Corporations and Franchising CHAPTER TWENTY-SEVEN

Corporations and Franchising

CHAPTERTWENTY-SEVEN

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Nature of a Corporation

• A corporation is an artificial legal entity created by permission of the state or federal government. – A corporation is an entity that is separate and distinct

from its owners. – A corporation does business in its own name and may

do the following in its own name:• Buy and sell property• Sue and be sued• Borrow money


Corporations

• A profit corporation is organized to make money. – Professional corporation: one which is organized to

operate a professional practice. • Directors and stockholders must be licensed to practice the

profession for which the corporation is created.

– Closed corporation: one in which stock is held by a few people, often members of the same family.

– Private corporation:• Some private corporations are operated under federal tax

law as S Corporations, which means the owners are taxed as partners in a partnership.


Forming a Corporation

• The people forming a corporation (incorporators) must create articles of incorporation or charter and file the documents with the appropriate government office to apply for incorporation. – Generally the articles of incorporation include the

following:• The law requires that the corporation name include the word

corporation or some abbreviation, to let the public know with whom it is dealing.

• Additionally, to avoid confusion, the name must not be similar to an existing name, nor can the name mislead the public by appearing to indicate the organization has some special government status.


Forming a Corporation (continued)

– Generally, the articles of incorporation also include the following:

• Purpose of the corporation• Corporation’s term of existence• Location of principal business office• Names and addresses of the incorporators• A description of the capital makeup: a statement of number

of shares and types of stock the corporation is authorized to issue.

– Shares of stock are the means to evidence ownership in the corporation.


Forming a Corporation (continued)

• Two additional steps are required to form a corporation:– Obtain tax identification numbers from the Internal

Revenue Service and, where required, the state taxing authority.

– Prepare the corporate bylaws. • Bylaws are the rules for managing the internal affairs of the

corporation. • Bylaws lay out the duties and powers of the corporate

officers and time and place of corporate meetings (board meetings, shareholder meetings etc.).


Ownership of a Corporation

• A corporation is owned by its stockholders.• Ownership is evidenced by a stock certificate showing

ownership of preferred or common stock. – Preferred stock has a first claim to dividends and also a prior

claim to assets before common shareholders if the corporation is dissolved.

– Common stock is the ordinary stock of a corporation and gives the owner the right to vote at stockholders’ meetings and to share in the profits of the corporation.

• Common shareholders have the lowest priority when it comes to a claim on earnings or to the distribution of assets in a dissolution.


Rights of Stockholders

• Stockholders have the right to vote on all matters requiring stockholder approval.– This includes the right to elect the directors of the

corporation. – Votes are usually conducted at a stockholders’

meeting. • Those who cannot attend a stockholders’ meeting can select a

proxy to cast their vote on their behalf. • Most voting is done on a one-vote-per-share basis. • Sometimes cumulative voting is permitted, in which

stockholders may cast a number of votes equal to the number of shares owned times the number of directors to be elected. All of these votes can be cast for one or multiple directors.


Rights of Stockholders (continued)

• Stockholders have the right to share in profits of the corporation, proportional to their ownership of shares.

• Stockholders have the right to to inspect the books and records of the corporation and to copy them, provided the purpose is reasonable.

• Unless modified by the articles of incorporation, a stockholder has a preemptive right. – This means a stockholder may purchase shares to maintain his

or her proportional interest in the ownership of the corporation when new shares are issued.


Liabilities of Stockholders

• One of the major attractions of the corporate form of ownership is the limited liability of the shareholders.– Generally, the liability of the shareholders is limited to

the amount they have invested in the purchase of the corporation’s shares.

– In limited situations, creditors may be able to pierce the corporate veil and pursue the individual shareholders.


Financing a Corporation

• A common form of debt financing for a corporation is a bond.

• There are many different types of bonds, including:– Mortgage and equipment bonds: bonds whose payback to

creditors is secured by specific property– Debenture bonds: bonds that are unsecured, and collection by

creditors is ensured only by the general assets of the corporation.

– Convertible bonds: bonds that may be converted into common stock of the corporation.

– Callable bonds: bonds the corporation can redeem and pay off

at a set price.


Managing a Corporation

• Stockholders: – Elect and remove directors – Vote on basic changes such as:

• Amending bylaws (rules which the corporation must follow in managing its affairs)

• Terminating the corporation

• Merging, consolidating, or selling a significant portion of the corporation’s assets

• Directors:– Set the policy and direction for the corporation– Select the officers of the corporation


Managing a Corporation (continued)

• Officers: run the corporation’s affairs on a day-to-day basis. – Officers are employees of the corporation.– Officers manage the corporation and are accountable

to the directors and stockholders of the corporation. – Officers hire other corporation employees who handle

the details of the corporation’s business.


Corporate Powers

• The powers for a corporation are set out in the corporate charter, corporate bylaws, or state corporation statutes.

• The most important corporate powers are:– To have a name and corporate seal– To enjoy perpetual existence– To sue and be sued in the corporation’s own name To acquire

and dispose of real property– To borrow money for any corporate purpose


Powers, Duties, and Liabilities of Directors

• Powers of directors:– Set corporate policy and direction– Elect the officers

• Duties of directors:– Oversee management of the corporation– Act in the best interest of the corporation

• Liability of directors: – Directors are liable if negligent in carrying out their

duty to oversee management of the corporation.– Directors are liable for improper use of corporate

funds.


Terminating a Corporation

• Corporate existence terminates:– When the term stated in the articles of

incorporation ends.• Generally, a corporation is formed with a perpetual

existence. • Some charters, however, provide for a term of corporate

life such as 50 years.

– When the corporate charter is revoked by the state.

• Often done for failure to pay corporate taxes or continuous violations of state statutes regulating corporations.


Terminating a Corporation (continued)

• Corporate existence terminates: (continued)– When there is a consolidation or merger– When the shareholders agree to terminate the

corporate existence


Consolidations and Mergers

• Consolidation: two or more corporations join together to form a new corporation.

–The old corporations dissolve, with the assets and liabilities of each being assumed by the new.

• Merger: one corporation buys another corporation.

–The purchasing corporation remains in existence, assuming all the assets and liabilities of the corporation acquired.


Purchase of Assets

• Some corporate acquisitions are accomplished by purchasing assets. – The acquiring corporation does not need shareholder

approval for this transaction. • The selling corporation must obtain approval of its

stockholders.

– Generally, the acquiring corporation does not assume the liabilities of the corporation whose assets are purchased.

– This method does require that the assets acquired be valued at fair market value, which can be time consuming and expensive.


Purchase of Stock

• A corporation may purchase enough stock of another corporation to achieve a controlling interest.

• Advantage:– Ease of valuation: the purchase price is the value of the stock

and not the individual assets. • The purchase may be paid for in cash or shares of the acquiring

corporation, or a combination of both.

• Disadvantages:– The acquiring corporation must receive stockholder approval for

such an acquisition.– Also, the acquiring corporation must assume the debts and

liabilities of the acquired corporation.


Advantages and Disadvantages of Corporations

• Advantages:– Ability to continue through changes in ownership

(unlike a sole proprietorship or partnership) – Ease of transferring ownership– Centralized management– Limited liability of shareholders– Availability of many fringe benefits including tax

savings devices such as pension and profit sharing plans.


Advantages and Disadvantages of Corporations (continued)

• Disadvantages:– Expensive and complicated to organize– Extensive government regulation

• Government regulation of corporate activities includes filing various regular reports on corporate activity

• Government regulation on the issuance of stock and payment of dividends


Franchising

• Franchisor: the person who grants the franchise– Gives the right to the franchisee to use the

franchisor’s name, trademark, and logo – Gives the franchisee know-how, assistance, and

training to operate the business

• Franchisee: the person receiving the franchise right– Pays initial franchise fee and additional fees,

usually based on sales– Often required to purchase inventory and

equipment from the franchisor


Franchising (continued)

• A franchise is essentially a contract relationship. – The contract spells out the terms of the franchise

arrangement including: • The term of the franchise• The monthly or annual franchise fee• The territory in which the franchise will operate



• Two basic types of franchises– Product franchising where the franchisee sells the

product manufactured or distributed by the franchisor.– Business plan franchising where a service or

business plan is the primary element of the contract. • Most fast food restaurants are examples of the business plan

method of franchising.



• Major abuses of the franchising system:– Some franchisors fail to disclose to the franchisee all

the risks associated with the business. – Franchisees often don’t make provisions for the

improper termination or default of a franchisor.• Franchisee can be left burdened with a large capital

investment and no franchise.

– Some franchise agreements don’t mention territory and thus the franchisee can find franchised competition operating fairly close to their business.

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Corporations and Franchising CHAPTER TWENTY-SEVEN