The Legal Side of Getting a Business Up and Running


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  • Sole Proprietorship is oldest and simplest form of business Difference Between Partnership and Joint Venture is that Partnership is ongoing business relationship whereas joint venture is typically restricted to a particular transaction.
  • The Legal Side of Getting a Business Up and Running

    1. 1. THE LEGAL SIDE OF GETTING A BUSINESS UP AND RUNNING Presented By Teri G. Rasmussen, Partner and Vice Chair of Business Law Practice Group of LANE, ALTON & HORST, LLC
    2. 2. Teri G. Rasmussen Partner and Vice Chair, Business Law Practice Group Lane, Alton & Horst, LLC [email_address] (614) 233-4753 <ul><li>Lane, Alton & Horst, LLC </li></ul><ul><li>Two Miranova Place, Suite 500 </li></ul><ul><li>Columbus, Ohio 43215 </li></ul><ul><li> </li></ul>
    3. 3. Teri G. Rasmussen Business Acquisitions and Sales General Corporate and Business Law Joint Ventures and Strategic Alliances Corporate Governance and Shareholder Disputes Contracts and Loan/Lease Documentation Business Formation and Financing Business Planning Creditors’ Rights and Debt Collection Business Bankruptcy and Insolvency UCC and Secured Transactions Commercial Finance Litigation Real Estate
    4. 4. Teri G. Rasmussen B.A., with honors, 1981, University of Iowa J.D., cum laude , 1984, University of Michigan Bar Admissions: Supreme Court of Ohio, 1984 U.S. District Court, Southern District of Ohio, 1984 U.S. District Court, Northern District of Ohio, 1993 U. S. Sixth Circuit Court of Appeals, 1997 Professional Associations: Columbus (Former Chair, Financial Institutions Committee), Ohio State (Former Chair, Subcommittee of Accounts, Payments, and Letters of Credit of Banking, Commercial and Bankruptcy Committee) and American Bar Associations American Bankruptcy Institute National Association of Women Business Owners (NAWBO) Executive Women’s Golf Association (EWGA)
    5. 5. EVERY Business Has a Legal Form <ul><li>If you don’t make a Decision, the Law will make one for you. </li></ul><ul><li>A one-person business will automatically be a sole proprietorship . </li></ul><ul><li>A business with two or more Owners will automatically be treated as a general partnership </li></ul>
    6. 6. The TYPE of LEGAL ENTITY Matters <ul><li>Level of Formality Required for Recordkeeping </li></ul><ul><li>Level of Formality Required in Decisionmaking </li></ul><ul><li>Effect of Death or Disability of Anyone Actively “Involved” in the “Management” of the Business </li></ul><ul><li>Taxes – Who Pays and How Much </li></ul><ul><li>Ability of Business Creditors, Disgruntled Employees, and Others to Reach Personal Assets of Owner(s) </li></ul><ul><li>Who Has “Say” in, or Control of Business and its Operations </li></ul>
    7. 7. Customizing the Governance and Legal Structure of a Business <ul><li>TYPE of LEGAL STRUCTURE </li></ul><ul><li>matters less than </li></ul><ul><li>SPECIFIC DECISIONS concerning relationships among owners, as well as the management and operation of the business </li></ul>
    8. 8. <ul><li>Selecting a Legal Form </li></ul><ul><li>for Your Business </li></ul><ul><li>IS NOT </li></ul><ul><li>a Multiple Choice Test </li></ul>
    9. 9. Factors to Consider in Choosing a Legal Structure <ul><li>How much record-keeping are you able and willing to do on a continuing periodic basis? </li></ul><ul><li>What is YOUR tolerance for risk? </li></ul><ul><ul><li>What sort of risks are you most comfortable having? </li></ul></ul><ul><ul><li>What sort of risks do you MOST need/want to avoid? </li></ul></ul><ul><li>How will the business be financed? </li></ul><ul><ul><li>Outside Investors and Creditors </li></ul></ul><ul><ul><li>Personal and Family Funds </li></ul></ul>
    10. 10. Factors to Consider in Choosing a Legal Structure <ul><li>What sort of business risks are there in your industry or type of business? </li></ul><ul><li>How much government regulation is your business generally subject to? </li></ul><ul><li>Where will your business sell or provide good and/or services? </li></ul><ul><ul><li>Locally or within one state? </li></ul></ul><ul><ul><li>Regionally? </li></ul></ul><ul><ul><li>Nationally? </li></ul></ul><ul><ul><li>Worldwide? </li></ul></ul>
    11. 11. Factors to Consider in Choosing a Legal Structure <ul><li>Short and Long Term Objectives and Goals </li></ul><ul><li>Size and Character of Business in Three Years? In Five Years? </li></ul><ul><ul><li>Revenues and Sales </li></ul></ul><ul><ul><li>Employees </li></ul></ul><ul><ul><li>Number and Diversity of Ownership </li></ul></ul>
    12. 12. Factors to Consider When You Are Not the Only Owner <ul><li>How well do you know your fellow owner(s) and can you really trust them? </li></ul><ul><li>Compatibility of Owners in Temperament, Work Habits, Spending, Risk Tolerance, Etc. </li></ul><ul><li>Strengths and Weaknesses of Fellow Owner(s) – Could a Weakness Cause a Problem for the Business and How Can That be Guarded Against </li></ul>
    13. 13. Factors to Consider When You Are Not the Only Owner <ul><li>How Many Owners Will There Be? </li></ul><ul><li>Will the owners be individuals or business entities? </li></ul><ul><li>What Role, Responsibilities and/or Duties Will Each Owner Have? How will these be Shared or Allocated? </li></ul><ul><li>Will any owner(s) or group of owners have veto power with respect to certain specific issues? </li></ul>
    14. 14. Factors to Consider When You Are Not the Only Owner <ul><li>Are you the “money” person or the “sweat equity” person? </li></ul><ul><li>What happens if an owner wants out of the business? </li></ul><ul><ul><li>Getting Investment Out of the Business </li></ul></ul><ul><ul><li>Transfer, and Restrictions on Transfer, of Ownership </li></ul></ul><ul><li>What happens to ownership interest upon death or disability of owner? </li></ul><ul><li>Will some owners get their “investment” back sooner than other owners? </li></ul>
    15. 15. Basic Legal Structure Choices <ul><li>Sole Proprietorship </li></ul><ul><li>Partnership </li></ul><ul><ul><li>Limited </li></ul></ul><ul><ul><li>General </li></ul></ul><ul><li>Corporation </li></ul><ul><ul><li>C-Corp </li></ul></ul><ul><ul><li>S-Corp </li></ul></ul><ul><li>Limited Liability Company (LLC) </li></ul>
    16. 16. Basic Types of Ownership Interests Partnership Partnership Interest Corporation Shares of Capital Stock LLC Membership Interest
    17. 17. Limitations on Number of Owners <ul><li>One Owner - </li></ul><ul><ul><li>Can be Sole Proprietorship only if an Individual </li></ul></ul><ul><ul><li>Can be a Corporation or LLC. </li></ul></ul><ul><ul><li>Cannot be a Partnership </li></ul></ul><ul><li>Two or More Owners – </li></ul><ul><ul><li>Can be Partnership or LLC </li></ul></ul><ul><ul><li>Can be Corporation </li></ul></ul><ul><ul><ul><li>S-Corps Cannot have More Than 75 Shareholders </li></ul></ul></ul><ul><ul><li>Cannot be Sole Proprietorship </li></ul></ul>
    18. 18. Special Restrictions on Ownership of an S-Corp <ul><li>Limited to 75 Shareholders </li></ul><ul><li>Only U.S. Citizens May Be Shareholders </li></ul><ul><li>C-Corps Cannot Be a Shareholder </li></ul><ul><li>Cannot Have other S-Corps, LLCs, Partnerships or many types of Trusts as Shareholders </li></ul>
    19. 19. Sole Proprietorship Background and History <ul><li>No separate existence from owner. </li></ul><ul><ul><li>Business assets in owner’s personal name </li></ul></ul><ul><ul><li>Owner signs contract in personal capacity </li></ul></ul><ul><ul><li>If owner dies or becomes disabled, so does business </li></ul></ul><ul><ul><li>Profits and losses from, as well as expenses of, business included on individual income tax return </li></ul></ul>
    20. 20. Weighing the Sole Proprietorship Alternative <ul><li>Advantages </li></ul><ul><li>Maximum authority and control </li></ul><ul><li>Simplest and least expensive to start – just find a location and open the doors </li></ul><ul><li>Appropriate for very small service business not likely to borrow much money and not likely to be sued </li></ul><ul><li>Business losses can offset income from other sources </li></ul><ul><li>Disadvantages </li></ul><ul><li>Death or Illness endangers business </li></ul><ul><li>Growth limited by personal energies </li></ul><ul><li>Obtaining financing and investment may be difficult </li></ul><ul><li>Personal and business affairs easily mixed </li></ul>
    21. 21. Weighing the Sole Proprietorship Alternative Tax Considerations <ul><li>Business profits of a sole proprietorship can be taken only as salary and wages which are subject to both income tax and self-employment tax. </li></ul><ul><li>Business profits of a corporation could also be taken as dividends or distributions not subject to self-employment tax. </li></ul>
    22. 22. Sole Proprietorship Responsibilities <ul><li>While sole proprietorships are the simplest and most easily formed business structure, you still have legal responsibilities. </li></ul><ul><ul><li>There may be local registration, license or permit laws required to make the business legitimate </li></ul></ul><ul><ul><ul><li>Visit the website of the 1 st Stop Business Connection, a program sponsored by the Ohio Department of Development's Small Business Development Centers and the U.S. Small Business Administration where you can download a tailored FREE business information kit containing the basics all businesses must know and the state-level regulations and forms specifically for your business. </li></ul></ul></ul><ul><ul><li> </li></ul></ul>
    23. 23. Purpose of Forming Partnership <ul><li>Nothing more than a common law contract between owners </li></ul><ul><li>To operate broad-based business </li></ul><ul><li>To share in the responsibilities of management </li></ul><ul><li>To divide the profits realized from the enterprise </li></ul>
    24. 24. Partnership Characteristics <ul><li>Almost any management and profit-sharing arrangement can be agreed upon among the partners </li></ul><ul><li>Must have at least two partners at all times </li></ul><ul><li>Joint Venture or Strategic Alliance differs from true partnership because it is generally limited to an isolated and particular transaction. </li></ul>
    25. 25. What to Include in Partnership Agreement <ul><li>Name of Partnership </li></ul><ul><li>Contributions to Partnership Made by Each Partner and When Made </li></ul><ul><li>Allocations of Profits and Losses; Draws </li></ul><ul><ul><li>In proportion to % interest? </li></ul></ul><ul><ul><li>Distributions only at end of year? </li></ul></ul><ul><ul><li>Regular periodic draws? </li></ul></ul><ul><ul><li>Responsive to financial needs of each partner? </li></ul></ul><ul><li>Individual Authority of Each Partner to Bind Partnership </li></ul><ul><li>Partnership Decision-making Procedure </li></ul><ul><li>Management Duties, or Absence of Same, of Each Partner </li></ul><ul><li>Admission of New Partners </li></ul><ul><li>Effect of Withdrawal or Death of Partner; Buyout Procedures </li></ul><ul><li>Dispute Resolution Process </li></ul>
    26. 26. General Partnership Definition Ohio law defines a general partnership as “ an association of two or more persons to carry on as co-owners, a business for profit” Ohio Rev. Code 1775.05(A)
    27. 27. Creation of General Partnership <ul><li>Can be “accidentally” created – formation occurs whenever parties expressly or implicitly start sharing profits and losses and the management of the business </li></ul><ul><li>Can be created orally – no written agreement required, though recommended </li></ul>
    28. 28. Distinguishing Characteristics of General Partnership <ul><li>All of the Partners </li></ul><ul><li>Manage the company together </li></ul><ul><li>Have joint responsibility for all of Partnership debts </li></ul><ul><li>Have authority to make contracts and decisions on their own for partnership </li></ul>
    29. 29. Status of General Partnership <ul><li>Treated as a separate entity from its Partners for limited non-tax purposes </li></ul><ul><ul><li>Holds Assets in Name of Partnership </li></ul></ul><ul><ul><li>Contracts Executed in Partnership Name </li></ul></ul><ul><ul><li>Must File Separate Tax Return, but does not pay taxes </li></ul></ul><ul><li>Both partnership and general partners can be sued for partnership obligations </li></ul><ul><li>Partners pay taxes on partnership income and report on their tax returns </li></ul>
    30. 30. Limited Partnership <ul><li>Only valid if written and formed in compliance with statutory requirements </li></ul><ul><li>One General Partner – same responsibilities as in general partnership </li></ul><ul><li>Other Limited Partners – Have limited rights in exchange for limited liability for partnership debts </li></ul>
    31. 31. General and Limited Partnerships Comparison <ul><li>General Partnership </li></ul><ul><li>All Partners Participate in Management </li></ul><ul><li>Dissolves upon death or withdrawal of any partner </li></ul><ul><li>Limited Partnership </li></ul><ul><li>Limited Partners Must Not Be Involved in Day-to-Day Operations </li></ul><ul><li>Dissolves only upon death or withdrawal of General Partner </li></ul><ul><li>More Complex than General Partnership </li></ul>
    32. 32. Weighing the Partnership Alternative <ul><li>Advantages </li></ul><ul><li>Two (or more) heads are better than one </li></ul><ul><li>Income passes through to Partners </li></ul><ul><li>Management Structure Flexibility </li></ul><ul><li>No qualification requirements for doing business in other states </li></ul><ul><li>Disadvantages </li></ul><ul><li>Difficult to get rid of bad partners </li></ul><ul><li>More Expensive to form than sole proprietorship, especially in case of limited partnerships </li></ul><ul><li>Difficult to transfer ownership interest </li></ul><ul><li>Hazy line of authority in general partnership </li></ul><ul><li>Cannot have both management responsibilities and limited liability </li></ul>
    33. 33. Usefulness of Partnership Alternative <ul><li>General Partnership is obsolete except in very special circumstances </li></ul><ul><ul><li>Owner is particularly concerned about deductibility and capital gains treatment of continuing payments to retiring partners (IRC 736(a)) </li></ul></ul><ul><ul><li>Important that business not be treated as entity for tax purposes (e.g. oil and gas investments) </li></ul></ul><ul><li>Limited Partnership duplicated and supplemented by LLC alternative </li></ul>
    34. 34. Corporations <ul><li>C-Corp - for larger more mature businesses, especially those publicly held, and for those anticipating making initial public offerings (IPO) of capital stock in the near future </li></ul><ul><li>S-Corp – for smaller privately held businesses with less than 75 owners, all of whom are individuals </li></ul>
    35. 35. Formation of Corporation <ul><li>Corporation has NO owners until stock shares have actually been issued to owners by the Incorporator. </li></ul><ul><li>Corporation IS NOT validly formed until </li></ul><ul><ul><li>Shareholders elect Directors </li></ul></ul><ul><ul><li>AND </li></ul></ul><ul><ul><li>Directors appoint Officers. </li></ul></ul>
    36. 36. Corporation Formation Procedure <ul><li>Articles of Incorporation are signed by “Incorporator”, who may or may not become a Shareholder, and filed with the Secretary of State. </li></ul><ul><li>Incorporator receives subscriptions and payment for shares and issues them to owners. </li></ul><ul><li>Incorporator calls first meeting of Shareholders to elect Directors, adopt Code of Regulations, and transact any other business. </li></ul><ul><li>4. After Shareholders elect Directors, Directors pass resolution appointing Officers. </li></ul>
    37. 37. Corporate Governance <ul><li>Shareholders have no authority to control day-to-day management or business operations </li></ul><ul><li>Shareholders elect Directors </li></ul><ul><ul><li>Board of Directors set general policy </li></ul></ul><ul><li>Board of Directors appoint Officers such as President, Vice President, Treasurer, and Secretary </li></ul><ul><ul><li>Officers manage day-to-day operations of company </li></ul></ul><ul><ul><li>Officers are answerable to Board for their actions </li></ul></ul>
    38. 38. Distinguishing Characteristics of Corporations <ul><li>Ownership interests are known as “shares” or “stock” and are freely transferable to anyone else unless shareholders otherwise agree </li></ul><ul><li>Shareholders are not liable for company obligations except under highly unusual circumstances, but the company itself will be held liable </li></ul><ul><li>Existence continues even after departure of original owners or key individuals </li></ul>
    39. 39. Comparing Corporations to Partnerships and Sole Proprietorship <ul><li>In comparison with partnerships or sole proprietorships </li></ul><ul><ul><li>Extensive record-keeping required </li></ul></ul><ul><ul><li>Employees, including the owner(s), able to participate in various types of insurance, profit-sharing, and other benefits otherwise not available </li></ul></ul><ul><ul><li>More Flexible approaches to taxation </li></ul></ul><ul><ul><li>More complicated and expensive to form </li></ul></ul>
    40. 40. Weighing the Incorporation Alternative: Effect Upon Personal Liability <ul><li>Incorporating </li></ul><ul><li>Helps separate your personal identity from that of your business . Once incorporated, the shareholders of a corporation have only the money they put into the company to lose, and usually no more as a result of being a shareholder. </li></ul><ul><li>Remaining Unincorporated </li></ul><ul><li>Sole proprietors and general partners are subject to unlimited personal liability for business debt or law suits against their company. Creditors of the sole proprietorship or partnership, including ordinary suppliers, vendors, and other trade creditors can bring suit against the owners of the business and can move to seize the owners’ homes, cars, savings or other personal assets. </li></ul>
    41. 41. Limited Liability Myth <ul><li>Insulation from all potential liability and become immune from lawsuits? Unfortunately </li></ul><ul><li>Banks and other lenders typically require personal guarantees of owners </li></ul><ul><li>Accidents and injuries to others resulting from the business are covered by insurance or owner remains personally liable for his own personal actions. </li></ul>
    42. 42. Where Limited Liability Really Does Come In Handy <ul><li>EXAMPLE </li></ul><ul><li>Kevin is the owner of a small manufacturing business. When business prospects look good, he orders $50,000 worth of supplies and uses them in creating merchandise. </li></ul><ul><ul><li>Unfortunately, there's a sudden drop in demand for his products, and Kevin can't sell the items he's produced. When the company that sold Kevin the supplies demands payment, he can't pay the bill. </li></ul></ul><ul><ul><li>As sole proprietor, Kevin is personally liable for this business obligation. This means that the creditor can sue him and go after not only Kevin's business assets, but his other property as well. This can include his house, his car and his personal bank account. </li></ul></ul>
    43. 43. Weighing the Incorporation Alternative: Credibility of Business <ul><li>Adds Credibility. A corporate structure communicates permanence, credibility and stature. Even if you are the only stockholder or employee, your incorporated business may be perceived as a much larger and more credible company. </li></ul>
    44. 44. Weighing the Incorporation Alternative: Tax Advantages Available <ul><li>Tax Advantages – Deductible Employee Benefits. Incorporating usually provides tax-deductible benefits for you and your employees. </li></ul><ul><ul><li>Even if you are the only shareholder and employee of your business, benefits such as health insurance, life insurance, travel and entertainment expenses may now be deductible. </li></ul></ul><ul><ul><li>Corporations usually provide an increased tax shelter for qualified pensions plans or retirement plans (e.g. 401K’s). </li></ul></ul>
    45. 45. Weighing the Incorporation Alternative: Attracting Capital and Financing <ul><li>Incorporated </li></ul><ul><li>Capital can be more easily raised with a corporation through the sale of stock. </li></ul><ul><li>Investors are more likely to purchase shares in a corporation where there usually is a separation between personal and business assets. </li></ul><ul><li>Some banks prefer to lend money to corporations. </li></ul><ul><li>Unincorporated </li></ul><ul><li>With sole proprietorships and partnerships, investors are much harder to attract because of the inability to have control without personal liability. </li></ul>
    46. 46. Weighing the Incorporation Alternative: Disclosure of Ownership <ul><li>Incorporated </li></ul><ul><li>Can offer anonymity to its owners. </li></ul><ul><li>E xample: If you want to open an independent small business of any kind and do not want your involvement to be public knowledge, your best choice may be to incorporate. </li></ul><ul><li>Unincorporated </li></ul><ul><li>If you open as a sole proprietorship, it is nearly impossible to hide the fact that you are the owner. </li></ul><ul><li>As a partnership, you will most likely be required to register your name and the names of your partners with the state and/or county officials in which you are doing business. </li></ul>
    47. 47. Weighing the Incorporation Alternative: Centralized Management <ul><li>Incorporated </li></ul><ul><ul><li>With a corporation’s centralized management, all decisions are made by your board of directors. </li></ul></ul><ul><ul><li>Your shareholders cannot unilaterally bind your company by their acts simply because of their investment. </li></ul></ul><ul><li>Unincorporated </li></ul><ul><li>With partnerships, each individual general partner may make binding agreements on behalf of the business that may result in serious financial difficulty to you or the partnership as a whole. </li></ul>
    48. 48. Weighing the Incorporation Alternative: Transferring Ownership <ul><li>Incorporated </li></ul><ul><li>Ownership of a corporation may be transferred, without substantially disrupting operations or the need for complex legal documentation, through the sale of stock. </li></ul><ul><li>Unincorporated </li></ul><ul><li>Cannot sell sole proprietorship as a going concern, i.e. can only sell individual assets </li></ul><ul><li>Partnership may dissolve; generally not easily transferable </li></ul>
    49. 49. Close Corporations <ul><li>A close corporation is a special sort of </li></ul><ul><li>S-corporation designed for businesses with only a few owners. </li></ul><ul><ul><li>Allows owners by agreement to bypass many of the usual formalities required of corporations, thereby simplifying management of company affairs </li></ul></ul><ul><ul><li>Requires a written agreement complying with specific statutory requirements (Ohio Rev. Code 1701.591) </li></ul></ul><ul><ul><li>Often has restrictions on ability of shareholders to transfer ownership </li></ul></ul>
    50. 50. Impetus for Emergence of Limited Liability Company (LLC) <ul><li>Arose from Desire </li></ul><ul><li>of business owners and investors </li></ul><ul><li>To combine the limited liability protection provided by corporation law with </li></ul><ul><li>Advantageous income treatment available to Partnerships </li></ul><ul><ul><li>BUT WITHOUT </li></ul></ul><ul><ul><li>Management issues of Limited Partnerships </li></ul></ul><ul><ul><li>S-Corp Restrictions on Type and Number of Shareholders Permitted </li></ul></ul>
    51. 51. Statutory History of Development of Limited Liability Company (LLC) <ul><li>Relatively recent legal form of business allowing owners to take advantage of the benefits of both the corporation and partnership forms of business </li></ul><ul><ul><li>First statute enacted in Wyoming in 1977 </li></ul></ul><ul><ul><li>Gained popularity after IRS ruled LLC could be treated as a partnership for federal income tax purposes (IRS Rev. Rul. 88-76) </li></ul></ul><ul><ul><li>Ohio has allowed since 1994 </li></ul></ul><ul><ul><ul><li>Single member LLC permitted since 1997 </li></ul></ul></ul><ul><ul><ul><li>Written Agreement Not Required; Default Provisions of Ohio Rev. Code 1705.13 would govern </li></ul></ul></ul><ul><ul><li>Now available in all 50 States </li></ul></ul>
    52. 52. Types of Limited Liability Company <ul><li>Manager Managed </li></ul><ul><ul><li>Similar to Corporation with only a single Member or small group of selected Members in control of management of business and affairs of company </li></ul></ul><ul><li>Member Managed </li></ul><ul><ul><li>More like a Partnership with all Members actively participating in management of company and it business affairs </li></ul></ul>
    53. 53. Limited Liability Company Characteristics <ul><ul><li>LLCs are not corporations or partnerships, but in many ways offer the best of both. </li></ul></ul><ul><ul><ul><li>Many small business owners and entreprenuers prefer LLCs because they combine the limited liability protection of a corporation with the flexibility and “pass through” of a sole proprietorship or partnership . </li></ul></ul></ul><ul><ul><ul><li>LLC can choose to be taxed as either a corporation or partnership </li></ul></ul></ul>
    54. 54. Limited Liability Company Characteristics <ul><li>Unlimited number of Members with any mix of individuals and business entities </li></ul><ul><li>Management Participation without loss of Limited Liability Protection </li></ul><ul><li>Flexible allocations and distributions of profits and losses </li></ul><ul><li>Flexible Control and Governance </li></ul><ul><li>Minimal Statutory Formalities Required </li></ul><ul><li>Taxation Options – Can choose to be taxed either as corporation or as a partnership </li></ul>
    55. 55. LLC Formation Procedure <ul><li>LLC is validly formed when its Articles of Organization are filed with the Ohio Secretary of State. </li></ul><ul><li>2. If LLC does not have an Operating Agreement, Ohio law will apply certain “default” provisions regarding its governance and the operation of its business. </li></ul>
    56. 56. Manager Managed LLC <ul><li>Manager(s) selected and replaced in whatever manner agreed upon by Members </li></ul><ul><li>In general, Manager(s) make all decisions concerning the company’s business, operational, and financial affairs without input or prior approval of Members </li></ul><ul><li>Some major substantive decisions still reserved to Members </li></ul><ul><li>Manager does not have to be a Member </li></ul><ul><li>Any number of Managers permitted </li></ul>
    57. 57. Member Managed LLC <ul><li>Ohio statutory provisions govern unless displaced by provisions of a written Operating Agreement </li></ul><ul><li>Can vote by headcount, pro rata Membership Interest, or any other system agreed upon by the Members </li></ul><ul><li>A Member’s management voting rights do not have have any relationship to that Member’s ownership interest </li></ul>
    58. 58. Weighing the LLC Alternative – Similarities to S-Corp <ul><li>Both LLCs and S-Corps offer their owners limited liability protection and are both pass-through tax entities . </li></ul><ul><ul><li>Pass-through taxation allows the income or loss generated by the business to be reflected on the personal income tax return of the owners. This means that if you have business losses you want to use to offset other income you might have from another job or from your spouse's employment, for example, you can claim those losses on your personal income tax.This special tax status eliminates any possibility of double taxation for S corporations and LLCs </li></ul></ul>
    59. 59. Weighing the LLC Alternative – Differences From S-Corp <ul><li>LLCs are more flexible in the way profits can be distributed </li></ul><ul><ul><li>An S-corporation can only have one class of stock and your percentage of ownership determines the percentage of pass-through income. </li></ul></ul><ul><ul><li>LLC can have many different classes of interest, and the percentage of pass-through income is not tied to ownership percentage . The pass-through percentage can be set by agreement of the members in the LLC's operating agreement. </li></ul></ul>
    60. 60. Weighing the LLC Alternative – Comparison to Limited Partnership <ul><li>Limited Partnership must have at least one owner with unlimited liability; LLC does not. </li></ul><ul><ul><li>Consequence: For total limited liability, additional corporation or LLC must be formed to be the required general partner </li></ul></ul><ul><li>Limited Partnership must have at least two owners; LLC can have just one. </li></ul><ul><ul><li>Consequence: An individual could establish an LLC to hold property he or she plans to use for gifting purposes in the future, but have that entity ignored for federal income tax purposes until the gift is made (at which point it becomes a partnership for tax purposes) </li></ul></ul>
    61. 61. Special Advantages of LLC <ul><li>If you're thinking about forming an &quot;S&quot; corporation : </li></ul><ul><ul><li>An &quot;S&quot; corporation is taxed in the same way as an LLC, but it has some restrictions on </li></ul></ul><ul><ul><ul><ul><li>the number and types of shareholders , </li></ul></ul></ul></ul><ul><ul><ul><ul><li>how profits and losses can be allocated among the owners, and </li></ul></ul></ul></ul><ul><ul><ul><ul><li>The kinds of stock they can issue to investors. </li></ul></ul></ul></ul><ul><ul><li>The LLC has none of these restrictions </li></ul></ul>
    62. 62. Special Advantages of LLC <ul><li>If you're thinking of forming a partnership : </li></ul><ul><li>A partnership is taxed in the same way as an LLC but </li></ul><ul><li>doesn't offer the limited liability without giving up management responsibilities to all partners that an LLC offers to all its members. </li></ul>
    63. 63. Special Advantages of LLC <ul><li>If you're planning to start a business that will hold real property that will appreciate </li></ul><ul><ul><ul><li>“ C” corporations and their shareholders are subject to tax on the appreciation when assets are sold or liquidated </li></ul></ul></ul><ul><ul><ul><li>An LLC and its members are not subject to this double taxation </li></ul></ul></ul>
    64. 64. Special Advantages of LLC <ul><li>If you're forming a business in which you'll have investors who will want to be paid back their investment before the other owners receive anything : </li></ul><ul><ul><li>Instead of being restricted to dividing up profits proportionate to the percentage of ownership (as in a corporation), an LLC allows members to decide what share of the profits and losses each owner will receive. </li></ul></ul>
    65. 65. Decision Points in Selecting Legal Structure of Business <ul><li>ECONOMIC </li></ul><ul><li>Allocation of Profits and Losses </li></ul><ul><li>Distribution Entitlement and Order </li></ul><ul><li>MANAGEMENT and </li></ul><ul><li>DECISION-MAKING </li></ul><ul><li>OWNERSHIP TRANSFERS </li></ul>
    66. 66. Economic Decision Points Allocation of Profits and Losses <ul><li>Unless Otherwise Agreed by Owners </li></ul><ul><li>General Partnership – Divided equally among partners regardless of relative amount of contribution </li></ul><ul><li>Limited Partnership – Based upon relative value of contribution not yet returned to partner </li></ul><ul><li>Corporation – Divided on a pro rata based on number of shares held </li></ul><ul><li>LLC – Divided on a pro rata based on membership interest held </li></ul>
    67. 67. Economic Decision Points Distribution Entitlement and Order <ul><li>Unless Otherwise Agreed by Owners </li></ul><ul><li>General Partnership – Partners entitled to receive profits as they occur </li></ul><ul><li>Limited Partnership – Partners have no right to receive any distributions until they withdraw or partnership dissolves </li></ul><ul><li>Corporation – Directors have discretion to determine when dividends will be distributed </li></ul><ul><li>LLC – Members have no right to receive any distributions until they withdraw or company dissolves </li></ul>
    68. 68. Practical Criteria 1. How many owners are there and who are they? 2. What is the current and anticipated personal and business relationship between the owners ?
    69. 69. Practical Criteria <ul><li>Are you the dominant, subordinate, or equal owner in the business? </li></ul><ul><ul><li>“ Money” Owner or “Sweat Equity” </li></ul></ul><ul><ul><li>Controlling Ownership Interest </li></ul></ul><ul><ul><li>Controlling Vote </li></ul></ul>
    70. 70. Practical Criteria 4. Are some or all of the owners actively involved in the day-to-day operations of the business? 5. Are owners relying on the business as their primary source of income ?
    71. 71. Practical Criteria <ul><li>6. What is procedure for making important business decisions and who makes them? </li></ul><ul><ul><li>One owner or group </li></ul></ul><ul><ul><li>Headcount or Pro Rata </li></ul></ul>
    72. 72. Practical Criteria <ul><li>What is “exit strategy” for realizing investment in the business? </li></ul><ul><ul><ul><li>Voluntary Amicable Departure </li></ul></ul></ul><ul><ul><ul><li>Dispute Among Owners </li></ul></ul></ul><ul><ul><ul><li>Occurrence of Certain Events </li></ul></ul></ul><ul><ul><ul><li>Achievement of Designated Benchmarks </li></ul></ul></ul><ul><ul><ul><li>Death of Owner </li></ul></ul></ul>
    73. 73. Practical Criteria <ul><li>1. How many owners are there and who are they? </li></ul><ul><li>2. What is the current and anticipated personal and business relationship between the owners? </li></ul><ul><li>3. Are you the dominant, subordinate, or equal owner in the business? </li></ul><ul><ul><ul><li>“ Money” Owner or “Sweat Equity” </li></ul></ul></ul><ul><ul><ul><li>Controlling Ownership Interest </li></ul></ul></ul><ul><ul><ul><li>Controlling Vote </li></ul></ul></ul><ul><li>4. Are some or all of the owners actively involved in the day-to-day operations of the business? </li></ul><ul><li>5. Are owners relying on the business as their primary source of income? </li></ul><ul><li>6. What is procedure for making important business decisions and who makes them? </li></ul><ul><li>7. What is “exit strategy” for realizing investment in the business? </li></ul><ul><ul><ul><li>Voluntary Amicable Departure </li></ul></ul></ul><ul><ul><ul><li>Dispute Among Owners </li></ul></ul></ul><ul><ul><ul><li>Occurrence of Certain Events </li></ul></ul></ul><ul><ul><ul><li>Achievement of Designated Benchmarks </li></ul></ul></ul><ul><ul><ul><li>Death of Owner </li></ul></ul></ul>
    74. 74. Agreements Among Owners Partnership Agreement Close Corporation Agreement Buy-Sell Agreement Operating Agreement
    75. 75. Ensuring an Exit Strategy <ul><li>“ Push-Pull” </li></ul><ul><li>Right of First Refusal </li></ul><ul><li>Cross Purchase </li></ul><ul><li>Puts </li></ul><ul><li>Calls </li></ul>
    76. 76. WITHOUT A BUY-SELL AGREEMENT….. <ul><li>Minority Owners Have Little or No Opportunity to Exit Business Without Substantial Loss </li></ul><ul><li>Unless the business as a whole is being sold to a third party, owners wishing to leave the business in general have no right to demand that the company or the other owners redeem their ownership interest by buying the departing owner out at any price. Nor does the company or other owner have any responsibility to help find a replacement owner willing to buy the ownership interest. Thus if no purchaser can be found, the owner wishing to sever his ties with the business has no way to obtain the value of his investment. </li></ul>
    77. 77. “ Push-Pull” Exit <ul><li>In two person businesses, a “push-pull” clause sets up a procedure allowing either owner to buy out, or be bought out by , the other owner. </li></ul><ul><ul><li>If Tom decides he doesn’t want to continue in business with Kate for any reason, or for no reason, Tom has a decision to make. He must determine whether he </li></ul></ul><ul><ul><ul><li>wants to continue running the business, but without Kate, or </li></ul></ul></ul><ul><ul><ul><li>would rather move on and leave Kate with the business. </li></ul></ul></ul>
    78. 78. “ Push-Pull” Buy-Out <ul><li>Suppose Tom elects to buy Kate out and run the business by himself. He must then come up with the purchase price at which he is willing to buy all of Kate’s ownership interest. At that juncture, Kate has two choices. </li></ul><ul><ul><li>Kate can accept Tom’s offer and sell out to him at the price offered </li></ul></ul><ul><ul><ul><li>Tom offers Kate $100,000 for her ownership interest. Kate accepts and sells her ownership interest to Tom for $100,000 . </li></ul></ul></ul><ul><ul><li>Kate can decide to buy Tom out at the same price Tom had offered to her. </li></ul></ul><ul><ul><ul><li>Tom offers Kate $100,000 for her ownership interest. Kate rejects the offer and must then pay Tom $100,000 for his ownership interest. </li></ul></ul></ul>
    79. 79. “ Push-Pull” Sell-Out <ul><li>If Tom would rather end his ownership of the company, he notifies Kate of the price at which he is willing to sell all of his ownership interest. </li></ul><ul><ul><ul><li>Tom tells Kate he wants $100,000 for his ownership interest </li></ul></ul></ul><ul><ul><li>Kate then chooses between accepting Tom’s request to become the sole owner of the business </li></ul></ul><ul><ul><ul><ul><li>Kate pays Tom $100,000 for his ownership interest </li></ul></ul></ul></ul><ul><ul><li>and having him buy her out at that same price . </li></ul></ul><ul><ul><ul><ul><li>Kate rejects Tom’s offer. Tom must then pay her $100,000 for her ownership interest </li></ul></ul></ul></ul>
    80. 80. Exit Through Puts and Calls <ul><li>In businesses with more owners, a “put” or “call” option requires the purchase or sale of an owner’s ownership interest by the company or other owners upon the occurrence of certain predetermined events or achievement of particular benchmarks. </li></ul>
    81. 81. Cross Purchase <ul><li>     Your Family Can Receive the Benefit of Your Investment Upon Your Death or Disability Without Argument </li></ul><ul><li>  </li></ul><ul><li>Under a “cross purchase” provision, owners agree that on a pro rata basis they will purchase the ownership interest of a disabled or deceased owner at an agreed predetermined price or based upon a specified formula. Sometimes owners agree to purchase life insurance on one another to provide a source of funding for this obligation. </li></ul>
    82. 82. Right of First Refusal <ul><li> You Can Control Who the Other Owners Are or Will Be </li></ul><ul><li>  </li></ul><ul><li>A “right of first refusal” allows the company or fellow owners to match an offer made by a third party for the ownership interest. Provisions requiring owners to be active in the business or preventing them from having full voting rights unless all or a certain portion of the remaining owners agree can ensure that owners share a similar philosophy or that the business stays in the family. </li></ul>
    83. 83. Business Structure Options Available to Sole Owner <ul><li>Cannot Be Partnership </li></ul><ul><li>Corporation </li></ul><ul><ul><li>Must Ensure Proper Formation Procedure Followed to Be Valid </li></ul></ul><ul><ul><li>Must Comply with Formalities Required by Law on an Ongoing Basis </li></ul></ul><ul><li>Limited Liability Company </li></ul>
    84. 84. Business Structure Options Available to “Equal” Owners Both Involved in Operations of the Business <ul><li>General Partnership </li></ul><ul><ul><li>No Limited Liability Protection </li></ul></ul><ul><ul><li>Few Formalities Required </li></ul></ul><ul><li>S Corporation </li></ul><ul><ul><li>Difficult to Merge into LLC </li></ul></ul><ul><ul><li>Governance and Growth Limitations </li></ul></ul><ul><li>Limited Liability Company </li></ul><ul><ul><li>Can mimic partnership management without losing limited liability protection </li></ul></ul><ul><ul><li>No Limitations to Subsequent Merger </li></ul></ul><ul><ul><li>Can later easily add members with differing equity and management rights </li></ul></ul>
    85. 85. Business Structure Options Available to Multiple Owners with Differing Equity and Management Rights <ul><li>General Partnership </li></ul><ul><ul><li>All Owners Participate in Management </li></ul></ul><ul><ul><li>No Limited Liability Protection </li></ul></ul><ul><li>Limited Partnership </li></ul><ul><ul><li>LLC has same and additional beneficial characteristics </li></ul></ul><ul><li>S Corporation </li></ul><ul><ul><li>Multiple classes of owners not permitted </li></ul></ul><ul><ul><li>Voting Rights Must Reflect Extent of Ownership Interest </li></ul></ul><ul><li>Limited Liability Corporation </li></ul><ul><ul><li>Unlimited Flexibility </li></ul></ul>
    86. 86. Making a Business Work From a Legal Standpoint <ul><li>Make some preliminary decisions about how business will be run. </li></ul><ul><ul><li>How will major decisions be made among owners? </li></ul></ul><ul><ul><li>Which owners will be actively involved in the business? </li></ul></ul><ul><ul><li>Under what conditions will there be new owners? </li></ul></ul><ul><li>Answers will guide but NOT require selection of particular structure. </li></ul>
    87. 87. Making a Business Work From a Legal Standpoint <ul><li>In most cases, choice is really between </li></ul><ul><ul><li>For One Owner - LLC and Sole Proprietorship </li></ul></ul><ul><ul><li>For Multiple Owners - LLC and S Corporation </li></ul></ul><ul><li>Contents of Governing Documents is Crucial Regardless of Choice Made </li></ul>
    88. 88. <ul><li>Choosing a Legal Structure for a Business is Less About the Nature of the Business Today Than Planning for Facing Challenges Lying Ahead. </li></ul>