Entity Choice, the Corporate Form, and Finance

Four friends launch a fashion business together, never file anything with the state, and share profits from the business. A factory is owed $40,000. What is the most likely legal structure?

• A. LLC

• B. Corporation

• C. General partnership

• D. Limited partnership

C. General partnership

The four founders in Question 1 cannot pay the factory's $40,000 invoice. Who can the factory potentially pursue?

• A. Only the business's assets

• B. Only the founder who signed the factory contract

• C. The partners personally, jointly and severally

• D. Nobody, because no entity was formally created

C. The partners personally, jointly and severally

A founder is choosing among business entities. Which four factors are the central trade-offs?

• A. Branding, advertising, location, and employees

• B. Liability, tax, control, and access to capital

• C. Patents, copyrights, trademarks, and trade dress

• D. Revenue, inventory, pricing, and marketing

B. Liability, tax, control, and access to capital

A designer operates a fashion business alone, never forms an entity, and signs contracts personally. What is the most likely structure?

• A. Sole proprietorship

• B. LLC

• C. Corporation

• D. LLP

A. Sole proprietorship

A fashion investment fund wants a structure where one party manages the business and has unlimited liability, while passive investors have liability capped at their contributions. Which entity fits?

• A. General partnership

• B. Limited partnership

• C. LLP

• D. S corporation

B. Limited partnership

A young fashion company wants limited liability, pass-through taxation by default, and flexibility in determining how members vote and divide profits. Which structure is generally the best fit?

• A. General partnership

• B. LLC

• C. C corporation only

• D. Sole proprietorship

B. LLC

Four founders create an LLC but never create an operating agreement. They later disagree over voting rights and profit distributions. What is the likely consequence?

• A. The LLC automatically becomes a corporation.

• B. The founders lose limited liability.

• C. State default rules may govern the LLC.

• D. The LLC is automatically dissolved.

C. State default rules may govern the LLC.

Which statement correctly describes the three levels of a corporation?

• A. Shareholders run daily operations; officers elect directors; directors own the company.

• B. Shareholders own the company; directors direct it; officers run it day to day.

• C. Directors own the company; shareholders run it; officers elect directors.

• D. Officers own the company; shareholders supervise employees; directors sign contracts.

B. Shareholders own the company; directors direct it; officers run it day to day.

A corporation owes a supplier $100,000. The corporation is properly maintained and the founder did not personally guarantee the debt. Who is generally responsible?

• A. The founder personally

• B. The corporation

• C. Every employee

• D. The board members personally

B. The corporation

A fashion startup considers an S corporation because it wants pass-through taxation. Later, it hopes to receive an investment from a venture capital fund. What is the major problem?

• A. S corporations cannot have limited liability.

• B. S corporations cannot have any investors.

• C. A venture fund generally cannot be an eligible S-corporation shareholder.

• D. S corporations must be taxed twice.

C. A venture fund generally cannot be an eligible S-corporation shareholder.

A startup wants preferred investors to receive economic rights that ordinary shareholders do not receive. Why can this create a problem for S-corporation status?

• A. S corporations cannot issue any stock.

• B. S corporations generally cannot have more than one class of economic rights.

• C. Preferred stock automatically creates unlimited liability.

• D. Preferred stock converts the company into an LLC.

B. S corporations generally cannot have more than one class of economic rights.

A fashion startup expects to raise multiple rounds of venture capital, issue preferred stock, and have numerous outside investors. Which structure is generally best designed for this?

• A. General partnership

• B. LP

• C. C corporation

• D. Sole proprietorship

C. C corporation

A C corporation earns profits and pays federal corporate income tax. It then distributes some profits to shareholders as dividends. What is the basic tax issue?

• A. The income may be taxed at both the corporate and shareholder levels.

• B. The shareholders pay no tax.

• C. The corporation is automatically tax-exempt.

• D. The business becomes an S corporation.

A. The income may be taxed at both the corporate and shareholder levels.

A founder of an LLC personally commits a tort against a customer while running the business. Can the founder rely on the LLC's liability shield to avoid personal liability for their own conduct?

• A. Yes, always.

• B. No, limited liability generally does not protect someone from liability for their own acts.

• C. Yes, if the LLC has an operating agreement.

• D. Yes, if the company is incorporated in Delaware.

B. No, limited liability generally does not protect someone from liability for their own acts.

A company has its own bank account, maintains separate books, signs contracts in the company's name, and has appropriate capital. It later becomes insolvent. Is insolvency alone enough to pierce the corporate veil?

• A. Yes.

• B. No; a company being thin or insolvent alone does not automatically justify veil piercing.

• C. Yes, if the company has fewer than five employees.

• D. Yes, if the company loses money in its first year.

B. No; a company being thin or insolvent alone does not automatically justify veil piercing.

Which fact would most strongly support a veil-piercing argument?

• A. The company had a bad financial year.

• B. The company had only three employees.

• C. The owner routinely commingled personal and company funds and ignored corporate separateness.

• D. The company operated in multiple states.

C. The owner routinely commingled personal and company funds and ignored corporate separateness.

A designer creates a fashion collection before the company is formed. After formation, the company begins selling the collection, but the designer never transfers the designs to the company. Who initially owns the pre-formation designs?

• A. Automatically the company

• B. The state

• C. The designer, until properly assigned

• D. The company's investors

C. The designer, until properly assigned

A founder wants to transfer copyright in designs created before the company existed into the new company. What is generally required?

• A. An oral agreement

• B. A written assignment

• C. Nothing; formation automatically transfers the copyrights

• D. A new trademark registration

B. A written assignment

A venture investor purchases preferred stock in a fashion startup. Which right is commonly associated with preferred stock?

• A. Unlimited personal liability for founders

• B. Liquidation preference and protective provisions

• C. Automatic ownership of the founders' IP

• D. Guaranteed annual profits

B. Liquidation preference and protective provisions

A founder receives $300,000 through a SAFE with a $4 million post-money valuation cap. Which statement is most accurate?

• A. It is a traditional loan requiring interest and maturity.

• B. It is an investment designed to convert into equity rather than operate like ordinary debt.

• C. It immediately makes the investor a director.

• D. It transfers ownership of the company's trademarks.

B. It is an investment designed to convert into equity rather than operate like ordinary debt.

A founder posts on Instagram to 500,000 followers: “Invest in our startup now!” The company is raising money under a securities exemption. Why could this post create a legal issue?

• A. Selling equity is never regulated.

• B. The post may constitute general solicitation, which matters under securities exemptions such as Rule 506(b).

• C. Social media posts automatically convert equity into debt.

• D. Only public companies are subject to securities laws.

B. The post may constitute general solicitation, which matters under securities exemptions such as Rule 506(b).