Discussing Franchise Costs And Using Freddys

after Discussing About Franchising Costs And Used Freddys As An Exa

After discussing about franchising costs and used Freddy's as an example. Pick another company that franchises and search the information on opening a franchise. Include costs, up-front cash required, royalty (profits paid to franchiser), and any other important information. Consider and answer the following on how profit(loss) is allocated per entity. The entity in question earned $1 million in profits for the fiscal year. Discuss how this profit is allocated with the following entities:

  • Sole Proprietor, who receives this profit?
  • Partnership, two partners, no agreement on profit(loss) allocation regarding the $1 million in profit for this fiscal year. How would you suggest a 'reasonable allocation' be for the distribution of profit(loss) between the partner in charge of operations versus the 'capital partner'?
  • Corporations, who gets the profits in a corporate form? Would a corporation be required to distribute profits? If not, then who gets the profits? Perhaps the reason for the account 'retained earnings.'
  • Limited Liability Company (don't consider the 'S' corporation for this), who gets the $1 million in profit for this 'pass-through' entity? Assume there was a managing partner and nine limited partners. The managing partner, operations partner, works for a salary. If the entity turns a profit, then the managing, operations partner will share equally with the limited partners.

Paper For Above instruction

The exploration of franchising costs and profit allocation methods across different business structures reveals significant differences in financial management and equity sharing. Franchising, as a popular model for expanding business operations, involves various startup costs, ongoing fees, and strategic profit-sharing arrangements that depend on the type of business entity involved. Additionally, understanding how profits are allocated in sole proprietorships, partnerships, corporations, and limited liability companies provides vital insights into financial planning and management for entrepreneurs and stakeholders alike.

Franchising Costs and Example: Chick-fil-A

To illustrate franchising costs, let's consider Chick-fil-A, a well-known franchiser in the fast-food industry. Unlike traditional franchise opportunities, Chick-fil-A operates a unique franchise model with substantial upfront costs and specific financial commitments. The initial franchise fee is notably low at approximately $10,000 (Chick-fil-A, 2022). However, franchisees are required to make a significant investment in equipment, real estate, and other startup costs, which typically range from $342,000 to $1.6 million depending on the location (Franchise Direct, 2023). Importantly, Chick-fil-A retains ownership of the store and controls site selection, and franchisees pay a 15% royalty on gross sales plus a 50% share of profits after operating expenses (Chick-fil-A, 2022). These fees highlight that franchise costs extend beyond the initial fee, involving continual royalty payments that impact profit margins.

Profit Allocation in Different Business Structures

Understanding profit allocation requires examining each business structure's legal and financial framework. These include sole proprietorships, partnerships, corporations, and limited liability companies (LLCs). Each has distinct mechanisms regarding profit sharing, tax implications, and ownership rights.

Sole Proprietorship

In a sole proprietorship, the owner personally owns the business and is responsible for its liabilities. The $1 million profit earned in a fiscal year belongs entirely to the sole proprietor. This income is reported on the owner's individual tax return, typically through Schedule C of Form 1040. The owner can withdraw profits at will, and these withdrawals are not considered salary but rather a distribution of profits, which are taxed as personal income (Investopedia, 2021). Therefore, the sole proprietor receives the entire $1 million after tax obligations are satisfied.

Partnership

For partnerships, where two or more individuals share ownership, profit distribution is governed through partnership agreements. In the absence of an explicit agreement, profits are generally split equally. However, the question specifies no prior agreement, so a 50-50 split seems reasonable for illustrative purposes. The partnership reports its income on Form 1065, and profits are passed through to individual partners via Schedule K-1s, which they then report on their personal tax returns (IRS, 2022). Each partner’s share of the profit is taxed personally, regardless of whether distributions were made.

To suggest a 'reasonable allocation' reflecting contribution, the partner in charge of operations might receive a higher share—say, 60%—to recognize their role, while the capital partner receives 40%. This approach incentivizes operational efforts and acknowledges the capital investment's importance. Alternatively, profit could be distributed based on capital contribution ratios if known. Clear agreements mitigate disputes and reflect each partner’s role and stake more fairly (Gowthorpe & Rose, 2020).

Corporations

In a corporate structure, profits are generally retained within the company or distributed as dividends to shareholders. If dividends are paid, shareholders who hold stock are entitled to receive a share proportional to their ownership—whether common or preferred stock. Profits not distributed are kept as 'retained earnings' on the balance sheet, finance growth, or pay off debt. The corporation pays corporate taxes on profits; then, dividends are taxed again at the shareholder level, leading to double taxation in C-corporations (Kember, 2020).)

In this context, the profits of $1 million could be distributed among shareholders in proportion to their holdings if dividends are declared. Otherwise, the undistributed portion remains part of retained earnings, serving as internal reserves for future investments or operational needs.

Limited Liability Company (LLC)

An LLC offers a flexible structure with pass-through taxation, where profits are allocated directly to members based on the operating agreement or ownership percentages. In this scenario, the LLC comprises a managing partner and nine limited partners. The management partner earns a salary for operational duties, and profits are then shared equally among all members, including limited partners, after salary payments.

Assuming the $1 million profit, the managing partner receives a salary, and the remaining profit is divided equally among all ten members—one managing partner and nine limited partners—each receiving 10% of the residual profit. This arrangement aligns with typical LLC practices, emphasizing flexibility and equitable sharing of profits and losses (Lins, 2022). It also incentivizes active participation in management while rewarding limited partners’ investments.

Conclusion

The method of profit allocation fundamentally depends on the legal structure and the agreements in place. Sole proprietors have complete control and receive all profits; partnerships require equitable or agreed-upon sharing; corporations distribute profits via dividends; and LLCs allow flexible arrangements that reflect ownership and operational roles. Recognizing these distinctions helps entrepreneurs make informed decisions that align with their business goals and stakeholder interests.

References

  • Chick-fil-A. (2022). Franchise Information. https://www.chick-fil-a.com/our-story/franchising
  • Franchise Direct. (2023). Chick-fil-A Franchise Cost & Requirements. https://www.franchisedirect.com/food/franchise/chick-fil-a/
  • Gowthorpe, B., & Rose, S. (2020). Small Business Finance: Theories and Evidence. Routledge.
  • Investopedia. (2021). Sole Proprietorship. https://www.investopedia.com/terms/s/soleproprietor.asp
  • IRS. (2022). Partnerships (Form 1065, Schedule K-1). https://www.irs.gov/forms-pubs/about-form-1065
  • Kember, S. (2020). Corporate Dividends and Taxation. Journal of Financial Perspectives, 32(4), 45-60.
  • Lins, K. (2022). LLCs and Pass-Through Taxation. Business Law Journal, 14(3), 112–118.
  • Investopedia. (2021). Business Structures. https://www.investopedia.com/terms/b/business-structure.asp
  • Gowthorpe, B., & Rose, S. (2020). Small Business Finance: Theories and Evidence. Routledge.
  • Kember, S. (2020). Corporate Dividends and Taxation. Journal of Financial Perspectives, 32(4), 45-60.

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