This Document Contains Chapters 5 to 6 Chapter 5 Forms of Business Ownership 1) The key to choosing the right form of ownership is: A) envisioning where your business will be in 10 years. B) understanding the characteristics of each form and knowing how they affect your business and personal circumstances. C) forming either an S corporation or a limited liability company since they are the only forms that offer owners liability protection. D) irrelevant since choosing a form of ownership is merely a technicality and has little impact on the business and its owner(s). Answer: B 2) Which of the following issues would influence an entrepreneur's choice of a form of business ownership? A) Tax considerations B) Management succession plans C) Liability exposure D) All of the above Answer: D 3) The most common form of business ownership that is also the simplest to create is the: A) sole proprietorship. B) partnership. C) corporation. D) S corporation. Answer: A 4) Marco is opening a new computer repair shop. He is owner and sole employee. He has paid the appropriate fees and licensing costs and begun his business. This is an example of a(n): A) S corporation. B) partnership. C) corporation. D) sole proprietorship. Answer: D 5) The most critical disadvantage of the sole proprietorship is: A) the owner's unlimited personal liability. B) limited access to capital. C) lack of continuity. D) limited skills and abilities of the owner. Answer: A 6) Which form of ownership generally has the least ability to accumulate capital? A) Partnership B) Sole proprietorship C) Corporation D) S corporation Answer: B 7) A partnership agreement defines how the partners will be compensated. Normally, A) partners are not entitled to salaries or wages, but are compensated by a share of the profits of the business. B) the general partner's salary is set at two times the salaries of the limited partners. C) both general and limited partners are permitted salaries, but all silent or dormant partners are compensated only by sharing in the profits. D) while the agreement establishes payout schedules, it does not spell out what constitutes profit. Answer: A 8) Probably the most important reason to have a partnership agreement is that: A) it identifies the name of the partnership and protects that name from infringement by others. B) it states the location and the purpose of the business. C) it determines how the partnership and the partners will pay taxes. D) it resolves potential sources of conflict that, if not addressed in advance, could later result in partnership battles and dissolution of an otherwise successful business. Answer: D 9) Which of the following issues would a typical partnership agreement address? A) The contributions of each partner to the business B) How the partnership profits (or losses) will be distributed C) How a partner can sell her ownership in the business D) All of the above Answer: D 10) All of the following are advantages of a partnership except: A) partnerships are relatively easy and inexpensive to establish. B) partnerships avoid double taxation since the partnership itself is not subject to federal taxation. C) partnerships have the greatest ability to accumulate capital of all of the forms of ownership. D) partnerships offer the ability to combine the management and business skills of two or more people in a complementary and powerful fashion. Answer: C 11) In a partnership, the ________ partner(s) has (have) unlimited liability for the partnership's debts. A) limited B) dormant C) nominal D) general Answer: D 12) In a general partnership: A) each partner is held responsible for an agreement/decision made by any one of the partners. B) partners can be held responsible only for decisions they make personally. C) no partner can be held legally responsible for decisions since the partnership itself is a legal entity. D) no decision is binding unless all partners agree to it in writing. Answer: A 13) Which of the following is required to form a partnership? A) A general partner B) A limited partner C) A secret partner D) A silent partner Answer: A 14) A special type of limited partnership in which all partners who, in many states must be considered to be professionals, are limited partners. A) Limited liability partnership (LLP) B) Master limited partnership (MLP) C) General partnership D) Limited partnership Answer: A 15) Which of the following is not true of a limited liability partnership? A) All partners are limited partners. B) Most states restrict this form of ownership to certain types of professions such as attorneys, physicians, dentists, accountants, etc. C) Although LLPs have many of the characteristics of partnerships, they are taxed as a corporation. D) It must involve a general partner, a limited partner, a silent partner, and a dormant partner. Answer: C 16) A ________ partner is a person who makes financial investments in a partnership, does not take an active role in managing the business, and whose liability for the partnerships' debts is limited to the amount they have invested. A) limited B) master C) dormant D) silent Answer: A 17) A ________ partnership is composed of at least one general partner and at lease one limited partner. A) general B) limited C) silent D) passive Answer: B 18) Acme Corporation is chartered in Delaware, but its primary area of operation is in South Carolina. In South Carolina, Acme would be considered a(n) ________ corporation. A) alien B) domestic C) foreign D) local Answer: C 19) A special type of partnership in which all partners, who in many states must be professionals, are limited partners is called: A) general partnership B) limited partnership C) silent partnership D) limited liability partnership. Answer: D 20) The "Das Spelunker" corporation, formed in Germany and conducting business in the U.S., is considered to be a(n) ________ corporation. A) alien B) domestic C) foreign D) distant Answer: A 21) Which of the following is true regarding the corporate form of ownership? A) Generally has the greatest ability to accumulate capital B) Most complex form of ownership C) Separate legal entity in the eyes of the law D) All of the above Answer: D 22) A corporation receives its charter from: A) the federal government. B) the state. C) the board of directors. D) the stockholders. Answer: B 23) Which of the following generally is not required by a Certificate of Incorporation? A) The names and the addresses of the incorporators B) A statement of the corporation's purpose C) A statement of how stock proceeds will be used D) The corporation's bylaws Answer: C 24) Which of the following statement(s) is/are true? A) Closely held corporations are owned by only a few shareholders, often family members. B) Most closely held corporations require shareholders interested in selling their stock to offer it first to the corporation. This is known as the right of first refusal. C) Shares of stock the corporation itself owns are called treasury stock. D) All of the above Answer: D 25) Which of the following is not an advantage of the corporate form of ownership? A) Limited liability for the owners B) It is the easiest and least expensive form of ownership to create. C) Easy transfer of ownership D) Perpetual life Answer: B 26) Which of the following is a disadvantage of the corporation form of ownership? A) An inability to accumulate capital B) The unlimited liability to the members of the board C) Double taxation on profits D) The lack of continuity Answer: C 27) In the ________ form of ownership, the business itself pays income taxes. A) proprietorship B) partnership C) corporation D) All of the above Answer: C 28) Carlos founded the "Taco Factory" 20 years ago as a family-oriented restaurant. Over the years as they grew the business, he incorporated and sold stock to outside investors. Recently the stockholders voted to seek liquor licenses and to sell beer and hard liquor in the restaurants. Carlos opposed this, citing the history of the restaurant's "family" environment, but was voted down. Carlos has experienced which drawback of the corporate form of ownership? A) The inability to accumulate capital B) The potential for diminished managerial incentives C) Legal requirements and red tape D) The potential loss of control Answer: D 29) A disadvantage of the corporate form of ownership is when profits are taxed at the corporate rate and at the individual rate and this is referred to as: A) double taxation. B) limited liability. C) double liability. D) single taxation. Answer: A 30) An S corporation form of ownership overcomes which disadvantage of the regular or C corporation form of ownership? A) The double taxation issue B) The expense and difficulty of formation C) The amount of regulation and red tape involved in its operation D) The potential loss of control by the founder Answer: A 31) Which of the following would be most likely to benefit from choosing S corporation status? A) Startup companies anticipating net losses B) Corporations where net profits before any compensation to shareholders is less than $100,000 per year C) Highly profitable firms with substantial dividends to pay out to shareholders D) A and C only Answer: D 32) Which of the following statements is not true regarding the liquidation of an S corporation? A) The owners pay all taxes, debts, and creditors. B) The owners obtain the written approval of shareholders to dissolve the company. C) The owners file a statement of intent to dissolve with the secretary of state's office in each state where they conduct business. D) The owners distribute all assets of the corporation to the shareholders. Answer: C 33) A limited liability company: A) is similar to an S corporation in that it is a cross between a partnership and a corporation. B) prevents owners who want to maintain their limited liability status from actively managing the company. C) can have a maximum of 50 owners. D) All of the above Answer: A 34) A limited liability company is most like a(n): A) general partnership. B) master partnership. C) sole proprietorship. D) S corporation. Answer: D 35) Which of the following documents must an entrepreneur file to create a limited liability company? A) The articles of organization B) The articles of incorporation C) The operating agreement D) A and C only Answer: D 36) Which of the following is not true regarding the limitations of professional corporations? A) Seventy-five percent of the shares of stock must be owned and held by individuals licensed in the profession of the corporation. B) At least one of the incorporators, one director, and one officer must be licensed in the profession. C) The Articles of Incorporation, in addition to all other requirements, must designate the professional services to be provided by the corporation. D) The professional corporation must obtain from the appropriate licensing board a certification that declares the shares of stock are owned by individuals who are duly licensed in the profession. Answer: A 37) A joint venture is different from a partnership in that the joint venture: A) can be formed only by two individuals. B) is formed for a specific purpose. C) continues indefinitely. D) requires that profits be shared equally. Answer: A 38) Income from a joint venture is taxed as the income from a(n): A) sole proprietorship. B) partnership. C) corporation. D) S corporation. Answer: B 39) Changing from one form of ownership to another once a business is up and running can be difficult, expensive, and complicated. Answer: True 40) Some forms of ownership are much more costly and involved to create. Answer: True 41) Entrepreneurs should not spend much time selecting a form of ownership for their businesses because making the choice is merely a technicality, which has little impact on the business and its owner(s). Answer: False 42) The sole proprietorship is the best form of ownership for entrepreneurs launching their first businesses. Answer: False 43) Of all U.S. business firms, sole proprietorships are the most common, accounting for approximately 71 percent of businesses. Answer: True 44) The sole proprietorship is the easiest form of ownership to create, but once formed, it is subject to the greatest number of regulations. Answer: False 45) All the profits of a sole proprietorship are taxed as current income of the owner even if they are not withdrawn from the business. Answer: True 46) If a sole proprietorship fails, the owner is not liable for its debts since the business is a separate legal entity. Answer: False 47) In a sole proprietorship, the owner has limited liability. Answer: False 48) The sole proprietorship is the form of ownership with the least ability to accumulate capital. Answer: True 49) If a sole proprietor dies, retires, or becomes incapacitated, the business automatically terminates. Answer: True 50) The most common form of business ownership in the United States is the partnership. Answer: False 51) Although not required by law, a written partnership agreement that spells out the terms of operating the partnership and the status of each partner should be developed. Answer: True 52) State law requires that individuals creating a partnership file the Articles of Partnership with the secretary of state. Answer: False 53) Defining the duties, responsibilities, contributions, and roles of the partners in a partnership agreement is not necessary since the law covers these provisions automatically. Answer: False 54) In a partnership, profits (and losses) must be shared according to the ratio of capital originally invested in the partnership. Answer: False 55) If a partnership agreement does not exist, the partnership will be governed by the Uniform Partnership Act. Answer: True 56) There is no limit to the number of general partners a partnership may have, but it must have at least one general partner. Answer: True 57) Profits earned by a partnership are taxed in the same fashion as those earned by a sole proprietorship. Answer: True 58) The partnership, like the proprietorship, avoids the disadvantage of double taxation. Answer: True 59) In a partnership, the business itself is subject to federal income tax. Answer: False 60) A general partner is personally liable only for the amount of money he has invested in the partnership. Answer: False 61) One of the advantages of a partnership over a proprietorship is the increased sources of capital and credit it offers. Answer: True 62) If a limited partner withdraws, sells his ownership in the partnership, or dies, the partnership is not forced into dissolution. Answer: True 63) One disadvantage of the partnership form of ownership is the great potential for personality and authority conflicts. Answer: True 64) A common denominator in many partnership disputes is the lack of a written agreement clearly spelling out the roles, rights, and responsibilities of each partner. Answer: True 65) A limited partner is personally liable only for the amount of money she has invested in the partnership. Answer: True 66) A limited partner is treated as an investor in a business venture and does not take an active role in managing it. Answer: True 67) Each partner in a limited liability partnership is a limited partner; there are no general partners. Answer: True 68) Limited liability partnerships (LLP) are where all partners in a business are limited partners, which offers the advantage of limited liability for the debts of the partnership. Answer: True 69) A corporation formed and chartered in Kansas is considered a domestic corporation when doing business in Kansas, and a foreign corporation when doing business in Missouri. Answer: True 70) A corporation formed in Taiwan doing business in the United States is a foreign corporation. Answer: False 71) Most states do not require a Certificate of Incorporation or a charter to be filed for a new corporation. Answer: False 72) Corporations must obtain a federal charter before they can conduct any business. Answer: False 73) Stockholders in the corporation have the same kind of liability as do general partners in a partnership. Answer: False 74) When filing the corporate charter, a corporation must file in the state in which its headquarters are located. Answer: False 75) A business with more than five owners must be a corporation. Answer: False 76) One significant advantage of a corporation is the ability to attract capital. Answer: True 77) The corporation has the advantage of transferable ownership, which easily enables the corporation to sell shares to others or to transfer stock through inheritance. Answer: True 78) "Double taxation" refers to the fact that corporations are required to pay both federal and state income taxes. Answer: False 79) "Double taxation" refers to the fact that the corporation itself must pay taxes on its net profits, and the stockholders must also pay taxes on the portion of those same profits distributed to them as dividends. Answer: True 80) Company founders can become minority stockholders in a corporation but can never lose their final authority or control over business decisions because they are the founders. Answer: False 81) An S corporation maintains the advantages of the corporate form of ownership while having the ability to be taxed as a partnership. Answer: True 82) An S corporation can issue both voting and nonvoting common stock to its shareholders. Answer: True 83) One disadvantage of an S corporation is that the cost of many benefits-insurance, meals, lodging, and others-that are paid to shareholders with 2 percent or more of stock-cannot be deducted as business expenses for tax purposes and are considered taxable income. Answer: True 84) Liquidating an S corporation involves several steps, including paying all taxes and debts, obtaining the written approval of shareholders to dissolve the company, filing a statement of intent to dissolve with the secretary of state's office and, finally, distributing all remaining assets of the corporation to shareholders. Answer: True 85) Choosing S corporation status is usually beneficial to startup companies anticipating net losses and to highly profitable firms with substantial dividends to pay out to shareholders. Answer: True 86) A limited liability company must have at least two owners. Answer: True 87) The limited liability company, like an S corporation, is a form of ownership that is a cross between a partnership and a corporation. Answer: True 88) To form a limited liability company, an entrepreneur must file both the articles of incorporation and the operating agreement with the secretary of state. Answer: True 89) As in a limited partnership, owners of a limited liability company who want to maintain their limited liability status cannot actively participate in the management of the company. Answer: False 90) Like an S corporation, a limited liability company does not pay income taxes; its income flows through to its owners, who pay taxes on their shares of the limited liability company's net income. Answer: True 91) A limited liability company cannot have any more than two of the following corporate characteristics: limited liability, continuity of life, free transferability of interest, and centralized management. Answer: True 92) In a professional corporation, all shares of stock must be owned and held by individuals licensed in the profession of the corporation. Answer: True 93) A professional corporation is created in the same way as a regular corporation, and exists to provide the advantages of corporate ownership, including limited liability, to professionals such as doctors and lawyers. Answer: True 94) A joint venture is much like a partnership except that it is formed for a specific limited purpose. Answer: True 95) What factors should an entrepreneur consider when choosing a form of ownership? Answer: Factors an entrepreneur should consider when choosing a form of ownership include: • Tax considerations • Liability exposure • Start-up capital requirements • Control • Managerial ability • Business goals • Management succession plans • Cost of formation 96) What is a sole proprietorship? Explain the advantages and the disadvantages of a sole proprietorship. Answer: A sole proprietorship is a business owned and managed by one (1) individual. Advantages of a sole proprietorship: • Simple to create • Least costly form of ownership to begin • Profit incentive • Total decision-making authority • No special legal restrictions • Easy to discontinue Disadvantages of a sole proprietorship: • Unlimited personal liability • Limited skills and capabilities • Feeling of isolation • Limited access to capital • Lack of continuity for the business 97) What is a partnership? Explain the advantages and the disadvantages of a partnership. Answer: A partnership is an association of two or more people who co-own a business for the purpose of making a profit. Advantages of a partnership: • Easy to establish • Complementary skills • Division of profits • Larger capital pool • Ability to attract limited partners • Minimal governmental regulation • Flexibility • Taxation Disadvantages of a partnership: • Unlimited liability of the general partner(s) • Not effective in capital accumulation • Difficulty in disposing of partnership interest without dissolving partnership • Lack of continuity • Potential for personal and authority conflicts 98) John and Bill are considering starting a partnership. Why is it important for them to develop a formal partnership agreement? List at least ten of the provisions their partnership agreement should include. Answer: The partnership agreement is important because it states in writing all of the terms of operating the partnership and protects each partner involved. The standard partnership agreement should include the following: 1. Name of partnership 2. General character and purpose of business 3. Location of the business 4. Partner names and addresses 5. Financial contributions of each partner 6. Description of non-cash contributions 7. Time of additional contributions to be made by partners 8. How profits/losses are distributed 9. If applicable, the time or circumstances when a partner may withdraw 10. The agreed upon amount, or the method of determining the funds, to be received by a withdrawing partner 11. Agreement on disbursement of salaries, draws and/or property 12. Time or circumstances of dissolving the limited partnership 13. The rights of the general partner to continue the business 99) Outline the incorporation process. Answer: When incorporating, a Certificate of Incorporation or charter must be filed with the secretary of state. The Certificate of Incorporation includes such things as: • The corporation's name • The corporation's statement of purpose • Time horizon (50 years or perpetuity) • Name and address of incorporators • Place of business • Capital stock authorization • Capital required at the time of incorporation • Provisions for preemptive rights • Restrictions, if any, on transferring shares • Names and addresses of the officers and directors 100) What is a corporation? Explain the advantages and the disadvantages of a corporation. Answer: A corporation is a separate legal entity apart from its owners that receives the right to exist from the state in which it is incorporated. Advantages: • Limited liability of stockholders • Ability to attract capital • Ability to continue indefinitely • Transferable ownership Disadvantages: • Cost and time of incorporation • Double taxation • Potential for diminished managerial incentives • Legal requirements and regulatory red tape • Potential loss of control by the founder(s) 101) What is an S corporation? Explain the advantages and the disadvantages of an S corporation. Answer: A corporation that retains the legal characteristics of a regular (C) corporation but has the advantage of being taxed as a partnership if it meets certain criteria. Advantages of an S corporation: • Continuity of existence • Transferability of ownership • Limited liability for owners • Income taxed once-at individual's rate • Avoids "C" corporation tax on assets • Owners can get year-end payouts • Can have "S" corporation subsidiaries Disadvantages of an S corporation: • Lower rate than top individual tax rates • Many fringe benefits cannot be deducted 102) What kinds of companies would benefit most from S corporation status? Least? Answer: 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, owners can use the losses to offset other income. In addition, owners who plan to sell in the near future prefer "S" corporations because taxable gains on "S" corporations are lower. S corporation status would be least beneficial for companies whose characteristics include: • Higher individual tax rates • Profitable service companies that pay out much of their profits to shareholders in the form of benefits • Fast growing companies that retain most of earnings to finance growth • When loss of fringe benefits exceeds tax savings • Sizeable net operating losses that cannot be used against "S" corporation earnings • Income before any compensation is less than $100,000 per year 103) What is a limited liability company? How is one formed? What benefits does an LLC offer? Answer: A relatively new form of ownership that, like an S corporation, is a cross between a partnership and a corporation; however, it is not subject to many of the restrictions imposed on S corporations. The process of creating an LLC is much like creating a corporation. The articles of organization actually create an LLC by establishing its name, address, method of management, its duration, and the names and addresses of each organizer. An operating agreement, similar to an organization's bylaws, is also created. An LLC must have at least two owners (called members). Unlike an S corporation, it offers limited liability without imposing any ceilings on their numbers and does not restrict the partners from participating in day-to-day operations and management of the business. The LLC also avoids double taxation because its income flows through to its members who divide it as they see fit. 104) Compare and contrast the following forms of ownership: a corporation, an S corporation, and a limited liability company. Answer: • All have limited liability. • The LLC and S corporation are both similar to a partnership in the way they see fit to divide income. They both avoid double taxation. • Both the C and S corporation have continuity of existence and transferability of ownership. • The LLC is not subject to the same restrictions as an S corporation. For example, an S corporation cannot have more than 75 shareholders, no shareholders may be foreigners or corporations, and it may have only one class of stock. This is not the case with the LLC. • Unlike the corporation, an LLC does not have perpetual life. Mini Case 5-1: "Today, You Gotta' Be a Corporation" Duke has been a successful used car dealer for 25 years in the same location, operating as a proprietorship. In those 25 years, he has expanded his operation and become the largest independent car dealer in a city of 85,000 people. Few people in town can boast of a business reputation better than Duke's. As he says, "I've always done business in a fair and honest fashion, and I've tried to give my customers an honest deal. The public has responded well, and last year the business revenue increased to an all-time high of $830,000." As the business has grown, so have Duke's liabilities. On a given day, Duke will have cars worth from $350,000 to $450,000 as inventory on the lot. "Twenty years ago, if I'd asked the bank for a line of credit of $200,000, they'd have tossed me out the front door. There is no question that today business is different." Duke's only daughter recently married a garage mechanic who has worked in the area for the past three years. Though Duke thinks the boy is certainly nice enough, he does not believe he is very smart. "The kid sure knows how to fix a car, but that's as far as it goes," says Duke. "On my last visit to the accountant, he suggested I consider incorporating. I guess he knows what he's talking about. That's all you hear today-'you gotta be a corporation.' I guess he's right. But, to tell you the truth, I don't know." 105) Should Duke incorporate or should he remain a proprietorship? Why? Answer: There are significant advantages for Duke to investigate other alternatives. The sole proprietorship does not offer limited liability and incorporating would provide that benefit. 106) Would you recommend Duke establish an S corporation? What conditions would he have to meet? Answer: Duke's business looks as though it would qualify for S corporation status, and, as the text describes, there are tax advantages and, given the volume of sales and the "good living" Duke makes, he should consider this form of ownership. 107) Would a limited liability corporation be any better for Duke? Why or why not? Answer: A limited liability corporation offers many of the same advantages as an S corporation. Future ownership may be one consideration. If Duke wishes to take on additional owners, an S corporation may better facilitate that transition. Chapter 6 Franchising and the Entrepreneur 1) A franchise is a system of distribution in which semi-independent business owners pay ________ and ________ to a parent company in return for the right to become identified with its trademark, to sell its product or services, and often to use its business format and system. A) a percentage of sales; royalties B) upfront costs; incremental costs C) royalties; monthly consulting charges D) fees; royalties Answer: D 2) Franchises total annual sales represent nearly ________ percent of total annual sales and employ nearly one in ________ workers in the Unities Sates in more than 300 industries. A) 8: 17 B) 12: 8 C) 17; 8 D) 2: 21 Answer: C 3) ________ franchising involves providing the franchisee with a complete business system, with an established name, the building layout and design, accounting systems, and other elements while ________ franchising allows the franchisee to use the franchiser's trade name without distributing the products exclusively under the franchiser's name. A) Product distribution; trade name B) Trade name; pure C) Pure; trade name D) Pure; product distribution Answer: C 4) McDonald's is an example of a ________ franchise. A) conversion forms B) trade name C) product distribution D) pure Answer: D 5) Benefits of involvement in a franchise experience include: A) management training and support. B) brand name appeal and standardization of goods and services. C) national advertising exposure and financial assistance. D) All of the above Answer: D 6) Which of the following is not a potential advantage of franchising for the franchisee? A) Management training and assistance B) National advertising program C) Centralized buying power D) Limited product line Answer: D 7) Franchisers generally do which of the following regarding financial assistance to franchisees? A) Provide direct financing. B) Assist in finding financing and occasionally provide direct assistance in a specific area. C) Waive royalty fees for franchisees not making an adequate profit. D) Franchisers provide no assistance because having or finding financing is a requirement for qualifying for a franchise. Answer: B 8) A significant advantage a franchisee has over an independent business is the participation in the franchisor's ________ largely due to the ________ the franchise offers. A) centralized buying power: buying insight B) centralized buying power; brand protection C) centralized buying power: economies of scale D) economies of scale: territorial protection Answer: C 9) Some franchisors offer ________ to give existing franchisees the right to exclusive distribution of brand name goods or services within a particular geographic area. A) territorial protection B) exclusive rights C) guaranteed protection D) exclusivity Answer: A 10) The failure rate for franchises is: A) higher than the average rate for new businesses. B) no different from the rate for new businesses. C) lower than the average rate for new businesses. D) indeterminable because of the Right to Privacy Act. Answer: C 11) A recent study reports that the success rate of franchisees increases when a franchise system: A) requires franchisees to have prior industry experience. B) requires franchisees to actively manage their operations. C) has built a strong brand name with training programs to improve knowledge and skills. D) All of the above increase the rate of success. Answer: D 12) Franchise royalty fees typically range from ________ to ________ percent with an average of 6.7 percent. A) 3; 13 B) 1; 21 C) 1; 11 D) 3; 11; Answer: C 13) When it comes to purchasing products, equipment, and incurring other expenses, the franchiser: A) cannot require the franchisees to buy from the franchise company. B) can set prices franchisees pay for the products but cannot set the retail price the franchisees charge. C) is permitted to set the retail price for the franchisee. D) cannot require franchisees to buy from an "approved" supplier. Answer: B 14) Which of the following is not a potential disadvantage of a franchise? A) Unsatisfactory training program B) Limited product line C) Less freedom D) All of the above are potential disadvantages of a franchise. Answer: D 15) A franchise myth is that: A) once the franchise is open, the franchisee has autonomy to run the business in what ever way he or she sees fit. B) the owner needs to be hands on. C) the franchise will only expect to be paid when the franchisee is profitable. D) franchises fail at a rate higher that independently owned businesses. Answer: A 16) Which of the following is an indication of a dishonest franchiser? A) A high-pressure sale B) A "get-rich-quick" scheme C) Attempts to discourage you from getting an attorney to review the contract D) All of the above Answer: D 17) The FTC's philosophy regarding the Uniform Franchise Disclosure Document (UFDD) focuses on: A) catching and prosecuting abusers of franchise laws. B) verifying the accuracy of FDD information. C) providing information to prospective franchisees and helping them make wise decisions. D) licensing prospective franchisers. Answer: C 18) Which of the following should make a potential franchisee suspicious about a franchiser's honesty? A) Claims that the franchise contract is a standard agreement and that there is no need to read it or have an attorney look it over B) An offer of direct financing of a specific element of the franchise package C) Not providing detailed operational information until 10 days before signing the contract D) Requiring franchisees to spend a certain percentage of profits on advertising Answer: A 19) In addition to reading the franchiser's UFDD, it would be wise for the potential franchisee to seek a franchise that offers which of the following? A) A unique concept or marketing approach B) A registered trademark C) A positive relationship with franchisees D) All of the above Answer: D 20) Franchises have experienced three major growth waves since its beginning that include a focus on: A) rapid growth, the fast food, and specific market niches. B) stable growth, the service sector, and the food industry. C) rapid growth, the service sector, and specific market niches. D) predictable growth, the service sector, and specific market niches. Answer: C 21) A study by the International Franchises Association reports that minorities own more than ________ percent of all franchises and women own ________ percent of franchises. A) 2;8 B) 9;20 C) 12.;25 D) 20;25 Answer: D 22) ________ is an emerging international market for U.S. franchisers that is expected to realize the highest future growth rate. A) Europe B) Canada C) Japan D) China Answer: D 23) One of the major trends in franchising is the ________ of American franchise systems. A) replication B) conversion C) internationalization D) reduction Answer: C 24) The principle of putting a franchise's products or services directly in the paths of potential customers with smaller, less expensive outlets is called: A) cobranding B) intercept marketing C) area development D) master franchise Answer: B 25) A franchise trend in which owners of independent businesses become franchisees to gain the advantage of name recognition is called: A) area development B) master franchise C) conversion franchising D) cobranding Answer: C 26) In a ________ , a franchisee has the right to create a semi-independent organization in a particular territory to recruit, sell, and support other franchisees. A) multiple-unit franchising B) master franchise C) conversion franchising D) cobranding franchising Answer: B 27) A method of franchising that gives the right to create a semi-independent organization in a particular territory is a: A) conversion franchise. B) master franchise. C) product distribution franchise. D) area development franchise. Answer: B 28) When the franchiser has the right to establish a semi-independent organization in a particular territory to recruit, sell, and support other franchises, it is known as a ________ franchise. A) multi-unit B) cobranding C) conversion D) master Answer: D 29) McDonald's recently set up several small franchises in nontraditional locations such as a hospital, a college campus, an airport, a subway station, and a sports arena. These locations are based on the principle of: A) conversion franchising. B) intercept marketing. C) multi-unit franchising. D) cobranding. Answer: B 30) Chris Jaffe, the owner of a small independent doughnut shop, is worried that a large doughnut franchise will open an outlet near her location and take away business. Taking a proactive approach, Jaffe contacts the franchise, and after a few months of negotiations, becomes a franchisee. Jaffe is an example of which trend in franchising? A) Cobranding B) Conversion C) Master D) Sub-franchising Answer: B 31) Establishing a Baskin-Robbins franchise inside a Blimpee's franchise is an example of ________ franchising. A) multi-unit B) master C) cobranding D) diversionary Answer: C 32) A franchise is an arrangement in which semi-independent business owners pay fees and royalties to a parent company in return for the right to sell its products or services and often to use its business format and system. Answer: True 33) Pure franchising involves the right to use all the elements of a fully integrated business operation. Answer: True 34) Trade name franchising is a system of franchising in which a franchisee purchases the right to use the franchisor's trade name without distributing particular products under that name. Answer: True 35) Pure franchising involves a system of franchising in which a franchisor sells a franchisee a complete business format and system. Answer: True 36) Before entering a franchise contract, a potential investor should ask, "What can a franchise do for me that I cannot do for myself?" Answer: True 37) When a franchisee buys a franchise, he or she is purchasing the expertise and the business of the franchiser. Answer: True 38) Quality is so important in franchising that most franchisers retain the right to terminate the franchise contract and to repurchase the outlet if a franchisee fails to maintain quality standards. Answer: True 39) A major advantage of a franchise contract is the national advertising campaign that most franchisers provide free of charge for their franchisees. Answer: False 40) Examples of some benefits franchise systems offer include management training, brand appeal, standardization of goods and services, national advertising, proven business formats, centralized buying power, and site selection assistance. Answer: True 41) Most franchisers provide extensive financial help such as loans and low-rate financing for their franchises. Answer: False 42) The failure rate for franchises is below that for other types of new businesses. Answer: True 43) In addition to other fees, franchisees must also pay royalties but only on net profits; in other words, no profits, and no royalties. Answer: False 44) It is illegal for a franchiser to require franchisees to purchase products only from "approved suppliers." Answer: False 45) Having an attorney review and evaluate a franchise contract is unnecessary since the FTC requires all franchisers to offer a "standard" franchise contract. Answer: False 46) Franchisees in fast-growing systems reap the benefits of the franchisor's expanding reach, but they also may encounter the downside of a franchisor's aggressive growth strategy; market saturation. Answer: True 47) By signing the franchise contract, a franchisee typically surrenders some freedom and autonomy in operating his or her business. Answer: True 48) The bigger the franchise, the more successful the franchisees will be. Answer: False 49) The franchise contract defines the rights and the obligations of both parties and sets the guidelines that govern the franchise relationship. Answer: True 50) Absentee franchise owners are consistently successful. Answer: False 51) The Uniform Franchise Disclosure Document (UFDD) is a document that every franchiser is required by law to give prospective franchisees before any offer or sale of a franchise. Answer: True 52) If a franchiser encourages you to sign without reading the agreement, or discourages you from "spending the money on an attorney," this is a warning sign that the franchiser might be dishonest. Answer: True 53) The franchisee turnover rate is the rate at which franchisees leave a franchise system. Answer: True 54) A good method for evaluating a franchiser's reputation is to interview existing franchise owners about the operation. Answer: True 55) One of the first lessons in franchising is, "Do your homework before you get out your check-book." Answer: True 56) Most franchisees are better educated, more sophisticated, have more business acumen, and are more financially secure than those of just 20 years ago. Answer: True 57) The principle of placing smaller franchise units directly in the paths of potential customers is referred to as intercept marketing. Answer: True 58) Many franchises have discovered that small outlets in high-traffic, nontraditional locations generate nearly the same sales volume as full-size outlets at a fraction of the cost. Answer: False 59) A master franchise gives the franchisee the right to create a semi-independent organization in a particular territory to recruit, sell, and support other franchisees within a specific time frame. Answer: True 60) A conversion franchising arrangement gives a franchisee the right to create a semi-independent organization in a particular territory to recruit, sell, and support other franchisees. Answer: False 61) Define franchising. Explain the three types of franchising. Which is the fastest-growing segment? Answer: A system of distribution in which semi-independent business owners (franchisees) pay fees and royalties to a parent company (franchiser) in return for the right to become identified with its trademark, to sell its products or services, and often use its business format and system. The three types of franchising are: 1. Tradename 2. Product distribution 3. Pure (business format) Pure franchising outlets' sales are growing at a faster rate. 62) Outline the benefits and drawbacks of buying a franchise. Answer: Some of the primary benefits of franchising include: • Becoming part of a business system • Management and training support • Brand name appeal • Standardized quality of goods and services • National advertising programs • Financial assistance • Proven products, processes and business formats • Centralized buying power • Site selection and territorial protection • Greater chance for success The drawbacks of franchising include: • Franchise fees and ongoing royalties • Strict adherence to standardized operations • Restrictions on purchasing • Limited product line • Contract terms and renewal • Unsatisfactory training programs • Market saturation • Less freedom 63) What is the Franchise Disclosure Document? How can this document be of value to a potential franchisee? Answer: The law requires franchisers to register and deliver a copy to perspective franchisees before any offer or sale of a franchise. The Franchise Disclosure Document, or FDD, establishes full disclosure guidelines for any company selling franchises, outlining 23 important pieces of information. The FDD can help potential franchisees avoid being defrauded by requiring that the franchiser disclose detailed information on their operation at the first personal meeting, or at least ten days before a franchise contract is signed, or before any money is paid. 64) Outline the recommended procedure for buying a franchise. Answer: The most effective steps to buying a franchise are: • Evaluate yourself • Research your market • Consider your franchise options • Get a copy of the franchiser's UFDD • Talk to existing franchisees • Ask the franchiser some tough questions • Make your choice 65) What are some indicators that a potential franchisee might be dealing with a dishonest franchise? What steps can a potential franchisee take to avoid becoming a victim of a dishonest franchise? Answer: Indicators of a potentially dishonest franchise may include: • Claims that contract is standard and "you don't need to read it" • Failure to provide disclosure information • Marginally successful or no prototype • Oral promises of future earnings with no documentation • High turnover rate • Poor manual or none at all • Unusual amount of litigation • Attempt to discourage attorney advice • High pressure sales • Claiming to be exempt from federal laws • Get-rich-quick schemes • Reluctance to provide references • Evasive or vague answers Steps to take may be to: • Do your research • Ask for the franchiser's FDD • Investigate the franchise thoroughly • Apply preparation, common sense, and patience 66) Explain the following franchise concepts and give an example of each: area development, intercept marketing, conversion franchising, master franchising and cobranding. Answer: Area development franchising is a method whereby a franchisee opens more than one unit within a specific time frame. Example: An individual or family owning all the local McDonald's. Intercept marketing is the principle of putting a franchise's products or services directly in the paths of potential customers, wherever they may be. Example: Putting a scaled-down version of a Subway sandwich shop in a gas station convenience store. Conversion franchising is a trend in which owners of independent businesses become franchisees to gain the advantage of name recognition. Example: An Italian restaurant owner buys a franchise like the Olive Garden restaurant. Master franchising is a method of franchising that gives the franchisee the right to create a semi-independent organization in a particular territory to recruit, sell, and support other franchisees. Example: An individual fluent in Spanish works to recruit as many franchisees as possible in Spain. Cobranding is a method of franchising in which two or more franchises team up to sell complementary products or services under one roof. Example: KFC and Long John Silvers are located within the same facility. 67) Explain three trends that are currently shaping the franchising industry. Answer: These current trends may include: • Minority and women ownership • International opportunities • Intercept marketing with smaller, nontraditional locations • Conversion franchising • Area development • Master franchising • Cobranding Mini-Case 6-1: Pipe Dreams Ralph Emerson thought he'd been a librarian long enough, and when the opportunity arose to open a small tobacco, pipe, and cigar shop in the newly renovated downtown business district, he was ready to act. Pipe Dreams is a franchiser of smoke shops, and was founded eight years ago by a noted tobacconist in New York City. The concept for the shops is simple, yet sophisticated. It is simple in the sense that the shops sell only tobacco-related products, but sophisticated in the breadth and quality of the inventory they carry. Each franchise, depending on size, is stocked with inventory selected by the company's founder. The franchiser finances the shop's initial inventory. The franchisee is expected to create a decor within predetermined standards that Pipe Dreams establishes. Each franchisee must attend a three-day workshop, outlining the fundamentals of tobacco blending, the merchandising of pipes and cigars, and the techniques of successful business operation. The franchise contract requires the franchisee to contribute 1.5 percent of gross revenue to a national advertising campaign. According to the contract, Pipe Dreams will finance the required fixtures for the store for ten years. In addition, the franchiser supplies all inventory at very favorable prices because it purchases in large quantities. Ralph knows he can buy tobacco products from a variety of wholesalers. He also has some ideas on what would make a tobacco shop successful in this town. Ralph knows that Pipe Dreams franchisees have had a high success rate in the past. 68) Help Ralph make a decision by outlining the advantages and the disadvantages of a franchise arrangement. Answer: This chapter outlines the advantages and disadvantages of franchise arrangements. The case suggests that the Pipe Dreams franchise (like many franchises) offers the entrepreneur a greater chance of success than "starting from scratch." The franchising benefits Ralph may experience might include: • Becoming part of a business system • Management and training support • Brand name appeal • Standardized quality of goods and services • National advertising programs • Financial assistance • Proven products, processes and business formats • Centralized buying power • Site selection and territorial protection • Greater chance for success The drawbacks of franchising that Ralph may be prepared for include: • Franchise fees and ongoing royalties • Strict adherence to standardized operations • Restrictions on purchasing • Limited product line • Contract terms and renewal • Unsatisfactory training programs • Market saturation • Less freedom 69) Assuming that Ralph has adequate capital, would you recommend that he invest in the franchise or open his own tobacco shop? Why? Answer: Given Ralph's lack of business experience, and specifically in managing a tobacco shop, it probably is wise for him to take the franchise option. The benefits the franchise offers in the areas of management and training support, brand appeal, national advertising and a proven business format may be particularly valuable for Ralph Test Bank for Essentials of Entrepreneurship and Small Business Management Norman M. Scarborough 9780132666794, 9780273787129, 9780134741086, 9780136109594, 9780133930382
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