PowerPoint Presentation by Charlie Cook The University of West Alabama Entrepreneurship theory | process | practice Donald F. Kuratko Richard M. Hodgetts Seventh edition Part 4 Initiating Entrepreneurial Ventures © 2007 Thomson/South-Western. All rights reserved. CHAPTER 12 Legal Structures for Entrepreneurial Ventures

Chapter Objectives 1. 1.To examine the legal forms of organization—sole proprietorship, partnership, corporation, and franchising 2. 2.To illustrate the advantages and disadvantages of each of these four legal forms 3. 3.To compare the characteristics of a sole proprietorship, partnership, and a corporation 4. 4.To explain the nature of the limited partnership, and limited liability partnerships (LLPs) 5. 5.To examine how an S corporation works Studying this chapter should provide you with the entrepreneurial knowledge needed: © 2007 Thomson/South-Western. All rights reserved.12–2

Chapter Objectives (cont’d) 6. 6.To define the additional classifications of corporations, including limited liability companies (LLCs) 7. 7.To review the costs and benefits associated with the corporate form of organization 8. 8.To examine the franchise structure, benefits, and drawbacks Studying this chapter should provide you with the entrepreneurial knowledge needed: © 2007 Thomson/South-Western. All rights reserved.12–3

© 2007 Thomson/South-Western. All rights reserved.12–4 Identifying Legal Structures A legal structure that will best suits the demands of the venture addresses:  Changing tax laws  Liability situations  The availability of capital  The complexity of business formation. Three primary legal forms of organization  Sole proprietorship  Partnership  Corporation

© 2007 Thomson/South-Western. All rights reserved.12–5 Sole Proprietorships Sole Proprietorship  A business that is owned and operated by one person. The enterprise has no existence apart from its owner.  To establish a sole proprietorship, a person merely needs to obtain whatever local and state licenses are necessary to begin operations.

© 2007 Thomson/South-Western. All rights reserved.12–6 Sole Proprietorships (cont’d) Advantages  Ease of formation  Sole ownership of profits  Decision making and control vested in one owner  Flexibility  Relative freedom from governmental control  Freedom from corporate business taxes Disadvantages  Unlimited liability  Lack of continuity  Less available capital  Relative difficulty obtaining long-term financing  Relatively limited viewpoint and experience

© 2007 Thomson/South-Western. All rights reserved.12–7 Partnerships Partnership  An association of two or more persons acting as co- owners of a business for profit.  The Uniform Partnership Act is generally followed by most states as the guide for legal requirements in forming partnerships. Articles of Partnership  Clearly outline the financial and managerial contributions of the partners and carefully delineate the roles in the partnership relationship.

© 2007 Thomson/South-Western. All rights reserved.12–8 Articles of Partnership Items Name, purpose, domicile Duration of agreement Character of partners (general or limited, active or silent) Contributions by partners (at inception, at later date) Division of profits and losses Draws or salaries Rights of continuing partner(s) Death of a partner (dissolution and windup) Release of debts Business expenses (method of handling) Separate debts Authority (individual partner’s authority on business conduct) Books, records, and method of accounting Sale of partnership interest Arbitration Settlement of disputes Additions, alterations, or modifications of partnership Required and prohibited acts Absence and disability Employee management

© 2007 Thomson/South-Western. All rights reserved.12–9 Partnerships (cont’d) Advantages  Ease of formation  Direct rewards  Growth and performance facilitated  Flexibility  Relative freedom from governmental control and regulation  Possible tax advantage Disadvantages  Unlimited liability of at least one partner  Lack of continuity  Relative difficulty obtaining large sums of capital  Bound by the acts of just one partner  Difficulty of disposing of partnership interest

© 2007 Thomson/South-Western. All rights reserved.12–10 Specific Forms of Partnerships Limited Partnership  Permits capital investment without responsibility for management and without liability for losses beyond the initial investment.  Are governed by the Uniform Limited Partnerships Act (ULPA). Limited Liability Partnerships (LLP)  A form of partnership that allows professionals the tax benefits of a partnership while avoiding personal liability for the malpractice of other partners.

© 2007 Thomson/South-Western. All rights reserved.12–11 Figure 12.1 Factors Associated With Partnership Success Source: Jakki Mohr and Robert Spekman, “Characteristics of Partnership Success: Partnership Attributes, Communication Behavior, and Conflict Resolution Techniques,” Strategic Management Journal 15 (1994): 137.

© 2007 Thomson/South-Western. All rights reserved.12–12 Corporations Corporation  “An artificial being, invisible, intangible, and existing only in contemplation of the law”. –Supreme Court Justice John Marshall  As such, a corporation is a separate legal entity apart from the individuals who own it. Forming a Corporation  Subscriptions for capital stock must be taken and a tentative organization created.  Approval (a charter) must be obtained from the secretary of state in the state in which the corporation is to be formed.

© 2007 Thomson/South-Western. All rights reserved.12–13 Corporations (cont’d) Advantages  Limited liability  Transfer of ownership  Unlimited life  Relative ease of securing capital in large amounts  Increased ability and expertise Disadvantages  Activity restrictions  Lack of representation  Regulation  Organizing expenses  Double taxation

© 2007 Thomson/South-Western. All rights reserved.12–14 Specific Forms of Partnerships and Corporations Limited Partnerships  Have two or more partners without responsibility for management and without liability for losses beyond their investment with the right to share in the profits. Former under The Uniform Limited Partnership Act (ULPA).Former under The Uniform Limited Partnership Act (ULPA). Limited Liability Partnership (LLP)  A relatively new form of partnership that allows professionals the tax benefits of a partnership while avoiding personal liability for the malpractice of other partners.

© 2007 Thomson/South-Western. All rights reserved.12–15 Specific Forms of Partnerships and Corporations (cont’d) S Corporation  Takes its name from Subchapter S of the Internal Revenue Code.  Is commonly known as a “tax option corporation”—it is taxed similarly to a partnership.  Avoids the imposition of income taxes at the corporate level yet retain the benefits of a corporate form (especially the limited liability).

© 2007 Thomson/South-Western. All rights reserved.12–16 Guidelines for S Corporations The corporation must be a domestic corporation. The corporation must not be a member of an affiliated group of corporations. The shareholders of the corporation must be individuals, estates, or certain trusts. Corporations, partnerships, and nonqualifying trusts cannot be shareholders. The corporation must have 100 or fewer shareholders. Only one class of stock, although not all shareholders may have the same voting rights. No shareholder may be a nonresident alien.

© 2007 Thomson/South-Western. All rights reserved.12–17 Specific Forms of Partnerships and Corporations (cont’d) Limited Liability Company (LLC)  A hybrid form of business enterprise that offers the limited liability of a corporation but the tax advantages of a partnership.  Disadvantage is that LLC statutes differ from state to state, and thus any firm engaged in multi-state operations may face difficulties.

© 2007 Thomson/South-Western. All rights reserved.12–18 Other Corporation Classifications Domestic Corporations  A corporation operating within the particular state in which it is registered. Foreign Corporations  Domestic corporation doing business in a state other than the state in which it is registered Public and Private Corporations Nonprofit Corporations Professional Corporations Close Corporations

© 2007 Thomson/South-Western. All rights reserved.12–19 Costs Associated with Incorporation Lawyers’ fees Accountants’ fees Fees to the state Unemployment insurance taxes Employer’s contribution to Social Security Annual legal and accounting fees

© 2007 Thomson/South-Western. All rights reserved.12–20 Franchising Franchising  Any arrangement in which the owner of a trademark, trade name, or copyright has licensed others to use it in selling goods or services.  The franchisee (a purchaser of a franchise) is generally legally independent but economically dependent on the integrated business system of the franchisor (the seller of the franchise). Franchise Law  The Uniform Franchise Offering Circular (UFOC) is divided into 23 items that provide different segments of information for prospective franchisees.

© 2007 Thomson/South-Western. All rights reserved.12–21 Franchising Advantages  Training and guidance  Brand-name appeal  A proven track record  Financial assistance Disadvantages  Franchise fees  Franchisor control  Unfulfilled promises of franchisor

© 2007 Thomson/South-Western. All rights reserved.12–22 The Costs of Franchising The basic franchise fee Insurance Opening product inventory Remodeling and leasehold improvements Utility charges Payroll Debt service Bookkeeping and accounting fees Legal and professional fees State and local licenses, permits, and certificates Source: Donald F. Kuratko, “Achieving the American Dream as a Franchisee,” Small Business Network (July 1987): 2.

© 2007 Thomson/South-Western. All rights reserved.12–23 Key Terms and Concepts close corporation corporation domestic corporation double taxation foreign corporation franchise limited liability company (LLC) limited liability partnership (LLP) limited partnership nonprofit corporation partnership private corporation professional corporation public corporation S corporation sole proprietorship Uniform Franchise Offering Circular (UFOC) Uniform Limited Partnership Act (ULPA) Uniform Partnership Act unlimited liability