Basic Business Organizations Class 7

Starting a Business The first question: What form should the business take? Sole proprietorship Partnership Limited liability company Corporation

Choosing the Form Consider Formation issues Liability protection Management structure Taxation considerations Exit strategies/transferability of interests

Sole Proprietorship The most common form of business organization. One (sole) owner (or – in WA – a married couple) Business does not have to be registered with the secretary of state Profits and losses are the personal profits and losses of the owner and are taxed as such Personal assets of owner are available to satisfy debts of the business

Advantages Owner is in complete control & receives all profits Flexibility Ease of creation; maintenance

Disadvantages Owner is personally liable for all torts and contracts Lacks continuity after death Difficult to raise financing

An Example Child care provider Wants to work out of her house How does she form this business? What legal process is required? http://www.access.wa.gov/business/index.aspx http://www.sba.gov/aboutsba/sbaprograms/onlinewbc/index.html

Partnership There are three kinds of partnership General Partnership Limited Partnership Limited Liability Partnership

Uniform Act Washington has adopted the Revised Uniform Partnership Act The statute governs to Determine whether a partnership exists Fill in the missing terms of a partnership agreement http://apps.leg.wa.gov/RCW/default.aspx?cite=25.05

Partnership Association of 2 or more persons to carry on as co-owners of a business for profit. More than one common owner Governed by contract Profits and debts are shared by the partners Partners share in management of business

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 of any one partner Difficult to raise financing

Partnership Responsibilities Partners have a fiduciary duty to the partnership and each other. Liable to the partnership for intentional misconduct or gross negligence Cannot compete with the partnership May not take an advantage from the partnership without consent of the partners In case of conflict of interest, partnership profits must be given to the partnership

Joint Liability Because a general partnership is considered a single business entity, the partners are all liable for the acts of any partner Personal property of each partner may be used to satisfy the debts of the partnership

Termination Dissolution by Acts of the Partners Withdrawal of any partner from the partnership Agreement of the partners Dissolution by Operation of Law Death of a partner Dissolution by Judicial Decree

Limited Partnership In a limited partnership, at least one of the partners does not share in the right to manage the business The limited partner invests money, but has no decision-making authority The liability of the limited partner is limited to his or her investment in the business

Limited Liability Partnership An LLP is a kind of general partnership that is governed by statute The difference between general and limited liability partnerships is that in an LLP the partners are not liable for the debts of the partnership Clients or customers of the LLP must be informed of the limited liability

Limited Liability Co. A form of business ownership that permits small business owners to limit their liability to the amount of their investments These are governed by statute RCW 25.15

LLC Agreement Operating agreement is analogous to corporation’s bylaws. Agreements may be oral and contain provisions relating to management, dividends, meetings, transfer of membership interests, etc. Generally, if the operating agreement is silent, courts will apply partnership principles.

Advantages Member liability is limited to amount of investment. Can be treated as a “pass through” entity for tax purposes (like partnership). Profits can be distributed to members without the double taxation of a corporation. Members pay personal income tax on received dividends.

Corporations A business entity formed by shareholders The corporation is an artificial “person” for the purpose of conducting a business and can Own property Enter into contracts Sue and be sued

Advantages The liability of shareholders (the owners) of a corporation is limited to the individual’s investment The business has a perpetual existence

Disadvantages Takes a lot of attention at the formation stage Requires ongoing efforts – reporting requirements, annual meetings Double taxation http://apps.leg.wa.gov/RCW/default.aspx?cite=23B

Rights of the Corporation Because a corporation is a legal “person,” it has constitutional rights. Equal protection; Access to the courts, can sue and be sued; Right to due process; Freedom from unreasonable search and seizure and double jeopardy. Freedom of speech. http://www.youtube.com/view_play_list?p=FA50FBC214A6CE87

Torts and Criminal Acts A corporation is liable for the torts committed by its agents or officers within the course and scope of their employment under the doctrine of respondeat superior. Corporation can be liable for criminal acts, but only fined. Responsible officers may go to prison.

Corporate Express Powers The express powers of a corporation are found in the corporation’s articles of incorporation, the laws of the state of incorporation, and in the state and federal corporations. Corporate by-laws may also grant or limit a corporation’s express powers.

Corporate Implied Powers Corporation has implied powers to perform all acts reasonably necessary to accomplish its corporate purposes: Borrow and lend money. Extend credit. Make charitable contributions. A corporate officer can bind corporation in contract in matters connected with the ordinary business affairs of the corporation.

Ultra Vires Doctrine Corporate acts that are beyond the express or implied powers of the corporation are considered to be “ultra vires” and unlawful.

Classification of Corporations Domestic corporation does business in its state of its incorporation. Foreign corporation from another state doing business in Washington. Alien Corporation: formed in another country doing business in United States.

Kinds of Corporations Public and Private. Nonprofit. Close Corporations. Shares held by few shareholders. More informal management – similar to a partnership. Restriction on transfer of shares.

Kinds of Corporations “S Corporations” – IRS classification that enables corporation to avoid “double taxation” – only dividends to the shareholders, not corporate profits, are taxed. IRS requirements: Corporation is domestic, with fewer than 75 shareholders, only one class of stock, no shareholder can be a non-resident alien. Professional Corporations.

Basics of Formation The corporation is created by Articles of Incorporation These must include Name of the corporation Purpose List of incorporators and directors Name and address of registered agent Share structure Articles are filed with Secretary of State

Corporate Status De Jure: substantial statutory requirements are met; cannot be attacked by state or 3rd parties. De Facto: statutory requirements not met, but promoters made good faith effort to comply with corporate law; corporate status can only be attacked by state. By Estoppel: if it acts like a corporation, it cannot avoid liability by claiming that no corporation exists.

Piercing the Corporate Veil Where the corporate form is used solely to shield individuals from liability Generally, owner co-mingles personal and corporate assets Sometimes no stock is issued or Formation or regulatory rules are ignored

Corporate Hierarchy Shareholders Board of Directors Officers Employees Clients/Customers

Corporate Structure The owners of the corporation are the shareholders. Create the capital of the corporation Have no management authority Elect board of directors Must approve changes in articles of incorporation and other major changes

Corporate Structure The Board of Directors Elected by the shareholders Have management responsibility Appoint, supervise, remove officers of the corporation The Directors have a fiduciary relationship with shareholders

Corporate Structure Officers and Executives Elected/appointed by the board of directors Responsible for carrying out board’s policies and directives Responsible for management of business Have a fiduciary duty to act in the best interests of the shareholders and the corporation

Requirements Corporations are required to: Hold annual meetings of shareholders. Give reasonable notice of meetings. Provide reasonable access to books and records to shareholders.

Securities Regulation Two major securities laws Securities Act of 1933 Securities Exchange Act of 1934

Insider Trading Occurs when someone with reliable secret information uses that information to benefit from stock trades. Is a crime, punishable by fine and imprisonment.

Sarbanes-Oxley Act Enacted after the Enron accounting scandal to require additional protections for investors.

Additional Regulations Sherman (Antitrust) Act Prohibits price fixing and illegal monopolies Clayton Act Prohibits anticompetitive mergers Robinson-Patman Act Prohibits price discrimination aimed at putting small competitors out of business

Merger and Consolidation Corporations can grow and expand by: Mergers. Consolidation. Purchase of another corporation’s assets. Purchases of a controlling interest in another corporation.

Termination Termination of a corporation, like a partnership, consists of two phases: Dissolution (voluntary or involuntary); and Liquidation.