CLASS #4 CHAPTER 19: FORMS OF BUSINESS ORGANIZATIONS
Sole proprietorships
--Simplest and most prevalent form of business enterprise --One individual owns all of the assets of the business and is solely and personally liable for all of its debts, contract obligations, and tort liabilities --Name must be registered with the state if it is any name other than the name of the owner --Ends on the discontinuation of the business or death of proprietor
B-Corps two purposes
1. Profits for shareholders 2. Creation of general public benefits However, no duty to maximize shareholder value just cant purposefully make it bad.
Master Limited Partnerships
A business structure that is currently available to a select group of entities, primarily mineral or natural resource companies --Raises money on public exchanges and doesn't pay income tax at the corporate level i.e it is a pass-through entity --Investors are insulated from liability and can publicly trade their shares --Shareholders have fewer rights than in a typical corporation --Tax laws very complex with various law that prohibit or limit certain entities, such as mutual funds, from investing.
Low Profit Limited Liability Companies
A low profit company that can distribute its profits to investors while serving a philanthropic purpose --"A for profit company with a nonprofit soul" --L3Cs must have a primarily charitable purpose --Major criticism is that they evade the striter disclosure requirements imposed on tax-exempt entities (501(c)s) --It is not clear that L3Cs can accept investments from private foundations that those foundations could not make in LLCs (though that is one of the main reasons L3Cs were developed)
Uniform Limited Partnership Act
A person who contributes capital thinking they are limited partners wont be liable as general partners if they renounce their interest but could be liable to third parties before the certification limited partnership was filed
B-Corps Required to consider effects of actions on:
Ability to accomplish purpose, shareholders, employees, customers, community, environment, short and long term interests.
Advantages of General Partnership
Allows for a wide variety of operatinal and profit-sharing arrangements --Only subkect to one level of tax --report indivudal returns to be taxed as personal income --***Pass through entity - passes income on to the owners and/or investors. Flow-through entities are a common device used to limit taxation by avoiding double taxation. Only the investors/owners are taxed on revenues, not the entity itself.
Corporations
An organization authorized by state law to act as a legal entity distinct from its owners owned by shareholders --Board of directors is elected by shareholders and has central decision making authority Corporate charter --C Corporations --S Corporations --Close Corporations --Closely Held Corporation
Ability to raise venture capital for C-Corporation
Are used to raise money from venture capitalists instead of tax advantages from pass through entities for 2 reasons: --Most venture capital firms raise money from large insitutional investors such as pension funds, university endowments, and such. Nonprofit can only raise this capital tax-free from a issuer of securities that is NOT a pass-through entity --Second, Most start-ups want the abiltiy to sell securities to outside investors at a significantly higher price than was paid by the founders at the outset. In order to avoid having some of the value of the founders' shares treated as employee compensation, companies issue two classes of stock : Common stock to the founders and preferred stock to outside investors. And, S corps cant do this because only issue one type of stock
Important distinctions for tax considerations
C-Corp worse for taxes because no pass-through entity, so gets taxed twice while LLC and partnership are able to distribute appreciated value tax-free and S corporations only tax it at the shareholder level.
Formation of General partnership
Can be created with nothing more than a handshake and a general understanding between the partners --Intention of one party alone cant create a partnership --Doesn't require a minimum amount of capital for fromation --Doesn't need to be given a name
General Partnership With a written agreement
Can overide many of the provisions of partnership statutes that could turn out to be undesirable to the partners Agreement usually includes: Term of existence, capital characteristics, division of profits and losses between partners, partnership slaries or withdrawals, duties of partners, consequences if a partner decides to sell their interest or become uninvolved in another way
Limited Liability Companies
Combines the tax advantages of pass through entity with the limited liability advantages of a corporation --Articles of organization / certificate formation must be filed with state agency --Owners of the company are called members, members elect managers to operate the business, managers appoint officers --Must include the words L.L.C. - certificate of formation-Delaware, or articles of organization-Cali
4 and 2
Companies must elect benefit corporation status within____ years of the first effective date of legislation in their state of incorporation or ____ years of initial certification, whichever is later.
how to reduce double taxation
Corporate income can be offset by tax deductible payments to shareholders like interest payments or employee compensation payments --Tax liability of the shareholders can be reduced to the extent the business retains it's earnings instead of distributing them Operating losses- can help reduce it when deducted with taxes lower net income
Close Corporation
Corporation that has elected to be a close corporation (by stating in its certificate of incorporation that it is such) and has a small number of shareholders, typically no more than thirty --Has the ability to alter certain typical corporation proceedings via shareholder voting --Most close corporations can manage the corporation directly (instead of delegating that responsibilty to managers or directors), so long as certain percentage of the shareholders agree to this in writing.
General Partnership
Created when two or more persons agree to place their money, efforts, labor, or skills in a business and to share the profits and lossess --Agreement can be express or implied --Must share in real profits, not just wages/compensation --Each may have the authority to bind the partnership with respect to third parties --partnership can acquire property in the name of the partnership, not just in the name of the partners --Up to any majority holding partners on whether to continue the general partnership within 90 days of the death, bankruptcy, or withdrawal of the other partner
Fiduciary Duties of LLCs managers
Delaware - Managers and controlling members of an LLC owe a fiduciary duty of care and loyalty to the LLC and its members --New York - Managers of an LLC have a fiduciary duty to the limited liability company and sometimes directly to other members of the LLC --California - Operating agreement may not eliminate the duty of loyalty or obligation of good faith and fair dealing and duty of care.
Limited Liability Partnerships
Designed primarily for groups of professionals such as law or accounting firms --can be granted without significant modification of the business's partnership agreement --Retain pass-through taxation treatment --Limited liability refers to the fact that partners are only liable for their own malpractice, negligence, or wrongful conduct and can't be vicariously liable for the misconduct or malpractice of another partner --Some states protect their partners from commercial liabilities (such as trade debt)
Operation of a General Partnership (unless written agreement stating otherwise)
Direct owner management and control of business -- each partner's assets are vulnerable to the decisions of the fellow partners --Unless specified otherwise, partnership law requires agreement from all partners for anything --Each partner is an agent of the partnership and all partners are liable for debts incurred as it was incurred with EXPRESSED AUTHORITY.
Uniform Partnership Act
Even without a written agreement partners share profits if working together in a general partnership.
Advantages of Sole Proprietorships
Flexibility afforded by having one person in complete control --Easiest and least costly form of business organization to set up --Pay only one level of income taxes --Proprietor receives all profits generated by the business
Benefit Corporations
For-profit corporations that use the power of business to solve social and environmental problems --Need to have a purpose of creating general public benefit in addition to other corporate purposes --Must distribute annual benefit report outling the social and environmental performance benchmarked against a third-party standard --No duty to maximize shareholder value --Required to consider effects of actions on: Ability to accomplish purpose, shareholders, employees, customers, community, environement, short and long term interests. --Must have two primary purposes profits for shareholders and creation of general public benefits --B Lab certifies "B Corps as meeting their standards for scial performance. Companies must elect benefit corporation status within four years of the first effective date of legislation in their state of incorporation or two years of initial certification, whichever is later.
Closely Held Corporation
Has a small number of shareholders and it is characterized by the absence of a market for its stock --Greater duty of loyalty and care on the corporation's directors and majority shareholders.
Needed to qualify for a S-Corporation
In order to qualify you: Can't have more than 100 shareholders --Must have only one class of stock --Must be domestic --Must file a timely election signed by all shareholders to be treated as an S corporation --Must not be ineligible i.e. financial institution, insurance company, or domestic international sales companies
Disadvantages of General Partnership
Individual partners are subject to personal liability for the obligations of the partnership Creditors of the partnership have claims against the assets of individual partners
Income Tax Considerations
Internal Revenue Code of 1986 - comparing taxable entries with pass-through entities
Winding up (part of dissolution) of general partnership
Involves setting accoounts and liquidating assets of the partnership for the purpose of making distributions and terminating the concern --- partnership continues through process as do fiduciary duties
Limited Liability Companies advantage to S Corporations
Lack of restrictions on shareholders and the ability to have more than one class of securities
Advantages of Corporations
Liability of shareholders is limited to their investments --Ability to raise significant capital by selling transferable ownership shares of corporate stock to investors --Perpetual life i.e. the corporation continues to exist even when shares or investors decide to sell their interest
Disadvantages of Limited Partnerships
More difficult to create than a general partnership --Needs certification
Joint Venture Differences From General Partnership
NOT a continuing relationship ends when project is finished So, authority to bind one member in partnership is more limited than general partnership, so should make it clear to third parites that it is not a partnership. This distinction should be reflected in the entity's name and in the recitation of its legal status in its contracts
Formal requirements for Limited Partnerships
Needs a certificate of limited partnership to be filed with state authority but also needs to designate the limited partners
Capitalization on C Corps
No tax laws impose restrictions on their Capitalization. Tax treatment of each type of capital instrument may differ from its classification by the corporation e.g debt can be treated as stock if the corporation has too little equity capital and "interest payments" may be classified as non-deductible dividends instead that are taxable to the shareholders
Termination (part of dissolution and winding up) of general partnership
Occurs when all the partnership affairs are wound up and the partners' authority to act for the partnership is completely extinguished
Dissolution of general partnership
Occurs when the partners no loner carry on business together. Can happen because the partnership was formed unlawfully. Must finish all current work before dissolution
Ability to raise venture capital for partnerships, LLCs and S corps
Offer many tax advantages however they are rarely used for a business that intends to raise venture capital
Joint Ventures
One time partnership of two or more parties for a specific purpose Similar to general partnership, Joint Venture requires that the parties: --Share a community of interest -- Have the mutual right to direct and govern --Share the partnership's profits and losses --Combine their property, money, effort, skill, or knowledge in the undertaking
Limited Participation in limited Partnerships
Only reserved for partners that do not control the business If they have a voice in company open themselves up for liability beyond original capital investment Name cant appear in the name of partnership
Fiduciary duty of general partnership
Partners owe each other a duty of loyalty and a duty of care and must carry them out with the obligation of good faith and fair dealing
Main advantage of Limited Partnerships
Partnership is created to attract investors with the assurance of limited liability
Disadvantage of Sole Proprietorships
Proprietor loses all money in the event of a loss --Heightened risk --More difficult to raise capital
S-Corp Allocation of losses
S Corporation is even more limited than C-Corp since it has only one classification of stock and must allocate strictly in proportion to stock ownership
C Corporation property transfers
Since it is a taxable entity, the transfer of any kind of property is a taxable transaction
Limited Partnerships
Special type of partnership consisting of general partners and limited partners --General partners remain jointly and severally liable for partnership obligations and are responsible for the management of the partnership --Limited partners assume no liability for partnership debts beyond the amount of capital they have contributed and have no right to participate in the management of the partnership
How start-ups raise more money
Start-ups want to sell securities to outside investors at a higher price than originally owned by founders, so issue two stocks common stocks to founders and Preferred stock to outside investors
S Corporations taxes on appreciated value
Taxable income is passed through and will be taxed only at shareholder level.
Limited Liability Companies Advantages
Taxed as partnerships --can limit their liability to the amount invested --All owners can participate fully in the management of the business --Flexible allocations of profits and losses --Lack of restrictions on shareholders and the ability to have more than one class of securities --No limit on the number of members it can have --Investors can be corporations, partnership, and foreigners
S Corporations
Taxed as pass through entity i.e. shareholders pay tax on their pro rata shares of the corporation's income
Pass through entity
Term for General Partnership meaning that it passes income on to the owners and or investors. Common device used to limit taxation by avoiding double taxation. Only the investors/owners are taxed on revenues, not the entity itself
C-Corp Allocation of losses
There is no comparable allocation of losses
Allocation of losses for Partnerships and LLCs
They can allocate income or loss to specific partners to generate a valuable tax deferral for that member
C Corporations
Two levels of taxation, both corporate and shareholder --Pays tax on income generated by the business and the shareholders pay tax on that same income when it is distributed as dividends
Limited Liability Copmanies advantage to limited partnerships
Unlike the general partners even the controlling members in limit their liability to the amount invested
C-Corp Cash distribution
When receiving cash the income is taxed at the corporate level when earned, and taxed again at the individual level when distributed.
Corporate charter
articles of incorporation or certificate of incorporation: most charters give corporations the broad power to engage in any lawful business. Corporations are owned by shareholders.
Partnership or LLC
easiest corporations to distribute tax-free appreciation of value for a property compared to a corporation
C Corporation taxes on appreciated value
when a any liquid asset appreciates in value there is a corporate taxes and shareholder taxes