Transcript Chapter 1

Organizational Forms
Sole Proprietorship
Partnership
Regular “C” Corporation
Subchapter S Corporation
Limited Partnership (LP)
Limited Liability Partnership (LLP)
Limited Liability Company (LLC)
Not-For-Profit
Important Considerations
Control: How many cooks in the kitchen?
Flexibility: A sports car or a battleship?
Liability: Who gets left holding the bag?
Longevity: Nobody lives forever…
Access to Capital: Sweat equity or OPM?
Taxation: Once, twice, or not at all?
Bureaucratic BS: How red is the tape?
Cost: Pay a little or pay a lot?
Sole Proprietorship
Simplest to start and maintain
Most common structure
Least costly
Highest personal risk
Income is taxed as personal
income
Sole Proprietor Taxation
Taxable income “passes through” the
business
Personal income and business
income are combined and taxed as
one
Puts you in a high tax bracket
Losses can be used to offset
personal income
Sole Proprietorship Taxes
Form 1040 (PDF)
Schedule C: Profit and Loss From
Business -- Sole Proprietor (PDF)
Form 1040 ES: Acceleration Estimate
Tax for Individuals -- Must estimate
expected income tax for the coming
year (PDF)
Quarterly vouchers and payments
Sole Proprietorship Legal
No registration required if business is in
your own name
If you change the name or use anything
other than your own name, must file
Certificate of Conducting Business
Under An Assumed Name with Secretary
of State.
Right of Survivorship Document – Says
what will happen in case of your death
To end business – Liquidate assets, pay off
debts, and walk away.
Sole Proprietorship Summary
Control: You’ve got it all
Flexibility: It’s your decision (alone)
Liability: You’ve got it all
Longevity: Nobody lives forever…
Capital: Your money, bank debt, and
trade credit
Taxation: Once, but not many breaks
Bureaucratic BS: Almost none
Cost: Very little
Partnership
Use if more than one person’s
capital (including human capital) is
involved
Agreement can be oral or written,
but non-idiots put it in writing
Terminates with the death of any
partner in most states – Can use
“Key Person” insurance to provide
for the continuation of the
partnership
Liability is joint and several unless
there are limited partners
Partnership Taxes
Form 1040 with proportional share of
partnership income
Form 1065: US Partnership Return of
Income (PDF)
Schedule K-1: Partner’s Share of Income
Credits, Deductions, etc. (PDF)
Each partner calculates and files an
estimated tax
Quarterly vouchers and payments
Types of Partnerships
General Partnership
Partners are equally liable (joint and
several)
Partners share workload and
decision making
Operates on a calendar year
Generally cash-based accounting
Types of Partnerships
Limited Partnership
 One or more partners are merely investors
and do not participate in running the
business or making decisions.
 Limited partners have share of ownership
but liability is limited to the amount of the
investment
 Must have at least one general partner
 Limited liability attracts equity investors,
thus increasing the availability of capital.
Partnership Legal Stuff
The partnership name and information about
the partners must be filed
Written partnership agreement is optional
Estate planning (what happens when a
partner dies) is essential, but complicated
All personal assets of all general partners are
at risk
Partnership terminates with the death of any
partner unless partnership agreement
specifies otherwise
Partnership Summary
Control: Shared between the partners
Flexibility: Now it’s a committee...
Liability: Joint and several
Longevity: Nobody lives forever…
Capital: Partners’ money and some debt
Taxation: Once, but not many breaks
Bureaucratic BS: Some - Partnership
agreements, more stringent records
Cost: Very little
Corporations
 Most difficult and costly to set up
 Provides specific benefits to the owners
 Separate legal entity – provides limited
liability for all owners
 Best access to capital markets
 Easiest in which to transfer ownership
 Income is taxed twice – once at the corporate
level and once at the personal level – but
otherwise gets very favorable tax treatment
 Most closely scrutinized by the US
Government and (if publicly traded) by the
SEC
The Corporate Form
• Ownership
The shareholders (also known as
stockholders or equity holders) are the
owners of the corporation.
• Control
Ultimate control rests with the shareholders,
but the managers control the day to day
operations.
• Risk Bearing
While all parties associated with the
corporation bear risk, shareholders bear all
residual risk.
Flow of Control in a
Corporation
Shareholders
Board of Directors
Managers
Corporation Taxes
VERY complicated and constantly changing
Owners (shareholders) file a Form 1040 for
personal tax with dividend income included
The corporation files a Form 1120 (PDF) – US
Corporation Income Tax Return – if gross
receipts, or total income, or total assets are
over $500,000 or if several other conditions
are not met (see instructions)
Form 1120A (short form) (PDF) if all three are
under $500,000 and other conditions are met.
Constitutional Protections for Corporations
• Right to due process and equal protection:
Corporations enjoy the right to equal
protection and due process of law under the
Fourteenth and Fifth Amendments to the U.S.
Constitution and under similar provisions of
most state constitutions.
• Freedom of speech:
Absent some narrowly drawn restrictions
serving compelling state interests,
corporations have the right to express
themselves on matters of public importance
whether or not those issues "materially affect"
corporate business.
Constitutional Protections for Corporations
• Right to counsel:
While a corporation cannot be imprisoned, a criminal
action can result in fines and other penalties that could
harm shareholders, officers, and other persons. Thus,
a corporate criminal defendant has a Sixth
Amendment right to counsel. But note, because a
corporation faces no risk of incarceration, it has no
right to appointed counsel if it cannot afford to retain
private counsel.
• No privilege against self-incrimination:
Corporations have no privilege against selfincrimination (e.g. to prevent disclosure of
incriminating corporate records).
Piercing the Corporate Veil
Creditors may attempt to recover money
from shareholders if:
 The business was initially underfunded or
“thinly capitalized”
 The owners failed to treat the business as
a separate entity themselves:
•
Fail to use Inc. or Corp or LLC in dealings
•
•
Co-mingle assets or funds
Fail to keep good records and hold meetings
Forming a Corporation
What do you need?
$50 (In Mississippi) to file
Articles of Incorporation
Company name (unique)
Directors
Business address
[Federal Tax ID]
[Corporate Charter]
Need Help?
 Small Business Development Center
(link)
 Small Business Administration (link)
 Mississippi Secretary of State (link)
 Incorporate USA (link)
 Company Corporation (link)
Corporation Summary
Control: LOTS of cooks
Flexibility: Now it’s a BIG committee...
Liability: Limited personal liability
Longevity: Nobody lives forever… So what?
Capital: Best access of all forms
Taxation: Twice, but many deductions and
breaks (may be eliminated or reduced)
Bureaucratic BS: Lots and lots and lots and…
Cost: Can be substantial
Subchapter S Corporation
Owners retain limited liability
Taxed as a partnership - eliminates double
taxation and makes it easier for owners
to be compensated
All profits are taxed and distributed
annually
Subchapter S Corporation
A corporation can elect S-Corp status within
75 days of formation if:
1. It is a domestic corporation (i.e., it
operates in the state in which it is
franchised
2. There is only one class of stock
3. It has 75 or fewer stockholders
4. All stockholders are US citizens or
resident aliens
5. There are no subsidiaries
Limited Liability Company (LLC)
Owned by “members” who may run the
company or appoint managers to do it.
Can have as few as one manager.
Members and managers have limited liability
Taxed like a Subchapter S Corporation
without having to conform to the S Corp
restrictions
Limited liability can make it harder to raise
capital - may require personal guarantees
Limited Liability Company (LLC)
Becoming one of the most popular
structures for small businesses because
of its simplicity, but there are many
statutory formalities that must be followed,
so compliance can impose a large
expense.
If you expect to go public in the future, this
form poses several large problems.
Limited Liability Partnership (LLP)
Also called a Professional Corporation
Used primarily by those who render professional
services - lawyers, accountants, doctors,
architects, social workers, etc.
Some tax advantages - possible tax shelter
Unlike a limited partnership, all partners can have
limited liability and still be active participants.
Limited liability may not be all that limited. Personal
guarantees are commonly required for unsecured
loans.
Selection Considerations
 Will you need to sell ownership to raise
equity?
 How willing are you to dilute your ownership?
 How risky is the business?
 How important is transferability of
ownership?
 Are you in a high personal tax bracket?
 Do you expect losses for some time?
 Is “Inc” worth something to the company’s
image?
Notes on sources for this presentation
This presentation is based on and includes
material provided in:
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Chapter 2 slide presentation for Corporate
Finance by Emery and Finnerty (Prentice Hall)
Small Business Financing: How and Where to
Get It, published by CCH Inc, 1998
Ready or Not, Get Set Go; by Hamilton and
Taylor – published by Professional Prodigy, Inc
MyCorporation.com
Aswath Damodaran: Corporate Finance Theory
and Practice – John Wiley & Sons
Professor’s Disclaimer
I have no original thoughts.
Therefore, every piece of
material in this presentation
most likely came from
someone else. None of it is
my personal work. Sources
are listed on the previous
slide.