Final Exam for Legal Environment of Business— Business Entities and Organization

Sole Proprietorships

  • A business owned and operated by a single individual, where the owner is personally liable for all debts and obligations of the business.

  • This structure is easy to establish and maintain, making it a popular choice for small businesses and freelancers. Because of this, it is the most dominant form of business in the US, seeing as it is the cheapest and simplest to start.

  • The business is not a separate legal entity and upon the sole proprietor’s death, the business dissolves.

  • Land and assets are not owned by the business but instead by the individual.

  • Income is reported solely on personal tax returns, meaning that it is only taxed once.

Advantages of Sole Proprietorships

  • Simplicity in formation and operation, as there are minimal regulatory requirements.

  • Complete control over business decisions, allowing for quick and flexible decision-making.

  • Direct access to profits, enabling the owner to retain all earnings without sharing with partners or shareholders.

  • Tax benefits, as sole proprietors typically report business income on their personal tax returns, potentially resulting in lower overall tax rates.

  • One decision maker, meaning no disagreements with other owners.

  • No necessity for a lawyer

Disadvantages of Sole Proprietorships

  • Unlimited personal liability, meaning the proprietor can be sued for all of his or her personal assets.

  • Funding is completely up to the proprietor

General Partnerships

  • This is an association of two or more people for profit.

  • Both partners contribute assets.

  • It is not a separate legal entity, meaning that the partners but not the business can be sued.

  • Upon the death of a partner, the business is dissolved.

  • No lawyer is required; partnerships begin by just doing business

  • Partners make decisions jointly, meaning there is opportunity for disputes.

  • It is not requirement, but it is highly recommended to enlist an attorney for the partnership agreement (contract).

  • In the absence of an agreement, the law makes it for you.

  • Partners have unlimited persoanl liability.

  • Income is reported on personal tax returns.

Advantages of General Partnerships

  • These are easy to create.

  • Income is taxed only once (at owner level).

  • Owners get to select who they are partners with.

Disadvantages of General Partnerships

  • Unlimited personal liability (and perhaps having to purchase insurance for this)

Duties within General Partnerships

  • Fiduciary duties: in good faith, work for the good of the partnership and don’t do anything to undermine it— in other words, don’t start a business that competes with the partnership and a partner must disclose material facts pertaining to the welfare of the business.

  • Obedience duty: must follow agreement in place

  • Duty of Care: must perform management to the best of one’s ability

Miscellaneous Notes on Partnerships

  • The agreement spells out the partners duties, rights, and obligations.

  • Partners can be different percentages involvement wise, and this is reflected in the taxes they pay.

  • Partnership by Estoppel: if someone is represented legally as a partner and they don’t say anything about it, they can be collected against. They also cannot deny being a partner.

Termination of a Partnership

  • Two parts.

  • Dissolution and winding up

Dissolution

  • This is when a partner stops fufilling his or her role by default or choice.

  • An example of this is if they are declared insane or if the allotted amount if time for the contract tolls.

Winding up

  • This is when partners finish ongoing business, pay debts, and collect the money they are owed.

  • Assets don’t have to be sold but may be liquidated.

Limited Partnerships

  • These must have at least ine general partner and one limited partner.

  • Liability is limited to the amount the limited partner invested, meaning the limited partners personal assets can’t be taken.

  • Limited partner(s) have no say in management.

  • The death of a limited partner does not lead to the dissolution of the partnership, but the death of a general partner does.

  • It is a separate legal entity, meaning the state government is involved in formation; in Georgia, this means it is the responsibility of the Secretary of State (for domestic entities)

  • A registered agent and a certificate is required and the name of the partnership must be approved by the Secretary of State.

  • The business files an informational return but partners report the income on their personal taxes.

  • The limited party doesn’t get to decide if they receive the money they are reporting, which can lead to phantom income.

Limited Liability Partnership

  • This is typically used when all partners are professionals such as doctors or lawyers.

  • These professionals are held to a higher duty, placing them at risk for malpractice.

  • The limited liability partnership protects a partner from the malpractice of their counterpart.

  • This prevents them from being sued for their personal assets over a mistake that wasn’t their own.

  • These partnerships are usually not considered a separate legal entity.

Corporations

  • Must be formed through the Secretary of State

  • Name must include “Inc.” or “Co.”

  • Registered agent and articles of incorporation are necessary.

  • Shareholder agreement is highly recommended.

  • Stockholders are owners of the corporation but the business is managed by a board of directors they elect.

  • These individuals on the board usually have other jobs.

  • The board also hires officers that carry out day to day functions.

  • These are separate legal entities, meaning death of an owner, board member, or officer have no effect on the corporation’s existence.

  • Ownership is easily transferred.

  • Owner has limited liability.

  • Dividends declared by Board of Directors.

  • Shareholders report retained earnings as income, meaning money is taxed twice, with the exception of S Corporations.

S Corps

  • These have no more than 100 shareholders

  • These are taxed like partnerships; paid by the shareholders not the entity.

Advantages of Corporations

  • Limited liability

  • Sell more shares to make more money

Disadvantages of Corporations

  • Taxed twice (besides S Corps)

  • Formalities: particularly required annual board and shareholder meetings.

  • Failure of these meetings to occur means the business can no longer be considered a corporation and thus will be treated as a partnership with unlimited personal liability.

Limited Liability Corporation

  • Newest form of business that began in Wyoming.

  • This is a separate legal entity that must be acquired through the Secretary of State.

  • No annual meetings or formalities.

  • Owners of an LLC interest are referred to as members.

  • Members have management say-so and limited liability.

  • Must file articles of incorporation and have an agent.

  • Name of the business must indicate type of entity.

Taxation of an LLC

  • Can elect to be taxed as partnership OR corporation (the owner or twice)

  • Some elect to be taxed as an entity and at the owner level in order to pay dividends

  • Currently, corporate tax rates are low.

Qualification

  • If you have a LLC from a different state, you must register it as a foreign entity.

  • If you don’t, it reverts to a partnership thus creating more liability.

  • The corporation resides in every state where it has a member residing.

Operation

  • No operating agreement is required but it is highly recommended.

  • Each member gets a vote as to whether the business is member or manager managed.

  • Any member can bind the LLC in obligations of contracts if member managed.

  • If manager managed, the manager doesn’t have to be a member or owner, but only the manager can bind the LLC into a contract.

Franchises

  • These are businesses that exist because of a relationship between a franchiser and a franchisee who operates under a trademark.

  • These are a lot like contracts because of the specified rights and obligations for the parties.

Advantages

  • Franchiser has expertise

  • Customers may be familiar with the brand

Disadvantages

  • Lack of control

  • Can be shut down

  • Franchisor gets a cut w/ very little risk but can suffer from damaged reputation

3 Types of Franchises

Chain Style

  • Required to follow their standards

  • Operates under their name

Distributorship

  • Franchiser develops product

  • They then pay someone else to sell it

Manufacturing

  • Franchiser gives someone instructions to build and put out