Sole Proprietorship and General Partnership
These are the 2 most fundamental forms of business entities. They are the only 2 forms of businesses you don’t need to register something with the state.
| Sole proprietorship | One person engaged in business for profit Pro: Easy and cheep to create, no double taxation, owner has complete control Con: Unlimited personal liability |
| General partnership | More than one person engaged in business for profit Uniform Partnership Act (UPA) or Revised Uniform Partnership Act (RUPA) Partnership Agreement Flow-through taxation (no double taxation) Joint and several liability (each partner is liable for the entire amount of all partnership debts) Incoming and outgoing partner liability (new partner is not reliable for any existing debts, but liable for anything happened even after leaving) |
Rights and Duties of a Partner
More owners mean more complexity. Most rights can be altered by the partnership agreement, but most duties can not.
Partners have rights to manage, profits / losses, information, be repaid (reimbursement, indemnification, etc), but have NO right to compensation. Partners also have fiduciary duties of loyalty, care, obedience; and duty to inform.
Special forms of partnership
In order to mitigate the risk associated with unlimited personal liability for partners in a general partnership, states have adopted other forms of partnership. For all of these you have to file with Secretary of State:
| LLP (limited liability partnership) | Exactly like a general partnership, but no personal liability for partners. Only available for certain industries. |
| LP (limited partnership) | There are 2 classes of partners: general partners and limited partners. General partners can vote and manage, and be liable. Limited partners are not liable for anything, but can not vote / manage. (Investors) |
| LLLP (limited liability limited partnership) | Exactly like LP, but with all partners has limited liability. Uncommon |
Corporations
Corporations are the most common form of limited liability business entity. Corporation exist separately from their owners. Corporations are people. Shareholders are owners of a corporation. The key characteristics of corporations are:
- limited liability of shareholders
- free transferability of shares
- centralized management (the owners of a corporation do not manage the affairs of the business, they appoint other people to do that)
- perpetual existence
C-corp and S-corp are tax designations, they have nothing to do with the structure of a corporation. C-corp means double taxation, while S-corp means flow-through taxation.
Forming a new corporation
There are several steps that have to be taken to form a corporation:
- Choose a state. Each state’s corporation law is different. Some states are friendly to managers, some states are friendly to shareholders.
- Choose a name. Names can not be confusingly similar with another name in the state. It must contain any of these magic words: corporation, incorporated, limited, company, corp., inc., ltd., co.
- File the documents (Articles of Incorporation).
- Hold some meetings to adopt bylaws, elect directors, and appoint officers (who actually run the things).
Rights, Powers and Liability of Shareholders
Shareholders must meet annually. There are also special meetings, only things on the agenda will be discussed. The main thing they vote on is the board of directors when whose term is up. Usually there is one vote per share.
Under cumulative voting, you could pull all of your votes across all of the open director seats, and put them on one, or divide them however you want. This gives minority shareholders a much greater ability to have someone they like appointed to at least one director seat.
Shareholders often enter into what we called voting agreements with one another. This is where they agree to vote the same way, or they can transfer their legal title to their shares to a trustee who votes the shares of multiple shareholders at the same time.
Liability
Almost all of the time, a shareholder is only liable to up to the amount of its investment. The exception is this doctrine called “piecing the corporate veil”. The corporation’s debts can not go through the veil to shareholders unless it is pierced. There are 2 ways that the veil can be pierced:
- failure to observe corporate formalities (e.g. keeping finance separate).
- corporation formed with insufficient capital
Rights
Shareholders’ rights usually include:
- Contractual rights (via shareholders agreements), for example: buy/sell or first refusal.
- Preemptive rights (if granted by the corporation), for example: all existing shareholders have rights to purchase a pro rata share of any new stock issuances in order to maintain their percentage of ownership.
- Rights to sue (directors or officers for mismanagement)
- direct – individual damage
- derivative – on behalf of corporation
Rights, Duties and Liability of Directors / Officers
Directors’ job is to set strategy for the company and appoint officers. Many corporations have inside and outside directors. As a general rule, directors are not liable for the reasonable decision they make. Directors are protected by business judgement rule. But directors are liable for breaching duties or misleading shareholders.
The duties of directors are about the same to those of partners in a partnership. The rights of directors include:
- Compensation
- Indemnification
- Inspection and participation
Officers’ job is to do day-to-day management. The duties and liability are essential the same to those of directors. But when it comes to the rights, since officers are just employees of an organization, they don’t really have many statutory rights.
Limited Liability Company
LLC is essentially a hybrid between a corporation and a partnership. Beginning in the late 70s, Wyoming was the first state to adopt a Limited Liability Company statute, and other states came on board.
A few really key concept behind LLC:
- Flexibility. You can choose how it is structured, how you want to be taxed… all sorts of things are super flexible.
- Limited liability of owners, even without observing formalities.
A few key terms about LLC:
| Member | Owners are called members, same as shareholders in corporation. |
| Membership interest | Same as a share or stock interest in corporation, voting rights, distribution rights, etc. |
| Article of Organization | Same as Article of Incorporation in corporation. |
| Operating Agreement | Same as bylaws in corporation. |
LLC are flexible in terms of taxation and management.:
| Taxed as partnership | Taxed as corporation | |
| Managed by member | partnership | a unique entity |
| Managed by manager | S-corp | corporation |
Forming an LLC is basically the same to that of a corporation. But you don’t have all the meetings that corporations must have.
My Certificate
For more on Forms of Business Organizations, please refer to the wonderful course here https://www.coursera.org/learn/corporate-commercial-law-part2
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