1. Business Entity Formations
Nema Koohmaraie and Matt Hinrikus
UNL College of Law – Entrepreneurship Legal Clinic

2. Disclaimer
The content of this presentation is intended solely as a brief summary of entity choices available to individuals starting a business operation. The information provided during this presentation shall not be construed as legal advice
We are not tax experts. Consult your accountant or tax attorneys to supplement the tax considerations

3. Discussion Points Overview of Business Entity Structures
Benefits & Values of Entity Formation
Types of Entities
Sole Proprietorship
Partnership – General or Limited
Corporation – C-Corp. or S-Corp.
Limited Liability Company (LLC)
Differences

4. Benefits of Entity Formation
Corporate Shield – a.k.a., liability protection
Appearance of Legitimacy
Means to raise capital from outside investors
Method of combining valuable assets
E.g., intellectual property
Business continuity and planning
What we mean by the “corporate shield’ is that by creating a Corporation or LLC (we’ll get to later in the presentation), shareholders, limited partners, and liability company members, among others, are generally not liable for the liabilities of the company in which they have an ownership interest.
HOWEVER, until a company is formally incorporated by filing documents with the State, the entrepreneur is acting in a personal capacity and is personally liable

5. Sole Proprietorship
Composed of one individual who owns and operates a business – Default entity
No separation or distinction as between the owner and the business
No statutory requirements to create
Trade Name Application if going to conduct business in something other than the name of the owner
Applicable licenses or permits
Unlike corporations and LLCs, it is considered to be “without” a ‘legal’ structure
Unlike all the other business structures we’ll discuss, sole proprietorships are “creatures of business engagement”
Legally speaking, the business owner and the business are the SAME actual & legal person

6. Sole Proprietorship Taxation Liability of Owner
Owner of the business reports income or loss directly on his or her personal income tax return
Liability of Owner
Owner of the business is personally liable for debts & obligations of business and for negligent acts committed by themselves and their employees if acting within the scope of employment
It is important to note that in our hypothetical, or in any case where there remains only one business owner, he or she CAN have employees. In this case, because there is still only one business owner, the legal structure remains a sole proprietorship.
Personally liable means in a lawsuit, the suing party can come after the personal assets of the business owner.
**Business owners operating as a sole proprietorship CAN attempt to limit their liability via contract law
e.g., can only go after certain assets in a K claim
Liability can be mitigated only to the amount of the liability insurance policy

7. Partnerships
An association of two or more persons to carry on a business for profit as co-owners
Two Types
General Partnership
Limited Partnership
Why choose a partnership? – simple way to pool resources amongst individuals
“Persons” includes entities
“Business” means any trade, occupation, or profession
When these characteristics are present, a rebuttable presumption exists that the business is operating as a General P’ship
Neb. Rev. Stat.  presumption – profit-sharing is indicative of a partnership

8. General Partnership Partnership Formation Operations Default entity
Automatically forms when two or more individuals are carrying on a business for profit as co-owners
Operations
Partnership Agreement; OR
Revised Uniform Partnership Act (governing law)
Nothing must be filed with the state.
To override the state’s P'ship statute, the parties must execute a P'ship Agreement – GET IT IN WRITING!
certain limitations and items that canNOT be overridden
unreasonably restrict right of access to books & records
eliminate duty of loyalty
unreasonably reduce duty of care
eliminate obligation of good faith and fair dealing
vary the power, of a partner, to dissociate as a partner [among others]

9. General Partnership Taxation
Partnership files an informational income tax return, but the Partnership itself does not pay income taxes
Pass-Through Entity
Income or loss is attributed to the owners/partners equally
Note: Sharing of profits or losses can be determined by the Partnership Agreement
Similar to Sole Proprietorships
all owners/partners of the business are personally liable for debts & obligations of business AND of torts committed by himself or other partners if acting in OCB or w/ authority of the P’ship

10. General Partnership Liability of Owners/Partners
Shared liability by all partners
Joint and Several
Any one partner can bind other partners
Contract
Negligence

11. General Partnership Advantages Disadvantages
Simple and Inexpensive to create
Partners report their share of profits or losses on their own income tax return
Disadvantages
Partners are personally liable for debts & obligations of the business

12. Limited Partnership Formation Operations – Two Types of Partners
Must file a Certificate of Limited Partnership with Secretary of State
Operations – Two Types of Partners
General Partners: Active investor and actively involved in the day to day operations and management
Limited Partners: Do not participate in day to day operations and management – passive investors
Limited partnerships are created when one or more partners would like to join the business venture, but wants to also limit their liability
Note the difference! – first business entity structure that REQUIRES the individuals to file with state
Note: I.R.C. has Passive Activity rules which reduces the amount an individual can deduct as losses if the venture constitutes a “passive activity” w/in the I.R.C.
Query: When does a limited partner do enough to be classified as a general partner?
too much involvement by a limited partner could result in losing the liability protection – BE CAREFUL!

13. Limited Partnership Taxation Liability of Owners/Partners
Based on value of individual contributions
Tax liability is not equal among partners
Liability of Owners/Partners
General Partners: Subject to personal liability for debts & obligations of business (similar to General Partnership)
Limited Partners: Not subject to personal liability for debts & obligations of business

14. Limited Partnership Advantages Disadvantages
Limited partners are not personally liable for business debts (generally)
General partner can raise capital from the passive investors (limited partners) without giving up management in business
Disadvantages
General Partners are personally liable for business debts

15. Alternatives
Is there a way to limit the liability of all owners while allowing easy transferability of ownership interests?
YES – Corporations or Limited Liability Companies

16. Limited Liability Entities
Our purpose today  Corporations or LLCs
Legal entity, separate & distinct from the owners
Created by statutory law
Limited liability of business owners
Not liable for debts incurred by the business
Unless exceptions apply – Piercing Corporate Veil
Nebraska Business Corporation Act
Nebraska Uniform Limited Liability Company Act (NULLCA)
Limited Liability  THE reason why people incorporate; it protects their personal assets and well-being from the business risks and obligations
Explain PCV doctrine  essentially, corporations and LLCs (more so corporations) are required to follow certain corporate formalities such as annual meetings. Failure to do so may result in a Court invoking the PCV doctrine which essentially treats the business entity and the owners as own, thereby making the owners personally liable for the debts of the business – Courts say the owners have treated the business as their “Alter Ego”

17. Requirements Must file with the Nebraska Secretary of State
Articles of Incorporation (Corporations)
Certificate of Organization (LLCs)
Must draft and execute – governing document
Corporate Bylaws (Corporations)
Operating Agreement (LLCs)
Depending on the statute, certain information is required to be included in the Articles of Incorporation and Certificate of Organization
For example, for Articles of Incorporation
(1) corporate name, (2) # of shares corporation is authorized to issue and type of classes, (3) street address of registered office and agent
(4) name and address of each incorporator, (5) provision if you’re limiting or eliminating the requirement of annual meeting of SH
Governing document must be drafted and executed, but is NOT required to be filed with the Secretary of State
essentially, it governs the operations of the business

18. Limited Liability Entity or Not
Increased Likelihood of incurring liability
Selling products or services
Hiring more employees
Entering into contracts – e.g., leases, loans, sales
Multiple owners
Additional investors
What are some things to consider when deciding to “incorporate”

19. Corporation or LLC Things to Consider: Financing needs Management
Investors, Venture Capitalists, Angel Capitalists tend to prefer corporation status
Management
Board of Directors & Officers (Corporations); OR
Member- or Manager-Managed (LLCs)
Tax & Liability
They prefer the corporation status because of the stock and governance traits
corporations have been around much longer so Courts have much more familiarity with them and the issues surrounding them
Some investors may also consider State of Incorporation
Delaware, as compared to Nebraska, has a long and rich history of interpreting, deciding and developing corporate law

20. Corporations Corporate law is state law
Approx. 50% of corporations incorporate in Delaware
Internal Affairs Rule: the laws of the state of incorporation govern internal corporate affairs
Foreign Business Rule: if incorporated in a state other than where conducting business, must qualify/register to operate business in the “foreign” jurisdiction

21. Corporations Operations
Shares of Stock = Ownership Interest = Shareholder
Board of Directors = primary decision makers
Election process is established in the Articles or Bylaws
Can reserve certain decision-marking authority to Shareholders
Officers = day to day decision makers
Elected by Board of Directors
President, VP, Secretary, Treasurer, etc.
**In most closely-held corporations (aka, small businesses) many of the same people with be the Owner/Shareholder, on the Board of Directors, and an Officer
Thus, it is absolutely critical that when you are acting on behalf of the business, you are cognizant of what “HAT” you’re wearing

22. Corporations Liability of Owners/Shareholders
Separate legal entity, distinct from Owner/Shareholders
General Rule: Entity is liable for corporate debts & obligations
Exceptions:
Piercing the Corporate Veil (PCV)
Personal Contractual Guarantees
PCV, as explained earlier, is a judicially-created exception to the rule of limited liability. It is a fact intensive analysis that varies from case to case.

23. Corporations Two Choices: C-Corporations (C-Corp.)
S-Corporations (S-Corp.)
There are two main types of corporations one should consider
**Note, in the eyes of the State of Nebraska, there is no difference. Only in the eyes of the IRS is there a difference.
Difference is what Subchapter of the I.R.C. is the corporation taxed under

24. C-Corporation Taxation Double Taxation
First, taxed at the corporate level – corporation reports and pays income taxes
Second, taxed at the individual level – shareholders report and pay income tax on any distributions paid out to them
Note: this does NOT mean you pay twice as much in taxes!

25. S-Corporation
Corporation that makes a valid election to be taxed under Subchapter S of Chapter 1 of the Internal Revenue Code
File Form 2553
Taxation
Pass-Through
No taxation at corporate level
Only taxed at individual level if shareholders are paid distributions
Election – must intentionally seek status as an S-Corp.
Pass-Through Taxation is the MAIN benefit in S-Corp. status
Liability – same as the C-Corp.  limited, unless an exception applies

26. S-Corporation Restrictions on S-Corporation Domestic Corporation
Allowed only 1 class of stock
Maximum of 100 shareholders
Shareholders must be U.S. citizens or residents
Profits and Losses allocated proportionately
Restrictions on S-Corp. status:
All SHs must be an actual human being, not an entity – could provide issues with investors that want to invest through another business entity
Can only have 1 class of stock – could provide issues with investors that want preferred stock
CAN have voting and non-voting classes of stock, though
Maximum of 100 SHs
Domestic Corporation
Profits & Losses allocated proportionately

27. Limited Liability Company
Flexible structure: Can take the form of a General Partnership, but provides the limited liability of a corporation
Formation
Must file Certificate of Organization with Nebraska Secretary of State
In legal jargon, LLCs are relatively “young” – first state passed legislation in 1978 – so there just is not as much case law or judicial interpretation or development of LLC law

28. Limited Liability Company
Operations
Operating Agreement (governing contract)
Nebraska Limited Liability Company ct (governing law)
Management Structure
Member-Managed – Default
All members (owners) have decision-making authority in day to day operations of business
Manager-Managed
Must be elected in the Operating Agreement
Decision-making authority is given to one or more persons

29. Limited Liability Company
Taxation – various possibilities
Default: Pass-Through entity
Election
C-Corporation treatment: taxed at corporate and individual levels; OR
S-Corporation treatment: Pass-Through entity
Liability
Neither members or managers are subject to personal liability for debts & obligations of business
Liability  same exceptions from the corporate context apply here as well!

30. Limited Liability Company
Advantages
Owners have limited liability for business debts even if they participate in management of the business
Profit and Loss can be allocated differently than ownership interest
Choice of taxation structure
Disadvantages
More expensive to create than a Partnership or Sole Proprietorship

31. Summary Business Entity Formation matters greatly Tax Implications
Liability of Owners
Future Financing & Investor Preference
Internal Operations
Default Rules

32. Contact Us Write us: Entrepreneurship Legal Clinic
University of Nebraska College of Law
7 McCollum Hall
Lincoln, NE
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