introduction 1 entrepreneurs wishing to start a new business must be aware of advantages and...

Introduction

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Entrepreneurs wishing to start a new business must be aware of advantages and disadvantages of various business entities for their endeavor. Consider:Ease of creation.Owners’ liability.Tax considerations.Need for Capital.

Sole Proprietorships

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The owner is the business; anyone who does business without creating a separate business organization has a sole proprietorship.

Advantages DisadvantagesOwner is in complete control & receives all profits

Owner is personally liable for all torts/contracts

Flexibility Lacks continuity after death

Ease of creation; maintenance Difficult to raise financing

Partnerships

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A (general) Partnership is an association of two or more persons to carry on a business as co-owners for profit. (UPA).

Advantages DisadvantagesEasy to create and maintain Partners are personally liable

for all torts/contracts

Flexible, informal Dissolved upon death

Partners share profits and losses equally

Difficult to raise financing

Rights Among Partners

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In the absence of a partnership agreement (oral or written) state statutes govern the rights among partners: Management: equal, each one vote, majority

wins; need unanimous consent for some actions.

Partnership Interest: equal profits, losses shared as profits shared.

Duties and Liabilities of Partners

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Fiduciary Duties: Partners are fiduciaries and general agents of one another and the partnership.

Authority of Partners: Partners have implied authority to conduct ordinary partnership business but need unanimous consent to sell assets or donate to charity.

Joint Liability for Contracts. If Partner is sued for Partnership debt, Partner has right to insist that other partners be sued with her.

Duties and Liabilities of Partners

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Joint and Several Liability for Torts. JSL means 3rd party can sue either one or all

partners. 3rd party may collect against personal assets of all partners.

Liability of Incoming Partner & Outgoing Partner. New admitted partner has no personal liability for existing partnership debts and obligations.

The Nature of the Corporation

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A corporation is a creature of statute, an artificial “person.”Most states follow the Model Business

Corporation Act (MBCA) or the RMBCA, that are model corporation laws.

The shares (stock) of a corporation are owned by at least one shareholder (stockholder).

Limited Liability of Shareholders

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The corporation provides limited liability for stockholders.

In certain situations, the corporate “veil” of limited liability can be pierced, holding the shareholders personally liable.

Corporate Taxation

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Corporate profits can either be kept as retained earnings or passed on to the shareholders as dividends.

Corporate profits are taxed under federal and state law as a separate “person” from its shareholders.

Regular “C” corporations are taxed twice: at the corporate level and at the shareholder level.

Classification of Corporations

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Domestic corporation does business in its state of incorporation.

Foreign corporation from X state doing business in Z state.

Alien Corporation: formed in another country doing business in United States.


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Public and Private.Nonprofit.Close Corporations.

Shares held by few shareholders.More informal management,similar to a

partnership.Restriction on transfer of shares.


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“S Corporations”: Avoids the federal “double taxation” of regular corporations at the corporate level. Only dividends are taxed to the shareholders as personal income. IRS requirements:Corporation is domestic, fewer than 75

shareholders, only one class of stock, no shareholder can be a non-resident alien.

Professional Corporations.

Corporate Formation

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The process of incorporation generally involves two steps:Preliminary and Promotional Activities; and

The Legal Process of Incorporation.

Incorporation Procedures

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Promotion

Name Search

File Articles of Incorporation

Subscribers

1st Organiza-tional Meeting

State Charter


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State Chartering: Select state (some states such as Delaware cater to corporations).

Articles of Incorporation: primary enabling document filed with the Secretary of State that includes basic information about the corporation. Person(s) who execute the articles are the incorporators.


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Choose and reserve a Corporate Name.Name must have the proper suffix:

“corporation,” “corp.,” “Incorporated.” You should also consider registering the

corporation as a “dot com” at networksolutions.com or register.com.

http://www.networksolutions.com/

http://www.simplenet.com/


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Purpose: trend towards “any legal business.”

Duration: usually perpetual.Capital Structure: Most states requires

some minimal capitalization (Texas used to require $1,000), plus number and class(es) of shares authorized and “par value” of shares at incorporation.


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Internal Organization: usually included in the bylaws.

Registered Office and Agent: specific person that will receive any legal notice and documents from state and/or 3rd parties.

Incorporators (usually the promoter): at least one with name and address.

First Organizational Meeting

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After the corporation is “chartered” (created) it and can do business.

Shareholders should have the first organizational meeting to: approve the bylaws, elect directors, hire officers and adopt pre-incorporation contracts and activities.

Corporate Management-Directors and Officers

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Every corporation is governed by a board of directors.

Individual directors are not agents of corporation, only the board itself can act as a “super-agent” and bind the corporation.

A director can also be a shareholder, especially in closely-held corporations.

Election of Directors

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Subject to statutory limitations, the number of directors is set forth in the articles of incorporation:Directors appointed at the first organizational

meeting.In closely held companies, directors are

generally the incorporators and/or the shareholders.

Term of office is generally for one year.Director can be removed for cause (for failing

to perform a required duty).

Board of Directors Meetings

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Directors hold meetings pursuant to bylaws with recorded minutes.

Special meetings may be called with sufficient notice.

Meetings require QUORUM (minimum number of directors to conduct official corporate business, usually majority).

Each director generally has one vote.

Role of Corporate Officers and Executives

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Officers serve at the pleasure of the Board of Directors but have fiduciary duties to company as well.

Their employment relationships are generally governed by contract law and employment law.

Duties and Liabilities of Directors and Officers

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Directors and officers are fiduciaries of the corporation. They owe ethical and legal duties to the corporation and shareholders:

Duty of Care : Directors/officers are expected to act in good faith and the best interests of the corporation. Failure to exercise due care may subject individual directors or officers personally liable.


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Duty of Care (cont’d):Make informed and reasonable decisions;

Rely on competent consultants and experts; and

Exercise reasonable supervisionBut…”Business Judgment Rule”


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A dissenting director is rarely held liable for mismanagement of corporation. Dissent must be registered with the corporate secretary and posted in the minutes of the meetings.


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Duty of Loyalty: subordination of personal interests to the welfare of the corporation.No competition with Corporation.No “corporate opportunity.”No conflict of interests.No insider trading.No transaction that is detrimental to minority

shareholders.

Conflicts of Interest

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Full disclosure of any potential conflicts of interest and abstain from voting on any transaction that may benefit the director/officer personally.

However, if transaction was fair and reasonable, it will not be voidable if approved by majority of disinterested directors.

Corporate Ownership--Shareholders

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Ownership of shares grants a shareholder an equitable ownership interest in a corporation.

Shareholders generally have no right to manage the daily affairs of the corporation, but do so indirectly by electing directors.

Shareholders are generally protected from personally liability by the corporate veil of limited liability.

Shareholder Powers

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Shareholder powers include approving all fundamental changes to the corporation:Amending articles of incorporation or bylaws.

Approval of mergers or acquisition.Sale of all corporate assets or dissolution.

Shareholders also elect and remove the board of directors.

Shareholder Meetings

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Shareholders’ meetings must occur at least annually. Voting requirements and procedures are:Quorum of shareholders owning more than

50% of shares must be present to conduct business;

Shareholders may appoint a proxy or enter into a voting trust agreement.

Shareholder Voting

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Common shareholder entitled to one vote per share.

Articles and by-laws can exclude or limit voting rights of certain classes of stock.

Quorum must be present -- shareholders representing more than 50% of outstanding shares must be present.

Shareholder Voting

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Shareholders may vote on resolutions.Need majority present for most

resolutions.Need a “super majority” (e.g., 67%)

for important matters: sale of assets, etc..

Voting lists by corporate secretary contains record of stock ownership.

Shareholder Voting

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Methods of Increasing Minority Share-holder Power Within the Corporation:Cumulative Voting allows minority

shareholders to get a board member elected.x # to be elected x shareholders # of shares =

shareholder can cast them all for one board nominee.Shareholder Voting Agreements.Voting Trusts.

Shareholders’ Rights

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Shareholders have the right:To vote.To have a stock certificate.To purchase newly issued stock.To dividends, when declared by board.To inspect corporate records.To transfer shares, with some exceptions.To a proportionate share of corporate assets on

dissolution.To file suit on behalf of corporation.

Preemptive Rights

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Common law concept which is a preference to existing shareholders to purchase a pro-rated share of newly-issued stock within a certain period of time.

Provided for in the articles of incorporation.Significant in a close corporation to prevent

dilution and loss of control.

Dividends

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Distribution of corporate profits or income. Only as ordered by the Board.Can be stock, cash, property, stock of other

corporations.State laws control the sources of revenues for

dividends, which may be paid from retained earnings, net profits and surplus.

Limited Partnerships

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Agreement of two or more persons to carry on a business for profit with at least one general partner and one limited partner.

Limits the liability of some of its owners (the limited partners) to their investment.

LP is a creature of state statute. Filing a certificate with the Secretary of State is required.

LP – Rights and Liabilities

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The General partner assumes all management and personal liability.

Limited Partner contributes cash but has no management rights. Liability is limited to the amount of investment. A limited partner can forfeit this “veil” of immunity by taking part in the management of the LP.

LP -- Rights and Liabilities

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General partners are personally liable to 3rd parties for breach of contract and tort liability. However, a corporation (or an LLC) can be a general partner and have limited liability.

Limited partners have the right to inspect the LP’s books and be informed of the LP’s business.

Limited Liability Companies

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Like corporations, LLC’s are creatures of state law. The owners are called “members” (not shareholders) and their ownership is called an “interest” (not shares).

LLC’s are formed by filing Articles of Organization with the Secretary of State.

LLC Advantages & Disadvantages

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Advantages DisadvantagesMember liability is limited to amount of investment.

State statutes are not uniform.

Can be treated as a “pass through” entity for tax purposes.

Not all states recognize LLC’s.

Profits can be distributed to members without the double taxation of a corporation. Members pay personal income tax on received dividends.

LLC Formation

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Articles of Organization require:Name of Business.Principal Address.Name and Address of Registered Agent.Names of the Owners; andHow the LLC will be managed.

Business name must include LLC or Limited Liability Company.

LLC Operating Agreement

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Operating agreement (in Texas a “Company Agreement”) is analogous to corporation’s bylaws.

Operating agreements may be oral and contain provisions relating to management, dividends, meetings, transfer of membership interests, and other significant issues.

Generally, if the operating agreement is silent, courts will apply partnership principles.

Management of an LLC

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There are two options for management, generally set forth in the articles of organization:Member-Managed: all of the members participate

in management, like a partnership.Manager-Managed: members are elected to

manage the LLC. If the articles are silent, statutes provide either

that each member has one vote or votes are made based on percentage of ownership.

Limited Liability Partnerships

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Creature of state statute, similar to an LLC, except that an LLP is designed for professionals who normally do business as a partnership (lawyers and accountants).

LLP allows partnership to limit personal liability of the partners but allows “pass through” tax advantages.

Liability in an LLP

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Recall that partnership law makes all partners jointly and severally for another partner’s tort, including personal assets.

The LLP allows professionals to avoid personal liability for the malpractice of other partners.

Supervising Partner is also liable for acts of subordinate.

Merger and Consolidation

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Business Entities can grow and expand by:Mergers.Consolidation.Purchase of another entity’s assets.Purchases of a controlling ownership interest

in another entity.

Merger

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Legal combination of two or more entities (A & B) after which only A entity remains. A’s organizational docs are amended to include a certificate of merger. After merger, A continues as the surviving entity with all of B’s rights and obligations.

AA BB

AA

Consolidation

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Occurs when two or more corporations (A & B) combine such that both cease to exist and a new corporation emerges which has all the rights and obligations previously held by A and B.

C’s articles of consolidation take the place of the original articles of A and B.

AA BB

CC

Conversion

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Occurs when entities of one type become a different type of entity.

C’s articles of consolidation take the place of the original articles of A and B.

AA BB

CC

Purchase of Assets

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The acquiring corporation extends its ownership and control over the physical assets of another company.

Acquiring corporation shareholders do not need to approve unless:Acquiring corporation is paying for assets with its

own stock and there is not enough stock authorized or

Acquiring corporation sells on a national exchange, is paying with its own stock, and newly issued stock = 20% or more than the outstanding shares.

Purchase of Assets: Liabilities

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Generally, an acquiring corporation is not liable for liabilities of selling corporation unless:The acquiring corporation impliedly or expressly

assumes the liabilities.Sale amounts to what is really a merger or

consolidation.Purchaser continues the seller’s business and

retains the same personnel.Sale is fraudulently executed to escape liability.

The selling corporation needs both board and shareholder approval.

Purchase of Stock

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Alternative to merger or consolidation is the purchase of a controlling interest (e.g., 51%) of a “target” corporation’s stock (called a “takeover”) giving the purchaser corporation controlling interest in the target.

The aggressor deals entirely with the target’s shareholders.

Purchase of Stock: Tender

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Tender Offers.A publicly advertised offer addressed to all

shareholders of the target is called a tender offer.

Tender offer is usually higher than market value per share but conditioned on the acquisition of a certain % of sharesCan be in exchange for aggressor's stock.Sec strictly regulates tender offers.

Termination

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Termination of a corporation, like a partnership, consists of two phases: Dissolution (voluntary or involuntary); and Liquidation.

Dissolution can brought about by: Act of legislature. Certificate expiration. Voluntary approval by shareholders and

board. Unanimous action by all shareholders. Court order.

Dissolution

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Shareholders can initiate dissolution by a unanimous vote to dissolve.

Or, the Board can initiate by submitting a proposal to the shareholders for a vote at the annual shareholder meeting or specially-called meeting.

Liquidation

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Voluntary Dissolution. Board liquidates and acts as trustees of

assets.Court will appoint a receiver if:

Board refuses; orCreditors want a receiver.

Involuntary Dissolution.Court appoints receiver.

Other Forms/Entities

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Joint VentureSyndicateJoint Stock CompanyBusiness TrustCooperative AssociationUnincorporated Association

Joint Ventures

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Joint Venture: two or more entities combine efforts or property for a single transaction or project.

Unless agreed otherwise, JV’s share profits and losses equally.

Common in international transactions when U.S. companies wish to expand overseas.

JV Characteristics

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Resembles a partnership and is taxed like a partnership. However, a JV is limited in time and scope, whereas a partnership is an ongoing business. Other differences:JV members has less implied and apparent

authority than partners.Death of JV member does not terminate JV.

JV members can specify duration. If not, then JV terminates when purpose is accomplished.

Other Entities

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Syndicate (Investment Group): group of individuals getting together to finance a particular project.

Joint Stock Company is a hybrid of partnership and corporation: (1) ownership represented by shares of stock; (2)managed by directors and officers of the company; and (3) can have a perpetual existence.

Other Entities

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Business Trust is created by a written agreement setting forth the interests of the beneficiaries and obligations and powers of trustees. Legal ownership and management of property remains with trustees and profits distributed to the beneficiaries.

Cooperative is an association organized to provide a not-for-profit service to members.

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