Sole Proprietorships, Partnerships, and Limited Liability Organizations CHAPTER TWENTY-SIX

Copyright © Houghton Mifflin Company. All rights reserved.26 | 2 Forms of Business Ownership In considering the legal form of organizing your business the following factors are essential to consider: –The number of owners –Tax consideration –The need for limited liability –Whether you plan to go public in the future (inviting the public to join in ownership of the business) –How ownership of the business will be transferred –Whether you need to borrow a large sum of money to operate the business –The work and expertise involved in setting up the business

Copyright © Houghton Mifflin Company. All rights reserved.26 | 3 Sole Proprietorship Anyone can start a sole proprietorship. –There are no formalities required to start this form of business. –Anyone starting a business must comply with all governmental requirements that apply to a business in general and the particular type of business started. General items would include: –Registering to collect state and local taxes –Registering the name of the business, if the business is operated under a name different than the owner’s name Particular items would include licenses (e.g., to practice medicine).

Copyright © Houghton Mifflin Company. All rights reserved.26 | 4 Sole Proprietorship (continued) Advantages of a sole proprietorship: –Easy to form a sole proprietorship: no legal formalities, except those mentioned previously –Very flexible form of business that allows the owner to manage the business as he or she pleases. –All profit goes to the owner of the business

Copyright © Houghton Mifflin Company. All rights reserved.26 | 5 Sole Proprietorship (continued) Disadvantages of a sole proprietorship: –The owner must supply all capital (money and other property) to get the business started; often limited capital of the owner can lead to business failure. –The risk of not being successful and losing all or most of the money is borne by the owner. –The owner alone is liable for all the debts of the business. –The business ceases to exist when the owner retires or passes away.

Copyright © Houghton Mifflin Company. All rights reserved.26 | 6 Partnership Partnership: an association of two or more persons to carry on as co-owners of a business for profit. The essential elements of a partnership: –Sharing profits and losses –Joint ownership of partnership assets –Shared management

Copyright © Houghton Mifflin Company. All rights reserved.26 | 7 Partnership (continued) Where the partners decide to use a name other than their own names, the partnership’s assumed name must be registered in a public office. A partnership is treated as a legal entity that: –Can buy, hold title to, and sell real estate in its own name –Can open a bank account and purchase securities in its own name

Copyright © Houghton Mifflin Company. All rights reserved.26 | 8 Partnership (continued) A partnership is treated as a legal entity that: (continued) –Is treated as a separate entity for accounting purposes –Is treated as a separate entity in bankruptcy proceedings –Can be sued in its own name (in some states) –For tax purposes, passes income, losses, and deductions to the individual partners. A partnership is required to report its activities to the IRS.

Copyright © Houghton Mifflin Company. All rights reserved.26 | 9 Partnership (continued) Advantages of a partnership: –Ease of organization and dissolution –Informal management structure –Lack of a partnership income tax Disadvantages of a partnership: –Unlimited liability of partners for partnership debts and torts –Difficulty settling disputes among partners –Difficulty transferring a partnership interest –Lack of continuity –The danger of dissolution if a partner withdraws or dies

Copyright © Houghton Mifflin Company. All rights reserved.26 | 10 Types of Partnerships General partnership: customary partnership in which all partners share equal liability for debts and torts of the partnership –General partner: fully active in partnership affairs –Silent partner: inactive in general partnership but is known to the public as a partner –Secret partner: active in the partnership but unknown to the public –Dormant partner: neither active in the partnership nor known to the public as a partner

Copyright © Houghton Mifflin Company. All rights reserved.26 | 11 Types of Partnerships (continued) Limited partnership: a partnership with both general and limited partners –A limited partner contributes cash or property to the business but does not take part in the management or operation of the partnership. –A limited partner has no liability beyond his or her investment in the business. –If the limited partner does participate in the operation of the partnership, he or she may be viewed and treated as a general partner.

Copyright © Houghton Mifflin Company. All rights reserved.26 | 12 Forming a Partnership Two or more parties can form a partnership expressly, or a partnership can be implied from the parties’ actions. An express partnership agreement can be oral or written. –An express agreement should always be written to prevent confusion or misunderstanding. A partnership exists by implication if the parties join together and operate a business; share control, profits, and interest in business property; and show intention to have a partnership.

Copyright © Houghton Mifflin Company. All rights reserved.26 | 13 Operation of a Partnership Partnerships operate according to: –The provisions of the partnership agreement, –The Uniform Partnership Act, –Principles of contract and agency law, and –According to custom, the nature of the business and the partners’ relationship with each other.

Copyright © Houghton Mifflin Company. All rights reserved.26 | 14 Rights of Partners Partners have important rights: –Partners participate equally in management of the partnership, except as the right is modified in the partnership agreement. Decisions are made by majority vote of the partners. A unanimous vote is required to amend the partnership agreement or when there is a material change to the nature of the business. –Partners share the profits and losses of the partnership, except as the right is modified by the partnership agreement.

Copyright © Houghton Mifflin Company. All rights reserved.26 | 15 Rights of Partners (continued) Partners have important rights (continued): –Partners share in the property of the partnership, except as the right is modified in the partnership agreement. –Each partner has the right to inspect the books and records of the partnership. –Each partner has a right to an accounting to determine the value of each partner’s ownership interest.

Copyright © Houghton Mifflin Company. All rights reserved.26 | 16 Duties of Partners The relationship of partners is based on trust and confidence. Their duties include the following: –Loyalty: partners must act in good faith and in the best interests of the partnership. –A partner must use reasonable skill and care in conducting partnership business. Additionally, the partner must devote time and effort to the business. –A partner must account to other partners for actions taken and any benefits obtained.

Copyright © Houghton Mifflin Company. All rights reserved.26 | 17 Powers of the Partners Powers of a partner to act for a partnership may be express or implied. Powers include: –Power to make contracts for the partnership Provided the contract is in the ordinary course of partnership business –Power to buy and sell partnership property –Power to borrow money for the partnership –Power to hire employees and appoint agents for the partnership To work in the ordinary course of the partnership business

Copyright © Houghton Mifflin Company. All rights reserved.26 | 18 Liability of Partners Partners have obligations to the other partners and outsiders. A breach of these obligations may impose liability on all the partners. A partner is liable to other partners for his or her share of the partnership’s debts and obligations. Partners are liable to outsiders for: –Contracts made by other partners –Torts committed by one partner for which the partnership is liable. In this case, all of the partners are jointly and severally liable. (Joint and several liability means the wronged party can sue all of the partners or any one of the partners individually.)

Copyright © Houghton Mifflin Company. All rights reserved.26 | 19 Liability of Partners (continued) If a partner commits a crime in the course of partnership operations and the penalty for the crime is a fine, the partners are jointly liable to pay the fine. If a judgment is obtained against a partnership, partnership assets are used first to satisfy the claim. –If partnership assets are insufficient in satisfying the claim, the creditor can go after the individual assets of the partners.

Copyright © Houghton Mifflin Company. All rights reserved.26 | 20 Termination of a Partnership Termination of a partnership is referred to as dissolution. Dissolution can occur for several reasons: –Term of partnership expires –Change in members of the partnership –Death of a partner –Bankruptcy –Court order Many partnership agreements provide for the continuation of the partnership upon the admission of a new partner, retirement, or death of a partner.

Copyright © Houghton Mifflin Company. All rights reserved.26 | 21 Limited Partnership A limited partnership is designed to allow limited partners to invest while limiting their liability to their investment. Every limited partnership must have at least one general partner (unlimited liability) and one limited partner (liability limited to investment). A limited partnership can dissolve for the same reasons as a general partnership.

Copyright © Houghton Mifflin Company. All rights reserved.26 | 22 Limited Liability Company A limited liability company is a hybrid partnership and corporation. The purpose is to provide the members of the limited liability company with the limited liability of a corporation. Members have the opportunity for active participation in management (as opposed to a limited partnership) and the opportunity to be treated as a partnership for income tax purposes. –Partnership treatment for income tax purposes may be more favorable taxwise than treatment as a corporation. There are few disadvantages to a limited liability company which is why it has become a popular method of business organization.

Copyright © Houghton Mifflin Company. All rights reserved.26 | 23 Limited Liability Partnership A limited liability partnership (LLP) is similar to a limited liability company. A limited liability partnership allows professionals such as doctors, lawyers, accountants, etc. to enjoy the advantages of limited liability, with the potential tax benefits of a partnership. Not all states have enacted LLP laws; thus, the limited liability protection may not always be available.

Copyright © Houghton Mifflin Company. All rights reserved.26 | 24 Other Forms of Business Organization Joint venture: two or more separate businesses join together to work on a project. –Can be treated as a partnership or corporation. Syndicate: often used by individuals to purchase assets such as real estate, franchises etc. Cooperative: nonprofit arrangement set up to provide certain benefits to members. –Depending upon state laws a cooperative may be treated as a corporation or partnership.