Business Organization

Introduction
Entrepreneurs wishing to start a new
business must be aware of advantages
and disadvantages of various business
entities for their endeavor. Consider:
üEase of creation.
üOwners’ liability.
üTax considerations.
üNeed for Capital.
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Limited liability >< unlimited liability?
Unlimited liability: the owner(s) is/are liable
without limit for the debts of the entity.
Limited liability: the liability of the
members to contribute to the debts of the
entity is limited.

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Salomon v A Salomon and Co Ltd [1897] AC 22
Facts:
Salomon was a boot manufacturer who originally
operated the business as a sole trader. He converted
the business into a company, as several of his sons
worked in the business and he wished to give each a
share. The subscribers to the memorandum were
Salomon, his wife and five children. They each took
one share. However, evidence was raised to show
that the wife and five children held their shares as
nominees for Salomon with the result that Salomon
and Co Ltd was in reality a “one man” company. He
was also appointed the managing director of the
company and two of his sons were appointed as
directors. 4
Salomon v A Salomon and Co Ltd [1897] AC 22
Facts:
Salomon sold his business to the company and
received more shares and securities in the form of
debentures and secured loans from the company in
payment. The company then experienced the
difficulties and eventually went into liquidation. The
creditors of the company sued Salomon for the
company’s debts. They argued that Salomon should
be liable for as it was just an alias for Salomon
himself. Salomon, on the other hand, argued that he
was not the company and therefore could not be
made liable for its debts.

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Salomon v A Salomon and Co Ltd [1897] AC 22
Decision:
The court held that the company was a separate
entity from its shareholders. It had conducted
business in its own right and was not just alias of
Salomon. Therefore, Salomon was not liable to
indemnity the company.

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 Common business forms in the world
Germany The US The UK

- Individual Enterprise - Sole proprietorship -Sole trader

(Einzelunternehmen) - General partnership - Partnership
- Private Company
(GbR) - Limited liability -Limited liability
- General Partnership partnership/ Limited partnership
(OHG) partnership/ Limited
-Company limited by
- Limited Partnership liability limited
shares
(KG) partnership
- Limited Liability -Company limited by
- Corporation (inc.)
Company (GmbH) guarantee
- Public limited - Limited Liability
-Unlimited liability
company (AG) Company (LLC)
company
- European Company
(SE)
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Sole Proprietorships &
Partnerships
 § 1: Sole Proprietorships
The owner is the business; anyone who does business
without creating a separate business organization has
a sole proprietorship.
üTaxation.
üOrganizational Fees.
üTransaction of Business in Other States.
Advantages Disadvantages
Owner is in complete control Owner is personally liable
& receives all profits for all torts/contracts
No double taxation Lacks continuity after death
Easy and inexpensive to Difficult to raise financing
create and operate
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 § 2: Partnerships
(General) Partnership is created when two or
more people agree to carry on business for
profit as co-owners with equal right to
manage and share profits (UPA).
Advantages Disadvantages
Easy to create and maintain Partners are personally
liable for all torts/contracts
Flexible, informal Dissolved upon death
Partners share profits and Difficult to raise financing
losses equally
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 Partnerships [2]
Sources of Law:
üState common law.
üUniform Partnership Act (UPA), adopted by all
states in some form.
üRevised Uniform Partnership Act (RUPA):
adopted by some states.

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 Partnership Formation
Partnership agreements can be oral unless
Statute of Frauds requires a written agreement.
Practically, agreements should be in writing.
Partners must have legal capacity. UPA permits
corporations to be a partner.
By Estoppel: parties who are not partners hold
themselves out to 3rd Parties and 3rd Party
relies to her detriment.

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 Partnership Operations
In the absence of a partnership
agreement (oral or written) state statutes
govern the rights among partners:
üManagement: equal, each one vote, majority
wins; need unanimous consent for some
actions.
üPartnership Interest: equal profits, losses shared
as profits shared.

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Special forms of partnerships
Limited Liability Partnership (LLP):
- Like a general partnership, but no personal
liability for partners
- Only limited to certain industries
Limited partnership (LP): general partners
and limited partners
üGeneral partners: unlimited liability, but have
managing/voting rights
üLimited partners: limited liability, but cannot
manage/vote => basically investors
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 Limited Liability
Partnerships (LLPs)
Partners in an LLP are not personally
liable for debts of the partnership
(whether arising from contract or tort).

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 Limited Partnerships
Have general (active management) and
limited (money-only) partners.
In a limited partnership, only the general
partners are personally liable.
In a limited liability limited partnership
(LLLP), the general partner is not
personally liable for the debts of the
partnership.
Formation of limited partnerships require
a filed certificate of limited partnership. 21
 § 3: Corporations
Corporations offer limited liability –
usually the managers’ and investors’
personal property is not at risk.
Corporate stock can be bought and sold,
making investments easy to get.
Corporations involve a lot of expense and
effort to create and operate.

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 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.
üC - corp: Double taxation
üS - corp: Flow-through taxation (even without
distributions)

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

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 “S” Corporations
Shareholders of S corps have the best of
all worlds: the limited liability of a
corporation and the tax status of a
partnership.
The disadvantages of an S corp are:
üThere can only be one class of stocks.
üThere can be no more than 75 shareholders.
üShareholders cannot be partnerships or other
corporations.
üShareholders must be U.S. citizens or residents.

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Limited Liability Companies
 Introduction
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.
 LLC Formation
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. (see
LLC rules at Texas Secretary of State).
 LLC Formation [2]
Articles of Organization require:
üName of Business.
üPrincipal Address.
üName and Address of Registered Agent.
üNames of the Owners; and
üHow the LLC will be managed.
Business name must include LLC or
Limited Liability Company.
 LLC Citizenship
An LLC is a legal entity separate from its
owners.
For federal jurisdiction based on
diversity, an LLC may be treated
differently than a corporation.
For diversity purposes the citizenship of
an LLC is the citizenship of its members,
which may live in multiple jurisdictions.
 LLC Advantages
& Disadvantages
Advantages Disadvantages
Member liability is limited to State statutes are not uniform.
amount of investment.
Can be treated as a “pass through” Not all states recognize LLC’s.
entity for tax purposes.
Profits can be distributed to
members without the double
taxation of a corporation. Members
pay personal income tax on
received dividends.
 LLC Operating Agreement
Operating 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.
 LLC Management
There are two options for management, generally
set forth in the articles of organization:
üMember-Managed: all of the members participate in
management, like a partnership.
üManager-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.
 Phrase True False
1 A sole proprietorship is a business owned
by one or more people
2 Unlimited liability is an advantage of a
sole proprietorship
3 A partnership is simply a business owned
by two or more people who have not filed
papers to become a corporation.
4 A corporation is treated as a person,
separate and distinct from its owners.

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 Phrase True False
1 A Sole Proprietorship is a one-person business
that is perhaps the easiest and simplest business
enterprise to organize
2 A limited liability company (LLC) is taxed like
a partnership but provides limited liability for
its owners, similar to a corporation.
3 A limited liability company (LLC) is formed
when a general partnership files a statement of
qualification with the appropriate public
official.
4 The CEO has to pay the debt for limited
liability company
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