09.01 Selection & Formation of Business Entity & Related Operation & Termination Flashcards
Define sole proprietorship.
A single-owner business. The liabilities and assets in this form of doing business belong solely to its owner. Its profits and losses belong to the sole owner. The sole proprietorship is not a separate legal or taxable entity. Unlimited personal liability means that sole proprietor’s personal assets are subject to attachment and judgment by creditors of the sole proprietorship. This form of business is very informal.
Define general partnership.
A general partnership is defined as an association of two or more persons to carry on as co-owners of a business for profit. If the business makes a profit, that profit will “pass through” to the partners for income tax purposes. Whether distributed or not, profits are allocated and taxable directly to the partners.
Under the Revised Uniform Partnership Act (RUPA), which is the uniform law adopted in most states for governing partnerships, both the partnership assets as well as the assets of the general partners are subject to creditor attachment to satisfy liabilities of the partnership.
Define limited partnership.
A limited partnership consists of at least one general partner and at least one limited partner. Limited partners give up their general management rights that partners in general partnership have in exchange for limited liability that is the same as shareholders of a corporation. Only the general partner has personal liability.
Define limited liability company.
An LLC allows owners to enjoy limited liability but could still have pass-through tax benefits of the partnership form of business. In some cases, LLCs may also elect to be taxed as if they were S corps. The LLC owners can have management rights or they can designate one of the owners as a manager for the LLC.
Define corporation.
A corporation is a separate legal entity owned by shareholders who will have limited liability. The use of an artificial legal entity encourages people to invest in others’ business ideas.
Define limited liability partnership.
LLPs were created to provide professionals who form general partnerships (e.g. accountants) with limited liability for malpractice/negligence claims. Becoming an LLP does not require a change in structure and retains all the other features of a general partnership.
In LLPs, partners are generally liable for (a) their own malpractice and (b) the malpractice of those they directly supervise. In exchange for providing this extensive liability protection, many states require LLPs to carry minimum levels of malpractice insurance to help ensure that clients harmed by malpractice will have a viable remedy.
Define limited liability limited partnerships.
LLLPs allows the general partner(s) of a limited partnership to have the same limited liability as the limited partners. The general partners in an LLLP are not jointly and severally liable for the partnership debts.
Define joint venture.
A general partnership for a specific activity or a one-time transaction.
Define Subchapter C Corporation.
A corporation with the usual double taxation of corporations.
Define Subchapter S Corporation.
A C corporation can make an election under Subchapter S of the IRC and after meeting those requirements (e.g. less than 100 shareholders) enjoy a single level of taxation. Double taxation is eliminated through a Subchapter S election. A Subchapter S corporation can flow through its income to its shareholders.
Define professional corporation.
A PC allows accountants, doctors, lawyers, and some other professionals to gain the benefits of the corporate form, particularly that of offering benefits to employees. The shareholders in PCs enjoy limited liability except for their own malpractice.
Sole proprietorship - ease of formation?
No formal requirements
Sole proprietorship - personal liability?
Yes
Sole proprietorship - taxation?
Owner is the business, reported on Schedule C, form 1040
Sole proprietorship - level of control?
Owner has complete and independent control.
Sole proprietorship - ease of transfer?
Contract of sale and transfer of title to the business’s property.
General partnership - ease of formation?
Can be informal; formal requirements in some states
General partnership - personal liablity?
Yes
General partnership - taxation?
Flow-through
General partnership - level of control?
Partnership votes; unanimous votes in some circumstances
General partnership - ease of transfer?
Requires approval of partners
Limited partnership - ease of formation?
Formal requirements
Limited partnership - personal liability?
Personal liability for general partners only
Limited partnership - taxation?
Flow-through
Limited partnership - level of control?
General partner makes most decisions
Limited partnership - ease of transfer?
Would require approval of limited partners
Limited liability company - ease of formation?
Formal requirements
Limited liability company - personal liability?
No
Limited liability company - taxation?
Flow-through
Limited liability company - level of control?
Managing partner runs day-to-day; can be given complete authority.
Limited liability company - ease of transfer?
Would require approval of owners unless express authority given to managing partner
Corporation - ease of formation?
Formal requirements
Corporation - personal liability?
No
Corporation - taxation?
Double taxation
Corporation - level of control?
Executives and board control corporation; shareholders vote for board members
Corporation - ease of transfer?
Shareholder approval required.
Limited liability partnership - ease of formation?
Formal requirements; insurance mandates; special general partnership for professionals
Limited liability partnership - personal liability?
Yes, except for professional negligence
Limited liability partnership - taxation?
Flow-through
Limited liability partnership - level of control?
Can operate as a GP, with all members having a say in management
Limited liability partnership - ease of transfer?
Would require approval of partners
Limited liability limited partnership - ease of formation?
Formal requirements; limited states allow
Limited liability limited partnership - personal liability?
Limited liability, even for general partner
Limited liability limited partnership - taxation?
Flow-through
Limited liability limited partnership - level of control?
General partner has management authority
Limited liability limited partnership - ease of transfer?
Would require approval of limited partners
Professional corporation - ease of formation?
Formal requirements
Professional corporation - personal liability?
Yes, except for malpractice liability
Professional corporation - taxation?
Double-taxation unless Subchapter S election
Professional corporation - level of control?
General corporation law applies
Professional corporation - ease of transfer?
Would require approval of shareholders.
What law governs partnerships?
Revised Uniform Partnership Act (RUPA)
What law governs limited partnerships?
Revised Uniform Limited Partnership Act (RULPA)
What law governs corporations?
Revised Model Business Corporation Act (RMBCA)
What is the process of formation of sole proprietorships?
No formal filing with the state is required. May need to acquire a tax number and applicable licenses (e.g. sales tax license, liquor license)
What is the process of formation of a general partnership?
Informal formation - can be formed simply by conduct of the parties. A written partnership agreement is not required.
Formal formation - A written partnership agreement is a means for governing the partners’ relationships. Some states require partnerships to be registered or require a filing of a Statement of Partnership Authority.
What is the process of formation of a limited partnership?
An LP is a statutory creature. The documents required to be filed are: articles of LP or the partnership agreement; background info on pending litigation, criminal records, and/or bankruptcies; annual updates of information about the LP.
If documents are not filed, then they have only a GP with full personal liability for all partners.
What is the process of formation of an LLP?
An LLP is created under either the GP Uniform Partnership Act or the RUPA. There is no specific uniform law for LLPs.
Those forming the LLP must be licensed professionals; should have a formal written agreement establishing the LLP; registration or application must be completed; LLP may need to register with applicable licensing agents for the profession; must establish that it carries sufficient malpractice insurance to cover litigation/damages.
If requirements are not met, then they have only a GP with full personal liability for all partners.
What is the process formation of an LLLP?
The organizers must form a LP and make an election to be an LLLP in their filing of a certificate of LP with the state.
If, however, the LLLP is not formed properly, the general partner is considered a general partner and is jointly and severally liable for the limited partnership’s debts and liabilities once the partnership assets are exhausted.
What is the process formation of an LLC?
An LLC is a legal entity that must be properly formed to create a legal entity and to provide the limited liability the organizers need. To properly form an LLC, there must be a public filing with the state. Some states require articles of organization to be filed, others permit the filing of an operating agreement for formation if all the necessary info is included (e.g. name, address, principal officers, background info on the members, manager, statutory agent).
Operating agreements generally include percentage of interest held by each owner, allocation of P&L, rights and duties of members, & transfer rights.
What is the process of formation of a corporation?
The RMBCA requires filing of articles of incorporation that must include: corporate name; # authorized shares; address of initial registered office of the corp & registered agent; names and addresses of the incorporators.
The general process for forming a corp includes: filing articles of incorporation with the SOS and publication of the articles.
After formal filing of the articles, the corp must: hold an organizational meeting (elect board members, contracts entered into are adopted or rejected); draft & adopt bylaws; obtain certificates of authority to do business in other jurisdictions.
What if a corporation is not formed properly?
Failure to comply with the filing requirements means that a valid corporation has not been formed.
Those running the unincorporated structure would have full personal liability for the corporation.
What is a promoter?
These are individuals who form the corporation. Promoters are those who undertake to supply what the corporation needs before the corporation is formed. Promoters are entitled to have their pre- incorporation contracts covered when the corporation is formed if they meet certain requirements.
What are the duties of a promoter?
Promoters are held to owe a fiduciary duty of loyalty to: the proposed corporation, other promoters, and contemplated investors.
Promoters are usually forbidden from profiting from pre-incorporation contracts unless they: make full disclosure to an independent board of directors and gain their approval; or make full disclosure to all original shareholders and gain their approval.
What is the promoter liability on promoter pre-incorporation contracts?
The promoter is an agent acting for a corporation. A promoter cannot contract as an agent for an entity that does not exist yet (agency relationship). The promoter is entering into contracts that are signed by the promoter. There is no principal because the corporation does not exist yet, legally.
Promoters are liable on the contracts they negotiate unless the contract with the third party clearly and explicitly indicates that the third party is looking only to the corp for performance.
Even if the corp is formed and adopts the contract, the promoter is liable.
The promoter and corp can seek a novation.
What is the corporate liability on promoter’s contracts?
A corp is liable on contracts negotiated by its promoters if it comes into existence and ratifies the contract. The corp can ratify the promoter’s contracts in the following ways:
Expressly - via the board of directors’ resolution
Impliedly - knowing and voluntary acceptance following full disclosure of the benefits and costs of the contract.
Once it adopts the promoter’s contracts, the corp has the right to enforce those contracts against third parties.
What is the process to terminate a sole proprietorship?
A sole proprietorship naturally terminates when the sole owner dies or otherwise departs the business. Owners may also terminate the business at any time they choose to do so.
The process of termination in a sole proprietorship is one of disposing and/or selling inventory (the “Going out of Business” sale) and taking an inventory of all the assets, cancelling accounts, and notifying governmental agencies about license terminations.
What is the process to terminate a general partnership?
The process to end a partnership may be governed by the partnership agreement, which outlines the grounds for dissolution and/or termination. If there is no partnership agreement, then the RUPA provides the grounds and process for termination.
What are the three events that can lead to the termination of a general partnership?
Dissociation - notice of a partner’s express will to dissolver the partnership; death of a partner; bankruptcy of a partner; expulsion of a partner under the terms of the partnership agreement; occurrence of an event stipulated in the partnership agreement as causing dissociation.
Dissolution
Winding up (AKA Liquidation or Termination) - creditors must be paid first; if funds are left, distributed to partners.
What is the process to terminated LPs, LLPs, and LLLPs?
The process of dissociation, winding up, and liquidation (termination) for the various forms of limited partnerships (including LLPs and LLLPs) is sufficiently similar to that of general partnerships that it need not be separately treated. However, the departure of a limited partner will not result in the dissolution of a limited partnership.
The departure of a GP of any of these limited partnerships need not result in termination. Still, to validly exist, there must be a least one GP.
What is the process to terminate a corporation?
Corporations may be voluntarily or involuntarily dissolved.
Voluntary - by shareholder vote
Involuntary - dissolved by third parties.
List the ways in which a corporation could be involuntarily dissolved?
Dissolved by secretary of state for: failure to pay franchise taxes; failure to file annual reports; failure to properly establish and maintain a registered agent or office.
Dissolved by the courts - judicially
Dissolved through action by the state attorney general if: failed to file annual reports; fraudulently obtained approval for its articles of incorporation; abused its legal authority.
Dissolved in an action by shareholders: if management is deadlocked; those controlling the corporation are acting in an illegal/oppressive ay; if shareholders are deadlocked and cannot elect directors.
Dissolved in an action by creditors: if the creditor’s claim has been reduced to judgment, the judgment remains unsatisfied, and the corp is insolvent; the corp has admitted in writing that the creditor’s claim is due and owning and the corp is insolvent.
What is the process of liquidation of a corporation?
After dissolution, the corporate business and affairs must be wound up and liquidated. Directors will not be personally liable to claimants for claims barred or satisfied if they have complied with the RMBCA’s statutory procedures of: giving notice to known claimants; publishing notice of dissolution; requesting that other claimants present their claims; and obtaining appropriate judicial determinations.
What is the process to terminate an LLC?
For LLCs, the processes for termination commonly follow the dissociation-winding up-termination approach of RUPA for general partnerships.
Sole proprietorship - document for formation?
No
Partnership (informal) - document for formation?
No
Partnership (formal) - document for formation?
Articles of partnership or partnership agreement
Limited partnership - document for formation?
Articles of limited partnership or limited partnership agreement
LLP - document for formation?
Articles of partnership or partnership agreement; Registration requirements; Malpractice insurance proof
LLLP - document for formation?
Creation of limited partnership plus disclosure of limited liability of general partner
LLC - document for formation?
Formal public filing required
Corporation - document for formation?
Articles of incorporation must be filed with the state
Sole proprietorship - formal filing?
No
Partnership (informal) - formal filing?
No
Partnership (formal) - formal filing?
No
Limited partnership - formal filing?
Yes
LLP - formal filing?
Yes
LLLP - formal filing?
Yes
LLC - formal filing?
Yes
Corporation - formal filing?
Yes
Sole proprietorship - other filings?
Business licenses
Partnership (informal) - other filings?
Registration and licenses
Partnership (formal) - other filings?
Registration; annual disclosures; licenses
Limited partnership - other filings?
Annual disclosures; licenses
LLP - other filings?
Filing with state bar or other professional organizations
LLLP - other filings?
Use of LLLP in name; annual updates
LLC - other filings?
Operating agreement; annual filing required
Corporation - other filings?
Selection of Subchapter C or Subchapter S status for tax purposes; licenses; foreign corporation registrations
Sole proprietorship - liability with proper creation?
Full personal liability
Partnership (informal) - liability with proper creation?
All partners have full personal liability
Partnership (formal) - liability with proper creation?
All partners have full personal liability
Limited partnership - liability with proper creation?
Full personal liability of general partner; limited liability for limited partners
LLP - liability with proper creation?
Partner who commits malpractice (negligence) is liable but other partners are not liable unless they supervised the work
LLLP - liability with proper creation?
General partner has limited liability the same as limited partners
LLC - liability with proper creation?
Limited liability for owners
Corporation - liability with proper creation?
Shareholders have limited liability - will lose only their investment
Sole proprietorship - liability without proper creation?
Penalties for failure to have license
Partnership (informal) - liability without proper creation?
Liability for failure to register or obtain license
Partnership (formal) - liability without proper creation?
All partners have full personal liability
Limited partnership - liability without proper creation?
All partners (general and limited) are treated as general partners with full personal liability
LLP - liability without proper creation?
Full liability of all partnership assets for all malpractice
LLLP - liability without proper creation?
Full personal liability of the general partner - joint and several liability
LLC - liability without proper creation?
No personal liability except for improper formation
Corporation - liability without proper creation?
No personal liability unless promoter issues. Also, “watered shares” or corporate veil pierced.
In a partnership, how are earnings split between the partners?
The partnership agreement can provide for any distribution of earnings that the partners agree to. If there is no partnership agreement, the earnings are split equally.
If the agreement states to split profits 75/25 but no agreement on losses, then losses are also split 75/25.
In an LP, LLP, and LLLP, how are earnings split between the partners?
Each partner’s profits and losses are determined by the value or percentage of the capital contributions that the partner has made.
What are the types of corporate securities?
Equity securities: Common stock; Preferred stock; Treasury stock.
Define equity securities.
The basic types of equity securities are common stock, preferred stock, and treasury stock.
Define common stock.
The owners of common stock are the true owners of a corporation. They bear the most risk and have the most to gain. Common shareholders have the following rights: to vote for directors; to share pro rata in the profits of the corporation when paid out as dividends; to share in the surplus of assets over liabilities, if any, when the corporation dissolves.
Define preferred stock.
Preferred shareholders may have economic rights that are superior to those of common shareholders in term of either dividend rights or assets upon dissolution.
Define treasury stock.
Treasury stock is common stock that was once issued to shareholders but has now been repurchased by the corporation. Such stock is often distributed to shareholders pro rata as a share dividend.
True or false: Shares must be issued in exchange for consideration that meets both quality and quantity tests.
True.
What does the quality test require?
The quality test requires that consideration be paid in a proper form: money, services performed, and property received.
What is the quantity test?
Par value is face value. The consideration paid should be worth, at a minimum, the par value of the shares.
Define watered shares.
If shares are issued for less than par value or less than the RMPBCA authorized purchase price, then they are called watered shares.
What are the three main types of debt securities?
Notes - short-term unsecured debt instruments
Debentures - long-term unsecured debt instruments
Bonds - dent instruments secured by corporate property
What are the types of dividends a corporation can issue?
Cash, stock, and property dividends.
What effect does declaring dividends have on the shareholders?
Once dividends are declared, the receiving shareholders are unsecured creditors of the corporation for that amount until they are actually paid.
In an LLC, how are earnings split between the partners?
Earnings are shared as agreed in the operating agreement. If the operating agreement does not address earnings, they a shared in accordance with members’ capital accounts.
