CHAPTER 29 Starting a Business
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Quote of the Day “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
Sole Proprietorships • A sole proprietorship is an unincorporated business owned by one person. • Sole proprietorships are easy and inexpensive to create and operate. • Earnings are reported on the owner’s personal tax returns.
Creating a Partnership • The association of two or more persons to carry on as co-owners a business for profit forms a partnership, whether or not the persons intend to form a partnership. • Each partner is a general partner. • Partners can be held personally liable for the partnership actions and debts. • Unless otherwise agreed, partners share profits, losses and management equally. Click here to see a sample partnership agreement online.
Partnership Pros & Cons • Advantages: • They don’t pay taxes • They are easy to form. • Disadvantages: • Each partner is liable personally. • Funding may be difficult (can’t sell shares). • Management may be difficult. • Transferability is limited.
Partnership by Estoppel • Partnership by estoppel applies if: • Participants tell other people that they are partners (even though they are not), or they allow other people to say, without contradiction, that they are partners. • A third party relies on this assertion; and • The third party suffers harm.
Management Rights • Each and every partner has equal rights in the management and conduct of the business, unless the partners agree otherwise. • Large partnerships usually designate managing partners (sometimes called members of the executive committee). • Sometimes, managing is done almost dictatorially by the partner who brings in the most business (the “rainmaker.”)
Duty of Care • Partners are liable for: • gross negligence, • reckless conduct, • intentional misconduct, or • a knowing violation of the law. • Partners are not liable for ordinary negligence.
Duty of Loyalty • Partners have a fiduciary duty to their partnership. • Some actions which may violate this fiduciary duty include: • Competing with the partnership • Taking a business opportunity away from the partnership • Using partnership property for private profit • Conflicts of interest
Dissociation • Dissociation occurs if a partner quits. • When one or more partners dissociate, the partnership can either buy out the departing partner(s) and continue in business or wind up the business and terminate the partnership. • A partner always has the power to leave a partnership but may not have the right.
Terminating a Partnership • Partnership at Will vs. Term Partnership • Partnership at Will -- the partners have not agreed in advance how long their partnership will last; any of them may leave at any time. • Term Partnership -- the partners have decided on a length of time or a particular task to be completed; the partnership automatically ends at the end of the time or task.
Termination of the Partnership Business • Ending a partnership business involves three steps: • Dissolution --decision to end business; can be voluntary or automatic. • Winding Up -- During the winding up process, all debts of the partnership are paid, and the remaining proceeds are distributed to the partners. • Termination -- the end; happens when winding up is complete.
Professional Corporations • Most states let professionals incorporate. • In many states, PCs provide more liability protection than a partnership. • The corporation may be liable for an individual member’s mistakes, but the innocent professionals are not at risk.
Limited Partnerships • Have both general (active) and limited (money-only) partners. • In a limited partnership, only the general partners are personally liable. • In a limited liability limited partnership, the general partner is not personally liable for the debts of the partnership. • Formation of limited partnerships require a filed certificate of limited partnership.
Corporations • Corporations offer limited liability – usually the managers’ and investors’ personal property is not at risk. • Corporate stock can be bought and sold, making investments easy to get. • Corporations involve a lot of expense and effort to create and operate.
Close Corporations • “Close corporation” and “closely held corporation” refer to a corporation whose stock is not publicly traded on a stock exchange. • Common provisions of close corporations: • Protection of Minority Shareholders • Transfer Restrictions • Flexibility • Dispute Resolution
“S” Corporations • Shareholders of S corps have the best of all worlds: the limited liability of a corporation and the tax status of a partnership. • The disadvantages of an S corp are: • There can only be one class of stocks. • There can be only 75 shareholders. • Shareholders cannot be partnerships or other corporations. • Shareholders must be U.S. citizens.
Limited Liability Companies • An LLC offers the limited liability of a corporation and the tax status of a partnership, without the disadvantages of an S corporation. • The LLC is popular because it has: • Limited Liability, Favorable Tax Status, Duration, Management, Flexibility • The biggest disadvantage with LLC is the legal uncertainty involved since it is a fairly new type of business. State laws vary, and case precedents are few.
Limited Liability Partnerships (LLPs) • Partners in an LLP are not personally liable for debts of the partnership (whether arising from contract or tort).
Joint Venture • A joint venture is a partnership for a limited purpose. • Nonprofit enterprises do not qualify as a joint venture.
Franchises • Are not actually a separate form of business – they can take almost any one of the ones discussed already. • Franchising is a popular method of starting a business that is a compromise between employment and starting your own business. • Franchisees have freedom to make many choices, but are limited in other ways.
“No one form of organization is right for every business. The proper choice depends upon factors such as sources of financing, tax issues, liability concerns, and the entrepreneur’s goals.”