Business Ownership

Chapter 2: Business Ownership

2.1 INTRODUCTION

  • Construction contracting companies, like all business entities, can take various forms of ownership, each with advantages and drawbacks.

  • The choice of ownership type is critical and should involve consultations with business, tax, and legal experts.

  • A comprehensive discussion of ownership forms is beyond this chapter, but it highlights key considerations and implications for construction firms.

2.2 ALTERNATIVE FORMS

  • Typical forms of business ownership for construction firms include:

    • Individual Proprietorship

    • Partnership

    • Corporation

  • Each ownership type has distinct financial, taxation, and legal implications that must be understood thoroughly.

  • Choosing the appropriate ownership type is essential and should be performed with expert guidance.

2.3 CONSTRUCTION CONTRACTING FIRMS

  • The construction industry allows for easy entry; individuals can begin with little or no capital.

  • There are approximately 700,000 construction contractor businesses in the U.S.

    • 75% are individual proprietorships

    • 5% are partnerships

    • 20% are corporations

  • While large construction firms exist, small and medium firms dominate the sector.

2.4 THE INDIVIDUAL PROPRIETORSHIP

  • Definition: Simplest form of business ownership, also known as sole ownership.

  • **Forming Process: **

    • Easiest and least costly to establish and maintain.

    • Minimal government regulations; requires only insurance, tax registration, and possible contractor licensing.

  • Owner's Role:

    • Proprietor personally owns, manages, and provides capital for the business.

    • All contracts and transactions are done in the owner’s name.

  • Advantages:

    • Tax benefits compared to other forms.

    • Simplified organization and freedom of operation.

    • No formalities hindering business termination apart from settling debts.

  • Disadvantages:

    • Unlimited personal liability for business debts.

    • No continuity upon the owner's death unless specified in the will.

    • Financing options limited to personal contributions, borrowing, or asset sales.

    • Income is taxed at normal individual rates on all earnings, impacting total income tax liability.

2.5 THE GENERAL PARTNERSHIP

  • Definition: An unincorporated group of two or more individuals who co-own a business to generate profit.

  • Benefits:

    • Pooling of assets, talents, and credit enhances financial capacity.

    • Collective decision-making allows for broader operations than any single partner can achieve.

  • Partner Contributions:

    • Each brings capital and shares management according to the partnership agreement.

    • Profits and losses typically allocated based on ownership percentage.

  • Legal Status:

    • Not recognized as a separate entity except for specific legal purposes (e.g., can own property).

    • Taxed at the individual partner level, each must report their share of profits.

  • Liability:

    • Each partner is personally liable for business debts; automatic personal liabilities from actions taken by any partner during business operations.

    • Joint liability for debts, meaning creditors can go after any partner's assets.

2.6 ESTABLISHING A PARTNERSHIP

  • Uniformity of Laws:

    • Most states use the Uniform Partnership Act. Legal advice is crucial for drafting Articles of Partnership.

  • Typical Provisions in Partnership Agreements:

    • Names and addresses of partners

    • Business name and purpose

    • Start date and location of operation

    • Contribution details and division of responsibilities

    • Voting rights and drawing account stipulations

    • Bankruptcy, disability, and dissolution provisions

2.7 LIABILITY OF A GENERAL PARTNER

  • Agency Law:

    • Each partner is an agent of the partnership and can bind partners in business transactions.

  • Joint and Several Liability:

    • Partners share liability jointly, and an injured party can pursue any partner for damages.

  • Withdrawals and Liabilities:

    • Withdrawing partners maintain responsibility for debts incurred while in partnership unless otherwise agreed.

2.8 DISSOLUTION OF A PARTNERSHIP

  • Automatic Termination:

    • Occurs upon death of a partner but can be bypassed with agreement provisions.

  • Voluntary Dissolution:

    • Requires partnership agreement to settle affairs, clear accounts, and pay creditors.

  • Debt Priority:

    • Outside creditors are prioritized over partner contributions for debt settlement.

2.9 SUBPARTNERSHIP

  • Definition:

    • An agreement whereby a general partner shares profit or loss with a non-partner (subpartner) without management input.

  • Liabilities:

    • Subpartner has no liability to partnership creditors since they're not an official partner.

2.10 THE LIMITED PARTNERSHIP

  • Formation Requirements:

    • Must have at least one general partner and one limited partner.

  • Characteristics:

    • General partners manage the business and have unlimited liability.

    • Limited partners invest but cannot participate in management, liability capped to their investment.

  • Advantages:

    • Allows for capital raising with limited liability for investors.

2.11 THE CORPORATION

  • Definition:

    • A legal entity with rights separated from its owners (stockholders).

  • Formation:

    • Established under state law, requires filing articles of incorporation.

  • Advantages:

    • Limited liability, perpetual existence, ease in capital raising, and shareholders pay tax only on dividends received.

  • Disadvantages:

    • Subject to double taxation on profits.

2.12 THE FOREIGN CORPORATION

  • Definition: Created in one state but operating in others.

  • Certification: Needs to file for a certificate to operate in foreign states.

2.13 STOCKHOLDERS

  • Ownership:

    • Corporations owned through shares, rights to profit and assets.

  • Transferability:

    • Shares generally freely transferable, aiding in ownership mobility.

  • Types of Stock:

    • Common vs. preferred, each with its rights and implications regarding profit distribution and management involvement.

2.14 CORPORATE DIRECTORS AND OFFICERS

  • Board of Directors:

    • Elected by shareholders, responsible for governance and policy.

    • Act collectively and ensure management prudence.

  • Officers' Role:

    • Includes positions like president and treasurer; appointed to manage daily operations, can act as agents of the corporation.

2.15 THE S CORPORATION

  • Taxation Alternative:

    • Meets IRS criteria to be taxed as a partnership, avoiding corporate tax rates.

  • Eligibility Requirements:

    • U.S.-based, limited number of shareholders, single class of stock.

2.16 EMPLOYEE STOCK OWNERSHIP PLAN (ESOP)

  • Definition:

    • Deferred compensation allowing employees to invest in their company’s stock.

  • Purpose:

    • Accommodates capital growth, owner retirement, and employee benefits.

2.17 LIMITED LIABILITY COMPANY (LLC)

  • Advantages:

    • Combines limited liability with pass-through taxation without S corporation restrictions.

  • Formation:

    • Members execute an LLC agreement under state laws.

2.18 THE JOINT VENTURE

  • Nature:

    • Temporary collaboration among contractors to execute a specific project.

  • Benefits:

    • Allows pooling of resources, skills, and technology to undertake projects beyond individual capabilities.

  • Agreement:

    • A dedicated contract outlines terms, responsibilities, and operational details.

2.19 SUMMARY AND CONCLUSIONS

  • Owners must carefully consider ownership structures, weighing all advantages and disadvantages.

  • Recommendations to involve legal, tax, and business advisors when selecting the form of ownership.

CHAPTER 2 REVIEW QUESTIONS

  1. Advantages of limited partnership ownership?

  2. Difference between public and private corporation?

  3. Define joint venture contractor and its use rationale.

  4. Define ESOP and its applications.

  5. Meaning/significance of foreign corporation?

  6. Key advantages/disadvantages of

    • Sole proprietorship

    • General partnership

    • Limited partnership

    • Corporation

    • S corporation

  7. Rationale of corporate double taxation.

  8. Number of firms classifying as construction firms; most prevalent form?

  9. Duties/responsibilities of board of directors vs. corporate officers.

  10. Define LLC and one key advantage.