Business Organizations

Sole Proprietorship

• Report income, expenses, and loss on personal income tax return.
• To expand, a sole proprietor must either have assets/cash or obtain a loan.
• The sole proprietor is personally responsible for meeting all business needs.

Partnership (General Partnership)

• By default, when more than one person starts a business, it's a partnership (typically a general partnership).
• Owned by general partners.
• General partners have personal liability; personal assets are at risk if the business can't cover its liabilities.
• The partnership itself doesn't file a tax return; income, expenses, and losses are reported at the partner level.

Limited Partnership

• Requires at least one general partner and one limited partner.
• General Partner:
  • Manages the business.
  • Has unlimited personal liability.
• Limited Partner:
  • Liability is limited to their investment in the partnership.
  • Has no say in management.
• Important to have an agreement in place ensuring limited partners receive enough money from the partnership to cover taxes on what they report.

Corporation

• Owned by shareholders and managed by a board of directors.
• Officers are typically elected to carry out the business.
• Small corporations may have shareholders acting as the board of directors and officers.
• Shareholders generally have limited personal liability (assuming everything is done correctly); they can lose their investment, but personal assets are protected.
• Corporations file their own tax returns and pay income taxes.
• Shareholders report dividends on their personal income tax returns.
• Double Taxation: Corporate income is taxed at the corporate level, and dividends are taxed again at the shareholder level.
  • The professor calls this "steams".
• To avoid double taxation, a corporation can elect to become an S corporation by making an election under Subchapter S of the Internal Revenue Code.
• S Corporation:
  • Taxed like a partnership; the corporation files an informational return, and income/expenses/losses are reported on the shareholders' personal income tax returns (taxed only once).
  • May not be the best selection if you don't qualify.
• Downsides of Corporations:
  • Double taxation (unless S election is made).
  • Formalities such as annual shareholders and board of directors meetings.
  • Failure to meet these formalities can result in the business being treated as a general partnership, exposing the owners to expanded liability.

Limited Liability Company (LLC)

• A newer form of business organization.
• All states now recognize LLCs; Wyoming was the first.
• Owners of an LLC are called members.
• Members have limited personal liability, limited to their investment in the company.
• Members generally have a say in the management of the LLC.
• LLCs do not have the same required formalities as corporations (no mandatory annual meetings or meeting minutes).
• Taxation of LLCs:
  • An LLC can elect to be taxed like a partnership (taxed once at the owner level; LLC files an informational return).
  • Or, an LLC can elect to be taxed like a corporation (potentially advantageous if the company will not make distributions, as corporate tax rates may be lower than individual rates).
• Creating an LLC:
  • More complex than creating a sole proprietorship or general partnership.
  • LLC is a separate legal entity.
  • Requires filing articles of organization with the state (e.g., Georgia Secretary of State).
  • The name of the LLC must include "Limited Liability Company" or "LLC".
  • Must designate a registered agent located in the state to receive service of process if the LLC is sued.
• Operating in Multiple States:
  • If an LLC does business in a state other than the one in which it was organized, it must qualify as a foreign company in that state.
  • Failure to do so can result in the business being treated as a sole proprietorship or general partnership in the other state, exposing the owners to unlimited personal liability.
• Diversity of Citizenship:
  • For purposes of diversity jurisdiction, an LLC resides in every state where it has a member residing.
• Operating Agreement:
  • Not required to create an LLC, but highly recommended.
  • An operating agreement spells out the rights, obligations, and duties of the members.
  • If there is no operating agreement, state law will govern (which may not be desirable).
  • The operating agreement should address how the LLC will be managed (member-managed or manager-managed).
• Management of LLCs:
  • Member-Managed LLC: Managed by the members; most decisions require a majority vote; any member can bind the LLC to a contract.
  • Manager-Managed LLC: Members elect a manager (who may or may not be a member) to manage the LLC; only the manager can sign contracts and bind the LLC.
• When doing business with an LLC, it is common to request a copy of the operating agreement to determine who has the authority to bind the LLC to a contract.
• Even if you're one person, you can still form an LLC and be a single-member LLC. You've got liability protection, you've got tax flexibility, you don't have to have meetings. The only downside really is is you're have to get in touch with some lawyer to draft an operating agreement, and you have to get in touch with the secretary of state, which really isn't that hard either.

Specialized Forms of Business (Briefly Mentioned)

• Cooperatives: Not a major focus for the test.
• Joint Stock Companies: Rarely encountered in practice; not a focus for the test.
• Business Trusts: The professor has encountered them, but they are not a focus for the test.
• Syndicates: Avoid them; not a focus for the test.
• Joint Ventures: The professor would recommend forming an LLC instead, so don't worry about that for the test either.

Franchises

• A franchise involves a franchisor (who owns trade names and trademarks) and a franchisee (who runs the business based on the franchisor's know-how).
• The relationship is governed by a franchise agreement (a contract).
• Advantages of Franchises:
  • Established business model and brand recognition.
  • Access to the franchisor's expertise and training.
  • National or worldwide advertising.
• Disadvantages of Franchises:
  • Lack of flexibility; the franchisee must follow the franchisor's standards and methods.
  • Ongoing fees and royalties paid to the franchisor.
  • The franchisor can terminate the franchise agreement if the franchisee fails to comply with the terms of the agreement.
• Types of Franchises:
  • Chain-Style Business Operation: The franchisee operates under the franchisor's business name and must follow the franchisor's standards and methods (e.g., McDonald's, Chick-fil-A, UPS Store).
  • Distributorship: The franchisor manufactures a product and licenses a dealer to sell the product in certain territories (e.g., car dealerships).
  • Manufacturing Arrangement: The franchisor provides a formula or necessary ingredient to make a product, and the franchisee manufactures and sells the product according to the franchisor's standards (e.g., Coca-Cola bottling companies).
• A franchise agreement is a contract, and disputes are resolved through breach of contract claims.