Basic Business Organizations

Class 7

Starting a Business

The first question: What form should the business

take?▪ Sole proprietorship▪ Partnership▪ Limited liability company▪ Corporation

Choosing the FormConsider

Formation issues Liability protection Management structure Taxation considerations Exit strategies/transferability of

interests

Sole ProprietorshipThe most common form of business

organization. One (sole) owner (or – in WA – a

married couple) Business does not have to be

registered with the secretary of state Profits and losses are the personal

profits and losses of the owner and are taxed as such

Personal assets of owner are available to satisfy debts of the business

AdvantagesOwner is in complete control &

receives all profitsFlexibilityEase of creation; maintenance

DisadvantagesOwner is personally liable for all torts

and contractsLacks continuity after deathDifficult to raise financing

An ExampleChild care provider

Wants to work out of her house How does she form this business? What legal process is required?

http://www.access.wa.gov/business/index.aspxhttp://www.sba.gov/aboutsba/sbaprograms/onlinewbc/index.html

PartnershipThere are three kinds of partnership

General Partnership Limited Partnership Limited Liability Partnership

Uniform ActWashington has adopted the Revised

Uniform Partnership ActThe statute governs to

Determine whether a partnership exists Fill in the missing terms of a partnership

agreement

http://apps.leg.wa.gov/RCW/default.aspx?cite=25.05

PartnershipAssociation of 2 or more persons

to carry on as co-owners of a business for profit. More than one common owner Governed by contract Profits and debts are shared by the

partners Partners share in management of

business

Advantages

Easy to create and maintainFlexible, informalPartners share profits and losses

equally

Disadvantages

Partners are personally liable for all torts/contracts

Dissolved upon death of any one partner

Difficult to raise financing

Partnership ResponsibilitiesPartners have a fiduciary duty to

the partnership and each other. Liable to the partnership for intentional

misconduct or gross negligence Cannot compete with the partnership May not take an advantage from the

partnership without consent of the partners

In case of conflict of interest, partnership profits must be given to the partnership

Joint Liability

Because a general partnership is considered a single business entity, the partners are all liable for the acts of any partner

Personal property of each partner may be used to satisfy the debts of the partnership

Termination

Dissolution by Acts of the Partners Withdrawal of any partner from the

partnership Agreement of the partners

Dissolution by Operation of Law Death of a partner

Dissolution by Judicial Decree

Limited PartnershipIn a limited partnership, at least

one of the partners does not share in the right to manage the business

The limited partner invests money, but has no decision-making authority

The liability of the limited partner is limited to his or her investment in the business

Limited Liability PartnershipAn LLP is a kind of general

partnership that is governed by statute The difference between general

and limited liability partnerships is that in an LLP the partners are not liable for the debts of the partnership

Clients or customers of the LLP must be informed of the limited liability

Limited Liability Co.A form of business ownership

that permits small business owners to limit their liability to the amount of their investments These are governed by statute

▪ RCW 25.15

LLC AgreementOperating agreement is analogous

to corporation’s bylaws.Agreements may be oral and

contain provisions relating to management, dividends, meetings, transfer of membership interests, etc.

Generally, if the operating agreement is silent, courts will apply partnership principles.

Advantages

Member liability is limited to amount of investment.

Can be treated as a “pass through” entity for tax purposes (like partnership).

Profits can be distributed to members without the double taxation of a corporation. Members pay personal income tax on received dividends.

Corporations

A business entity formed by shareholders

The corporation is an artificial “person” for the purpose of conducting a business and can Own property Enter into contracts Sue and be sued

Advantages

The liability of shareholders (the owners) of a corporation is limited to the individual’s investment

The business has a perpetual existence

DisadvantagesTakes a lot of attention at the

formation stageRequires ongoing efforts –

reporting requirements, annual meetings

Double taxation

http://apps.leg.wa.gov/RCW/default.aspx?cite=23B

Rights of the Corporation Because a corporation is a legal

“person,” it has constitutional rights. Equal protection; Access to the courts, can sue and be sued; Right to due process; Freedom from unreasonable search and

seizure and double jeopardy. Freedom of speech.

http://www.youtube.com/view_play_list?p=FA50FBC214A6CE87

Torts and Criminal ActsA corporation is liable for the torts

committed by its agents or officers within the course and scope of their employment under the doctrine of respondeat superior.

Corporation can be liable for criminal acts, but only fined. Responsible officers may go to prison.

Corporate Express Powers

The express powers of a corporation are found in the corporation’s articles of incorporation, the laws of the state of incorporation, and in the state and federal corporations.

Corporate by-laws may also grant or limit a corporation’s express powers.

Corporate Implied PowersCorporation has implied powers

to perform all acts reasonably necessary to accomplish its corporate purposes:

▪ Borrow and lend money.▪ Extend credit.▪ Make charitable contributions.

A corporate officer can bind corporation in contract in matters connected with the ordinary business affairs of the corporation.

Ultra Vires Doctrine

Corporate acts that are beyond the express or implied powers of the corporation are considered to be “ultra vires” and unlawful.

Classification of Corporations

Domestic corporation does business in its state of its incorporation.

Foreign corporation from another state doing business in Washington.

Alien Corporation: formed in another country doing business in United States.

Kinds of CorporationsPublic and Private.Nonprofit.Close Corporations.

Shares held by few shareholders. More informal management –

similar to a partnership. Restriction on transfer of shares.

Kinds of Corporations“S Corporations” – IRS

classification that enables corporation to avoid “double taxation” – only dividends to the shareholders, not corporate profits, are taxed. IRS requirements: Corporation is domestic, with fewer

than 75 shareholders, only one class of stock, no shareholder can be a non-resident alien.

Professional Corporations.

Basics of FormationThe corporation is created by

Articles of Incorporation These must include

▪ Name of the corporation▪ Purpose▪ List of incorporators and directors▪ Name and address of registered agent▪ Share structure

Articles are filed with Secretary of State

Corporate StatusDe Jure: substantial statutory

requirements are met; cannot be attacked by state or 3rd parties.

De Facto: statutory requirements not met, but promoters made good faith effort to comply with corporate law; corporate status can only be attacked by state.

By Estoppel: if it acts like a corporation, it cannot avoid liability by claiming that no corporation exists.

Piercing the Corporate VeilWhere the corporate form is

used solely to shield individuals from liability Generally, owner co-mingles

personal and corporate assets Sometimes no stock is issued or Formation or regulatory rules are

ignored

Corporate HierarchyShareholders

Board of Directors

Officers

Employees

Clients/Customers

Corporate StructureThe owners of the corporation

are the shareholders. Create the capital of the

corporation▪ Have no management authority▪ Elect board of directors▪ Must approve changes in articles of

incorporation and other major changes

Corporate StructureThe Board of Directors

Elected by the shareholders Have management responsibility Appoint, supervise, remove officers

of the corporationThe Directors have a fiduciary

relationship with shareholders

Corporate StructureOfficers and Executives

Elected/appointed by the board of directors

Responsible for carrying out board’s policies and directives

Responsible for management of business

Have a fiduciary duty to act in the best interests of the shareholders and the corporation

RequirementsCorporations are required to:

Hold annual meetings of shareholders.

Give reasonable notice of meetings.

Provide reasonable access to books and records to shareholders.

Securities Regulation

Two major securities laws Securities Act of 1933 Securities Exchange Act of 1934

Insider TradingOccurs when someone with reliable secret information uses that information to benefit from stock trades.

Is a crime, punishable by fine and imprisonment.

Sarbanes-Oxley ActEnacted after the Enron accounting

scandal to require additional protections for investors.

Additional RegulationsSherman (Antitrust) Act

Prohibits price fixing and illegal monopolies

Clayton Act Prohibits anticompetitive mergers

Robinson-Patman Act Prohibits price discrimination aimed

at putting small competitors out of business

Merger and ConsolidationCorporations can grow and

expand by: Mergers. Consolidation. Purchase of another corporation’s

assets. Purchases of a controlling interest

in another corporation.

Termination

Termination of a corporation, like a partnership, consists of two phases: Dissolution (voluntary or

involuntary); and Liquidation.