Starting a Business: LLCs and Other Options

“Business underlies everything in our national life, including our spiritual life. Witness the fact that in the Lord’s Prayer, the first petition is for daily bread. No one can worship God or love his neighbor on an empty stomach.” Woodrow Wilson, United States president

 An unincorporated business owned by one person  Advantages ◦ Can run a business without taking any formal steps to create an organization ◦ Not required to register with the government ◦ Not required to file a separate tax return  Disadvantages ◦ Owner responsible for all of the business’s debts ◦ Owner of a sole proprietorship has limited options for financing the business

 Limited liability ◦ Protects managers and investors from personal liability for the debts of the corporation and the actions of others  Transferability of interests ◦ Provide flexibility for enterprises small and large  Duration ◦ Perpetual existence – Can continue without their founders

 Logistics ◦ Corporations involve a lot of expense and effort to create and operate  Taxes ◦ Because corporations are taxable entities, they must pay taxes and file returns

 Shareholders of S corps have: ◦ The limited liability of a corporation ◦ The tax status of a partnership  Restrictions faced are: ◦ There can only be one class of stock ◦ There can be no more than 100 shareholders ◦ Shareholders cannot be partnerships or other corporations ◦ Shareholders must be U.S. citizens or residents ◦ Shareholders must agree that company should be an S corporation

 A company whose stock is not publicly traded  Common provisions of close corporations: ◦ Protection of minority shareholders ◦ Transfer restrictions ◦ Flexibility ◦ Dispute resolution

 An LLC offers the limited liability of a corporation and the tax status of a partnership ◦ Limited liability – Members are not personally liable for the debts of the company ◦ Tax status – Income flows through the company to the individual members, avoiding double taxation of a corporation ◦ Formation – To organize an LLC, charter and operating agreement is necessary

◦ Flexibility – Can have members that are corporations, partnerships, or nonresident aliens ◦ Transferability of interests – Members must obtain the unanimous permission of the remaining members before transferring ownership rights ◦ Duration – LLC can continue in operation even after a member withdraws ◦ Going public – Loses its favorable tax status and is taxed as a corporation, not a partnership

◦ Changing forms – Not considered a sale and does not have the same adverse tax impact ◦ Piercing the LLC veil – If corporate shareholders do not comply with the technicalities of the law:  May be held personally liable for the debts of the corporation ◦ Legal uncertainty – New form of organization and the issues of law are not clear  Lawsuits are expensive in both time and money

◦ Choices: LLC v. corporation  Tax status of an LLC is a major advantage over a corporation  Reasons for venture capitalists to prefer C corporations  Arcane tax issues  C corporations are easier to merge, sell, or take public  Corporations can issue stock options  General legal uncertainty involving LLCs

 Hybrids are called: ◦ Flexible-purpose organizations ◦ Benefit corporations ◦ Low-profit limited liability companies ◦ Community interest companies  Such businesses focus on the interests of: ◦ Stakeholders ◦ Community ◦ Environment

 Partnership: An unincorporated association of two or more co-owners who carry who operate a business for profit  Each co-owner is a general partner

 Taxes – Profits flow through the owners  Liability – Partner is personally liable for the debts of the enterprise ◦ Whether or not she caused them  Management rights ◦ Partners share both profits and losses equally ◦ Each partner has an equal right to manage the business

 Management duties – Have a fiduciary duty ◦ Partners are liable to the partnership for gross negligence ◦ Partners cannot compete with the partnership ◦ Partner may not take an opportunity away from the partnership unless the other partners consent ◦ If a partner engages in conflict of interest:  He must turn over to the partnership any profits he earned from that activity

 Transfer of ownership ◦ Firm cannot sell shares ◦ Partner has the right to transfer the value of partnership interest:  Not the interest itself  Formation – Easy to form ◦ If two or more people do business together, sharing management, profits and losses:  They have a partnership and subject to all rules of partnership law

 Partnership by estoppel exists if: ◦ Participants tell other people that they are partners, or allow other people to say that they are partners ◦ Third party relies on this assertion ◦ Third party suffers harm  Termination ◦ Dissociation: When a partner quits a partnership ◦ Partnership can either:  Buy out the departing partner(s) and continue in business  Wind up the business and terminate the partnership

 Partners are not liable for debts of the partnership  An LLP is not a taxable entity and it has the right to choose its duration

 Structure ◦ Limited partnerships must have at least:  One limited partner and one general partner  Liability ◦ Limited partners are not personally liable:  General partners are liable ◦ Limited liability limited partnership:  General partner is not personally liable for the debts of the partnership

 Taxes ◦ Limited partnerships are not taxable entities  Formation ◦ General partners must file a certificate of limited partnership with their Secretary of State  Management ◦ General partners have the right to manage a limited partnership ◦ Limited partners have few management rights

 Transfer of ownership ◦ Limited partners have the right to transfer the value of their partnership interest  Can sell the interest itself if agreement permits  Duration ◦ Limited partnerships have perpetual existence

 Most professionals are allowed to incorporate  Provide more liability protection than a partnership  Corporation may be liable for an individual member’s mistakes, but the innocent professionals are not at risk

 Limitations ◦ All shareholders of the corporation must be members of the same profession ◦ Required legal technicalities for forming and maintaining a professional corporation are:  Expensive and time-consuming ◦ Tax issues can be complicated

 Partnership for a limited purpose  Each organization retains its own identity

 Are not actually a separate form of business ◦ They can take almost any one of the ones discussed already  Franchising is a compromise between employment and starting your own business  Franchisees have freedom to make many choices, but are limited in other ways  Can be very costly to acquire  Franchisors must comply with the Federal Trade Commission’s rule

 Franchisor must deliver to a potential purchaser a Franchise Disclosure Document (FDD) ◦ Purpose is to ensure that the franchisor discloses all relevant facts