HOSPITALITY BUSINESS STRUCTURE

1. THE IMPORTANCE OF BUSINESS STRUCTURE.

The importance of selecting the proper organizational and operational structures for a
hospitality business.

- ORGANIZATIONAL STRUCTURE: The legal entity that owns a business. Organizational

structure refers to the legal formation of the business entity. It represents the relationship
between the business owners and the outside world. This legal formation is important because
the courts and all levels of government treat businesses and their owners differently, based on
their organizational structure. Therefore, it is important to select an organizational structure that
works to the advantage of both the business and its owner.

- OPERATING STRUCTURE: The relationship between a business’s ownership and its

management. Operating structure refers to the relationship between a business’s owners and its
management. The composition of a business’s management can be just as important as its type
of structure. Operating structures of different hospitality organizations vary greatly. For example,
the individual owner of a restaurant may, in fact, also manage it on a day-to-day basis. In
another operating structure, however, a hotel may actually be owned by one legal entity, be
managed by another legal entity, and have contractual relationships about precisely how it is to
be managed with yet another legal entity.

It is important to know which state law governs the requirements of a business entity.

Ex: State of Delaware

2. COMMON HOSPITALITY ORGANIZATIONAL STRUCTURES.

The various organizational business structures used in the hospitality industry.

LEGALESE

- SOLE PROPRIETORSHIP: A business organization in which one person owns and, often,
operates the business. A sole proprietorship is the simplest of all organizational structures.
 + In this structure, a single individual owns all of the business and is responsible for all of
its debts. The majority of small businesses in the United States are sole
proprietorships.In a sole proprietorship, the personal assets of the owner can be used to
pay any losses, taxes, or damages resulting from lawsuits against the business.There is
no personal protection from any of the risks associated with owning a business. Put
another way, the sole proprietor has unlimited liability for the indebtedness of his or her
business. Profits in a sole proprietorship are taxed at the same rate as the owner’s
personal income tax.
+ If the owner of a sole proprietorship is operating under an “assumed name,” a name
other than his or her own, an assumed-name certificate should be filed with the local
government. Any entity operating under an assumed name—not just sole proprietorships
—should file a certificate disclosing the ownership and ownership structure of the
operation. In many states, filing this certificate is required by law.

LEGALESE

- GENERAL PARTNERSHIP: A business organization in which two or more owners agree to

share the profits of the business but are also jointly and severally liable for its debts. A general
partnership is similar to a sole proprietorship, except that it consists of two or more owners who
agree to share the responsibility for the operations, financial performance, and liability of the
business. Partnerships are formed through oral or written contracts. Generally, these
agreements will specify the contributions and responsibilities of each partner:

● How much money each partner will contribute to the business

● How much time each partner will contribute to the business
● Who will make decisions on how the business is operated
● How profits will be divided
● How losses will be shared
● A procedure for transfer of ownership, if one or more partners wishes to sell his or her
portion of the business or becomes unable to participate as a partner

LEGALESE

- LIMITED PARTNERSHIP (LP): A business organization with two classes of owners. The
limited partner invests in the business but may not exercise control over its operation, in return
for protection from liability. The general or managing partner assumes full control of the
business operation but can also be held liable for any debts the operation incurs. While a sole
proprietorship has only one owner, and a general partnership may consist of several owners, a
limited partnership (LP) consists of two classes of owners: the limited partner and the general
(or managing) partner. The limited partner is simply someone who invests money in the
partnership. The general partner may or may not be an investor but serves as the business’s
operating and financial manager.

LEGALESE

Limited partner: The entity in a limited partnership relationship who is liable only to the extent
of his or her investment. Limited partners have no right to manage the partnership.

General (or managing) partner: The entity in a limited partnership relationship that makes the
management decisions and can be held responsible for all debts and legal claims against the
business.

+ As a general rule, liability will be limited if a partner is not directly involved in the day-to-
day managerial decision making of the business. The legal principle involved is one of
control.
+ The taxation on the profits of a limited partnership is similar to the taxation requirements
of general partnerships. The profits are distributed to the partners and taxed at the same
rate as the owner’s personal income tax.
+ The limited partnership is a special type of business arrangement provided for by state
law. A limited partnership is closely regulated by the state in which it operates, and it is
the state that permits limited partners to invest in a business and be exempt from a large
share of the liability should the business fail.

LEGALESE

- C CORPORATION: A group of individuals granted a charter, legally recognizing them as a

separate entity with rights and liabilities distinct from those of its members.

- Shares: Fractional portions of a company in which the owner of the portion has voting rights
and rights to a respective fraction of the assets of the company.

- A C corporation, often referred to simply as a corporation, is formed when groups of individuals

elect to band together to achieve a common purpose. When they do, the corporation has a legal
identity completely separate from that of its individual owners. The actual owners of a
corporation are called shareholders because they own shares, or portions, of the business.
Legally, shareholders have the power to determine a corporation’s direction and the way it is
managed.

+ Corporations are different from sole proprietorships or partnerships in that it is the

corporation itself, rather than the individual owners, that is liable for any debts incurred.
This is a powerful advantage.
+ A C corporation gets its name from Chapter C of the United States Internal Revenue
Code (IRC). Although C corporations eliminate individual liability, they also have a
significant disadvantage. Profits from a C corporation are taxed twice. The first tax is
levied on the profits the corporation earns. After those taxes are paid, the after-tax profits
that remain can be distributed to the corporation’s shareholders in the form of dividends
(A portion of profits received by a shareholder, usually in relation to his or her ownership
(shares) of a corporation).

LEGALESE

- S CORPORATION: A type of business entity that offers liability protection to its owners and is
exempt from corporate taxation on its profits. Some restrictions limit the circumstances under
which an S corporation can be formed.

There is a type of corporation that avoids the double taxation inherent in a C corporation. This is
known as an S corporation, and it also gets its name from the U.S. tax code. An S corporation is
also known as a subchapter S corporation. The S corporation format makes good sense for
many hospitality businesses, such as family-owned operations. There are several requirements
for establishing and maintaining an S corporation status:

● There is a limit of no more than 100 shareholders.

● Only one class of stock is issued.
● All shareholders must be U.S. citizens or residents.
● All shareholders must be individuals, trusts, or estates, rather than partnerships or
corporations.
● Some types of corporations such as financial institutions, insurance companies, or
domestic international sales corporations are not eligible.
 + In an S corporation, any profits from the business are distributed directly to the
shareholders in proportion to their ownership of the corporation. The profits are reported
on the individual owners’ income tax returns and are taxed at the individuals’ taxable
rates, which is similar to the favorable taxation treatment of a partnership; however,
shareholders also receive the liability protection of a corporation.

LEGALESE

- LIMITED LIABILITY COMPANY (LLC): A type of business organization that protects the
owners from liability for debts incurred by the business, without the need for some of the formal
incorporation requirements. The federal government does not tax the profits of LLCs; however,
some states do, while others do not.

+ The limited liability company is a fairly new type of entity, created by some states to
combine the best features of a corporation with the simplicity of a partnership. Under the
typical LLC statute, the members (similar to shareholders in a corporation or partners in
a partnership) are all protected from the company’s debts, unless they undertake
personal responsibility for a debt, such as personally guaranteeing a loan for the
business. Thus, a member can serve as the company’s owner or manager, yet still
protect his or her personal assets from liability.

3. COMMON HOSPITALITY OPERATING STRUCTURES.

The most common operational business structures used in the hospitality industry.

LEGALESE

- OWNER-OPERATOR: A type of operating structure in which the owners of a business are

directly responsible for its day-to-day operation. Also known, in some cases, as an
“independent.”

+ Owner-operators may own a single small business or they may own multiunit facilities in
several geographic areas. In many cases, the owner-operator structure is used by
families that pass restaurants or lodging facilities on to new generations of hospitality
managers.
+ The actual organizational structures used by owner-operators may vary from single
proprietorship to various forms of partnerships and corporations. As the independent
 owner-operator of your own business, you will have complete freedom to implement any
policies, procedures, and products you feel are appropriate.
+ In many cases, independent business operators who start businesses experience
markedly lower expenditures on both initial investment and promotion than do some
other operational structures; however, their long-term survival rate is typically lower than
with some other operational structures.

LEGALESE

- FRANCHISE: A contract between a parent company (franchisor) and an operating company

(franchisee) to allow the franchisee to run a business with the brand name of the parent
company, as long as the terms of the contract concerning methods of operation are followed.

+ In a franchise operating structure, the actual owner of a hospitality facility (the

franchisee) agrees to operate that facility in a specific manner in exchange for the
franchise. A franchise can take many forms, but, as stated previously, it is generally the
right to use the name, trademark, and procedures established by the franchisor for the
sale of a product or service in a specific geographic area.

LEGALESE

Franchisee: The person or business that has purchased and/or received a franchise.

Franchisor: The person or business that has sold and/or granted a franchise.

Licensor: One who grants a license.

License: Legal permission to do a certain thing or operate in a certain way.

Licensee: One who is granted a license.

+ In a typical franchise operating structure, an owner gives up part of his or her freedom to
make operational decisions in exchange for the franchisor’s expertise and the marketing
power of the franchisor’s brand name.
+ If a business owner elects to operate a franchise, he or she can gain the marketing support of an
established trademarked name; credibility with potential investors, lenders, customers, and
 vendors; and, in many cases, assistance with operational problems that are encountered →
advantages.
+ Disadvantages: the franchisor will charge the franchisee an initial fee, plus a percentage
of gross revenue. In addition, both parties will sign a legal agreement, which outlines the
duties and responsibilities of both the franchisor and franchisee. This franchise
agreement is often referred to as a licensing agreement, because the franchise
company (licensor) is granting the right, or license, to operate as one of its franchisees
(licensee).

LEGALESE

- Management company: An entity that, for a fee, assumes responsibility for the day-to-day
operation of a business.

- MANAGEMENT CONTRACT: The legal agreement that defines the responsibilities of a

business owner and the management company chosen to operate the owner’s business.

LEGALESE

- REIT: Short for “real estate investment trust,” a very special form of business structure in
which the owners of a business are generally prohibited from operating it.

- The REIT is a popular ownership model for hotels because the Real Estate Investment Trust
Act of 1960 set up three key provisions when it created REITs:

1. Owners that operate as REITs pay no tax on corporate income.

2. In order to get that tax break, REITs must pay out at least 90 to 95 percent of every dollar in
income to their shareholders in the form of dividends.

3. Companies can pass the tax savings from the dividend deduction on to shareholders, making
REITs an attractive investment.

LEGALESE

- CONDOMINIUM: A multipleunit complex (i.e., hotel, apartment house, office building), the
units of which are individually owned with each owner receiving a recordable deed to the
individual unit purchased, including the right to sell that unit and sharing in joint ownership of all
common grounds, hallways, and on-site facilities.

Fractional ownership: A purchase arrangement in which a condominium owner purchases the

use of his or her unit for a portion (fraction) of a year. The fraction may be defined in terms of
the number of days per year (e.g., 30, 60, etc.) or very specific days and/or months (e.g.,
January 1 through March 31). Individual units purchased under such an arrangement are
commonly known as fractionals.

Condominium homeowners’ association (CHOA): A group of condo owners, elected by all of

the condo owners in a project, to interpret, develop, and implement the policies and procedures
required to effectively manage their condominium complex.

+ A “condo” hotel can refer to many types of hotel operating structures, ranging from a
traditional hotel with residential condominiums next door, or on the top few floors, to
properties where some or all of the hotel rooms have actually been turned into
condominiums and are then sold to individual owners/investors. These owners may own
their condominium units entirely, or they may have purchased fractional ownership.
+ In contrast to a traditional hotel developer who normally faces many years of operation
before a significant return on capital can be expected, a condo hotel developer expects
to sell some or all of the guestrooms constructed to individual unit owners prior to, or
immediately upon, completion of the hotel. In summary, the condo hotel developer
expects, and thus far has been achieving, higher rates of return than those rates
achievable by traditional hotel development.
+ In completed condo hotel projects, the business operating structure employed typically
takes one of two forms. In the first, the project’s developer retains ownership of, and
typically manages, the revenue generating areas such as restaurants, lounge, meeting
space and the like. In such an arrangement, the operating structure employed may be
that of an owner-operator, a management contract, or even a franchise. In the second
case, all of the hotel’s commercial areas are turned over to and operated by a
condominium homeowners’ association (CHOA).

4. THE AGENCY RELATIONSHIP.

The responsibilities and obligations created by an agency relationship.

In the United States, regardless of the business structure selected, the relationship between
businesses and their hired help usually takes the form of one of three concepts:

1. Master–servant

2. Agent–principal

3. Independent contractor

- THE MASTER–SERVANT RELATIONSHIP: The master–servant relationship implies that the

employee is under the direct control of the employer, and since the employers are presumed to
be in control of their employees, employers are generally held responsible for the behavior of
the employees when they are working.

- THE AGENT–PRINCIPAL RELATIONSHIP: When employees act on behalf of the principal,

they are usually referred to as agents of the principal. Agents have a fiduciary duty
(responsibility) to act in the best interests of the principal. In general, a contract is used to
specify the specific terms of a principal–agent relationship.

+ In many cases, the distinction between the agent–principal relationship and the master–
servant is quite blurred. As empowerment becomes more widespread in hospitality
workplaces, this distinction may fade altogether. Servants who are given more discretion
and more authority will be more frequently categorized as agents. The distinction
becomes important when you are trying to assess the responsibility of the employer for
the acts of the employee.

Because principals are held responsible for the actions of their agents, agents have a fiduciary
responsibility to act in the best interest of their principals. The agent generally has five duties:

1. Utmost care: The agent is bound to a very high standard to ensure the maximum protection
of the principal’s interest.

2. Integrity: The agent must act with fidelity and honesty.

3. Honesty and duty of full disclosure: The agent must make honest and full disclosure of all
facts that could influence in any way the principal’s decisions, actions, or willingness to follow
the advice of the agent.
4. Loyalty: The agent is obligated to refrain from acquiring any interest adverse to that of a
principal without full and complete disclosure of all material facts and obtaining the principal’s
informed consent. This precludes the agent from personally benefiting from secret profits,
competing with the principal, or obtaining an advantage from the agency for personal benefit of
any kind.

5. Duty of good faith: The agent must act with total truthfulness, absolute integrity, and total
fidelity to the principal’s interest.

LEGALESE

Principal: Employer, the person hiring and directing employees (agents) to perform his/her/its
business.

Agent: A person authorized to act for or to represent another, usually referred to as the
principal.

Respondeat superior: Literally; “let the master respond,” a legal theory that holds the employer
(master) responsible for the acts of the employee.

Fiduciary responsibility: The requirement that agents act in the best interest of their
principals.

- THE INDEPENDENT CONTRACTOR: A person or entity that contracts with another to

perform a particular task but whose work is not directed or controlled by the hiring party.