Copyright Atomic Dog Publishing, 2006

Copyright Atomic Dog Publishing, 2006

Chapter 8Business Legal Forms


8-1 Introduction

• Capital, revenue and cost are deeply intertwined—actions taken to modify one component usually have an effect on the other two.

• Launching a new venture normally requires an infusion of capital during the early stages. Before capital can be raised, the venture must

establish a legal form that will enable it to solicit and raise debt or equity capital.

All entrepreneurs must decide what type of legal form they should use as the structural basis of their company.


8-2 Sole Proprietorship

• Oldest, common form of private business ownership in the United States—owned and managed by one individual. The person may receive help from others in operating

the business but is the only owner. In the eyes of the law, the sole proprietor is the

company. The sole proprietor owns a small service or retail

operation and is usually an active manager. The owner provides the capital needed to start and

operate the business—personal savings or borrowed money.

Managerial ability accounts for the success or failure of the business.


8-2a Advantages of a Sole Proprietorship

• Advantages of a sole proprietorship include: Ease of starting Control Sole participation in profits and losses Use of owner’s abilities Tax breaks Secrecy Ease of dissolving


8-2b Disadvantages of a Sole Proprietorship• Disadvantages of a sole proprietorship include:

Unlimited liability Difficulty in raising capital Limitations in managerial ability Lack of stability Demands on time Difficulty in hiring and keeping highly motivated

employees


8-3 Partnership

• Partnership law in the United States has been derived from the Uniform Partnership Act (UPA). The more recent Revised Uniform Partnership Act

(RUPA) was approved in 1994—in line with modern business practices and trends; retaining many of the valuable provisions in the original act.

It was amended in 1997 to provide limited liability for partners in a limited liability partnership.

• Section 6 Uniform Partnership Act defines partnership as “an association of two or more persons to carry on as co-owners of a business for profit.”


8-3 Partnership (cont.)

Partnership can be based on a written contract or a voluntary and legal oral agreement.

Partnership is similar in many respects to a sole proprietorship.

Co-owners share everything, including the risk, hard work, assets, and profits.


8-3a Partnership Types

• There are three major partnership types: General partnership: A business with at least one

general partner who has unlimited liability for the debts of the business. - They have the authority to act as an owner.- They can engage the partnership in binding agreements.- The partnership is responsible for all actions of each

owner. Limited partnership: Has at least one general partner

and one or more limited partners.- Limited partnerships are usually found in service

industries or in professional firms such as real estate and dentistry.

- They are also used extensively to enable various international arrangements.


8-3a Partnership Types (cont.)

Joint venture: A special type of partnership established to carry out a special project or to operate for a specific time period. - A joint venture in the United States or abroad is less

than the ordinary partnership; continues as a business. - There is some confusion among the courts as to

whether a joint venture is a partnership.- Working in a joint venture with an international partner

can make it easier to enter foreign markets.


8-3b Advantages of a Partnership

• Advantages of a partnership include: Greater access to capital Combined managerial skills Ease of starting Clear legal status Tax advantages


8-3c Disadvantages of a Partnership

• Disadvantages of a partnership include: Unlimited liability Potential disagreements Investment withdrawal difficulty Limited capital availability Instability


8-4 Limited Liability Company

• The limited liability company (LLC) is a relatively new legal form that has now been adopted in all fifty states. The LLC limits the liability exposure of all investors to

the amount of their investment. - Anyone can participate in the management and still have

limited liability protection. To form a limited liability company (LLC), business

owners must file formal articles of organization with their state's LLC filing office and comply with other state filing requirements.- LLC can have an unlimited number of investors, known

as members. - It is also required to prepare an operating agreement.


8-4a Advantages of a Limited Liability Company

• Advantages of a limited liability company include: Limited liability Pass-through taxation Investors can manage Unlimited membership Ease of organizing


8-4b Disadvantages of a Limited Liability Company

• The disadvantages of an LLC are due primarily to its relatively recent adoption by state legislatures. Many people still don’t understand it well, and courts

have only begun to form a record of common law.

• Other disadvantages include: Difficulty raising money No continuity of life Limited transferability


8-5 Corporation

• Corporation: Artificial legal entity typically chartered by a state is formed to operate a business. The corporation is completely separate from its owners Has its own life Is liable for its own debts Must pay its own taxes

• Two types of corporations exist: C-corporation—more commonly known.

- It is the legal structure for many of the largest companies in the world.

- A C-corporation files and pays corporate income taxes directly.


8-5 Corporation (cont.)

- If the entrepreneur plans to retain profits to finance growth, repay debt, or make other capital expenditures then a C-corporation form makes sense.

- C-corporations can take advantage of corporate income tax rates.

- The C-corporation status has the ability to provide greater flexibility in terms of planning and controlling federal income taxes.

- C-corporations also can deduct the cost of certain fringe benefit packages.

- The C-corporation is taxed twice on its profits—double taxation.

- C-corporation has advantages for fund-raising because it is the only business form that is allowed to sell both common and preferred stock.



• The Omnibus Budget Reconciliation Act of 1983— S-corporation—uses noncorporate tax rates at the request of the shareholders. To qualify as an S-corporation, a business must meet

the following requirements:- It must be incorporated within the United States.- It can only sell shares of common stock.- All shareholders must be residents of the United States.- Shareholders must be natural persons, estates, or

trusts.- No shareholder can be a partnership or a corporation.- Some states limit the number of shareholders.- No more than 20 percent of its income can come from

passive activities.



S-corporation has advantages and disadvantages. - Primary advantage—The shareholders’ tax brackets can

result in tax savings. - Primary disadvantage—The tax law governing the

S-corporation is very complex.

• Corporations can change legal form from S-corporation status to C-corporation status fairly easily, but there are costs involved.


8-5a Advantages of a Corporation

• Advantages of a corporation include: Limited liability Skilled management team Transfer of ownership Greater capital base Stability Legal-entity status


8-5b Disadvantages of a Corporation

• Disadvantages of a corporation include: Difficulty and expense of starting Lack of control Multiple taxation and fees Lack of secrecy Lack of personal interest Credit limitations


8-6 Nonprofit Corporation

• Many organizations are nonprofit corporations—not profit-seeking enterprises. This includes universities and other schools, charities,

churches, volunteer organizations, credit unions, country clubs, government organizations, cooperatives, and a number of other organizations.

• Nonprofits have to make a profit in order to continue to operate. However they are prohibited by law from distributing

earnings (paying dividends) to owners. Donations, dues, and the sale of goods or services

provide the funds to pay employees and finance operations.

Copyright Atomic Dog Publishing, 2006

Documents

limited liability

3a partnership

sole proprietorship

sole proprietorship

legal form

partnership

united states

general partner