Ch 31- Starting a Business LLCs and Other Options Textbook PDF

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Professor Betanzos
Textbook: Business Law and the Legal Environment...

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Ch 31- Starting a Business: LLCs and Other Options Textbook Wednesday, November 18, 2020

11:24 AM

Chapter 31 I. Sole Proprietorships a. Introduction i. The most common form of business ii. Sole Propiertoship: An unincorporated business owned by 1 person iii. Advanages of sole propietorship: 1) Ease of formation: No formal steps are necessary to creat a s.p. 2) Taxes: A sole propietorship is a flow-through tax entity (an organization that does not pay income tax on its profits bu instead passes them through to its owners who pay personal income tax on all business profits.) iv. Disadvantages of sole propietorship: 1) Liability: As the owner of the business, Linda is responsib for all of its debts. If the company can't pay its suppliers o someone is injured, Linda is personally liable. She may have to sell her house to pay the debt. 2) Limited Capital: the owner of a s.p. has limited options for financing her business. Debt is generally her only source working capital b/c she has not stock or memberships to sell. For this reason, sole proprietorship works best for business w/o large capital needs. II. CORPORATIONS: They are the dominant form of organization b/c they have been around for a long time--> they are numerous and the law regulates them is well developed and offer some significant advantages t their owners. a. Corporations in General i. Advantages of a Corporation 1) Limited Liability: if a business flops, its shareholders los their investment in the company but not their other assets

their investment in the company but not their other assets Limited liability doesn't protect against all debts, individua are always responsible for their own acts. A corporation shields managers and investors from personal liability for the debts of the corporation and the actions of others, but not against liability for their own torts and crimes. 2) Transferability of Interests- Corporations provide flexibility for enterprises small (w/ one owner) and large (w/thousands of shareholders). Partnership interests are not transferable w/o the permission of the other partners, whereas corporate stock can be bought and sold easily. 3) Duration: When a sole propietor dies, legally, so does their business. But corporations have perpetual existence they can continue w/o their founders. ii. Disadvantages of a Corporation: 1) Logistics: Corporations require expense and effort to crea and operate. The cost of establishing a corp includes lega and filing fees and the expense of annual filing and taxes. Corps must also hold meetings for both shareholders and directors. Failure to comply w/ these requirements can destory the limited liability of the organization 2) Taxes: Limited Liability companies (LLCs)- taxes paid directly by owners. b. Special Types of Corporations: Both the federal tax code and stat laws allow for special types of corporations. i. S Corporations- A corporation that provides limited liability to owners and the tax status of a flow-through entity. 1) Congress created "S corps" to encourage entrepenurship through tax breaks 2) All of an S corp's profits (and losses) pass through to the shareholders, who pay tax at their indivial rates. It avoids the double taxation of a regular corp ("C Corp) 3) C Corporation: A corporation that provides limited liability to its owners, but is a taxable entity. 4) S Corps do face some major restrictions: a) There can be only one class of stock b) There can be no more than 100 shareholders. c) Shareholders must be individuals, estates, charities,

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pension funds, or trusts, not partnerships or corporations. ii. 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 some state laws. 1) Although the rules of close corporations may vary fro state to state, generally these organizations share certain features: a) Protection of minority shareholders: A minority shareholder who is being mistreated by the majority cannot simply sell his shares and depart. Therefore, close corporation laws typically protect minority shareholders by providing that majority shareholders owe them a fiduciary duty. b) Transfer restrictions: The shareholders of a close corporation often need to work closely together in the management of the company. Therefore, the charter may require that a shareholder first offer shares to th others before selling them to an outsider. In that way the remaining shareholders have some control over who their new co-owners will be. c) Flexibility: Close corporations can typically operate without a board of directors, a formal set of bylaws, o annual shareholder meetings. d) Dispute resolution: The shareholders are allowed t agree in advance that any one of them can dissolve the corporation if some particular event occurs, if the choose, for any reason at all. Even w/o such an agreement, a shareholder can ask a court to dissolve a close corporation if the other owners behave "oppresively" or "unfairly"

III. LIMITED LIABILITY CORPORATIONS: An LLC offers the limited liability of a corporation and the tax status of a flow-through entity. As such, it is an extremely useful form or organization often favorerd by entrepreneurs bc it offers the best of both worlds- limite liability and lower taxes. a. Formation:

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i. It is easy to form an LLC; the only required document is a certificate of organization (charter). It's short, continuing bas info like name and address, must be filed w/ the secretary of state in the jurisdiction in which the LLC is being formed. ii. An LLC should have an operating agreement that sets out the rights and obligations of the members. Not required, bu can be very helpful. If an LLC doesn't have an operating agreement, then the default provisions of the state's LLC statut govern the organization. Flexibility: Unlike S Corporations, LLC's can have member that are corporations, partnerships, or non-resident aliens. LLC's can also have different members of classes. Unlike corporations, LLC's are n required to hold annual meetings or maintain a minute book. Transferability of Interests: As a general rule, unless the operatin agreement provides otherwise, existing members of an LLC cannot transfer their ownership rights, nor can the LLC admit a new membe w/o the unanimous permission of the other members. However, members can transfer their economic interests in an LLC- that is, the right to share in the profits of the enterprise. In other words, membe can transfer their right to receive a check from the LLC, but not their right to participate in decision making. Duration: Some state laws provide that LLCs automatically dissolv upon the withdrawal of a member (owing to, for example, death, resignation, or bankruptcy). However, more state laws or the ULLCA provide that an LLC has perpetual existence and, thus, continues in operation even after a member withdrawals. Unless, that is, the operating agreement provides otherwise. Going Public: Once an LLC goes public, it loses its favorable tax status and is taxed as a corporation, not as a partnership. Thus, the is no advantage to using the LLC form of organization for a publicly traded company. And there are some disadvantages: Unlike corporations, publicly traded LLCs do not enjoy a well-established s of statutory and case law that is relatively consistent across the man states. For this reason, privately held companies that begin as LLCs often change to corporations when they go public. Changing Forms: Some companies that are now corporations might prefer to be LLCs. However, the IRS would consider this change to be a sale of the corporate assets and would levy a tax on the value th t F thi f ti h d th

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these assets. For this reason, few corporations have made the change. However, switching from a partnership to an LLC or from an LLC to a corporation is not considered a sale and does not have the same adverse tax impact. g. Piercing the Company Veil: Limited Liability is one of the great advantages of an LLC. However, if members abuse their rights, a court may remove their limited liability. This process is called piercin the company veil. A court may pierce an LLC's veil in 4 circumstances: i. Failure to observe formalities: Members must treat the LLC like separate organization. Thus, if an LLC enters into an agreeme a legitimate contract needs to be signed. ii. Commingling Assets: This trap is the most dangerous iii. Inadequate Capitalization iv. Fraud h. Legal Uncertainty: i. Choces: LLC versus Corporation

IV. SOCIAL ENTERPRISES: These organizations pledge to behave in a socially responsible manner even a they pursue profits, they are NOT nonprofits. Their focus is on the triple bottom line: "people, plant, and profits." In other words, they must create value for some combination of their stakeholders (employees, suppliers, customers, creditors), their community, the environment, and their investors. To supply with the Model Benefit Corporation Act, an organization must: 1. State in its charter that it is a benefit corporation 2. Obtain approval of its charter from 2/3 of its shareholders. 3. Measure its social benefit using a standard set by an objective 3rd party, and 4. Prepare an annual benefit report assessing its performance in creating a public benefit

V. General Partnerships: 1. Partnership: An unincorporated association of 2 or more co-owners who operate a business for profit. 2. General Partner: One of the owners of a general partnership. A. Tax Status:

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