lesson 18

Question 1

basic types of business organizations

Answer 1

sole proprietorships, partnerships, corporations, other

Question 2

types of partnerships

Answer 2

general and limited liability

Question 3

types of corporations

Answer 3

• class C corporations
• subchapter S corporations
• closely held corporations
• professional corporations
• limited liability corporations

Question 4

types of other bus. organizations

Answer 4

joint venture, franchises

Question 5

factors to look at when comparing types of bus. orgs

Answer 5

ease or difficulty of formation/transfer, tax consequences, liability of owners, length of existence

Question 6

sole proprietorships

Answer 6

one person, easiest to form

Question 7

characteristics of sole proprietorships

Answer 7

1. no filing or registration required
2. no formal docs to prepare describing bus. operations
3. tax “pass-through”, meaning the business is not separately taxed
4. no shield or protection from liability

Question 8

general partnership

Answer 8

an unincorporated association of 2 or more co-owners who operate a business for profit

Question 9

general partnership formation, raising capital, and transfers

Answer 9

• easy formation, default status for two or more people that do not know any better
• raising capital is more difficult, can’t sell stock and must rely on individual contributions of partners
• partnership interests cannot be transferred/sold without permission of other partners

Question 10

general partnership taxes, profits/duties, and liability

Answer 10

• tax “pass-through” with profits reported on individual tax returns
• unless agreed otherwise, partners equally share profits and management duties
• individual liability for debts and claims against the partnership even if the debt/claim was caused by another partner

Question 11

limited liability partnerships

Answer 11

maintains certain benefits of partnership but also limits personal liability of partners

Question 12

limited liability partnerships characteristics

Answer 12

• easy to form
• tax “pass-through” to individual partners, not taxed separately
• partners are not liable to debts and claims against partnership
• does require filings with state, strict compliance required

Question 13

Joe and Bill form a limited liability partnership by filing all required docs with the state. on the third year, they don’t file annual reports, and in year 4 the partnership is sued.

Answer 13

because they weren’t in good standing by failing to file, courts held no limited liability partnership existed, and they were each personally liable

Question 14

corporations

Answer 14

a formal organization that is created (incorporated) by the state

Question 15

general corporations are

Answer 15

class C corporations

Question 16

class C corporations characteristics

Answer 16

• can be expensive to form and maintain
• primary advantage: no liability to shareholders/owners
• primary disadvantage: double taxed, corporation is taxed on profits and when profits are distributed to individual shareholders, they are taxed again
• transferability is relatively simple, owners can come and go by buying shares of stock

Question 17

subchapter S corporations

Answer 17

“S corps”, best of both worlds

Question 18

S corps characteristics

Answer 18

• individual shareholders are not liable for debts or claims against S corp
• profits of S corp “pass-through” directly to owners/shareholders, corp is not separately taxed
• limitations on who can form an S corp

Question 19

who can form an S corp

Answer 19

• limit of 100 shareholders
• can only be one class of stock
• shareholders must be individuals, estates, etc, cannot be partnerships/corps
• all shareholders must be US citizens
• all shareholders must agree the business is to be an S corp

Question 20

close corporations

Answer 20

designed to protect small business owners, somewhat similar to S corp

Question 21

close corporations characteristics

Answer 21

• 50 or less shareholders
• shareholders operate the bus. themselves
• may operate without formal board of directors
• protection of minority shareholders
• transferability may require that existing shareholders be offered the first option to purchase shares of a shareholder that wants to sell

Question 22

protection of minority shareholders in close corps

Answer 22

since these corps have few shareholders and little stock, it is difficult/impossible to sell as there is no real market. it would be easy for the majority shareholders to mistreat the minority. therefore, close corps usually require that the majority have a fiduciary duty to the minority

Question 23

professional corporations

Answer 23

PCs, these organizations are still around but newer options may be better for new formations. primarily used for groups like doctors and lawyers that want to limit liability

Question 24

PC characteristics

Answer 24

• no liability for actions of other members
• all shareholders must be of same profession
• taxation is very complex

Question 25

limited liability company

Answer 25

best of both worlds, relatively new (1977)

Question 26

LLC characteristics

Answer 26

- owners have no personal liability - no double tax, there is a pass-through - easy to create, little paperwork to maintain - flexibility of ownership with other businesses having the option to be members of LLC - should have well-planned operating agreement - duration is perpetual unless operating agreement provides otherwise

Question 27

pierce the corporate veil

Answer 27

allow for individual liability in LLC

Question 28

reasons to pierce the corporate veil

Answer 28

1. failure to observe formalities 2. commingling assets 3. inadequate capitalization 4. fraud

Question 29

commingling assets

Answer 29

owners need to keep their personal assets separate and distinct from assets of LLC. if a court cannot determine the owner, it will pierce

Question 30

inadequate capitalization

Answer 30

if owners do not contribute enough money to reasonably operate it, court may require further contribution from members

Question 31

fraud

Answer 31

court will not allow a member to use the protection of LLC as a shield against liability for their own wrongdoing

Question 32

failure to observe formalities

Answer 32

if member does not observe the distinction between their individual status and the status of the LLC or if the member does not treat the LLC like a separate org.

Question 33

test applied to determine whether to pierce veil:

Answer 33

1. did defendant control LLC? 2. did defendant engage in improper conduct? 3. as a result of improper conduct, was plaintiff unable to collect from LLC? if answer is yes to all 3, court will pierce veil

Question 34

joint ventures

Answer 34

partnership for a limited purpose. once venture is over, business relationship ends.

Question 35

joint ventures characteristics

Answer 35

- liability for taxes and debts is shared among participants - often its a partnership between 2 businesses that recognize they can profit by working with each other - partners maintain their independence

Question 36

franchises

Answer 36

not specifically a separate business formation. combines the best of both worlds by allowing franchisee to be a relatively independent owner with the advantage of working as part of an existing business

Question 37

there are over ______ franchised business outlets that employ ______ people.

Answer 37

750,000, 10 million

Question 38

if an individual member enters into a contract with an LLC,

Answer 38

they should put it in writing and observe all formalities. otherwise, courts may simply determine the LLC is a shell and not a separate entity

Question 39

McDonalds franchise in a small town

Answer 39

allows the franchisee to own and operate the day-to-day business with existing logos, products, policies, etc. franchisee also receives a continuing level of support and advertising from franchisor

Question 40

some drawbacks to franchises

Answer 40

1. control 2. high costs 3. royalty fees 4. supplies manufactured by franchisor, franchisee must purchase from them 5. joint advertising 6. system standards

Question 41

franchise drawback - control

Answer 41

some franchisors exert tight control over franchisees that may interfere with franchisee's desire to be relatively independent

Question 42

franchise drawback - royalty fees

Answer 42

required to be paid back to franchisor as a percentage of gross sales

Question 43

franchise drawback - joint advertising

Answer 43

when franchisor engages in regional or national advertising, franchisee may be required to contribute to these costs and expenses

Question 44

franchise drawback - system standards

Answer 44

in order to maintain uniform image, franchisees are ordinarily required to update their buildings and change furniture, counters, etc. (costs substantial sums)

Question 45

federal trade commission's franchise rule

Answer 45

protects franchisees, requires that 14 calendar days before a franchise contract is signed or any money is paid to the franchisor, the franchisor must provide a copy of their franchise disclosure document

Question 46

franchise disclosure document 14 minimums

Answer 46

1. history of franchisor and key executives 2. litigation with franchisees 3. bankruptcy filings by company 4. costs to buy and operate franchise 5. restrictions on products, customers, etc 6. territory franchisee may operate 7. franchisor's training program 8. required ad expenses 9. list of current franchisees and those that left recently 10. audited financials for franchisor 11. sample set of contracts franchisee is expected to sign

Question 47

joe started a business in his garage selling plants. He formed an LLC with himself as the only member with an official address the same as his home address. Bought $50,000 worth of plants to sell from nursery, 5000 down payment and financed remainder with nursery. Owner of nursery did not know to get security interest in plants, joe wants to shut down his business. Before he does so, he purchased a new computer on credit for $2000. Joe shuts down business which has no money in LLC accounts. The nursery and computer store both sued Joe for the debts owed on the plants and computer. Joe responds that the LLC bought the products and has no money, so there is nothing to get. Others claim the court should pierce the corporate veil.

Answer 47

courts will pierce the corporate veil because of fraud and failure to observe formalities