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Module 11 Notes

by: Megan Angelo

Module 11 Notes ENTR-27056-003

Megan Angelo
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About this Document

Legal Form of Business
Intro to Entrepreneurship
Kipp A. Krukowski (P)
Class Notes
Intro to Entreprenuarship




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This 7 page Class Notes was uploaded by Megan Angelo on Monday March 28, 2016. The Class Notes belongs to ENTR-27056-003 at Kent State University taught by Kipp A. Krukowski (P) in Spring 2016. Since its upload, it has received 38 views. For similar materials see Intro to Entrepreneurship in Entrepreneurship at Kent State University.


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Date Created: 03/28/16
Legal Form of Business Module 11 Choosing the right legal form of business depends upon: • Legal and tax ramifications • Liability issues • Operational control issues • Long-term intent regarding the business • Need to raise capital, now or in the future Sole Proprietorships Advantages of sole proprietorships: • Easy and inexpensive to create • 100% of ownership and profits stay with the owner • Complete decision making authority for the owner • Income is taxed only once (at the owner’s personal income tax rate) • No major tax or other reporting requirements exist (Form Schedule C is included in the sole proprietor’s annual Form 1040) Disadvantages of sole proprietorships: • Owner has unlimited liability for all claims against the business • Any and all debts or claims against the business must be paid from the owner’s business or personal assets • Difficult for the owner to raise debt capital • Survival of the business depends upon the survival of the owner Partnerships Partnership • Two or more people agree to share the assets, liabilities and profits of a business (ideally via a written partnership agreement). Advantages: • Have same advantages as sole proprietorships • Shared risk of doing business • Shared partner clout with multiple financial statements • Shared ideas, expertise, decision making • Partners receive pass-through earnings and losses taxed once at their personal tax rates (Schedule K-1 is included in each partner’s annual Form1040) Disadvantages: • Partners are personally liable for all business debts and obligations • Individual partners can bind the partnership (and hence the other partners) contractually • Technical Partnership Dissolution results when a partner leaves or dies (unless otherwise stated in a written partnership agreement) • Partners can be sued individually for the full amount of partnership debt and obligations • Taxed on earnings whether distributed or not Partnership Agreement Based on the Uniform Partnership Act, a written partnership agreement defines the relationship between partners in terms of: • Business responsibilities • Profit sharing • Transfer of interest Wise options for partners to pursue: Buy-sell Agreement: • Who is entitled to purchase a departing partner’s share? • What events can trigger a buyout? • How is the departing partner’s interest to be valued? Key-person life insurance: • Life insurance policy on principal partner members • Use proceeds upon a partner death to buy out the partner’s heir(s) and keep the business going Structuring an Effective Partnership Agreement Critical Issues to Address: • Legal name of the business • Duration of the business • Nature of the business • Partner contributions • Personal transactions of the partners with the business • Withdrawals • Authority of the partners • Agreement to settle issues using arbitration • Dissolution of the business Corporation U.S. Supreme Court definition of Corporation • “An artificial being, invisible, intangible, and existing only in contemplation of the law.” Powers include right to: • Sue and be sued • Acquire-sell real property • Lend money Owners’ rights: • Stockholders invest capital in exchange for shares of stock • No personal liability for the corporation’s debts • Can only lose the money they invest Advantages: • Limited liability for owners • Capital can be raised through the sale of stock • Ownership is easily transferable • Binding contracts do not need individual owner signatures • Enjoys status and deference in business circles • Employee access to retirement funds, defined-contribution, profit- sharing and stock option plans • The entrepreneur can hold personal assets which can be leased to the corporation for a feeDisadvantages: • Most complex legal form to organize • Costs more to create • Subject to more governmental regulation • Stockholders do not receive personal benefit of business losses • After formation, ownership control passes to the Board of Directors • Shareholders elect the Board of Directors • Board of Directors elects the officers of the company • Double layer of income taxation • Corporation and dividend recipient (if applicable) each pay Where to incorporate: 1) In the state in which the business is located 2) Alternatively, in states with more favorable tax laws • Do your homework 3) Delaware - if seeking venture capital or intend to go public • Cheaper to get the large amount of authorized shares needed • Courts deemed most favorable to business S Corporations One creates an S corporation by first forming a C corporation and then “electing” S corporation status by filing a form with the IRS. Advantages: – Business losses can be passed through for taxation at entrepreneur’s personal tax rate (S-Corp is taxed as a partnership) (Schedule K-1 included in the shareholder’s annual Form 1040) – Avoids double taxation of C-Corporation Disadvantages: • Retained earnings may not be available for expansion or diversification of the company as S-Corps tend to distribute all or most of their earnings to their owners • Taxed on earnings whether distributed or not • No deductions for many “employee-owner” fringe benefits • Example: health benefits provided to employee-owners • Check with your CPA for annual changes Professional Service Corporations Examples: • Firms formed by CPA’s, doctors, architects, attorneys Anyone who holds shares in the corporation must be licensed to provide the services it offers. Some states require this legal form. 35% flat tax rate…but the tax is rarely paid • Income is typically “bonus-ed out” Benefit: Limited liability with regard to legal issues outside of the area of professional malpractice The Nonprofit Corporation A corporation established for charitable, public or religious purposes or for mutual benefit as recognized by federal and state laws. Advantages: • Attractive to corporate donors for business expense deductions • Can seek cash and in-kind contributions of equipment, supplies, personnel • Can apply for grants from government and private agencies • May qualify for tax-exempt status Disadvantages: • Profits cannot be distributed as dividends • Corporate money cannot be contributed to political campaigns or used for lobbying • Entrepreneur gives up proprietary interest in the corporation and whatever he contributes to it • Upon dissolution, all assets must transfer to another tax-exempt nonprofit organization • Substantial profits must come only from related activities • It may have to pay taxes on profits B Corporation • A benefit corporation or B-corporation is a type of for-profit corporate entity, legislated in 28 U.S. states (not Ohio), that includes positive impact on society and the environment, in addition to profit, as its legally defined goals. B corps differ from traditional American corporations in purpose, accountability, and transparency, but not in taxation. • A benefit corporation’s directors and officers operate the business with the same authority as in a traditional corporation but are required to consider the impact of their decisions not only on shareholders but also on society and the environment. • Benefit corporation laws address concerns held by entrepreneurs who wish to raise growth capital but fear losing control of the social or environmental mission of their business. Limited Liability Company Privately-held companies which incorporate under strict guidelines Advantages: • Can elect to be taxed like an S-Corp • Limited liability • Centralized management • Free transferability of interests • No limits on number of members or status • As compared to the S Corporation, which is limited to a certain number and type of shareholder (LLC’s and corporations cannot be shareholders and no more than 100 shareholders) • Owners can be managers and have limited liability • This is not true in a partnership Disadvantages: • Formation filing fee is required (like a corporation) • Consensus is difficult if there are many members • Sale of a member’s ownership in the LLC can trigger a need to register with the SEC if not all members elect to be “active” managers of the LLC • May not have foreign ownership rights • May not be recognized abroad as a legal entity • May have foreign members • Unlike an S Corporation, which cannot have non-resident alien shareholders Making the Decision About Legal Form Ask the right questions: • Does the founding team have the necessary operational skills to handle the applicable legal requirements? • Do the founders have the required start up capital? • Are the founders willing/able to assume personal liability for claims against the business? • Do the founders wish to have complete control over operations? • Do the founders expect initial losses? • Do the founders expect to sell the business some day? Choosing the right form at each milestone: • Know the strategic plan (end game) from the outset • Know the possibilities for changing legal form • Know expected capital and liquidity needs • Know the tax implications for owner-members


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