Introduction

•  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

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

Advantages Disadvantages
Owner is in complete control Owner is personally liable
& receives all profits for all torts/contracts
Flexibility Lacks continuity after death
Ease of creation; Difficult to raise financing
maintenance
Sole Proprietorship

•  Major disadvantage is that the owner is personally liable for all losses
or liabilities incurred by the business enterprise.

 Franchises
•  Franchise: agreement so that Franchisor (Owner of trademark, trade name
or copyright) licenses Franchisee to use the trade mark, trade name or
copyright in the sale of goods or services.
•  Types of Franchises:
•  Distributorship.
•  Chain Style Business Operation.
•  Manufacturing or Processing Arrangement.
Laws Governing Franchising
•  Governed by commercial sales and contract law. If franchise is primarily
for the sale of goods, UCC Article 2 governs.
•  State and federal laws regulate franchising to protect franchisee.
•  The contract states parties’ rights and duties and can include an exclusive
“territory” to market goods/services.
 Franchise Contract
• The Franchise Contract can include:
• Franchisee’s type of business entity including capital structure,
sales quotas and record keeping.
• Location of the Franchise
• Premises is leased or purchased.
• Quality Control is a legitimate issue for Franchisor
because of good will, reputation and trademark value.
Courts will not question Franchisor’s strict supervision
but Franchisor may be liable for torts of agents.

Franchise Termination

•  Duration of the franchise is a matter determined by contract of the

parties.
•  Provides Remedies for Default and Breach.
•  Wrongful Termination.
•  Good Faith and Fair Dealing.

 Partnerships and Limited
Liability Partnerships

Copyright © 2009 South-Western Legal Studies in Business,

a part of South-Western Cengage Learning.
Basic Partnership Concepts
•  Partnerships are governed both by common law and by statutory
laws.
•  Agency Concepts and Partnership Law:
•  Each partner is deemed to be an agent of the other.
•  There may be imputation of liability.
•  Each partner is a fiduciary of the other.
Uniform Partnership Act
•  Partners are agents and fiduciaries of one another, but differ from
agents in that they are also co-owners and share in profits and
losses.
•  In the absence of a partnership agreement, the Uniform Partnership
Act, as adopted by most states, governs the partnership.
When Does A Partnership Exist?

•  Partnership is created when two or more

persons agree to carry on business for
profit as co-owners with equal right to
manage and share profits (UPA).
Definition of Partnership

Advantages Disadvantages
Easy to create and Partners are
maintain personally liable for all
torts/contracts
Flexible, informal Dissolved upon death
Partners share profits Difficult to raise
and losses equally financing
 Partnership Formation
•  Partnership Agreement (can be oral, written).
•  Duration of Partnership.
•  Partnership for a term.
•  Partnership at will. Partnership agreements can be oral unless Statute of Frauds
requires a written agreement. Practically, agreements should be in writing.
Partnership Formation

•  Capacity. Partners must have legal capacity.

•  Corporations. UPA permits corporations to be a partner.
Partnership by Estoppel
• Occurs when a person who is not a
partner holds himself out to 3rd Parties
and the 3rd Party relies to her detriment.
• Two Aspects of Liability:
•  Person who misrepresents he is a partner is liable.
•  Any person consenting to the misrepresentation is also liable.
 Partnership by Estoppel
•  When real partnership exists:
•  A partner represents a non-partner is in fact a partner,
•  The non-partner is an agent whose acts are binding on the partner only, not the
partnership.
•  Remember: Partnership by estoppel requires third party reasonably rely
on the representation to her detriment.
 Dissolution
•  By Acts of the Partners:
•  Partners can agree to Agreement.
•  Partner’s Withdrawal.
•  Partnership for term – breach.
•  No term -- no breach.
•  Admission of a new partner.
•  A transfer of a partner’s interest.
•  Although the transferee does not become a partner.
•  By assignment or attachment by creditor.
Dissolution

•  By Operation of Law:
•  Death of a partner.
•  Bankruptcy of a partner.
•  Bankruptcy of partnership.
•  Illegality.
Dissolution

•  By Judicial Decree:
•  Insanity.
•  Incapacity.
•  Business Impracticality.
•  Improper Conduct.
•  Other Circumstances (personal dissension).
Notice of Dissolution

•  To avoid liability for apparent authority, apply the agency rules by

giving:
•  Actual notice.
•  Constructive notice.
Partnership Buy-Sell Agreements

Partners can agree in advance that, in the event of the death of one
of the partners or some other event, what occurs: e.g., how much
the deceased partner or her estate will get for interest, or whether
the other partners can acquire the partnership interest. Partnership
can buy life insurance to cover this accounting on partner’s death.
 Limited Liability Partnerships
•  Creature of state statute 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
•  Recall that partnership law makes all partners jointly and severally liable
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.
 Family Limited
Liability Partnerships
•  FLLP is a limited liability partnership in which the majority of the
partners are related to each other.
•  Used frequently for agriculture.
Limited Partnerships

•  Entity that limits the liability of some of its owners (the limited
partners).
•  Creature of state statute. Filing a certificate with the Secretary of
State is required.
•  Agreement between at least one general partner and one limited
partner to carry on a business for profit.
Limited Partnerships

•  Only General Partners can manage, but they have a fiduciary

obligation to LP’s.
•  LP’s enjoy limited liability as long as they do not engage in
management functions.
•  An LP will be liable to a 3rd party if the 3rd party believes, based on
conduct, that the LP is a general partner.
Rights and Liabilities of Partners

•  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.
Dissolution of the LP

•  Dissolved in much the same way as a general partnership

•  Retirement, withdrawal, death, bankruptcy or mental incompetence
of a general partner will trigger dissolution unless the remaining
GP’s consent to continue.
•  Creditors are paid first then partners.

LLLP’s

•  Limited Liability Limited Partnership is a type of limited partnership.

•  Difference between LP and LLLP is that the general partner has
limited liability, like a limited partner, up to the amount of
investment.
•  Most states do not allow for LLLP’s.
 Limited Liability Companies
and Special Business Forms

Copyright © 2009 South-Western Legal Studies in Business,

a part of South-Western Cengage Learning.
Limited Liability Companies
•  Limited liability companies are relatively new creatures of state
statute.
•  An LLC is a hybrid entity that combines the limited liability of a
corporation and the tax advantages of a partnership.
•  LLC’s are increasingly become the entity of choice for businesses.
Limited Liability Companies

•  1997 IRS rules provide that any unincorporated business (including

LLC’s) will automatically be taxed as a partnership unless otherwise
indicated on the tax return.
•  LLC’s are attractive in today’s global business environment because
they allow foreign investors to own interests.
 Nature of the LLC
•  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).
•  Members of an LLC enjoy limited liability.
LLC Formation

•  Articles of Organization require:

•  Name of Business.
•  Principal Address.
•  Name and Address of Registered Agent.
•  Names of the Owners; and
•  How the LLC will be managed.
•  Business name must include LLC or Limited Liability Company.
Advantages and
Disadvantages of the LLC

Advantages
Member liability is limited to
amount of investment.
Can be treated as a “pass
through” entity for tax purposes.
Disadvantages
State statutes are not uniform.
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.
 Management of an LLC

• 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.
Special Business Forms

•  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.
 Other Entities
•  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.
 CORPORATIONS—Formation
and Financing

Copyright © 2009 South-Western Legal Studies in Business,

a part of South-Western Cengage Learning.
The Nature and Classification of Corporations

•  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).
Corporate Personnel

•  Individual shareholders own corporation.

•  Shareholders elect board of directors to manage corporation.
•  Board of directors hires officers to run corporation on a daily basis.
Limited Liability of Shareholders

•  The corporation substitutes itself for the natural persons in

conducting corporate business and incurring liability, but its
authority and liability are separate and apart from the shareholders.
•  In certain situations, the corporate “veil” of limited liability can be
pierced, holding the shareholders personally liable.
Corporate Taxation

•  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. “S” corporations have income pass down to
the individual shareholder.
Constitutional Rights
of Corporations
•  Corporation’s rights :
•  Freedom from unreasonable search and seizure and double jeopardy.
•  Freedom of speech.
•  Only officers and directors have protection against self-incrimination.
•  However, corporations do not have full protection of privileges and
immunities clause.
Torts and Criminal Acts
•  A corporation is liable for the torts committed by its agents or officers
within the course and scope of their employment under the doctrine
of respondeat superior.
•  Corporation can be liable for criminal acts, but only fined.
Responsible officers may go to prison.

Classification of Corporations

•  Public and Private.

•  Nonprofit.
•  Close Corporations.
•  Shares held by few shareholders.
•  More informal management,similar to a partnership.
•  Restriction on transfer of shares.
Incorporation Procedures

•  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.
Venture Capital

•  Venture Capital: start-up businesses and high-risk enterprises need

start-up and expansion capital. The start-up typically gives a share of
its stock.
•  Private Equity Capital: obtain capital from wealthy investors.
Ultimately, the company may sell shares in an IPO.
•  Locating potential investors online.