Entre Chapter 13

B Corporation

The B Corporation is also known as a benefit corporation, a for-profit entity with a social mission.While these organizations are very similar to other for-profit organizations, they do differ in a number of important ways: purpose, accountability, and transparency.

Questions to ask before deciding on legal form

1. Does the founding team have all the skills needed to operate this venture? 2. Do the founders have the capital required to start the business alone or must they raise it through equity capital or debt? 3. Will the founders be able to run the business and cover living expenses for the first year? 4. Are the founders willing and able to assume personal liability for any claims against the business? 5. Do the founders wish to have complete control over the operations of the business? 6. Do the founders expect to have initial losses or will the business be profitable almost from the beginning? 7. Do the founders expect to sell the business some day?

buy-sell agreement

A buy-sell agreement is a binding contract between the partners. It contains three primary clauses that govern the following issues: 1. Who is entitled to purchase a departing partner's share of the business? May only another partner do so, or is an outsider permitted to buy in? 2. What events can trigger a buyout? Typically, those events include a death, disability, or other form of incapacity; a divorce; or an offer from the outside to buy the partner out. 3. What price will be paid for the partner's interest? Having these issues decided from the beginning prevents disagreements and legal battles with the departing partner or with the estate of a deceased partner.

Types of Legal Structures

All businesses operate under one of four broad legal structures— sole proprietorship, partnership, limited liability company, or corporation.

S-corporation

An S-corporation, unlike the C-corporation, is not a tax-paying entity. It is merely a financial vehicle that passes the profits and losses of the corporation to the shareholders. It is treated much like a sole proprietorship or a partnership in the sense that if the business earns a profit, that profit becomes the income of the owners/shareholders, and it is the owners who pay the tax on that profit at their individual tax rates. In this way, it avoids the double taxation found in the C-corporate structure. However, in all other respects it operates under the same requirements as the C-corporation. You will need to file articles of incorporation, have a board of directors, hold an annual shareholders' meeting, keep corporate minutes, and hold shareholder votes on major decisions. Approximately six states tax S-corporations like regular corporations, so it is important to check with the tax division of the state in which you will do business to find out if a tax will be imposed. The S-corporation permits business losses to be passed through and taxed at the owner's personal tax rate. This offers a significant benefit to people who need to offset income from other sources. The businesses that benefit most from an S-corporation structure are those that don't have a need to retain earnings. You should probably not elect the S-corporation option if you want to retain earnings for expansion or diversification, or if there are significant passive losses from investments such as real estate. This is because unless the business has regular positive cash flow, it could face a situation in which profit is passed through to the owners to be taxed at their personal rate, but the firm has generated insufficient cash to pay those taxes, so they must come out of the pockets of the shareholders. Furthermore, although most deductions and expenses are allowed, S-corporations cannot take advantage of deductions based on medical reimbursements or health insurance plans.

C-Corporation

Even the most traditional of legal forms—the corporation—has evolved over time. Yet it remains the most commonly chosen legal structure for a growing company that seeks outside capital in the form of equity or debt. Because it is a legal entity, the corporation can enter into contracts, sue, and be sued without the signature of the owners. The C-corporation offers several important advantages. It enjoys limited liability in that its owners are liable for its debts and obligations only to the limit of their investment. Corporations typically enjoy more status and deference in business circles than do other legal forms, principally because they are a legal entity that cannot be destroyed by the death of one—or even all—of the principal shareholders. Corporations do, however, have disadvantages that must be carefully considered. They are certainly more complex to organize, are subject to more governmental regulation, and cost more to create than sole proprietorships or partnerships. A more cumbersome disadvantage derives from the fact that the corporation is literally a person for tax purposes. Consequently, if it makes a profit, it must pay a tax, whether or not those profits were distributed as dividends to the shareholders. And, unlike partners or sole proprietors, shareholders of C-corporations do not receive the pass-through benefit of losses (the S-corporation does enjoy these benefits).

nonprofit corporation

It is not outside the realm of possibility for a nonprofit corporation to be a high- growth, world-class company; however, it is not generally started with that goal in mind. A nonprofit corporation is a corporation established for charitable, public (scientific, literary, or educational), or religious purposes, or for mutual benefit (such as trade associations, tennis clubs), as recognized by federal and state laws. Nonprofit organizations offer many advantages to entrepreneurs seeking to be socially responsible or just to start a business doing something they love that helps others. The nonprofit with tax-exempt status is attractive to corporate donors, who can deduct their donations as a business expense. The nonprofit can seek cash and in-kind contributions of equipment, supplies, and personnel. It can apply for grants from government agencies and private foundations. The nonprofit may qualify for tax-exempt status, which means that it is free from paying taxes on income generated from nonprofit activities. There are a few disadvantages to a nonprofit organization. For example, profits earned by the corporation cannot be distributed as dividends, and corporate money cannot be contributed to political campaigns or used to engage in lobbying. In forming the nonprofit corporation, the entrepreneur gives up proprietary interest in the corporation and dedicates all the assets and resources of the corporation to tax-exempt activities. If a nonprofit corporation is ever dissolved, its assets must be distributed to another tax-exempt organization. This means that the nonprofit form is not suitable for ventures that need to access the capital markets either public or private. Finally, the nonprofit cannot make substantial profits from unrelated activities, and it must pay taxes on the profits it does make.

Sole Proprietorship

More than 76 percent of all businesses in the United States are sole proprietorships, probably because the sole proprietorship is the easiest form to create. In a sole proprietorship, the owner is the only person responsible for the activities of the business and, therefore, is the only one to enjoy the profits and suffer the losses. A sole proprietorship enjoys several advantages. First, it is easy and inexpensive to create. It gives the owner 100 percent of the company and 100 percent of the profits and losses. The owner also has complete authority to make decisions about the direction of the business. In addition, the income from the business is taxed only once, at the owner's personal income tax rate, and there are no major reporting requirements such as those imposed on corporations. There are, however, some distinct disadvantages that deserve serious consideration. The sole proprietor has unlimited liability for all claims against the business; that is, any debts incurred or judgments must be paid from the owner's assets. Therefore, the sole proprietor puts at risk his or her home, bank accounts, and any other assets. In today's litigious environment, exposure to lawsuits is substantial. Another complication associated with a sole proprietorship is that the business's ability to survive is dependent on the owner; therefore, the death or incapacitation of the owner can be catastrophic for the business if the owner did not transfer ownership through a will.

The traditional view of legal forms

The traditional view of legal forms was that you started your business as a sole proprietor and then changed to a partnership or corporation as your business grew and you required more protection. A study done by the SBA Office of Advocacy found that this view is now out of date

Partnership

When two or more people agree to share the assets, liabilities, and profits of a business, the legal structure is termed a partnership. The partnership form is an improvement over the sole proprietorship from the standpoint that the business can draw on the skills, knowledge, and financial resources of more than one person. There are two types of partnerships: general and limited. In a general partnership, all the partners assume unlimited personal liability and responsibility for management of the business. In a limited partnership, by contrast, the general partners have unlimited liability, and they seek investors whose liability is limited to their monetary investment. Partnerships have all the advantages of sole proprietorships plus the added advantage of sharing the risk of doing business. Partnerships also suffer from several disadvantages that you should consider carefully before choosing this form. Partners are personally liable for all business debts and obligations of the partnership, even when individual partners bind the partnership to a contract or other business deal. Although the law does not require it, it is extremely wise for a partnership to draw up a written partnership agreement, based on the Uniform Partnership Act, which spells out business responsibilities, profit sharing, and transfer of interest. This is advisable because partnerships are inherently fraught with problems that arise from the different personalities and goals of the people involved. A written document executed at the beginning of the partnership will mitigate eventual disagreements and provide for an orderly dissolution should irreconcilable differences arise.