Entrepreneur

1. Chapter 11
Choosing the Legal
Form of
Organization
–Ref: Dr. Thomas Lectures – University of Central Florida (UCF) USA
–Based on the Book “Launching New Ventures”; by Kathleen R. Allen; 5th Edition

2. Learning Objectives
Ownership/Business Structures
• Distinguish between sole proprietorships and partnerships
• Discuss the corporate form and its advantages and
disadvantages
• Explain the limited liability company
• Define the nonprofit corporation
• Make the decision about which legal form to use for which
purpose
• Discuss how a business entity can evolve from one legal
form to another

3. Table 11.1: Comparison of Legal Forms
Legal Form
General Partnership
S-Corp
C-Corp Full Corporate Non-Profit
Bridge Forms LLC
Partnership Limited Partnership
Sole Proprietor

4. Sole Proprietorships and Partnerships
• Legal structure alternatives for business:
– Sole Proprietorship
– Partnership
– Limited Liability Company
– Corporation (C or Subchapter S)
• Choosing the right structure depends upon:
– Legal and tax ramifications

5. Sole Proprietorships
• Advantages of sole proprietorships:
– Easy and inexpensive to create
– 100% of ownership+ profits stay with the owner
– Complete decision making authority for the owner
– Income is taxed only at the owner’s personal
income tax rate
– No major reporting requirements exist

6. Sole Proprietorships (continued)
• Disadvantages of sole proprietorships:
– Owner has unlimited liability for all claims against
the business-all debts must be paid from the
owner’s assets
– Difficult for the owner to raise debt capital
– Survival of the business depends upon the owner

7. Partnerships
• Partnership - two or more people agree to share the assets,
liabilities, profits of a business
• 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 at
their personal tax rates

8. Partnerships (continued)
• Disadvantages:
– Partners are personally liable for all business debts and
obligations
– Individual partners can bind the partnership contractually
– Partnership dissolution results when a partner leaves or
dies (unless otherwise stated in partnership agreement)
– Partners can be sued individually for the full amount of
partnership debt

9. Partnership Agreement
• Based on the Uniform Partnership Act, it
defines the relationship between partners in
terms of
– business responsibilities
– profit sharing
– transfer of interest

10. Partnership Agreement (continued)
• Buy-sell Agreement:
– Who is entitled to purchase departing partner’s share?
– What events trigger a buyout?
– What is the price to be paid for the partner’s interest?
• Key-person life insurance
– Life insurance policy on principal partner members
– Use of proceeds upon partner death to buy out partner or
keep the business going

11. Table 11.2: Structuring an Effective
Partnership Agreement

12. Corporation
• U.S. Supreme Court Definition : “An artificial
being, invisible, intangible, and existing only in
contemplation of the law.”
• Powers include rights to:
– Sue and be sued
– Acquire-sell real property
– Lend money
• Owners rights:
– As stockholders they invest capital in exchange for shares
– No liability for corporation’s debts
– Can only lose the money they invest

13. C-Corporation
• Advantages:
– Limited liability for owners
– Capital can be raised through sale of stock
– Ownership is transferable
– Binding contracts do not need individual owner signature
– 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 back to the corporation for a fee

14. C-Corporation (continued)
• Disadvantages:
– More complex to organize
– Subject to more governmental regulation
– Cost more to create
– Stockholders do not receive benefit of losses
– Ownership control passes to the board of
directors

15. C-Corporation (continued)
• Where to incorporate:
– In the state in which the business is located
– In states with favorable tax laws
– Delaware - if seeking venture capital

16. S-Corporation
• Advantages:
– Business losses can be passed through for taxation at
entrepreneur’s personal tax rate
– Avoids double taxation of income
• Disadvantages:
– Retained earnings no longer available for expansion or
diversification
– No deductions on medical reimbursements or health
insurance plans

17. Professional Corporations
• Licensed service professionals’ corporation
organized to provide their services

18. Limited Liability Company
• Privately held companies which incorporate under strict
guidelines
• Advantages:
– Tax and liability pass through obligations
– Limited liability
– Continuity of life
– Centralized management
– Free transferability of interests
– No limits on number of members or status

19. Limited Liability Company
(continued)
• Disadvantages:
– Formation filing fee is obligatory
– Consensus is difficult if there are many members
– It is not a separate tax-paying entity
– Members must file quarterly IRS statements
– Can be obliged to register with the SEC
– May not have foreign ownership rights

20. The Nonprofit Corporation
• A corporation established for charitable, public, 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-private agencies
– May qualify for tax-exempt status

21. The Nonprofit Corporation
(continued)
• Disadvantages:
– Profits cannot be distributed as dividends
– Corporate money cannot be contributed to political
campaigns or for lobbying
– Entrepreneur gives up proprietary interest in the
corporation
– Upon dissolution, all assets must transfer to another tax-
exempt nonprofit organization
– Substantial profits must come only from related activities
– It must pay taxes on profits

22. Making the Decision About Legal Form
• Ask the right questions
– Does the founding team have the necessary operational
skills?
– Do the founders have the required start up capital?
– Will the founders be able to run the business and cover
the first year’s living expenses?
– 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?

23. Making the Decision About Legal
Form (continued)
• Choosing the right form at each milestone:
– Know the strategic plan from the outset
– Know the possibilities for changing legal form
– Know the expected capital and liquidity needs
– Know the tax implications for owners-members