglected geographic regions and business sectors. Reexamine corporate tax policy. More thinking is needed about whether provisions in our tax code discourage small business development in a way that is harmful to the broader economy and that places the United States at a relative disadvantage internationally. For example, Congress might consider whether it would be beneficial, on net, to lower employment taxes as a way of spurring hiring at businesses with high-growth potential. In addition, some analysts believe there would be gains from increasing tax credits for research and development and further lowering taxes on

capital equipment. A design priority in all cases should be simplicity, as complicated rules can limit take-up among smaller firms that do not have extensive accounting or legal expertise. Promote education and research. Entrepreneurs report difficulty in finding workers with the skills they need for manufacturing, technology and other jobs that do not require four-year college degrees. Access to such educational opportunities, including tailored vocational training, should be affordable and ubiquitous. At the university level, improvements are needed in the way academic research is brought to the commercial market. Continued public and private support for basic research might be wise, particularly if we are in a trough between waves of innovation, as some analysts believe. The large investments by the National Science Foundation, National Institutes of Health, Defense Advanced Research Projects Agency, and other ambitious public and private programs laid the groundwork for many of the high-growth businesses of today. It may be worth exploring whether support for research in softer areas than the sciences might do an equal or better job of inspiring innovations. Rethink immigration policy. A reconsideration of limits on H1-B visas might help entrepreneurs struggling with shortages of workers with particular skills. In addition, current immigration policy discourages immigrants who want to establish entrepreneurial businesses in America. Any efforts to expand immigration are frequently perceived as taking jobs away from Americans, but studies have shown that new businesses create jobs for Americans. Explore ways to foster innovation-friendly environments. Some regions of the United States clearly do a better job of encouraging innovation. Silicon Valley is the classic example, but there may be as many as 40 such clusters scattered around the country. While clusters often arise organically, typically near major universities, some states have made an explicit commitment to innovation and entrepreneurship. Examples include the Massachusetts Technology Collaborative and Californias Biological Technologies Initiative, involving community colleges statewide. Federal, state and local policymakers should keep a keen eye on ways of adapting best practices from these initiatives as information becomes available about which elements are most effective. Strengthen government counseling programs. The SBA might do more to expand and tailor its already successful growth counseling programs to better meet the needs of both Main Street and potential high-growth businesses, as well as firms at different developmental stages. Any effort to expand small businesses opportunities for federal grants and contracts should be accompanied by significant streamlining of the application process. The importance and benefits of small businesses today Many businesses start as one person's idea. The creator is often an entrepreneur who spots a gap in the market or a commercial opportunity. S/he turns the idea into a marketable product or service. There are four main types of business: manufacturing, wholesale, retail and service. Some characteristics found in successful entrepreneurs, show they are: prepared to take risks driven by achievement not put off by failure self-motivated determined to stay ahead of the competition. For example, Simon Woodruff opened up his first Yo Sushi restaurant by copying an idea he saw in Japan. The business grew into a chain of successful restaurants with a novel approach to serving Japanese food and drink. Henry John Heinz's first product in 1869 was horseradish, followed by pickles, sauerkraut, and vinegar. All were delivered by horse-drawn wagons to grocers in and around Pittsburgh. Heinz developed many of the world's best known branded products e.g. tomato ketchup, baked beans, and baby foods. Today's small business sector creates many of the new ideas and innovations future generations will take for granted e.g. ingenious website designs, clockwork radios. Small businesses Small businesses are vital to the success of

the economy. Not only as they provide the success stories of the future, but also because they meet local needs (e.g. hairdresser, financial consultant, emergency,and plumber). They serve the requirements of larger businesses e.g. for photography services, printed stationery, catering and routine maintenance. Of course, you don't have to set up your own enterprise to be enterprising. Being entrepreneurial simply means developing the right skills, attitudes and initiatives to make an innovative contribution to an organization. This case study gives you some idea of what is involved and how exciting it can be. Most UK businesses today are small. Two thirds are owned and run by one person. Nearly 90% employ less than 6 people. They are also an important source of employment. Just over 2.5 million UK workers are self-employed; one in eight of all workers. It is from these small companies that tomorrow's big names will probably arise. Benefits Small businesses survive and prosper for many different reasons: Developing personal relationships small businesses are well placed to build personal relationships with customers, employees, and suppliers. With a small business you know who you are dealing with; you can 'put a face' to the person you are in contact with. Person-to-person interaction is as important as ever in building strong relationships. Responding flexibly to problems and challenges - in a small business there is little hierarchy or chain of command. Large businesses may have set ways of operating and establish procedures that are hard to change. Small businesses are often far more flexible. It can also reach a quick decision on whether or not it can do what is required. Inventiveness and innovation - small businesses are well positioned to introduce and develop new ideas. This is due to their owners not having to report or seek approval from anyone else. For example, when Anita Roddick set up The Body Shop, she developed a range of environmentally friendly cosmetics in unsophisticated packaging. This would have been frowned on in a conventional cosmetics company. Low overheads - due to the small scale of operation, small businesses have lower overhead costs. They operate in small premises with low heating and lighting costs, and limited rent and rates to pay. Low costs result in lower prices for consumers. Catering for limited or niche markets -large firms with high overheads must produce high levels of output to spread costs. By contrast, small firms are able to make a profit on much lower salesfigures. They can therefore sell into much smaller markets: e.g. a local window cleaner serving a few hundred houses, a specialist jewellery maker with personal clients. The main reason many people choose to set up a small business, is because it gives them independence. They also reap the rewards for themselves; these are two powerful incentives. As the economy heads into recovery, entrepreneurs should be gearing up for growth. That makes it an excellent time to put strategic planning at the top of the agenda. "Strategic planning means looking at where you want your company to be in the next 3-to-5 years and determining what you need to do to get there," BDC Consulting manager Nyron Drepaul says. "Whether it's buying a competitor, increasing your capital or aiming for higher growth, you need the right strategies, structure, plans and controls in place to optimize the return on your investment." A common misconception is that strategic planning is only for large companies. But the reality is that most businesses can greatly benefit from the exercise. "If you're always busy putting out fires, you may feel you have no time for planning," Drepaul says. "But by developing big-picture strategies to guide your day-to-day operations and setting goals, you're no longer flying blind. A long-term plan simply increases your chances of success." Another reason for entrepreneurs to make strategic planning a priority is that it reduces risk, particularly in periods of economic uncertainty. "As part of the process, you'll be assessing your current situation, resources, strengths and weaknesses, competitors and the business environment. This way, you will be better equipped to make decisions and therefore to minimize risk." For Drepaul, strategic planning also helps entrepreneurs to shake things up a little. "It's a way to rekindle the entrepreneurial drive that got you started in the first place. For example, you may have started out with a dream of a $10-million business with

stores all over the world. But along the way, you got distracted by daily challenges, lost sight of that dream and settled for less than your true potential." "Strategic planning reignites that passion for what you're doing. If you have a real plan with goals, it's very rewarding to achieve each milestone. That sense of satisfaction builds the momentum you need to push even further." Drepaul recommends entrepreneurs involve their employees in the strategic planning exercise, particularly in smaller companies. When employees contribute, they take ownership of the plan and help you reach your goals, he says. "This builds enthusiasm in your company and gets everybody on the same page." For example, entrepreneurs can ask employees to brainstorm about a company's strengths and weaknesses. After all, your staff knows your company inside out. A crucial part of successful strategic planning is to ensure you seek an external, objective point of view. Most small businesses don't have the resources and expertise in-house to guide them through the strategic planning process. "A consultant can give you a fresh perspective on your business, help you envision the future you want and define your long-term goals," Drepaul says. "An expert can also ensure you follow a rigorous plan with clear timelines and assigned responsibilities. Starting a Business Step 1 Choose a business for which you have a passion. The launch process will go much smoother if you enjoy what you are doing. Determine if you want to start a business from scratch, buy an existing business or buy into a franchise. Starting from scratch is the most labor-intensive route, but buying an existing business can mean buying a previous owner&amp;rsquo;s headache. Buying into a franchise provides a successful business model, but a lot of freedom to adopt your own personal touches is forfeited. Step 2 Write a business plan. Some would argue that a business plan is not necessary to start a business. Although you do not need a plan to start a business, the absence of one is akin to setting sail around the world without a map. Think of the business plan as the map for the business. The plan keeps the business on task during the startup process and during operation. A business plan also is a requirement for any business that will seek outside financing from a bank or investors. Step 3 Choose a business structure. Every business is required to declare itself a sole proprietorship, partnership, limited liability company or corporation. Determining which structure is best for you will depend on the amount of asset and taxation protection needed, if you will be running the business alone or with one or more partners, and how much flexibility you desire. Step 4 Acquire all required licenses and permits. Requirements vary by state, so check with your Secretary of State&amp;rsquo;s office and local county clerk&amp;rsquo;s office to get the list of required documents. Operating A Business Step 1 Set up an accounting system or hire an accountant. Knowing how the business is doing financially is important for planning and survival. Using an accounting software package will make tracking business transactions easier, if you choose to do the accounting yourself. If you opt to hire an accountant, provide the information to him so he can start managing the account as soon as possible. Step 2 Advertise your business. No one will buy your products or services if they do not know you exist. Create a website and advertise in different mediums, such as newspapers and radio. Ask customers for referrals. Network with other business owners to help with recognition and gain referrals for new business. Step 3 Secure insurance for the business. Some states require a business to carry insurance. Others, such as Texas, do not require it but recommend it as a business practice. Liability insurance protects the business in the event of litigation. Consider life and disability insurance, health insurance and renters&amp;rsquo; insurance, if you are leasing an office or storefront. Starting a Business Step 1 Choose a business for which you have a passion. The launch process will go much smoother if you enjoy what you are doing. Determine if you want to start a business from scratch, buy an existing business or buy into a franchise. Starting from scratch is the most labor-intensive route, but buying an existing business can mean buying a previous owner&amp;rsquo;s headache. Buying into a franchise provides a successful business model, but a lot of freedom to adopt your own personal touches is forfeited. Step 2 Write a business plan. Some would argue that a business plan is not necessary to start a business. Although

you do not need a plan to start a business, the absence of one is akin to setting sail around the world without a map. Think of the business plan as the map for the business. The plan keeps the business on task during the startup process and during operation. A business plan also is a requirement for any business that will seek outside financing from a bank or investors. Step 3 Choose a business structure. Every business is required to declare itself a sole proprietorship, partnership, limited liability company or corporation. Determining which structure is best for you will depend on the amount of asset and taxation protection needed, if you will be running the business alone or with one or more partners, and how much flexibility you desire. Step 4 Acquire all required licenses and permits. Requirements vary by state, so check with your Secretary of State&amp;rsquo;s office and local county clerk&amp;rsquo;s office to get the list of required documents. Operating A Business Step 1 Set up an accounting system or hire an accountant. Knowing how the business is doing financially is important for planning and survival. Using an accounting software package will make tracking business transactions easier, if you choose to do the accounting yourself. If you opt to hire an accountant, provide the information to him so he can start managing the account as soon as possible. Step 2 Advertise your business. No one will buy your products or services if they do not know you exist. Create a website and advertise in different mediums, such as newspapers and radio. Ask customers for referrals. Network with other business owners to help with recognition and gain referrals for new business. Step 3 Secure insurance for the business. Some states require a business to carry insurance. Others, such as Texas, do not require it but recommend it as a business practice. Liability insurance protects the business in the event of litigation. Consider life and disability insurance, health insurance and renters&amp;rsquo; insurance, if you are leasing an office or storefront. FORMS OF BUSINESS OWNERSHIP AND FRANCHISING The Sole Proprietorship The Partnership Corporations Other Forms of Ownership Franchising Types of Franchising The Benefits of Buying a Franchise The Drawbacks of Buying a Franchise Franchising and the Law The Right Way to Buy a Franchise Trends Shaping Franchising Conclusion One of the first decisions an entrepreneur faces when starting a new business is selecting the form of ownership for the new business venture, Too often, entrepreneurs give little thought to

choosing a form of ownership and simply select the form that is most popular, even though it may not suit (heir needs best. Although the decision is not irreversible, changing from one form of ownership to another once a business is up and running can be difficult, expensive, and complicated. That's why it is so important for an entrepreneur to make the right choice at the outset. This seemingly mundane decision can have a significant impact on almost every aspect of a business and its owner(s)-from the taxes the company pays fellow it raises money to the owner's liability for the company's debts and her ability to transfer the business to the next generation. Each form of ownership has its own unique set advantages and disadvantages. The key to choosing the '"right" form of ownership is understanding the characteristics of each one and knowing how they affect an entrepreneur's business and personal circumstances. Although there is no best form of ownership, there may be a form of ownership that is best for each entrepreneur's circumstances. The following are a few considerations that every entrepreneur should review prior to making the final form of ownership choice: Tax considerations. The graduated tax rates under each form of ownership, the government's constant tinkering with the tax code, and the year-to-year fluctuations in a company's income mean that an entrepreneur must calculate the firm's tax bill under each ownership option every year. Liability exposure. Certain forms of ownership offer business owners greater protection from personal liability due lo financial problems, faulty products, and a host of other difficulties. Entrepreneurs must decide the extent lo which they arc willing to assume personal responsibility for their companies' obligations. Start-up capital requirements. Forms of ownership differ in their ability lo raise start-up cap-ital. Depending on how much capital an entrepreneur needs and where she plans to get it, some forms are superior to others. Control, By choosing certain forms of ownership, Lin entrepreneur automatically gives up some control over the company. Entrepreneurs must decide early on how much control they ire willing to sacrifice in exchange for help from other people in building a successful business. Business goals. How big and how profitable an entrepreneur plans for the business to become will influence the form of ownership chosen. Businesses often switch forms of ownership as they grow, but moving from some formats to others can be extremely complex and expensive. Management succession plans. When choosing a form of ownership, business owners must look ahead to the day when they will pass their companies on to the next generation or to a buyer. Some forms of ownership make this transition much smoother than others. Cost of formation. Some forms of ownership, are much more costly and involved to create. An entrepreneur must weigh carefully the benefits and the costs of the particular form he or she chooses. Entrepreneurs have a wide choice of forms of ownership, In recent years, various hybrid forms of business ownership have emerged. This chapter will attempt to outline the key features of the most common forms of ownership, beginning with the sole proprietorship, the partnership, and the corporation THE SOLE PROPRIETORSHIP The sole proprietorship is a business owned and managed by one individual. This form of ownership is by far the most popular. Approximately 73 percent of all businesses in the United States are proprietorships (see Figure 4.1). The Advantages of a ProprietorshipSIMPLE TO CREATE. One of the most attractive features of a proprietorship is how fast and simple it is to begin. If an entrepreneur wants to operate a business under his own name (e.g., Strossner's Bakery), he simply obtains the necessary licenses from state, county, and/or local governments and begins operation! For most entrepreneurs, it would not be impossible to start a proprietorship in a single day.

LEAST COSTLY FORM OF OWNERSHIP TO BEGIN. In addition to being easy to begin, the proprietorship is generally the least expensive form of ownership to establish There is no need to create and file legal documents that are recommended for partnership and required for corporations. An entrepreneur simply, goes to the city or county government, states the nature of the business he will start, and pays the appropriate fees an license costs. Paying these fees and license costs gives the entrepreneur the right to duct business in that particular jurisdiction. Someone planning to conduct business under a trade name should acquire a certified. of doing business under an assumed name from the secretary of state. The fee for filing this certificate usually is nominal. Acquiring this certificate involves conducting a legal search to ensure that the name chosen is not already registered as a trademark or a service ram with the secretary of state. Filing this certificate also notifies the state whom the owner the business is. In a proprietorship, the owner is the business. PROFIT INCENTIVE. One major advantage of the proprietorship is that once the owner pays all of the company's expenses, she can keep the remaining profits (less taxes of course). The profit incentive is a powerful one, and profits represent an excellent way: "keeping score" in the game of the business. TOTAL DECISION-MAKING AUTHORITY. Because the sole proprietor is into] control of operations, she can respond quickly to changes, which is an asset in a rapid shifting market. The freedom to set the company's course of action is a major motivation force. For those who thrive on the enjoyment of seeking new opportunities in business, the freedom of fast, flexible decision making is vital. Sole proprietor Max Gouge of Industrial Propane & Petroleum says, "1 like the feeling of being on my own ... I make this company work." 1 NO SPECIAL LEGAL RESTRICTIONS. The proprietorship is the least regulated form of business ownership. In a time when government requests for information seem neverending, this feature has much merit. EASY TO DISCONTINUE. If the entrepreneur decides to discontinue operations, he can terminate (he business quickly, even though he will still be personally liable for any outstanding debts and obligations that the business cannot pay. The Disadvantages of a Proprietorship UNLIMITED PERSONAL LIABILITY. Probably the greatest disadvantage of a sole proprietorship is the unlimited personal liability of the owner, which means that the sole proprietor is personally liable for all of the business's debts. Remember: In a proprietorship, the owner ii the business. He owns all of the business's assets, and if the business Ms, creditors can force the sale of these assets to cover its debts. If unpaid business debts remain, creditors can also force the sale of the proprietor's personal assets to recover payment. In short, the company's debts are the owner's debts. Laws vary from one state to mother, but most stales require creditors to leave the failed business owner a minimum amount of equity in a home, a car. and some personal items. The reality: Failure of a business can ruin a sole proprietor financially. LIMITED SKILLS AND CAPABILITIES. A sole proprietor may not have the wide range of skills running a successful business requires. Each of us has areas in which our education, training, and work experiences have taught us a great deal; yet there are other areas in which our decisionmaking ability is weak. Many business failures occur because owners lack the skills, knowledge, and experience in areas that are vital to business success. Owners lend to push aside problems they don't understand or don't feel comfortable with in favor of those they can solve more easily. Unfortunately, the problems they set aside seldom solve themselves. By the time an owner decides to ask for help in addressing these problems, it may be too late to save the company. FEELINGS OF ISOLATION. Running a business alone allows an entrepreneur maximum flexibility, but it also creates feelings of isolation that there is no one else to turn to for help in solving problems or getting feedback on a new idea. Lee Gardner, the sole proprietor of a company

that arranges sponsorships for spoiling events, says, '"After 1 set up my company. I realized I was all by myself and responsible for everything. Building a business brick by brick, alone, is not easy." 2 LIMITED ACCESS TO CAPITAL .If the business is to grow and expand, a sole proprietor generally needs additional financial resources. However, many proprietors have already put all they have into their businesses and have used their personal resources as collateral on existing loans, making it difficult to borrow additional funds. A sole proprietorship is limited to whatever capital the owner can contribute and whatever money he can borrow. In short, proprietors, unless they have great personal wealth, find it difficult to raise additional money while maintaining sole ownership. Most banks and other lending institutions have well-defined formulas for determining borrowers' eligibility. Unfortunately, many sole proprietorships cannot meet those borrowing requirements, especially in the early days of business. LACK OF CONTINUITY FOR THE BUSINESS .Lack of continuity is inherent in a sole proprietorship. If the proprietor dies, retires, or becomes incapacitated, the business automatically terminates. Unless a family member or employee can take over (which means that person is now a sole proprietor), the business could be in jeopardy. Because people look for secure employment and an opportunity for advancement, proprietorships, being small, often have trouble recruiting and retaining good employees, If no one is trained to run the business, creditors can petition the courts to liquidate the assets of the dissolved business to pay outstanding debts. Some entrepreneurs find that forming partnerships is one way to overcome the disadvantages of the sole proprietorship. For instance, when one person lacks specific managerial skills or has insufficient access to needed capital, he can compensate for these weaknesses by forming a partnership with someone with complementary management skills or money to invest. THE PARTNERSHIP A partnership is an association of two or more people who co-own a business for the purpose of making a profit. In a partnership, the co-owners (partners) share the business's assets, liabilities, and profits according to the terms of a previously established partnership agreement. The law does not require a partnership agreement (also known as the articles of partnership), but it is wise to work with an attorney to develop one that spells out the exact status and responsibility of each partner. All too often the parties think they know what they arc agreeing to, only to find later that no real meeting of the minds took place. The partnership agreement is a document that states in writing all of the terms of operating the partnership and protects each partner involved. Every partnership should be based on a written agreement. "When two entrepreneurial personalities are combined, there is a tremendous amount of strength and energy, but it must be focused in the same direction, or it will tear the relationship apart," explains one business writer. "A good partnership agreement will guide you through the good times, provide you with a method for handling problems, and serve as the infrastructure for a successful operation." 3 When no partnership agreement exists, the Uniform Partnership Act (UPA) governs a partnership, but its provisions may not be as favorable as a specific agreement hammered out among the partners. Creating a partnership agreement is not costly. In most cases, the partners can discuss each of the provisions in advance. Once they have reached an agreement, an attorney can draft the formal document. Banks will often want to see a copy of the partnership agreement before lending the business money. Probably the most important feature of the partnership agreement is that it resolves potential sources of conflict that, if not addressed in advance, could later result in partnership battles and the dissolution of an otherwise successful business. Spelling out detailsespecially sticky ones such as profit splits, contributions, workloads, decision-making authority, dispute resolution, dissolution, and others-in a written agreement at the outset will help avoid

damaging tension in j partnership that could lead to a business "divorce." Business divorces, like marital ones, are almost always costly and unpleasant for everyone involved. Unfortunately, the tendency for partners just starting out is to ignore writing a partnership agreement as they ride the emotional high of launching a company together. According to one writer, "In the eager, hectic days of startup, when two people com together with a 'brilliant idea, they never imagine that some day, they may not want to lit partners anymore. Instead, their thoughts race to marketing strategies, product develop merit, sales pitches, and customer service."4 The result? Every year, thousands of partners find themselves mired in irreconcilable disputes that damage their businesses because they failed to establish a partnership agreement. Generally, a partnership agreement can include any terms the partners want (unless they are illegal). The standard partnership agreement will likely include the following: 1. Name of Ike partnership. 2. Purpose of the business. What is the reason the business was brought into being? 3. Domicile of the business. Where will the principal business be located? 4. Duration of the partnership. How long will the partnership last? 5. Names of the partners and their legal addresses. 6. Contributions of each partner to the business at the creation of the partnership and later. This would include each partner's investment in the business. In some situations, a partner may contribute assets that are not likely to appeal- on a balance sheet. Experience, sales contacts, or a good reputation in the community may be reasons for asking a person to join in partnership. 7. Agreement on how the profits or losses will be distributed. 8. An agreement on salaries or drawing rights against profits for each partner. 9. Procedure for expansion through the addition of new partners. 10. If the partners voluntarily dissolve the partnership, how will the partnership's assets be distributed? 11. Sale of partnership interest. The articles or partnership should include terms defining how a partner can sell his or her interest in the business. 12. Salaries, draws, and expense accounts for the partners. How much money will each partner draw from the business? Under what circumstances? How often? 13. Absence or disability of one of the partners. If a partner is absent or disabled for an extended period of time, should the partnership continue? Will the absent or disabled partner receive the same share of profits as she did prior to her absence or disability? Should tile absent or disabled partner be held responsible for debts incurred while unable to participate? 14. Dissolution of 'the partnership. Under what circumstances will the partnership dissolve? 15. Alterations or modifications of the partnership agreement. No document is written to last forever. Partnership agreements should contain provisions for alterations or modifications. THE UNIFORM PARTNERSHIP ACT. The Uniform Partnership Act (UPA) codifies lit body of law dealing with partnerships in the United States (except in Louisiana, which has no! adopted the UPA and where state law governs in the absence of a partnership agreement), Under the UPA, the three key elements of any partnership are common ownership interest in a business, sharing the business's profits and losses, and the right to participate in managing the operation of the partnership. Under the act, each partner has the right to: 1. share in the management and operations of the business. 2. share in any profits the business might earn from operations. 3. receive interest on additional advances made to the business. 4. be compensated for expenses incurred in the name of the partnership. 5. have access to the business's books and records.

6. receive a formal accounting of the partnership's business affairs. The UPA also sets forth the partners1 general obligations. Each partner is obligated to: 1. share in any losses sustained by the business. 2. work for the partnership without salary. 3. submit differences that may arise in the conduct of the business to majority vote or arbitration. 4. give the other partner complete information about all business affairs. 5. give a forma! accounting of the partnership's business affairs. Beyond what the law prescribes, a partnership is based above all else on mutual trust and respect. Any partnership missing these elements is destined to fail. The Advantages of the Partnership EASY TOESTABLISH. Like the proprietorship, the partnership is easy and inexpensive to establish. The owners must obtain the necessary business licenses and submit a minimal number of forms. In most states, partners must file a certificate for conducting business as partners if the business is run under a trade name. COMPLEMENTARY SKILLS . In a sole proprietorship, the owner must wear lots of different hats, and not all of them will fit well. In successful partnerships, the parties' skill and abilities usually complement one another, strengthening the company's managerial foundation. Bill Martin and Greg Wright, friends since high school, relied on their complements skills to build a successful partnership, a Web site for investors called Raging Bull Inc. <www.ragingbutl.com>. While still in college, the two decided to combine their passion for investing and the internet into a business. Wright used his computer skills (and those of his college roommate) to work out the operational and technical aspects of creating the Web site, while Martin used his network of connections through an investment club to locale the material for the site 'a contents. Traffic on their site started slowly but began if build over time, ultimately attracting so many users that @ Ventures, a venture capital firm invested $2 million in the start-up company. Today Raging Bull Inc. is a multimilliondollar business thanks to the complementary skills of its founders.5 DIVISION OF PROFITS. There arc no restrictions on how partners distribute the company's profits as long as they are consistent with the partnership agreement and do not viol late the rights of any partner. The partnership agreement should articulate the nature of each partner's contribution and proportional share of the profits. If the partners fail to era ate an agreement, the UPA says that the partners share equally in the partnership's profits, even if their original capital contributions are unequal. LARGER POOL OF CAPITAL. The partnership form of ownership can significant! broaden the pool of capital available to a business. Each partner's asset base improves the business's ability to borrow needed funds; together the partners' personal assets will support a larger borrowing capacity. ABILITY TO ATTRACT LIMITED PARTNERS . When partners share in owning, operating, and managing a business, they are general partners. General partners have unlimited liability for the partnership's debts and usually take an active role in managing the business. Every partnership must have at least one general partner, although there is not limit on the number of general partners a business can have. Limited partners cannot participate in the day-to-day management of a company, and they have limited liability for the partnership's debts. If the business fails, they lose only what they have invested in it and no more, Limited partners usually are just financial investors in a business. A

limited partnership can attract investors by offering them limited liability and the potential to realize a substantial return on their investments if the business is successful. Many individuals find it very profitable to invest in high-potential small businesses, but only if they avoid the disadvantages of unlimited liability while doing so. LITTLE GOVERNMENTAL REGULATION . Like the proprietorship, the partnership form of operation is not burdened with red tape. FLEXIBILITY. Although not as flexible as sole ownership, the partnership can generally BTIquickly to changing market conditions because no giant organization stifles quick and creative responses to new opportunities. TAXATION. The partnership itself is not subject to federal taxation. It serves as a conduit for the profit or losses it earns or incurs; its net income or losses are passed along to the partners as personal income, and the partners pay income tax on their distributive shares. The partnership, like the proprietorship, avoids the "double taxation" disadvantage associated with the corporate form of ownership. The Disadvantages of the Partnership UNLIMITED LIABILITY OF AT LEAST ONE PARTNER . At least one member of every partnership must be a general partner. The general partner has unlimited personal liability, even though he is often the partner with the least personal resources. CAPITAL ACCUMULATION. Although the partnership form of ownership is superior proprietorship in its ability to attract capital, it is generally not as effective as the corporate of ownership, which can raise capital by selling shares of ownership to outside investors. DIFFICULTY IN DISPOSING OF PARTNERSHIP INTEREST WITHOUT DISSOLVING THE PARTNERSHIP. Most partnership agreements restrict how a partner (s) of his share of the business. Often, a partner is required to sell his interest to partner (s). Even if the original agreement contains such a requirement and clearly delineates how the value of each partner's ownership will be determined, there is no guarantee that the other partner (s) will have the financial resources to buy the seller's inter-a When the money is not available to purchase a partner's interest, the other partner (s) may be forced either to accept a new partner, or to dissolve the partnership, distribute the remaining assets, and begin again. When a partner withdraws from the partnership, the partnership ceases to exist unless there are specific provisions in the partnership agreement for a smooth transition. When a general partner dies, becomes incompetent, or withdraws m the business, the partnership automatically dissolves, although it may not terminate. Even when there are numerous partners, if one chooses to disassociate her name from the business, the remaining partners will probably form a new partnership. LACK CONTINUITY. If one partner dies, complications arise. Partnership interest is often nontransferable through inheritance because the remaining partner(s) may not want to be in a partnership with the person who inherits the deceased partner's interest. Partners can make provisions in the partnership agreement to avoid dissolution due to death if all parties agree to accept as partners those who inherit the deceased's interest. POTENTIAL FOR PERSONALITY AND AUTHORITY CONFLICTS. Being in a partnership is much like being in a marriage. Making sure partners' work habits, goals, ethics, and general business philosophy are compatible is an important step in avoiding a nasty business divorce. "People always think you invest in the product or the equipment, but the biggest investment is in the partnership-in each other," says Liz Davidson, who with partner Alex Andrade, runs a successful investment firm in New York City. 6 However, no matter how compatible partners are, friction among them is inevitable. The key is having a mechanism such as a partnership agreement and open lines of communication for controlling it. The demise of many

partnerships can often be traced to interpersonal conflicts and the lack of a procedure to resolve those conflicts. Limited Partnerships A limited partnership, which is a modification of a general partnership, is composed of a] least one general partner and at least one limited partner, in a limited partnership, the general partner is treated, under the law, exactly as in a general partnership. The limited partner is treated more as an investor in the business venture: limited partners have limited liability. They can lose only the amount invested in the business. Most states have ratified the Revised Uniform Limited Partnership Act. The formation of a limited partnership requires its founder to file a certificate of limited partnership in the state in which the limited partnership plans to conduct business. The certificate of limited partnership should include the following information: 1. the name of the limited partnership. 2. the general character of its business. 3. the address of the office of the firm's agent authorized to receive summonses or other legal notices. 4. the name and business address of each partner, specifying which ones are general partners and which are limited partners. 5. the amount of cash contributions actually made, and agreed to be made in the future, by each partner. 6. a description of the value of monkish contributions made or to be made by each partner. 7. the times at which additional contributions are to be made by any of the partners. 8. whether and under what conditions a limited partner has the right to grant limited partner status to an assignee of his or her interest in the partnership. 9. if agreed upon, the time or the circumstances when a partner may withdraw from the firm(unlike the withdrawal of a general partner, the withdrawal of a limited partner does not automatically dissolve a limited partnership). 10. if agreed upon, the amount of, or the method of determining, the funds to be received by a withdrawing partner. 11. any right of a partner to receive distributions of cash or other property from the firm, and the times and circumstances for such distributions. 12. the time or circumstances when the limited partnership is to be dissolved. 13. the rights of the remaining general partners to continue the business after withdrawal of a general partner. 14. any other matters the partners want to include. The general partner has the same rights and duties as under a general partnership: the right to make decisions for the business, to act as an agent for the partnership, to use the property of the partnership for normal business, and to share in the business's profits. The limited partner does not have the right to manage the business in any way. In fact, if he or she takes part in managing the business, a limited partner may actually forfeit limited liability, taking on the liability status of a general partner. Limited partners can, however, make management suggestions to the general partners, inspect the business, and make copies of business records. A limited partner is, of course, entitled to a share of the business's profits as agreed on and specified in the certificate of limited partnership. The primary disadvantage of limited partnership is the complexity and the cost of establishing them. Dogwood Stable of Aiken, South Carolina<www.dogwoodstable.com>, relies on limited partnerships to give sophisticated investors the opportunity to share in the excitement of owning a racehorse. Cot Campbell, owner of Dogwood Stable, reduces the risk of investing in a racehorse by

grouping several horses of different ages, price, and breeding potential into syndicates and then selling shares of ownership in each syndicate to limited partners. Dogwood Stable holds 5 percent of every syndicate as the general partner and sells four 23.75 percent shares to limited partners at prices ranging from $11,000 to $77,000 each. Although only about 10 percent of individual racehorse owners earn a profit each year, investors in limited partnerships such as those offered by Dogwood Stable have a 25 percent chance of at least breaking even. The star of Dogwood Stable's limited partnership so far is Summer Squall, whose winnings and stud fees totaled more than $2.5 million. Limited partners in this syndicate earned many times their original $55,900 investments (although most investors admit that the excitement of the race is the real reason they invest). 7 Limited Liability Partnerships Many states now recognize limited liability partnerships (LLPs) in which all partners in a business are limited partners, having only limited liability for the debts of the partnership. Most states restrict LLPs to certain types of professionals such as attorneys, physicians, dentists, accountants, and others. Just as with any limited partnership, the partners must file a certificate of limited partnership in the state in which the partnership will conduct business, and the partnership must identify itself as an LLP to those with whom it does business. Also, like every partnership, an LLP does not pay taxes; its income is passed through to the limited partners, who pay taxes on their shares of the company's income. Master Limited Partnership A relatively new form of business structure, master limited partnership (MLP), is just like regular limited partnerships, except its shares are traded just like shares of common stock. An MLP provides most of the same advantages to investors as a corporation- including limited liability. One analyst says that a master limited partnership "looks like a corporation, acts like a corporation, and trades on major stock exchanges like a corporation."8 Congress originally allowed MLPs be taxed as partnerships. However, in 1987, it ruled that any MLP not involved in natural resources or real estate would be taxed as a corporation, eliminating their ability to avoid the "double taxation" disadvantages. MLP profits typically must be divided among thousands of partners. CORPORATIONS The corporation is the most complex of the three major forms of business ownership. It is a separate entity apart from its owners and may engage in business, make contracts, sue and be sued, own property, and pay taxes. The Supreme Court has defined the corporation as "an artificial being, invisible, intangible, and existing only in contemplation of the law."9 Because the life of the corporation is independent of its owners, the shareholders can sell their interests in the business without affecting its continuation. Corporations (also known as "C corporations") are creations of the state. When a corporation K founded, it accepts the regulations and restrictions of the state in which it is incorporated and any other state in which it chooses to do business. A corporation doing business in the state in which it is incorporated is a domestic corporation. When a corporation conducts business in another state, that state considers it to be a foreign corporation. Corporations that are formed in other countries but do business in the United States are alien corporations. Generally, the corporation must report annually its financial operations to its home slate's secretary of state. These financial reports become public record. If a corporation's stock is sold in more than one state, the corporation must comply with federal regulation governing the sale of corporate securities. There are substantially more reporting requirements for a corporation than for the other forms of ownership. How to IncorporateMost .states allow entrepreneurs to incorporate without the assistance of an attorney. Sons states even provide incorporation kits lo help in the incorporation process. Although it is cheaper for entrepreneurs to complete the process themselves, it is not always the best idea. In some stale, the application process is complex, and the required forms are confusing. The price for

filing incorrectly can be high. If an entrepreneur completes the incorporation process improperly, it is generally invalid. Once the owners decide to form a corporation, they must choose a state in which! incorporate. If the business will operate within a single state, it is probably most logical! incorporate in (hat stale. States differ-sometimes rather dramatically-in the requirements they place on the corporations they charter and how they treat corporations chartered in other states. They also differ in the tax rate they impose on corporations, the restrictions placed on their activities, the capital required to incorporate, and the fees or organization tax charged to incorporate, Delaware, for instance, offers low incorporate fees and minimal legal requirements. Every state requires a certificate of incorporation or charter to be filed with the secretary) of state. The following information is generally required to be in the certificate of incorporation: The corporation's name. The corporation must choose a name that is not so similar to that of another firm in that stale [hat it causes confusion or lends itself to deception. It must ate include a term such as corporation, incorporated, company, or limited lo notify the public that [hey are dealing with a corporation. The corporation's statement of purpose. The incorporators must stale in general terms the intended nature of the business. The purpose must, of course, be lawful. An illustration might be '"to engage in the sale of office furniture and fixtures." The purpose should be broad enough to allow for some expansion in the activities of the business as it develops. The corporation's time horizon. In must cases, Corporations arc formed with no specific termination date: they are formed "for perpetuity." However, it is possible to incorporate for a specific duration (e.g.. 50 years). Names and addresses of the incorporators. The incorporators must be identified in the articles of incorporation and are liable under the law to attest that all information in the articles of incorporation is correct. In some states, one or more of the incorporators must reside in the stale in which the corporation is being created. Place of business. The street and mailing addresses of the corporation's principal office must be listed. For a domestic corporation, this address must be in the state in which incorporation takes place. Capital stock authorization The articles of incorporation must include the amount and class (or type) of capital stock the corporation wants to be authorized lo issue. This is not the number of shares it must issue: a corporation can issue any number of shares up to the amount authorized. This section must also define the different classifications of stock and any social rights, preferences, or limits each class has. Capital required at the time of incorporation. Some states require a newly formed corporation to deposit in a bank a specific percentage of the stock's par value prior to incorporating. Provisions for preemptive rights, if any, that are granted lo stockholders. Restrictions on transferring shares. Many closely held corporal ions-those owned by a fen shareholders, often family members-require shareholders interested in selling their stock to offer it first to the corporation. (Shares the corporation itself owns arc called treasury stock.) To maintain control over their ownership, many closely held corporations exercise their right, known as the right of first refusal Names and addresses of the officers and directors of the corporation. Rules under which the corporation will operate. Bylaws are the rules and regulations the officers and directors establish for the corporation's internal management and operation.

Once the secretary of state of the incorporating state has approved a request for incorporation and the corporation pays its lees, the approved articles of incorporation become its charter. With the charter in hand, the next order of business is to hold an organizational meeting for the stockholders to formally elect directors who in turn will appoint the corporate officers. The Advantages of the Corporation LIMITED LIAB1LPTY OF STOCKHOLDERS . Because it is a separate legal entity, a Corporation allows investors to limit their liability to the total amount of their investment in the business. This legal protection of personal assets beyond the business is of critical con-am to many potential investors. This shield of limited liability may not be impenetrable, however. Because .start-up companies arc so risky, lenders and other creditors require the owners to personally guarantee loam made to the corporation. Robert Morris Associates, a national organization of bunk loan officers, estimates that 95 percent of small business owners have to sign personal guarantees to gel the financing they need. By making these guarantees, owners are pulling Recent personal assets at risk (just as in a proprietorship) despite choosing the corporate form ownership, recent court decisions have extended the personal liability of small corporation owners beyond the financial guarantees that banks and other lenders require, "piercing the corporate veil" much more than ever before. Increasingly, courts are holding entrepreneurs personally liable for environmental, pension, and legal claims against their corporations-much to the surprise of the owners, who chose the corporate form of ownership to shield themselves from such liability.l0 Problems usually arise when entrepreneurs fail to "maintain the integrity" of a corporation by failing to capitalize it sufficiently, neglecting corporate formalities such as holding annual meetings or filing required reports, or commingling their personal assets and those of the corporation. For example, the owner of a Los Angeles boatyard often paid his personal expenses with checks written on his corporation's Recount. When a customer sued the company and won, the court ruled that the judgment applied not only to the corporation's assets but also to the owner's personal assets because he had failed to keep the two separated. 11 ABILITY TO ATTRACT CAPITAL. Based on the protection of limited liability, corporations have proved to be the most effective form of ownership for accumulating large mounts of capital. Limited only by the number of shares authorized in its charter (which an be amended), the corporation can raise money to begin business and expand as opportunity dictates by selling shares of its stock to investors. A corporation can sell its stock to limited number of private investors (a private placement) or to the public (a public offering). ABILITY TO CONTINUE INDEFINITELY. Unless a corporation fails to pay its taxes is limited to a specific length of life by its charter, it can continue indefinitely. The corporation's existence docs not depend on the fate of any single individual. Unlike a proprietorship or partnership in which the death of a founder ends the business, a corporation lives beyond the lives of those who gave it life. This perpetual life gives rise to the next major advantage-transferable ownership. TRANSFERABLE OWNERSHIP . If stockholders in a corporation are displeased with, the business's progress, they can sell their shares to someone else. Millions of shares of stock representing ownership in companies are traded daily on the world's stock exchanges. Shareholders can also transfer their stock through inheritance to a new generation of owners. During all of these transfers of ownership, the corporation continues to conduct business as usual. Unlike that of large corporations whose shares are traded on organized stock exchanges. the stock of many small corporations is held by a small number of people ("closely held"), often company founders, family members, or employees. The small number of people holding the stock means

that the resale market for shares is limited, which could make the transfer of ownership more difficult. The Disadvantages of Corporations COST AND TIME INVOLVED IN THE INCORPORATION PROCESS. Corporations can be costly and time-consuming to establish. The owners are giving birth to an artificial legal entity, and the gestation period can be prolonged for the novice. In sonic states an attorney must handle the incorporation process, but in most slates entrepreneurs can complete all of the required forms alone. However, an owner must exercise great caution when incorporating without the help of an attorney. Also, incorporating a business requires various fees that are not applicable to proprietorships or partnerships. Creating a corporation can cost between $500 and $2,500, typically averaging around $1,000. DOUBLE TAXATION. Because a corporation is a separate legal entity, it must pay taxes on its net income at the federal level, in most states, and to some local government as well. Before stockholders receive a penny of its net income as dividends, a corporal inn must pay these taxes at the corporate tax rate. Then stockholders must pay taxes on the dividends they receive from these same profits al the individual tax rate. Thus, a corporation's profits are taxed twice. This double taxation is a distinct disadvantage of the corporate form of ownership. POTENTIAL FOR DIMINISHED MANAGERIAL INCENTIVES. As Corporations grow, they often require additional managerial expertise beyond that which the founder can provide. Because she created the company and often has most of her personal wealth tied up in it, the entrepreneur has an intense interest in making it a success and is willing to make sacrifices for it. Professional managers the entrepreneur brings in to help run the business as it grows do not always have the same degree of interest in or loyalty to fat company. As a result, the business may suffer without the founder's energy, care, and dew lion. One way to minimize this potential problem is to link managers' (and even employees') compensation to the company's financial performance through a profit-sharing a bonus plan. Corporations can also stimulate managers' and employees' incentive on the job by creating an employee stock ownership plan (ESOP) in which managers and employee1 become pail or whole owners in the company. LEGAL REQUIREMENTS AND REGULATORY RED TAPE . Corporations are subject to more legal, reporting, and financial requirements than other forms of ownership. Corporate officers must meet more stringent requirements for recording and reporting management decisions and actions. They must also hold annual meetings and consult the board of directors about major decisions that are beyond day-to-day operations. Manage may be required to submit some major decisions to the stockholders for approval Corporations that are publicly held must file quarterly and annual reports with a Securities and Exchange Commission (SEC). POTENTIAL LOSS OF CONTROL BY THE FOUNDER(S). When entrepreneurs sell shares of ownership in their companies, they relinquish some control. Especially when they need large capital infusions for start-up or growth, entrepreneurs may have to give up significant amounts of control, so much, in fact, that the founder becomes a minority shareholder. Losing majority ownership-and, therefore, control-in her company leaves the- founder in a precarious position. She no longer has the power to determine the company's direction; "outsiders" do. In some cases, founders' shares have been so diluted that majority shareholders actually vote them out of their jobs! Even Bill Gales, one of the wealthiest people in the world, has seen his ownership in Microsoft Inc., the company he founded with Paul Allen as a partnership in 1975, dwindle from 50 percent at start-up to 44.8 percent when the company went public in iy86, to 18.5 percent today. Over the years, Gates's ownership in Microsoft was diluted ax he sold stock in the company to raise the capital needed to fuel its rapid growth. Don't feel too sorry for Bill Gates, however. His 18.5 percent stake in the company he cofounded is now worth more than $75 billion dollars! 12

OTHER FORMS OF OWNERSHIP In addition to the sole proprietorship, the partnership, and the corporation, entrepreneurs can choose from other forms of ownership, including the S corporation, the limited Liability company, the professional corporation, and the joint venture. The S Corporation In 1954, the Internal Revenue Service Code created the subchapter S corporation. In recent years, the IRS has changed the title to S corporation and has made a few modifications in its qualifications. An S corporation is only a distinction that is made for federal income tax purposes and is, in terms of legal characteristics, no different from any other corporation. Although Congress recently simplified some of the rules and requirements For S corporations, a business seeking "S" status still must meet the following criteria; 1. It must be a domestic (U.S.) corporation. 2. It cannot have a nonresident alien as a shareholder. 3. It can issue only one class of common stock, which means that all shares must carry the same rights (e.g., the right to dividends or liquidation rights). The exception is voting rights, which may differ. In other words, an S corporation can issue voting and nonvoting common stock. 4. It must limit its shareholders to individuals, estates, and certain trusts, although tax-exempt creations such as employee stock ownership plans (ESOPs) and pension plans can now be shareholders. 5. It cannot have more than 75 shareholders (increased from 35), which is an important benefit for family businesses making the transition from one generation of owners to another. Violating any of these terms automatically terminates a company's "S" status. If a corporation satisfies the definition for an S corporation, the owners must actually elect to be treated as one. The election is made by filing IRS Form 2553 at any time during the year, and all shareholders must consent to have the corporation treated as an S corporation. THE ADVANTAGES OF AN S CORPORATION. The S corporation retains all of the advantages of a regular corporation, such as continuity of existence, transferability of ownership, and limited personal liability for its owners. The most notable provision of the S corporation is that it passes all of its profits or losses through to the individual shareholders, and its income is taxed only once at the individual tax rate. Thus, electing S corporation status avoids a primary disadvantage of the regular (or "C") corporation-double taxation. In essence, the tax treatment of an S corporation is exactly like that of a partnership; its owners report their proportional shares of the company's profits on their individual income tax returns and pay taxes on those profits at the individual rate (even if they never take the money out of the business). Another advantage the S corporation offers is avoiding the lax C corporations pay on assets that have appreciated in value and are sold. Also, owners of S corporations enjoy the ability to make year-end payouts to themselves if earnings are high. In a C corporation, owners have no such luxury because the IRS watches for excessive compensation to owners/managers. One significant change to the laws governing S corporations that benefits entrepreneurs involves subsidiary companies. Before 1998, if an entrepreneur owned separate but affiliated companies, she had to maintain each one as a distinct S corporation with its own accounting records and tax return. Under current law, that business owner can set up all o! these affiliated companies as qualified S corporation subsidiaries ("Q Subs") under the umbrella of a single company, each with its own separate legal identity, and still file a single tax return for the parent company. For entrepreneurs with several lines of businesses, this change means greatly simplified tax filing. Owners also can use losses from one subsidiary company to offset profits from another to minimize their tax bills. "The advent of the Q Sub has made [S corporations! more useful and popular than ever," says one tax expert.13

DISADVANTAGES OF AN S CORPORATION . When the Tax Reform Act (TRA)of 1986 restructured individual and corporate lax rates, many business owners switched to S corporations lo lower their tax bills. For the first time since Congress enacted the federal income tax in 1913, the maximum individual rate was lower than the maximum corporate rate. However, in 1993, Congress realigned the tax structure by raising the maximum personal tax rate to 39.6 percent from 31 percent. This new rate is 4.6 percent higher than the maximum corporate lax rate of 35 percent. Although these changes make S corporation status much less attractive than before, entrepreneurs considering switching to C corporation status must consider the total impact of such a change on their companies, especially if they pay out a significant amount of earnings lo owners. In addition to the tax implications of making the switch from an S corporation, owners should consider the size of the company's net income, the tax rates of its shareholders, plans (and their timing) to sell m company, and the impact of the C corporation's double-taxation penalty on income distributed as dividends. Another disadvantage of the S corporation is that the costs of many fringe benefits-insurance, meals, lodging, and so on-paid to shareholders with 2 percent or more of stop cannot be deducted as business expenses for lax purposes; these benefits are then considered to be taxable income. In addition, S corporations offer shareholders only a limit range of retirement benefits, whereas regular corporations make a wide range of retirement plans available. WHEN IS AN S CORPORATION A WISE CHOICE? Choosing S corporation status is usually beneficial to start-up companies anticipating net losses and to highly profitable firms with substantial dividends to pay out to shareholders. In these cases the owner can use the loss to offset other income or is in a lower tax bracket than the corporation, thus saving money in the long run. Companies that plan to reinvest most of their earnings to finance growth also find S corporation status favorable, Small business owners who intend to sell their companies in the near future will prefer "S" over "C" status because the taxable gains on the sale of an S corporation are generally lower than those of a C corporation. On the other hand, small companies with the following characteristics are not likely to benefit from S corporation status: highly profitable personal service companies with large numbers of shareholders, in which most of the profits are passed on to shareholders as compensation or retirement benefits. fast-growing companies that must retain most of their earnings to finance growth and capital spending. corporations in which the loss of fringe benefits to shareholders exceeds tax savings. corporations in which the income before any compensation to shareholders is less than $100,000 per year. corporations with sizable net operating losses that cannot be used against S corporation earnings. The Limited Liability Company (LLC) A relatively new creation, the limited liability company (LLC) is, like an S corporation, across between a partnership and a corporation, LLCs, however, are not subject to many of the restrictions currently imposed on S corporations and offer more flexibility than S corporations. For example, S corporations cannot have more than 75 shareholders, none of whom can be foreigners or corporations. S corporations are also limited to only one class of stock. LLCs eliminate those restrictions. An LLC must have at least two owners (called "members"), but it offers its owners limited liability without imposing any requirements on their characteristics or any ceiling on their numbers. Unlike a limited partnership, which prohibits limited partners from participating in the day-to-day management of the business, an LLC does not restrict its members' ability to become involved in managing the company.

In addition to offering its members the advantage of limited liability, LLCs also avoid is double taxation imposed on C corporations. Like an S corporation, an LLC does not pay income taxes; its income flows through to the members, who are responsible for paying income taxes on their shares of the LLCs net income. Because they are not subject to lie many restrictions imposed on other forms of ownership, LLCs offer entrepreneurs mot her significant advantage: flexibility. Like a partnership, an LLC permits its members ID divide income (and, thus, tax liability) as they see fit. These advantages make the LLC" an ideal form of ownership for small companies in virtually any industry-retail, wholesale, manufacturing, real estate, or service. Because they offer the tax advantage of a partnership, the legal protection of a corporation, and maximum flexibility. LLCs have become an extremely popular form of ownership among entrepreneurs. For example, Marian Fletcher launched a profitable party planning and catering strike in 1995 as a sole proprietorship. Her company, Let's Go Party, grew quickly, and Fletcher wanted to bring her daughter into the business as an owner. Reviewing the montages and disadvantages of each form of ownership led Fletcher to create an UC "We decided this was the best way to go for us," she says. "In case anything hap-pens daughter and I won't be liable for anything more than what we have invested in the company already." Fletcher, who set up her LLC without the help of an attorney for just $50, also found the LLC's tax treatment to he a major advantage for her and her daughter. 14 Creating an LLC is much like creating a corporation. Forming an LLC requires an entrepreneur to file two documents with the secretary of state: the articles of organization and the operating agreement. The LLC's articles of organization, similar to the corpora lion's articles of incorporation, actually creates the LLC by establishing its name address, its method of management (board managed or member managed), its duration and the names and addresses of each organizer. In most states the company's name mill contain the words "limited liability company," "limited company," or the letters "L.L.C or "L.C." Unlike a corporation, an LLC does not have perpetual life; in most stales LLC's charter may not exceed 30 years. However, the same factors that would cause a partnership to dissolve would also cause the dissolution of an LLC before its charter expires. The operating agreement, similar to a corporation's bylaws, outlines the provision governing the way the LLC will conduct business, such as members' capital contribution to the LLC, the admission or withdrawal of members, distributions from the business, and how the LLC will be managed. To ensure that their LLCs are classified as a partnership for tax purposes, entrepreneurs must draft the operating agreement carefully. The operating agreement must create an LLC that has more characteristics of a partnership than of a corporation to maintain this favorable tax treatment. Specifically, an LLC cannot have an more than two of the following four corporate characteristic: 1. Limited liability. Limited liability exists if no member of the LLC is personally liable for the debts or claims against the company. Because entrepreneurs choosing this form of ownership usually do so to get limited liability protection, the operating agreement almost always contains this characteristic. 2. Continuity of life. Continuity of life exists if the company continues to exist in spite of changes in stock ownership. To avoid continuity of life, any LLC member must have the power to dissolve the company. Most entrepreneurs choose to omit this characteristic from their LLC's operating agreements. 3. Free transferability of interest. Free transferability of interest exists if each LLC member has the power lo transfer his ownership to another person freely and without the consent of other members. To avoid this characteristic, the operating agreement must state that a recipient of a member's LLC stock cannot become a substitute member without the consent of the remaining members. 4. Centralized management. Centralized management exists if a group that does not include all LLC members has the authority to make management decisions and to conduct company business.

To avoid this characteristic, the operating agreement must slate that the company elects lo be "member managed." Despite their universal appeal to entrepreneurs, LLCs suffer some disadvantages. They can be expensive to create, often costing between SI .500 and $5,000. Although an LLC may be ideally suited for an entrepreneur launching a new company, it may pose problems for business owners considering converting an existing business to an LLC. Switching to an LLC from a general partnership, a limited partnership, or a sole proprietorship by reorganizing lo bring in new owners is usually not a problem. However, owners of corporations and S corporations would incur large tax obligations if they convened their companies lo LLCs. To date, the biggest disadvantage of the LLC stems from its newness. As yet, no uniform legislation for LLCs exists (although a Uniform Limited Liability Act is pending at the federal level). Every state now recognizes the LLC as a legal form of ownership. The Professional Corporation Professional corporations arc designed to offer professionals-lawyers, doctors, dentists, accountants, and others-the advantages of the corporate form of ownership. They are ideally suited for professionals, who must always be concerned about malpractice lawsuits, because they offer limited liability. For example, if three doctors formed a professional corporation. none of them would be liable for the others' malpractice. (Of course, each would be liable for her own actions.) Owners create a professional corporation in the same way as a regular corporation. Such corporations are often identified by the abbreviations P.C. (professional corporation), P.A. (professional association), or S.C. (service corporation). YOU BE THE CONSULTANT... Which Form Is Best? Watoma Kinsey and her daughter Katrina arc about to launch a business that specializes in children's parties. Their target audience it, upscale families who want to throw unique, memorable parties to celebrate .special occasions for their children between the ages of 5 and 15. The Kinseys have leased a large building and have renovated it to include many features designed to appeal to kids, including special gym equipment, a skating rink, an obstacle course, a mockup of a pirate ship, a ball crawl, and even a moveable haunted house. They can offer simple birthday parties (cake and ice cream included! or special theme parties as elaborate as the customer wants. Their company will provide magicians, clowns, comedians, jugglers, tumblers, and a variety of other entertainers. Watoma and Katrina have invested $45,000 each to get the business ready to launch. Based on the quality of their business plan and their preparation, the Kinscys have negotiated a $40,000 hank loan. Because they both have families, the Kinseys want to minimize their exposure to potential legal arid financial problems, A large portion of their Start-up costs went to purchase a liability insurance policy to cover the Kinseys in case a child is injured at a party. If their business plan is accurate, the Kinseys will earn a small profit in their first year (about $1,500) and a more attractive profit of $16,000 in their second year of operation. Within five years, they expect their company to generate as much as $50,000 in profits. The Kinseys have agreed to split the profits-and the workload-equally. If the business is as successful as they think it will be, the Kinseys eventually want to franchise their company. That, however, is part of their long-range plan. For now, they want to perfect their business system and prove that it can be profitable before they try to duplicate it in the form of franchises. As they move closer to the launch date for their business, the Kinseys are reviewing the different forms of ownership. 1. Which form(s) of ownership would you recommend to the Kinseys? Explain. 2. Which form(s) of ownership would you recommend the Kinscys avoid! Explain.

3. What factors should the Kinseys consider as they try to choose the form of ownership that is best for them? The Joint Venture A joint venture is very much like a partnership, except that it is formed for a specific, limited purpose. For instance, suppose that you have a 500-acre tract of land 60 miles from Chicago that has been cleared and is normally used in agricultural production. You have a friend who has solid contacts among major musical groups and would like to put on a concert. You expect prices for your agricultural products to be low this summer, so you and your friend form a joint venture for the specific purpose of staging a three-day concert. Your contribution will he the exclusive use of the land for one month, and your friend will provide all tile performers as well as technicians, facilities, and equipment. All costs will be paid out of receipts and the net profits will be split, with you receiving 20 percent for the use of your land. When the concert is over, the facilities removed, and the accounting for all costs completed, you and your friend split the profits 20-80, and the joint venture terminates. In any endeavor in which neither party can effectively achieve the purpose alone, a joint venture becomes a common form of ownership. The "partners" form a new joint venture for each new project they undertake. The income derived from a joint venture is taxed as if it arose from a partnership. Table 4.1 provides a summary of the key features of the major forms of ownership discussed in this chapter. FRANCHISING Franchising has come a long way from its beginnings in the 1850s when the Singer Sewing Machine Company began licensing distributors to sell its sewing machines. Today, approximately 4,500 franchisers operate more than 600.000 franchise outlets throughout the world, and more are opening al an incredible pace. A new franchise opens somewhere in the world every 6.5 minutes! 15 Franchises account for 44 percent of all retail sales, totaling more than $1 trillion, and they employ some 8 million people in more than 100 major industries.16 Much of franchising's popularity stems from its ability to offer those who lack business experience the chance to own and operate a business with a high probability of success. This booming industry has moved far beyond the traditional boundaries of fast food into fields as diverse as maid services and bakeries to computer sales and pet-sitting. In franchising, semi-independent business owners (franchisees) pay fees and royalties lo a parent company (franchiser) in return for the right to become identified with its trademark, to sell its products or services, and often to use its business format and system. Franchisees do not establish their own autonomous businesses; instead, they buy a "success package" from the franchiser, who shows them how lo use it. Franchisees, unlike independent business owners, don't have the freedom to change the way they run their businesses-for example, shifting advertising strategies or adjusting product lines-but they do have a formula for success that (he franchiser has worked out. "The secret (o success in franchising is following the formula precisely," says one writer. "Successful franchisers claim that neglecting to follow the formula is one of the chief reasons that franchisees fail"17 Anita Schlachter, co-owner of a highly successful Maaco (automotive services) franchise with her husband and her son, is convinced that the system the franchiser taught them is the key lo their company's progress and growth to date. The Schlachters follow the franchiser's plan, using it as a road map to success. "If you listen to what your franchiser says and fallow its policies and procedures, you'll be successful," she says. "Those who think they know more should not go into franchising." 18 Franchising is based on a continuing relationship between a franchiser and a franchisee. The franchiser provides valuable services such as market research, a proven business system, name recognition, and many other forms of assistance; in return, the franchisee pays an initial franchise

fee as well as an ongoing percentage of his sales to the franchiser as royalties and agrees to operate his outlet according to the franchiser's system. Because franchisers develop the business systems their franchisees use and direct their distribution methods, they maintain substantial control over their franchisees. This standardization lies at the core of franchising's success as a method of distribution. TYPES OF FRANCHISING There are three basic types of franchising; trade-name franchising, product distribution franchising, and pure franchising. Trade-name franchising involves a brand name such as True Value Hardware or Western Auto. Here the franchisee purchases the right to use the franchiser's trade name without distributing particular products exclusively under the franchiser's name. Product distribution franchising involves a franchiser's licensing a franchisee to sell specific products under the franchiser's brand name and trademark through a Selective, limited distribution network. This system is commonly used to market automobiles (Chevrolet, Oldsmobile, Chrysler), gasoline products (ExxonMobil, Sunoco, Texaco), soft drinks (Pepsi-Cola, Coca-Cola), bicycles (Schwinn), appliances, cosmetics, and other products. These two methods of franchising allow franchisees to acquire some of the parent company's identity. Pure (or comprehensive or business format) franchising involves providing the franchisee with a complete business formal, including a license for a trade name, the products or services to be sold, the physical plant, the methods of operation, a marketing strategy plan, a quality control process, a two-way communications system, and the necessary business services. The franchisee purchases the right lo use all the elements of a fully integrated business operation. Pure franchising is the most rapidly growing of all types of franchising and is common among fast-food restaurants, hotels, business service firms, car rental agencies, educational institutions, beauty aid retailers, and many others. Although product and trade-name franchises annually ring up more sales than pure franchisees, pure franchising outlets' sales arc growing much faster. THE BENEFITS OF BUYING A FRANCHISE A franchisee gets the opportunity lo own a small business relatively quickly, and, because of the identification with an established product and brand name, a franchise often reaches the breakeven point faster than an independent business would. Still, most new franchise outlets don't break even for at least six to eighteen months. Franchisees also benefit from the franchiser's business experience. In fact.experience is the essence of what a franchisee is buying from a franchiser. Many entrepreneurs go into business by themselves and make many costly mistakes, Given the thin margin for error in the typical start-up, a new business owner cannot afford In make many mistakes. In a franchising arrangement, the franchiser already has worked out the kinks in the system by trial and error, and franchisees benefit from that experience. A franchiser has climbed up the learning curve and can share with franchisees the secrets of success they have discovered in the industry. Gary Mandichak, owner of a successful Petland franchise, says, "[Franchisers! have the experience they know what works and what doesn't, and they know what's happening in the market."19 Franchisees also earn a great deal of satisfaction from their work. According to a recent Gallup survey of franchise owners, 82 percent of franchisees said they were "'somewhat satisfied" to "very satisfied" with their work.Plus. 75 percent said they would purchase their franchises again if given the opportunity (compared to just 39 percent of Americans who say they would choose the same job or business again).20 Another survey reported that 94 percent of franchise owners rated their operations as "very successful" or "successful."21 Before jumping at a franchise opportunity, an entrepreneur should consider careful!} the question, "What can a franchise do for me that 1 cannot do for myself7" The answer lo this question will depend on the particular situation and is not as important as the systematic evaluation of the franchise opportunity. After careful deliberation, one person ma;1 conclude that the franchise

offers nothing that she could not do independently, and another may decide that a franchise is the key to success as a business owner. Franchisees often cite the following advantages that are discussed next. Management Training and Support Recall from Chapter I that one of the leading causes of business failure is incompetent management. Franchisers are well aware of this and, in an attempt to reduce the number of franchise casualties, offer managerial training programs to franchisees prior to opening a new outlet Many franchisers, especially the well-established ones, also provide follow-up training and counseling services. This service is vital since most franchisers do not require a franchisee to have experience in the business. These programs teach franchisees the details they need to know for day-to-day operations as well as the nuances of running their businesses successfully, Training programs often involve both classroom and on-site instruction to leach franchisees the basic operations of the business. Before beginning operations, McDonalds franchisees spend 14 days in Illinois at Hamburger University where they learn everything from how lo scrape the grill correctly to "how to manage a $1.6 million business.'"22 Maaco franchisees spend four weeks at (he company's headquarters delving into a five-volume set operations manuals and learning to run an auto services shop. H & R Block trains it? franchisees to unravel the mysteries of tax preparation, whereas Dunkin' Donuts trains a franchisee for as long as live weeks in everything from accounting to dough making. To ensure franchisees' continued success, many franchisers supplement their start-up training programs with ongoing instruction and support. Franchisers offer these training programs because they realize that their ultimate success depends on the franchisee's success. Despite the positive features of training, inherent dangers exist in the trainer/trainee relationship. Every would-be franchisee should be aware that, in some cases, "assistance" from the franchiser tends to drift into "control" over the franchisee's business. Some franchisers also charge fees for their training services, so the franchisee should know exactly what she is agreeing to and what it costs. Brand-Name Appeal A licensed franchisee purchases the right lo use a nationally known and advertised brand name for a product or service. Thus, the franchisee has the advantage of identifying his business with a widely recognized trademark, which usually provides a great deal of drawing power. Customers recognize the identifying trademark, the standard symbols, the store design, and the products of an established franchise. Indeed, one of franchising's basic tenets is cloning the franchiser's success. For example, nearly everyone is familiar with the golden arches of McDonald's or the red roof of the Red Roof Inn, and the standard products and quality offered at each. A customer is confident that the quality and content of a meal at McDonald's in Fort Lauderdale will be consistent with a meal at a San Francisco McDonald's. "It's a tremendous advantage to open a business with a recognizable trademark that creates almost instant foot traffic," says franchise attorney and expert Andrew Caffey.'23 Standardized Quality of Goods and Services Because a franchisee purchases a license to sell the franchiser's product or service and the privilege of using the associated brand name, the quality of the goods or service sold determines the franchiser's reputation. Building a sound reputation in business is not achieved quickly, although destroying a good reputation lakes no lime at all. If some franchisees were allowed to operate at substandard levels, the image of the entire chain would suffer irreparable damage; therefore, franchisers normally demand compliance with uniform standards of quality and service throughout the entire chain. In many cases, the franchiser conducts periodic inspections of local facilities to

assist in maintaining acceptable levels of performance. For instance, John Schnatter, founder of Papa John's, a fast-growing pizza franchise, makes personal visits to some of his franchisees' stores four to five times each week tomake sure they are performing up to the company's high-quality standards. Franchisees say that Schnatter, known for his attention to detail, often checks pizzas for air bubbles in the crust or tomato sauce for freshness. "Pizza is Schnatter's life, and he takes it very seriously," says one industry analyst. 24 Maintaining quality is so important that most franchisers retain the right to terminate the franchise contract and to repurchase the outlet if the franchisee fails to comply with established standards. National Advertising Programs An effective advertising program is essential to the success of virtually all franchise operations. Marketing a brand-name product or service over a wide geographic area requires! far-reaching advertising campaign. A regional or national advertising program benefits all franchisees. Normally, such an advertising campaign is organized and controlled by [hi franchiser. It is financed by each franchisee's contribution of a percentage of monthly sales, usually 1 to 5 percent, or a flat monthly fee. For example. Subway franchisees must pay 3.5 percent of gross revenues lo the Subway national advertising program. These funds are pooled and used for a cooperative advertising program, which has more impact than if the franchisees spent the same amount of money separately. Many franchisers also require franchisees 10 spend a minimum amount on local advertising. To supplement their national advertising efforts, both Wendy's and Burger Kin; require franchisees to spend at least 3 percent of grass sales on local advertising. Sore franchisers assist each franchisee in designing and producing its local ads. Many companies help franchisees create promotional plans and provide press releases and advertisements for grand openings. Financial Assistance Because they rely on their franchisees' money to grow their businesses, franchisers typically do not provide any extensive financial help for franchisees. Franchisers rarely make loans to enable franchisees to pay the initial franchise fee. However, once a franchiser locates a suitable prospective franchisee, it may offer the qualified candidate direct financial assistance in specific areas, such as purchasing equipment, inventory, or even the franchise fee. Because the start-up costs of some franchises ar already at breathtaking levels, some franchisers find that they must offer direct financial assistance. For example, US Franchise Systems, franchiser of Microtel Inn and Hawthorn Suits hotels, has set up a subsidiary, US Funding Corporation, that makes available to its franchisees $200 million in construction and mortgage financing. Not only has the in-house financing program cut the lime required to open a new hotel franchise, hut it also has accelerated the franchise's growth rate.25 Nearly half of the International Franchise Association's members indicate that they offer some type of financial assistance to their franchises; however, only one-fourth off: direct financial assistance. In most instances, financial assistance from franchisers takes form other than direct loans, leases, or short-term credit. Franchisers usually arc willing! assist qualified franchisees in establishing relationships with banks, private investors, and other sources of funds. Such support and connections from the franchiser enhance a franchisee's credit standing because lenders recognize the lower failure rate among establish franchises. Preferred relationships between lenders and franchisers can be critical because finding financing for a franchise can be challenging, just like attracting capital for any business start-up. For instance, when Jana Sappenfield began searching for $1.6 million of the $l.9 million needed to purchase a Primrose School franchise, the franchiser helped her connect with Newcourt/AT&T, a Small Business Administration-certified lender that has established preferred relationships with

about 25 different franchised companies. "They were familiar with Primrose," says Sappenfield, "so no time was wasted researching or approving the franchiser." Because Primrose School had already accepted Sappenfield's application for a franchise, her loan request sailed easily through Newcourl/AT&T's approval process, "We know the leadership and have an understanding of the selection criteria at the franchises we work with regularly," says a top executive at Newcourt/AT&T. "Consequently, when an approved loan application comes in from a [preferred franchise], wears certain the candidate is qualified." Sappenfield's first Primrose School franchise was so successful that she has since purchased a second one.26 Proven Products and Business FormatsWhat a franchisee essentially purchases is a franchiser's experience, expertise, and products. A franchise owner does not have to build the business from scratch. Instead of being forced to rely solely on personal ability to establish a business and attract a clientele, a franchisee can depend on the methods and techniques of an established business. These standardized procedures and operations greatly enhance the franchisee's chances of success and avoid the most inefficient type of learning-trial and error. With a franchise, a franchisee docs not have to struggle for recognition in the local marketplace as much as an independent owner might. Kenneth Gabler's independent video rental store had the largest share of the local market when his landlord leased space in the same shopping center to a nationally known video franchise. West Coast Video. When he discovered that the unit was company owned, Gabler offered to buy it. "I figured that if I stayed an independent and tried 10 compete, West Coast would take away 30 percent of my business anyway. So it was cheaper for me to pay the $15,000 initial fee and a 7 percent royalty every month," he says. West Coast Video's broader tape selection, marketing techniques, and recognized name "have helped tremendously," according to Gabler. Since he converted his business to a franchise, Gabler's sales have tripled! 27 Centralized Buying Power A significant advantage a franchisee has over an independent small business owner is participation in the franchiser's centralized and large-volume buying power. If franchisers sell goods and supplies to franchisees (not all do), they may pass on to franchisees any cost savings from quantity discounts they earn by buying in volume. For example, it is unlikely that a small, independent ice cream parlor could match the buying power of Baskin-Robbins, with its 3,000-plus retail ice cream stores. In many instances, economies of scale simply preclude the independent owner from competing head-to-head with a franchise operation. Site Selection and Territorial Protection A proper location is critical to the success of any small business, and franchises are no exception. In fact, franchise experts consider the three most important factors in franchising to be location, location, and location. Becoming affiliated with a franchiser may he the best way to get into prime locations. Many franchisers will make an extensive location analysis for each new outlet, including researching traffic patterns, zoning ordinances, accessibility, and population density. McDonald's, for example, is well known for its ability to obtain prime locations in high-traffic areas. Although choosing] location is the franchisee's responsibility, the franchiser usually reserves the right to approve the final site. Choosing a suitable location requires a location analysis, including studies of traffic patterns, zoning ordinances, accessibility, population density, and demographics. Some franchisers offer franchisees territorial protection, which gives existing franchisees the right to exclusive distribution of brand-name goods or services within a particular geographic urea. A clause establishing such a protective zone that bars other outlet from the same franchise gives franchisees significant protection and security. The size of j franchisee's territory varies from industry to industry. For example, one national fast-foot restaurant agrees not to license another franchisee within 1.5' miles of existing locations. But one soft-serve ice cream franchiser defines its franchisees' territories on the basis of zip code designations. The purpose of such protection is

to prevent an invasion of the existing franchisee's territory and the accompanying dilution of sales. As existing markets has become increasingly saturated with franchise outlets, the placement of new outlets hi become a source of friction between franchisers and franchisees. Existing franchisee; charge that franchisers are encroaching on their territories by granting new franchises K close to them that their sales are diluted. Although most franchises offer their franchise;! some type of territorial protection, the contract of one popular submarine sandwich company offers no such protection and stales that the franchiser may compete with its franchisees, even if it "adversely affects" their sales.28 Greater Chance for Success Investing in a franchise is not risk free. Between 200 and 300 new franchise companies enter the market each year, and not all of them survive. But available statistics suggest that franchising is less risky than building a business from the ground up. One expert says that "becoming a franchisee can be the safest way to scratch the entrepreneurial itch." 29 Approximately 24 percent of new businesses fail by the second year of operation; in contrast. only about 7 percent of all franchises will fail by the second year. After six years, 85 percent of franchises are still in business compared to just 50 percent of independent businesses.30 This impressive success rate for franchises is attributed to the broad range of Services, assistance, and guidelines the franchiser provides. These statistics must be interpreted carefully, however, because when a franchise is in danger of failing, the franchise often repurchases or relocates the outlet and does not report it as a failure. As a result, soil] franchisers boast of never experiencing a failure. According to the American Hi Association's Franchise Committee, one-third of the franchisees in a typical franchise SB tem are making a decent profit, one-third are breaking even, and one-third are losing money. 31 The risk of purchasing a franchise is two-pronged: success-or failure-depends on the entrepreneur's managerial skills and motivation and on the franchiser's business experience and system. Many owners are convinced that franchising has been a crucial part: their success. "It's the opportunity to be in business for yourself but not by yourself." says one franchiser.32 THE DRAWBACKS OF BUYING A FRANCHISE Obviously, the benefits of franchising can mean the difference between success and failure for a small business. However, the franchisee must sacrifice some freedom to the franchiser. The prospective franchisee must explore other limitations of franchising before undertaking this form of ownership. Franchise Fees and Profit Sharing Virtually all franchisers impose sonic type of fees and demand a share of the franchisee's sales revenues in return for the use of the franchiser's name, products or services, and business system. The fees and the initial capital requirements vary among the different franchisers. The Commerce Department reports that total investments for franchises range from $1,000 for business services up lo $10 million for hotel and motel franchises. For example, H & R Block requires a capital investment of $2,000 lo $3,000, and the Atlanta Bread Company estimates the total cost of opening a franchise lo range from 5362,000 to $584,000, depending on the size and location of the outlet, A McDonald's franchise requires an investment of $408,600 to $647,000 (but McDonald's owns the land and the building). The average start-up cost for a franchise is between $150,000 and $200,000. 33Start-up costs for franchises often include numerous additional fees. Most franchises impose a franchise fee up front for the right to use the company name. Other start-up costs might include site purchase and preparation, construction, signs, fixtures, equipment, management assistance, and training. Some franchise fees include these costs, whereas others do not. Fur example, Closets by Design, a company that designs and installs closet- and garage-organizers, entertainment centers, and home office systems, charges a franchise fee ranging from $19,500 to

$34,900.which includes both a license for an exclusive territory and management training and support. Before signing any contract, a prospective franchisee should determine the total cost of a franchise, something every franchiser is required to disclose in item 10 of its Uniform Franchising Offering Circular (see "Franchising and the Law" on page 128). Franchisers also impose continuing royalty fees as pro fit-sharing devices. The royalty usually involves a percentage of gross sales with a required minimum, or a flat fee levied on the franchise. Royalty fees range from 1 percent to 11 percent, although most franchises assess a rate between 3 percent and 7 percent. The Atlanta Bread Company, for example, charges franchisees a royally of 5 percent of gross sales, which is payable weekly. These ongoing royalties can increase a franchisee's overhead expenses significantly. Because the franchiser's royalties and fees are calculated as a percentage of a franchisee's sales, the franchiser gets paid-even if the franchisee fails to earn a profit. Sometimes unprepared franchisees discover (too late) that a franchiser's royalties and fees are the equivalent of the normal profit margin for a franchise. To avoid such problems, a prospective franchisee should find out which fees are required (some are merely recommended) and then determine what services and benefits the fees cover. One of the best ways to do this is to itemize what you are getting for your money, and then determine whether the cost corresponds to [he benefits provided. Be sure to gel the details on all expenses-amount, time of payment, and financing arrangements; find out which items, if any, arc included in the initial franchise fee and which ones are "extra." Strict Adherence to Standardized Operations Although the franchisee owns the business, she does not have the autonomy of an independent owner. To protect its public image, the franchiser requires that the franchisee maintain certain operating standards. If a franchise constantly fails to meet the minimum standards established for the business, the franchiser may terminate its license. Determining compliance with standards is usually accomplished by periodic inspections. At times, strict adherence to franchise standards may become a burden lo the franchisee. The owner may believe dial the written reports the franchiser demands require an excessive amount of time. In other instances, the owner may be required to enforce specific rules she believes arc inappropriate or unfair. Restrictions on Purchasing In the interest of maintaining quality standards", franchisees may be required to purchase products, special equipment, or other items from the franchiser or from an "approved'" supplier. For example, Kentucky Fried Chicken requires that franchisees use only seasoning blended by a particular company because a poor image could result from franchisees using inferior products to cut costs. Under some conditions, such purchase arrangements may b challenged in court as a violation of antitrust laws, but generally, franchisers have a legs right to see that franchisees maintain acceptable quality standards. Franchisees at seven chains have Tiled antitrust suits alleging that franchisers overcharge their outlets for sup plies and equipment and eliminate competition by failing to approve alternative suppliers.34 A franchiser may legally set the prices paid for the products it sells but may not establish the retail prices to be charged on products sold by the franchisee. A franchiser ca suggest retail prices for franchisee's products and services but cannot force the franchise to abide by them. Limited Product Line In most cases, the franchise agreement stipulates that the franchise can sell only those products approved by the franchiser. Unless willing to risk license cancellation, a franchisee must avoid selling any unapproved products through the franchise.

A franchise may be required to carry an unpopular product or be prevented from introducing a desirable one by the franchise agreement. A franchisee's freedom to adapt a product line to local market conditions is restricted. However, some franchisers solicit product suggestions from their franchisees. In fact, a McDonald's franchisee. Herb Peterson, created the highly successful Egg McMuffin while experimenting with a Teflon-coated egg ring that gave fried eggs rounded' corners and a poached appearance, Peterson put his round eggs on English muffins, adorned them with Canadian bacon and melted cheese, and showed his creation to McDonald's elm Ray Kroc. Kroc devoured two of them and was sold on the idea when Peterson's wife suggested the catchy name. In 1975, McDonald's became the first fast-food franchise to open its doors for breakfast, and the Egg McMuffin became a staple on the breakfast menu. 35 Unsatisfactory Training Programs Every would-be franchisee must be wary of the Unscrupulous franchiser who promise extensive services, advice, and assistance but delivers nothing. For example, one owner relied on the franchiser lo provide what had been described as an "extensive, rigorous training program" after paying a handsome technical assistance fee. The program was nothing but an of pamphlets and doit-yourself study guides. Other examples include those impatient entrepreneurs who paid initial franchise fees without investigating the business and never ton' from the franchiser again. Although disclosure rules have reduced the severity of the problem, dishonest characters still thrive on unprepared prospective franchisees. Market Saturation As the owners of many fast-food and yogurt and ice cream franchises have discovered, mark saturation is a very real danger. Although some franchisers offer franchisees territorial protection, others do not. Territorial encroachment has become a hotly contested issue in franchising as growth-seeking franchisers have exhausted most of the prime locations and are now setting up new franchises in close proximity to existing ones. In some areas of the country, franchisees are upset, claiming that their markets are oversaturated and their sales are suffering. Less Freedom When franchisees sign a contract, they agree to sell the franchiser's product or service by following its prescribed formula. This feature of franchising is the source of the system's success, but it also gives many franchisees the feeling that they are reporting to a "boss." Franchisers want lo ensure success, and most monitor their franchisees' performances closely lo make sure franchisees follow the system's specifications. Strict uniformity is the rule rather than the exception. '"There is no independence. Successful franchisees are happy prisoners," says one writer. Entrepreneurs who want to be their own bosses often are disappointed with a franchise. "I've seen too many people buy a franchise, and the reason they're unsuccessful is that they think they have a better idea how to run that McDonald's than McDonald's has," says one franchising expert.37 Highly independent, "go-my-own-way" individuals probably should not choose the franchise route to business ownership. Table 4.2 describes ten myths of franchising. Myth#I. Franchising is the safest way to go into business because franchises never fail. Although the failure rate for franchises i5 lower than that of independent businesses, there are ho guarantees d success. Franchises can-and do-fail. Potential franchisees must exercise the same degree of caution in judging the risk of a franchise as the/ would any other business. Myth #2. I'll be able to open my franchise for less money than the franchiser estimates. Launching a bunching a business, including a franchise, normally takes more money and more time than entrepreneurs estimate. Be prepared. One franchisee of a retail computer store advises," If a franchiser tells you you'll need $ 100,000 to get started, you better have $ 150,000."

Myth #3. The bigger the franchise organization, the more successful I'll be. Bigger is not always better in the franchise industry. Some of the largest franchise operations are struggling to maintain their growth rates because the best locations arc already taken. Market saturation is a significant problem for many large franchises, and smaller franchises are accounting for much of the growth in the industry. Myth #4. I'll use 80 percent of the franchiser's business system, but I'll improve on it by substituting my experience and know-how. When franchisees buy a franchise, they are buying, in essence, the franchiser's experience and know-how. Why pay all of that money to a franchiser if you aren't willing to use their system? Myth #5. All franchises are the same. Each franchise has its own unique requirements, procedures, and culture. Naturally, some will suit you better than others. Avoid the tendency to select the franchise offering the lowest cost; ask the franchiser and existing franchisees lots of questions to determine whether you'll be comfortable in that system. Myth #6. I don't have to be a "hands-on" manager. I can be an absentee owner and still be very successful. Most franchisers shy away from absentee owners. They know that franchise success requires lots of hands-on attention, and the owner is the best person to provide that requires lots of hands-on attention, and the owner is the best person to provide that. Myth #7. Anyone can be a satisfied, successful franchise owner. With more than 4,500 franchises available, the odds of finding a franchise that appeals to your tastes is high. However, not everyone is cut out to be franchisee. Those "free spirits" who insist on doing things their way will most likely be miserable in a franchise. Myth #8. Franchising is the cheapest way to get into business for yourself. Although bargains do exist in franchising, the price tag for buying into some systems is breathtaking, sometimes running into several hundreds of thousands of dollars. Franchisers look for candidates who are on solid financial footing. Myth #9. The franchiser will solve my business problems for me; after all, that's why I pay an ongoing royalty. Although franchisers offer franchisees start-up and ongoing training programs, they will nor run their franchisees businesses for them. Your job is to take the formula that the franchiser has developed and make it work in your location. Expect to solve many of your own problems. Myth #10. Once I open my franchise, I'll be able to run things the way I want to. Franchisees are not free to run their businesses any way they see fit. Every franchisee signs a contract that requires him or her to run the business according to the franchiser's requirements. Franchisees who violate the terms of chat agreement run the risk of having their franchise relationship cancelled. FRANCHISING ANDTHE LAW The franchising boom spearheaded by McDonald's and others in the late 1950s brought with it many prime investment opportunities. However, the explosion of legitimate franchises also ushered in with it numerous fly-by-night franchisers who defrauded their franchisees. In response to these specific incidents and to the potential for deception inherent in a franchise relationship, California in 1971 enacted the first Franchise Investment Law. The law (and those of 16 other states that have since passed similar laws) requires franchisers to register a Uniform Franchise Offering Circular (UFOC) and deliver a copy to prospective franchisees before any offer or sale of a franchise. The UFOC establishes full disclosure guidelines for any company selling franchises. In October 1979, the Federal Trade Commission (FTC) enacted the Trade Regulation Rule, requiring all franchisers to disclose detailed information on their operations at the first personal meeting, or at least 10 days before a franchise contract is signed, or before any money is paid. The FTC rule covers all franchisers, even those in the 33 states lacking franchise disclosure laws. The purpose of the regulation is to assist the potential franchisee's investigation of the franchise deal

and to introduce consistency into the franchiser's disclosure statements. In 1994, the FTC modified the requirements for the UFOC, making more information available to prospective franchisees and making the document: shorter and easier to read and understand. The FTC's philosophy is not so much to prosecute abusers as to provide information to prospective franchisees and help them make intelligent decisions. Although the FTC requires each franchiser to provide a potential franchisee with this information, it does not verify its accuracy. Prospective franchisee! should use these data only as a starting point for the investigation. The Trade Regulation Rule requires a franchiser to include 23 major topics in its disclosure statement: 1. Information identifying the franchiser and its affiliates and describing their business experience and the franchises being sold. 2. Information identifying and describing the business experience of each of the franchiser! officers, directors, and management personnel responsible for the franchise program. 3. A description of the lawsuits in which the franchiser and its officers, directors, and managers have been involved. Although most franchisers will have been involved in some type of litigation, an excessive number of lawsuits, particularly if they relate to the same problem, is alarming. "The history of the litigation will tell you the future of your relationship [with the franchiser]," says the founder of a maid-service franchise.38 4. Information about any bankruptcies in which the franchiser and its officers, directors, and managers have been involved. 5. Information about the initial franchise fee and other payments required to obtain the franchise, including the intended use of the fees. Initial fees typically range from $10,000 to $30,000. 6. A description of any continuing payments franchisees arc required to make after start-up, including royalties, service fees, training fees, lease payments, advertising or market! charges, and others. 7. A detailed description of the payments a franchisee must make to fulfill the initial investment requirement and how and Lo whom they are made. The categories covered are the initial franchise Ice, equipment, opening inventory, initial advertising fee, signs, training, teal estate, working capital, legal, accounting, and utilities. These estimates, usually stated in the form of a range of numbers, give prospective franchisees an idea of how much their total start-up costs will be. 8. Information about quality restrictions on goods, services, equipment, supplies, inventory, and other items used in the franchise and where franchisees may purchase them, including restricted purchases from the franchiser. 9. A statement (in tabular form) of the franchisee's obligations under the franchise contract, including items such as selecting a site, paying fees, maintaining quality standards, keeping records, transferring or renewing the franchise relationship, and others. 10. A description of any financial assistance available from the franchiser in the purchase of the franchise. 11. A description of all obligations the franchiser must fulfill in helping a franchisee prepare to open and operate a unit. Plus, information covering location selection methods and the training program provided to franchisees. In addition lo the training they provide new franchisees, many franchisers offer help with a grand opening for each outlet and on-site management assistance for a short time to get franchisees started. 12. A description of any territorial protection that will be granted lo the franchise and a statement as to whether the franchiser may locate a company-owned store or other outlet in that territory. 13. All relevant information about the franchiser's trademarks, service marks, trade names, logos, and commercial symbols, including where they arc registered. Look for a strong trademark or service mark that is registered with the U.S. Patent and Trademark Office. 14. Similar information on any patents and copyrights the franchiser owns, and the rights to these transferred to franchisees.

15. A description of the extent lo which franchisees must participate personally in the operation of the franchise. Many franchisers look for "hands-on'' franchisees and discourage "absentee owners." 16. A description of any restrictions on the goods or services franchises are permitted to sell and with whom franchisees may deal. The agreement usually restricts franchisees to selling only those items approved by the franchiser. 17. A description of the conditions under which the franchise may be repurchased or refused renewal by the franchiser, transferred to a third party by the franchisee, and terminated or modified by either party. This section also addresses the method established for resolving disputes. 18. A description of the involvement of celebrities and public figures in the franchise. 19. A complete statement of the basis for any earnings claims made lo the franchisee, including the percentage of existing franchises that have actually achieved the results that are claimed. New rules put two requirements on franchisers making earnings claims: (a) Any earnings claim must be included in the UFOC, and (b) the claim must "have a reasonable basis at the lime it is made." However, franchisers are not required to make any earnings claims at all; in fact, only about 25 percent of franchisers make earnings claims in their circulars, primarily because of liability concerns about committing such numbers to paper. 39 20 Statistical information about the present number of franchises; the number of franchises projected for the future: the number of franchises terminated: the number the franchiser has not renewed; the number repurchased in the past; and a list of the names and addresses (organized by state) of other franchisees in the system. 21. The franchiser's financial statements. 22. A copy of all franchise and other contracts (leases, purchase agreements, etc.) the franchisee will be required to sign. 23. A standardized, detachable "receipt" to prove that the prospective franchisee received a copy of the UFOC. The information contained in the UFOC does not fully protect a potential franchise from deception, nor does it guarantee success. It does, however, provide enough information to begin a thorough investigation of the franchiser and the franchise deal. THE RIGHT WAY TO BUY AFRANCHISE The UFOC is a powerful tool designed to help would-be franchisees select the franchise that is right for them and to avoid being duped by dishonest franchisers. The best defenses a prospective entrepreneur has against unscrupulous franchisers are preparation, common sense, and patience. By investigating thoroughly before investing in a franchise, a potential franchisee minimizes the risk of being hoodwinked into a nonexistent business. Asking the fight questions and resisting the urge to rush into an investment decision helps a potential franchisee avoid being taken by unscrupulous operators. Potential franchisees must beware because franchise fraud still exists in this rapidly growing field. A recent conference of state securities regulators named "illegal franchise, offers" as one of the top I0 financial frauds in the United States? The president of one franchise consulting firm estimates that 5 to 10 percent of franchisers are dishonest--"the rogue elephants of franchising." Dishonest franchisers tend to follow certain patterns, and well-prepared franchisees who know what to look for can avoid trouble. The following clues should arouse the suspicion of an entrepreneur about to invest in a franchise: Claims that the franchise contract is a standard one and that "you don't need to read it." A franchiser who fails to give you a copy of the required disclosure document at your first faceto-face meeting. A marginally successful prototype store or no prototype at all. A poorly prepared operations manual outlining the franchise system or no manual (or system) at all.

 Oral promises of future earnings without written documentation. A high franchisee turnover rate or a high termination rate. An unusual amount of litigation brought against the franchiser. Attempts to discourage you from allowing an attorney to evaluate the franchise contract before you sign it. No written documentation to support claims and promises. A high-pressure sale--sign the contract now or lose the opportunity. Claiming to be exempt from federal laws requiring complete disclosure of franchise details. "Get-rich-quick schemes," promises of huge profits with only minimum effort. Reluctance to provide a list of present franchisees for you to interview. Evasive, vague answers to your questions about the franchise and its operation. Not every franchise "horror story" is the result of dishonest franchisers. More often than not, the problems that arise in franchising have more to do with franchisees who buy legitimate franchises without proper research and analysis. They end up in businesses they don't enjoy and that they are not well suited to operate. How can you avoid this mistake? The following steps will help you make the right choice. Evaluate Yourself Before looking at any franchise, an entrepreneur should study her own traits, goals, experience, likes, dislikes, risk orientation, income requirements, time and family commitments, and other characteristics. Will you be comfortable working in a structured environment? What kinds of franchises fit your desired lifestyle? In what region of the country or world do you want to live and work? What is your ideal job description? Knowing what you enjoy doing (and what you don't want to do) will help you narrow your search. The goal is to find the franchise that is right--for you! One characteristic successful franchisees have in common is that they genuinely enjoy their work. Table 4.3 provides a test for prospective franchisees that helps them evaluate their franchise potential. Of those people who set out Co buy a. franchise, only IS percent actually buy one. Some of that 15 percent make the wrong decision. They discover too late that they are not cut out to be franchisees. Do you hive what it takes to be a successful franchisee? The following quiz will help you determine your "franchise quotient." 1. You own a company. How much operational detail are you comfortable with? a. I want direct control over all operations. b. I delegate less than half. c. I delegate more than half. 2. You have three job offers with comparable salary and benefits. Choose one. a. Small company but high management responsibility and exposure. b. Mid-sized company with less personal exposure but more prestigious name. c. Large company with least personal exposure but very well-known name. 3. You reach a major stumbling block on a project, You: a. Seek help from others immediately. b. Think it through and then present possible solutions to your superior. c. Keep working until you resolve it on your own. 4. Which investment sounds most appealing? a. Five percent fixed return over a period of time. b. From -20 percent to +50 percent loss or return over a period of time, depending on changing economic situations. 5. Which business arrangement is most appealing? a. You're the sole owner. b. You're in a partnership and own a majority of the stock.

c. You're in an equal partnership. 6. Your company's sales technique increases sales 10 percent per year. You used a technique elsewhere you feel will result in 15 percent to 20 percent annual increases, but it requires extra time and capital. You: a. Avoid the risk and stay with the present plan. b. Suggest your new method, showing previous results. c. Privately use your system, and show the results later. 7. You suggest your system to your boss, and he says, "Don't rock the boat." You: a. Drop your different approach. b. Approach your boss at a later time. c. Go to your boss's boss with your suggestion. d. Use your own system anyway. 8. Which would mean the most to you? a. Becoming the president of a company. b. Becoming the highest-paid employee of a company. c. Winning the highest award for achievement in your profession. 9. What three activities do you find most appealing? a. Sales and marketing. b. Administration. c. Payroll. d. Training. e. Customer service. f. Credit and collections. g. Management. 10. What work pace do you generally prefer? a. Working on one project until it is completed. b. Working on several projects at one time. Scoring: 1. A=5,B=3,C=1. 2. A=3,B-2,C=1. 3. A=1,B=5,C=7. 4, A=2,B=6. 5. A=7, B=5, C=2. 6 A=1,B=6,C=10. 7. A=l, B=5,C=8,D=10. 8. A=8.B=2,C=5. 9. A=10,B=1,C=3,D=3, E=8,F=2,G=5. 10. A=3,B=6. Total Score: 20-33 You're a corporate player and are happiest in a structured environment. Franchising suits you. 34-71 You're a potentially good franchisee. 72-85 You're an entrepreneur who prefers total independence. Research Your Market Before shopping for a franchise, research the market in the area you plan, to serve. How fail is the overall area growing? In which areas is that growth occurring fastest? Investing some lime at the library developing a profile of the customers in your target area is essential; otherwise, you will be flying blind. Who arc your potential customers? What are their characteristics and their income and education levels? What kinds of products and services M they buy? What gaps exist in the market? These gaps represent potential franchise opportunities for you. Market research also should confirm that a franchise is not merely part o: a fad that will quickly fade. Steering clear of fads and into long-term trends is one way to sustain the success of a franchise. Before Papa John's Pizza allows franchisees to open any store, it requires them If spend six months to a year evaluating the market potential of the local area. " We don't just move into an area and open up 200 stores," says one manager. "We do it one store at a time." 41

Consider Your Franchise Options The International Franchise Association publishes the Franchise Opportunities Guide which lists its members and some basic information about them. Many cities host franchise trade shows throughout the year where hundreds of franchisers gather 10 sell their franchises. Attending one of these franchise showcases is a convenient, efficient way to collect information about a variety of available opportunities. Many business magazines such as Entrepreneur, Inc., Business Start-Ups, Your Company, and others devote at least one issue to franchising, in which they often list hundreds of franchises. These guides can help yd find a suitable franchise within your price range. Get a Copy of the Franchiser's UFOC Once you narrow down your franchise choices, you should contact each franchise and get a copy of its UFOC. Then read it! This document is an important tool in your search ford right franchise, and you should make the most of it. When evaluating a franchise opportunity, what should a potential franchisee look for? Although there's never a guarantee I success, the following characteristics make a franchise stand out. A unique concept or marketing approach. "Me-too" franchises arc no more successful than "metoo" independent businesses. Pizza franchiser Papa John's has achieved an impressive growth rate by emphasizing the quality of its ingredients, whereas Domino's is known for its fast delivery. Profitability. A franchiser should have a track record of profitability and so should its franchisees. If a franchiser is not profitable, its franchisees are not likely to be cither. Franchise who follow the business format should expect to earn a reasonable rate of return. A registered trademark. Name recognition is difficult to achieve without a well-known and protected trademark. A business system that works, A franchiser should have in place a system that is efficient and well documented in its manuals. A solid training program. One of the most valuable components of a franchise system is the training it offers franchisees. The system should be relatively easy to teach. Affordability. A franchisee should not have to take on an excessive amount of debt to purchase a franchise. Being forced to borrow too much money to open a franchise outlet can doom a business from the outset. Respectable franchisers verify prospective franchise financial qualifications as part of the screening process. A positive relationship with franchisees. The must successful franchises are those that see their franchisees as partners and treat them accordingly. The UFOC covers the 23 items discussed in the previous section and includes a copy of the company's franchise agreement and any contracts accompanying it. Although the law requires a UFOC to be written in plain English rather than "legalese," it is best to have an attorney experienced in franchising to review the UFOC and discuss its provisions with you, Watch for clauses that give the franchiser absolute control and discretion. The franchise contract summarizes the details that will govern the franchiser-franchisee relationship over its life, Ii outlines exactly the rights and the obligations of each party and sets the guidelines that govern the franchise relationship. Still, a recent study by the FTC suggests that40 percent of new franchisees sign contracts without reading them!42 When one fast-id franchiser took a survey of its franchisees, it discovered that fewer than 10 percent id bothered to read either the UFOC or the franchise contract.4' Because franchise contacts typically are long terra (50 percent run for 15 years or more), it is extremely important for prospective franchisee^ lo understand their terms before they sign them. One of the most revealing items in the UFOC is the franchisee turnover rate, the rate a! which franchisees leave the system. ! f the turnover rate is less than 5 percent, the franchise is probably sound. However, a franchise turnover rate approaching 20 percent is a sign of serious,

underlying problems in a franchise. Satisfied franchisees are not inclined lo leave a successful system. Talk to Existing Franchisees One of the best ways to evaluate the reputation of a franchiser is to interview (in person) several franchise owners who have been in business at least one year about the positive and le negative features of the agreement and whether the franchiser delivered what was promised. Did the franchise estimate their start-up costs accurately? Do they get the support the franchiser promised them? Has the franchise met their expectations concerning profitability and return on investment? Knowing what they know now, would they buy the franchise again? Bob Phillips, a CPA looking to make a career change, wanted to make sure that he purchased the right franchise, so he invested time poring over the UFOCs he had collected from the dozen franchises that interested him. Father than rely on the documents alone to judge the franchises, Phillips made calls to franchisees that he randomly selected from the lists included in the UFOCs (item 20). His conversations with franchisees convinced him that Ranch j, a chain of fast-food grilled chicken stores, was the best choice for him. "Almost every one wanted a second location," he says. "That's indicative of a healthy franchise system." Phillips is convinced that his thorough research led him to the right franchise. Today he owns two Ranch I franchises that generate more than $2 million in Saks, and he plans to open eight more outlets within three years.44 Interviewing past franchisees to gel their perspectives on the franchiser-franchisee relationship is also helpful. Why did they leave? Franchisees of some companies have formed associations, which might provide prospective franchisees with valuable information. Other sources of information include the American Association of Franchisees and Dealers, the American Franchise Association, and the International Franchise Association. Ask the Franchiser Some Tough Questions Take the time to ask the franchiser questions about the company and its relationship with its franchisees. You will be in this relationship a long time, and you need to know as much about it as you possibly can beforehand. What is its philosophy concerning the relationShip? What is the company culture like? How much input do franchisee's have into the system? What are the franchise's future expansion plans? How will they affect your franchise? Are you entitled to an exclusive territory? Under what circumstances can either party terminate the franchise agreement? What happens if you decide to sell your franchise in the future? Under what circumstances would you not be entitled to renew the agreement? What kind of profits can you expect? (If the franchiser made no earnings claims in item 19 of the UFOC, why not?) Does the franchiser have a well-formulated strategic plan? YOU BE THE CONSULANT... The Opportunityof a Lifetime "Honey, I think I've found it!" said Joe Willingham to his wife Allie. "This is just what I've been looking for, and just in lime, too. My severance package from the company runs out next month. The man said that if we invested in this franchise now, we could be bringing in good money by then. It's that easy!" Allie knew that Joe had been working hard at finding another job since he had been a victim of his company's latest downsizing, but jobs were scarce even for someone with his managerial experience and background in manufacturing. "Nobody wants to hire a 51-year-old man with experience when they can hire 23-year-old college graduates at less than half the salary and teach them what they need to know," Joe told her after months of fruitless job hunting. That's when Joe got the idea of setting up his own business. Rather than start an independent business from scratch, Joe felt more comfortable, given his 26-year corporate career, opening a franchise. "A franchiser can give me the support I need," he told Allie. "Tell me about this franchise," Allie said.

"'It's a phenomenal opportunity for us," Joe said, barely able to contain his excitement. "I saw this booth for American Speedy Print at the Business Expo this morning. There were all kinds of franchises there, but this one really caught my eye,"' Joe said as he pulled a rather plain-looking photocopy of a brochure from his briefcase. "Is that their brochure?" asked Allie. "Well, the company is growing so fast that they have temporarily run out of their normal literature. This is just temporary." "Oh. . .You would think that a printing franchise could print flashier brochures even on short notice, but I guess. . . ," said Allie. "The main thing is the profit potential this business has," said Joe. "1 met one of their franchisees. I tell you the guy was wearing a $2,000 suit if ever there was one, and he had expensive jewelry dripping from his fingers. He's making a mint with this franchise, and he said we could too!" Joe continued, "With the severance package I have from the company, we could pay the $10,000 franchise fee and lease most of the equipment we need to get started. It'll take every penny of my package, but, hey, it's an investment in our future. The representative said the company would help us with our grand opening and would help us compile a list of potential customers." "What would you print?" asked Allie. "Anything!" said Joe. "The franchisee I talked to does flyers, posters, booklets, newsletters, advertising pieces . . . you name it!" "Wow! It seems like you'd need lots of specialized equipment to do all of that. How much does the total franchise package cost?" said Allie. "Well. I'm not exactly sure. He never gave me an exact figure, but we can lease all the equipment we need from the franchiser!" "Is this all of the material they gave you? I thought franchisers were supposed to have some kind of information packet to give to people," said Allie. "Yeah. I asked him about that," said Joe. "He said that American Speedy Print is just a small franchise. They'd rather put their money into building a business and helping their franchisees succeed than into useless paperwork that nobody reads anyway. It makes sense to me." "I guess so. . . ," Allie said reluctantly. "I think we need to take this opportunity, Hon," Joe said, with a look that spoke of determination and enthusiasm. "'Besides, he said that there was another couple in this county that is already looking at this franchise, and that the company will license only one franchisee in this area. They don't want to saturate the market. He thinks they may take it. I think we have to move on this now, or we'll lose the opportunity of a lifetime." Allie had not seen Joe exhibit this much enthusiasm and excitement for anything since he had lost his job at the plant. Piles of rejection letters from his job search had sapped Joe's zest for living. Allie was glad to sec "the m Joe" return, but she still had her doubts about the franchise opportunity Joe was describing. "It might just be the opportunity of a lifetime, Joe," she said, "'But don't you think we need to find out a little more about this franchise before we invest that much money? I mean. . . ." "Hon, I'd love to do that, but like the man said, we may miss out on the opportunity of a lifetime if we don't sig today. I think we've got to move on this thing now!" 1. What advice would you offer Joe about investing in this franchise? 2. Map out a plan for Joe to use in finding the right franchise for him. What can Joe do to protect himself from making a bad franchise investment? 3. Summarize the advantages and disadvantages Joe can expect if he buys a franchise. Make Your ChoiceThe first lesson in franchising is "Do your homework before you gel out your checkbook." Once you have done your research, you can make an informed choice about which franchise is right fur you. Then it is time to put together a solid business plan that will serve as road map to

success in the franchise you have selected. The plan is also a valuable tool louse as you arrange the financing for your franchise. We will discuss the components of a business plan in Chapter 9. Appendix A at the end of this chapter offers a checklist of questions a potential franchisee should ask before entering into any franchise agreement. TRENDS SHAPING FRANCHISING Franchising has experienced three major growth waves since its beginning. The first wave occurred in the early 1970s when fast-food restaurants used the concept to grow rapidly. The lastfood industry was one of the first to discover the power of franchising, but other presses soon look notice and adapted the franchising concept to their industries. The second wave took place in the mid-1980s as our nation's economy shifted heavily toward BE service sector. Franchises followed suit, springing up in every service business imaginable-from maid services and copy centers to mailing services and real estate. The third wave began in the early 1990s and continues today. It is characterized by new, low-cost franchises that focus on specific market niches. In the wake of major corporate downsizing and the burgeoning costs of traditional franchises, these new franchises allow would-be entrepreneurs to get into proven businesses faster and at lower costs. These companies feature start-up costs from $2,000 to $250,000 and span a variety of industriesfrom leak detection in homes and auto detailing to day care and tile glazing. Other significant trends affecting franchising are discussed next. Changing Face of Franchisees Franchises today are better educated, arc more sophisticated, have more business acumen, dare more financially secure than those of just 20 years ago. Franchising is attracting Riled, experienced businesspeople whose goal is to own multiple outlets that cover entire Males or regions. For instance, when Krispy Krene Doughnuts began to move its popular product north mm its southern stronghold, the Lev family-father Howard, sons Russel and Mel, and nuephew John Faber-bought the franchise for the entire state, of New York. While on a trip to the South, Mel discovered the tasty orbs and brought some back to his family, who quickly devoured than. Once they returned to their home in New York, the Levs decided to become franchisees. All experienced in business (Howard and Mel once owned a shirt- company), the Levs and Faber have opened 10 stores and have plans for dozens more. International Opportunities One of the major trends in franchising is the internationalization of U.S. franchise systems. Increasingly, franchising is becoming a major export industry for the United Stales. Growing numbers of U.S. franchises are moving into international markets lo boost sales and profits as the domestic market becomes saturated. According to a report by Arthur Andersen, 44 percent of U.S. franchisers have international locations, up from 34 percent in 1989. International expansion is a relatively new phenomenon in franchising, however approximately 75 percent of franchisers established their first foreign outlet within the par 10 years.46 Canada is the primary market for U.S. franchisers, with Mexico, Japan, and Europe following. These markets are most attractive to franchisers because they are similar to the U.S. market-rising personal incomes, strong demand for consumer goods, growing service economies, and spreading urbanization. As they venture into foreign markets, franchisers have learned that adaptation is one key to success. Although a franchise's overall business format may not change in foreign markets, some of the details of operating its local outlets must. For instance, fast-food chains in other countries often must make adjustments to their menus to please local) palates. In Japan, McDonald's (known as "Makudonarudo") outlets sell teriyaki burgers, rice burgers, and katsu burgers (cheese wrapped in a roast pork cutlet lopped with katsu sauce and shredded cabbage) in addition lo their traditional American fare. In the Philippines, the McDonald's menu includes a spicy Filipino-style burger, spaghetti, and chicken with rice.

Countries that recently have thrown off the chains of communism are turning to frail chising to help them move toward a market economy. Some countries of Eastern Europe, including Hungary, Poland, and Yugoslavia, already have attracted franchiese. Even Russia is fertile ground for franchising. McDonald's scored a hit with its 700-sii restaurant in Moscow. Despite being one of the largest McDonald's outlets in the world, "the wailing line winds along busy Pushkin Square for well over 500 yards," report one Soviet magazine.47 Franchisers in these countries must have patience, however Lack of capital, archaic infrastructure, and a shortage of hard currencies mean if profits will be slow in coining. Most franchisers recognize the difficulties of developing franchises in foreign markets and start slowly. According to Arthur Anderson, 79 pc cent of franchisers doing business internationally have fewer than 100 outlets in foreign countries.48 Smaller, Nontraditional Locations As the high cost of building full-scale locations continues to climb, more franchisers are searching out nontraditional locations in which to build smaller, less expensive outlets. Based on the principle of intercept marketing, the idea is to put a franchise's produce services directly in the paths of potential customers, wherever they may be. Locations within locations have become popular. Franchises are putting scaled-down outlets on college campuses, in high school cafeterias, in sports arenas, in hospitals, on airline flights and in zoos. St. Louis-based Pizzas of Eight already has outlets inside convenience stores, supermarkets, and bowling alleys and plans to open others in video stores.49 Many franchisees have discovered that smaller outlets in these nontraditional locations gents nearly the same sales volume as full-sized outlets at just a fraction of the cost! Steve Siegel, owner of 35 Dunkin' Donuts shops in the Boston area, recently be branching out into small, nontraditional locations where pedestrian traffic counts are high. One of his most profitable spots measures just 64 square feel, but because it is in a business district filled with office workers, it generates a high volume of sales. 50 Such locations will be a key to continued franchise growth in the domestic market. Conversion Franchising The recent trend toward conversion franchising, in which owners of independent businesses become franchisees to gain [he advantage of name recognition, will continue. In a franchise conversion, the franchiser gets immediate entry into new markets and experienced operators; franchisees gel increased visibility and often a big sales boost. In fact, the average sales gain in the first year for converted franchises is 20 percent.51 The biggest force in conversion franchising has been Century 21, the real estate sales company. Multiple-Unit Franchising Multiple-unit franchising (MUF) became extremely popular in the early 1990s. In multiple-unit franchising, a franchisee opens more than one unit in a broad territory within a specific lime period. "Multiple ownership of units by franchisees has exploded." says one franchise expert. "Twenty or 30 years ago, it would have been rare for any one franchisee mown 10 or 20 units. Now it's not uncommon . . . for one franchisee to own 60, 70, or 1200 units. Franchisers are finding it's far more efficient in the long run to have one well-trained franchisee operate a number of units than to train many franchises."52 The popularity of multiple-unit franchising has paralleled the trend toward increasingly experienced, sophisticated franchisees, who set high performance goals that a single outlet can-it meet. The typical multiple-unit franchisee owns between three and six units, but some franchisees own many more. Master Franchising A master franchise (or subfranchise) gives a franchisee the right to create a semi-independent organization in a particular territory to recruit, sell, and support other franchisees. A master franchisee buys the right to develop subfranchise within a broad geographic area or sometimes an entire country. Subfranchising "turbocharges" a franchiser's growth. Many franchisers use it to

open outlets in international markets more quickly and efficiently because the master franchisees understand local laws and the nuances of selling in local markets. For instance, a master franchisee with TCBY International, a yogurt franchise, has opened 21 stores in China and in Hong Kong. Based on his success in these markets, the company has sold him the master franchise in India.53 Piggybacking (or Combination Franchising) Some franchisers also are discovering new ways to reach customers by teaming up with other franchisers selling complementary products or services. A growing number of companies are piggybackingoutlets-combining two or more distinct franchises under one roof. This "buddy system" approach works best when the two franchise ideas are compatible and appeal to similar customers. For example, franchisers Dunkin' Donuts, Togos' Entry sandwich shops, and ice cream retailer Baskin-Robbins are working together to Id hundreds of combination outlets, a concept that has proved to be highly successful.54 properly planned, piggybacked franchises can magnify many times over the sales and profits of individual, self-standing outlets. One Baskin-Robbins franchisee saw his sales mo 25 percent when he added a Blimpie Subs and Salads franchise to his existing ice cream shop. Another enterprising franchisee who combined Shell Oil (gas station), Charley's Steakery (sandwich shop), and TCBY (frozen yogurt) franchises under one roof in Columbus, Ohio, says that sales are running 10 percent more than the three outlets would generate in separate locations.55 Serving Aging Baby Boomers Now that dual-career couples have become the norm, especially among baby boomers, the market for franchises offering convenience and time-saving devices is booming. Customers are willing to pay for products and services that will save them time or trouble, and franchises are ready to provide them. Franchisees of Around Your Neck go into the homes and offices of busy male executives to sell men's apparel and accessories ranging from shirts and ties to custom-made suits. Other areas in which franchising is experiencing rapid growth include home delivery of meals, house-cleaning services, continuing education and training (especially computer and business training), leisure activities (such as hobbies, health spas, and travel-related activities), products and services aimed at home-based businesses, and health care. "People are interested in anything that will make lit! simpler for them," explains one franchise consultant.56 CONCLUSION Franchising has proved its viability in the U.S. economy and has become a key part oft] small business sector because it offers many would-be entrepreneurs the opportunity it own and operate a business with a greater chance for success. Despite its impressive growth rate to date, the franchising industry still has a great deal of room to grow. Describing the future of franchising, one expert says, "Franchising has not yet come close to reaching its full potential in the American marketplace." 57 CHAPTER SUMMARY 1-A. Explain the advantages and the disadvantages of the sole proprietorship. A sole proprietorship is a business owned and managed by one individual and is the most popular form of ownership. Sole proprietorships offer these advantages: They are simple to create; they are the least costly Form to begin; the owner has total decision-making authority; there are no special legal restrictions; and they are easy to discontinue. They also suffer from these disadvantages: unlimited personal liability of owner; limited managerial skills and capabilities; limited access to capital; and lack of continuity. 1-B. Explain the advantages and the disadvantages of the partnership. A partnership is an association of two or more people who co-own a business for the purpose of making a profit. Partnerships offer these advantages: ease of establishing; complementary skills of

partners; division of profits; larger pool of capital available; ability to attract limited partners; little government regulation; flexibility; and tax advantages. Partnerships suffer from these disadvantages: unlimited liability of at least one partner; difficulty in disposing of partnership interest; lack of continuity; potential for personality and authority conflicts; and partner bound by the law of agency. 1-C. Explain the advantages and the disadvantages of it corporation. A corporation, the most complex of the three basic forms of ownership, is a separate legal entity. To from a corporation, an entrepreneur must file the articles of incorporation with the slate in which the company will incorporate. Corporations offer these advantages: limited liability of stockholders; ability to attract capital; ability to continue indefinitely; and transferable ownership. Corporations suffer from these disadvantages: a and lime involved in incorporating; double taxation potential for diminished managerial incentives; to requirements and regulatory red tape; and potential loss of control by the founder(s). 2. Discuss the advantages and the disadvantages of the S corporation, the limited liability company, the professional corporation, and the joint venture. Entrepreneurs can also choose from several 4 forms of ownership, including S corporations and limited liability companies. An S corporation offers its owners limited liability protection but avoids the double taxation of C corporations. A limited liability company, like an S corporation, is a cross between a partnership and a corporation, yet it operates without the restrictions imposed on an S corporation. To create an LLC, an entrepreneur must file the articles of organization and [he operating agreement with the secretary of state. A professional corporation offers professionals the benefits of the corporate form of ownership. A joint venture is like a partnership, except [ha! it is formed for a specific purpose. 3. Describe the three types of franchising: trade name, product distribution, and pure. Trade-name franchising involves a franchisee's purchasing the right to become affiliated with a franchiser's trade name without distributing its products exclusively. Product distribution franchising involves licensing a franchisee to sell products or services under (he franchiser's brand name through a selective, limited distribution network. Pure franchising involves selling it franchisee a complete business format. 4. Explain the benefits and [he drawbacks of buying a franchise. Franchises offer many benefits: management training and support; brand name appeal; standardized quality of goods and services; national advertising programs; financial assistance; proven products and business formats; centralized buying power; territorial protection; and a greater chance of success. Franchising also suffers from certain drawbacks; franchise fees and profit sharing; strict adherence to standardized operations; restrictions on purchasing; limited product lines: unsatisfactory training programs; market saturation; and less freedom. 5. Understand the laws covering franchise purchases. The Federal Trade Commission (FTC) enacted the Trade Regulation Rule in 1979, which requires all franchisers to disclose detailed information on their operations at the first personal meeting or at least 10 days before a franchise contract is signed, or before any money is paid. The FTC rule covers all franchisers. The Trade Regulation Rule requires franchisers to provide information on 23 topics in their disclosure statements. Seventeen states have passed their own franchise laws requiring franchisers to provide prospective franchisees a Uniform Franchise Offering Circular (UFOC). 6. Discuss the right way to buy a franchise.

The following steps will help you make the right franchise choice: Evaluate yourself; research your market; consider your franchise options; gel a copy of the franchiser's UFOC; talk to existing franchisees; ask the franchiser some tough questions; and make your choice. 7. Outline the major trends shaping franchising. Key trends shaping franchising today include the changing face of franchisees; international franchise opportunities; smaller, nontraditional locations; conversion franchising; multiple-unit franchising; master franchising; and piggybacking (or combination franchising). DISCUSSION QUESTIONS 1. What factors should an entrepreneur consider before choosing a form of ownership? 2. Why arc sole proprietorships so popular as a form of ownership? 3. How does personal conflict affect partnerships? 4. What issues should the articles of partnership address? Why are the articles important to a successful partnership? 5. Can one partner commit another to a business deal without the other's consent? Why? 6. What issues should the certificate of incorporation cover? 7. How docs an S corporation differ from a regular corporation? 8. What role do limited partners play in a partnership? What happens if a limited partner takes an active role in managing the business? 9. What advantages docs a limited liability company offer over an S corporation? A partnership? 10. How is an LLC created? What criteria must an LLC meet to avoid double taxation? 11. Briefly outline the advantages and disadvantages of the major forms of business ownership. 12. What is franchising? 13. Describe the three types of franchising and give an example of each. 14. Discuss the advantages and the limitations of franchising for the franchisee. 15. Why might an independent entrepreneur be dissatisfied with a franchising arrangement? 16. What kinds of clues should tip off a prospective franchisee that he is dealing with a disreputable franchiser? 17. What steps should a potential franchisee take before investing in a franchise? 18. What is the function of the FTC's Trade Regulation Rule? Outline the protection the Trade Regulation Rule gives all prospective franchisees. 19. Describe the current trends in franchising. 20. One franchisee says, "Franchising is helpful because it gives you somebody [the franchiser] to get you going, nurture you, and shove you along a little. But the franchiser won't make you successful. That depends on what you bring to the business, how hard you are prepared to work, and how committed you are to finding the right franchise for you." Do you agree? Explain. Beyond the Classroom... 1. Interview five local small business owners . What form of ownership did each choose? Why? Prepare a brief report summarizing your findings, and explain advantages and disadvantages those owners face because of their choices. 2. Invite entrepreneurs who operate as partners to your classroom. Do they have written partnership agreement? Are their skills complementary? How do they divide responsibility for running their company? How do the handle decision making? What do they do when disputes and disagreements arise? 3. Visit a local franchise operation. Is it a trade-name, product distribution, or pure franchise? To what extent did the franchisee investigate before investing? What assistance does the franchiser provide? How does the franchisee feel about the franchise contract he signed? What would he do differently now? 4. a. Consult a copy of the International Franchise Association publication Franchise Opportunities Handbook (the library should have a copy). Write several franchisers in a particular business

category and ask for their franchise packages. Write a report comparing their treatment of the topics covered by the Trade Regulation Rule. b. Analyze the terms of their franchise contracts. What are the major differences? Are some terms more favorable than others? If you were about to invest in the franchise, which terms would you want to change? 5. Ask a focal franchisee to approach his regional franchise representative about leading a class discussion on franchising. 6. Contact the International Franchise Association (1350 New York Avenue, N.W, Suite 900, Washington, D.C., 20005-4709, 202-628-8000) for a copy of Investigate before Investing. Prepare a report outlining what a prospective franchisee should do before buying a franchise. FORMS OF BUSINESS OWNERSHIP AND FRANCHISING The Sole Proprietorship The Partnership Corporations Other Forms of Ownership Franchising Types of Franchising The Benefits of Buying a Franchise The Drawbacks of Buying a Franchise Franchising and the Law The Right Way to Buy a Franchise Trends Shaping Franchising One of the first decisions an entrepreneur faces when starting a new business is selecting the form of ownership for the new business venture, Too often, entrepreneurs give little thought to choosing a form of ownership and simply select the form that is most popular, even tough it may not suit (heir needs best. Although the decision is not irreversible, changing from one form of ownership to another once a business is up and running can be difficult, expensive, and complicated. That's why it is so important for an entrepreneur to make the right choice at the outset. This seemingly mundane decision can have a significant impact on almost every aspect of a business and its owner(s)-from the taxes the company pays fellow it raises money to the owner's liability for the company's debts and her ability to transfer the business to the next generation. Each form of ownership has its own unique set advantages and disadvantages. The key to choosing the '"right" form of ownership is understanding the characteristics of each one and knowing how they affect an entrepreneur's business and personal circumstances. Although there is no best form of ownership, there may be a form of ownership that is best for each entrepreneur's circumstances. The following are a few considerations that every entrepreneur should review prior lo making the final form of ownership choice: Tax considerations. The graduated tax rates under each form of ownership, the government's constant tinkering with the tax code, and the year-to-year fluctuations in a company's income mean that an entrepreneur must calculate the firm's tax bill under each ownership option every year. Liability exposure. Certain forms of ownership offer business owners greater protection from personal liability due lo financial problems, faulty products, and a host of other difficulties. Entrepreneurs must decide the extent lo which they arc willing to assume personal responsibility for their companies' obligations. Start-up capital requirements. Forms of ownership differ in their ability lo raise start-up cap-ital. Depending on how much capital an entrepreneur needs and where she plans to get it, some forms are superior to others.

Control, By choosing certain forms of ownership, Lin entrepreneur automatically gives up some control over the company. Entrepreneurs must decide early on how much control they ire willing to sacrifice in exchange for help from other people in building a successful business. Business goals. How big and how profitable an entrepreneur plans for the business to become will influence the form of ownership chosen. Businesses often switch forms of ownership as they grow, but moving from some formats to others can be extremely complex and expensive. Management succession plans. When choosing a form of ownership, business owners must look ahead to the day when they will pass their companies on to the next generation or to a buyer. Some forms of ownership make this transition much smoother than others. Cost of formation. Some forms of ownership, are much more costly and involved to create. An entrepreneur must weigh carefully the benefits and the costs of the particular form he or she chooses. Entrepreneurs have a wide choice of forms of ownership, In recent years, various hybrid forms of business ownership have emerged. This chapter will attempt to outline the key features of the most common forms of ownership, beginning with the sole proprietorship, the partnership, and the corporation THE SOLE PROPRIETORSHIP The sole proprietorship is a business owned and managed by one individual. This form of ownership is by far the most popular. Approximately 73 percent of all businesses in the United States are proprietorships The Advantages of a Proprietorship SIMPLE TO CREATE . One of the most attractive features of a proprietorship is how fast and simple it is to begin. If an entrepreneur wants to operate a business under his own name (e.g., Strossner's Bakery), he simply obtains the necessary licenses from state, county, and/or local governments and begins operation! For most entrepreneurs, it would not be impossible to start a proprietorship in a single day. LEAST COSTLY FORM OF OWNERSHIP TO BEGIN . In addition to being easy to begin, the proprietorship is generally the least expensive form of ownership to establish There is no need to create and file legal documents that are recommended for partnership and required for corporations. An entrepreneur simply, goes to the city or county government, states the nature of the business he will start, and pays the appropriate fees an license costs. Paying these fees and license costs gives the entrepreneur the right to duct business in that particular jurisdiction. Someone planning to conduct business under a trade name should acquire a certified. of doing business under an assumed name from the secretary of state. The fee for filing this certificate usually is nominal. Acquiring this certificate involves conducting a legal search to ensure that the name chosen is not already registered as a trademark or a service ram with the secretary of state. Filing this certificate also notifies the state whom the owner the business is. In a proprietorship, the owner is the business. PROFIT INCENTIVE . One major advantage of the proprietorship is that once the owner pays all of the company's expenses, she can keep the remaining profits (less taxes of course). The profit incentive is a powerful one, and profits represent an excellent way: "keeping score" in the game of the business. TOTAL DECISION-MAKING AUTHORITY . Because the sole proprietor is into] control of operations, she can respond quickly to changes, which is an asset in a rapid shifting market. The freedom to set the company's course of action is a

major motivation force. For those who thrive on the enjoyment of seeking new opportunities in business, the freedom of fast, flexible decision making is vital. Sole proprietor Max Gouge of Industrial Propane & Petroleum says, "1 like the feeling of being on my own ... I make this company work." 1 NO SPECIAL LEGAL RESTRICTIONS . The proprietorship is the least regulated form of business ownership. In a time when government requests for information seem neverending, this feature has much merit. EASY TO DISCONTINUE . If the entrepreneur decides to discontinue operations, he can terminate (he business quickly, even though he will still be personally liable for any outstanding debts and obligations that the business cannot pay. The Disadvantages of a Proprietorship UNLIMITED PERSONAL LIABILITY. Probably the greatest disadvantage of a sole proprietorship is the unlimited personal liability of the owner, which means that the sole proprietor is personally liable for all of the business's debts. Remember: In a proprietorship, the owner ii the business. He owns all of the business's assets, and if the business Ms, creditors can force the sale of these assets to cover its debts. If unpaid business debts remain, creditors can also force the sale of the proprietor's personal assets to recover payment. In short, the company's debts are the owner's debts. Laws vary from one state to mother, but most stales require creditors to leave the failed business owner a minimum amount of equity in a home, a car. and some personal items. The reality: Failure of a business can ruin a sole proprietor financially. LIMITED SKILLS AND CAPABILITIES . A sole proprietor may not have the wide range of skills running a successful business requires. Each of us has areas in which our education, training, and work experiences have taught us a great deal; yet there are other areas in which our decision-making ability is weak. Many business failures occur because owners lack the skills, knowledge, and experience in areas that are vital to business success. Owners lend to push aside problems they don't understand or don't feel comfortable with in favor of those they can solve more easily. Unfortunately, the problems they set aside seldom solve themselves. By the time an owner decides to ask for help in addressing these problems, it may be too late to save the company. FEELINGS OF ISOLATION. Running a business alone allows an entrepreneur maximum flexibility, but it also creates feelings of isolation that there is no one else to turn to for help in solving problems or getting feedback on a new idea. Lee Gardner, the sole proprietor of a company that arranges sponsorships for spoiling events, says, '"After 1 set up my company. I realized I was all by myself and responsible for everything. Building a business brick by brick, alone, is not easy." 2 LIMITED ACCESS TO CAPITAL. If the business is to grow and expand, a sole proprietor generally needs additional financial resources. However, many proprietors have already put all they have into their businesses and have used their personal resources as collateral on existing loans, making it difficult to borrow additional funds. A sole proprietorship is limited to whatever capital the owner can contribute and whatever money he can borrow. In short, proprietors, unless they have great personal wealth, find it difficult to raise additional money while maintaining sole ownership. Most banks and other lending institutions have well-defined formulas for determining borrowers' eligibility. Unfortunately, many sole proprietorships cannot meet those borrowing requirements, especially in the early days of business. LACK OF CONTINUITY FOR THE BUSINESS.

Lack of continuity is inherent in a sole proprietorship. If the proprietor dies, retires, or becomes incapacitated, the business automatically terminates. Unless a family member or employee can take over (which means that person is now a sole proprietor), the business could be in jeopardy. Because people look for secure employment and an opportunity for advancement, proprietorships, being small, often have trouble recruiting and retaining good employees, If no one is trained to run the business, creditors can petition the courts to liquidate the assets of the dissolved business to pay outstanding debts. Some entrepreneurs find that forming partnerships is one way to overcome the disadvantages of the sole proprietorship. For instance, when one person lacks specific managerial skills or has insufficient access to needed capital, he can compensate for these weaknesses by forming a partnership with someone with complementary management skills or money to invest. THE PARTNERSHIP A partnership is an association of two or more people who co-own a business for the purpose of making a profit. In a partnership, the co-owners (partners) share the business's assets, liabilities, and profits according to the terms of a previously established partnership agreement. The law does not require a partnership agreement (also known as the articles of partnership), but it is wise to work with an attorney to develop one that spells out the exact status and responsibility of each partner. All too often the parties think they know what they arc agreeing to, only to find later that no real meeting of the minds took place. The partnership agreement is a document that states in writing all of the terms of operating the partnership and protects each partner involved. Every partnership should be based on a written agreement. "When two entrepreneurial personalities are combined, there is a tremendous amount of strength and energy, but it must be focused in the same direction, or it will tear the relationship apart," explains one business writer. "A good partnership agreement will guide you through the good times, provide you with a method for handling problems, and serve as the infrastructure for a successful operation." 3 When no partnership agreement exists, the Uniform Partnership Act (UPA) governs a partnership, but its provisions may not be as favorable as a specific agreement hammered out among the partners. Creating a partnership agreement is not costly. In most cases, the partners can discuss each of the provisions in advance. Once they have reached an agreement, an attorney can draft the formal document. Banks will often want to see a copy of the partnership agreement before lending the business money. Probably the most important feature of the partnership agreement is that it resolves potential sources of conflict that, if not addressed in advance, could later result in partnership battles and the dissolution of an otherwise successful business. Spelling out detailsespecially sticky ones such as profit splits, contributions, workloads, decision-making authority, dispute resolution, dissolution, and others-in a written agreement at the outset will help avoid damaging tension in j partnership that could lead to a business "divorce." Business divorces, like marital ones, are almost always costly and unpleasant for everyone involved. Unfortunately, the tendency for partners just starting out is to ignore writing a partnership agreement as they ride the emotional high of launching a company together. According to one writer, "In the eager, hectic days of startup, when two people com together with a 'brilliant idea, they never imagine that some day, they may not want to lit partners anymore. Instead, their thoughts race to marketing strategies, product develop merit, sales pitches, and customer service."4 The result? Every year, thousands of partners find themselves mired in irreconcilable disputes that damage their businesses because they failed to establish a partnership agreement. Generally, a partnership agreement can include any terms the partners want (unless they are illegal). The standard partnership agreement will likely include the following: 1. Name of Ike partnership. 2. Purpose of the business. What is the reason the business was brought into being? 3. Domicile of the business. Where will the principal business be located?

4. Duration of the partnership. How long will the partnership last? 5. Names of the partners and their legal addresses. 6. Contributions of each partner to the business at the creation of the partnership and later. This would include each partner's investment in the business. In some situations, a partner may contribute assets that are not likely to appeal- on a balance sheet. Experience, sales contacts, or a good reputation in the community may be reasons for asking a person to join in partnership. 7. Agreement on how the profits or losses will be distributed. 8. An agreement on salaries or drawing rights against profits for each partner. 9. Procedure for expansion through the addition of new partners. 10. If the partners voluntarily dissolve the partnership, how will the partnership's assets be distributed? 11. Sale of partnership interest. The articles or partnership should include terms defining how a partner can sell his or her interest in the business. 12. Salaries, draws, and expense accounts for the partners. How much money will each partner draw from the business? Under what circumstances? How often? 13. Absence or disability of one of the partners. If a partner is absent or disabled for an extended period of time, should the partnership continue? Will the absent or disabled partner receive the same share of profits as she did prior to her absence or disability? Should tile absent or disabled partner be held responsible for debts incurred while unable to participate? 14. Dissolution of 'the partnership. Under what circumstances will the partnership dissolve? 15. Alterations or modifications of the partnership agreement. No document is written to last forever. Partnership agreements should contain provisions for alterations or modifications. THE UNIFORM PARTNERSHIP ACT. The Uniform Partnership Act (UPA) codifies lit body of law dealing with partnerships in the United Slates (except in Louisiana, which has no! adopted the UPA and where state law governs in the absence of a partnership agreement), Under the UPA, the three key elements of any partnership are common ownership interest in a business, sharing the business's profits and losses, and the right to participate in managing the operation of the partnership. Under the act, each partner has the right to: 1. share in the management and operations of the business. 2. share in any profits the business might earn from operations. 3. receive interest on additional advances made to the business. 4. be compensated for expenses incurred in the name of the partnership. 5. have access to the business's books and records. 6. receive a formal accounting of the partnership's business affairs. The UPA also sets forth the partners1 general obligations. Each partner is obligated to: 1. share in any losses sustained by the business. 2. work for the partnership without salary. 3. submit differences that may arise in the conduct of the business to majority vote or arbitration. 4. give the other partner complete information about all business affairs. 5. give a forma! accounting of the partnership's business affairs. Beyond what the law prescribes, a partnership is based above all else on mutual trust and respect. Any partnership missing these elements is destined to fail. The Advantages of the Partnership EASY TOESTABLISH.

Like the proprietorship, the partnership is easy and inexpensive to establish. The owners must obtain the necessary business licenses and submit a minimal number of forms. In most states, partners must file a certificate for conducting business as partners if the business is run under a trade name. COMPLEMENTARY SKILLS . In a sole proprietorship, the owner must wear lots of different hats, and not all of them will fit well. In successful partnerships, the parties' skill and abilities usually complement one another, strengthening the company's managerial foundation. Bill Martin and Greg Wright, friends since high school, relied on their complements skills to build a successful partnership, a Web site for investors called Raging Bull Inc. <www.ragingbutl.com>. While still in college, the two decided to combine their passion for investing and the internet into a business. Wright used his computer skills (and those of his college roommate) to work out the operational and technical aspects of creating the Web site, while Martin used his network of connections through an investment club to locale the material for the site 'a contents. Traffic on their site started slowly but began if build over time, ultimately attracting so many users that @ Ventures, a venture capital firm invested $2 million in the start-up company. Today Raging Bull Inc. is a multimilliondollar business thanks to the complementary skills of its founders.5 DIVISION OF PROFITS. There arc no restrictions on how partners distribute the company's profits as long as they are consistent with the partnership agreement and do not viol late the rights of any partner. The partnership agreement should articulate the nature of each partner's contribution and proportional share of the profits. If the partners fail to era ate an agreement, the UPA says that the partners share equally in the partnership's profits, even if their original capital contributions are unequal. LARGER POOL OF CAPITAL . The partnership form of ownership can significant! broaden the pool of capital available to a business. Each partner's asset base improves the business's ability to borrow needed funds; together the partners' personal assets will support a larger borrowing capacity. ABILITY TO ATTRACT LIMITED PARTNERS. When partners share in owning, operating, and managing a business, they are general partners. General partners have unlimited liability for the partnership's debts and usually take an active role in managing the business. Every partnership must have at least one general partner, although there is not limit on the number of general partners a business can have. Limited partners cannot participate in the day-to-day management of a company, and they have limited liability for the partnership's debts. If the business fails, they lose only what they have invested in it and no more, Limited partners usually are just financial investors in a business. A limited partnership can attract investors by offering them limited liability and the potential to realize a substantial return on their investments if the business is successful. Many individuals find it very profitable to invest in high-potential small businesses, but only if they avoid the disadvantages of unlimited liability while doing so. LITTLE GOVERNMENTAL REGULATION. Like the proprietorship, the partnership form of operation is not burdened with red tape. FLEXIBILITY. Although not as flexible as sole ownership, the partnership can generally BTIquickly to changing market conditions because no giant organization stifles quick and creative responses to new opportunities. TAXATION. The partnership itself is not subject to federal taxation. It serves as a conduit for the profit or losses it earns or incurs; its net income or losses are passed along to the partners as personal income, and the partners pay income tax on their distributive shares. The partnership, like the

proprietorship, avoids the "double taxation" disadvantage associated with the corporate form of ownership. The Disadvantages of the Partnership UNLIMITED LIABILITY OF AT LEAST ONE PARTNER. At least one member of every partnership must be a general partner. The general partner has unlimited personal liability, even though he is often the partner with the least personal resources. CAPITAL ACCUMULATION. Although the partnership form of ownership is superior proprietorship in its ability to attract capital, it is generally not as effective as the corporate of ownership, which can raise capital by selling shares of ownership to outside investors. DIFFICULTY IN DISPOSING OF PARTNERSHIP INTEREST WITHOUT DISSOLVING THE PARTNERSHIP. Most partnership agreements restrict how a partner (s) of his share of the business. Often, a partner is required to sell his interest to partner (s). Even if the original agreement contains such a requirement and clearly delineates how the value of each partner's ownership will be determined, there is no guarantee that the other partner (s) will have the financial resources to buy the seller's inter-a When the money is not available to purchase a partner's interest, the other partner (s) may be forced either to accept a new partner, or to dissolve the partnership, distribute the remaining assets, and begin again. When a partner withdraws from the partnership, the partnership ceases to exist unless there are specific provisions in the partnership agreement for a smooth transition. When a general partner dies, becomes incompetent, or withdraws m the business, the partnership automatically dissolves, although it may not terminate. Even when there are numerous partners, if one chooses to disassociate her name from the business, the remaining partners will probably form a new partnership. LACK CONTINUITY. If one partner dies, complications arise. Partnership interest is often nontransferable through inheritance because the remaining partner(s) may not want to be in a partnership with the person who inherits the deceased partner's interest. Partners can make provisions in the partnership agreement to avoid dissolution due to death if all parties agree to accept as partners those who inherit the deceased's interest. POTENTIAL FOR PERSONALITY AND AUTHORITY CONFLICTS. Being in a partnership is much like being in a marriage. Making sure partners' work habits, goals, ethics, and general business philosophy are compatible is an important step in avoiding a nasty business divorce. "People always think you invest in the product or the equipment, but the biggest investment is in the partnership-in each other," says Liz Davidson, who with partner Alex Andrade, runs a successful investment firm in New York City. 6 However, no matter how compatible partners are, friction among them is inevitable. The key is having a mechanism such as a partnership agreement and open lines of communication for controlling it. The demise of many partnerships can often be traced to interpersonal conflicts and the lack of a procedure to resolve those conflicts. Limited Partnerships A limited partnership, which is a modification of a general partnership, is composed of a] least one general partner and at least one limited partner, in a limited partnership, the general partner is treated, under the law, exactly as in a general partnership. The limited partner is treated more as an investor in the business venture: limited partners have limited liability. They can lose only the amount invested in the business. Most states have ratified the Revised Uniform Limited Partnership Act. The formation of a limited partnership requires its founder to file a certificate of limited partnership in the state in which the

limited partnership plans to conduct business. The certificate of limited partnership should include the following information: 1. the name of the limited partnership. 2. the general character of its business. 3. the address of the office of the firm's agent authorized to receive summonses or other legal notices. 4. the name and business address of each partner, specifying which ones are general partners and which are limited partners. 5. the amount of cash contributions actually made, and agreed to be made in the future, by each partner. 6. a description of the value of monkish contributions made or to be made by each partner. 7. the times at which additional contributions are to be made by any of the partners. 8. whether and under what conditions a limited partner has the right to grant limited partner status to an assignee of his or her interest in the partnership. 9. if agreed upon, the time or the circumstances when a partner may withdraw from the firm(unlike the withdrawal of a general partner, the withdrawal of a limited partner does not automatically dissolve a limited partnership). 10. if agreed upon, the amount of, or the method of determining, the funds to be received by a withdrawing partner. 11. any right of a partner to receive distributions of cash or other property from the firm, and the times and circumstances for such distributions. 12. the time or circumstances when the limited partnership is to be dissolved. 13. the rights of the remaining general partners to continue the business after withdrawal of a general partner. 14. any other matters the partners want to include. The general partner has the same rights and duties as under a general partnership: the right to make decisions for the business, to act as an agent for the partnership, to use the property of the partnership for normal business, and to share in the business's profits. The limited partner does not have the right to manage the business in any way. In fact, if he or she takes part in managing the business, a limited partner may actually forfeit limited liability, taking on the liability status of a general partner. Limited partners can, however, make management suggestions to the general partners, inspect the business, and make copies of business records. A limited partner is, of course, entitled to a share of the business's profits as agreed on and specified in the certificate of limited partnership. The primary disadvantage of limited partnership is the complexity and the cost of establishing them. Dogwood Stable of Aiken, South Carolina<www.dogwoodstable.com>, relies on limited partnerships to give sophisticated investors the opportunity to share in the excitement of owning a racehorse. Cot Campbell, owner of Dogwood Stable, reduces the risk of investing in a racehorse by grouping several horses of different ages, price, and breeding potential into syndicates and then selling shares of ownership in each syndicate to limited partners. Dogwood Stable holds 5 percent of every syndicate as the general partner and sells four 23.75 percent shares to limited partners at prices ranging from $11,000 to $77,000 each. Although only about 10 percent of individual racehorse owners earn a profit each year, investors in limited partnerships such as those offered by Dogwood Stable have a 25 percent chance of at least breaking even. The star of Dogwood Stable's limited partnership so far is Summer Squall, whose winnings and stud fees totaled more than $2.5 million. Limited partners in this syndicate earned many times their original $55,900 investments (although most investors admit that the excitement of the race is the real reason they invest). 7 Limited Liability Partnerships

Many states now recognize limited liability partnerships (LLPs) in which all partners in a business are limited partners, having only limited liability for the debts of the partnership. Most states restrict LLPs to certain types of professionals such as attorneys, physicians, dentists, accountants, and others. Just as with any limited partnership, the partners must file a certificate of limited partnership in the state in which the partnership will conduct business, and the partnership must identify itself as an LLP to those with whom it does business. Also, like every partnership, an LLP does not pay taxes; its income is passed through to the limited partners, who pay taxes on their shares of the company's income. Master Limited Partnership A relatively new form of business structure, master limited partnership (MLP), is just like regular limited partnerships, except its shares are traded just like shares of common stock. An MLP provides most of the same advantages to investors as a corporation- including limited liability. One analyst says that a master limited partnership "looks like a corporation, acts like a corporation, and trades on major stock exchanges like a corporation."8 Congress originally allowed MLPs be taxed as partnerships. However, in 1987, it ruled that any MLP not involved in natural resources or real estate would be taxed as a corporation, eliminating their ability to avoid the "double taxation" disadvantages. MLP profits typically must be divided among thousands of partners. CORPORATIONS The corporation is the most complex of the three major forms of business ownership. It is a separate entity apart from its owners and may engage in business, make contracts, sue and be sued, own property, and pay taxes. The Supreme Court has defined the corporation as "an artificial being, invisible, intangible, and existing only in contemplation of the law."9 Because the life of the corporation is independent of its owners, the shareholders can sell their interests in the business without affecting its continuation. Corporations (also known as "C corporations") are creations of the state. When a corporation K founded, it accepts the regulations and restrictions of the state in which it is incorporated and any other state in which it chooses to do business. A corporation doing business in the state in which it is incorporated is a domestic corporation. When a corporation conducts business in another state, that state considers it to be a foreign corporation. Corporations that are formed in other countries but do business in the United States are alien corporations. Generally, the corporation must report annually its financial operations to its home slate's secretary of state. These financial reports become public record. If a corporation's stock is sold in more than one state, the corporation must comply with federal regulation governing the sale of corporate securities. There are substantially more reporting requirements for a corporation than for the other forms of ownership. How to Incorporate Most .states allow entrepreneurs to incorporate without the assistance of an attorney. Sons states even provide incorporation kits lo help in the incorporation process. Although it is cheaper for entrepreneurs to complete the process themselves, it is not always the best idea. In some stale, the application process is complex, and the required forms are confusing. The price for filing incorrectly can be high. If an entrepreneur completes the incorporation process improperly, it is generally invalid. Once the owners decide to form a corporation, they must choose a state in which! incorporate. If the business will operate within a single state, it is probably most logical! incorporate in (hat stale. States differ-sometimes rather dramatically-in the requirements they place on the corporations they charter and how they treat corporations chartered in other states. They also differ in the tax rate they impose on corporations, the restrictions placed on their activities, the capital required to incorporate, and the fees or organization tax charged to incorporate, Delaware, for instance, offers low incorporate fees and minimal legal requirements.

Every state requires a certificate of incorporation or charter to be filed with the secretary) of state . The following information is generally required to be in the certificate of incorporation: The corporation's name. The corporation must choose a name that is not so similar to that of another firm in that stale [hat it causes confusion or lends itself to deception. It must ate include a term such as corporation, incorporated, company, or limited lo notify the public that [hey are dealing with a corporation. The corporation's statement of purpose . The incorporators must stale in general terms the intended nature of the business. The purpose must, of course, be lawful. An illustration might be '"to engage in the sale of office furniture and fixtures." The purpose should be broad enough to allow for some expansion in the activities of the business as it develops. The corporation's time horizon. In must cases, Corporations arc formed with no specific termination date: they are formed "for perpetuity." However, it is possible to incorporate for a specific duration (e.g.. 50 years). Names and addresses of the incorporators. The incorporators must be identified in the articles of incorporation and are liable under the law to attest that all information in the articles of incorporation is correct. In some states, one or more of the incorporators must reside in the stale in which the corporation is being created. Place of business. The street and mailing addresses of the corporation's principal office must be listed. For a domestic corporation, this address must be in the state in which incorporation takes place. Capital stock authorization. The articles of incorporation must include the amount and class (or type) of capital stock the corporation wants to be authorized lo issue. This is not the number of shares it must issue: a corporation can issue any number of shares up to the amount authorized. This section must also define the different classifications of stock and any social rights, preferences, or limits each class has. Capital required at the time of incorporation. Some states require a newly formed corporation to deposit in a bank a specific percentage of the stock's par value prior to incorporating. Provisions for preemptive rights, if any, that are granted lo stockholders. Restrictions on transferring shares. Many closely held corporal ions-those owned by a fen shareholders, often family members-require shareholders interested in selling their stock to offer it first to the corporation. (Shares the corporation itself owns arc called treasury stock.) To maintain control over their ownership, many closely held corporations exercise their right, known as the right of first refusal Names and addresses of the officers and directors of the corporation. Rules under which the corporation will operate. Bylaws are the rules and regulations the officers and directors establish for the corporation's internal management and operation. Once the secretary of state of the incorporating state has approved a request for incorporation and the corporation pays its lees, the approved articles of incorporation become its charter. With the charter in hand, the next order of business is to hold an organizational meeting for the stockholders to formally elect directors who in turn will appoint the corporate officers. The Advantages of the Corporation LIMITED LIAB1LPTY OF STOCKHOLDERS. Because it is a separate legal entity, a Corporation allows investors to limit their liability to the total amount of their investment

in the business. This legal protection of personal assets beyond the business is of critical con-am to many potential investors. This shield of limited liability may not be impenetrable, however. Because .start-up companies arc so risky, lenders and other creditors require the owners to personally guarantee loam made to the corporation. Robert Morris Associates, a national organization of bunk loan officers, estimates that 95 percent of small business owners have to sign personal guarantees to gel the financing they need. By making these guarantees, owners are pulling Recent personal assets at risk (just as in a proprietorship) despite choosing the corporate form ownership, recent court decisions have extended the personal liability of small corporation owners beyond the financial guarantees that banks and other lenders require, "piercing the corporate veil" much more than ever before. Increasingly, courts are holding entrepreneurs personally liable for environmental, pension, and legal claims against their corporations-much to the surprise of the owners, who chose the corporate form of ownership to shield themselves from such liability.l0 Problems usually arise when entrepreneurs fail to "maintain the integrity" of a corporation by failing to capitalize it sufficiently, neglecting corporate formalities such as holding annual meetings or filing required reports, or commingling their personal assets and those of the corporation. For example, the owner of a Los Angeles boatyard often paid his personal expenses with checks written on his corporation's Recount. When a customer sued the company and won, the court ruled that the judgment applied not only to the corporation's assets but also to the owner's personal assets because he had failed to keep the two separated. 11 ABILITY TO ATTRACT CAPITAL . Based on the protection of limited liability, corporations have proved to be the most effective form of ownership for accumulating large mounts of capital. Limited only by the number of shares authorized in its charter (which an be amended), the corporation can raise money to begin business and expand as opportunity dictates by selling shares of its stock to investors. A corporation can sell its stock to limited number of private investors (a private placement) or to the public (a public offering). ABILITY TO CONTINUE INDEFINITELY. Unless a corporation fails to pay its taxes is limited to a specific length of life by its charter, it can continue indefinitely. The corporation's existence docs not depend on the fate of any single individual. Unlike a proprietorship or partnership in which the death of a founder ends the business, a corporation lives beyond the lives of those who gave it life. This perpetual life gives rise to the next major advantage-transferable ownership. TRANSFERABLE OWNERSHIP. If stockholders in a corporation are displeased with, the business's progress, they can sell their shares to someone else. Millions of shares of stock representing ownership in companies are traded daily on the world's stock exchanges. Shareholders can also transfer their stock through inheritance to a new generation of owners. During all of these transfers of ownership, the corporation continues to conduct business as usual. Unlike that of large corporations whose shares are traded on organized stock exchanges. the stock of many small corporations is held by a small number of people ("closely held"), often company founders, family members, or employees. The small number of people holding the stock means that the resale market for shares is limited, which could make the transfer of ownership more difficult. The Disadvantages of Corporations COST AND TIME INVOLVED IN THE INCORPORATION PROCESS. Corporations can be costly and time-consuming to establish. The owners are giving birth to an artificial legal entity, and the gestation period can be prolonged for the novice. In sonic states an attorney must handle the incorporation process, but in most slates entrepreneurs can complete all

of the required forms alone. However, an owner must exercise great caution when incorporating without the help of an attorney. Also, incorporating a business requires various fees that are not applicable to proprietorships or partnerships. Creating a corporation can cost between $500 and $2,500, typically averaging around $1,000. DOUBLE TAXATION. Because a corporation is a separate legal entity, it must pay taxes on its net income at the federal level, in most states, and to some local government as well. Before stockholders receive a penny of its net income as dividends, a corporal inn must pay these taxes at the corporate tax rate. Then stockholders must pay taxes on the dividends they receive from these same profits al the individual tax rate. Thus, a corporation's profits are taxed twice. This double taxation is a distinct disadvantage of the corporate form of ownership. POTENTIAL FOR DIMINISHED MANAGERIAL INCENTIVES . As Corporations grow, they often require additional managerial expertise beyond that which the founder can provide. Because she created the company and often has most of her personal wealth tied up in it, the entrepreneur has an intense interest in making it a success and is willing to make sacrifices for it. Professional managers the entrepreneur brings in to help run the business as it grows do not always have the same degree of interest in or loyalty to fat company. As a result, the business may suffer without the founder's energy, care, and dew lion. One way to minimize this potential problem is to link managers' (and even employees') compensation to the company's financial performance through a profit-sharing a bonus plan. Corporations can also stimulate managers' and employees' incentive on the job by creating an employee stock ownership plan (ESOP) in which managers and employee1 become pail or whole owners in the company. LEGAL REQUIREMENTS AND REGULATORY RED TAPE . Corporations are subject to more legal, reporting, and financial requirements than other forms of ownership. Corporate officers must meet more stringent requirements for recording and reporting management decisions and actions. They must also hold annual meetings and consult the board of directors about major decisions that are beyond day-to-day operations. Manage may be required to submit some major decisions to the stockholders for approval Corporations that are publicly held must file quarterly and annual reports with a Securities and Exchange Commission (SEC). POTENTIAL LOSS OF CONTROL BY THE FOUNDER(S). When entrepreneurs sell shares of ownership in their companies, they relinquish some control. Especially when they need large capital infusions for start-up or growth, entrepreneurs may have to give up significant amounts of control, so much, in fact, that the founder becomes a minority shareholder. Losing majority ownership-and, therefore, control-in her company leaves the- founder in a precarious position. She no longer has the power to determine the company's direction; "outsiders" do. In some cases, founders' shares have been so diluted that majority shareholders actually vote them out of their jobs! Even Bill Gales, one of the wealthiest people in the world, has seen his ownership in Microsoft Inc., the company he founded with Paul Allen as a partnership in 1975, dwindle from 50 percent at start-up to 44.8 percent when the company went public in iy86, to 18.5 percent today. Over the years, Gates's ownership in Microsoft was diluted ax he sold stock in the company to raise the capital needed to fuel its rapid growth. Don't feel too sorry for Bill Gates, however. His 18.5 percent stake in the company he cofounded is now worth more than $75 billion dollars! 12 OTHER FORMS OF OWNERSHIP In addition to the sole proprietorship, the partnership, and the corporation, entrepreneurs can choose from other forms of ownership, including the S corporation, the limited Liability company, the professional corporation, and the joint venture. The S Corporation In 1954, the Internal Revenue Service Code created the subchapter S corporation. In recent years, the IRS has changed the title to S corporation and has made a few

modifications in its qualifications. An S corporation is only a distinction that is made for federal income tax purposes and is, in terms of legal characteristics, no different from any other corporation. Although Congress recently simplified some of the rules and requirements For S corporations, a business seeking "S" status still must meet the following criteria; 1. It must be a domestic (U.S.) corporation. 2. It cannot have a nonresident alien as a shareholder. 3. It can issue only one class of common stock, which means that all shares must carry the same rights (e.g., the right to dividends or liquidation rights). The exception is voting rights, which may differ. In other words, an S corporation can issue voting and nonvoting common stock. 4. It must limit its shareholders to individuals, estates, and certain trusts, although tax-exempt creations such as employee stock ownership plans (ESOPs) and pension plans can now be shareholders. 5. It cannot have more than 75 shareholders (increased from 35), which is an important benefit for family businesses making the transition from one generation of owners to another. Violating any of these terms automatically terminates a company's "S" status. If a corporation satisfies the definition for an S corporation, the owners must actually elect to be treated as one. The election is made by filing IRS Form 2553 at any time during the year, and all shareholders must consent to have the corporation treated as an S corporation. THE ADVANTAGES OF AN S CORPORATION. The S corporation retains all of the advantages of a regular corporation, such as continuity of existence, transferability of ownership, and limited personal liability for its owners. The most notable provision of the S corporation is that it passes all of its profits or losses through to the individual shareholders, and its income is taxed only once at the individual tax rate. Thus, electing S corporation status avoids a primary disadvantage of the regular (or "C") corporation-double taxation. In essence, the tax treatment of an S corporation is exactly like that of a partnership; its owners report their proportional shares of the company's profits on their individual income tax returns and pay taxes on those profits at the individual rate (even if they never take the money out of the business). Another advantage the S corporation offers is avoiding the lax C corporations pay on assets that have appreciated in value and are sold. Also, owners of S corporations enjoy the ability to make year-end payouts to themselves if earnings are high. In a C corporation, owners have no such luxury because the IRS watches for excessive compensation to owners/managers. One significant change to the laws governing S corporations that benefits entrepreneurs involves subsidiary companies. Before 1998, if an entrepreneur owned separate but affiliated companies, she had to maintain each one as a distinct S corporation with its own accounting records and tax return. Under current law, that business owner can set up all o! these affiliated companies as qualified S corporation subsidiaries ("Q Subs") under the umbrella of a single company, each with its own separate legal identity, and still file a single tax return for the parent company. For entrepreneurs with several lines of businesses, this change means greatly simplified tax filing. Owners also can use losses from one subsidiary company to offset profits from another to minimize their tax bills. "The advent of the Q Sub has made [S corporations! more useful and popular than ever," says one tax expert.13 DISADVANTAGES OF AN S CORPORATION. When the Tax Reform Act (TRA)of 1986 restructured individual and corporate lax rates, many business owners switched to S corporations lo lower their tax bills. For the first time since Congress enacted the federal income tax in 1913, the maximum individual rate was lower than the maximum corporate rate. However, in 1993, Congress realigned the tax structure by raising the maximum personal tax rate to 39.6 percent from 31 percent. This new rate is 4.6 percent higher

than the maximum corporate lax rate of 35 percent. Although these changes make S corporation status much less attractive than before, entrepreneurs considering switching to C corporation status must consider the total impact of such a change on their companies, especially if they pay out a significant amount of earnings lo owners. In addition to the tax implications of making the switch from an S corporation, owners should consider the size of the company's net income, the tax rates of its shareholders, plans (and their timing) to sell m company, and the impact of the C corporation's double-taxation penalty on income distributed as dividends. Another disadvantage of the S corporation is that the costs of many fringe benefits-insurance, meals, lodging, and so on-paid to shareholders with 2 percent or more of stop cannot be deducted as business expenses for lax purposes; these benefits are then considered to be taxable income. In addition, S corporations offer shareholders only a limit range of retirement benefits, whereas regular corporations make a wide range of retirement plans available. WHEN IS AN S CORPORATION A WISE CHOICE? Choosing S corporation status is usually beneficial to start-up companies anticipating net losses and to highly profitable firms with substantial dividends to pay out to shareholders. In these cases the owner can use the loss to offset other income or is in a lower tax bracket than the corporation, thus saving money in the long run. Companies that plan to reinvest most of their earnings to finance growth also find S corporation status favorable, Small business owners who intend to sell their companies in the near future will prefer "S" over "C" status because the taxable gains on the sale of an S corporation are generally lower than those of a C corporation. On the other hand, small companies with the following characteristics are not likely to benefit from S corporation status: highly profitable personal service companies with large numbers of shareholders, in which most of the profits are passed on to shareholders as compensation or retirement benefits. fast-growing companies that must retain most of their earnings to finance growth and capital spending. corporations in which the loss of fringe benefits to shareholders exceeds tax savings. corporations in which the income before any compensation to shareholders is less than $100,000 per year. corporations with sizable net operating losses that cannot be used against S corporation earnings. The Limited Liability Company (LLC) A relatively new creation, the limited liability company (LLC) is, like an S corporation, across between a partnership and a corporation, LLCs, however, are not subject to many of the restrictions currently imposed on S corporations and offer more flexibility than S corporations. For example, S corporations cannot have more than 75 shareholders, none of whom can be foreigners or corporations. S corporations are also limited to only one class of stock. LLCs eliminate those restrictions. An LLC must have at least two owners (called "members"), but it offers its owners limited liability without imposing any requirements on their characteristics or any ceiling on their numbers. Unlike a limited partnership, which prohibits limited partners from participating in the day-to-day management of the business, an LLC does not restrict its members' ability to become involved in managing the company. In addition to offering its members the advantage of limited liability, LLCs also avoid is double taxation imposed on C corporations. Like an S corporation, an LLC does not pay income taxes; its income flows through to the members, who are responsible for paying income taxes on their shares of the LLCs net income. Because they are not subject to lie many restrictions imposed on other forms of ownership, LLCs offer entrepreneurs mot her significant advantage: flexibility. Like a partnership, an LLC permits its members ID divide income (and, thus, tax liability) as they see fit.

These advantages make the LLC" an ideal form of ownership for small companies in virtually any industry-retail, wholesale, manufacturing, real estate, or service. Because they offer the tax advantage of a partnership, the legal protection of a corporation, and maximum flexibility. LLCs have become an extremely popular form of ownership among entrepreneurs. For example, Marian Fletcher launched a profitable party planning and catering strike in 1995 as a sole proprietorship. Her company, Let's Go Party, grew quickly, and Fletcher wanted to bring her daughter into the business as an owner. Reviewing the montages and disadvantages of each form of ownership led Fletcher to create an UC "We decided this was the best way to go for us," she says. "In case anything hap-pens daughter and I won't be liable for anything more than what we have invested in the company already." Fletcher, who set up her LLC without the help of an attorney for just $50, also found the LLC's tax treatment to he a major advantage for her and her daughter. 14 Creating an LLC is much like creating a corporation. Forming an LLC requires an entrepreneur to file two documents with the secretary of state: the articles of organization and the operating agreement. The LLC's articles of organization, similar to the corpora lion's articles of incorporation, actually creates the LLC by establishing its name address, its method of management (board managed or member managed), its duration and the names and addresses of each organizer. In most states the company's name mill contain the words "limited liability company," "limited company," or the letters "L.L.C or "L.C." Unlike a corporation, an LLC does not have perpetual life; in most stales LLC's charter may not exceed 30 years. However, the same factors that would cause a partnership to dissolve would also cause the dissolution of an LLC before its charter expires. The operating agreement, similar to a corporation's bylaws, outlines the provision governing the way the LLC will conduct business, such as members' capital contribution to the LLC, the admission or withdrawal of members, distributions from the business, and how the LLC will be managed. To ensure that their LLCs are classified as a partnership for tax purposes, entrepreneurs must draft the operating agreement carefully. The operating agreement must create an LLC that has more characteristics of a partnership than of a corporation to maintain this favorable tax treatment. Specifically, an LLC cannot have an more than two of the following four corporate characteristic: 1. Limited liability. Limited liability exists if no member of the LLC is personally liable for the debts or claims against the company. Because entrepreneurs choosing this form of ownership usually do so to get limited liability protection, the operating agreement almost always contains this characteristic. 2. Continuity of life. Continuity of life exists if the company continues to exist in spite of changes in stock ownership. To avoid continuity of life, any LLC member must have the power to dissolve the company. Most entrepreneurs choose to omit this characteristic from their LLC's operating agreements. 3. Free transferability of interest. Free transferability of interest exists if each LLC member has the power lo transfer his ownership to another person freely and without the consent of other members. To avoid this characteristic, the operating agreement must state that a recipient of a member's LLC stock cannot become a substitute member without the consent of the remaining members. 4. Centralized management. Centralized management exists if a group that does not include all LLC members has the authority to make management decisions and to conduct company business. To avoid this characteristic, the operating agreement must slate that the company elects lo be "member managed." Despite their universal appeal to entrepreneurs, LLCs suffer some disadvantages. They can be expensive to create, often costing between SI .500 and $5,000. Although an LLC may be ideally suited for an entrepreneur launching a new company, it may pose problems for business owners

considering converting an existing business to an LLC. Switching to an LLC from a general partnership, a limited partnership, or a sole proprietorship by reorganizing lo bring in new owners is usually not a problem. However, owners of corporations and S corporations would incur large tax obligations if they convened their companies lo LLCs. To date, the biggest disadvantage of the LLC stems from its newness. As yet, no uniform legislation for LLCs exists (although a Uniform Limited Liability Act is pending at the federal level). Every state now recognizes the LLC as a legal form of ownership. The Professional Corporation Professional corporations arc designed to offer professionals-lawyers, doctors, dentists, accountants, and others-the advantages of the corporate form of ownership. They are ideally suited for professionals, who must always be concerned about malpractice lawsuits, because they offer limited liability. For example, if three doctors formed a professional corporation. none of them would be liable for the others' malpractice. (Of course, each would be liable for her own actions.) Owners create a professional corporation in the same way as a regular corporation. Such corporations are often identified by the abbreviations P.C. (professional corporation), P.A. (professional association), or S.C. (service corporation). YOU BE THE CONSULTANT... Which Form Is Best? Watoma Kinsey and her daughter Katrina arc about to launch a business that specializes in children's parties. Their target audience it, upscale families who want to throw unique, memorable parties to celebrate .special occasions for their children between the ages of 5 and 15. The Kinseys have leased a large building and have renovated it to include many features designed to appeal to kids, including special gym equipment, a skating rink, an obstacle course, a mockup of a pirate ship, a ball crawl, and even a moveable haunted house. They can offer simple birthday parties (cake and ice cream included! or special theme parties as elaborate as the customer wants. Their company will provide magicians, clowns, comedians, jugglers, tumblers, and a variety of other entertainers. Watoma and Katrina have invested $45,000 each to get the business ready to launch. Based on the quality of their business plan and their preparation, the Kinscys have negotiated a $40,000 hank loan. Because they both have families, the Kinseys want to minimize their exposure to potential legal arid financial problems, A large portion of their Start-up costs went to purchase a liability insurance policy to cover the Kinseys in case a child is injured at a party. If their business plan is accurate, the Kinseys will earn a small profit in their first year (about $1,500) and a more attractive profit of $16,000 in their second year of operation. Within five years, they expect their company to generate as much as $50,000 in profits. The Kinseys have agreed to split the profits-and the workload-equally. If the business is as successful as they think it will be, the Kinseys eventually want to franchise their company. That, however, is part of their long-range plan. For now, they want to perfect their business system and prove that it can be profitable before they try to duplicate it in the form of franchises. As they move closer to the launch date for their business, the Kinseys are reviewing the different forms of ownership. 1. Which form(s) of ownership would you recommend to the Kinseys? Explain. 2. Which form(s) of ownership would you recommend the Kinscys avoid! Explain. 3. What factors should the Kinseys consider as they try to choose the form of ownership that is best for them? The Joint Venture A joint venture is very much like a partnership, except that it is formed for a specific, limited purpose. For instance, suppose that you have a 500-acre tract of land 60 miles from Chicago that has been cleared and is normally used in agricultural production. You have a friend who has solid contacts among major musical groups and would like to put on a concert. You expect prices for

your agricultural products to be low this summer, so you and your friend form a joint venture for the specific purpose of staging a three-day concert. Your contribution will he the exclusive use of the land for one month, and your friend will provide all tile performers as well as technicians, facilities, and equipment. All costs will be paid out of receipts and the net profits will be split, with you receiving 20 percent for the use of your land. When the concert is over, the facilities removed, and the accounting for all costs completed, you and your friend split the profits 20-80, and the joint venture terminates. In any endeavor in which neither party can effectively achieve the purpose alone, a joint venture becomes a common form of ownership. The "partners" form a new joint venture for each new project they undertake. The income derived from a joint venture is taxed as if it arose from a partnership. Table 4.1 provides a summary of the key features of the major forms of ownership discussed in this chapter. FRANCHISING Franchising has come a long way from its beginnings in the 1850s when the Singer Sewing Machine Company began licensing distributors to sell its sewing machines. Today, approximately 4,500 franchisers operate more than 600.000 franchise outlets throughout the world, and more are opening al an incredible pace. A new franchise opens somewhere in the world every 6.5 minutes! 15 Franchises account for 44 percent of all retail sales, totaling more than $1 trillion, and they employ some 8 million people in more than 100 major industries.16 Much of franchising's popularity stems from its ability to offer those who lack business experience the chance to own and operate a business with a high probability of success. This booming industry has moved far beyond the traditional boundaries of fast food into fields as diverse as maid services and bakeries to computer sales and pet-sitting. In franchising, semi-independent business owners (franchisees) pay fees and royalties lo a parent company (franchiser) in return for the right to become identified with its trademark, to sell its products or services, and often to use its business format and system. Franchisees do not establish their own autonomous businesses; instead, they buy a "success package" from the franchiser, who shows them how lo use it. Franchisees, unlike independent business owners, don't have the freedom to change the way they run their businesses-for example, shifting advertising strategies or adjusting product lines-but they do have a formula for success that (he franchiser has worked out. "The secret (o success in franchising is following the formula precisely," says one writer. "Successful franchisers claim that neglecting to follow the formula is one of the chief reasons that franchisees fail"17 Anita Schlachter, co-owner of a highly successful Maaco (automotive services) franchise with her husband and her son, is convinced that the system the franchiser taught them is the key lo their company's progress and growth to date. The Schlachters follow the franchiser's plan, using it as a road map to success. "If you listen to what your franchiser says and fallow its policies and procedures, you'll be successful," she says. "Those who think they know more should not go into franchising." 18 Franchising is based on a continuing relationship between a franchiser and a franchisee. The franchiser provides valuable services such as market research, a proven business system, name recognition, and many other forms of assistance; in return, the franchisee pays an initial franchise fee as well as an ongoing percentage of his sales to the franchiser as royalties and agrees to operate his outlet according to the franchiser's system. Because franchisers develop the business systems their franchisees use and direct their distribution methods, they maintain substantial control over their franchisees. This standardization lies at the core of franchising's success as a method of distribution. TYPES OF FRANCHISING

There are three basic types of franchising; trade-name franchising, product distribution franchising, and pure franchising. Trade-name franchising involves a brand name such as True Value Hardware or Western Auto. Here the franchisee purchases the right to use the franchiser's trade name without distributing particular products exclusively under the franchiser's name. Product distribution franchising involves a franchiser's licensing a franchisee to sell specific products under the franchiser's brand name and trademark through a Selective, limited distribution network. This system is commonly used to market automobiles (Chevrolet, Oldsmobile, Chrysler), gasoline products (ExxonMobil, Sunoco, Texaco), soft drinks (Pepsi-Cola, Coca-Cola), bicycles (Schwinn), appliances, cosmetics, and other products. These two methods of franchising allow franchisees to acquire some of the parent company's identity. Pure (or comprehensive or business format) franchising involves providing the franchisee with a complete business formal, including a license for a trade name, the products or services to be sold, the physical plant, the methods of operation, a marketing strategy plan, a quality control process, a two-way communications system, and the necessary business services. The franchisee purchases the right lo use all the elements of a fully integrated business operation. Pure franchising is the most rapidly growing of all types of franchising and is common among fast-food restaurants, hotels, business service firms, car rental agencies, educational institutions, beauty aid retailers, and many others. Although product and trade-name franchises annually ring up more sales than pure franchisees, pure franchising outlets' sales arc growing much faster. THE BENEFITS OF BUYING A FRANCHISE A franchisee gets the opportunity lo own a small business relatively quickly, and, because of the identification with an established product and brand name, a franchise often reaches the breakeven point faster than an independent business would. Still, most new franchise outlets don't break even for at least six to eighteen months. Franchisees also benefit from the franchiser's business experience. In fact.experience is the essence of what a franchisee is buying from a franchiser. Many entrepreneurs go into business by themselves and make many costly mistakes, Given the thin margin for error in the typical start-up, a new business owner cannot afford In make many mistakes. In a franchising arrangement, the franchiser already has worked out the kinks in the system by trial and error, and franchisees benefit from that experience. A franchiser has climbed up the learning curve and can share with franchisees the secrets of success they have discovered in the industry. Gary Mandichak, owner of a successful Petland franchise, says, "[Franchisers! have the experience they know what works and what doesn't, and they know what's happening in the market."19 Franchisees also earn a great deal of satisfaction from their work. According to a recent Gallup survey of franchise owners, 82 percent of franchisees said they were "'somewhat satisfied" to "very satisfied" with their work.Plus. 75 percent said they would purchase their franchises again if given the opportunity (compared to just 39 percent of Americans who say they would choose the same job or business again).20 Another survey reported that 94 percent of franchise owners rated their operations as "very successful" or "successful."21 Before jumping at a franchise opportunity, an entrepreneur should consider careful!} the question, "What can a franchise do for me that 1 cannot do for myself7" The answer lo this question will depend on the particular situation and is not as important as the systematic evaluation of the franchise opportunity. After careful deliberation, one person ma;1 conclude that the franchise offers nothing that she could not do independently, and another may decide that a franchise is the key to success as a business owner. Franchisees often cite the following advantages that are discussed next. Management Training and Support

Recall from Chapter I that one of the leading causes of business failure is incompetent management. Franchisers are well aware of this and, in an attempt to reduce the number of franchise casualties, offer managerial training programs to franchisees prior to opening a new outlet Many franchisers, especially the well-established ones, also provide follow-up training and counseling services. This service is vital since most franchisers do not require a franchisee to have experience in the business. These programs teach franchisees the details they need to know for day-to-day operations as well as the nuances of running their businesses successfully, Training programs often involve both classroom and on-site instruction to leach franchisees the basic operations of the business. Before beginning operations, McDonalds franchisees spend 14 days in Illinois at Hamburger University where they learn everything from how lo scrape the grill correctly to "how to manage a $1.6 million business.'"22 Maaco franchisees spend four weeks at (he company's headquarters delving into a five-volume set operations manuals and learning to run an auto services shop. H & R Block trains it? franchisees to unravel the mysteries of tax preparation, whereas Dunkin' Donuts trains a franchisee for as long as live weeks in everything from accounting to dough making. To ensure franchisees' continued success, many franchisers supplement their start-up training programs with ongoing instruction and support. Franchisers offer these training programs because they realize that their ultimate success depends on the franchisee's success. Despite the positive features of training, inherent dangers exist in the trainer/trainee relationship. Every would-be franchisee should be aware that, in some cases, "assistance" from the franchiser tends to drift into "control" over the franchisee's business. Some franchisers also charge fees for their training services, so the franchisee should know exactly what she is agreeing to and what it costs. Brand-Name Appeal A licensed franchisee purchases the right lo use a nationally known and advertised brand name for a product or service. Thus, the franchisee has the advantage of identifying his business with a widely recognized trademark, which usually provides a great deal of drawing power. Customers recognize the identifying trademark, the standard symbols, the store design, and the products of an established franchise. Indeed, one of franchising's basic tenets is cloning the franchiser's success. For example, nearly everyone is familiar with the golden arches of McDonald's or the red roof of the Red Roof Inn, and the standard products and quality offered at each. A customer is confident that the quality and content of a meal at McDonald's in Fort Lauderdale will be consistent with a meal at a San Francisco McDonald's. "It's a tremendous advantage to open a business with a recognizable trademark that creates almost instant foot traffic," says franchise attorney and expert Andrew Caffey.'23 Standardized Quality of Goods and Services Because a franchisee purchases a license to sell the franchiser's product or service and the privilege of using the associated brand name, the quality of the goods or service sold determines the franchiser's reputation. Building a sound reputation in business is not achieved quickly, although destroying a good reputation lakes no lime at all. If some franchisees were allowed to operate at substandard levels, the image of the entire chain would suffer irreparable damage; therefore, franchisers normally demand compliance with uniform standards of quality and service throughout the entire chain. In many cases, the franchiser conducts periodic inspections of local facilities to assist in maintaining acceptable levels of performance. For instance, John Schnatter, founder of Papa John's, a fast-growing pizza franchise, makes personal visits to some of his franchisees' stores four to five times each week to make sure they are performing up to the company's high-quality standards. Franchisees say that Schnatter, known for his attention to detail, often checks pizzas for

air bubbles in the crust or tomato sauce for freshness. "Pizza is Schnatter's life, and he takes it very seriously," says one industry analyst. 24 Maintaining quality is so important that most franchisers retain the right to terminate the franchise contract and to repurchase the outlet if the franchisee fails to comply with established standards. National Advertising Programs An effective advertising program is essential to the success of virtually all franchise operations. Marketing a brand-name product or service over a wide geographic area requires! far-reaching advertising campaign. A regional or national advertising program benefits all franchisees. Normally, such an advertising campaign is organized and controlled by [hi franchiser. It is financed by each franchisee's contribution of a percentage of monthly sales, usually 1 to 5 percent, or a flat monthly fee. For example. Subway franchisees must pay 3.5 percent of gross revenues lo the Subway national advertising program. These funds are pooled and used for a cooperative advertising program, which has more impact than if the franchisees spent the same amount of money separately. Many franchisers also require franchisees 10 spend a minimum amount on local advertising. To supplement their national advertising efforts, both Wendy's and Burger Kin; require franchisees to spend at least 3 percent of grass sales on local advertising. Sore franchisers assist each franchisee in designing and producing its local ads. Many companies help franchisees create promotional plans and provide press releases and advertisements for grand openings. Financial Assistance Because they rely on their franchisees' money to grow their businesses, franchisers typically do not provide any extensive financial help for franchisees. Franchisers rarely make loans to enable franchisees to pay the initial franchise fee. However, once a franchiser locates a suitable prospective franchisee, it may offer the qualified candidate direct financial assistance in specific areas, such as purchasing equipment, inventory, or even the franchise fee. Because the start-up costs of some franchises ar already at breathtaking levels, some franchisers find that they must offer direct financial assistance. For example, US Franchise Systems, franchiser of Microtel Inn and Hawthorn Suits hotels, has set up a subsidiary, US Funding Corporation, that makes available to its franchisees $200 million in construction and mortgage financing. Not only has the in-house financing program cut the lime required to open a new hotel franchise, hut it also has accelerated the franchise's growth rate.25 Nearly half of the International Franchise Association's members indicate that they offer some type of financial assistance to their franchises; however, only one-fourth off: direct financial assistance. In most instances, financial assistance from franchisers takes form other than direct loans, leases, or short-term credit. Franchisers usually arc willing! assist qualified franchisees in establishing relationships with banks, private investors, and other sources of funds. Such support and connections from the franchiser enhance a franchisee's credit standing because lenders recognize the lower failure rate among establish franchises. Preferred relationships between lenders and franchisers can be critical because finding financing for a franchise can be challenging, just like attracting capital for any business start-up. For instance, when Jana Sappenfield began searching for $1.6 million of the $l.9 million needed to purchase a Primrose School franchise, the franchiser helped her connect with Newcourt/AT&T, a Small Business Administration-certified lender that has established preferred relationships with about 25 different franchised companies. "They were familiar with Primrose," says Sappenfield, "so no time was wasted researching or approving the franchiser." Because Primrose School had already accepted Sappenfield's application for a franchise, her loan request sailed easily through Newcourl/AT&T's approval process, "We know the leadership and have an understanding of the

selection criteria at the franchises we work with regularly," says a top executive at Newcourt/AT&T. "Consequently, when an approved loan application comes in from a [preferred franchise], wears certain the candidate is qualified." Sappenfield's first PrimroseSchool franchise was so successful that she has since purchased a second one.26 Proven Products and Business Formats What a franchisee essentially purchases is a franchiser's experience, expertise, and products. A franchise owner does not have to build the business from scratch. Instead of being forced to rely solely on personal ability to establish a business and attract a clientele, a franchisee can depend on the methods and techniques of an established business. These standardized procedures and operations greatly enhance the franchisee's chances of success and avoid the most inefficient type of learning-trial and error. With a franchise, a franchisee docs not have to struggle for recognition in the local marketplace as much as an independent owner might. Kenneth Gabler's independent video rental store had the largest share of the local market when his landlord leased space in the same shopping center to a nationally known video franchise. West Coast Video. When he discovered that the unit was company owned, Gabler offered to buy it. "I figured that if I stayed an independent and tried 10 compete, West Coast would take away 30 percent of my business anyway. So it was cheaper for me to pay the $15,000 initial fee and a 7 percent royalty every month," he says. West Coast Video's broader tape selection, marketing techniques, and recognized name "have helped tremendously," according to Gabler. Since he converted his business to a franchise, Gabler's sales have tripled! 27 Centralized Buying Power A significant advantage a franchisee has over an independent small business owner is participation in the franchiser's centralized and large-volume buying power. If franchisers sell goods and supplies to franchisees (not all do), they may pass on to franchisees any cost savings from quantity discounts they earn by buying in volume. For example, it is unlikely that a small, independent ice cream parlor could match the buying power of Baskin-Robbins, with its 3,000-plus retail ice cream stores. In many instances, economies of scale simply preclude the independent owner from competing head-to-head with a franchise operation. Site Selection and Territorial Protection A proper location is critical to the success of any small business, and franchises are no exception. In fact, franchise experts consider the three most important factors in franchising to be location, location, and location. Becoming affiliated with a franchiser may he the best way to get into prime locations. Many franchisers will make an extensive location analysis for each new outlet, including researching traffic patterns, zoning ordinances, accessibility, and population density. McDonald's, for example, is well known for its ability to obtain prime locations in high-traffic areas. Although choosing] location is the franchisee's responsibility, the franchiser usually reserves the right to approve the final site. Choosing a suitable location requires a location analysis, including studies of traffic patterns, zoning ordinances, accessibility, population density, and demographics. Some franchisers offer franchisees territorial protection, which gives existing franchisees the right to exclusive distribution of brand-name goods or services within a particular geographic urea. A clause establishing such a protective zone that bars other outlet from the same franchise gives franchisees significant protection and security. The size of j franchisee's territory varies from industry to industry. For example, one national fast-foot restaurant agrees not to license another franchisee within 1.5' miles of existing locations. But one soft-serve ice cream franchiser defines its franchisees' territories on the basis of zip code designations. The purpose of such protection is to prevent an invasion of the existing franchisee's territory and the accompanying dilution of sales. As existing markets haw become increasingly saturated with franchise outlets, the placement of new outlets hi become a source of friction between franchisers and franchisees. Existing

franchisee; charge that franchisers are encroaching on their territories by granting new franchises K close to them that their sales are diluted. Although most franchises offer their franchise;! some type of territorial protection, the contract of one popular submarine sandwich company offers no such protection and stales that the franchiser may compete with its franchisees, even if it "adversely affects" their sales.28 Greater Chance for Success Investing in a franchise is not risk free. Between 200 and 300 new franchise companies enter the market each year, and not all of them survive. But available statistics suggest that franchising is less risky than building a business from the ground up. One expert says that "becoming a franchisee can be the safest way to scratch the entrepreneurial itch." 29 Approximately 24 percent of new businesses fail by the second year of operation; in contrast. only about 7 percent of all franchises will fail by the second year. After six years, 85 percent of franchises are still in business compared to just 50 percent of independent businesses.30 This impressive success rate for franchises is attributed to the broad range of Services, assistance, and guidelines the franchiser provides. These statistics must be interpreted carefully, however, because when a franchise is in danger of failing, the franchise often repurchases or relocates the outlet and does not report it as a failure. As a result, soil] franchisers boast of never experiencing a failure. According to the American Hi Association's Franchise Committee, one-third of the franchisees in a typical franchise SB tem are making a decent profit, one-third are breaking even, and one-third are losing money. 31 The risk of purchasing a franchise is two-pronged: success-or failure-depends on the entrepreneur's managerial skills and motivation and on the franchiser's business experience and system. Many owners are convinced that franchising has been a crucial part: their success. "It's the opportunity to be in business for yourself but not by yourself." says one franchiser.32 THE DRAWBACKS OF BUYING A FRANCHISE Obviously, the benefits of franchising can mean the difference between success and failure for a small business. However, the franchisee must sacrifice some freedom to the franchiser. The prospective franchisee must explore other limitations of franchising before undertaking this form of ownership. Franchise Fees and Profit Sharing Virtually all franchisers impose sonic type of fees and demand a share of the franchisee's sales revenues in return for the use of the franchiser's name, products or services, and business system. The fees and the initial capital requirements vary among the different franchisers. The Commerce Department reports that total investments for franchises range from $1,000 for business services up lo $10 million for hotel and motel franchises. For example, H & R Block requires a capital investment of $2,000 lo $3,000, and the Atlanta Bread Company estimates the total cost of opening a franchise lo range from 5362,000 to $584,000, depending on the size and location of the outlet, A McDonald's franchise requires an investment of $408,600 to $647,000 (but McDonald's owns the land and the building). The average start-up cost for a franchise is between $150,000 and $200,000. 33 Start-up costs for franchises often include numerous additional fees. Most franchises impose a franchise fee up front for the right to use the company name. Other start-up costs might include site purchase and preparation, construction, signs, fixtures, equipment, management assistance, and training. Some franchise fees include these costs, whereas others do not. Fur example, Closets by Design, a company that designs and installs closet- and garage-organizers, entertainment centers, and home office systems, charges a franchise fee ranging from $19,500 to $34,900.which includes both a license for an exclusive territory and management training and support. Before signing any contract, a prospective franchisee should determine the total cost of a franchise, something every

franchiser is required to disclose in item 10 of its Uniform Franchising Offering Circular (see "Franchising and the Law" on page 128). Franchisers also impose continuing royalty fees as pro fit-sharing devices. The royalty usually involves a percentage of gross sales with a required minimum, or a flat fee levied on the franchise. Royalty fees range from 1 percent to 11 percent, although most franchises assess a rate between 3 percent and 7 percent. The Atlanta Bread Company, for example, charges franchisees a royally of 5 percent of gross sales, which is payable weekly. These ongoing royalties can increase a franchisee's overhead expenses significantly. Because the franchiser's royalties and fees are calculated as a percentage of a franchisee's sales, the franchiser gets paid-even if the franchisee fails to earn a profit. Sometimes unprepared franchisees discover (too late) that a franchiser's royalties and fees are the equivalent of the normal profit margin for a franchise. To avoid such problems, a prospective franchisee should find out which fees are required (some are merely recommended) and then determine what services and benefits the fees cover. One of the best ways to do this is to itemize what you are getting for your money, and then determine whether the cost corresponds to [he benefits provided. Be sure to gel the details on all expenses-amount, time of payment, and financing arrangements; find out which items, if any, arc included in the initial franchise fee and which ones are "extra." Strict Adherence to Standardized Operations Although the franchisee owns the business, she does not have the autonomy of an independent owner. To protect its public image, the franchiser requires that the franchisee maintain certain operating standards. If a franchise constantly fails to meet the minimum standards established for the business, the franchiser may terminate its license. Determining compliance with standards is usually accomplished by periodic inspections. At times, strict adherence to franchise standards may become a burden lo the franchisee. The owner may believe dial the written reports the franchiser demands require an excessive amount of time. In other instances, the owner may be required to enforce specific rules she believes arc inappropriate or unfair. Restrictions on Purchasing In the interest of maintaining quality standards", franchisees may be required to purchase products, special equipment, or other items from the franchiser or from an "approved'" supplier. For example, Kentucky Fried Chicken requires that franchisees use only seasoning blended by a particular company because a poor image could result from franchisees using inferior products to cut costs. Under some conditions, such purchase arrangements may b challenged in court as a violation of antitrust laws, but generally, franchisers have a legs right to see that franchisees maintain acceptable quality standards. Franchisees at seven chains have Tiled antitrust suits alleging that franchisers overcharge their outlets for sup plies and equipment and eliminate competition by failing to approve alternative suppliers.34 A franchiser may legally set the prices paid for the products it sells but may not establish the retail prices to be charged on products sold by the franchisee. A franchiser ca suggest retail prices for franchisee's products and services but cannot force the franchise to abide by them. Limited Product Line In most cases, the franchise agreement stipulates that the franchise can sell only those products approved by the franchiser. Unless willing to risk license cancellation, a franchisee must avoid selling any unapproved products through the franchise. A franchise may be required to carry an unpopular product or be prevented from introducing a desirable one by the franchise agreement. A franchisee's freedom to adapt a product line to local market conditions is restricted. However, some franchisers solicit product suggestions from their

franchisees. In fact, a McDonald's franchisee. Herb Peterson, created the highly successful Egg McMuffin while experimenting with a Teflon-coated egg ring that gave fried eggs rounded' corners and a poached appearance, Peterson put his round eggs on English muffins, adorned them with Canadian bacon and melted cheese, and showed his creation to McDonald's elm Ray Kroc. Kroc devoured two of them and was sold on the idea when Peterson's wife suggested the catchy name. In 1975, McDonald's became the first fast-food franchise to open its doors for breakfast, and the Egg McMuffin became a staple on the breakfast menu. 35 Unsatisfactory Training Programs Every would-be franchisee must be wary of the Unscrupulous franchiser who promise extensive services, advice, and assistance but delivers nothing. For example, one owner relied on the franchiser lo provide what had been described as an "extensive, rigorous training program" after paying a handsome technical assistance fee. The program was nothing but an of pamphlets and doit-yourself study guides. Other examples include those impatient entrepreneurs who paid initial franchise fees without investigating the business and never ton' from the franchiser again. Although disclosure rules have reduced the severity of the problem, dishonest characters still thrive on unprepared prospective franchisees. Market Saturation As the owners of many fast-food and yogurt and ice cream franchises have discovered, mark saturation is a very real danger. Although some franchisers offer franchisees territorial protection, others do not. Territorial encroachment has become a hotly contested issue in franchising as growth-seeking franchisers have exhausted most of the prime locations and are now setting up new franchises in close proximity to existing ones. In some areas of the country, franchisees are upset, claiming that their markets are oversaturated and their sales are suffering. Less Freedom When franchisees sign a contract, they agree to sell the franchiser's product or service by following its prescribed formula. This feature of franchising is the source of the system's success, but it also gives many franchisees the feeling that they are reporting to a "boss." Franchisers want lo ensure success, and most monitor their franchisees' performances closely lo make sure franchisees follow the system's specifications. Strict uniformity is the rule rather than the exception. '"There is no independence. Successful franchisees are happy prisoners," says one writer. Entrepreneurs who want to be their own bosses often are disappointed with a franchise. "I've seen too many people buy a franchise, and the reason they're unsuccessful is that they think they have a better idea how to run that McDonald's than McDonald's has," says one franchising expert.37 Highly independent, "go-my-own-way" individuals probably should not choose the franchise route to business ownership. Table 4.2 describes ten myths of franchising. Myth#I. Franchising is the safest way to go into business because franchises never fail. Although the failure rate for franchises i5 lower than that of independent businesses, there are ho guarantees d success. Franchises can-and do-fail. Potential franchisees must exercise the same degree of caution in judging the risk of a franchise as the/ would any other business. Myth #2. I'll be able to open my franchise for less money than the franchiser estimates. Launching a bunching a business, including a franchise, normally takes more money and more time than entrepreneurs estimate. Be prepared. One franchisee of a retail computer store advises," If a franchiser tells you you'll need $ 100,000 to get started, you better have $ 150,000." Myth #3. The bigger the franchise organization, the more successful I'll be. Bigger is not always better in the franchise industry. Some of the largest franchise operations are struggling to maintain their growth rates because the best locations arc already taken. Market saturation is a significant

problem for many large franchises, and smaller franchises are accounting for much of the growth in the industry. Myth #4. I'll use 80 percent of the franchiser's business system, but I'll improve on it by substituting my experience and know-how. When franchisees buy a franchise, they are buying, in essence, the franchiser's experience and know-how. Why pay all of that money to a franchiser if you aren't willing to use their system? Myth #5. All franchises are the same. Each franchise has its own unique requirements, procedures, and culture. Naturally, some will suit you better than others. Avoid the tendency to select the franchise offering the lowest cost; ask the franchiser and existing franchisees lots of questions to determine whether you'll be comfortable in that system. Myth #6. I don't have to be a "hands-on" manager. I can be an absentee owner and still be very successful. Most franchisers shy away from absentee owners. They know that franchise success requires lots of hands-on attention, and the owner is the best person to provide that requires lots of hands-on attention, and the owner is the best person to provide that. Myth #7. Anyone can be a satisfied, successful franchise owner. With more than 4,500 franchises available, the odds of finding a franchise that appeals to your tastes is high. However, not everyone is cut out to be franchisee. Those "free spirits" who insist on doing things their way will most likely be miserable in a franchise. Myth #8. Franchising is the cheapest way to get into business for yourself. Although bargains do exist in franchising, the price tag for buying into some systems is breathtaking, sometimes running into several hundreds of thousands of dollars. Franchisers look for candidates who are on solid financial footing. Myth #9. The franchiser will solve my business problems for me; after all, that's why I pay an ongoing royalty. Although franchisers offer franchisees start-up and ongoing training programs, they will nor run their franchisees businesses for them. Your job is to take the formula that the franchiser has developed and make it work in your location. Expect to solve many of your own problems. Myth #10. Once I open my franchise, I'll be able to run things the way I want to. Franchisees are not free to run their businesses any way they see fit. Every franchisee signs a contract that requires him or her to run the business according to the franchiser's requirements. Franchisees who violate the terms of chat agreement run the risk of having their franchise relationship cancelled. FRANCHISING ANDTHE LAW The franchising boom spearheaded by McDonald's and others in the late 1950s brought with it many prime investment opportunities. However, the explosion of legitimate franchises also ushered in with it numerous fly-by-night franchisers who defrauded their franchisees. In response to these specific incidents and to the potential for deception inherent in a franchise relationship, California in 1971 enacted the first Franchise Investment Law. The law (and those of 16 other states that have since passed similar laws) requires franchisers to register a Uniform Franchise Offering Circular (UFOC) and deliver a copy to prospective franchisees before any offer or sale of a franchise. The UFOC establishes full disclosure guidelines for any company selling franchises. In October 1979, the Federal Trade Commission (FTC) enacted the Trade Regulation Rule, requiring all franchisers to disclose detailed information on their operations at the first personal meeting, or at least 10 days before a franchise contract is signed, or before any money is paid. The FTC rule covers all franchisers, even those in the 33 states lacking franchise disclosure laws. The purpose of the regulation is to assist the potential franchisee's investigation of the franchise deal and to introduce consistency into the franchiser's disclosure statements. In 1994, the FTC modified the requirements for the UFOC, making more information available to prospective franchisees and making the document: shorter and easier to read and understand. The FTC's philosophy is not so

much to prosecute abusers as to provide information to prospective franchisees and help them make intelligent decisions. Although the FTC requires each franchiser to provide a potential franchisee with this information, it does not verify its accuracy. Prospective franchisee! should use these data only as a starting point for the investigation. The Trade Regulation Rule requires a franchiser to include 23 major topics in its disclosure statement: 1. Information identifying the franchiser and its affiliates and describing their business experience and the franchises being sold. 2. Information identifying and describing the business experience of each of the franchiser! officers, directors, and management personnel responsible for the franchise program. 3. A description of the lawsuits in which the franchiser and its officers, directors, and managers have been involved. Although most franchisers will have been involved in some type of litigation, an excessive number of lawsuits, particularly if they relate to the same problem, is alarming. "The history of the litigation will tell you the future of your relationship [with the franchiser]," says the founder of a maid-service franchise.38 4. Information about any bankruptcies in which the franchiser and its officers, directors, and managers have been involved. 5. Information about the initial franchise fee and other payments required to obtain the franchise, including the intended use of the fees. Initial fees typically range from $10,000 to $30,000. 6. A description of any continuing payments franchisees arc required to make after start-up, including royalties, service fees, training fees, lease payments, advertising or market! charges, and others. 7. A detailed description of the payments a franchisee must make to fulfill the initial investment requirement and how and Lo whom they are made. The categories covered are the initial franchise Ice, equipment, opening inventory, initial advertising fee, signs, training, teal estate, working capital, legal, accounting, and utilities. These estimates, usually stated in the form of a range of numbers, give prospective franchisees an idea of how much their total start-up costs will be. 8. Information about quality restrictions on goods, services, equipment, supplies, inventory, and other items used in the franchise and where franchisees may purchase them, including restricted purchases from the franchiser. 9. A statement (in tabular form) of the franchisee's obligations under the franchise contract, including items such as selecting a site, paying fees, maintaining quality standards, keeping records, transferring or renewing the franchise relationship, and others. 10. A description of any financial assistance available from the franchiser in the purchase of the franchise. 11. A description of all obligations the franchiser must fulfill in helping a franchisee prepare to open and operate a unit. Plus, information covering location selection methods and the training program provided to franchisees. In addition lo the training they provide new franchisees, many franchisers offer help with a grand opening for each outlet and on-site management assistance for a short time to get franchisees started. 12. A description of any territorial protection that will be granted lo the franchise and a statement as to whether the franchiser may locate a company-owned store or other outlet in that territory. 13. All relevant information about the franchiser's trademarks, service marks, trade names, logos, and commercial symbols, including where they arc registered. Look for a strong trademark or service mark that is registered with the U.S. Patent and Trademark Office. 14. Similar information on any patents and copyrights the franchiser owns, and the rights to these transferred to franchisees. 15. A description of the extent lo which franchisees must participate personally in the operation of the franchise. Many franchisers look for "hands-on'' franchisees and discourage "absentee owners."

16. A description of any restrictions on the goods or services franchises are permitted to sell and with whom franchisees may deal. The agreement usually restricts franchisees to selling only those items approved by the franchiser. 17. A description of the conditions under which the franchise may be repurchased or refused renewal by the franchiser, transferred to a third party by the franchisee, and terminated or modified by either party. This section also addresses the method established for resolving disputes. 18. A description of the involvement of celebrities and public figures in the franchise. 19. A complete statement of the basis for any earnings claims made lo the franchisee, including the percentage of existing franchises that have actually achieved the results that are claimed. New rules put two requirements on franchisers making earnings claims: (a) Any earnings claim must be included in the UFOC, and (b) the claim must "have a reasonable basis at the lime it is made." However, franchisers are not required to make any earnings claims at all; in fact, only about 25 percent of franchisers make earnings claims in their circulars, primarily because of liability concerns about committing such numbers to paper. 39 20 Statistical information about the present number of franchises; the number of franchises projected for the future: the number of franchises terminated: the number the franchiser has not renewed; the number repurchased in the past; and a list of the names and addresses (organized by state) of other franchisees in the system. 21. The franchiser's financial statements. 22. A copy of all franchise and other contracts (leases, purchase agreements, etc.) the franchisee will be required to sign. 23. A standardized, detachable "receipt" to prove that the prospective franchisee received a copy of the UFOC. The information contained in the UFOC does not fully protect a potential franchise from deception, nor does it guarantee success. It does, however, provide enough information to begin a thorough investigation of the franchiser and the franchise deal. THE RIGHT WAY TO BUY AFRANCHISE The UFOC is a powerful tool designed to help would-be franchisees select the franchise that is right for them and to avoid being duped by dishonest franchisers. The best defenses a prospective entrepreneur has against unscrupulous franchisers are preparation, common sense, and patience. By investigating thoroughly before investing in a franchise, a potential franchisee minimizes the risk of being hoodwinked into a nonexistent business. Asking the fight questions and resisting the urge to rush into an investment decision helps a potential franchisee avoid being taken by unscrupulous operators. Potential franchisees must beware because franchise fraud still exists in this rapidly growing field. A recent conference of state securities regulators named "illegal franchise, offers" as one of the top I0 financial frauds in the United States? The president of one franchise consulting firm estimates that 5 to 10 percent of franchisers are dishonest--"the rogue elephants of franchising." Dishonest franchisers tend to follow certain patterns, and well-prepared franchisees who know what to look for can avoid trouble. The following clues should arouse the suspicion of an entrepreneur about to invest in a franchise: Claims that the franchise contract is a standard one and that "you don't need to read it." A franchiser who fails to give you a copy of the required disclosure document at your first faceto-face meeting. A marginally successful prototype store or no prototype at all. A poorly prepared operations manual outlining the franchise system or no manual (or system) at all. Oral promises of future earnings without written documentation. A high franchisee turnover rate or a high termination rate.

 An unusual amount of litigation brought against the franchiser. Attempts to discourage you from allowing an attorney to evaluate the franchise contract before you sign it. No written documentation to support claims and promises. A high-pressure sale--sign the contract now or lose the opportunity. Claiming to be exempt from federal laws requiring complete disclosure of franchise details. "Get-rich-quick schemes," promises of huge profits with only minimum effort. Reluctance to provide a list of present franchisees for you to interview. Evasive, vague answers to your questions about the franchise and its operation. Not every franchise "horror story" is the result of dishonest franchisers. More often than not, the problems that arise in franchising have more to do with franchisees who buy legitimate franchises without proper research and analysis. They end up in businesses they don't enjoy and that they are not well suited to operate. How can you avoid this mistake? The following steps will help you make the right choice. Evaluate Yourself Before looking at any franchise, an entrepreneur should study her own traits, goals, experience, likes, dislikes, risk orientation, income requirements, time and family commitments, and other characteristics. Will you be comfortable working in a structured environment? What kinds of franchises fit your desired lifestyle? In what region of the country or world do you want to live and work? What is your ideal job description? Knowing what you enjoy doing (and what you don't want to do) will help you narrow your search. The goal is to find the franchise that is right--for you! One characteristic successful franchisees have in common is that they genuinely enjoy their work. Table 4.3 provides a test for prospective franchisees that helps them evaluate their franchise potential. Of those people who set out Co buy a. franchise, only IS percent actually buy one. Some of that 15 percent make the wrong decision. They discover too late that they are not cut out to be franchisees. Do you hive what it takes to be a successful franchisee? The following quiz will help you determine your "franchise quotient." 1. You own a company. How much operational detail are you comfortable with? a. I want direct control over all operations. b. I delegate less than half. c. I delegate more than half. 2. You have three job offers with comparable salary and benefits. Choose one. a. Small company but high management responsibility and exposure. b. Mid-sized company with less personal exposure but more prestigious name. c. Large company with least personal exposure but very well-known name. 3. You reach a major stumbling block on a project, You: a. Seek help from others immediately. b. Think it through and then present possible solutions to your superior. c. Keep working until you resolve it on your own. 4. Which investment sounds most appealing? a. Five percent fixed return over a period of time. b. From -20 percent to +50 percent loss or return over a period of time, depending on changing economic situations. 5. Which business arrangement is most appealing? a. You're the sole owner. b. You're in a partnership and own a majority of the stock. c. You're in an equal partnership.

6. Your company's sales technique increases sales 10 percent per year. You used a technique elsewhere you feel will result in 15 percent to 20 percent annual increases, but it requires extra time and capital. You: a. Avoid the risk and stay with the present plan. b. Suggest your new method, showing previous results. c. Privately use your system, and show the results later. 7. You suggest your system to your boss, and he says, "Don't rock the boat." You: a. Drop your different approach. b. Approach your boss at a later time. c. Go to your boss's boss with your suggestion. d. Use your own system anyway. 8. Which would mean the most to you? a. Becoming the president of a company. b. Becoming the highest-paid employee of a company. c. Winning the highest award for achievement in your profession. 9. What three activities do you find most appealing? a. Sales and marketing. b. Administration. c. Payroll. d. Training. e. Customer service. f. Credit and collections. g. Management. 10. What work pace do you generally prefer? a. Working on one project until it is completed. b. Working on several projects at one time. Scoring: 1. A=5,B=3,C=1. 2. A=3,B-2,C=1. 3. A=1,B=5,C=7. 4, A=2,B=6. 5. A=7, B=5, C=2. 6 A=1,B=6,C=10. 7. A=l, B=5,C=8,D=10. 8. A=8.B=2,C=5. 9. A=10,B=1,C=3,D=3, E=8,F=2,G=5. 10. A=3,B=6. Total Score: 20-33 You're a corporate player and are happiest in a structured environment. Franchising suits you. 34-71 You're a potentially good franchisee. 72-85 You're an entrepreneur who prefers total independence. Research Your Market Before shopping for a franchise, research the market in the area you plan, to serve. How fail is the overall area growing? In which areas is that growth occurring fastest? Investing some lime at the library developing a profile of the customers in your target area is essential; otherwise, you will be flying blind. Who arc your potential customers? What are their characteristics and their income and education levels? What kinds of products and services M they buy? What gaps exist in the market? These gaps represent potential franchise opportunities for you. Market research also should confirm that a franchise is not merely part o: a fad that will quickly fade. Steering clear of fads and into long-term trends is one way to sustain the success of a franchise. Before Papa John's Pizza allows franchisees to open any store, it requires them If spend six months to a year evaluating the market potential of the local area. " We don't just move into an area and open up 200 stores," says one manager. "We do it one store at a time." 41 Consider Your Franchise Options

The International Franchise Association publishes the Franchise Opportunities Guide which lists its members and some basic information about them. Many cities host franchise trade shows throughout the year where hundreds of franchisers gather 10 sell their franchises. Attending one of these franchise showcases is a convenient, efficient way to collect information about a variety of available opportunities. Many business magazines such as Entrepreneur, Inc., Business Start-Ups, Your Company, and others devote at least one issue to franchising, in which they often list hundreds of franchises. These guides can help yd find a suitable franchise within your price range. Get a Copy of the Franchiser's UFOC Once you narrow down your franchise choices, you should contact each franchise and get a copy of its UFOC. Then read it! This document is an important tool in your search ford right franchise, and you should make the most of it. When evaluating a franchise opportunity, what should a potential franchisee look for? Although there's never a guarantee I success, the following characteristics make a franchise stand out. A unique concept or marketing approach. "Me-too" franchises arc no more successful than "metoo" independent businesses. Pizza franchiser Papa John's has achieved an impressive growth rate by emphasizing the quality of its ingredients, whereas Domino's is known for its fast delivery. Profitability. A franchiser should have a track record of profitability and so should its franchisees. If a franchiser is not profitable, its franchisees are not likely to be cither. Franchise who follow the business format should expect to earn a reasonable rate of return. A registered trademark. Name recognition is difficult to achieve without a well-known and protected trademark. A business system that works, A franchiser should have in place a system that is efficient and well documented in its manuals. A solid training program. One of the most valuable components of a franchise system is the training it offers franchisees. The system should be relatively easy to teach. Affordability. A franchisee should not have to take on an excessive amount of debt to purchase a franchise. Being forced to borrow too much money to open a franchise outlet can doom a business from the outset. Respectable franchisers verify prospective franchise financial qualifications as part of the screening process. A positive relationship with franchisees. The must successful franchises are those that see their franchisees as partners and treat them accordingly. The UFOC covers the 23 items discussed in the previous section and includes a copy of the company's franchise agreement and any contracts accompanying it. Although the law requires a UFOC to be written in plain English rather than "legalese," it is best to have an attorney experienced in franchising to review the UFOC and discuss its provisions with you, Watch for clauses that give the franchiser absolute control and discretion. The franchise contract summarizes the details that will govern the franchiser-franchisee relationship over its life, Ii outlines exactly the rights and the obligations of each party and sets the guidelines that govern the franchise relationship. Still, a recent study by the FTC suggests that40 percent of new franchisees sign contracts without reading them!42 When one fast-id franchiser took a survey of its franchisees, it discovered that fewer than 10 percent id bothered to read either the UFOC or the franchise contract.4' Because franchise contacts typically are long terra (50 percent run for 15 years or more), it is extremely important for prospective franchisee^ lo understand their terms before they sign them. One of the most revealing items in the UFOC is the franchisee turnover rate, the rate a! which franchisees leave the system. ! f the turnover rate is less than 5 percent, the franchise is probably sound. However, a franchise turnover rate approaching 20 percent is a sign of serious,

underlying problems in a franchise. Satisfied franchisees are not inclined lo leave a successful system. Talk to Existing Franchisees One of the best ways to evaluate the reputation of a franchiser is to interview (in person) several franchise owners who have been in business at least one year about the positive and le negative features of the agreement and whether the franchiser delivered what was promised. Did the franchise estimate their start-up costs accurately? Do they get the support the franchiser promised them? Has the franchise met their expectations concerning profitability and return on investment? Knowing what they know now, would they buy the franchise again? Bob Phillips, a CPA looking to make a career change, wanted to make sure that he purchased the right franchise, so he invested time poring over the UFOCs he had collected from the dozen franchises that interested him. Father than rely on the documents alone to judge the franchises, Phillips made calls to franchisees that he randomly selected from the lists included in the UFOCs (item 20). His conversations with franchisees convinced him that Ranch j, a chain of fast-food grilled chicken stores, was the best choice for him. "Almost every one wanted a second location," he says. "That's indicative of a healthy franchise system." Phillips is convinced that his thorough research led him to the right franchise. Today he owns two Ranch I franchises that generate more than $2 million in Saks, and he plans to open eight more outlets within three years.44 Interviewing past franchisees to gel their perspectives on the franchiser-franchisee relationship is also helpful. Why did they leave? Franchisees of some companies have formed associations, which might provide prospective franchisees with valuable information. Other sources of information include the American Association of Franchisees and Dealers, the American Franchise Association, and the International Franchise Association. Ask the Franchiser Some Tough Questions Take the time to ask the franchiser questions about the company and its relationship with its franchisees. You will be in this relationship a long time, and you need to know as much about it as you possibly can beforehand. What is its philosophy concerning the relationShip? What is the company culture like? How much input do franchisee's have into the system? What are the franchise's future expansion plans? How will they affect your franchise? Are you entitled to an exclusive territory? Under what circumstances can either party terminate the franchise agreement? What happens if you decide to sell your franchise in the future? Under what circumstances would you not be entitled to renew the agreement? What kind of profits can you expect? (If the franchiser made no earnings claims in item 19 of the UFOC, why not?) Does the franchiser have a well-formulated strategic plan? YOU BE THE CONSULANT... The Opportunityof a Lifetime "Honey, I think I've found it!" said Joe Willingham to his wife Allie. "This is just what I've been looking for, and just in lime, too. My severance package from the company runs out next month. The man said that if we invested in this franchise now, we could be bringing in good money by then. It's that easy!" Allie knew that Joe had been working hard at finding another job since he had been a victim of his company's latest downsizing, but jobs were scarce even for someone with his managerial experience and background in manufacturing. "Nobody wants to hire a 51-year-old man with experience when they can hire 23-year-old college graduates at less than half the salary and teach them what they need to know," Joe told her after months of fruitless job hunting. That's when Joe got the idea of setting up his own business. Rather than start an independent business from scratch, Joe felt more comfortable, given his 26-year corporate career, opening a franchise. "A franchiser can give me the support I need," he told Allie. "Tell me about this franchise," Allie said.

"'It's a phenomenal opportunity for us," Joe said, barely able to contain his excitement. "I saw this booth for American Speedy Print at the Business Expo this morning. There were all kinds of franchises there, but this one really caught my eye,"' Joe said as he pulled a rather plain-looking photocopy of a brochure from his briefcase. "Is that their brochure?" asked Allie. "Well, the company is growing so fast that they have temporarily run out of their normal literature. This is just temporary." "Oh. . .You would think that a printing franchise could print flashier brochures even on short notice, but I guess. . . ," said Allie. "The main thing is the profit potential this business has," said Joe. "1 met one of their franchisees. I tell you the guy was wearing a $2,000 suit if ever there was one, and he had expensive jewelry dripping from his fingers. He's making a mint with this franchise, and he said we could too!" Joe continued, "With the severance package I have from the company, we could pay the $10,000 franchise fee and lease most of the equipment we need to get started. It'll take every penny of my package, but, hey, it's an investment in our future. The representative said the company would help us with our grand opening and would help us compile a list of potential customers." "What would you print?" asked Allie. "Anything!" said Joe. "The franchisee I talked to does flyers, posters, booklets, newsletters, advertising pieces . . . you name it!" "Wow! It seems like you'd need lots of specialized equipment to do all of that. How much does the total franchise package cost?" said Allie. "Well. I'm not exactly sure. He never gave me an exact figure, but we can lease all the equipment we need from the franchiser!" "Is this all of the material they gave you? I thought franchisers were supposed to have some kind of information packet to give to people," said Allie. "Yeah. I asked him about that," said Joe. "He said that American Speedy Print is just a small franchise. They'd rather put their money into building a business and helping their franchisees succeed than into useless paperwork that nobody reads anyway. It makes sense to me." "I guess so. . . ," Allie said reluctantly. "I think we need to take this opportunity, Hon," Joe said, with a look that spoke of determination and enthusiasm. "'Besides, he said that there was another couple in this county that is already looking at this franchise, and that the company will license only one franchisee in this area. They don't want to saturate the market. He thinks they may take it. I think we have to move on this now, or we'll lose the opportunity of a lifetime." Allie had not seen Joe exhibit this much enthusiasm and excitement for anything since he had lost his job at the plant. Piles of rejection letters from his job search had sapped Joe's zest for living. Allie was glad to sec "the m Joe" return, but she still had her doubts about the franchise opportunity Joe was describing. "It might just be the opportunity of a lifetime, Joe," she said, "'But don't you think we need to find out a little more about this franchise before we invest that much money? I mean. . . ." "Hon, I'd love to do that, but like the man said, we may miss out on the opportunity of a lifetime if we don't sig today. I think we've got to move on this thing now!" 1. What advice would you offer Joe about investing in this franchise? 2. Map out a plan for Joe to use in finding the right franchise for him. What can Joe do to protect himself from making a bad franchise investment? 3. Summarize the advantages and disadvantages Joe can expect if he buys a franchise. Make Your ChoiceThe first lesson in franchising is "Do your homework before you gel out your checkbook." Once you have done your research, you can make an informed choice about which franchise is right fur you. Then it is time to put together a solid business plan that will serve as road map to

success in the franchise you have selected. The plan is also a valuable tool louse as you arrange the financing for your franchise. We will discuss the components of a business plan in Chapter 9. Appendix A at the end of this chapter offers a checklist of questions a potential franchisee should ask before entering into any franchise agreement. TRENDS SHAPING FRANCHISING Franchising has experienced three major growth waves since its beginning. The first wave occurred in the early 1970s when fast-food restaurants used the concept to grow rapidly. The lastfood industry was one of the first to discover the power of franchising, but other presses soon look notice and adapted the franchising concept to their industries. The second wave took place in the mid-1980s as our nation's economy shifted heavily toward BE service sector. Franchises followed suit, springing up in every service business imaginable-from maid services and copy centers to mailing services and real estate. The third wave began in the early 1990s and continues today. It is characterized by new, low-cost franchises that focus on specific market niches. In the wake of major corporate downsizing and the burgeoning costs of traditional franchises, these new franchises allow would-be entrepreneurs to get into proven businesses faster and at lower costs. These companies feature start-up costs from $2,000 to $250,000 and span a variety of industriesfrom leak detection in homes and auto detailing to day care and tile glazing. Other significant trends affecting franchising are discussed next. Changing Face of Franchisees Franchises today are better educated, arc more sophisticated, have more business acumen, dare more financially secure than those of just 20 years ago. Franchising is attracting Riled, experienced businesspeople whose goal is to own multiple outlets that cover entire Males or regions. For instance, when Krispy Krene Doughnuts began to move its popular product north mm its southern stronghold, the Lev family-father Howard, sons Russel and Mel, and nuephew John Faber-bought the franchise for the entire state, of New York. While on a trip to the South, Mel discovered the tasty orbs and brought some back to his family, who quickly devoured than. Once they returned to their home in New York, the Levs decided to become franchisees. All experienced in business (Howard and Mel once owned a shirt- company), the Levs and Faber have opened 10 stores and have plans for dozens more. International Opportunities One of the major trends in franchising is the internationalization of U.S. franchise systems. Increasingly, franchising is becoming a major export industry for the United Stales. Growing numbers of U.S. franchises are moving into international markets lo boost sales and profits as the domestic market becomes saturated. According to a report by Arthur Andersen, 44 percent of U.S. franchisers have international locations, up from 34 percent in 1989. International expansion is a relatively new phenomenon in franchising, however approximately 75 percent of franchisers established their first foreign outlet within the par 10 years.46 Canada is the primary market for U.S. franchisers, with Mexico, Japan, and Europe following. These markets are most attractive to franchisers because they are similar to the U.S. market-rising personal incomes, strong demand for consumer goods, growing service economies, and spreading urbanization. As they venture into foreign markets, franchisers have learned that adaptation is one key to success. Although a franchise's overall business format may not change in foreign markets, some of the details of operating its local outlets must. For instance, fast-food chains in other countries often must make adjustments to their menus to please local) palates. In Japan, McDonald's (known as "Makudonarudo") outlets sell teriyaki burgers, rice burgers, and katsu burgers (cheese wrapped in a roast pork cutlet lopped with katsu sauce and shredded cabbage) in addition lo their traditional American fare. In the Philippines, the McDonald's menu includes a spicy Filipino-style burger, spaghetti, and chicken with rice. Countries that recently have thrown off the chains of communism are turning to frail chising to help them move toward a market economy. Some countries of Eastern Europe, including Hungary,

Poland, and Yugoslavia, already have attracted franchiese. Even Russia is fertile ground for franchising. McDonald's scored a hit with its 700-sii restaurant in Moscow. Despite being one of the largest McDonald's outlets in the world, "the wailing line winds along busy Pushkin Square for well over 500 yards," report one Soviet magazine.47 Franchisers in these countries must have patience, however Lack of capital, archaic infrastructure, and a shortage of hard currencies mean if profits will be slow in coining. Most franchisers recognize the difficulties of developing franchises in foreign markets and start slowly. According to Arthur Anderson, 79 pc cent of franchisers doing business internationally have fewer than 100 outlets in foreign countries.48 Smaller, Nontraditional Locations As the high cost of building full-scale locations continues to climb, more franchisers are searching out nontraditional locations in which to build smaller, less expensive outlets. Based on the principle of intercept marketing, the idea is to put a franchise's produce services directly in the paths of potential customers, wherever they may be. Locations within locations have become popular. Franchises are putting scaled-down outlets on college campuses, in high school cafeterias, in sports arenas, in hospitals, on airline flights and in zoos. St. Louis-based Pizzas of Eight already has outlets inside convenience stores, supermarkets, and bowling alleys and plans to open others in video stores.49 Many franchisees have discovered that smaller outlets in these nontraditional locations gents nearly the same sales volume as full-sized outlets at just a fraction of the cost! Steve Siegel, owner of 35 Dunkin' Donuts shops in the Boston area, recently be branching out into small, nontraditional locations where pedestrian traffic counts are high. One of his most profitable spots measures just 64 square feel, but because it is in a business district filled with office workers, it generates a high volume of sales. 50 Such locations will be a key to continued franchise growth in the domestic market. Conversion Franchising The recent trend toward conversion franchising, in which owners of independent businesses become franchisees to gain [he advantage of name recognition, will continue. In a franchise conversion, the franchiser gets immediate entry into new markets and experienced operators; franchisees gel increased visibility and often a big sales boost. In fact, the average sales gain in the first year for converted franchises is 20 percent.51 The biggest force in conversion franchising has been Century 21, the real estate sales company. Multiple-Unit Franchising Multiple-unit franchising (MUF) became extremely popular in the early 1990s. In multiple-unit franchising, a franchisee opens more than one unit in a broad territory within a specific lime period. "Multiple ownership of units by franchisees has exploded." says one franchise expert. "Twenty or 30 years ago, it would have been rare for any one franchisee mown 10 or 20 units. Now it's not uncommon . . . for one franchisee to own 60, 70, or 1200 units. Franchisers are finding it's far more efficient in the long run to have one well-trained franchisee operate a number of units than to train many franchises."52 The popularity of multiple-unit franchising has paralleled the trend toward increasingly experienced, sophisticated franchisees, who set high performance goals that a single outlet can-it meet. The typical multiple-unit franchisee owns between three and six units, but some franchisees own many more. Master Franchising A master franchise (or subfranchise) gives a franchisee the right to create a semi-independent organization in a particular territory to recruit, sell, and support other franchisees. A master franchisee buys the right to develop subfranchise within a broad geographic area or sometimes an entire country. Subfranchising "turbocharges" a franchiser's growth. Many franchisers use it to open outlets in international markets more quickly and efficiently because the master franchisees understand local laws and the nuances of selling in local markets.

For instance, a master franchisee with TCBY International, a yogurt franchise, has opened 21 stores in China and in Hong Kong. Based on his success in these markets, the company has sold him the master franchise in India.53 Piggybacking (or Combination Franchising) Some franchisers also are discovering new ways to reach customers by teaming up with other franchisers selling complementary products or services. A growing number of companies are piggybackingoutlets-combining two or more distinct franchises under one roof. This "buddy system" approach works best when the two franchise ideas are compatible and appeal to similar customers. For example, franchisers Dunkin' Donuts, Togos' Entry sandwich shops, and ice cream retailer Baskin-Robbins are working together to Id hundreds of combination outlets, a concept that has proved to be highly successful.54 properly planned, piggybacked franchises can magnify many times over the sales and profits of individual, self-standing outlets. One Baskin-Robbins franchisee saw his sales mo 25 percent when he added a Blimpie Subs and Salads franchise to his existing ice cream shop. Another enterprising franchisee who combined Shell Oil (gas station), Charley's Steakery (sandwich shop), and TCBY (frozen yogurt) franchises under one roof in Columbus, Ohio, says that sales are running 10 percent more than the three outlets would generate in separate locations.55 Serving Aging Baby Boomers Now that dual-career couples have become the norm, especially among baby boomers, the market for franchises offering convenience and time-saving devices is booming. Customers are willing to pay for products and services that will save them time or trouble, and franchises are ready to provide them. Franchisees of Around Your Neck go into the homes and offices of busy male executives to sell men's apparel and accessories ranging from shirts and ties to custom-made suits. Other areas in which franchising is experiencing rapid growth include home delivery of meals, house-cleaning services, continuing education and training (especially computer and business training), leisure activities (such as hobbies, health spas, and travel-related activities), products and services aimed at home-based businesses, and health care. "People are interested in anything that will make lit! simpler for them," explains one franchise consultant.56 CONCLUSION Franchising has proved its viability in the U.S. economy and has become a key part oft] small business sector because it offers many would-be entrepreneurs the opportunity it own and operate a business with a greater chance for success. Despite its impressive growth rate to date, the franchising industry still has a great deal of room to grow. Describing the future of franchising, one expert says, "Franchising has not yet come close to reaching its full potential in the American marketplace." 57 CHAPTER SUMMARY 1-A. Explain the advantages and the disadvantages of the sole proprietorship. A sole proprietorship is a business owned and managed by one individual and is the most popular form of ownership. Sole proprietorships offer these advantages: They are simple to create; they are the least costly Form to begin; the owner has total decision-making authority; there are no special legal restrictions; and they are easy to discontinue. They also suffer from these disadvantages: unlimited personal liability of owner; limited managerial skills and capabilities; limited access to capital; and lack of continuity. 1-B. Explain the advantages and the disadvantages of the partnership. A partnership is an association of two or more people who co-own a business for the purpose of making a profit. Partnerships offer these advantages: ease of establishing; complementary skills of partners; division of profits; larger pool of capital available; ability to attract limited partners; little government regulation; flexibility; and tax advantages.

Partnerships suffer from these disadvantages: unlimited liability of at least one partner; difficulty in disposing of partnership interest; lack of continuity; potential for personality and authority conflicts; and partner bound by the law of agency. 1-C. Explain the advantages and the disadvantages of it corporation. A corporation, the most complex of the three basic forms of ownership, is a separate legal entity. To from a corporation, an entrepreneur must file the articles of incorporation with the slate in which the company will incorporate. Corporations offer these advantages: limited liability of stockholders; ability to attract capital; ability to continue indefinitely; and transferable ownership. Corporations suffer from these disadvantages: a and lime involved in incorporating; double taxation potential for diminished managerial incentives; to requirements and regulatory red tape; and potential loss of control by the founder(s). 2. Discuss the advantages and the disadvantages of the S corporation, the limited liability company, the professional corporation, and the joint venture. Entrepreneurs can also choose from several 4 forms of ownership, including S corporations and limited liability companies. An S corporation offers its owners limited liability protection but avoids the double taxation of C corporations. A limited liability company, like an S corporation, is a cross between a partnership and a corporation, yet it operates without the restrictions imposed on an S corporation. To create an LLC, an entrepreneur must file the articles of organization and [he operating agreement with the secretary of state. A professional corporation offers professionals the benefits of the corporate form of ownership. A joint venture is like a partnership, except [ha! it is formed for a specific purpose. 3. Describe the three types of franchising: trade name, product distribution, and pure. Trade-name franchising involves a franchisee's purchasing the right to become affiliated with a franchiser's trade name without distributing its products exclusively. Product distribution franchising involves licensing a franchisee to sell products or services under (he franchiser's brand name through a selective, limited distribution network. Pure franchising involves selling it franchisee a complete business format. 4. Explain the benefits and [he drawbacks of buying a franchise. Franchises offer many benefits: management training and support; brand name appeal; standardized quality of goods and services; national advertising programs; financial assistance; proven products and business formats; centralized buying power; territorial protection; and a greater chance of success. Franchising also suffers from certain drawbacks; franchise fees and profit sharing; strict adherence to standardized operations; restrictions on purchasing; limited product lines: unsatisfactory training programs; market saturation; and less freedom. 5. Understand the laws covering franchise purchases. The Federal Trade Commission (FTC) enacted the Trade Regulation Rule in 1979, which requires all franchisers to disclose detailed information on their operations at the first personal meeting or at least 10 days before a franchise contract is signed, or before any money is paid. The FTC rule covers all franchisers. The Trade Regulation Rule requires franchisers to provide information on 23 topics in their disclosure statements. Seventeen states have passed their own franchise laws requiring franchisers to provide prospective franchisees a Uniform Franchise Offering Circular (UFOC). 6. Discuss the right way to buy a franchise. The following steps will help you make the right franchise choice: Evaluate yourself; research your market; consider your franchise options; gel a copy of the franchiser's UFOC; talk to existing franchisees; ask the franchiser some tough questions; and make your choice.

7. Outline the major trends shaping franchising. Key trends shaping franchising today include the changing face of franchisees; international franchise opportunities; smaller, nontraditional locations; conversion franchising; multiple-unit franchising; master franchising; and piggybacking (or combination franchising). DISCUSSION QUESTIONS 1. What factors should an entrepreneur consider before choosing a form of ownership? 2. Why arc sole proprietorships so popular as a form of ownership? 3. How does personal conflict affect partnerships? 4. What issues should the articles of partnership address? Why are the articles important to a successful partnership? 5. Can one partner commit another to a business deal without the other's consent? Why? 6. What issues should the certificate of incorporation cover? 7. How docs an S corporation differ from a regular corporation? 8. What role do limited partners play in a partnership? What happens if a limited partner takes an active role in managing the business? 9. What advantages docs a limited liability company offer over an S corporation? A partnership? 10. How is an LLC created? What criteria must an LLC meet to avoid double taxation? 11. Briefly outline the advantages and disadvantages of the major forms of business ownership. 12. What is franchising? 13. Describe the three types of franchising and give an example of each. 14. Discuss the advantages and the limitations of franchising for the franchisee. 15. Why might an independent entrepreneur be dissatisfied with a franchising arrangement? 16. What kinds of clues should tip off a prospective franchisee that he is dealing with a disreputable franchiser? 17. What steps should a potential franchisee take before investing in a franchise? 18. What is the function of the FTC's Trade Regulation Rule? Outline the protection the Trade Regulation Rule gives all prospective franchisees. 19. Describe the current trends in franchising. 20. One franchisee says, "Franchising is helpful because it gives you somebody [the franchiser] to get you going, nurture you, and shove you along a little. But the franchiser won't make you successful. That depends on what you bring to the business, how hard you are prepared to work, and how committed you are to finding the right franchise for you." Do you agree? Explain. Beyond the Classroom... Interview five local small business owners. What form of ownership did each choose? Why? Prepare a brief report summarizing your findings, and explain advantages and disadvantages those owners face because of their choices. 2. Invite entrepreneurs who operate as partners to your classroom. Do they have written partnership agreement? Are their skills complementary? How do they divide responsibility for running their company? How do the handle decision making? What do they do when disputes and disagreements arise? 3. Visit a local franchise operation. Is it a trade-name, product distribution, or pure franchise? To what extent did the franchisee investigate before investing? What assistance does the franchiser provide? How does the franchisee feel about the franchise contract he signed? What would he do differently now? 4. a. Consult a copy of the International Franchise Association publication Franchise Opportunities Handbook (the library should have a copy). Write several franchisers in a particular business category and ask for their franchise packages. Write a report comparing their treatment of the topics covered by the Trade Regulation Rule.

b. Analyze the terms of their franchise contracts. What are the major differences? Are some terms more favorable than others? If you were about to invest in the franchise, which terms would you want to change? 5. Ask a focal franchisee to approach his regional franchise representative about leading a class discussion on franchising. 6. Contact the International Franchise Association (1350 New York Avenue, N.W, Suite 900, Washington, D.C., 20005-4709, 202-628-8000) for a copy of Investigate before Investing. Prepare a report outlining what a prospective franchisee should do before buying a franchise. FORMS OF BUSINESS OWNERSHIP AND FRANCHISING The Sole Proprietorship The Partnership Corporations Other Forms of Ownership Franchising Types of Franchising The Benefits of Buying a Franchise The Drawbacks of Buying a Franchise Franchising and the Law The Right Way to Buy a Franchise Trends Shaping Franchising Conclusion One of the first decisions an entrepreneur faces when starting a new business is selecting the form of ownership for the new business venture, Too often, entrepreneurs give little thought to choosing a form of ownership and simply select the form that is most popular, even tough it may not suit (heir needs best. Although the decision is not irreversible, changing from one form of ownership to another once a business is up and running can be difficult, expensive, and complicated. That's why it is so important for an entrepreneur to make the right choice at the outset. This seemingly mundane decision can have a significant impact on almost every aspect of a business and its owner(s)-from the taxes the company pays fellow it raises money to the owner's liability for the company's debts and her ability to transfer the business to the next generation. Each form of ownership has its own unique set advantages and disadvantages. The key to choosing the '"right" form of ownership is understanding the characteristics of each one and knowing how they affect an entrepreneur's business and personal circumstances. Although there is no best form of ownership, there may be a form of ownership that is best for each entrepreneur's circumstances.

The following are a few considerations that every entrepreneur should review prior lo making the final form of ownership choice: Tax considerations. The graduated tax rates under each form of ownership, the government's constant tinkering with the tax code, and the year-to-year fluctuations in a company's income mean that an entrepreneur must calculate the firm's tax bill under each ownership option every year. Liability exposure. Certain forms of ownership offer business owners greater protection from personal liability due lo financial problems, faulty products, and a host of other difficulties. Entrepreneurs must decide the extent lo which they arc willing to assume personal responsibility for their companies' obligations. Start-up capital requirements. Forms of ownership differ in their ability lo raise start-up cap-ital. Depending on how much capital an entrepreneur needs and where she plans to get it, some forms are superior to others. Control, By choosing certain forms of ownership, Lin entrepreneur automatically gives up some control over the company. Entrepreneurs must decide early on how much control they ire willing to sacrifice in exchange for help from other people in building a successful business. Business goals. How big and how profitable an entrepreneur plans for the business to become will influence the form of ownership chosen. Businesses often switch forms of ownership as they grow, but moving from some formats to others can be extremely complex and expensive. Management succession plans. When choosing a form of ownership, business owners must look ahead to the day when they will pass their companies on to the next generation or to a buyer. Some forms of ownership make this transition much smoother than others. Cost of formation. Some forms of ownership, are much more costly and involved to create. An entrepreneur must weigh carefully the benefits and the costs of the particular form he or she chooses. Entrepreneurs have a wide choice of forms of ownership, In recent years, various hybrid forms of business ownership have emerged. This chapter will attempt to outline the key features of the most common forms of ownership, beginning with the sole proprietorship, the partnership, and the corporation THE SOLE PROPRIETORSHIP The sole proprietorship is a business owned and managed by one individual. This form of ownership is by far the most popular. Approximately 73 percent of all businesses in the United States are proprietorships (see Figure 4.1). The Advantages of a Proprietorship SIMPLE TO CREATE. One of the most attractive features of a proprietorship is how fast and simple it is to begin. If an entrepreneur wants to operate a business under his own name (e.g., Strossner's Bakery), he simply obtains the necessary licenses from state, county, and/or local governments and begins operation! For most entrepreneurs, it would not be impossible to start a proprietorship in a single day. LEAST COSTLY FORM OF OWNERSHIP TO BEGIN. In addition to being easy to begin, the proprietorship is generally the least expensive form of ownership to establish There is no need to create and file legal documents that are recommended for partnership and required for corporations. An entrepreneur simply, goes to the city or county government, states the nature of the business he will start, and pays the appropriate fees an license costs. Paying these fees and license costs gives the entrepreneur the right to duct business in that particular jurisdiction. Someone planning to conduct business under a trade name should acquire a certified. of doing business under an assumed name from the secretary of state. The fee for filing this certificate usually is nominal. Acquiring this certificate involves conducting a legal search to ensure that the name chosen is not already registered as a trademark or a service ram with the secretary of state.

Filing this certificate also notifies the state whom the owner the business is. In a proprietorship, the owner is the business. PROFIT INCENTIVE. One major advantage of the proprietorship is that once the owner pays all of the company's expenses, she can keep the remaining profits (less taxes of course). The profit incentive is a powerful one, and profits represent an excellent way: "keeping score" in the game of the business. TOTAL DECISION-MAKING AUTHORITY . Because the sole proprietor is into] control of operations, she can respond quickly to changes, which is an asset in a rapid shifting market. The freedom to set the company's course of action is a major motivation force. For those who thrive on the enjoyment of seeking new opportunities in business, the freedom of fast, flexible decision making is vital. Sole proprietor Max Gouge of Industrial Propane & Petroleum says, "1 like the feeling of being on my own ... I make this company work." 1 NO SPECIAL LEGAL RESTRICTIONS. The proprietorship is the least regulated form of business ownership. In a time when government requests for information seem neverending, this feature has much merit. EASY TO DISCONTINUE . If the entrepreneur decides to discontinue operations, he can terminate (he business quickly, even though he will still be personally liable for any outstanding debts and obligations that the business cannot pay. The Disadvantages of a Proprietorship UNLIMITED PERSONAL LIABILITY . Probably the greatest disadvantage of a sole proprietorship is the unlimited personal liability of the owner, which means that the sole proprietor is personally liable for all of the business's debts. Remember: In a proprietorship, the owner ii the business. He owns all of the business's assets, and if the business Ms, creditors can force the sale of these assets to cover its debts. If unpaid business debts remain, creditors can also force the sale of the proprietor's personal assets to recover payment. In short, the company's debts are the owner's debts. Laws vary from one state to mother, but most stales require creditors to leave the failed business owner a minimum amount of equity in a home, a car. and some personal items. The reality: Failure of a business can ruin a sole proprietor financially. LIMITED SKILLS AND CAPABILITIES. A sole proprietor may not have the wide range of skills running a successful business requires. Each of us has areas in which our education, training, and work experiences have taught us a great deal; yet there are other areas in which our decision-making ability is weak. Many business failures occur because owners lack the skills, knowledge, and experience in areas that are vital to business success. Owners lend to push aside problems they don't understand or don't feel comfortable with in favor of those they can solve more easily. Unfortunately, the problems they set aside seldom solve themselves. By the time an owner decides to ask for help in addressing these problems, it may be too late to save the company. FEELINGS OF ISOLATION . Running a business alone allows an entrepreneur maximum flexibility, but it also creates feelings of isolation that there is no one else to turn to for help in solving problems or getting feedback on a new idea. Lee Gardner, the sole proprietor of a company that arranges sponsorships for spoiling events, says, '"After 1 set up my company. I realized I was all by myself and responsible for everything. Building a business brick by brick, alone, is not easy." 2 LIMITED ACCESS TO CAPITAL.

If the business is to grow and expand, a sole proprietor generally needs additional financial resources. However, many proprietors have already put all they have into their businesses and have used their personal resources as collateral on existing loans, making it difficult to borrow additional funds. A sole proprietorship is limited to whatever capital the owner can contribute and whatever money he can borrow. In short, proprietors, unless they have great personal wealth, find it difficult to raise additional money while maintaining sole ownership. Most banks and other lending institutions have well-defined formulas for determining borrowers' eligibility. Unfortunately, many sole proprietorships cannot meet those borrowing requirements, especially in the early days of business. LACK OF CONTINUITY FOR THE BUSINESS. Lack of continuity is inherent in a sole proprietorship. If the proprietor dies, retires, or becomes incapacitated, the business automatically terminates. Unless a family member or employee can take over (which means that person is now a sole proprietor), the business could be in jeopardy. Because people look for secure employment and an opportunity for advancement, proprietorships, being small, often have trouble recruiting and retaining good employees, If no one is trained to run the business, creditors can petition the courts to liquidate the assets of the dissolved business to pay outstanding debts. Some entrepreneurs find that forming partnerships is one way to overcome the disadvantages of the sole proprietorship. For instance, when one person lacks specific managerial skills or has insufficient access to needed capital, he can compensate for these weaknesses by forming a partnership with someone with complementary management skills or money to invest. THE PARTNERSHIP A partnership is an association of two or more people who co-own a business for the purpose of making a profit. In a partnership, the co-owners (partners) share the business's assets, liabilities, and profits according to the terms of a previously established partnership agreement. The law does not require a partnership agreement (also known as the articles of partnership), but it is wise to work with an attorney to develop one that spells out the exact status and responsibility of each partner. All too often the parties think they know what they arc agreeing to, only to find later that no real meeting of the minds took place. The partnership agreement is a document that states in writing all of the terms of operating the partnership and protects each partner involved. Every partnership should be based on a written agreement. "When two entrepreneurial personalities are combined, there is a tremendous amount of strength and energy, but it must be focused in the same direction, or it will tear the relationship apart," explains one business writer. "A good partnership agreement will guide you through the good times, provide you with a method for handling problems, and serve as the infrastructure for a successful operation." 3 When no partnership agreement exists, the Uniform Partnership Act (UPA) governs a partnership, but its provisions may not be as favorable as a specific agreement hammered out among the partners. Creating a partnership agreement is not costly. In most cases, the partners can discuss each of the provisions in advance. Once they have reached an agreement, an attorney can draft the formal document. Banks will often want to see a copy of the partnership agreement before lending the business money. Probably the most important feature of the partnership agreement is that it resolves potential sources of conflict that, if not addressed in advance, could later result in partnership battles and the dissolution of an otherwise successful business. Spelling out detailsespecially sticky ones such as profit splits, contributions, workloads, decision-making authority, dispute resolution, dissolution, and others-in a written agreement at the outset will help avoid damaging tension in j partnership that could lead to a business "divorce." Business divorces, like marital ones, are almost always costly and unpleasant for everyone involved. Unfortunately, the tendency for partners just starting out is to ignore writing a partnership agreement as they ride the emotional high of launching a company together. According to one

writer, "In the eager, hectic days of startup, when two people com together with a 'brilliant idea, they never imagine that some day, they may not want to lit partners anymore. Instead, their thoughts race to marketing strategies, product develop merit, sales pitches, and customer service."4 The result? Every year, thousands of partners find themselves mired in irreconcilable disputes that damage their businesses because they failed to establish a partnership agreement. Generally, a partnership agreement can include any terms the partners want (unless they are illegal). The standard partnership agreement will likely include the following: 1. Name of Ike partnership. 2. Purpose of the business. What is the reason the business was brought into being? 3. Domicile of the business. Where will the principal business be located? 4. Duration of the partnership. How long will the partnership last? 5. Names of the partners and their legal addresses. 6. Contributions of each partner to the business at the creation of the partnership and later. This would include each partner's investment in the business. In some situations, a partner may contribute assets that are not likely to appeal- on a balance sheet. Experience, sales contacts, or a good reputation in the community may be reasons for asking a person to join in partnership. 7. Agreement on how the profits or losses will be distributed. 8. An agreement on salaries or drawing rights against profits for each partner. 9. Procedure for expansion through the addition of new partners. 10. If the partners voluntarily dissolve the partnership, how will the partnership's assets be distributed? 11. Sale of partnership interest. The articles or partnership should include terms defining how a partner can sell his or her interest in the business. 12. Salaries, draws, and expense accounts for the partners. How much money will each partner draw from the business? Under what circumstances? How often? 13. Absence or disability of one of the partners. If a partner is absent or disabled for an extended period of time, should the partnership continue? Will the absent or disabled partner receive the same share of profits as she did prior to her absence or disability? Should tile absent or disabled partner be held responsible for debts incurred while unable to participate? 14. Dissolution of 'the partnership. Under what circumstances will the partnership dissolve? 15. Alterations or modifications of the partnership agreement. No document is written to last forever. Partnership agreements should contain provisions for alterations or modifications. THE UNIFORM PARTNERSHIP ACT. The Uniform Partnership Act (UPA) codifies lit body of law dealing with partnerships in the United Slates (except in Louisiana, which has no! adopted the UPA and where state law governs in the absence of a partnership agreement), Under the UPA, the three key elements of any partnership are common ownership interest in a business, sharing the business's profits and losses, and the right to participate in managing the operation of the partnership. Under the act, each partner has the right to: 1. share in the management and operations of the business. 2. share in any profits the business might earn from operations. 3. receive interest on additional advances made to the business. 4. be compensated for expenses incurred in the name of the partnership. 5. have access to the business's books and records. 6. receive a formal accounting of the partnership's business affairs. The UPA also sets forth the partners1 general obligations. Each partner is obligated to: 1. share in any losses sustained by the business.

2. work for the partnership without salary. 3. submit differences that may arise in the conduct of the business to majority vote or arbitration. 4. give the other partner complete information about all business affairs. 5. give a forma! accounting of the partnership's business affairs. Beyond what the law prescribes, a partnership is based above all else on mutual trust and respect. Any partnership missing these elements is destined to fail. The Advantages of the Partnership EASY TOESTABLISH. Like the proprietorship, the partnership is easy and inexpensive to establish. The owners must obtain the necessary business licenses and submit a minimal number of forms. In most states, partners must file a certificate for conducting business as partners if the business is run under a trade name. COMPLEMENTARY SKILLS. In a sole proprietorship, the owner must wear lots of different hats, and not all of them will fit well. In successful partnerships, the parties' skill and abilities usually complement one another, strengthening the company's managerial foundation. Bill Martin and Greg Wright, friends since high school, relied on their complements skills to build a successful partnership, a Web site for investors called Raging Bull Inc. <www.ragingbutl.com>. While still in college, the two decided to combine their passion for investing and the internet into a business. Wright used his computer skills (and those of his college roommate) to work out the operational and technical aspects of creating the Web site, while Martin used his network of connections through an investment club to locale the material for the site 'a contents. Traffic on their site started slowly but began if build over time, ultimately attracting so many users that @ Ventures, a venture capital firm invested $2 million in the start-up company. Today Raging Bull Inc. is a multimilliondollar business thanks to the complementary skills of its founders.5 DIVISION OF PROFITS. There arc no restrictions on how partners distribute the company's profits as long as they are consistent with the partnership agreement and do not viol late the rights of any partner. The partnership agreement should articulate the nature of each partner's contribution and proportional share of the profits. If the partners fail to era ate an agreement, the UPA says that the partners share equally in the partnership's profits, even if their original capital contributions are unequal. LARGER POOL OF CAPITAL. The partnership form of ownership can significant! broaden the pool of capital available to a business. Each partner's asset base improves the business's ability to borrow needed funds; together the partners' personal assets will support a larger borrowing capacity. ABILITY TO ATTRACT LIMITED PARTNERS. When partners share in owning, operating, and managing a business, they are general partners. General partners have unlimited liability for the partnership's debts and usually take an active role in managing the business. Every partnership must have at least one general partner, although there is not limit on the number of general partners a business can have. Limited partners cannot participate in the day-to-day management of a company, and they have limited liability for the partnership's debts. If the business fails, they lose only what they have invested in it and no more, Limited partners usually are just financial investors in a business. A limited partnership can attract investors by offering them limited liability and the potential to realize a substantial return on their investments if the business is successful. Many individuals find it very profitable to invest in high-potential small businesses, but only if they avoid the disadvantages of unlimited liability while doing so.

LITTLE GOVERNMENTAL REGULATION .Like the proprietorship, the partnership form of operation is not burdened with red tape. FLEXIBILITY. Although not as flexible as sole ownership, the partnership can generally BTIquickly to changing market conditions because no giant organization stifles quick and creative responses to new opportunities. TAXATION. The partnership itself is not subject to federal taxation. It serves as a conduit for the profit or losses it earns or incurs; its net income or losses are passed along to the partners as personal income, and the partners pay income tax on their distributive shares. The partnership, like the proprietorship, avoids the "double taxation" disadvantage associated with the corporate form of ownership. The Disadvantages of the Partnership UNLIMITED LIABILITY OF AT LEAST ONE PARTNER. At least one member of every partnership must be a general partner. The general partner has unlimited personal liability, even though he is often the partner with the least personal resources. CAPITAL ACCUMULATION. Although the partnership form of ownership is superior proprietorship in its ability to attract capital, it is generally not as effective as the corporate of ownership, which can raise capital by selling shares of ownership to outside investors. DIFFICULTY IN DISPOSING OF PARTNERSHIP INTEREST WITHOUT DISSOLVING THE PARTNERSHIP. Most partnership agreements restrict how a partner (s) of his share of the business. Often, a partner is required to sell his interest to partner (s). Even if the original agreement contains such a requirement and clearly delineates how the value of each partner's ownership will be determined, there is no guarantee that the other partner (s) will have the financial resources to buy the seller's inter-a When the money is not available to purchase a partner's interest, the other partner (s) may be forced either to accept a new partner, or to dissolve the partnership, distribute the remaining assets, and begin again. When a partner withdraws from the partnership, the partnership ceases to exist unless there are specific provisions in the partnership agreement for a smooth transition. When a general partner dies, becomes incompetent, or withdraws m the business, the partnership automatically dissolves, although it may not terminate. Even when there are numerous partners, if one chooses to disassociate her name from the business, the remaining partners will probably form a new partnership. LACK CONTINUITY. If one partner dies, complications arise. Partnership interest is often nontransferable through inheritance because the remaining partner(s) may not want to be in a partnership with the person who inherits the deceased partner's interest. Partners can make provisions in the partnership agreement to avoid dissolution due to death if all parties agree to accept as partners those who inherit the deceased's interest. POTENTIAL FOR PERSONALITY AND AUTHORITY CONFLICTS. Being in a partnership is much like being in a marriage. Making sure partners' work habits, goals, ethics, and general business philosophy are compatible is an important step in avoiding a nasty business divorce. "People always think you invest in the product or the equipment, but the biggest investment is in the partnership-in each other," says Liz Davidson, who with partner Alex Andrade, runs a successful investment firm in New York City. 6 However, no matter how compatible partners are, friction among them is inevitable. The key is having a mechanism such as a partnership agreement and open lines of communication for controlling it. The demise of many

partnerships can often be traced to interpersonal conflicts and the lack of a procedure to resolve those conflicts. Limited Partnerships A limited partnership, which is a modification of a general partnership, is composed of a] least one general partner and at least one limited partner, in a limited partnership, the general partner is treated, under the law, exactly as in a general partnership. The limited partner is treated more as an investor in the business venture: limited partners have limited liability. They can lose only the amount invested in the business. Most states have ratified the Revised Uniform Limited Partnership Act. The formation of a limited partnership requires its founder to file a certificate of limited partnership in the state in which the limited partnership plans to conduct business. The certificate of limited partnership should include the following information: 1. the name of the limited partnership. 2. the general character of its business. 3. the address of the office of the firm's agent authorized to receive summonses or other legal notices. 4. the name and business address of each partner, specifying which ones are general partners and which are limited partners. 5. the amount of cash contributions actually made, and agreed to be made in the future, by each partner. 6. a description of the value of monkish contributions made or to be made by each partner. 7. the times at which additional contributions are to be made by any of the partners. 8. whether and under what conditions a limited partner has the right to grant limited partner status to an assignee of his or her interest in the partnership. 9. if agreed upon, the time or the circumstances when a partner may withdraw from the firm(unlike the withdrawal of a general partner, the withdrawal of a limited partner does not automatically dissolve a limited partnership). 10. if agreed upon, the amount of, or the method of determining, the funds to be received by a withdrawing partner. 11. any right of a partner to receive distributions of cash or other property from the firm, and the times and circumstances for such distributions. 12. the time or circumstances when the limited partnership is to be dissolved. 13. the rights of the remaining general partners to continue the business after withdrawal of a general partner. 14. any other matters the partners want to include. The general partner has the same rights and duties as under a general partnership: the right to make decisions for the business, to act as an agent for the partnership, to use the property of the partnership for normal business, and to share in the business's profits. The limited partner does not have the right to manage the business in any way. In fact, if he or she takes part in managing the business, a limited partner may actually forfeit limited liability, taking on the liability status of a general partner. Limited partners can, however, make management suggestions to the general partners, inspect the business, and make copies of business records. A limited partner is, of course, entitled to a share of the business's profits as agreed on and specified in the certificate of limited partnership. The primary disadvantage of limited partnership is the complexity and the cost of establishing them. Dogwood Stable of Aiken, South Carolina<www.dogwoodstable.com>, relies on limited partnerships to give sophisticated investors the opportunity to share in the excitement of owning a racehorse. Cot Campbell, owner of Dogwood Stable, reduces the risk of investing in a racehorse by

grouping several horses of different ages, price, and breeding potential into syndicates and then selling shares of ownership in each syndicate to limited partners. Dogwood Stable holds 5 percent of every syndicate as the general partner and sells four 23.75 percent shares to limited partners at prices ranging from $11,000 to $77,000 each. Although only about 10 percent of individual racehorse owners earn a profit each year, investors in limited partnerships such as those offered by Dogwood Stable have a 25 percent chance of at least breaking even. The star of Dogwood Stable's limited partnership so far is Summer Squall, whose winnings and stud fees totaled more than $2.5 million. Limited partners in this syndicate earned many times their original $55,900 investments (although most investors admit that the excitement of the race is the real reason they invest). 7 Limited Liability Partnerships Many states now recognize limited liability partnerships (LLPs) in which all partners in a business are limited partners, having only limited liability for the debts of the partnership. Most states restrict LLPs to certain types of professionals such as attorneys, physicians, dentists, accountants, and others. Just as with any limited partnership, the partners must file a certificate of limited partnership in the state in which the partnership will conduct business, and the partnership must identify itself as an LLP to those with whom it does business. Also, like every partnership, an LLP does not pay taxes; its income is passed through to the limited partners, who pay taxes on their shares of the company's income. Master Limited Partnership A relatively new form of business structure, master limited partnership (MLP), is just like regular limited partnerships, except its shares are traded just like shares of common stock. An MLP provides most of the same advantages to investors as a corporation- including limited liability. One analyst says that a master limited partnership "looks like a corporation, acts like a corporation, and trades on major stock exchanges like a corporation."8 Congress originally allowed MLPs be taxed as partnerships. However, in 1987, it ruled that any MLP not involved in natural resources or real estate would be taxed as a corporation, eliminating their ability to avoid the "double taxation" disadvantages. MLP profits typically must be divided among thousands of partners. CORPORATIONS The corporation is the most complex of the three major forms of business ownership. It is a separate entity apart from its owners and may engage in business, make contracts, sue and be sued, own property, and pay taxes. The Supreme Court has defined the corporation as "an artificial being, invisible, intangible, and existing only in contemplation of the law."9 Because the life of the corporation is independent of its owners, the shareholders can sell their interests in the business without affecting its continuation. Corporations (also known as "C corporations") are creations of the state. When a corporation K founded, it accepts the regulations and restrictions of the state in which it is incorporated and any other state in which it chooses to do business. A corporation doing business in the state in which it is incorporated is a domestic corporation. When a corporation conducts business in another state, that state considers it to be a foreign corporation. Corporations that are formed in other countries but do business in the United States are alien corporations. Generally, the corporation must report annually its financial operations to its home slate's secretary of state. These financial reports become public record. If a corporation's stock is sold in more than one state, the corporation must comply with federal regulation governing the sale of corporate securities. There are substantially more reporting requirements for a corporation than for the other forms of ownership. How to Incorporate Most .states allow entrepreneurs to incorporate without the assistance of an attorney. Sons states even provide incorporation kits lo help in the incorporation process. Although it is cheaper for entrepreneurs to complete the process themselves, it is not always the best idea. In some stale, the

application process is complex, and the required forms are confusing. The price for filing incorrectly can be high. If an entrepreneur completes the incorporation process improperly, it is generally invalid. Once the owners decide to form a corporation, they must choose a state in which! incorporate. If the business will operate within a single state, it is probably most logical! incorporate in (hat stale. States differ-sometimes rather dramatically-in the requirements they place on the corporations they charter and how they treat corporations chartered in other states. They also differ in the tax rate they impose on corporations, the restrictions placed on their activities, the capital required to incorporate, and the fees or organization tax charged to incorporate, Delaware, for instance, offers low incorporate fees and minimal legal requirements. Every state requires a certificate of incorporation or charter to be filed with the secretary) of state. The following information is generally required to be in the certificate of incorporation: The corporation's name. The corporation must choose a name that is not so similar to that of another firm in that stale [hat it causes confusion or lends itself to deception. It must ate include a term such as corporation, incorporated, company, or limited lo notify the public that [hey are dealing with a corporation. The corporation's statement of purpose. The incorporators must stale in general terms the intended nature of the business. The purpose must, of course, be lawful. An illustration might be '"to engage in the sale of office furniture and fixtures." The purpose should be broad enough to allow for some expansion in the activities of the business as it develops. The corporation's time horizon. In must cases, Corporations arc formed with no specific termination date: they are formed "for perpetuity." However, it is possible to incorporate for a specific duration (e.g.. 50 years). Names and addresses of the incorporators. The incorporators must be identified in the articles of incorporation and are liable under the law to attest that all information in the articles of incorporation is correct. In some states, one or more of the incorporators must reside in the stale in which the corporation is being created. Place of business. The street and mailing addresses of the corporation's principal office must be listed. For a domestic corporation, this address must be in the state in which incorporation takes place. Capital stock authorization. The articles of incorporation must include the amount and class (or type) of capital stock the corporation wants to be authorized lo issue. This is not the number of shares it must issue: a corporation can issue any number of shares up to the amount authorized. This section must also define the different classifications of stock and any social rights, preferences, or limits each class has. Capital required at the time of incorporation. Some states require a newly formed corporation to deposit in a bank a specific percentage of the stock's par value prior to incorporating. Provisions for preemptive rights, if any, that are granted lo stockholders. Restrictions on transferring shares. Many closely held corporal ions-those owned by a fen shareholders, often family members-require shareholders interested in selling their stock to offer it first to the corporation. (Shares the corporation itself owns arc called treasury stock.) To maintain control over their ownership, many closely held corporations exercise their right, known as the right of first refusal Names and addresses of the officers and directors of the corporation. Rules under which the corporation will operate . Bylaws are the rules and regulations the officers and directors establish for the corporation's internal management and operation.

Once the secretary of state of the incorporating state has approved a request for incorporation and the corporation pays its lees, the approved articles of incorporation become its charter. With the charter in hand, the next order of business is to hold an organizational meeting for the stockholders to formally elect directors who in turn will appoint the corporate officers. The Advantages of the Corporation LIMITED LIAB1LPTY OF STOCKHOLDERS. Because it is a separate legal entity, a Corporation allows investors to limit their liability to the total amount of their investment in the business. This legal protection of personal assets beyond the business is of critical con-am to many potential investors. This shield of limited liability may not be impenetrable, however. Because .start-up companies arc so risky, lenders and other creditors require the owners to personally guarantee loam made to the corporation. Robert Morris Associates, a national organization of bunk loan officers, estimates that 95 percent of small business owners have to sign personal guarantees to gel the financing they need. By making these guarantees, owners are pulling Recent personal assets at risk (just as in a proprietorship) despite choosing the corporate form ownership, recent court decisions have extended the personal liability of small corporation owners beyond the financial guarantees that banks and other lenders require, "piercing the corporate veil" much more than ever before. Increasingly, courts are holding entrepreneurs personally liable for environmental, pension, and legal claims against their corporations-much to the surprise of the owners, who chose the corporate form of ownership to shield themselves from such liability.l0 Problems usually arise when entrepreneurs fail to "maintain the integrity" of a corporation by failing to capitalize it sufficiently, neglecting corporate formalities such as holding annual meetings or filing required reports, or commingling their personal assets and those of the corporation. For example, the owner of a Los Angeles boatyard often paid his personal expenses with checks written on his corporation's Recount. When a customer sued the company and won, the court ruled that the judgment applied not only to the corporation's assets but also to the owner's personal assets because he had failed to keep the two separated. 11 ABILITY TO ATTRACT CAPITAL . Based on the protection of limited liability, corporations have proved to be the most effective form of ownership for accumulating large mounts of capital. Limited only by the number of shares authorized in its charter (which an be amended), the corporation can raise money to begin business and expand as opportunity dictates by selling shares of its stock to investors. A corporation can sell its stock to limited number of private investors (a private placement) or to the public (a public offering). ABILITY TO CONTINUE INDEFINITELY. Unless a corporation fails to pay its taxes is limited to a specific length of life by its charter, it can continue indefinitely. The corporation's existence docs not depend on the fate of any single individual. Unlike a proprietorship or partnership in which the death of a founder ends the business, a corporation lives beyond the lives of those who gave it life. This perpetual life gives rise to the next major advantage-transferable ownership. TRANSFERABLE OWNERSHIP. If stockholders in a corporation are displeased with, the business's progress, they can sell their shares to someone else. Millions of shares of stock representing ownership in companies are traded daily on the world's stock exchanges. Shareholders can also transfer their stock through inheritance to a new generation of owners. During all of these transfers of ownership, the corporation continues to conduct business as usual. Unlike that of large corporations whose shares are traded on organized stock exchanges. the stock of many small corporations is held by a small number of people ("closely held"), often company

founders, family members, or employees. The small number of people holding the stock means that the resale market for shares is limited, which could make the transfer of ownership more difficult. The Disadvantages of Corporations COST AND TIME INVOLVED IN THE INCORPORATION PROCESS. Corporations can be costly and time-consuming to establish. The owners are giving birth to an artificial legal entity, and the gestation period can be prolonged for the novice. In sonic states an attorney must handle the incorporation process, but in most slates entrepreneurs can complete all of the required forms alone. However, an owner must exercise great caution when incorporating without the help of an attorney. Also, incorporating a business requires various fees that are not applicable to proprietorships or partnerships. Creating a corporation can cost between $500 and $2,500, typically averaging around $1,000. DOUBLE TAXATION. Because a corporation is a separate legal entity, it must pay taxes on its net income at the federal level, in most states, and to some local government as well. Before stockholders receive a penny of its net income as dividends, a corporal inn must pay these taxes at the corporate tax rate. Then stockholders must pay taxes on the dividends they receive from these same profits al the individual tax rate. Thus, a corporation's profits are taxed twice. This double taxation is a distinct disadvantage of the corporate form of ownership. POTENTIAL FOR DIMINISHED MANAGERIAL INCENTIVES. As Corporations grow, they often require additional managerial expertise beyond that which the founder can provide. Because she created the company and often has most of her personal wealth tied up in it, the entrepreneur has an intense interest in making it a success and is willing to make sacrifices for it. Professional managers the entrepreneur brings in to help run the business as it grows do not always have the same degree of interest in or loyalty to fat company. As a result, the business may suffer without the founder's energy, care, and dew lion. One way to minimize this potential problem is to link managers' (and even employees') compensation to the company's financial performance through a profit-sharing a bonus plan. Corporations can also stimulate managers' and employees' incentive on the job by creating an employee stock ownership plan (ESOP) in which managers and employee1 become pail or whole owners in the company. LEGAL REQUIREMENTS AND REGULATORY RED TAPE. Corporations are subject to more legal, reporting, and financial requirements than other forms of ownership. Corporate officers must meet more stringent requirements for recording and reporting management decisions and actions. They must also hold annual meetings and consult the board of directors about major decisions that are beyond day-to-day operations. Manage may be required to submit some major decisions to the stockholders for approval Corporations that are publicly held must file quarterly and annual reports with a Securities and Exchange Commission (SEC). POTENTIAL LOSS OF CONTROL BY THE FOUNDER(S). When entrepreneurs sell shares of ownership in their companies, they relinquish some control. Especially when they need large capital infusions for start-up or growth, entrepreneurs may have to give up significant amounts of control, so much, in fact, that the founder becomes a minority shareholder. Losing majority ownership-and, therefore, control-in her company leaves the- founder in a precarious position. She no longer has the power to determine the company's direction; "outsiders" do. In some cases, founders' shares have been so diluted that majority shareholders actually vote them out of their jobs! Even Bill Gales, one of the wealthiest people in the world, has seen his ownership in Microsoft Inc., the company he founded with Paul Allen as a partnership in 1975, dwindle from 50 percent at start-up to 44.8 percent when the company went public in iy86, to 18.5 percent today. Over the years, Gates's ownership in Microsoft was diluted ax he sold stock in the company to raise the

capital needed to fuel its rapid growth. Don't feel too sorry for Bill Gates, however. His 18.5 percent stake in the company he cofounded is now worth more than $75 billion dollars! 12 OTHER FORMS OF OWNERSHIP In addition to the sole proprietorship, the partnership, and the corporation, entrepreneurs can choose from other forms of ownership, including the S corporation, the limited Liability company, the professional corporation, and the joint venture. The S Corporation In 1954, the Internal Revenue Service Code created the subchapter S corporation. In recent years, the IRS has changed the title to S corporation and has made a few modifications in its qualifications. An S corporation is only a distinction that is made for federal income tax purposes and is, in terms of legal characteristics, no different from any other corporation. Although Congress recently simplified some of the rules and requirements For S corporations, a business seeking "S" status still must meet the following criteria; 1. It must be a domestic (U.S.) corporation. 2. It cannot have a nonresident alien as a shareholder. 3. It can issue only one class of common stock, which means that all shares must carry the same rights (e.g., the right to dividends or liquidation rights). The exception is voting rights, which may differ. In other words, an S corporation can issue voting and nonvoting common stock. 4. It must limit its shareholders to individuals, estates, and certain trusts, although tax-exempt creations such as employee stock ownership plans (ESOPs) and pension plans can now be shareholders. 5. It cannot have more than 75 shareholders (increased from 35), which is an important benefit for family businesses making the transition from one generation of owners to another. Violating any of these terms automatically terminates a company's "S" status. If a corporation satisfies the definition for an S corporation, the owners must actually elect to be treated as one. The election is made by filing IRS Form 2553 at any time during the year, and all shareholders must consent to have the corporation treated as an S corporation. THE ADVANTAGES OF AN S CORPORATION . The S corporation retains all of the advantages of a regular corporation, such as continuity of existence, transferability of ownership, and limited personal liability for its owners. The most notable provision of the S corporation is that it passes all of its profits or losses through to the individual shareholders, and its income is taxed only once at the individual tax rate. Thus, electing S corporation status avoids a primary disadvantage of the regular (or "C") corporation-double taxation. In essence, the tax treatment of an S corporation is exactly like that of a partnership; its owners report their proportional shares of the company's profits on their individual income tax returns and pay taxes on those profits at the individual rate (even if they never take the money out of the business). Another advantage the S corporation offers is avoiding the lax C corporations pay on assets that have appreciated in value and are sold. Also, owners of S corporations enjoy the ability to make year-end payouts to themselves if earnings are high. In a C corporation, owners have no such luxury because the IRS watches for excessive compensation to owners/managers. One significant change to the laws governing S corporations that benefits entrepreneurs involves subsidiary companies. Before 1998, if an entrepreneur owned separate but affiliated companies, she had to maintain each one as a distinct S corporation with its own accounting records and tax return. Under current law, that business owner can set up all o! these affiliated companies as qualified S corporation subsidiaries ("Q Subs") under the umbrella of a single company, each with its own separate legal identity, and still file a single tax return for the parent company. For entrepreneurs with several lines of businesses, this change means greatly simplified tax filing.

Owners also can use losses from one subsidiary company to offset profits from another to minimize their tax bills. "The advent of the Q Sub has made [S corporations! more useful and popular than ever," says one tax expert.13 DISADVANTAGES OF AN S CORPORATION. When the Tax Reform Act (TRA)of 1986 restructured individual and corporate lax rates, many business owners switched to S corporations lo lower their tax bills. For the first time since Congress enacted the federal income tax in 1913, the maximum individual rate was lower than the maximum corporate rate. However, in 1993, Congress realigned the tax structure by raising the maximum personal tax rate to 39.6 percent from 31 percent. This new rate is 4.6 percent higher than the maximum corporate lax rate of 35 percent. Although these changes make S corporation status much less attractive than before, entrepreneurs considering switching to C corporation status must consider the total impact of such a change on their companies, especially if they pay out a significant amount of earnings lo owners. In addition to the tax implications of making the switch from an S corporation, owners should consider the size of the company's net income, the tax rates of its shareholders, plans (and their timing) to sell m company, and the impact of the C corporation's double-taxation penalty on income distributed as dividends. Another disadvantage of the S corporation is that the costs of many fringe benefits-insurance, meals, lodging, and so on-paid to shareholders with 2 percent or more of stop cannot be deducted as business expenses for lax purposes; these benefits are then considered to be taxable income. In addition, S corporations offer shareholders only a limit range of retirement benefits, whereas regular corporations make a wide range of retirement plans available. WHEN IS AN S CORPORATION A WISE CHOICE? Choosing S corporation status is usually beneficial to start-up companies anticipating net losses and to highly profitable firms with substantial dividends to pay out to shareholders. In these cases the owner can use the loss to offset other income or is in a lower tax bracket than the corporation, thus saving money in the long run. Companies that plan to reinvest most of their earnings to finance growth also find S corporation status favorable, Small business owners who intend to sell their companies in the near future will prefer "S" over "C" status because the taxable gains on the sale of an S corporation are generally lower than those of a C corporation. On the other hand, small companies with the following characteristics are not likely to benefit from S corporation status: highly profitable personal service companies with large numbers of shareholders, in which most of the profits are passed on to shareholders as compensation or retirement benefits. fast-growing companies that must retain most of their earnings to finance growth and capital spending. corporations in which the loss of fringe benefits to shareholders exceeds tax savings. corporations in which the income before any compensation to shareholders is less than $100,000 per year. corporations with sizable net operating losses that cannot be used against S corporation earnings. The Limited Liability Company (LLC) A relatively new creation, the limited liability company (LLC) is, like an S corporation, across between a partnership and a corporation, LLCs, however, are not subject to many of the restrictions currently imposed on S corporations and offer more flexibility than S corporations. For example, S corporations cannot have more than 75 shareholders, none of whom can be foreigners or corporations. S corporations are also limited to only one class of stock. LLCs eliminate those restrictions. An LLC must have at least two owners (called "members"), but it offers its owners limited liability without imposing any requirements on their characteristics or any ceiling on their

numbers. Unlike a limited partnership, which prohibits limited partners from participating in the day-to-day management of the business, an LLC does not restrict its members' ability to become involved in managing the company. In addition to offering its members the advantage of limited liability, LLCs also avoid is double taxation imposed on C corporations. Like an S corporation, an LLC does not pay income taxes; its income flows through to the members, who are responsible for paying income taxes on their shares of the LLCs net income. Because they are not subject to lie many restrictions imposed on other forms of ownership, LLCs offer entrepreneurs mot her significant advantage: flexibility. Like a partnership, an LLC permits its members ID divide income (and, thus, tax liability) as they see fit. These advantages make the LLC" an ideal form of ownership for small companies in virtually any industry-retail, wholesale, manufacturing, real estate, or service. Because they offer the tax advantage of a partnership, the legal protection of a corporation, and maximum flexibility. LLCs have become an extremely popular form of ownership among entrepreneurs. For example, Marian Fletcher launched a profitable party planning and catering strike in 1995 as a sole proprietorship. Her company, Let's Go Party, grew quickly, and Fletcher wanted to bring her daughter into the business as an owner. Reviewing the montages and disadvantages of each form of ownership led Fletcher to create an UC "We decided this was the best way to go for us," she says. "In case anything hap-pens daughter and I won't be liable for anything more than what we have invested in the company already." Fletcher, who set up her LLC without the help of an attorney for just $50, also found the LLC's tax treatment to he a major advantage for her and her daughter. 14 Creating an LLC is much like creating a corporation. Forming an LLC requires an entrepreneur to file two documents with the secretary of state: the articles of organization and the operating agreement. The LLC's articles of organization, similar to the corpora lion's articles of incorporation, actually creates the LLC by establishing its name address, its method of management (board managed or member managed), its duration and the names and addresses of each organizer. In most states the company's name mill contain the words "limited liability company," "limited company," or the letters "L.L.C or "L.C." Unlike a corporation, an LLC does not have perpetual life; in most stales LLC's charter may not exceed 30 years. However, the same factors that would cause a partnership to dissolve would also cause the dissolution of an LLC before its charter expires. The operating agreement, similar to a corporation's bylaws, outlines the provision governing the way the LLC will conduct business, such as members' capital contribution to the LLC, the admission or withdrawal of members, distributions from the business, and how the LLC will be managed. To ensure that their LLCs are classified as a partnership for tax purposes, entrepreneurs must draft the operating agreement carefully. The operating agreement must create an LLC that has more characteristics of a partnership than of a corporation to maintain this favorable tax treatment. Specifically, an LLC cannot have an more than two of the following four corporate characteristic: 1. Limited liability. Limited liability exists if no member of the LLC is personally liable for the debts or claims against the company. Because entrepreneurs choosing this form of ownership usually do so to get limited liability protection, the operating agreement almost always contains this characteristic. 2. Continuity of life. Continuity of life exists if the company continues to exist in spite of changes in stock ownership. To avoid continuity of life, any LLC member must have the power to dissolve the company. Most entrepreneurs choose to omit this characteristic from their LLC's operating agreements. 3. Free transferability of interest. Free transferability of interest exists if each LLC member has the power lo transfer his ownership to another person freely and without the consent of other members.

To avoid this characteristic, the operating agreement must state that a recipient of a member's LLC stock cannot become a substitute member without the consent of the remaining members. 4. Centralized management. Centralized management exists if a group that does not include all LLC members has the authority to make management decisions and to conduct company business. To avoid this characteristic, the operating agreement must slate that the company elects lo be "member managed." Despite their universal appeal to entrepreneurs, LLCs suffer some disadvantages. They can be expensive to create, often costing between SI .500 and $5,000. Although an LLC may be ideally suited for an entrepreneur launching a new company, it may pose problems for business owners considering converting an existing business to an LLC. Switching to an LLC from a general partnership, a limited partnership, or a sole proprietorship by reorganizing lo bring in new owners is usually not a problem. However, owners of corporations and S corporations would incur large tax obligations if they convened their companies lo LLCs. To date, the biggest disadvantage of the LLC stems from its newness. As yet, no uniform legislation for LLCs exists (although a Uniform Limited Liability Act is pending at the federal level). Every state now recognizes the LLC as a legal form of ownership. The Professional Corporation Professional corporations arc designed to offer professionals-lawyers, doctors, dentists, accountants, and others-the advantages of the corporate form of ownership. They are ideally suited for professionals, who must always be concerned about malpractice lawsuits, because they offer limited liability. For example, if three doctors formed a professional corporation. none of them would be liable for the others' malpractice. (Of course, each would be liable for her own actions.) Owners create a professional corporation in the same way as a regular corporation. Such corporations are often identified by the abbreviations P.C. (professional corporation), P.A. (professional association), or S.C. (service corporation). YOU BE THE CONSULTANT... Which Form Is Best? Watoma Kinsey and her daughter Katrina arc about to launch a business that specializes in children's parties. Their target audience it, upscale families who want to throw unique, memorable parties to celebrate .special occasions for their children between the ages of 5 and 15. The Kinseys have leased a large building and have renovated it to include many features designed to appeal to kids, including special gym equipment, a skating rink, an obstacle course, a mockup of a pirate ship, a ball crawl, and even a moveable haunted house. They can offer simple birthday parties (cake and ice cream included! or special theme parties as elaborate as the customer wants. Their company will provide magicians, clowns, comedians, jugglers, tumblers, and a variety of other entertainers. Watoma and Katrina have invested $45,000 each to get the business ready to launch. Based on the quality of their business plan and their preparation, the Kinscys have negotiated a $40,000 hank loan. Because they both have families, the Kinseys want to minimize their exposure to potential legal arid financial problems, A large portion of their Start-up costs went to purchase a liability insurance policy to cover the Kinseys in case a child is injured at a party. If their business plan is accurate, the Kinseys will earn a small profit in their first year (about $1,500) and a more attractive profit of $16,000 in their second year of operation. Within five years, they expect their company to generate as much as $50,000 in profits. The Kinseys have agreed to split the profits-and the workload-equally. If the business is as successful as they think it will be, the Kinseys eventually want to franchise their company. That, however, is part of their long-range plan. For now, they want to perfect their business system and prove that it can be profitable before they try to duplicate it in the form of franchises.

As they move closer to the launch date for their business, the Kinseys are reviewing the different forms of ownership. 1. Which form(s) of ownership would you recommend to the Kinseys? Explain. 2. Which form(s) of ownership would you recommend the Kinscys avoid! Explain. 3. What factors should the Kinseys consider as they try to choose the form of ownership that is best for them? The Joint Venture A joint venture is very much like a partnership, except that it is formed for a specific, limited purpose. For instance, suppose that you have a 500-acre tract of land 60 miles from Chicago that has been cleared and is normally used in agricultural production. You have a friend who has solid contacts among major musical groups and would like to put on a concert. You expect prices for your agricultural products to be low this summer, so you and your friend form a joint venture for the specific purpose of staging a three-day concert. Your contribution will he the exclusive use of the land for one month, and your friend will provide all tile performers as well as technicians, facilities, and equipment. All costs will be paid out of receipts and the net profits will be split, with you receiving 20 percent for the use of your land. When the concert is over, the facilities removed, and the accounting for all costs completed, you and your friend split the profits 20-80, and the joint venture terminates. In any endeavor in which neither party can effectively achieve the purpose alone, a joint venture becomes a common form of ownership. The "partners" form a new joint venture for each new project they undertake. The income derived from a joint venture is taxed as if it arose from a partnership. Table 4.1 provides a summary of the key features of the major forms of ownership discussed in this chapter. FRANCHISING Franchising has come a long way from its beginnings in the 1850s when the Singer Sewing Machine Company began licensing distributors to sell its sewing machines. Today, approximately 4,500 franchisers operate more than 600.000 franchise outlets throughout the world, and more are opening al an incredible pace. A new franchise opens somewhere in the world every 6.5 minutes! 15 Franchises account for 44 percent of all retail sales, totaling more than $1 trillion, and they employ some 8 million people in more than 100 major industries.16 Much of franchising's popularity stems from its ability to offer those who lack business experience the chance to own and operate a business with a high probability of success. This booming industry has moved far beyond the traditional boundaries of fast food into fields as diverse as maid services and bakeries to computer sales and pet-sitting. In franchising, semi-independent business owners (franchisees) pay fees and royalties lo a parent company (franchiser) in return for the right to become identified with its trademark, to sell its products or services, and often to use its business format and system. Franchisees do not establish their own autonomous businesses; instead, they buy a "success package" from the franchiser, who shows them how lo use it. Franchisees, unlike independent business owners, don't have the freedom to change the way they run their businesses-for example, shifting advertising strategies or adjusting product lines-but they do have a formula for success that (he franchiser has worked out. "The secret (o success in franchising is following the formula precisely," says one writer. "Successful franchisers claim that neglecting to follow the formula is one of the chief reasons that franchisees fail"17 Anita Schlachter, co-owner of a highly successful Maaco (automotive services) franchise with her husband and her son, is convinced that the system the franchiser taught them is the key lo their company's progress and growth to date. The Schlachters follow the franchiser's plan, using it as a road map to success. "If you listen to what your franchiser says and fallow its policies and procedures, you'll be successful," she says. "Those who think they know more should not go into franchising." 18

Franchising is based on a continuing relationship between a franchiser and a franchisee. The franchiser provides valuable services such as market research, a proven business system, name recognition, and many other forms of assistance; in return, the franchisee pays an initial franchise fee as well as an ongoing percentage of his sales to the franchiser as royalties and agrees to operate his outlet according to the franchiser's system. Because franchisers develop the business systems their franchisees use and direct their distribution methods, they maintain substantial control over their franchisees. This standardization lies at the core of franchising's success as a method of distribution. TYPES OF FRANCHISING There are three basic types of franchising; trade-name franchising, product distribution franchising, and pure franchising. Trade-name franchising involves a brand name such as True Value Hardware or Western Auto. Here the franchisee purchases the right to use the franchiser's trade name without distributing particular products exclusively under the franchiser's name. Product distribution franchising involves a franchiser's licensing a franchisee to sell specific products under the franchiser's brand name and trademark through a Selective, limited distribution network. This system is commonly used to market automobiles (Chevrolet, Oldsmobile, Chrysler), gasoline products (ExxonMobil, Sunoco, Texaco), soft drinks (Pepsi-Cola, Coca-Cola), bicycles (Schwinn), appliances, cosmetics, and other products. These two methods of franchising allow franchisees to acquire some of the parent company's identity. Pure (or comprehensive or business format) franchising involves providing the franchisee with a complete business formal, including a license for a trade name, the products or services to be sold, the physical plant, the methods of operation, a marketing strategy plan, a quality control process, a two-way communications system, and the necessary business services. The franchisee purchases the right lo use all the elements of a fully integrated business operation. Pure franchising is the most rapidly growing of all types of franchising and is common among fast-food restaurants, hotels, business service firms, car rental agencies, educational institutions, beauty aid retailers, and many others. Although product and trade-name franchises annually ring up more sales than pure franchisees, pure franchising outlets' sales arc growing much faster. THE BENEFITS OF BUYING A FRANCHISE A franchisee gets the opportunity lo own a small business relatively quickly, and, because of the identification with an established product and brand name, a franchise often reaches the breakeven point faster than an independent business would. Still, most new franchise outlets don't break even for at least six to eighteen months. Franchisees also benefit from the franchiser's business experience. In fact.experience is the essence of what a franchisee is buying from a franchiser. Many entrepreneurs go into business by themselves and make many costly mistakes, Given the thin margin for error in the typical start-up, a new business owner cannot afford In make many mistakes. In a franchising arrangement, the franchiser already has worked out the kinks in the system by trial and error, and franchisees benefit from that experience. A franchiser has climbed up the learning curve and can share with franchisees the secrets of success they have discovered in the industry. Gary Mandichak, owner of a successful Petland franchise, says, "[Franchisers! have the experience they know what works and what doesn't, and they know what's happening in the market."19 Franchisees also earn a great deal of satisfaction from their work. According to a recent Gallup survey of franchise owners, 82 percent of franchisees said they were "'somewhat satisfied" to "very satisfied" with their work.Plus. 75 percent said they would purchase their franchises again if given the opportunity (compared to just 39 percent of Americans who say they would choose the same job or business again).20 Another survey reported that 94 percent of franchise owners rated their operations as "very successful" or "successful."21

Before jumping at a franchise opportunity, an entrepreneur should consider careful!} the question, "What can a franchise do for me that 1 cannot do for myself7" The answer lo this question will depend on the particular situation and is not as important as the systematic evaluation of the franchise opportunity. After careful deliberation, one person ma;1 conclude that the franchise offers nothing that she could not do independently, and another may decide that a franchise is the key to success as a business owner. Franchisees often cite the following advantages that are discussed next. Management Training and Support Recall from Chapter I that one of the leading causes of business failure is incompetent management. Franchisers are well aware of this and, in an attempt to reduce the number of franchise casualties, offer managerial training programs to franchisees prior to opening a new outlet Many franchisers, especially the well-established ones, also provide follow-up training and counseling services. This service is vital since most franchisers do not require a franchisee to have experience in the business. These programs teach franchisees the details they need to know for day-to-day operations as well as the nuances of running their businesses successfully, Training programs often involve both classroom and on-site instruction to leach franchisees the basic operations of the business. Before beginning operations, McDonalds franchisees spend 14 days in Illinois at Hamburger University where they learn everything from how lo scrape the grill correctly to "how to manage a $1.6 million business.'"22 Maaco franchisees spend four weeks at (he company's headquarters delving into a five-volume set operations manuals and learning to run an auto services shop. H & R Block trains it? franchisees to unravel the mysteries of tax preparation, whereas Dunkin' Donuts trains a franchisee for as long as live weeks in everything from accounting to dough making. To ensure franchisees' continued success, many franchisers supplement their start-up training programs with ongoing instruction and support. Franchisers offer these training programs because they realize that their ultimate success depends on the franchisee's success. Despite the positive features of training, inherent dangers exist in the trainer/trainee relationship. Every would-be franchisee should be aware that, in some cases, "assistance" from the franchiser tends to drift into "control" over the franchisee's business. Some franchisers also charge fees for their training services, so the franchisee should know exactly what she is agreeing to and what it costs. Brand-Name Appeal A licensed franchisee purchases the right lo use a nationally known and advertised brand name for a product or service. Thus, the franchisee has the advantage of identifying his business with a widely recognized trademark, which usually provides a great deal of drawing power. Customers recognize the identifying trademark, the standard symbols, the store design, and the products of an established franchise. Indeed, one of franchising's basic tenets is cloning the franchiser's success. For example, nearly everyone is familiar with the golden arches of McDonald's or the red roof of the Red Roof Inn, and the standard products and quality offered at each. A customer is confident that the quality and content of a meal at McDonald's in Fort Lauderdale will be consistent with a meal at a San Francisco McDonald's. "It's a tremendous advantage to open a business with a recognizable trademark that creates almost instant foot traffic," says franchise attorney and expert Andrew Caffey.'23 Standardized Quality of Goods and Services Because a franchisee purchases a license to sell the franchiser's product or service and the privilege of using the associated brand name, the quality of the goods or service sold determines the

franchiser's reputation. Building a sound reputation in business is not achieved quickly, although destroying a good reputation lakes no lime at all. If some franchisees were allowed to operate at substandard levels, the image of the entire chain would suffer irreparable damage; therefore, franchisers normally demand compliance with uniform standards of quality and service throughout the entire chain. In many cases, the franchiser conducts periodic inspections of local facilities to assist in maintaining acceptable levels of performance. For instance, John Schnatter, founder of Papa John's, a fast-growing pizza franchise, makes personal visits to some of his franchisees' stores four to five times each week to make sure they are performing up to the company's high-quality standards. Franchisees say that Schnatter, known for his attention to detail, often checks pizzas for air bubbles in the crust or tomato sauce for freshness. "Pizza is Schnatter's life, and he takes it very seriously," says one industry analyst. 24 Maintaining quality is so important that most franchisers retain the right to terminate the franchise contract and to repurchase the outlet if the franchisee fails to comply with established standards. National Advertising Programs An effective advertising program is essential to the success of virtually all franchise operations. Marketing a brand-name product or service over a wide geographic area requires! far-reaching advertising campaign. A regional or national advertising program benefits all franchisees. Normally, such an advertising campaign is organized and controlled by [hi franchiser. It is financed by each franchisee's contribution of a percentage of monthly sales, usually 1 to 5 percent, or a flat monthly fee. For example. Subway franchisees must pay 3.5 percent of gross revenues lo the Subway national advertising program. These funds are pooled and used for a cooperative advertising program, which has more impact than if the franchisees spent the same amount of money separately. Many franchisers also require franchisees 10 spend a minimum amount on local advertising. To supplement their national advertising efforts, both Wendy's and Burger Kin; require franchisees to spend at least 3 percent of grass sales on local advertising. Sore franchisers assist each franchisee in designing and producing its local ads. Many companies help franchisees create promotional plans and provide press releases and advertisements for grand openings. Financial Assistance Because they rely on their franchisees' money to grow their businesses, franchisers typically do not provide any extensive financial help for franchisees. Franchisers rarely make loans to enable franchisees to pay the initial franchise fee. However, once a franchiser locates a suitable prospective franchisee, it may offer the qualified candidate direct financial assistance in specific areas, such as purchasing equipment, inventory, or even the franchise fee. Because the start-up costs of some franchises ar already at breathtaking levels, some franchisers find that they must offer direct financial assistance. For example, US Franchise Systems, franchiser of Microtel Inn and Hawthorn Suits hotels, has set up a subsidiary, US Funding Corporation, that makes available to its franchisees $200 million in construction and mortgage financing. Not only has the in-house financing program cut the lime required to open a new hotel franchise, hut it also has accelerated the franchise's growth rate.25 Nearly half of the International Franchise Association's members indicate that they offer some type of financial assistance to their franchises; however, only one-fourth off: direct financial assistance. In most instances, financial assistance from franchisers takes form other than direct loans, leases, or short-term credit. Franchisers usually arc willing! assist qualified franchisees in establishing relationships with banks, private investors, and other sources of funds. Such support and

connections from the franchiser enhance a franchisee's credit standing because lenders recognize the lower failure rate among establish franchises. Preferred relationships between lenders and franchisers can be critical because finding financing for a franchise can be challenging, just like attracting capital for any business start-up. For instance, when Jana Sappenfield began searching for $1.6 million of the $l.9 million needed to purchase a Primrose School franchise, the franchiser helped her connect with Newcourt/AT&T, a Small Business Administration-certified lender that has established preferred relationships with about 25 different franchised companies. "They were familiar with Primrose," says Sappenfield, "so no time was wasted researching or approving the franchiser." Because Primrose School had already accepted Sappenfield's application for a franchise, her loan request sailed easily through Newcourl/AT&T's approval process, "We know the leadership and have an understanding of the selection criteria at the franchises we work with regularly," says a top executive at Newcourt/AT&T. "Consequently, when an approved loan application comes in from a [preferred franchise], wears certain the candidate is qualified." Sappenfield's first Primrose School franchise was so successful that she has since purchased a second one.26 Proven Products and Business FormatsWhat a franchisee essentially purchases is a franchiser's experience, expertise, and products. A franchise owner does not have to build the business from scratch. Instead of being forced to rely solely on personal ability to establish a business and attract a clientele, a franchisee can depend on the methods and techniques of an established business. These standardized procedures and operations greatly enhance the franchisee's chances of success and avoid the most inefficient type of learning-trial and error. With a franchise, a franchisee docs not have to struggle for recognition in the local marketplace as much as an independent owner might. Kenneth Gabler's independent video rental store had the largest share of the local market when his landlord leased space in the same shopping center to a nationally known video franchise. West Coast Video. When he discovered that the unit was company owned, Gabler offered to buy it. "I figured that if I stayed an independent and tried 10 compete, West Coast would take away 30 percent of my business anyway. So it was cheaper for me to pay the $15,000 initial fee and a 7 percent royalty every month," he says. West Coast Video's broader tape selection, marketing techniques, and recognized name "have helped tremendously," according to Gabler. Since he converted his business to a franchise, Gabler's sales have tripled! 27 Centralized Buying Power A significant advantage a franchisee has over an independent small business owner is participation in the franchiser's centralized and large-volume buying power. If franchisers sell goods and supplies to franchisees (not all do), they may pass on to franchisees any cost savings from quantity discounts they earn by buying in volume. For example, it is unlikely that a small, independent ice cream parlor could match the buying power of Baskin-Robbins, with its 3,000-plus retail ice cream stores. In many instances, economies of scale simply preclude the independent owner from competing head-to-head with a franchise operation. Site Selection and Territorial Protection A proper location is critical to the success of any small business, and franchises are no exception. In fact, franchise experts consider the three most important factors in franchising to be location, location, and location. Becoming affiliated with a franchiser may he the best way to get into prime locations. Many franchisers will make an extensive location analysis for each new outlet, including researching traffic patterns, zoning ordinances, accessibility, and population density. McDonald's, for example, is well known for its ability to obtain prime locations in high-traffic areas. Although choosing] location is the franchisee's responsibility, the franchiser usually reserves the right to approve the final site. Choosing a suitable location requires a location analysis, including studies of traffic patterns, zoning ordinances, accessibility, population density, and demographics.

Some franchisers offer franchisees territorial protection, which gives existing franchisees the right to exclusive distribution of brand-name goods or services within a particular geographic urea. A clause establishing such a protective zone that bars other outlet from the same franchise gives franchisees significant protection and security. The size of j franchisee's territory varies from industry to industry. For example, one national fast-foot restaurant agrees not to license another franchisee within 1.5' miles of existing locations. But one soft-serve ice cream franchiser defines its franchisees' territories on the basis of zip code designations. The purpose of such protection is to prevent an invasion of the existing franchisee's territory and the accompanying dilution of sales. As existing markets haw become increasingly saturated with franchise outlets, the placement of new outlets hi become a source of friction between franchisers and franchisees. Existing franchisee; charge that franchisers are encroaching on their territories by granting new franchises K close to them that their sales are diluted. Although most franchises offer their franchise;! some type of territorial protection, the contract of one popular submarine sandwich company offers no such protection and stales that the franchiser may compete with its franchisees, even if it "adversely affects" their sales.28 Greater Chance for Success Investing in a franchise is not risk free. Between 200 and 300 new franchise companies enter the market each year, and not all of them survive. But available statistics suggest that franchising is less risky than building a business from the ground up. One expert says that "becoming a franchisee can be the safest way to scratch the entrepreneurial itch." 29 Approximately 24 percent of new businesses fail by the second year of operation; in contrast. only about 7 percent of all franchises will fail by the second year. After six years, 85 percent of franchises are still in business compared to just 50 percent of independent businesses.30 This impressive success rate for franchises is attributed to the broad range of Services, assistance, and guidelines the franchiser provides. These statistics must be interpreted carefully, however, because when a franchise is in danger of failing, the franchise often repurchases or relocates the outlet and does not report it as a failure. As a result, soil] franchisers boast of never experiencing a failure. According to the American Hi Association's Franchise Committee, one-third of the franchisees in a typical franchise SB tem are making a decent profit, one-third are breaking even, and one-third are losing money. 31 The risk of purchasing a franchise is two-pronged: success-or failure-depends on the entrepreneur's managerial skills and motivation and on the franchiser's business experience and system. Many owners are convinced that franchising has been a crucial part: their success. "It's the opportunity to be in business for yourself but not by yourself." says one franchiser.32 THE DRAWBACKS OF BUYING A FRANCHISE Obviously, the benefits of franchising can mean the difference between success and failure for a small business. However, the franchisee must sacrifice some freedom to the franchiser. The prospective franchisee must explore other limitations of franchising before undertaking this form of ownership. Franchise Fees and Profit Sharing Virtually all franchisers impose sonic type of fees and demand a share of the franchisee's sales revenues in return for the use of the franchiser's name, products or services, and business system. The fees and the initial capital requirements vary among the different franchisers. The Commerce Department reports that total investments for franchises range from $1,000 for business services up lo $10 million for hotel and motel franchises. For example, H & R Block requires a capital investment of $2,000 lo $3,000, and the Atlanta Bread Company estimates the total cost of opening a franchise lo range from 5362,000 to $584,000, depending on the size and location of the outlet, A McDonald's franchise requires an investment of $408,600 to $647,000 (but McDonald's owns the

land and the building). The average start-up cost for a franchise is between $150,000 and $200,000. 33 Start-up costs for franchises often include numerous additional fees. Most franchises impose a franchise fee up front for the right to use the company name. Other start-up costs might include site purchase and preparation, construction, signs, fixtures, equipment, management assistance, and training. Some franchise fees include these costs, whereas others do not. Fur example, Closets by Design, a company that designs and installs closet- and garage-organizers, entertainment centers, and home office systems, charges a franchise fee ranging from $19,500 to $34,900.which includes both a license for an exclusive territory and management training and support. Before signing any contract, a prospective franchisee should determine the total cost of a franchise, something every franchiser is required to disclose in item 10 of its Uniform Franchising Offering Circular (see "Franchising and the Law" on page 128). Franchisers also impose continuing royalty fees as pro fit-sharing devices. The royalty usually involves a percentage of gross sales with a required minimum, or a flat fee levied on the franchise. Royalty fees range from 1 percent to 11 percent, although most franchises assess a rate between 3 percent and 7 percent. The Atlanta Bread Company, for example, charges franchisees a royally of 5 percent of gross sales, which is payable weekly. These ongoing royalties can increase a franchisee's overhead expenses significantly. Because the franchiser's royalties and fees are calculated as a percentage of a franchisee's sales, the franchiser gets paid-even if the franchisee fails to earn a profit. Sometimes unprepared franchisees discover (too late) that a franchiser's royalties and fees are the equivalent of the normal profit margin for a franchise. To avoid such problems, a prospective franchisee should find out which fees are required (some are merely recommended) and then determine what services and benefits the fees cover. One of the best ways to do this is to itemize what you are getting for your money, and then determine whether the cost corresponds to [he benefits provided. Be sure to gel the details on all expenses-amount, time of payment, and financing arrangements; find out which items, if any, arc included in the initial franchise fee and which ones are "extra." Strict Adherence to Standardized Operations Although the franchisee owns the business, she does not have the autonomy of an independent owner. To protect its public image, the franchiser requires that the franchisee maintain certain operating standards. If a franchise constantly fails to meet the minimum standards established for the business, the franchiser may terminate its license. Determining compliance with standards is usually accomplished by periodic inspections. At times, strict adherence to franchise standards may become a burden lo the franchisee. The owner may believe dial the written reports the franchiser demands require an excessive amount of time. In other instances, the owner may be required to enforce specific rules she believes arc inappropriate or unfair. Restrictions on Purchasing In the interest of maintaining quality standards", franchisees may be required to purchase products, special equipment, or other items from the franchiser or from an "approved'" supplier. For example, Kentucky Fried Chicken requires that franchisees use only seasoning blended by a particular company because a poor image could result from franchisees using inferior products to cut costs. Under some conditions, such purchase arrangements may b challenged in court as a violation of antitrust laws, but generally, franchisers have a legs right to see that franchisees maintain acceptable quality standards. Franchisees at seven chains have Tiled antitrust suits alleging that franchisers overcharge their outlets for sup plies and equipment and eliminate competition by failing to approve alternative suppliers.34 A franchiser may legally set the prices paid for the products it sells but may not establish the retail prices to be charged on products sold

by the franchisee. A franchiser ca suggest retail prices for franchisee's products and services but cannot force the franchise to abide by them. Limited Product Line In most cases, the franchise agreement stipulates that the franchise can sell only those products approved by the franchiser. Unless willing to risk license cancellation, a franchisee must avoid selling any unapproved products through the franchise. A franchise may be required to carry an unpopular product or be prevented from introducing a desirable one by the franchise agreement. A franchisee's freedom to adapt a product line to local market conditions is restricted. However, some franchisers solicit product suggestions from their franchisees. In fact, a McDonald's franchisee. Herb Peterson, created the highly successful Egg McMuffin while experimenting with a Teflon-coated egg ring that gave fried eggs rounded' corners and a poached appearance, Peterson put his round eggs on English muffins, adorned them with Canadian bacon and melted cheese, and showed his creation to McDonald's elm Ray Kroc. Kroc devoured two of them and was sold on the idea when Peterson's wife suggested the catchy name. In 1975, McDonald's became the first fast-food franchise to open its doors for breakfast, and the Egg McMuffin became a staple on the breakfast menu. 35 Unsatisfactory Training Programs Every would-be franchisee must be wary of the Unscrupulous franchiser who promise extensive services, advice, and assistance but delivers nothing. For example, one owner relied on the franchiser lo provide what had been described as an "extensive, rigorous training program" after paying a handsome technical assistance fee. The program was nothing but an of pamphlets and doit-yourself study guides. Other examples include those impatient entrepreneurs who paid initial franchise fees without investigating the business and never ton' from the franchiser again. Although disclosure rules have reduced the severity of the problem, dishonest characters still thrive on unprepared prospective franchisees. Market Saturation As the owners of many fast-food and yogurt and ice cream franchises have discovered, mark saturation is a very real danger. Although some franchisers offer franchisees territorial protection, others do not. Territorial encroachment has become a hotly contested issue in franchising as growth-seeking franchisers have exhausted most of the prime locations and are now setting up new franchises in close proximity to existing ones. In some areas of the country, franchisees are upset, claiming that their markets are oversaturated and their sales are suffering. Less Freedom When franchisees sign a contract, they agree to sell the franchiser's product or service by following its prescribed formula. This feature of franchising is the source of the system's success, but it also gives many franchisees the feeling that they are reporting to a "boss." Franchisers want lo ensure success, and most monitor their franchisees' performances closely lo make sure franchisees follow the system's specifications. Strict uniformity is the rule rather than the exception. '"There is no independence. Successful franchisees are happy prisoners," says one writer. Entrepreneurs who want to be their own bosses often are disappointed with a franchise. "I've seen too many people buy a franchise, and the reason they're unsuccessful is that they think they have a better idea how to run that McDonald's than McDonald's has," says one franchising expert.37 Highly independent, "go-my-own-way" individuals probably should not choose the franchise route to business ownership. Table 4.2 describes ten myths of franchising. Myth#I. Franchising is the safest way to go into business because franchises never fail. Although the failure rate for franchises i5 lower than that of independent businesses, there are ho guarantees d success. Franchises can-and do-fail.

Potential franchisees must exercise the same degree of caution in judging the risk of a franchise as the/ would any other business. Myth #2. I'll be able to open my franchise for less money than the franchiser estimates. Launching a bunching a business, including a franchise, normally takes more money and more time than entrepreneurs estimate. Be prepared. One franchisee of a retail computer store advises," If a franchiser tells you you'll need $ 100,000 to get started, you better have $ 150,000." Myth #3. The bigger the franchise organization, the more successful I'll be. Bigger is not always better in the franchise industry. Some of the largest franchise operations are struggling to maintain their growth rates because the best locations arc already taken. Market saturation is a significant problem for many large franchises, and smaller franchises are accounting for much of the growth in the industry. Myth #4. I'll use 80 percent of the franchiser's business system, but I'll improve on it by substituting my experience and know-how. When franchisees buy a franchise, they are buying, in essence, the franchiser's experience and know-how. Why pay all of that money to a franchiser if you aren't willing to use their system? Myth #5. All franchises are the same. Each franchise has its own unique requirements, procedures, and culture. Naturally, some will suit you better than others. Avoid the tendency to select the franchise offering the lowest cost; ask the franchiser and existing franchisees lots of questions to determine whether you'll be comfortable in that system. Myth #6. I don't have to be a "hands-on" manager. I can be an absentee owner and still be very successful. Most franchisers shy away from absentee owners. They know that franchise success requires lots of hands-on attention, and the owner is the best person to provide that requires lots of hands-on attention, and the owner is the best person to provide that. Myth #7. Anyone can be a satisfied, successful franchise owner. With more than 4,500 franchises available, the odds of finding a franchise that appeals to your tastes is high. However, not everyone is cut out to be franchisee. Those "free spirits" who insist on doing things their way will most likely be miserable in a franchise. Myth #8. Franchising is the cheapest way to get into business for yourself. Although bargains do exist in franchising, the price tag for buying into some systems is breathtaking, sometimes running into several hundreds of thousands of dollars. Franchisers look for candidates who are on solid financial footing. Myth #9. The franchiser will solve my business problems for me; after all, that's why I pay an ongoing royalty. Although franchisers offer franchisees start-up and ongoing training programs, they will nor run their franchisees businesses for them. Your job is to take the formula that the franchiser has developed and make it work in your location. Expect to solve many of your own problems. Myth #10. Once I open my franchise, I'll be able to run things the way I want to. Franchisees are not free to run their businesses any way they see fit. Every franchisee signs a contract that requires him or her to run the business according to the franchiser's requirements. Franchisees who violate the terms of chat agreement run the risk of having their franchise relationship cancelled. FRANCHISING ANDTHE LAW The franchising boom spearheaded by McDonald's and others in the late 1950s brought with it many prime investment opportunities. However, the explosion of legitimate franchises also ushered in with it numerous fly-by-night franchisers who defrauded their franchisees. In response to these specific incidents and to the potential for deception inherent in a franchise relationship, California in 1971 enacted the first Franchise Investment Law. The law (and those of 16 other states that have since passed similar laws) requires franchisers to register a Uniform Franchise

Offering Circular (UFOC) and deliver a copy to prospective franchisees before any offer or sale of a franchise. The UFOC establishes full disclosure guidelines for any company selling franchises. In October 1979, the Federal Trade Commission (FTC) enacted the Trade Regulation Rule, requiring all franchisers to disclose detailed information on their operations at the first personal meeting, or at least 10 days before a franchise contract is signed, or before any money is paid. The FTC rule covers all franchisers, even those in the 33 states lacking franchise disclosure laws. The purpose of the regulation is to assist the potential franchisee's investigation of the franchise deal and to introduce consistency into the franchiser's disclosure statements. In 1994, the FTC modified the requirements for the UFOC, making more information available to prospective franchisees and making the document: shorter and easier to read and understand. The FTC's philosophy is not so much to prosecute abusers as to provide information to prospective franchisees and help them make intelligent decisions. Although the FTC requires each franchiser to provide a potential franchisee with this information, it does not verify its accuracy. Prospective franchisee! should use these data only as a starting point for the investigation. The Trade Regulation Rule requires a franchiser to include 23 major topics in its disclosure statement: 1. Information identifying the franchiser and its affiliates and describing their business experience and the franchises being sold. 2. Information identifying and describing the business experience of each of the franchiser! officers, directors, and management personnel responsible for the franchise program. 3. A description of the lawsuits in which the franchiser and its officers, directors, and managers have been involved. Although most franchisers will have been involved in some type of litigation, an excessive number of lawsuits, particularly if they relate to the same problem, is alarming. "The history of the litigation will tell you the future of your relationship [with the franchiser]," says the founder of a maid-service franchise.38 4. Information about any bankruptcies in which the franchiser and its officers, directors, and managers have been involved. 5. Information about the initial franchise fee and other payments required to obtain the franchise, including the intended use of the fees. Initial fees typically range from $10,000 to $30,000. 6. A description of any continuing payments franchisees arc required to make after start-up, including royalties, service fees, training fees, lease payments, advertising or market! charges, and others. 7. A detailed description of the payments a franchisee must make to fulfill the initial investment requirement and how and Lo whom they are made. The categories covered are the initial franchise Ice, equipment, opening inventory, initial advertising fee, signs, training, teal estate, working capital, legal, accounting, and utilities. These estimates, usually stated in the form of a range of numbers, give prospective franchisees an idea of how much their total start-up costs will be. 8. Information about quality restrictions on goods, services, equipment, supplies, inventory, and other items used in the franchise and where franchisees may purchase them, including restricted purchases from the franchiser. 9. A statement (in tabular form) of the franchisee's obligations under the franchise contract, including items such as selecting a site, paying fees, maintaining quality standards, keeping records, transferring or renewing the franchise relationship, and others. 10. A description of any financial assistance available from the franchiser in the purchase of the franchise. 11. A description of all obligations the franchiser must fulfill in helping a franchisee prepare to open and operate a unit. Plus, information covering location selection methods and the training program provided to franchisees. In addition lo the training they provide new franchisees, many franchisers offer help with a grand opening for each outlet and on-site management assistance for a short time to get franchisees started.

12. A description of any territorial protection that will be granted lo the franchise and a statement as to whether the franchiser may locate a company-owned store or other outlet in that territory. 13. All relevant information about the franchiser's trademarks, service marks, trade names, logos, and commercial symbols, including where they arc registered. Look for a strong trademark or service mark that is registered with the U.S. Patent and Trademark Office. 14. Similar information on any patents and copyrights the franchiser owns, and the rights to these transferred to franchisees. 15. A description of the extent lo which franchisees must participate personally in the operation of the franchise. Many franchisers look for "hands-on'' franchisees and discourage "absentee owners." 16. A description of any restrictions on the goods or services franchises are permitted to sell and with whom franchisees may deal. The agreement usually restricts franchisees to selling only those items approved by the franchiser. 17. A description of the conditions under which the franchise may be repurchased or refused renewal by the franchiser, transferred to a third party by the franchisee, and terminated or modified by either party. This section also addresses the method established for resolving disputes. 18. A description of the involvement of celebrities and public figures in the franchise. 19. A complete statement of the basis for any earnings claims made lo the franchisee, including the percentage of existing franchises that have actually achieved the results that are claimed. New rules put two requirements on franchisers making earnings claims: (a) Any earnings claim must be included in the UFOC, and (b) the claim must "have a reasonable basis at the lime it is made." However, franchisers are not required to make any earnings claims at all; in fact, only about 25 percent of franchisers make earnings claims in their circulars, primarily because of liability concerns about committing such numbers to paper. 39 20 Statistical information about the present number of franchises; the number of franchises projected for the future: the number of franchises terminated: the number the franchiser has not renewed; the number repurchased in the past; and a list of the names and addresses (organized by state) of other franchisees in the system. 21. The franchiser's financial statements. 22. A copy of all franchise and other contracts (leases, purchase agreements, etc.) the franchisee will be required to sign. 23. A standardized, detachable "receipt" to prove that the prospective franchisee received a copy of the UFOC. The information contained in the UFOC does not fully protect a potential franchise from deception, nor does it guarantee success. It does, however, provide enough information to begin a thorough investigation of the franchiser and the franchise deal. THE RIGHT WAY TO BUY AFRANCHISE The UFOC is a powerful tool designed to help would-be franchisees select the franchise that is right for them and to avoid being duped by dishonest franchisers. The best defenses a prospective entrepreneur has against unscrupulous franchisers are preparation, common sense, and patience. By investigating thoroughly before investing in a franchise, a potential franchisee minimizes the risk of being hoodwinked into a nonexistent business. Asking the fight questions and resisting the urge to rush into an investment decision helps a potential franchisee avoid being taken by unscrupulous operators. Potential franchisees must beware because franchise fraud still exists in this rapidly growing field. A recent conference of state securities regulators named "illegal franchise, offers" as one of the top I0 financial frauds in the United States? The president of one franchise consulting firm estimates that 5 to 10 percent of franchisers are dishonest--"the rogue elephants of franchising." Dishonest franchisers tend to follow certain patterns, and well-prepared franchisees who know what to look

for can avoid trouble. The following clues should arouse the suspicion of an entrepreneur about to invest in a franchise: Claims that the franchise contract is a standard one and that "you don't need to read it." A franchiser who fails to give you a copy of the required disclosure document at your first faceto-face meeting. A marginally successful prototype store or no prototype at all. A poorly prepared operations manual outlining the franchise system or no manual (or system) at all. Oral promises of future earnings without written documentation. A high franchisee turnover rate or a high termination rate. An unusual amount of litigation brought against the franchiser. Attempts to discourage you from allowing an attorney to evaluate the franchise contract before you sign it. No written documentation to support claims and promises. A high-pressure sale--sign the contract now or lose the opportunity. Claiming to be exempt from federal laws requiring complete disclosure of franchise details. "Get-rich-quick schemes," promises of huge profits with only minimum effort. Reluctance to provide a list of present franchisees for you to interview. Evasive, vague answers to your questions about the franchise and its operation. Not every franchise "horror story" is the result of dishonest franchisers. More often than not, the problems that arise in franchising have more to do with franchisees who buy legitimate franchises without proper research and analysis. They end up in businesses they don't enjoy and that they are not well suited to operate. How can you avoid this mistake? The following steps will help you make the right choice. Evaluate Yourself Before looking at any franchise, an entrepreneur should study her own traits, goals, experience, likes, dislikes, risk orientation, income requirements, time and family commitments, and other characteristics. Will you be comfortable working in a structured environment? What kinds of franchises fit your desired lifestyle? In what region of the country or world do you want to live and work? What is your ideal job description? Knowing what you enjoy doing (and what you don't want to do) will help you narrow your search. The goal is to find the franchise that is right--for you! One characteristic successful franchisees have in common is that they genuinely enjoy their work. Table 4.3 provides a test for prospective franchisees that helps them evaluate their franchise potential. Of those people who set out Co buy a. franchise, only IS percent actually buy one. Some of that 15 percent make the wrong decision. They discover too late that they are not cut out to be franchisees. Do you hive what it takes to be a successful franchisee? The following quiz will help you determine your "franchise quotient." 1. You own a company. How much operational detail are you comfortable with? a. I want direct control over all operations. b. I delegate less than half. c. I delegate more than half. 2. You have three job offers with comparable salary and benefits. Choose one. a. Small company but high management responsibility and exposure. b. Mid-sized company with less personal exposure but more prestigious name. c. Large company with least personal exposure but very well-known name. 3. You reach a major stumbling block on a project, You: a. Seek help from others immediately. b. Think it through and then present possible solutions to your superior.

c. Keep working until you resolve it on your own. 4. Which investment sounds most appealing? a. Five percent fixed return over a period of time. b. From -20 percent to +50 percent loss or return over a period of time, depending on changing economic situations. 5. Which business arrangement is most appealing? a. You're the sole owner. b. You're in a partnership and own a majority of the stock. c. You're in an equal partnership. 6. Your company's sales technique increases sales 10 percent per year. You used a technique elsewhere you feel will result in 15 percent to 20 percent annual increases, but it requires extra time and capital. You: a. Avoid the risk and stay with the present plan. b. Suggest your new method, showing previous results. c. Privately use your system, and show the results later. 7. You suggest your system to your boss, and he says, "Don't rock the boat." You: a. Drop your different approach. b. Approach your boss at a later time. c. Go to your boss's boss with your suggestion. d. Use your own system anyway. 8. Which would mean the most to you? a. Becoming the president of a company. b. Becoming the highest-paid employee of a company. c. Winning the highest award for achievement in your profession. 9. What three activities do you find most appealing? a. Sales and marketing. b. Administration. c. Payroll. d. Training. e. Customer service. f. Credit and collections. g. Management. 10. What work pace do you generally prefer? a. Working on one project until it is completed. b. Working on several projects at one time. Scoring: 1. A=5,B=3,C=1. 2. A=3,B-2,C=1. 3. A=1,B=5,C=7. 4, A=2,B=6. 5. A=7, B=5, C=2. 6 A=1,B=6,C=10. 7. A=l, B=5,C=8,D=10. 8. A=8.B=2,C=5. 9. A=10,B=1,C=3,D=3, E=8,F=2,G=5. 10. A=3,B=6. Total Score: 20-33 You're a corporate player and are happiest in a structured environment. Franchising suits you. 34-71 You're a potentially good franchisee. 72-85 You're an entrepreneur who prefers total independence. Research Your Market Before shopping for a franchise, research the market in the area you plan, to serve. How fail is the overall area growing? In which areas is that growth occurring fastest? Investing some lime at the library developing a profile of the customers in your target area is essential; otherwise, you will be flying blind. Who arc your potential customers? What are their characteristics and their income

and education levels? What kinds of products and services M they buy? What gaps exist in the market? These gaps represent potential franchise opportunities for you. Market research also should confirm that a franchise is not merely part o: a fad that will quickly fade. Steering clear of fads and into long-term trends is one way to sustain the success of a franchise. Before Papa John's Pizza allows franchisees to open any store, it requires them If spend six months to a year evaluating the market potential of the local area. " We don't just move into an area and open up 200 stores," says one manager. "We do it one store at a time." 41 Consider Your Franchise Options The International Franchise Association publishes the Franchise Opportunities Guide which lists its members and some basic information about them. Many cities host franchise trade shows throughout the year where hundreds of franchisers gather 10 sell their franchises. Attending one of these franchise showcases is a convenient, efficient way to collect information about a variety of available opportunities. Many business magazines such as Entrepreneur, Inc., Business Start-Ups, Your Company, and others devote at least one issue to franchising, in which they often list hundreds of franchises. These guides can help yd find a suitable franchise within your price range. Get a Copy of the Franchiser's UFOC Once you narrow down your franchise choices, you should contact each franchise and get a copy of its UFOC. Then read it! This document is an important tool in your search ford right franchise, and you should make the most of it. When evaluating a franchise opportunity, what should a potential franchisee look for? Although there's never a guarantee I success, the following characteristics make a franchise stand out. A unique concept or marketing approach. "Me-too" franchises arc no more successful than "metoo" independent businesses. Pizza franchiser Papa John's has achieved an impressive growth rate by emphasizing the quality of its ingredients, whereas Domino's is known for its fast delivery. Profitability. A franchiser should have a track record of profitability and so should its franchisees. If a franchiser is not profitable, its franchisees are not likely to be cither. Franchise who follow the business format should expect to earn a reasonable rate of return. A registered trademark. Name recognition is difficult to achieve without a well-known and protected trademark. A business system that works, A franchiser should have in place a system that is efficient and well documented in its manuals. A solid training program. One of the most valuable components of a franchise system is the training it offers franchisees. The system should be relatively easy to teach. Affordability. A franchisee should not have to take on an excessive amount of debt to purchase a franchise. Being forced to borrow too much money to open a franchise outlet can doom a business from the outset. Respectable franchisers verify prospective franchise financial qualifications as part of the screening process. A positive relationship with franchisees. The must successful franchises are those that see their franchisees as partners and treat them accordingly. The UFOC covers the 23 items discussed in the previous section and includes a copy of the company's franchise agreement and any contracts accompanying it. Although the law requires a UFOC to be written in plain English rather than "legalese," it is best to have an attorney experienced in franchising to review the UFOC and discuss its provisions with you, Watch for clauses that give the franchiser absolute control and discretion. The franchise contract summarizes the details that will govern the franchiser-franchisee relationship over its life, Ii outlines exactly the rights and the obligations of each party and sets the guidelines that govern the franchise

relationship. Still, a recent study by the FTC suggests that40 percent of new franchisees sign contracts without reading them!42 When one fast-id franchiser took a survey of its franchisees, it discovered that fewer than 10 percent id bothered to read either the UFOC or the franchise contract.4' Because franchise contacts typically are long terra (50 percent run for 15 years or more), it is extremely important for prospective franchisee^ lo understand their terms before they sign them. One of the most revealing items in the UFOC is the franchisee turnover rate, the rate a! which franchisees leave the system. ! f the turnover rate is less than 5 percent, the franchise is probably sound. However, a franchise turnover rate approaching 20 percent is a sign of serious, underlying problems in a franchise. Satisfied franchisees are not inclined lo leave a successful system. Talk to Existing Franchisees One of the best ways to evaluate the reputation of a franchiser is to interview (in person) several franchise owners who have been in business at least one year about the positive and le negative features of the agreement and whether the franchiser delivered what was promised. Did the franchise estimate their start-up costs accurately? Do they get the support the franchiser promised them? Has the franchise met their expectations concerning profitability and return on investment? Knowing what they know now, would they buy the franchise again? Bob Phillips, a CPA looking to make a career change, wanted to make sure that he purchased the right franchise, so he invested time poring over the UFOCs he had collected from the dozen franchises that interested him. Father than rely on the documents alone to judge the franchises, Phillips made calls to franchisees that he randomly selected from the lists included in the UFOCs (item 20). His conversations with franchisees convinced him that Ranch j, a chain of fast-food grilled chicken stores, was the best choice for him. "Almost every one wanted a second location," he says. "That's indicative of a healthy franchise system." Phillips is convinced that his thorough research led him to the right franchise. Today he owns two Ranch I franchises that generate more than $2 million in Saks, and he plans to open eight more outlets within three years.44 Interviewing past franchisees to gel their perspectives on the franchiser-franchisee relationship is also helpful. Why did they leave? Franchisees of some companies have formed associations, which might provide prospective franchisees with valuable information. Other sources of information include the American Association of Franchisees and Dealers, the American Franchise Association, and the International Franchise Association. Ask the Franchiser Some Tough Questions Take the time to ask the franchiser questions about the company and its relationship with its franchisees. You will be in this relationship a long time, and you need to know as much about it as you possibly can beforehand. What is its philosophy concerning the relationShip? What is the company culture like? How much input do franchisee's have into the system? What are the franchise's future expansion plans? How will they affect your franchise? Are you entitled to an exclusive territory? Under what circumstances can either party terminate the franchise agreement? What happens if you decide to sell your franchise in the future? Under what circumstances would you not be entitled to renew the agreement? What kind of profits can you expect? (If the franchiser made no earnings claims in item 19 of the UFOC, why not?) Does the franchiser have a well-formulated strategic plan? YOU BE THE CONSULANT... The Opportunityof a Lifetime"Honey, I think I've found it!" said Joe Willingham to his wife Allie. "This is just what I've been looking for, and just in lime, too. My severance package from the company runs out next month. The man said that if we invested in this franchise now, we could be bringing in good money by then. It's that easy!" Allie knew that Joe had been working hard at finding another job since he had been a victim of his company's latest downsizing, but jobs were scarce even for someone with his managerial experience and background in manufacturing. "Nobody wants to hire a 51-year-old man with

experience when they can hire 23-year-old college graduates at less than half the salary and teach them what they need to know," Joe told her after months of fruitless job hunting. That's when Joe got the idea of setting up his own business. Rather than start an independent business from scratch, Joe felt more comfortable, given his 26-year corporate career, opening a franchise. "A franchiser can give me the support I need," he told Allie. "Tell me about this franchise," Allie said. "'It's a phenomenal opportunity for us," Joe said, barely able to contain his excitement. "I saw this booth for American Speedy Print at the Business Expo this morning. There were all kinds of franchises there, but this one really caught my eye,"' Joe said as he pulled a rather plain-looking photocopy of a brochure from his briefcase. "Is that their brochure?" asked Allie. "Well, the company is growing so fast that they have temporarily run out of their normal literature. This is just temporary." "Oh. . .You would think that a printing franchise could print flashier brochures even on short notice, but I guess. . . ," said Allie. "The main thing is the profit potential this business has," said Joe. "1 met one of their franchisees. I tell you the guy was wearing a $2,000 suit if ever there was one, and he had expensive jewelry dripping from his fingers. He's making a mint with this franchise, and he said we could too!" Joe continued, "With the severance package I have from the company, we could pay the $10,000 franchise fee and lease most of the equipment we need to get started. It'll take every penny of my package, but, hey, it's an investment in our future. The representative said the company would help us with our grand opening and would help us compile a list of potential customers." "What would you print?" asked Allie. "Anything!" said Joe. "The franchisee I talked to does flyers, posters, booklets, newsletters, advertising pieces . . . you name it!" "Wow! It seems like you'd need lots of specialized equipment to do all of that. How much does the total franchise package cost?" said Allie. "Well. I'm not exactly sure. He never gave me an exact figure, but we can lease all the equipment we need from the franchiser!" "Is this all of the material they gave you? I thought franchisers were supposed to have some kind of information packet to give to people," said Allie. "Yeah. I asked him about that," said Joe. "He said that American Speedy Print is just a small franchise. They'd rather put their money into building a business and helping their franchisees succeed than into useless paperwork that nobody reads anyway. It makes sense to me." "I guess so. . . ," Allie said reluctantly. "I think we need to take this opportunity, Hon," Joe said, with a look that spoke of determination and enthusiasm. "'Besides, he said that there was another couple in this county that is already looking at this franchise, and that the company will license only one franchisee in this area. They don't want to saturate the market. He thinks they may take it. I think we have to move on this now, or we'll lose the opportunity of a lifetime." Allie had not seen Joe exhibit this much enthusiasm and excitement for anything since he had lost his job at the plant. Piles of rejection letters from his job search had sapped Joe's zest for living. Allie was glad to sec "the m Joe" return, but she still had her doubts about the franchise opportunity Joe was describing. "It might just be the opportunity of a lifetime, Joe," she said, "'But don't you think we need to find out a little more about this franchise before we invest that much money? I mean. . . ." "Hon, I'd love to do that, but like the man said, we may miss out on the opportunity of a lifetime if we don't sig today. I think we've got to move on this thing now!" 1. What advice would you offer Joe about investing in this franchise?

2. Map out a plan for Joe to use in finding the right franchise for him. What can Joe do to protect himself from making a bad franchise investment? 3. Summarize the advantages and disadvantages Joe can expect if he buys a franchise. Make Your ChoiceThe first lesson in franchising is "Do your homework before you gel out your checkbook." Once you have done your research, you can make an informed choice about which franchise is right fur you. Then it is time to put together a solid business plan that will serve as road map to success in the franchise you have selected. The plan is also a valuable tool louse as you arrange the financing for your franchise. We will discuss the components of a business plan in Chapter 9. Appendix A at the end of this chapter offers a checklist of questions a potential franchisee should ask before entering into any franchise agreement. TRENDS SHAPING FRANCHISING Franchising has experienced three major growth waves since its beginning. The first wave occurred in the early 1970s when fast-food restaurants used the concept to grow rapidly. The lastfood industry was one of the first to discover the power of franchising, but other presses soon look notice and adapted the franchising concept to their industries. The second wave took place in the mid-1980s as our nation's economy shifted heavily toward BE service sector. Franchises followed suit, springing up in every service business imaginable-from maid services and copy centers to mailing services and real estate. The third wave began in the early 1990s and continues today. It is characterized by new, low-cost franchises that focus on specific market niches. In the wake of major corporate downsizing and the burgeoning costs of traditional franchises, these new franchises allow would-be entrepreneurs to get into proven businesses faster and at lower costs. These companies feature start-up costs from $2,000 to $250,000 and span a variety of industriesfrom leak detection in homes and auto detailing to day care and tile glazing. Other significant trends affecting franchising are discussed next. Changing Face of Franchisees Franchises today are better educated, arc more sophisticated, have more business acumen, dare more financially secure than those of just 20 years ago. Franchising is attracting Riled, experienced businesspeople whose goal is to own multiple outlets that cover entire Males or regions. For instance, when Krispy Krene Doughnuts began to move its popular product north mm its southern stronghold, the Lev family-father Howard, sons Russel and Mel, and nuephew John Faber-bought the franchise for the entire state, of New York. While on a trip to the South, Mel discovered the tasty orbs and brought some back to his family, who quickly devoured than. Once they returned to their home in New York, the Levs decided to become franchisees. All experienced in business (Howard and Mel once owned a shirt- company), the Levs and Faber have opened 10 stores and have plans for dozens more. International Opportunities One of the major trends in franchising is the internationalization of U.S. franchise systems. Increasingly, franchising is becoming a major export industry for the United Stales. Growing numbers of U.S. franchises are moving into international markets lo boost sales and profits as the domestic market becomes saturated. According to a report by Arthur Andersen, 44 percent of U.S. franchisers have international locations, up from 34 percent in 1989. International expansion is a relatively new phenomenon in franchising, however approximately 75 percent of franchisers established their first foreign outlet within the par 10 years.46 Canada is the primary market for U.S. franchisers, with Mexico, Japan, and Europe following. These markets are most attractive to franchisers because they are similar to the U.S. market-rising personal incomes, strong demand for consumer goods, growing service economies, and spreading urbanization. As they venture into foreign markets, franchisers have learned that adaptation is one key to success. Although a franchise's overall business format may not change in foreign markets, some of the details of operating its local outlets must. For instance, fast-food chains in other countries often must make adjustments to their menus to please local) palates. In Japan, McDonald's (known as "Makudonarudo") outlets sell teriyaki burgers, rice burgers, and katsu burgers (cheese wrapped

in a roast pork cutlet lopped with katsu sauce and shredded cabbage) in addition lo their traditional American fare. In the Philippines, the McDonald's menu includes a spicy Filipino-style burger, spaghetti, and chicken with rice. Countries that recently have thrown off the chains of communism are turning to frail chising to help them move toward a market economy. Some countries of Eastern Europe, including Hungary, Poland, and Yugoslavia, already have attracted franchiese. Even Russia is fertile ground for franchising. McDonald's scored a hit with its 700-sii restaurant in Moscow. Despite being one of the largest McDonald's outlets in the world, "the wailing line winds along busy Pushkin Square for well over 500 yards," report one Soviet magazine.47 Franchisers in these countries must have patience, however Lack of capital, archaic infrastructure, and a shortage of hard currencies mean if profits will be slow in coining. Most franchisers recognize the difficulties of developing franchises in foreign markets and start slowly. According to Arthur Anderson, 79 pc cent of franchisers doing business internationally have fewer than 100 outlets in foreign countries.48 Smaller, Nontraditional Locations As the high cost of building full-scale locations continues to climb, more franchisers are searching out nontraditional locations in which to build smaller, less expensive outlets. Based on the principle of intercept marketing, the idea is to put a franchise's produce services directly in the paths of potential customers, wherever they may be. Locations within locations have become popular. Franchises are putting scaled-down outlets on college campuses, in high school cafeterias, in sports arenas, in hospitals, on airline flights and in zoos. St. Louis-based Pizzas of Eight already has outlets inside convenience stores, supermarkets, and bowling alleys and plans to open others in video stores.49 Many franchisees have discovered that smaller outlets in these nontraditional locations gents nearly the same sales volume as full-sized outlets at just a fraction of the cost! Steve Siegel, owner of 35 Dunkin' Donuts shops in the Boston area, recently be branching out into small, nontraditional locations where pedestrian traffic counts are high. One of his most profitable spots measures just 64 square feel, but because it is in a business district filled with office workers, it generates a high volume of sales. 50 Such locations will be a key to continued franchise growth in the domestic market. Conversion Franchising The recent trend toward conversion franchising, in which owners of independent businesses become franchisees to gain [he advantage of name recognition, will continue. In a franchise conversion, the franchiser gets immediate entry into new markets and experienced operators; franchisees gel increased visibility and often a big sales boost. In fact, the average sales gain in the first year for converted franchises is 20 percent.51 The biggest force in conversion franchising has been Century 21, the real estate sales company. Multiple-Unit Franchising Multiple-unit franchising (MUF) became extremely popular in the early 1990s. In multiple-unit franchising, a franchisee opens more than one unit in a broad territory within a specific lime period. "Multiple ownership of units by franchisees has exploded." says one franchise expert. "Twenty or 30 years ago, it would have been rare for any one franchisee mown 10 or 20 units. Now it's not uncommon . . . for one franchisee to own 60, 70, or 1200 units. Franchisers are finding it's far more efficient in the long run to have one well-trained franchisee operate a number of units than to train many franchises."52 The popularity of multiple-unit franchising has paralleled the trend toward increasingly experienced, sophisticated franchisees, who set high performance goals that a single outlet can-it meet. The typical multiple-unit franchisee owns between three and six units, but some franchisees own many more. Master Franchising A master franchise (or subfranchise) gives a franchisee the right to create a semi-independent organization in a particular territory to recruit, sell, and support other franchisees. A master

franchisee buys the right to develop subfranchise within a broad geographic area or sometimes an entire country. Subfranchising "turbocharges" a franchiser's growth. Many franchisers use it to open outlets in international markets more quickly and efficiently because the master franchisees understand local laws and the nuances of selling in local markets. For instance, a master franchisee with TCBY International, a yogurt franchise, has opened 21 stores in China and in Hong Kong. Based on his success in these markets, the company has sold him the master franchise in India.53 Piggybacking (or Combination Franchising) Some franchisers also are discovering new ways to reach customers by teaming up with other franchisers selling complementary products or services. A growing number of companies are piggybackingoutlets-combining two or more distinct franchises under one roof. This "buddy system" approach works best when the two franchise ideas are compatible and appeal to similar customers. For example, franchisers Dunkin' Donuts, Togos' Entry sandwich shops, and ice cream retailer Baskin-Robbins are working together to Id hundreds of combination outlets, a concept that has proved to be highly successful.54 properly planned, piggybacked franchises can magnify many times over the sales and profits of individual, self-standing outlets. One Baskin-Robbins franchisee saw his sales mo 25 percent when he added a Blimpie Subs and Salads franchise to his existing ice cream shop. Another enterprising franchisee who combined Shell Oil (gas station), Charley's Steakery (sandwich shop), and TCBY (frozen yogurt) franchises under one roof in Columbus, Ohio, says that sales are running 10 percent more than the three outlets would generate in separate locations.55 Serving Aging Baby Boomers Now that dual-career couples have become the norm, especially among baby boomers, the market for franchises offering convenience and time-saving devices is booming. Customers are willing to pay for products and services that will save them time or trouble, and franchises are ready to provide them. Franchisees of Around Your Neck go into the homes and offices of busy male executives to sell men's apparel and accessories ranging from shirts and ties to custom-made suits. Other areas in which franchising is experiencing rapid growth include home delivery of meals, house-cleaning services, continuing education and training (especially computer and business training), leisure activities (such as hobbies, health spas, and travel-related activities), products and services aimed at home-based businesses, and health care. "People are interested in anything that will make lit! simpler for them," explains one franchise consultant.56 CONCLUSION Franchising has proved its viability in the U.S. economy and has become a key part oft] small business sector because it offers many would-be entrepreneurs the opportunity it own and operate a business with a greater chance for success. Despite its impressive growth rate to date, the franchising industry still has a great deal of room to grow. Describing the future of franchising, one expert says, "Franchising has not yet come close to reaching its full potential in the American marketplace." 57 CHAPTER SUMMARY 1-A. Explain the advantages and the disadvantages of the sole proprietorship. A sole proprietorship is a business owned and managed by one individual and is the most popular form of ownership. Sole proprietorships offer these advantages: They are simple to create; they are the least costly Form to begin; the owner has total decision-making authority; there are no special legal restrictions; and they are easy to discontinue. They also suffer from these disadvantages: unlimited personal liability of owner; limited managerial skills and capabilities; limited access to capital; and lack of continuity. 1-B. Explain the advantages and the disadvantages of the partnership.

A partnership is an association of two or more people who co-own a business for the purpose of making a profit. Partnerships offer these advantages: ease of establishing; complementary skills of partners; division of profits; larger pool of capital available; ability to attract limited partners; little government regulation; flexibility; and tax advantages. Partnerships suffer from these disadvantages: unlimited liability of at least one partner; difficulty in disposing of partnership interest; lack of continuity; potential for personality and authority conflicts; and partner bound by the law of agency. 1-C. Explain the advantages and the disadvantages of it corporation. A corporation, the most complex of the three basic forms of ownership, is a separate legal entity. To from a corporation, an entrepreneur must file the articles of incorporation with the slate in which the company will incorporate. Corporations offer these advantages: limited liability of stockholders; ability to attract capital; ability to continue indefinitely; and transferable ownership. Corporations suffer from these disadvantages: a and lime involved in incorporating; double taxation potential for diminished managerial incentives; to requirements and regulatory red tape; and potential loss of control by the founder(s). 2. Discuss the advantages and the disadvantages of the S corporation, the limited liability company, the professional corporation, and the joint venture. Entrepreneurs can also choose from several 4 forms of ownership, including S corporations and limited liability companies. An S corporation offers its owners limited liability protection but avoids the double taxation of C corporations. A limited liability company, like an S corporation, is a cross between a partnership and a corporation, yet it operates without the restrictions imposed on an S corporation. To create an LLC, an entrepreneur must file the articles of organization and [he operating agreement with the secretary of state. A professional corporation offers professionals the benefits of the corporate form of ownership. A joint venture is like a partnership, except [ha! it is formed for a specific purpose. 3. Describe the three types of franchising: trade name, product distribution, and pure. Trade-name franchising involves a franchisee's purchasing the right to become affiliated with a franchiser's trade name without distributing its products exclusively. Product distribution franchising involves licensing a franchisee to sell products or services under (he franchiser's brand name through a selective, limited distribution network. Pure franchising involves selling it franchisee a complete business format. 4. Explain the benefits and [he drawbacks of buying a franchise. Franchises offer many benefits: management training and support; brand name appeal; standardized quality of goods and services; national advertising programs; financial assistance; proven products and business formats; centralized buying power; territorial protection; and a greater chance of success. Franchising also suffers from certain drawbacks; franchise fees and profit sharing; strict adherence to standardized operations; restrictions on purchasing; limited product lines: unsatisfactory training programs; market saturation; and less freedom. 5. Understand the laws covering franchise purchases. The Federal Trade Commission (FTC) enacted the Trade Regulation Rule in 1979, which requires all franchisers to disclose detailed information on their operations at the first personal meeting or at least 10 days before a franchise contract is signed, or before any money is paid. The FTC rule covers all franchisers. The Trade Regulation Rule requires franchisers to provide information on 23 topics in their disclosure statements. Seventeen states have passed their own franchise laws requiring franchisers to provide prospective franchisees a Uniform Franchise Offering Circular (UFOC).

6. Discuss the right way to buy a franchise. The following steps will help you make the right franchise choice: Evaluate yourself; research your market; consider your franchise options; gel a copy of the franchiser's UFOC; talk to existing franchisees; ask the franchiser some tough questions; and make your choice. 7. Outline the major trends shaping franchising. Key trends shaping franchising today include the changing face of franchisees; international franchise opportunities; smaller, nontraditional locations; conversion franchising; multiple-unit franchising; master franchising; and piggybacking (or combination franchising). DISCUSSION QUESTIONS 1. What factors should an entrepreneur consider before choosing a form of ownership? 2. Why arc sole proprietorships so popular as a form of ownership? 3. How does personal conflict affect partnerships? 4. What issues should the articles of partnership address? Why are the articles important to a successful partnership? 5. Can one partner commit another to a business deal without the other's consent? Why? 6. What issues should the certificate of incorporation cover? 7. How docs an S corporation differ from a regular corporation? 8. What role do limited partners play in a partnership? What happens if a limited partner takes an active role in managing the business? 9. What advantages docs a limited liability company offer over an S corporation? A partnership? 10. How is an LLC created? What criteria must an LLC meet to avoid double taxation? 11. Briefly outline the advantages and disadvantages of the major forms of business ownership. 12. What is franchising? 13. Describe the three types of franchising and give an example of each. 14. Discuss the advantages and the limitations of franchising for the franchisee. 15. Why might an independent entrepreneur be dissatisfied with a franchising arrangement? 16. What kinds of clues should tip off a prospective franchisee that he is dealing with a disreputable franchiser? 17. What steps should a potential franchisee take before investing in a franchise? 18. What is the function of the FTC's Trade Regulation Rule? Outline the protection the Trade Regulation Rule gives all prospective franchisees. 19. Describe the current trends in franchising. 20. One franchisee says, "Franchising is helpful because it gives you somebody [the franchiser] to get you going, nurture you, and shove you along a little. But the franchiser won't make you successful. That depends on what you bring to the business, how hard you are prepared to work, and how committed you are to finding the right franchise for you." Do you agree? Explain. Beyond the Classroom... 1. Interview five local small business owners. What form of ownership did each choose? Why? Prepare a brief report summarizing your findings, and explain advantages and disadvantages those owners face because of their choices. 2. Invite entrepreneurs who operate as partners to your classroom. Do they have written partnership agreement? Are their skills complementary? How do they divide responsibility for running their company? How do the handle decision making? What do they do when disputes and disagreements arise? 3. Visit a local franchise operation. Is it a trade-name, product distribution, or pure franchise? To what extent did the franchisee investigate before investing? What assistance does the franchiser provide? How does the franchisee feel about the franchise contract he signed? What would he do differently now?

4. a. Consult a copy of the International Franchise Association publication Franchise Opportunities Handbook (the library should have a copy). Write several franchisers in a particular business category and ask for their franchise packages. Write a report comparing their treatment of the topics covered by the Trade Regulation Rule. b. Analyze the terms of their franchise contracts. What are the major differences? Are some terms more favorable than others? If you were about to invest in the franchise, which terms would you want to change? 5. Ask a focal franchisee to approach his regional franchise representative about leading a class discussion on franchising. 6. Contact the International Franchise Association (1350 New York Avenue, N.W, Suite 900, Washington, D.C., 20005-4709, 202-628-8000) for a copy of Investigate before Investing. Prepare a report outlining what a prospective franchisee should do before buying a franchise. ENTREPRENEURSHIP 1. The form of business ownership that is a legal entity treated as an artificial person by the law is called: a. partnership b. general partnership c. sole proprietorship d. corporation Competency: Business Plan Task: Evaluate the types of business ownership/organization structure and understand the advantages and disadvantages of each. 2. John is reviewing the company's costs and expenses against revenue for the last year. John is reviewing the firm's: a. balance sheet b. sources and uses of funds statement c. income statement d. pro forma Competency: Financial Management Task: Collect and interpret financial data to prepare financial statements such as balance sheet, income statement, cash flow projections, and summary of sales and receipts. 3. A customer who purchases a television from Ace Appliance Store and pays for it in 36 monthly payments is using: a. debit card credit b. charge account credit c. installment credit d. trade credit Competency: Initial capital and credit Task: Identify types of sources of credit and credit terms. 4. Which one of the following best describes venture capitalist companies? a. corporations or partnerships that operate as liquidation groups b. provide investment support to young companies c. provide for the financing needs of large companies only d. no longer operate in the U.S. market Competency: Initial Capital and Credit Task: Identify and maintain records of the initial capital assets (current assets; investments; property, plant, and equipment; and intangible assets).5. Entrepreneurs should know who their customers are for all but one of the following reasons. a. Knowing who your customers are can help you estimate demand for products and services. b. Customers are a business' most important asset. c. Companies cannot remain in business without customers. d. Customers have no influence on product or services offered. Competency: Marketing Management Task: Develop and deliver effective customer relation skills to provide good customer service. 6. The systematic collection and recording of information about jobs in the organization is known as: a. job specification b. job evaluation c. job analysis d. the selection process Competency: Personnel Management Task: Prepare organization chart and job descriptions to expedite workflow. 7. Income tax, Social Security, Medicare, and unemployment tax are called: a. payroll taxes b. property taxes c. sales taxes d. income taxes Competency: Taxes Task: Apply regulations regarding employee/employer taxes 8. In making capital budget decisions, small business owners tend to rely, to a significant extent, on which one of the following? a. informed opinion b. intuition c. economic analysis d. government assessment Competency: Community/Business Relations Task: Examine federal, state, and local current events to determine their impact on the organization.9. What determines the type of economic system a country has? a. the resources of the country b. the political beliefs of the country's ruler c. the way the basic economic questions are answered d. the demands of the people Competency: Government Regulations Task: Understand the role of government in business. 10. The damages the parties to a contract specify in case of breach are called: a. monetary damages b. liquidated damages c. consequential damages d. compensatory damages Competency: Legal Issues Task: Demonstrate

knowledge and apply consumer protection laws.Entrepreneurship Answer Key 1) D 2) C 3) C 4) B 5) D 6) C 7) A 8) B 9) C 10) D Copyright of Future Business Leaders of America Phi Beta Lambda (FBLA-PBL) This document is property of Future Business Leaders of America Phi Beta Lambda (FBLA-PBL) and its contents may not be copied or emailed to multiple sites or posted to a listserve without the copyright holders express written permission. However, users may print, download, or email articles for individual use. A full version of this document can be purchased at http://www.fblamarketplace.com/ under the competitive events section. MUMBAI NEW YORK LONDON TOKYOHOME INDUSTRIAL POLICIES MSME NEWS PROJECT CONSULTANCY NEWSLINE

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PACKAGES JAN 23 HOW TO PREPARE A PROJECT REPORT January 23, 2011 | Leave a Comment When you approach a financial institution for financial assistance for your project, you need to submit a detailed project report along with your loan application. When you approach through a project consultants or a chartered accountant, the project report will be prepared by them who will also get all the documentation completed and will also represent your case. But the consultants charge a hefty fee as percentage of the loan applied for citing various extraneous reasons, you all know. For those entrepreneurs, who are educated and want to save on this avoidable expense, we give here below detailed guidelines on how to prepare a project report. We will also give brief details about various documents which financial institutions normally require you to submit along with the loan application. This will enable you to submit a complete loan application in one go and save time processing time. A detailed project report format along with financial and statistical statements will also be provided on nominal cost on a CD. A project report must contain the following:- INTRODUCTION. Here give brief details about the type of constitution i.e. a sole proprietary firm or partnership firm or limited liability partnership firm or a private limited or a limited company, a co-op society or a trust, under which the project will be operated. Also give details about its incorporation/establishment i.e. a newly established one or already existing. If an existing one, state since when. Details about the promoters/directors/partners and their experience in brief be also given. In case of an existing unit, give a brief account of the present activities of the firm/company, its level of operations and performance. Then state the proposed activity to be undertaken, why the project is being undertaken, level of operations, and steps so far undertaken towards implementation of the project. LOCATION OF THE PROJECT. Give details about the location of the project enlisting locational advantages, like proximity to market or special materials, availability of infrastructural facilities, availability of govt. incentives as reasons for selection of the particular location. PROJECT COST . This is the most important part of the project report because this determines the amount of loan on your project. You should take extra care in estimation of each head of the project cost because any mistake at this stage will mean under or over financing both of which are harmful in implementation of a project. The project cost comprises of the following: (a) LAND charges govt. fees for change of land use, if any. All expenses should be accurately estimated an included in the land cost. A format for giving information about land is . Give detailed particulars of area, location, basic cost of land, expenses on registration of sale deed, development enclosed herein after. (b) BUILDING.A detailed building plan of the proposed building should be got prepared along with an estimate of construction cost from an experienced architect who is conversant with the construction and design of buildings for the type of industry being set up by you, so that you dont miss on some important aspects which may cause problems later on. For arriving at the proposed building cost, dont forget to include the architects fee, cost of water harvesting system and other provisions like cost of installing a tube well or pump, roads and pavements etc. A format for giving details of the proposed building is attached herein after. (c) PLANT AND MACHINERY. You should carefully select the machinery suppliers after verification of their credentials for dealings, product quality, after sale service, prices and above all, suitability for your line of activity. This you can do by comparison with other manufacturers in the line and from their existing clients to check the veracity of claims made by various manufacturers. You should collect quotations from at least three different suppliers for submission to the financial institution. In case of imported machinery choice has to be made more carefully. You should select machinery on the basis of recommendations of their Indian customers, their international reputation. Sometimes we import new technology plants, in such cases their

suitability to indigenously available raw materials on mass production must be checked. Availability of spares must also be ensured. We have seen a number of units failing only such reasons. Financial institutions normally insist on financing at the lowest rates but you can always justify the selection of a supplier with higher quotes giving detailed variation in specifications and quality and particular requirements of your project. Cost of machinery should include basic cost of machines, excise duty, VAT, local taxes if any, freight, installation charges, cost electrical like cables, electric motors panels etc. In case of imported machinery custom duty clearance charges should also be included. In case of acquisition of plants on turn-key basis an agreement for performance must be executed with the supplier/manufacturer putting all the terms and conditions in black and white. Performance warranties/guarantees must be discussed with the manufacturers/suppliers. A format for preparing proposed list/estimated cost of machinery is attached here in after. (d) MISCELLANEOUS FIXED ASSETS. Other assets which are essential for the project must be provided. Assets like Generators, vehicles, lifts, firefighting equipment, air conditioning, and office equipment like computers etc., Weigh Bridge etc. are included in this. An accurate estimate of these assets should be made and included in the project cost. (e) PROVISION FOR CONTINGENCIES. There is considerable time gap between estimation of project cost and actual implementation of the project and it may spread to 1-2 years or more. There can be cost escalations during the implementation period. Therefore a provision to meet this unforeseen escalation in the cost of construction and prices of machinery and other assets need to be made in the project cost. Financial institutions insist on a provision of 10%. However the contingency provision would depend on various other things. In case confirmed orders for machinery have been placed, no provision for contingency need be made against such machinery. (f) PRELIMINARY & PRELIMINARY EXPENSES. A provision for various expenses considered preliminary and preoperative to the project also needs to be made. Expenses like various fees/securities to be deposited with various departments, like electricity deptt. for power connection, sales and excise department for licenses, fees for building plan approval, salary and wages of staff during implementation period, travel and other expenses, processing fee and other expenses of financial institutions, interest on loans for implementation period. Some of these expenses are financed by financial institutions. (g) MARGIN MONEY FOR WORKING CAPITAL . Working capital requirement for the project should be carefully estimated as per norms of banks which will give the extent of bank borrowing that will be available from the bank. Margins retained by banks differ from industry to industry, therefore you should enquire from your bank regarding margin norms before you workout the estimates of working capital. Margin money for working capital will form part of the project cost. A format for estimating working capital is attached hereinafter. 4. MEANS OF FINANCE. We have to show how we propose to finance the proposed project cost as estimated above. Various sources of finance are the following:- (a) Capital/Share capital. (b) Free Reserves(in case of existing units going for expansion projects) (c) Internal Accruals(in case of existing units going in for expansion) (d) Unsecured Loans from friends and relatives(These can be interest bearing or interest free) (e) Term Loans from Banks/Financial Institutions. (f) Capital Subsidy, if any available from the govt. Financing pattern should be selected carefully keeping in view the cost of funds which the project will be able to service. Extent of term loan which can be availed depends on the Debt-Equity Ratio (DER) and Promoters Contribution norms of the financial institution you are approaching. Usually a DER of 1:1 to 3:1 and Promoters contribution of 25% and above is insisted upon. You must ascertain these norms and decide on the financing pattern accordingly. This information is available on the websites of financial institutions. Please keep in mind that institutional term loans and interest bearing unsecured loans

forms DEBT and other means are EQUITY. You should also show the sources of finances to be raised while preparing details of assets and liabilities of the promoters. If part of the cost is to be financed out of free reserves or internal accruals, your financial statements should support that. In case of share capital to be raised give a list of proposed shareholders. In case share capital is to be raised by way of Public issue, complete details of the size of issue, draft prospectus, Time schedule, underwriters to the issue, managers to the issue Brokers, Bankers etc. Issue expenses should be given and provided in the project cost. 5. MANUFACTURING PROCESS. A detailed note on manufacturing process should be prepared which should include the following: - (a) Step wise all stages, from procurement of raw material to the packing of the finished product. (b) Which machinery /equipment will be used at every stage. (c) Process time at each stage. (d) A process-flow chart. 6. PRODUCTION FACTORS AND UTILITIES Give brief note on the following:- (a) SITE. Give locational advantages of the site selected for the project, infrastructural facilities available in the area. If there are any advantages like proximity to target market or source of raw material, it should be highlighted. (b) Availability of Labor. Indicate the type of skilled/semi-skilled labor required for the project and its availability in the area. (c) Power and Fuel. Indicate requirement of power and its availability from State Electricity Corporation/private provider. Arrangement for captive generation like provision of generating set should be mentioned. (d) Water. If water is required for manufacturing process give details of requirement, source, quality of available water and its cost. If a tube well or submersible pump need to be installed it should be mentioned and provision made in the project cost. (e) Disposal of effluents. Arrangements made for disposal of effluents emanating from the unit, if any, should be given and its cost be provided in the project cost. These arrangements should be in accordance with the norms of concerned pollution control authority. Provision needs to be made in the project cost. Approval from pollution control authority to establish and/or to operate, as applicable will have to be obtained. Sometimes certain projects are not permitted in certain areas due to pollution control norms, this aspect should be looked into while selecting the project site. TECHNICAL KNOWHOW. A detailed note on technical knowhow required for the project should be prepared giving details of the person or organization providing it. Terms and condition as agreed between the parties. A copy of the Agreement should also be attached. MARKETING AND DEVELOPMENT SCOPE OF THE PROJECT. A detailed note on the marketing plan and scope for development of the proposed project should be given. Proposed product/product mix and targeted users be mentioned. Authentic data from reliable sources on demand supply position should be used. Marketing survey, if any, done by the company itself can be given. In case of an existing company, present marketing network, list of customers or dealer net work can be discussed. Special marketing tie-up, if any, like OEM status, should be highlighted. 8. IMPLEMENTATION SCHEDULE. Time schedule for implementation of the project should bediscussed giving estimated time for completion of each stage as under: (a) Purchase of land and site development (b) Completion of building. (c) Purchase of Plant & Machinery and Installation. (d) Trial Production. (e) Commercial Production. FINANCIALS OF THE PROJECT.

Financial viability of the project is most important for the entrepreneur as well as the lending institution. This is to be projected through a number of financial statements. Most lending institutions ask for the following statements. a) Statement of working capital requirement. b) Statement of production sales and annual profitability. c) Statement of Break-even point d) Statement of Debt Service Coverage Ratio. e) Statement of Internal Rate of Return. f) Statement of sensitivity Analysis. g) Statement of Sources and Uses of fund. h) Projected Balance-sheet. These statements are prepared with projections for 5-10 years depending upon the proposed term of finance. For preparation of these statements the following supporting statements are also required to be made . a) Statement of installed capacity calculation and proposed utilization . b) Statement of Raw materials/consumables requirements. c) Statement of sales and production/product mix. d) Statement of salaries and wages-Direct & Indirect. e) Statement of interest on term loan/working capital loan/interest bearing deposits. f) Statement of Depreciation. 10. FINANCIAL RATIOS. A number of financial ratios are required to be calculated which are indicators of viability and other economic aspects of the project. Some of these ratios will be available from the above statements while others are required to be calculated from other data of the project. Ratios relevant for a project are as under: a) Debt Equity Ratio. b) Promoters Contribution (%). c) Break-Even Point. d) Debt Service Coverage Ratio. e) Internal Rate of return. f) Turn-over/Investment Ratio. g) Investment per Worker. h) Return on Capital Investment . 11. GOVT. APPROVALS. For setting up a project you need to obtain a number of Approvals/No Objection certificates from Govt. Authorities, few of which are indicated here-under: a) Approval of change of Land use/NOC from the Town and Country Planning deptt. of the State. b) Approval of Building Plan. c) Approval to establish/operate unit from the Pollution Control Authority. Clearance from the environment ministry for bigger projects. d) License/Permit required for certain industries e.g. for petro chemicals inds./explosives/Drugs Authority, We are a team of professionals from leading financial institutions keen to share their Knowledge andExperience with entrepreneurs. Guidelines for Prospective Entrepreneur General Information

Financial Assistance Project Report Training Marketing Promotional Schemes General Information What can be done for self-employment? A micro or small or medium enterprise can easily be set up for self-employment. You can choose an activity depending upon your interest and suitability not only to become self-employed but also to generate employment for others. What is a Micro, Small or Medium Enterprise? The earlier concept of Industries has been changed to Enterprises Enterprises have been classified broadly into: (i) Enterprises engaged in the Manufacture / production of Goods pertaining to any industry; & (ii) Enterprises engaged in providing / Rendering of services. Manufacturing enterprises have been defined in terms of investment in plant and machinery (excluding land & buildings) and further classified into : - Micro Enterprises - investment up to Rs.25 lakh. - Small Enterprises - investment above Rs.25 lakh& up to Rs. 5 crore - Medium Enterprises - investment above Rs. 5 crore& up to Rs.10 crore. Service enterprises have been defined in terms of their investment in equipment (excluding land & buildings) and further classified into: - Micro Enterprises investment up to Rs.10 lakh. - Small Enterprises investment above Rs.10 lakh & up to Rs.2 crore. - Medium Enterprisesinvestment above Rs. 2 crore & up to Rs. 5 crore It is not necessary to engage in manufacturing activity for self-employment. One can set up service enterprises as well . How do I select an activity for self-employment? For selecting an activity or enterprise, you will have to consider the following significant issues: Where do you want to promote the enterprise? What resources are available near the location of the enterprise? What kind of market or consumer pattern exists near the site of enterprise? What kind of contacts you have to exploit to your advantage for marketing of the product? What infrastructure is available at the location of your enterprise? How much capital is available? There are many other considerations including availability of skilled manpower, raw material, technology etc. before you narrow down your choice for selection of industry or activity. Who will assist in identifying the activity? MSME Development Institutes can assist you in identifying the activity based on the Industrial Potential Survey and product specific market studies. District Industries Centers/State Directorate of Industries also facilitate in identification of a suitable activity. What steps are required for identifying the activity?

A preliminary market study of product(s) or service(s) needs to be undertaken to analyse consumption and availability pattern. If there is a gap in demand and supply, the activity considered ideal for selection. Where is market information available? Market information is available with MSME Development Institutes (MSMEDIs) and DIC's of respective states/areas. Market Survey reports on various items and Industrial potential surveys of particular areas provide the information about the market potential of items. Industry and Trade associations, specialized institutions like PPDC can also provide such information. How can market potential be ascertained? Market potential can be ascertained by conducting preliminary study by prospective entrepreneur to get an in sight of the product/ services to be setup. An entrepreneur can estimate local demand, demand within the state or country, export market and future prospects of product(s)/service(s). Visit to wholesale and retail markets, bulk consumers etc. provides accurate information on market potential. Is there any agency providing guidance on marketing potential? MSMEDI and State Governments agencies viz. DICs and SIDCs provide guidance on market potential. The gap in demand & supply can be established through potential surveys and market assessments with the help of these agencies. Where can the enterprise be set up? The enterprise can be set up in a designated industrial areas, where infrastructure facilities are available and is near to the market identified. It can also be set up in any other area depending upon nature of activity and local municipal rules. What are the inputs required for setting up an enterprise? The following major inputs are required for setting up an enterprise: Land, building or shed Machinery and equipments Raw Materials Power and Water Skilled manpower Capital Are there any projects suitable for non-technical and inexperienced entrepreneurs?

There are many projects, which are suitable for non-technical and inexperienced entrepreneurs. Skilled manpower and technical personnel can be hired according to needs. Entrepreneurs can also join special short term training programmes. MSMEDI's, DIC's, NSIC etc. provide intensive consultancy to such first generation entrepreneurs. How can a new entrepreneur compete with the existing manufacturers? A prospective entrepreneur can take the advantage of opting for the latest technology and production process and operate at higher volume of operation. This leads to reduced production cost and production of quality goods and services. A new entrepreneur can thus provide improved quality goods and services at lower cost and further tap the market with innovative marketing approach. Financial Assistance Which are the agencies providing financial assistance? Financial assistance is available from institutions such as Nationalised Banks, Small Industries Development Bank of India, Regional Rural Banks, National Small Industries Corporation, State Financial Corporations etc. depending upon the project requirement and promoters background.

Financial assistance has two components. Loan for fixed capital is used to acquire Plant and Machinery, land and building. Working capital loan is used to meet day to day operational cost of the production. State Financial Corporation and National Small Industries Corporation generally provide working capital. However under a package assistance, State Financial Corporations also provide a composite loan covering plant and machinery and working capital. How to choose the most suitable source of funding? Any of the financial institutions can be approached to get funds keeping in view their specific schemes. Evaluate and compare the terms and conditions, including rate of interest and repayment period of loan offered by the different financial institutions. Select the financial institution, which offers funds at minimum interest rate as per your repayment plan to suit your project. Choose the Institution which is in close proximity to the project site if other terms and conditions are similar. What are the eligibility criteria for getting a loan? The major eligibility criteria is return on the investment and profitability of the project proposed to be set up. Any financial institution will support the project if repayment is assured. How much money the entrepreneur is required to invest out of his own resources? Some portion of total investment has to be contributed by the Entrepreneur out of own sources. This is called margin money. Financial Institutions insist on 10 to 25 per cent margin money depending upon the category of the entrepreneur, risk factor and existing scheme under which the project will be financed What to do if an entrepreneur does not have any money of his own? It is simple. One can arrange for loan for margin money under the scheme being operated by the State Commissioner/Directorate of Industries or State Bank of India. But this scheme is generally offered to professionally qualified entrepreneurs. Alternately you may have to prune down the size of your project in tune with available margin money. The financial institutions will prefer to support an entrepreneur, who is willing to put his/her own stake to some extent. What is the procedure for getting a loan? An entrepreneur should approach the concerned financial institution viz. State Financial Corporation, NSIC, Bank branches etc. Application in prescribed proformae has to be submitted along with project report including proof of ownership/availability of land/building, proof of residence, collateral securities (wherever applicable) etc. The loan is given by the institution if the application meets the norms. Can the loan be used to cover all types of investment in the project? The amount of loan can be used to cover all types of investment required in the project, such as machinery & equipment, and working capital, land and building. The lending agency for each component of loan may be same or different. Is there any agency for funding the land and building costs? The Banks and State Financial Corporations offer assistance for land/building/shed to certain extent. However, some qualifying parameters have been laid down by these institutions. In addition, Housing Development Corporation also provides funds for land /building. What are the general conditions for availing financial assistance?

The general conditions for getting financial assistance are: Eligibility criteria Technical /Economic viability Promoters contribution Capacity to repay loan Collateral securities/guarantee Is loan available from any other source for small projects? Loan is also offered under some special schemes like P.M.R.Y. which are directed towards creation of self-employment. Project Report What is a project report? The project report is a document, which gives an account of the project proposal to ascertain the prospects of the proposed plan/activity. The project report contains detailed information about: Land & building required Manufacturing Capacity per annum Manufacturing Process Machinery & equipment along with their prices and specifications Requirements of raw materials Power & Water required. Manpower needs Marketing Cost of the project and production. Financial analyses & economic viability of the project. How is a Project Report Prepared? A project report is prepared with the help of prescribed guidelines available with MSMEDI's, DIC's & financial institutions. Information about prices of machinery & equipment, raw material and other various inputs required for setting up an enterprise need to be collected from the market. Is there any standard model for preparing the project report? A model proforma for preparing the project report is available with MSMEDI's, DIC's & financial institutions. Every institution has its own model proforma. However contents of all the proforma are almost similar. Is a model project report available? Yes, Model project profiles are available with the MSMEDIs(formerly Small Industries Service Institute's) & DIC's for the guidance of entrepreneurs.. However, these project profiles have to be recast in accordance with specific needs of the entrepreneurs and the current prices of inputs. Which agency assists in preparation of Project Report? MSMEDIs, NSIC and State Govt. agencies viz. DICs, SFCs can help you in preparing the Project Report. You can also prepare the Project Report yourself by collecting detailed information on various points. What details are required for preparation of Project Report? Information in detail is required about the technical process, requirements of plant and machinery, raw materials, manpower requirement, market information and statutory representations (like pollution control and public safety) etc. The details of power and water tariff, land/shed/building and selling prices etc. needs to be collected as prevalent in the market. Which agencies can be approached for obtaining information for preparation of the Project Report? Entrepreneur can approach MSMEDIs and state Govt. agencies viz. Directorate of Industries, SFCs, DICs and market channels for getting information. Who can help in selecting production process, equipment etc? Micro, Small & Medium Enterprises Development Institutes (formerly Small Industries Service Institutes), Design and Development Centers like MSME Technology Development Centers (formerly PPDC's) /Tool Room's, Research and Developmental agencies such as NRDC's and Regional Research Laboratories can help you in selecting the right production process, suitable equipment's etc Training What basic training is required for setting up an enterprise? Basic

training differs from product to product but will necessary involve sharpening of entrepreneurial skills. Need based technical training is provided by the Govt. & State Govt. technical Institutions. What are the other types of training relevant for a new entrepreneur? One can acquire entrepreneurial skills by under going Entrepreneurial Development Programme and Management Development programme. What is the duration of such courses? These are short-term courses of 2 week's to 4 week's duration. Which are the agencies providing such training? There are a number of Government organisations as well as NGOs who conduct EDPs and MDPs. These EDPs and MDPs and are conducted by MSME's, NIESBUD, NSIC, IIE, NISIET, Entrepreneurship Development Institutes and other state government developmental agencies. Is different type of training available for different categories of entrepreneurs? Need based training courses are available for different categories of entrepreneurs. For example, Central Footwear Training Institute's provide training for footwear. Tool Room and Tool Design Institutes provide training in Engineering Industry. Likewise other technical training is provided by various institutions of centre and state govt. Are there any preferential criteria for imparting training? An entrepreneur desirous of setting up of enterprises or his representative is preferred for attending these training programmes which are offered on a nominal fee. However, there is no fee charged for imparting training for the entrepreneurs of NE region. Moreover, preference is accorded to weaker sections such as SC/ST, Women, Ex-servicemen. and Physically handicapped persons. Are there any short terms courses available? Short term technical training courses are conducted by SISIs and other technical institutions, which vary from 3 to 6 months of duration depending on nature of training. In addition, short-term training programmes for managers & supervisors are also conducted by MSME's to upgrade their knowledge and skills. Does any agency give on the spot training for installation and commissioning of equipment? Normally the suppliers of machinery & equipment provide on the spot training as well as facilities on the spot for installation and commissioning of equipment. However, SISIs also assist the entrepreneurs for installation and commissioning of machinery equipment at their premises. Is there any agency providing training for skill upgradation? Skill development/upgradation courses are offered by SISIs, NSIC, PPDCs etc. in different disciplines to skilled workers engaged in the micro, small and medium enterprises with a view to equip them with better and improved technologies of production. Which are the organisations providing training to improve management of an enterprise? SISIs, Management Development Institute's, NPC, NSIC etc. offer Management Development Programmes for acquiring knowledge about the different aspects of the management required for an operation of industry. Short-term courses of two to four weeks are available on Production Management, Marketing Management, Financial Management, Export Management, Export Procedure & Documentation, Packaging for Exports, Cost Reduction, Material Management etc. Are there institutions providing consultancy for development or setting up of project? SISIs, DICs and State industrial development corporations can provide consultancy for development or setting up of project. Suitable technologies are also offered by CSIR Laboratories, PPDC's, NRDCs, R&D institutions also offer consultancy at nominal charges. What kind of consultancy is offered by these agencies? The consultancy provided by these institutions includes identification of suitable product, market, technologies, Raw Materials, production method, regulatory requirement etc. In fact any problem can be addressed by these institutions for setting up or running of the enterprise. Which agencies provide information on plant and machinery, raw materials and other equipments? SISIs, DIC, CSIR Laboratories, PPDC's, NRDC, R&D institutions etc. provide information on plant and machinery, raw materials and other equipments. How does one tackle pollution control needs of the project? In case your product is covered under the list of the polluting industries as defined by the state government, it will be necessary to get specific clearance from the state Pollution Control Board/Committees. Pollution control equipments/measures will have to be installed by the enterprise as per need. Such polluting enterprises can only be set up in the

designated industrial areas or locations and may have to link up with the common affluent treatment facility, if available in the area. Which institutions provide details of pollution control requirements? Pollution control board/ Committees and State Directorate of industries provide details of pollution control requirements. SISIs, and DICs also help in understanding of pollution needs. Does any agency provide training in pollution control? MSME's provide training in pollution control for different type of industries as per their local needs. Pollution Control Boards & Ministry of Environment also support training efforts. Marketing How does a new entrepreneur market the product? This is an era of globalization and liberalization. The manufacturers have to offer goods and services of desired quality at optimum cost. Select the right market/consumers identified at the time of planning the unit. Establish Direct marketing channels or a network of dealers as per requirement of the product based upon initial survey. Highlight strengths of the product. How does one popularise the new product? You may create awareness among the buyers or consumers about your product's strong points in order to convince them of the utility of the product. Publicity in various available forms has to be arranged within the budgetary constraints. Sell your quality, to gain consumer's confidence. Review consumer feed back. Resort to live demonstration. MSME /NSIC help in popularising the product through domestic and international trade fairs/exhibitions. Are there any specialized agencies which offer marketing assistance? There are Governmental and non-governmental specialised agencies which provide marketing assistance. NSIC & KVIC are the devoted govt. agencies for providing marketing assistance to MSME units. Is there any other assistance offered by NSIC for marketing MSME Product? Besides promotion of MSME products through exhibitions, NSIC directly market the MSME produce in the domestic and overseas market. NSIC also manages a single point registration scheme for manufacturers for Govt. purchase. Units registered under this scheme get the benefits of free tender documents and exemption from earnest money deposit and performance guarantee. Does any agency help in exhibition of the product? MSME & NSIC help the micro, small and medium enterprises for exhibiting products of MSME in the domestic and international exhibition. Does any agency help in promoting exports? ITPO, DGFT, FIEO & Chambers of commerce in different countries Ministry of Commerce provide assistance in promoting exports. Office of the Development Commissioner (MSME), Government of India provides financial assistance to micro, small and medium scale entrepreneurs to display their products in overseas fairs and also for sales-cum-study tours abroad. Are there any special benefits for exports? MSME units gets special benefits such as duty draw back, advance licensing for import of capital goods and raw materials, pre- shipment and post shipment credit against firm export orders and marketing development assistance. Income tax benefit is available on exports earning. Promotional Schemes What is the policy of Government for promoting a micro, small and medium enterprises ? Government accords the highest preference to development of MSME by framing and implementing suitable policies and promotional schemes. Besides providing developed land and sheds to the entrepreneurs on actual cost basis with appropriate infrastructure, special schemes have been designed for specific purposes like quality upgradation, common facilities, entrepreneurship development and consultancy services at nominal charges. What is the incentive provided for quality upgradation ? Government of India has been executing the incentive scheme for providing reimbursement of charges for acquiring ISO 9000 certification to the extent of 75% of the cost subject to a maximum of Rs. 75,000/- in each case. ISO 9000 is a mechanism to facilitate adoption of consistent management practices and production technique as decided by the entrepreneur himself. This facilitates achievement of desired level of quality while keeping check on production process and management of the enterprise. Is there any concession on Excise Duty payable by small units ? MSME units with a turnover of Rs. 1 crore or less per year have been exempted from payment of Excise Duty. Moreover there is a general scheme of excise exemption for MSME brought out by the Ministry of Finance which covers most of the items. Under this, units having turnover of less

than Rs. 3 crores are eligible for concessional rate of Excise Duty. Moreover, there is an exemption from Excise Duty for MSME units producing branded goods in rural areas. Is priority there any on providing credit to MSME ? Credit to micro, small and medium scale sector has been covered under priority sector lending by banks. Small Industries Development Bank of India (SIDBI) has been established as the apex institution for financing the MSME. Specific schemes have been designed for implementation through SIDBI, SFCs, Scheduled Banks, SIDCs and NSIC etc. Loans upto Rs. 5 lakhs are made available by the banks without insisting on collaterals. Further Credit Guarantee Fund for micro, small and medium enterprises has been set up to provide guarantee for loans to MSME up to Rs. 25 lakhs extended by Commercial Banks and some Regional Rural Bank. What are the policies and schemes for promotion of MSME being implemented by State Governments? All the State Governments provide technical and other support services to small units through their Directorates of Industries, and District Industries Centres. Although the details of the scheme vary from state to state, the following are the common areas of support. Development and management of industrial estates Suspension/deferment of Sales Tax Power subsidies Capital investment subsidies for new units set up in a particular district Seed Capital/Margin Money Assistance Scheme Priority in allotment of power connection, water connection. Consultancy and technical support If I perform well, will my efforts be recognized ? Yes, Government of India runs a scheme for giving National Awards to micro, small and medium scale entrepreneurs providing quality products in 11 selected industry groups of consumer interest. The winners are given trophy, certificate and a cash price of Rs. 25000/- each.