Lecture Entity Formation Part2
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Lecture Entity Formation Part2

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Lecture on entity formation

Lecture on entity formation

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  • 1. Business Law Entity Formation: Factors to Consider
  • 2. 4 Basic Entity Types: An Overview
    • Sole proprietorship
      • Individual owner; everything belongs to the proprietor
    • General partnership
      • Partners = owners; no agreement needed (can be implied by actions)
  • 3. 4 Basic Entity Types: An Overview
    • Limited partnership
      • Gen partner = day to day; Limited partner = $
    • Corporation
      • Close vs publicy held
  • 4. Other Entity Types: An Overview
    • Limited Liability Companies (LLCs)
      • Like a corp, its own distinct entity (can sue/be sued in its own name; can buy/sell property)
      • Can also create PLLC – professional LLC for professionals (doctors, lawyers, accountants) – limited liability for malpractice of other members, unlimited liability for own malpractice
    • Limited Liability Partnerships (LLPs)
      • Allow partnerships, but shield assets of one partner from wrongdoing committed by other partners
    • Franchises
    • Joint Ventures
    • Cooperatives
    • Syndicates
  • 5. Entity Formation Decisions: The 7 Factors
    • Limited liability
    • Taxation
    • Formalities
    • Financing
    • Management
    • Life of the business
    • Liquidity of investment
  • 6. Factor 1: Limited Liability
    • “ Is my house safe?”
    • Concern for all, especially investors
    • Sole proprietors: no limited liability
    • General partners: no limited liability
    • Limited partners: investments are unprotected, but personal assets are protected
    • Shareholders: investments unprotected, but personal assets are protected absent contractual agreement otherwise
    • LLC Members: Limited liability (but not for own malpractice)
    • LLP partners: Limited liability (but not for own malpractice)
    • BUT – see next slide!
  • 7. Factor 1: Limited Liability
    • Not even a limited liability entity always protects personal assets
    • LaMontagne Builders v Bowman Brook
      • Specific issue:
      • General issue:
  • 8. Factor 1: Limited Liability
    • When you don’t treat the entity properly, you might lose is protection
      • (piercing the corporate veil – if undercapitalized; if used as an alter ego for shareholder/director/officer.)
    • See also Estate of Countryman p. 476
  • 9. Factor 1: Limited Liability
    • Back to George, Kim and Martha:
    • Which form provides greatest protection for Kim & Martha’s savings?
      • Kim: “large sum of $”; not able to operate the day-to-day business
      • Martha: $20k, but needs to keep some for son’s college; wants to co-manage
  • 10. Factor 2: Taxation
    • Sole Proprietorship: “It’s all personal” – SP taxed personally on income/loss
    • Partnership: Income/loss “passed through” to the partners and taxed to them personally according to their level of contribution
    • LLC: Taxation benefits of partnership
    • LLP: Taxed like a general partnership
    • Advantages:
      • Savings on taxes during early years if SP/P have other sources of income (take other income minus business losses)
      • Lower taxes on operations than with corporations
  • 11. Factor 2: Taxation
    • Corporation: usually taxed as its own entity based on its income. Shareholders usually pay income taxes on dividends they receive (“double taxation”)
    • $ (income)(taxed to corp)  Corporation  $ (dividends)(taxed to SH)  Shareholders
    • Exception: S-Corp
      • Taxed like a partnership – entity doesn’t pay corporate tax.
      • 100 or fewer shareholders
      • Shareholders can only be individuals (or estates)
      • Shareholders must agree in writing to partnership taxation
    • Corp tax rate varies from year to year (or administration to administration); many mechanisms available to reduce tax burden on shareholders
  • 12. Factor 3: Formalities
    • Sole proprietorship; general partnership: Few formalities
    • Limited partnerships; corporations; LLCs: Many formalities
    • LLP: Must file with state, maintain professional liability insurance
  • 13. Factor 3: Formalities
    • Back to G, K & M: which form of business is easiest to organize?
    • Why do we have formalities?
  • 14. Factor 4: Financing
    • How can we obtain financing? Loans, lines of credit, securities…
    • Large corporation: Limited liability for shareholders; can work w/ securities; seems “safer”
    • Small corporation: Limited liability for shareholders; continuity of life (unlike with partnerships/sole proprietorships)
  • 15. Factor 5: Management
    • Sole proprietorship: “It’s all personal” – the SP can decide everything about running the organization
    • General partnership: All GPs can make decisions; usually, they split it up, but to an outsider, any of them can usually make decisions on behalf of the partnership (“apparent authority”). Deadlocks/drawn-out discussions are possible.
    • Limited partnership: No difference for the GP(s), but limited partners can’t participate in management
  • 16. Factor 5: Management
    • Close corporation: Possible to have deadlocks; may have a CEO charged with day-to-day decision-making
    • Corporation: Officer(s) manage day-to-day; board may control policy; shareholders don’t usually participate (but are allowed to, generally)
    • Limited Liability Company: All investors share in the management; no restriction on number of members (akin to shareholders); may hire managers; duty to act in LLC’s best interests
  • 17. Factor 5: Management
    • S-Corps
      • Minority Shareholder Oppression
        • Minority shareholder gets “frozen out” – can stem from personality conflict, business decision disagreement…
        • Brooks v Hill
          • Specific issue: Is Leroy liable for minority shareholder oppression?
          • General issue: If a majority shareholder uses the business for his/her personal purposes, resulting in lower share value, and subsequently seeks to buy out a minority shareholder, is the majority shareholder liable for oppression?
  • 18. Factor 6: Life of the Business
    • Sole proprietorship: “It’s all personal” – business usually ends when SP can no longer run it b/c of death/disability
    • Partnership: Without advance written agreement to the contrary, partnership dissolves when a partner dies, becomes insolvent or leaves; termination at will, but can contract to provide damages to remaining partners. Partnership can be inherited.
  • 19. Factor 6: Life of the Business
    • Corporation: Strongest continuity of life – death/disability of a shareholder doesn’t affect legal status of the corporation. Easy to transfer ownership of shares. Easiest to preserve good will. (But, think about Apple and Steve Jobs)
    • LLC: Generally dissolved by death, retirement, bankruptcy, being left by one of the members. Remaining members can unanimously agree to continue the business operations.
  • 20. Factor 6: Life of the Business
    • In Re Garrison-Ashburn, LC
      • Specific issue:
      • General issue:
  • 21. Factor 7: Liquidity of Investment
    • Can you get your money back?
    • Sole proprietorship: “It’s all personal” – SP puts in own $; can take any of it not committed to third parties whenever
    • General partners: Can sell their stake at buyout time, but buyer doesn’t become a partner w/o unanimous consent of other Ps; hard to sell before buyout time; doesn’t benefit from goodwill if other Ps continue the business
    • Limited partners: Can sell, but not much of a market
    • Close corp: Restrictions may apply; market is small (strings attached; no incentive unless board influence is possible)
    • Public corp: Easy – just sell the shares on the public market.
  • 22. Factor 7: Liquidity of Investment
    • LLC: Member can transfer ownership interest. Transferee receives member’s share of profits, but not ability to manage w/o other members’ consent.