Chapter 15 The Entrepreneur’s Options

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

Introduction  Entrepreneurs wishing to start a new business must be aware of advantages and disadvantages of various business entities for their endeavor. Consider: Ease of creation. Owners’ liability. Tax considerations. Need for Capital.  Entrepreneurs wishing to start a new business must be aware of advantages and disadvantages of various business entities for their endeavor. Consider: Ease of creation. Owners’ liability. Tax considerations. Need for Capital.

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

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

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

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

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

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

LP – Rights and Liabilities  The General partner assumes all management and personal liability.  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.  Case Miller v. Dept of Revenue (1998).  The General partner assumes all management and personal liability.  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.  Case Miller v. Dept of Revenue (1998).

LP -- Rights and Liabilities  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.  Limited partners have the right to inspect the LP’s books and be informed of the LP’s business.  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.  Limited partners have the right to inspect the LP’s books and be informed of the LP’s business.

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

Limited Liability Companies  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).  LLC’s are formed by filing Articles of Organization with the Secretary of State.  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).  LLC’s are formed by filing Articles of Organization with the Secretary of State.

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

LLC Formation  Articles of Organization require: Name of Business. Principal Address. Name and Address of Registered Agent. Names of the Owners; and How the LLC will be managed.  Business name must include LLC or Limited Liability Company.  Articles of Organization require: Name of Business. Principal Address. Name and Address of Registered Agent. Names of the Owners; and How the LLC will be managed.  Business name must include LLC or Limited Liability Company.

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

Management of an LLC  There are two options for management, generally set forth in the articles of organization: Member-Managed: all of the members participate in management, like a partnership. Manager-Managed: members are elected to manage the LLC.  If the articles are silent, statutes provide either that each member has one vote or votes are made based on percentage of ownership.  There are two options for management, generally set forth in the articles of organization: Member-Managed: all of the members participate in management, like a partnership. Manager-Managed: members are elected to manage the LLC.  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  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).  LLP allows partnership to limit personal liability of the partners but allows “pass through” tax advantages.  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).  LLP allows partnership to limit personal liability of the partners but allows “pass through” tax advantages.

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

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

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

LP Management  Only General Partners can manage but they have a fiduciary obligation to LP’s.  LP’s enjoy limited liability as long as they do not engage in management functions.  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.  Only General Partners can manage but they have a fiduciary obligation to LP’s.  LP’s enjoy limited liability as long as they do not engage in management functions.  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  The General partner assumes all management and personal liability.  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.  Case Miller v. Dept of Revenue (1998).  The General partner assumes all management and personal liability.  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.  Case Miller v. Dept of Revenue (1998).

LP -- Rights and Liabilities  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.  Limited partners have the right to inspect the LP’s books and be informed of the LP’s business.  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.  Limited partners have the right to inspect the LP’s books and be informed of the LP’s business.

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

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

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

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

JV Characteristics  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: JV members has less implied and apparent authority than partners. Death of JV member does not terminate JV.  JV members can specify duration. If not, then JV terminates when purpose is accomplished.  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: JV members has less implied and apparent authority than partners. Death of JV member does not terminate JV.  JV members can specify duration. If not, then JV terminates when purpose is accomplished.

Other Entities  Syndicate (Investment Group): group of individuals getting together to finance a particular project.  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.  Syndicate (Investment Group): group of individuals getting together to finance a particular project.  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  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.  Cooperative is an association organized to provide a not-for-profit service to members.  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.  Cooperative is an association organized to provide a not-for-profit service to members.

Private Franchises  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.  Types: Distributorship. Chain Style Business Operation. Manufacturing or Processing Arrangement.  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.  Types: Distributorship. Chain Style Business Operation. Manufacturing or Processing Arrangement.

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

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