Leadership, Attitude, Performance...making learning pay! Law LAP 2 Performance Indicator: BL:006

LAP Leadership, Attitude, Performance ...making learning pay! Business Law LAP 2 Performance Indicator: BL:006 Select Forms of Business Ownership...
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LAP

Leadership, Attitude, Performance

...making learning pay!

Business Law LAP 2 Performance Indicator: BL:006

Select Forms of Business Ownership

Ownership: The good, the bad, the ugly Do you need a lawyer? Taking Care of Business

Getting your DBA

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Perez Inc.

Google, Starbucks, Coca-Cola, Nike, McDonald’s, Sony, and Disney are a few of the most famous companies in the world. Like most businesses, they started out small. They didn’t become large public corporations overnight. Years of planning, organizing, and thought went into each company’s development. As the businesses grew, their objectives changed, and their owners changed forms of legal ownership to accommodate those new objectives. And why do you need to know this? Well, someday you might become the next big entrepreneur. You might start out with a great concept for a sole proprietorship. Sometime down the road, your business may grow to the point that you want to take on a partner. Or, maybe you’ll want to expand internationally, which may require a lot of money—so you decide to incorporate your business. To start and expand your venture, you need to know how to establish ownership in a way that best meets your goals and legally protects your business.

Summarize the advantages and disadvantages of the most common types of business ownership. Demonstrate procedures for selecting a form of business ownership. 

Weigh Your Options When you select a form of business ownership, you have many options from which to choose, including sole proprietorships, partnerships, corporations, or hybrids. Your choice of a legal form of business ownership depends on your needs and goals. Since each business situation is unique, there are no hard and fast rules to use to determine the best form of ownership. Before you begin your start-up venture, you must weigh the advantages and disadvantages of each ownership structure. The ownership form that you choose affects the way that your business is taxed and what government regulations your business must follow. After you review the strengths and weaknesses of each business structure, you can determine the option that best suits your needs.

All by myself Sole proprietorship was the best choice of ownership for Mariana, who designs and makes her own line of jewelry. She sells her products at local craft fairs and is developing a web site. She is also working out an arrangement with a local retailer to sell her accessories on consignment. She chose sole proprietorship because she prefers to control all aspects of her business, from designing the jewelry to contacting customers to managing finances. As a busy student, she enjoys the flexibility of working around her school schedule. In addition to control and flexibility, other advantages of sole proprietorship include: • Ease of opening. Depending on the nature of the business, sole proprietorships are relatively simple to start. Unless your business requires certification or local permits, government intervention is minimal. • Owner retention of all profits. As the sole owner, you receive any profits earned by your business. With other forms of ownership, profits must be shared with others. • Privacy. As the owner, you are the only one who needs to know the details of your business. Therefore, you can more easily protect company secrets such as ideas, formulas, or recipes. Information regarding your business’s financial condition need only be shared with the Internal Revenue Service (IRS).

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Taking Care of Business

• Ability to act quickly in making decisions. Because you have total control, you do not have to involve others in business decisions. • Tax advantages. The profit you earn will be taxed the same as the earnings of an individual. These tax rates are usually lower than those of a corporation. In addition, many business expenses can be deducted. • Easy to close. Closing a sole proprietorship is usually as easy as opening one. You need only to pay your employees and creditors; store or sell your equipment; and as an act of goodwill, notify your customers. Although there are many perks, there are some disadvantages to sole-proprietorship ownership. These include: • Unlimited liability. As a sole proprietor, you bear all the risks. You are personally responsible for all of your business’s debt. If you cannot pay business-related debt with business income, bill collectors can take personal assets, such as your home or your car to pay off the debt. • Limited capital. Sole proprietors often have a difficult time obtaining large amounts of capital from lenders, who consider them to be a high-risk investment. As a business owner, you need enough capital to pay employees, purchase equipment, and run the business. Without adequate capital, business expansion can be delayed or halted, causing you to lose business to the competition. • Limited capabilities. As a business owner, you might have limited expertise in some areas of business. For example, you might have a strong background in finance but lack knowledge in sales promotion. You may not have the funds available to hire an expert or to pursue training for yourself. A lack of experience or knowledge in any given area can dramatically affect the success or failure of your venture. Without the input of others, you must depend on your own limited viewpoint. • Uncertain life. As a sole proprietor, you are “it.” If you become ill and cannot work, you might have to close your business. You can provide trusted colleagues with the legal right to run your business for a specific period of time, but this limits your control of business activities. In addition, your business will be dissolved if you file bankruptcy, go to prison, or die.

Howdy, partner Partnerships provide unique opportunities for potential business owners. Advantages in organizing your business as a partnership include: • Ease of start-up. Like sole proprietorships, partnerships are fairly easy and inexpensive to start. You may pay attorney fees if you develop a partnership agreement. If you are establishing a limited partnership, you might need to follow more government regulations than a general partnership or sole proprietorship. • Combined resources. Remember the sole proprietor who lacked sales promotion experience? Perhaps s/he should consider a partnership with a promotion specialist. By teaming up with another person or a group of people, you are combining your skills, experience, contacts, and capital. When partners have different skills, each can focus on a specific aspect of the business. By sharing responsibilities, businesses often run more efficiently and smoothly. Each partner usually brings his/her own networking contacts from previous business and educational experiences, family, and friends. The larger the number of contacts for each partner, the higher the chance of business success. By combining resources, you are also increasing the amount of capital to run the business. Furthermore, lenders may be more willing to lend funds and vendors more likely to increase or extend credit to partnerships than they are to a single individual. • Decreased competition. If two or more similar businesses combine, the competition will be decreased or eliminated. • Reduced expenses. When two or more businesses combine to form a partnership, expenses are often reduced because they are no longer being duplicated. For example, expenses may be decreased for promotion, office space, supplies, and utilities. • Tax advantages. Each partner pays income tax on her/his individual share of the profit. Taking Care of Business

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Many business owners find partnerships an attractive ownership option. However, there are disadvantages to consider, too. • Unlimited liability. In a general partnership, each partner is responsible for all partnership debt. Each member of a partnership can lose personal assets to pay business debt. If one partner unexpectedly leaves town, the other partner is responsible for all debt. As you can see, partnerships require a great deal of trust and integrity for success. In a limited partnership, the liability is limited to the amount invested in the business. • Limited capital. Although partners may bring more capital to the business than sole proprietors, the amount of capital is still limited to the amount that each partner contributes. In addition, lenders may still be reluctant to lend large amounts of money to partnerships. • Disagreements. It’s difficult to avoid conflict in relationships, and business partnerships are no different. Many times, partners disagree on business goals, finances, responsibilities, and division of profits. In extreme cases, partners need time-consuming and expensive external mediation to resolve difficult issues. Disagreements can affect the efficiency of the business; the morale of employees; and ultimately, the success or failure of the venture. Developing a detailed partnership agreement often helps resolve the conflict because it addresses many of the issues that cause potential disagreements. In 1916, the United States government developed the Uniform Partnership Act (updated in 1997), which serves as a guide for legally formulating a general partnership agreement. Since a limited partnership is more formal and specific in nature, this business structure is governed by the Uniform Limited Partnership Act (ULPA). • Difficulty in ending. Withdrawing from a partnership can be complicated. Disagreements may arise as to how to divide profits and assets. For example, if there is no written partnership agreement, the law states that profits must be divided equally, regardless of the contribution of each partner. In addition, each partner is bound by the contracts of the other partners. Addressing these types of issues can be very tricky, as well as costly in time and attorney fees. • Uncertain life/Transferability. Unless otherwise specified in a detailed partnership agreement, bankruptcy, death, and the withdrawal or admittance of a new partner dissolves the partnership. Remaining partners may start a new partnership if they have the money to buy the former partner’s share.

It’s a corporate thing Abby and Sam need to raise a lot of money—fast. Their small technological firm was just granted a multimillion-dollar contract, and to meet its terms, they must expand their business by hiring more employees and purchasing a lot of new (expensive!) equipment. To raise the capital they need, Abby and Sam plan to sell shares of stock and form a corporation. There are different types of corporations, including public, private, Subchapter “S,” and nonprofit. Government regulations and taxation vary among the different types of corporations. However, there are many common advantages among all the types of corporations: • Limited liability. Since a corporation is legally recognized as a separate entity, it carries the liability for the business. Owners of the corporation (shareholders or stockholders) risk only what they invest in the business. Their personal assets cannot be used to pay business debt. • Financial power. A corporation can raise money quickly by selling stock. Because the corporation has more owners than a sole proprietorship or a partnership, it tends to have a wider pool of financial resources. And, because the corporation is closely regulated by the government, financial institutions are usually more willing to lend larger amounts of capital. With more capital, the corporation has the financial resources to operate more efficiently and expand with greater ease. • Unlimited life. A corporation may exist indefinitely. Unlike sole proprietorships or partnerships, the death or withdrawal of an owner does not affect the life span of the corporation.



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Taking Care of Business

• Easy-to-transfer ownership. Ownership can be transferred simply by selling the stock to another person. A new stock certificate is issued in the name of the new stockholder, and the corporate records reflect the change. No permission is required by others. • Skilled personnel. By possessing wider financial resources than other forms of business ownership, a corporation can usually attract and afford to hire a variety of skilled personnel to manage and operate the business. This can result in a more efficiently run organization. Corporations face many challenges. Some of the disadvantages of establishing your business as a corporation include: • Difficulty in forming and operating. Forming a corporation is very time-consuming, complex, and expensive. It takes many people to get the corporation up and running. Decisions must be made about the value and class of stock and shareholder voting rights. The business must request approval from the state to register as a corporation and must use an attorney to file the necessary forms and fees. Fees can cost thousands of dollars. • More complex requirements. Not only is it more difficult to start a corporation than other forms of ownership, it is more complex to maintain. After the corporation is established, it must follow various federal and state regulations. Reporting and taxation requirements vary from state to state. Corporations are required to keep detailed reports for stockholders and to keep them informed of certain corporate transactions, meetings, and voting rights. It can be very expensive to maintain the necessary level of communication with stockholders. In addition, a new charter must be approved or the old one changed if the corporation decides to change activities.

Rhiannon started her marketing-research business as a sole proprietorship. Initially, this form of ownership was a good choice for her since she is a competitive risk-taker who prefers controlling every detail of her business. The company took off and grew very quickly. She is currently in the process of incorporating her business so that she can afford to build new facilities and expand her services. There is one aspect of incorporation, however, that troubles Rhiannon. She loses total control of the company by having to share ownership with stockholders. In addition, as required by law, the company needs to form a board of directors to govern business activities. She feels that a board of directors might inhibit her plans to expand the company. To meet governmental requirements, Rhiannon decides to sell a limited amount of stock to family and friends. She carefully selects board members who would most likely go along with her aggressive expansion plans. The four board members include her brother, cousin, former roommate, and former business colleague, all of whom reside in other parts of the country. To accommodate the requirement to hold periodic board meetings, the group plans to communicate annually by teleconferencing or holding a web-based meeting. Is it ethical for a company to select board members who are family and friends? How might Rhiannon’s business benefit by having a board of directors that includes people other than friends and family? Are teleconferences or web-based board meetings a good idea? Why or why not?

Taking Care of Business

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• Dual taxation. A corporation is required to pay more taxes than other ownership structures. A corporation is taxed on the profits made by the company itself. In addition, the shareholders are taxed on the dividends they earn on their investments. • Separate owners and managers. Stockholders in a corporation are not generally involved in the day-to-day operation of a corporation. They form a board of directors to make decisions about the business on their behalf, and managers carry out these decisions. Because of the separation of ownership and management, there is more opportunity for irregularities or misunderstandings.

A unique blend Hybrids combine various elements of sole proprietorships, partnerships, and corporations into one package. More business owners are choosing to establish ownership as either a limited liability company (LLC) or a limited liability partnership (LLP). Let’s find out why: • Limited liability. Like corporations, LLCs and LLPs cannot have personal assets taken to pay business debt. The owners (members) lose only what they have invested in the business if it fails.

• Life span. Depending on the state in which the business is registered, hybrids are required to dissolve after a specific time period, usually between 30 and 40 years. At that time, the owners can decide if they want to reorganize the business or let it dissolve. Limited life can be an attractive option for some business owners. There are relatively few disadvantages to establishing ownership as a hybrid. However, one disadvantage is that the requirements and laws to establish and operate hybrids vary from state to state. This can be problematic for businesses that operate in more than one state. Until all states agree to universal guidelines, this will continue to be a concern for business owners. If you choose to establish your business as a hybrid, you will need to follow the statutes in each state in which you do business. Verification of each state’s statutes can cost time and money.

Summary Before choosing a legal form of ownership for your business, you must weigh your options carefully. The form you choose should suit your specific needs and goals. Keep in mind that it will also determine your taxation and level of government involvement. There are advantages and disadvantages to each form of ownership.

• Taxation. LLCs and LLPs pay taxes on personal incometax returns. Since LLCs and LLPs are not considered separate entities, as is the case with corporations, hybrids are not subject to dual taxation. • Cost to start and operate. Hybrids are generally less expensive to start than corporations. Since LLPs are designed for business professionals such as lawyers and doctors, the members might need to carry a required amount of liability insurance. In addition, since dual taxation is not an issue, less paperwork and regulation make it easier and less expensive to manage and operate the business.

1. List the advantages of starting a sole proprietorship. 2. List the disadvantages of starting a sole proprietorship. 3. List the advantages of starting a partnership.

• Flexibility. The number of members permitted in LLCs are unlimited, unlike “S” corporations which must have 100 or fewer shareholders. Most states require only one member (owner) to establish a business as a hybrid. Members are permitted to run the company or to allow others to manage it for them. Like corporations, transfer of ownership is a fairly simple process. Membership changes do not automatically dissolve the company.

4. List the disadvantages of starting a partnership.

• Combined resources. Since LLCs/LLPs often have more owners than sole proprietorships or partnerships, hybrids tend to have a wider pool of financial resources, skills, talents, and contacts.

8. List the disadvantages of starting a hybrid company.



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5. List the advantages of starting a corporation. 6. List the disadvantages of starting a corporation. 7. List the advantages of starting a hybrid company.

Taking Care of Business

Make the Right Choice Once you understand the strengths and weaknesses of the different forms of business ownership, you must take steps to evaluate other factors, such as your personal needs and goals, before legally establishing your business. As your business grows, you will need to revisit these steps to select an ownership form to accommodate your changing company. Whatever your personal and professional circumstances are, you need to assess the following factors: • Determine the nature of the business. Is the business small and one that you can easily manage on your own? Perhaps owning a sole proprietorship is the best option for you. As the business grows and changes, you might consider reorganizing your company as a partnership, corporation, or hybrid. In some cases, business owners combine their individual businesses to form one organization (known as a merger). • Assess your desired level of independence or control. Do you want to make all the decisions and control all aspects of your business? If you do, sole proprietorship is a good option. If you do not feel comfortable making all the decisions and desire input from others, partnerships or hybrids might be ownership forms to consider. • Evaluate financial needs. If you have ample financial resources to operate a business on your own, you might consider forming a sole proprietorship. Otherwise, you might want to consider forming a partnership, corporation, or hybrid. For example, an entrepreneur who wants to start a construction company might need a lot of capital to purchase expensive equipment. The owner might consider a corporation as the appropriate form of business ownership so that s/he can raise the needed funds by selling shares of stock.

• Examine willingness to assume risk. Are you a risktaker? If so, you should consider a sole proprietorship or general partnership. Individuals using these ownership forms experience higher risk because they have unlimited liability. If you’re not a risk-taker, consider a corporation, limited partnership, or hybrid form of ownership since you risk only what you’ve invested in the business. • Analyze your experience and abilities. Suppose you’re a computer whiz, and you manage your money well. You decide to start a web design business. You might consider a sole proprietorship because you already have the skills and abilities to run the business. Imagine another scenario in which you have the computer skills but lack moneymanagement skills. You might consider finding a business partner who possesses financial-management experience to handle that part of the venture. • Implement steps to legalize the business. First, make sure that you obtain a copyright, trademark, or patent for a new idea or product to protect you and your business—no matter what form of business ownership you choose. Check with federal or state government offices or search the Internet for copyrighting, trademarking, or patenting procedures. Also, consider that each state has different certification requirements for certain professions. For example, CPAs, attorneys, educators, and hairstylists must obtain proper certification in the state(s) in which they work. To verify terms for your certification, check with a professional trade association or your state government office. The steps you take to legally establish your business vary among the ownership structures. You must follow different procedures based on the business structure you choose. For sole proprietorships, little work is required to set up your business. Other than verifying professional certification, you may be required to register your business name by completing a “Doing Business As” (DBA) form with your county government. A small registration fee may also be required. Due to the nature of certain businesses, you may need to obtain permits or meet specific health and safety requirements as mandated by your local government. Once you’ve covered those bases, you are legally ready to open for business.

Taking Care of Business

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General partnerships are almost as simple to set up as sole proprietorships. In addition to verifying certification, obtaining local permits, and paying registration fees, each member of the partnership should understand his/her rights and responsibilities in relation to business activities. Although not required for general partnerships, a written partnership agreement is always a good idea and can be developed by an attorney. Limited partnerships must file a partnership agreement to operate. Information in a standard partnership agreement includes: • The formation date of the partnership • Names and addresses of all partners • The purpose of the business • Managerial responsibilities of each partner • Allocation of investments, profits, losses, and salaries among partners

• Accounting procedures and the degree of accessibility to financial records of each partner • Duration of partnership • Conditions under which the partnership can be dissolved and procedures for doing so • Procedures and provisions for protecting surviving partners in the event of another partner’s death

The corporation business structure is the most complex to legally establish and requires the expertise of an attorney. To incorporate a business in the U.S., you must apply for a charter with the state government where the business is located. A document known as “Articles of Incorporation” is required by many states. Information in this document includes: • Classes and values of stock • Business name • Purpose

• Stockholder voting guidelines

• Location

• Names of the board of directors

• Amount of stock to be issued

• General powers, limitations, and activities of the corporation

Corporations must pay an incorporation fee that can range from several hundred to several thousand dollars, depending on the corporate structure. In addition, corporations encounter ongoing attorney and accounting fees, as well as government fees. LLPs and LLCs are a little more complicated to legally establish than sole proprietorships or partnerships, but less complex than corporations. In general, a hybrid must register to do business in the state in which it is located. And, like other ownership structures, the hybrid is subject to various initial and annual fees. These fees, however, are generally much less than those of a corporation. Some states require hybrids to have an operating agreement, which is similar to a partnership agreement. Since the rules vary from state to state, you need to contact your state government for details. Consulting an attorney to help with the 1. What steps should you take to select a form of details is not required, but is generally considered a good idea. ownership for your business?

Summary The steps for selecting a form of ownership for your business are as follows: determine the nature of the business; assess your desired level of independence or control; evaluate financial needs; examine willingness to assume risk; analyze your experience and abilities; and finally, implement steps to legalize the business.



2. What legal steps does it take to implement:

a. A sole proprietorship?



b. A partnership?



c. A corporation?



d. A hybrid?

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