Lecture Entity Formation Part2


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Lecture on entity formation

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Lecture Entity Formation Part2

  1. 1. Business Law Entity Formation: Factors to Consider
  2. 2. 4 Basic Entity Types: An Overview <ul><li>Sole proprietorship </li></ul><ul><ul><li>Individual owner; everything belongs to the proprietor </li></ul></ul><ul><li>General partnership </li></ul><ul><ul><li>Partners = owners; no agreement needed (can be implied by actions) </li></ul></ul>
  3. 3. 4 Basic Entity Types: An Overview <ul><li>Limited partnership </li></ul><ul><ul><li>Gen partner = day to day; Limited partner = $ </li></ul></ul><ul><li>Corporation </li></ul><ul><ul><li>Close vs publicy held </li></ul></ul>
  4. 4. Other Entity Types: An Overview <ul><li>Limited Liability Companies (LLCs) </li></ul><ul><ul><li>Like a corp, its own distinct entity (can sue/be sued in its own name; can buy/sell property) </li></ul></ul><ul><ul><li>Can also create PLLC – professional LLC for professionals (doctors, lawyers, accountants) – limited liability for malpractice of other members, unlimited liability for own malpractice </li></ul></ul><ul><li>Limited Liability Partnerships (LLPs) </li></ul><ul><ul><li>Allow partnerships, but shield assets of one partner from wrongdoing committed by other partners </li></ul></ul><ul><li>Franchises </li></ul><ul><li>Joint Ventures </li></ul><ul><li>Cooperatives </li></ul><ul><li>Syndicates </li></ul>
  5. 5. Entity Formation Decisions: The 7 Factors <ul><li>Limited liability </li></ul><ul><li>Taxation </li></ul><ul><li>Formalities </li></ul><ul><li>Financing </li></ul><ul><li>Management </li></ul><ul><li>Life of the business </li></ul><ul><li>Liquidity of investment </li></ul>
  6. 6. Factor 1: Limited Liability <ul><li>“ Is my house safe?” </li></ul><ul><li>Concern for all, especially investors </li></ul><ul><li>Sole proprietors: no limited liability </li></ul><ul><li>General partners: no limited liability </li></ul><ul><li>Limited partners: investments are unprotected, but personal assets are protected </li></ul><ul><li>Shareholders: investments unprotected, but personal assets are protected absent contractual agreement otherwise </li></ul><ul><li>LLC Members: Limited liability (but not for own malpractice) </li></ul><ul><li>LLP partners: Limited liability (but not for own malpractice) </li></ul><ul><li>BUT – see next slide! </li></ul>
  7. 7. Factor 1: Limited Liability <ul><li>Not even a limited liability entity always protects personal assets </li></ul><ul><li>LaMontagne Builders v Bowman Brook </li></ul><ul><ul><li>Specific issue: </li></ul></ul><ul><ul><li>General issue: </li></ul></ul>
  8. 8. Factor 1: Limited Liability <ul><li>When you don’t treat the entity properly, you might lose is protection </li></ul><ul><ul><li>(piercing the corporate veil – if undercapitalized; if used as an alter ego for shareholder/director/officer.) </li></ul></ul><ul><li>See also Estate of Countryman p. 476 </li></ul>
  9. 9. Factor 1: Limited Liability <ul><li>Back to George, Kim and Martha: </li></ul><ul><li>Which form provides greatest protection for Kim & Martha’s savings? </li></ul><ul><ul><li>Kim: “large sum of $”; not able to operate the day-to-day business </li></ul></ul><ul><ul><li>Martha: $20k, but needs to keep some for son’s college; wants to co-manage </li></ul></ul>
  10. 10. Factor 2: Taxation <ul><li>Sole Proprietorship: “It’s all personal” – SP taxed personally on income/loss </li></ul><ul><li>Partnership: Income/loss “passed through” to the partners and taxed to them personally according to their level of contribution </li></ul><ul><li>LLC: Taxation benefits of partnership </li></ul><ul><li>LLP: Taxed like a general partnership </li></ul><ul><li>Advantages: </li></ul><ul><ul><li>Savings on taxes during early years if SP/P have other sources of income (take other income minus business losses) </li></ul></ul><ul><ul><li>Lower taxes on operations than with corporations </li></ul></ul>
  11. 11. Factor 2: Taxation <ul><li>Corporation: usually taxed as its own entity based on its income. Shareholders usually pay income taxes on dividends they receive (“double taxation”) </li></ul><ul><li>$ (income)(taxed to corp)  Corporation  $ (dividends)(taxed to SH)  Shareholders </li></ul><ul><li>Exception: S-Corp </li></ul><ul><ul><li>Taxed like a partnership – entity doesn’t pay corporate tax. </li></ul></ul><ul><ul><li>100 or fewer shareholders </li></ul></ul><ul><ul><li>Shareholders can only be individuals (or estates) </li></ul></ul><ul><ul><li>Shareholders must agree in writing to partnership taxation </li></ul></ul><ul><li>Corp tax rate varies from year to year (or administration to administration); many mechanisms available to reduce tax burden on shareholders </li></ul>
  12. 12. Factor 3: Formalities <ul><li>Sole proprietorship; general partnership: Few formalities </li></ul><ul><li>Limited partnerships; corporations; LLCs: Many formalities </li></ul><ul><li>LLP: Must file with state, maintain professional liability insurance </li></ul>
  13. 13. Factor 3: Formalities <ul><li>Back to G, K & M: which form of business is easiest to organize? </li></ul><ul><li>Why do we have formalities? </li></ul>
  14. 14. Factor 4: Financing <ul><li>How can we obtain financing? Loans, lines of credit, securities… </li></ul><ul><li>Large corporation: Limited liability for shareholders; can work w/ securities; seems “safer” </li></ul><ul><li>Small corporation: Limited liability for shareholders; continuity of life (unlike with partnerships/sole proprietorships) </li></ul>
  15. 15. Factor 5: Management <ul><li>Sole proprietorship: “It’s all personal” – the SP can decide everything about running the organization </li></ul><ul><li>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. </li></ul><ul><li>Limited partnership: No difference for the GP(s), but limited partners can’t participate in management </li></ul>
  16. 16. Factor 5: Management <ul><li>Close corporation: Possible to have deadlocks; may have a CEO charged with day-to-day decision-making </li></ul><ul><li>Corporation: Officer(s) manage day-to-day; board may control policy; shareholders don’t usually participate (but are allowed to, generally) </li></ul><ul><li>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 </li></ul>
  17. 17. Factor 5: Management <ul><li>S-Corps </li></ul><ul><ul><li>Minority Shareholder Oppression </li></ul></ul><ul><ul><ul><li>Minority shareholder gets “frozen out” – can stem from personality conflict, business decision disagreement… </li></ul></ul></ul><ul><ul><ul><li>Brooks v Hill </li></ul></ul></ul><ul><ul><ul><ul><li>Specific issue: Is Leroy liable for minority shareholder oppression? </li></ul></ul></ul></ul><ul><ul><ul><ul><li>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? </li></ul></ul></ul></ul>
  18. 18. Factor 6: Life of the Business <ul><li>Sole proprietorship: “It’s all personal” – business usually ends when SP can no longer run it b/c of death/disability </li></ul><ul><li>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. </li></ul>
  19. 19. Factor 6: Life of the Business <ul><li>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) </li></ul><ul><li>LLC: Generally dissolved by death, retirement, bankruptcy, being left by one of the members. Remaining members can unanimously agree to continue the business operations. </li></ul>
  20. 20. Factor 6: Life of the Business <ul><li>In Re Garrison-Ashburn, LC </li></ul><ul><ul><li>Specific issue: </li></ul></ul><ul><ul><li>General issue: </li></ul></ul>
  21. 21. Factor 7: Liquidity of Investment <ul><li>Can you get your money back? </li></ul><ul><li>Sole proprietorship: “It’s all personal” – SP puts in own $; can take any of it not committed to third parties whenever </li></ul><ul><li>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 </li></ul><ul><li>Limited partners: Can sell, but not much of a market </li></ul><ul><li>Close corp: Restrictions may apply; market is small (strings attached; no incentive unless board influence is possible) </li></ul><ul><li>Public corp: Easy – just sell the shares on the public market. </li></ul>
  22. 22. Factor 7: Liquidity of Investment <ul><li>LLC: Member can transfer ownership interest. Transferee receives member’s share of profits, but not ability to manage w/o other members’ consent. </li></ul>