Chapter 15 The Entrepreneur s Options Learning Objectives

Chapter 15 The Entrepreneur’s Options

Learning Objectives q. What are the major forms of business organizations used by entrepreneurs in the U. S. ? q. What are the advantages and disadvantages associated with each form? q. Why have LLC’s and LLP’s become popular? q. What is a joint venture? What are other special business forms? q. What is a franchise and how is it created?

Introduction q. Entrepreneurs wishing to start a new business must be aware of advantages and disadvantages of various business entities for their endeavor. Consider: üEase of creation. üOwners’ liability. üTax considerations. üNeed for Capital.

Sole Proprietorships The owner is the business; anyone who does business without creating a separate business organization has a sole proprietorship. Advantages Owner is in complete control & receives all profits Disadvantages Owner is personally liable for all torts/contracts Flexibility Lacks continuity after death Ease of creation; maintenance Difficult to raise financing

Partnerships (General) Partnership is an association of two or more persons to carry on a business as co-owners for profit. (UPA). Advantages Easy to create and maintain Flexible, informal Partners share profits and losses equally Disadvantages Partners are personally liable for all torts/contracts Dissolved upon death Difficult to raise financing

Rights Among Partners q. In the absence of a partnership agreement (oral or written) state statutes govern the rights among partners: üManagement: equal, each one vote, majority wins; need unanimous consent for some actions. üPartnership Interest: equal profits, losses shared as profits shared.

Duties and Liabilities of Partners q Fiduciary Duties: Partners are fiduciaries and general agents of one another and the partnership. q Authority of Partners: Partners have implied authority to conduct ordinary partnership business but need unanimous consent to sell assets or donate to charity. q Joint Liability for Contracts. If Partner is sued for Partnership debt, Partner has right to insist that other partners be sued with her.

Duties and Liabilities of Partners q. Joint and Several Liability for Torts. üJSL means 3 rd party can sue either one or all partners. 3 rd party may collect against personal assets of all partners. q. Liability of Incoming Partner & Outgoing Partner. New admitted partner has no personal liability for existing partnership debts and obligations.

Limited Partnership q Agreement of two or more persons to carry on a business for profit with at least one general partner and one limited partner. q Limits the liability of some of its owners (the limited partners) to their investment. q LP is a creature of state statute. Filing a certificate with the Secretary of State is required.

LP – Rights and Liabilities q. The General partner assumes all management and personal liability. q. Limited Partner contributes cash but has no management rights. Liability is limited to the amount of investment. A limited partner can forfeit this “veil” of immunity by taking part in the management of the LP. q. Case Miller v. Dept of Revenue (1998).

LP -- Rights and Liabilities q. General partners are personally liable to 3 rd parties for breach of contract and tort liability. However, a corporation (or an LLC) can be a general partner and have limited liability. q. Limited partners have the right to inspect the LP’s books and be informed of the LP’s business.

Corporations q. Creature of statute. q. Separate legal “person. ” q. Owned by shareholders with limited liability up to the investment. q. Directors are elected by shareholders. q. Officers are hired by Directors. q. Double Taxed.

Limited Liability Companies q Like corporations, LLC’s are creatures of state law. The owners are called “members” (not shareholders) and their ownership is called an “interest” (not shares). q LLC’s are formed by filing Articles of Organization with the Secretary of State.

LLC Advantages & Disadvantages Advantages Disadvantages Member liability is limited to amount State statutes are not uniform. of investment. Can be treated as a “pass through” entity for tax purposes. Profits can be distributed to members without the double taxation of a corporation. Members pay personal income tax on received dividends. Not all states recognize LLC’s.

LLC Formation q. Articles of Organization require: üName of Business. üPrincipal Address. üName and Address of Registered Agent. üNames of the Owners; and üHow the LLC will be managed. q. Business name must include LLC or Limited Liability Company.

LLC Operating Agreement q. Operating agreement is analogous to corporation’s bylaws. q. Operating agreements may be oral and contain provisions relating to management, dividends, meetings, transfer of membership interests, and other significant issues. q. Generally, if the operating agreement is silent, courts will apply partnership principles. Case: Hurwitz v. Padden (1996).

Management of an LLC q. There are two options for management, generally set forth in the articles of organization: üMember-Managed: all of the members participate in management, like a partnership. üManager-Managed: members are elected to manage the LLC. q. If the articles are silent, statutes provide either that each member has one vote or votes are made based on percentage of ownership.

Limited Liability Partnerships q Creature of state statute, similar to an LLC, except that an LLP is designed for professionals who normally do business as a partnership (lawyers and accountants). q LLP allows partnership to limit personal liability of the partners but allows “pass through” tax advantages.

Liability in an LLP q. Recall that partnership law makes all partners jointly and severally for another partner’s tort, including personal assets. q. The LLP allows professionals to avoid personal liability for the malpractice of other partners. q. Supervising Partner is also liable for acts of subordinate.

Family Limited Liability Partnerships q. FLLP is a limited liability partnership in which the majority of the partners are related to each other. q. Used frequently for agriculture.

LP – Formation q Agreement of two or more persons to carry on a business for profit with at least one general partner and one limited partner. q Limits the liability of some of its owners (the limited partners) to their investment. q LP is a creature of state statute. Filing a certificate with the Secretary of State is required.

LP Management q. Only General Partners can manage but they have a fiduciary obligation to LP’s. q. LP’s enjoy limited liability as long as they do not engage in management functions. q. An LP will be liable to a 3 rd party if the 3 rd party believes, based on conduct, that the LP is a general partner.

LP – Rights and Liabilities q. The General partner assumes all management and personal liability. q. Limited Partner contributes cash but has no management rights. Liability is limited to the amount of investment. A limited partner can forfeit this “veil” of immunity by taking part in the management of the LP. q. Case Miller v. Dept of Revenue (1998).

LP -- Rights and Liabilities q. General partners are personally liable to 3 rd parties for breach of contract and tort liability. However, a corporation (or an LLC) can be a general partner and have limited liability. q. Limited partners have the right to inspect the LP’s books and be informed of the LP’s business.

LP -- Rights and Liabilities q On dissolution, the limited partner is entitled to return of capital contributions. q LP interests are considered securities and regulated by both federal and state securities laws. q Limited partners’ liability is limited to the capital investment.

Dissolution of the LP q Dissolved in much the same way as a general partnership (Chapter 33). q Retirement, withdrawal, death bankruptcy or mental incompetence of a general partner will trigger dissolution unless the remaining GP’s consent to continue. q Creditors are paid first then partners.

Limited Liability Limited Partnerships q. Limited Liability Limited Partnership is a type of limited partnership. q. Difference between LP and LLLP is that the general partner has limited liability, like a limited partner, up to the amount of investment. q. Most states do not allow for LLLP’s.

Special Business Forms q Joint Venture: two or more entities combine efforts or property for a single transaction or project. q Unless agreed otherwise, JV’s share profits and losses equally. q Common in international transactions when U. S. companies wish to expand overseas.

JV Characteristics q. Resembles a partnership and is taxed like a partnership. However, a JV is limited in time and scope, whereas a partnership is an ongoing business. Other differences: üJV members has less implied and apparent authority than partners. üDeath of JV member does not terminate JV. q. JV members can specify duration. If not, then JV terminates when purpose is accomplished.

Other Entities q Syndicate (Investment Group): group of individuals getting together to finance a particular project. q Joint Stock Company is a hybrid of partnership and corporation: (1) ownership represented by shares of stock; (2)managed by directors and officers of the company; and (3) can have a perpetual existence.

Other Entities q Business Trust is created by a written agreement setting forth the interests of the beneficiaries and obligations and powers of trustees. Legal ownership and management of property remains with trustees and profits distributed to the beneficiaries. q Cooperative is an association organized to provide a not-for-profit service to members.

Private Franchises q Franchisor (Owner of trademark, trade name or copyright) licenses Franchisee to use the trade mark, trade name or copyright in the sale of goods or services. q Types: ü Distributorship. ü Chain Style Business Operation. ü Manufacturing or Processing Arrangement.

Private Franchises q. Laws Governing Franchising üGoverned by commercial sales and contract law. If franchise is primarily for the sale of goods, UCC Article 2 governs. üState and federal laws regulate franchising to protect franchisee. q. The Franchise Contract üThe contract states parties’ rights and duties and can include an exclusive “territory” to market goods/services.

Private Franchises q. Franchise Contract üFranchise contract can specify Franchisee’s type of business entity including capital structure, sales quotas and record keeping. üQuality Control is a legitimate issue for Franchisor because of good will, reputation and trademark value. üCourts will not question Franchisor’s strict supervision but Franchisor may be liable for torts of agents.