Ch. 21 Starting a Business: LCCs and Other Options

The advantages of a sole proprietorship are:

* Ease of formation: If an individual runs a business without taking any formal steps to create an organization, she automatically has a sole proprietorship. * Taxes: A sole proprietorship is a flow-through tax entity; the business itself does not have to pay income taxes.

The disadvantages of a sole proprietorship:

* Liability * Limited capital: The owner of a sole proprietorship has limited options for financing her business; debt is the only source of capital; works best for small businesses without large capital needs

S Corporations

* Shareholders of S corps have both the limited liability of a corporation and the tax status of a flow-through entity. * S corps do face some major restrictions: - There can be only one class of stock. - There can be no more than 100 shareholders. - Shareholders must be individuals, estates, charities, pensions funds, or trusts, not partnerships or corporations. Shareholders must be citizens or residents of the United States, not nonresident aliens. All shareholders must agree that the company should be an S corporation.

A court may pierce an LLC's veil if members:

- Fail to observe formalities: If an LLC enters into an agreement with a member, a legitimate contract needs to be drafted and signed. - Commingle assets: An LLC and its members must keep their assets separate. - Fail to provide adequate capital - Commit fraud: Courts are unwilling to protect fraudsters who try to use an LLC as a shield against liability.

Management Duties

- Partners are liable to the partnership for gross negligence or intentional misconduct. - Partners cannot compete with the partnership. Each partner must turn over to the partnership all earnings from any activity that is related to the partnership's business. - A partner may not take on opportunity away from the partnership unless the other partners consent. - If a partner engages in a conflict of interest, he must turn over to the partnership any profits he earned from that activity.

Close corporations share certain requirements:

- Protection of minority shareholders: Close corporation laws typically protect minority shareholders by holding that majority shareholders owe them a fiduciary duty. - Transfer restrictions: The shareholders of a close corporation often need to work closely together in the management of the company. - Flexibility: Close corporations can typically operate without a board of directors, a formal set of bylaws, or annual shareholder meetings. - Dispute resolution: The shareholders are allowed to agree in advance that any one of them can dissolve the corporation if some particular events occurs or, if they choose, for any reason at all.

The FDD must provide information on

- The history of the franchisor and its key executives - Litigation with franchisees - Bankruptcy filings by the company and its officers and directors - Costs to buy and operate a franchise - Restrictions on suppliers, products, and customers - Territory--any limitations (in either the real or virtual worlds) on where they franchisee can sell or any restrictions on other franchisees selling in the same territory - Business continuity--the circumstances under which the franchisor can terminate the franchisee and the franchisee's rights to renew or sell the franchise - Required advertising expenses - A list of current franchisees and those that have left in the prior three years (a significant number of departures may be a bad sign)

To become a socially conscious organization, typically:

- Two-thirds of shareholders (or in some states more) must approve - The company must agree to measure its social benefit using a standard set by an objective third party - On its website, the company must assess and report regularly on its societal and environmental impact.

Three Steps to Termination

1. Dissolution - A partnership dissolves anytime the business cannot continue, when: a. a partner leaves, and the remaining partners cannot agree unanimously to continue on b. the partners decide to end the partnership c. the partnership business becomes illegal 2. Winding Up - During the winding up process, all debts of the partnership are paid, and the remaining proceeds are distributed to the partners. 3. Termination - Termination happens automatically once the winding up is finished. The partnership is not required to do anything official.

Advantages of a Corporation

1. Limited liability - If a business flops, its shareholders lose their investment in the company but not their other assets. - Individuals are always responsible for their own acts. - A corporation protects managers and investors from personal liability for the debts of the corporation and the actions of others, but not against liability for their own negligence (or other torts and crimes) 2. Transferability of interests - Partnership interest are not transferable without the permission of the other partners, whereas corporate stock can be bought and sold easily. 3. Duration - Corporations can continue without their founders.

Disadvantages of a Corporation

1. Logistics - Corporations require substantial expense and effort to create and operate. 2. Taxes - A corporation is a taxable entity, which means it must pay income taxes on profits and also file a tax return.

Close Corporations

A corporation with a small number of shareholders whose stock is not publicly traded and whose shareholders play an active role in management - it is entitled to special treatment under state law.

Piercing the company veil

A court holds members of an LLC personally liable for the debts of the organization.

Franchise Disclose Document (FDD)

A disclosure document that a franchisor must deliver to a potential purchaser.

Terminating a Partnership

A dissociation occurs when a partner quits. - A dissociation is a fork in the road: The partnership can either buy out the departing partner(s) and continue in business or wind up the business and terminate the partnership.

Transfer of Ownership

A partner cannot sell his share of the organization without the permission of the other partners.

Term partnership

A partnership in which the partners agree in advance how long it will last

Partnership at will

A partnership with no fixed duration - any of the partners may leave at any time, for any reason

LLC (Limited Liability Companies)

An LLC offers the limited liability of a corporation and the tax status of a flow-through entity.

Transferability of Interests

An a general rule, unless the operating agreement provides otherwise, existing members of an LLC cannot transfer their ownership rights, nor can the LLC admit a new member without the unanimous permission of the other members.

Flow-through tax entity

An organization that does not pay income tax on its profits but passes them through to its owners who pay the tax at their individual rates

Partnership

An unincorporated association of two or more co-owners who operate a business for profit

Liability

Each partner is personally liable for the debt of the enterprise whether or not she caused them. Thus, a partner is liable for any injury that another partner or an employee causes while on partnership business as well as for any contract signed on behalf of the partnership.

Formation (partnerships)

If two or more people do business together, sharing management, profits, and losses, they have a partnership, whether they know it or not, and are subject to all the rules of partnership law.

Formation

It is easy to form an LLC; the only required document is a charter.

Limited Liability Partnerships (LLP)

Limited Liability Partnerships (LLP): offer the limited liability of a corporation and the tax status of a flow-through organization. - Partners are not liable for the debts of the partnership, but they are liable for their own misdeeds. - To form an LLP, the partners must file a statement of qualification with state officials. LLPs must also file annual reports.

Going Public

Once an LLC goes public, it loses its favorable tax status and is taxed as a corporation, not a partnership.

General partner

One of the owners of a general partnerships

Professional Corporations

Professional corporations (PCs) are mostly a legacy form of organization. - PCs offer the limited liability of a regular corporation. - Therefore, the tax issues can be complicated and are a major reason why most professional groups now choose to be an LLC or an LLP.

Raising capital

The capital needs of the partnership must be provided by contributions from partners or by borrowing.

Duration

The current trend in state laws is to permit an LLC to continue in operation even after a member withdraws.

Partnerships are flow-through entities:

The partnership itself does not pay income tax, instead the profits pass through to the partners, who report it on their personal returns.

Limited Liability

The risk is only their investment, as if they were shareholders of a corporation.

Social enterprises

These organizations pledge to behave in a socially responsible manner

Managing partners or members of the executive committee

Those who take a lead role in running large partnerships

Management Rights

Unless the partnership agrees otherwise, partners share both profits and losses equally, and each partner has an equal right to manage the business.

Flexibility

Unlike S Corporations, LLCs can have members that are corporations, partnerships, or nonresident aliens.

Sole Proprietorship

an unincorporated business owned by one person