Copyright Atomic Dog Publishing, 2006


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Copyright Atomic Dog Publishing, 2006

  1. 1. Chapter 8 Business Legal Forms
  2. 2. 8-1 Introduction <ul><li>Capital, revenue and cost are deeply intertwined — actions taken to modify one component usually have an effect on the other two. </li></ul><ul><li>Launching a new venture normally requires an infusion of capital during the early stages. </li></ul><ul><ul><li>Before capital can be raised, the venture must establish a legal form that will enable it to solicit and raise debt or equity capital. </li></ul></ul><ul><ul><li>All entrepreneurs must decide what type of legal form they should use as the structural basis of their company. </li></ul></ul>
  3. 3. 8-2 Sole Proprietorship <ul><li>Oldest, common form of private business ownership in the United States — owned and managed by one individual. </li></ul><ul><ul><li>The person may receive help from others in operating the business but is the only owner. </li></ul></ul><ul><ul><li>In the eyes of the law, the sole proprietor is the company. </li></ul></ul><ul><ul><li>The sole proprietor owns a small service or retail operation and is usually an active manager. </li></ul></ul><ul><ul><li>The owner provides the capital needed to start and operate the business — personal savings or borrowed money. </li></ul></ul><ul><ul><li>Managerial ability accounts for the success or failure of the business. </li></ul></ul>
  4. 4. 8-2a Advantages of a Sole Proprietorship <ul><li>Advantages of a sole proprietorship include: </li></ul><ul><ul><li>Ease of starting </li></ul></ul><ul><ul><li>Control </li></ul></ul><ul><ul><li>Sole participation in profits and losses </li></ul></ul><ul><ul><li>Use of owner’s abilities </li></ul></ul><ul><ul><li>Tax breaks </li></ul></ul><ul><ul><li>Secrecy </li></ul></ul><ul><ul><li>Ease of dissolving </li></ul></ul>
  5. 5. 8-2b Disadvantages of a Sole Proprietorship <ul><li>Disadvantages of a sole proprietorship include: </li></ul><ul><ul><li>Unlimited liability </li></ul></ul><ul><ul><li>Difficulty in raising capital </li></ul></ul><ul><ul><li>Limitations in managerial ability </li></ul></ul><ul><ul><li>Lack of stability </li></ul></ul><ul><ul><li>Demands on time </li></ul></ul><ul><ul><li>Difficulty in hiring and keeping highly motivated employees </li></ul></ul>
  6. 6. 8-3 Partnership <ul><li>Partnership law in the United States has been derived from the Uniform Partnership Act (UPA). </li></ul><ul><ul><li>The more recent Revised Uniform Partnership Act (RUPA) was approved in 1994 — in line with modern business practices and trends; retaining many of the valuable provisions in the original act. </li></ul></ul><ul><ul><li>It was amended in 1997 to provide limited liability for partners in a limited liability partnership. </li></ul></ul><ul><li>Section 6 Uniform Partnership Act defines partnership as “an association of two or more persons to carry on as co-owners of a business for profit.” </li></ul>
  7. 7. 8-3 Partnership (cont.) <ul><ul><li>Partnership can be based on a written contract or a voluntary and legal oral agreement. </li></ul></ul><ul><ul><li>Partnership is similar in many respects to a sole proprietorship. </li></ul></ul><ul><ul><li>Co-owners share everything, including the risk, hard work, assets, and profits. </li></ul></ul>
  8. 8. 8-3a Partnership Types <ul><li>There are three major partnership types: </li></ul><ul><ul><li>General partnership: A business with at least one general partner who has unlimited liability for the debts of the business. </li></ul></ul><ul><ul><ul><li>They have the authority to act as an owner. </li></ul></ul></ul><ul><ul><ul><li>They can engage the partnership in binding agreements. </li></ul></ul></ul><ul><ul><ul><li>The partnership is responsible for all actions of each owner. </li></ul></ul></ul><ul><ul><li>Limited partnership: Has at least one general partner and one or more limited partners. </li></ul></ul><ul><ul><ul><li>Limited partnerships are usually found in service industries or in professional firms such as real estate and dentistry. </li></ul></ul></ul><ul><ul><ul><li>They are also used extensively to enable various international arrangements. </li></ul></ul></ul>
  9. 9. 8-3a Partnership Types (cont.) <ul><ul><li>Joint venture: A special type of partnership established to carry out a special project or to operate for a specific time period. </li></ul></ul><ul><ul><ul><li>A joint venture in the United States or abroad is less than the ordinary partnership; continues as a business. </li></ul></ul></ul><ul><ul><ul><li>There is some confusion among the courts as to whether a joint venture is a partnership. </li></ul></ul></ul><ul><ul><ul><li>Working in a joint venture with an international partner can make it easier to enter foreign markets. </li></ul></ul></ul>
  10. 10. 8-3b Advantages of a Partnership <ul><li>Advantages of a partnership include: </li></ul><ul><ul><li>Greater access to capital </li></ul></ul><ul><ul><li>Combined managerial skills </li></ul></ul><ul><ul><li>Ease of starting </li></ul></ul><ul><ul><li>Clear legal status </li></ul></ul><ul><ul><li>Tax advantages </li></ul></ul>
  11. 11. 8-3c Disadvantages of a Partnership <ul><li>Disadvantages of a partnership include: </li></ul><ul><ul><li>Unlimited liability </li></ul></ul><ul><ul><li>Potential disagreements </li></ul></ul><ul><ul><li>Investment withdrawal difficulty </li></ul></ul><ul><ul><li>Limited capital availability </li></ul></ul><ul><ul><li>Instability </li></ul></ul>
  12. 12. 8-4 Limited Liability Company <ul><li>The limited liability company (LLC) is a relatively new legal form that has now been adopted in all fifty states. </li></ul><ul><ul><li>The LLC limits the liability exposure of all investors to the amount of their investment. </li></ul></ul><ul><ul><ul><li>Anyone can participate in the management and still have limited liability protection. </li></ul></ul></ul><ul><ul><li>To form a limited liability company (LLC), business owners must file formal articles of organization with their state's LLC filing office and comply with other state filing requirements. </li></ul></ul><ul><ul><ul><li>LLC can have an unlimited number of investors, known as members. </li></ul></ul></ul><ul><ul><ul><li>It is also required to prepare an operating agreement. </li></ul></ul></ul>
  13. 13. 8-4a Advantages of a Limited Liability Company <ul><li>Advantages of a limited liability company include: </li></ul><ul><ul><li>Limited liability </li></ul></ul><ul><ul><li>Pass-through taxation </li></ul></ul><ul><ul><li>Investors can manage </li></ul></ul><ul><ul><li>Unlimited membership </li></ul></ul><ul><ul><li>Ease of organizing </li></ul></ul>
  14. 14. 8-4b Disadvantages of a Limited Liability Company <ul><li>The disadvantages of an LLC are due primarily to its relatively recent adoption by state legislatures. </li></ul><ul><ul><li>Many people still don’t understand it well, and courts have only begun to form a record of common law. </li></ul></ul><ul><li>Other disadvantages include: </li></ul><ul><ul><li>Difficulty raising money </li></ul></ul><ul><ul><li>No continuity of life </li></ul></ul><ul><ul><li>Limited transferability </li></ul></ul>
  15. 15. 8-5 Corporation <ul><li>Corporation: Artificial legal entity typically chartered by a state is formed to operate a business. </li></ul><ul><ul><li>The corporation is completely separate from its owners </li></ul></ul><ul><ul><li>Has its own life </li></ul></ul><ul><ul><li>Is liable for its own debts </li></ul></ul><ul><ul><li>Must pay its own taxes </li></ul></ul><ul><li>Two types of corporations exist: </li></ul><ul><ul><li>C-corporation — more commonly known. </li></ul></ul><ul><ul><ul><li>It is the legal structure for many of the largest companies in the world. </li></ul></ul></ul><ul><ul><ul><li>A C-corporation files and pays corporate income taxes directly. </li></ul></ul></ul>
  16. 16. 8-5 Corporation (cont.) <ul><ul><ul><li>If the entrepreneur plans to retain profits to finance growth, repay debt, or make other capital expenditures then a C-corporation form makes sense. </li></ul></ul></ul><ul><ul><ul><li>C-corporations can take advantage of corporate income tax rates. </li></ul></ul></ul><ul><ul><ul><li>The C-corporation status has the ability to provide greater flexibility in terms of planning and controlling federal income taxes. </li></ul></ul></ul><ul><ul><ul><li>C-corporations also can deduct the cost of certain fringe benefit packages. </li></ul></ul></ul><ul><ul><ul><li>The C-corporation is taxed twice on its profits — double taxation. </li></ul></ul></ul><ul><ul><ul><li>C-corporation has advantages for fund-raising because it is the only business form that is allowed to sell both common and preferred stock. </li></ul></ul></ul>
  17. 17. 8-5 Corporation (cont.) <ul><li>The Omnibus Budget Reconciliation Act of 1983 — S-corporation — uses noncorporate tax rates at the request of the shareholders. </li></ul><ul><ul><li>To qualify as an S-corporation, a business must meet the following requirements: </li></ul></ul><ul><ul><ul><li>It must be incorporated within the United States. </li></ul></ul></ul><ul><ul><ul><li>It can only sell shares of common stock. </li></ul></ul></ul><ul><ul><ul><li>All shareholders must be residents of the United States. </li></ul></ul></ul><ul><ul><ul><li>Shareholders must be natural persons, estates, or trusts. </li></ul></ul></ul><ul><ul><ul><li>No shareholder can be a partnership or a corporation. </li></ul></ul></ul><ul><ul><ul><li>Some states limit the number of shareholders. </li></ul></ul></ul><ul><ul><ul><li>No more than 20 percent of its income can come from passive activities. </li></ul></ul></ul>
  18. 18. 8-5 Corporation (cont.) <ul><ul><li>S-corporation has advantages and disadvantages. </li></ul></ul><ul><ul><ul><li>Primary advantage — The shareholders’ tax brackets can result in tax savings. </li></ul></ul></ul><ul><ul><ul><li>Primary disadvantage — The tax law governing the S-corporation is very complex. </li></ul></ul></ul><ul><li>Corporations can change legal form from S-corporation status to C-corporation status fairly easily, but there are costs involved. </li></ul>
  19. 19. 8-5a Advantages of a Corporation <ul><li>Advantages of a corporation include: </li></ul><ul><ul><li>Limited liability </li></ul></ul><ul><ul><li>Skilled management team </li></ul></ul><ul><ul><li>Transfer of ownership </li></ul></ul><ul><ul><li>Greater capital base </li></ul></ul><ul><ul><li>Stability </li></ul></ul><ul><ul><li>Legal-entity status </li></ul></ul>
  20. 20. 8-5b Disadvantages of a Corporation <ul><li>Disadvantages of a corporation include: </li></ul><ul><ul><li>Difficulty and expense of starting </li></ul></ul><ul><ul><li>Lack of control </li></ul></ul><ul><ul><li>Multiple taxation and fees </li></ul></ul><ul><ul><li>Lack of secrecy </li></ul></ul><ul><ul><li>Lack of personal interest </li></ul></ul><ul><ul><li>Credit limitations </li></ul></ul>
  21. 21. 8-6 Nonprofit Corporation <ul><li>Many organizations are nonprofit corporations — not profit-seeking enterprises. </li></ul><ul><ul><li>This includes universities and other schools, charities, churches, volunteer organizations, credit unions, country clubs, government organizations, cooperatives, and a number of other organizations. </li></ul></ul><ul><li>Nonprofits have to make a profit in order to continue to operate. </li></ul><ul><ul><li>However they are prohibited by law from distributing earnings (paying dividends) to owners. </li></ul></ul><ul><ul><li>Donations, dues, and the sale of goods or services provide the funds to pay employees and finance operations. </li></ul></ul>