Chapter 2: Business Organizations and Entity Choices

Choice-of-Entity Problem

Selecting the appropriate business structure for clients.

Limited Liability

Protection from personal responsibility for business debts.

Tax Treatment

Tax implications affecting business entity selection.

Governance

Rules and processes for managing a business entity.

Internal Conflict

Disputes among owners or stakeholders in a business.

Returns

Profits distributed to investors from business operations.

Liquidity

Ease of converting assets into cash.

Exit Strategy

Plan for selling or closing a business.

Capital Structure

Composition of a company's funding sources.

Red Tape

Bureaucratic hurdles affecting business operations.

Sole Proprietorship

Business owned and operated by one individual.

General Partnership

Business owned by two or more individuals jointly.

Limited Partnership

Partnership with general and limited partners.

Limited Liability Company

Hybrid entity offering limited liability and tax benefits.

Corporation

Legal entity separate from its owners, offering limited liability.

S Corporation

Corporation with special tax status under IRS rules.

Fiduciary Duties

Legal obligations to act in another party's best interest.

Passive Investors

Individuals who invest without active management involvement.

Double Taxation

Taxation of corporate profits and shareholder dividends.

Insolvency

Inability to pay debts as they come due.

Tort Liability

Legal responsibility for wrongful acts causing harm.

Business Counselor

Professional advising on business structure and legal issues.

Limited Liability Partnership (LLP)

Entity combining pass-through taxation and limited liability.

Limited Liability Company (LLC)

Business entity offering limited liability and tax benefits.

Pass-Through Taxation

Income taxed at individual owners' rates, not entity level.

Shareholders

Owners of a corporation with voting rights.

Board of Directors

Elected group responsible for company policymaking.

Corporate Officers

Appointed individuals managing day-to-day operations.

Chief Executive Officer (CEO)

Top executive making major business decisions.

General Partnership

Flexible management structure with equal decision-making rights.

Management Rights

Authority to make decisions within a business entity.

Conflict of Interest

Situation where a lawyer's duties may conflict.

ABA Model Rules 1.7

Allows concurrent representation with informed consent.

ABA Model Rules 1.13

Clarifies attorney's representation of the entity.

Informed Consent

Agreement given by clients after understanding implications.

Statutory Default Rules

Default legal provisions governing business entities.

Decision-Making Responsibility

Allocation of authority to make business decisions.

Management Flexibility

Ability to adjust management structure by agreement.

Deadlock

Inability to make decisions due to disagreements.

Policymaking Body

Group responsible for setting strategic direction.

Constituents

Individuals represented by an attorney in a business.

Ethical Rules

Guidelines governing attorney conduct and client relations.

Simultaneous Representation

Lawyer representing both entity and its constituents.

Lead Role in Management

Designated partner with primary decision-making authority.

Client Representation

Attorney's obligation to act in clients' best interests.

Model Rule 1.6

Prohibits disclosure of client confidences without consent.

Model Rule 1.4

Requires clients to be kept reasonably informed.

Returns

Earnings from business profits or ownership sales.

Liquidity

Ease of converting assets to cash.

Dividends

Payments to shareholders from corporate profits.

Shareholders

Investors owning shares in a corporation.

Partnerships

Business entities with shared ownership and profits.

General Partnerships

Partnerships allowing broad modifications of rules.

Statutory Tests

Legal requirements for corporate dividend payments.

Exchange-listed Corporations

Companies whose stocks are traded on exchanges.

Public Securities Exchanges

Markets for buying and selling securities.

Withdrawal Rights

Partners' ability to exit the partnership at will.

Buyout Terms

Agreed conditions for cashing out a partner.

Illiquid Investments

Assets difficult to convert to cash quickly.

Cash

Most liquid asset, easily spendable.

Fair Market Value

Price an asset can sell for in market.

Interest-bearing Bank Account

Account earning interest, highly liquid.

Certificate of Deposit

Investment with fixed term and higher interest.

Trade-off

Balancing liquidity against potential returns.

Governance Problem

Challenges in managing liquidity and returns together.

Investment Liquidity

Impact on ability to exit a firm.

Market Activity

Frequency of transactions in a given market.

Dissatisfaction with Company

Reason for shareholders to sell stock.

Dissatisfied Member

A member unhappy with firm decisions.

Ownership Shares

Equity interests in a business entity.

Majority Control

Ability of majority to make decisions unilaterally.

Vote with Feet

Selling investment to exit a situation.

Debt Financing

Borrowing money to fund business operations.

Equity Financing

Selling ownership interests to raise capital.

Pros and Cons

Advantages and disadvantages of financing methods.

Capital Structure

How a business finances its operations.

Business Entity Types

Different legal structures for businesses.

Founders' Capital

Initial funds provided by business founders.

Equity Investment

Investment in exchange for ownership interest.

Corporation

Business structure limiting personal liability for investors.

General Partnership

Business structure with shared management and liability.

Investment Bankers

Professionals assisting in capital sourcing.

Underwriters

Entities that help businesses raise capital.

Business Brokers

Intermediaries facilitating business sales and investments.

Piercing the Corporate Veil

Holding owners personally liable for corporate debts.

Bureaucratic Formalities

Legal requirements for maintaining business entity status.

Legal Existence

Formal recognition of a business as a legal entity.

Creation of Entity

Process of establishing a business's legal status.

General Partnership Formation

Can occur unintentionally without formal agreement.

Ordinary Formalities

Standard procedures businesses must follow legally.

Corporation

A business entity with formal filing requirements.

General Partnership

A business entity with minimal formation requirements.

Shareholder Meeting

Annual meeting required for corporations.

Board Meeting

Meeting for corporate governance with minutes.

Stock Transfer Ledger

Record of stock ownership changes in corporations.

Formal Books of Account

Required financial records for business entities.

Liquidity

Ease of converting investments into cash.

Unilateral Dissolution

One partner can dissolve the partnership independently.

Double Taxation

Corporations taxed on profits and dividends separately.

Pass-Through Taxation

Entity profits taxed only when distributed to owners.