Mba1034 cg law ethics week 11 business ownership 2013

BUSINESS OWNERSHIP :SOLE PROPRIETOR, PARTNERSHIPS AND

CORPORATIONS

Stephen Ong, BSc(Hons) Econs (LSE), MBA International Business(Bradford)

Visiting Fellow, Birmingham City UniversityVisiting Professor, Shenzhen University

MBA1034 GOVERNANCE, LAW & ETHICS

• Discussion: Auditor Independence

1

• Sole Proprietorship, Partnership, & Corporations

2

• Case Discussion : Premier Oil3

Today’s Overview

1. Open Discussion

• Rocco R. Vanasco, (1996),"Auditor independence: an international perspective", Managerial Auditing Journal, Vol. 11 No.: 9 pp. 4- 48

Overview• Introduction to business ownership• Sole proprietorship• Partnership• Corporations• Corporations and the Sarbanes-

Oxley Act• Other Forms of ownership

2. FORMS

OF BUSINESS OWNERSHIP

Choosing a Form of Ownership• There is no one “best” form of

ownership.• The best form of ownership depends on

an entrepreneur’s particular situation.• Key: Understanding the characteristics

of each form of ownership and how well they match an entrepreneur’s business and personal circumstances.

Factors Affecting the Choice• Tax considerations• Liability exposure• Start-up and future capital

requirements• Control• Managerial ability• Business goals• Management succession plans• Cost of formation

Major Forms of Ownership

• Sole Proprietorship• Partnership• Corporation• S Corporation• Limited Liability Company• Joint Venture

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FIGURE 1 (A) Forms of Business Ownership – Percentage of Business

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FIGURE 1 (B)

Forms of Business Ownership - Percentage of Sales

FIGURE1 (C)

Forms of Business Ownership - Percentage of Profit

2.1 SOLE

PROPRIETORSHIP

Entrepreneurship

• Entrepreneur: A person who forms and operates a new business either by himself or herself or with others

• Sole proprietorship: A form of business in which the owner is actually the business– The business is not a separate legal entity– Sole proprietor: The owner of a sole

proprietorship

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Creation of a Sole Proprietorship

• No federal or state government approval is required

• D.b.a. (doing business as): A designation for a business that is operating under a trade name

• Fictitious business name statement (certificate of trade name)– A document that is filed with the state that

designates:• A trade name of a business• The name and address of the applicant• The address of the business

Advantages of the Sole Proprietorship• Simple to create• Least costly form to begin• Profit incentive• Total decision making authority• No special legal restrictions• Easy to discontinue

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Disadvantages of the Sole Proprietorship

• Unlimited personal liability• Limited skills and capabilities• Feelings of isolation• Limited access to capital• Lack of continuity of the

business

Liability Features of the Basic Forms of Ownership

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Sole Proprietorship

Claims of Sole Proprietor’s CreditorsClaims of Sole Proprietor’s Creditors

Sole Proprietor’s Personal Assets

Sole Proprietor’s Personal Assets

Personal Liability of a Sole Proprietor

• Unlimited personal liability: The personal liability of a sole proprietor for the debts and obligations of a sole proprietorship

• Taxation of a sole proprietorship– A sole proprietorship does not pay taxes at

the business level– A sole proprietor has to file tax returns and

pay taxes to state and federal governments

Exhibit 1 - Sole Proprietorship

2.2 PARTNERSHIP

Partnership

• An association of two or more people who co-own a business for the purpose of making a profit.

• Always wise to create a partnership agreement.

• The best partnerships are built on trust and respect.

Advantages of the Partnership

• Easy to establish• Complementary skills of partners• Division of profits• Larger pool of capital• Ability to attract limited partners

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Types of Partners• General partners

– Take an active role in managing a business.– Have unlimited liability for the partnership’s

debts.– Every partnership must have at least one

general partner.• Limited partners

– Cannot participate in the day-to-day management of a company.

– Have limited liability for the partnership’s debts.

Advantages of the Partnership• Easy to establish• Complementary skills of partners• Division of profits• Larger pool of capital• Ability to attract limited partners• Minimal government regulation• Flexibility• Taxation

Disadvantages of the Partnership• Unlimited liability of at least one

partner


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Partnership

Claims of Partnership’s CreditorsClaims of Partnership’s Creditors

Partnership’s Assets

Partnership’s Assets

GeneralPartner’sPersonal

Assets

GeneralPartner’sPersonal

Assets

GeneralPartner’sPersonalAssets

GeneralPartner’sPersonalAssets

Disadvantages of the Partnership• Unlimited liability of at least one partner• Capital accumulation• Difficulty in disposing of partnership

interest without dissolving the partnership

• Lack of continuity• Potential for personality and authority

conflicts• Partners bound by law of agency

Limited Partnership

• A partnership composed of at least one general partner and one or more limited partners.

• A general partner in this partnership is treated exactly as in a general partnership.

• A limited partner has limited liability and is treated as an investor in the business.

General Partnership• An association of two or more persons to

carry on as co-owners of a business for profit [UPA Section 6(1)]– General partners (partners): Persons liable

for the debts and obligations of a general partnership

• Uniform Partnership Act (UPA): A model act that codifies partnership law– Most states have adopted the UPA in whole

or in part

Formation of a General Partnership• To qualify as a general partnership

under the UPA a business must be–An association of two or more

persons–Carrying on a business–As co-owners–For profit

Exhibit 2 - General Partnership

Name of a General Partnership

• A general partnership must file a fictitious business name statement with the appropriate government agency to operate under a trade name

• General partnership agreement–A written agreement that partners

sign to form a general partnership

Taxation of General Partnerships• Flow-through taxation

– The income and losses of partnership flow onto and have to be reported on the individual partners’ personal income tax returns

• Right to participate in management– Each partner has a right to participate in the

management of a partnership and has an equal vote on partnership matters• Unless otherwise agreed

Right to Share in Profits The right to share in the earnings from the

investment of capital Unless otherwise agreed

Right to an accounting Action for an accounting: A formal judicial

proceeding in which the court is authorised to Review the partnership and the partners’

transactions Award each partner his or her share of the

partnership assets

Tort Liability of General Partners• Unlimited personal liability of a general

partner– A general partner’s personal liability for the debts

and obligations of the general partnership• Joint and several liability: Tort liability of

partners together and individually– A plaintiff can sue one or more partners separately– If successful, the plaintiff can recover the entire

amount of the judgment from any or all of the defendant-partners who have been found liable

Contract Liability of General Partners

• General partners have unlimited personal liability for contracts of the partnership

• Under the UPA– General partners have joint liability for the

contracts and debts of the partnership– Joint liability: Liability of partners for contracts

and debts of the partnership• A plaintiff must name the partnership and all of the

partners as defendants in a lawsuit

Liability of Incoming General Partners

• A new partner who is admitted to a general partnership is –Liable for the existing debts and

obligations of the partnership only to the extent of his or her capital contribution

–Personally liable for debts and obligations incurred by the general partnership after becoming a partner

Dissolution of a General Partnership

• The change in the relationship of partners in a partnership caused by any partner ceasing to be associated in the carrying on of the business [UPA Section 29]

• Winding up: Liquidating a partnership’s assets and distributing the proceeds to satisfy claims against the partnership

Wrongful Dissolution

• A situation in which a partner withdraws from a partnership without having the right to do so at that time– The partner is liable for damages caused by the

wrongful dissolution of the partnership• Upon dissolution the debts are satisfied in the

following order [UPA Section 40(b)]• Creditors (except partners who are creditors)• Creditor-partners• Capital contributions• Profits

Continuation of a General Partnership After Dissolution• The surviving, or remaining,

partners have the right to continue a partnership after its dissolution–Continuation agreement – Expressly

sets forth:• The events that allow for continuation of

the partnership• The amount to be paid outgoing

partners and other details

Right of Survivorship• A rule which provides that upon the death of a

general partner:– The deceased partner’s right in specific partnership

property vests in the remaining partner or partners• The value of the deceased general partner’s interest in

the partnership passes to his or her beneficiaries or heirs

• Liability of outgoing partners– Personally liable for debts and obligations that exist

at the time of dissolution– Not liable for any new debts and obligations incurred

after the dissolution

Exhibit 3 - Limited Partnership

Uniform Limited Partnership Act• Contains a uniform set of provisions

for the formation, operation, and dissolution of limited partnerships

• Revised Uniform Limited Partnership Act (RULPA)–Provides a more modern,

comprehensive law for the formation, operation, and dissolution of limited partnerships

Formation of a Limited Partnership

• Certificate of limited partnership: A document that two or more persons must execute and sign that makes a limited partnership legal and binding– Under RULPA, two or more persons must execute

and sign the certificate– The certificate of limited partnership must be filed

with• The secretary of state of the appropriate state• The county recorder in the county or counties in which

the limited partnership carries on business, if required by state law

Defective Formation• Incorrect creation of a limited

partnership that occurs when:–A certificate of limited partnership is not

properly filed–There are defects in a certificate that is

filed–Some other statutory requirement for the

creation of a limited partnership is not met

Limited Partnership Agreement

• A document that sets forth:–The rights and duties of

general and limited partners–The terms and conditions

regarding the operation, termination, and dissolution of a partnership, and so on

Liability of General and Limited Partners

• Unlimited liability of general partners– The unlimited personal liability of general partners

of a limited partnership for the debts and obligations of the general partnership

• Limited liability of limited partners– The limited liability of limited partners of a limited

partnership only up to their capital contributions to the limited partnership

– Limited partners are not personally liable for the debts and obligations of the limited partnership

Personal Guarantee

• A creditor may require a limited partner to personally guarantee the repayment of a loan in order to extend credit to the limited partnership– If the limited partnership defaults on the loan:

• The creditor may enforce the personal guarantee and recover payment from the limited partner who personally guaranteed the repayment of the loan

Management of a Limited Partnership

• Under the RULPA– A limited partner is liable as a general partner if his

or her participation in the control of the business is substantially the same as that of a general partner

– The limited partner is liable only to persons who reasonably believed him or her to be a general partner

– New Section 303 of the RULPA permits limited partners to participate in the management of a limited partnership without losing their limited liability shield

Dissolution of a Limited Partnership

• A certificate of cancellation must be filed by the limited partnership with the secretary of state of the state in which the limited partnership is organized

• Distribution of assets of a limited partnership– Creditors of the limited partnership, including partners

who are creditors (except for liabilities for distributions)– Partners with respect to:

• Unpaid distributions• Capital contributions• The remainder of the proceeds

2.3CORPORATION

Corporation• A separate legal entity from its owners.• Types of corporations:

– Domestic – a corporation doing business in the state in which it is incorporated.

– Foreign – a corporation doing business in a state other than the state in which it is incorporated.

– Alien – a corporation formed in another country but doing business in the United States.

CorporationTypes of corporations:• Publicly held – a corporation that has a

large number of shareholders and whose stock usually is traded on one of the large stock exchanges.

• Closely held – a corporation in which shares are controlled by a relatively small number of people, often family members, relatives, or friends.

Advantages of the Corporation

• Limited liability of stockholders


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Corporation

Claims of Corporation’s CreditorsClaims of Corporation’s Creditors

Corporation’s Assets

Corporation’s Assets

Shareholder’sPersonal AssetsShareholder’s

Personal AssetsShareholder’s


Personal Assets

barrier barrier barrier

barrier

Advantages of the Corporation

• Limited liability of stockholders• Ability to attract capital• Ability to continue indefinitely• Transferable ownership

Disadvantages of the Corporation

• Cost and time of incorporation process• Double taxation• Potential for diminished managerial

incentives• Legal requirements and regulatory “red

tape”• Potential loss of control by founder(s)

S Corporation• No different from any other corporation

from a legal perspective.• An S corporation is taxed like a

partnership, passing all of its profits (or losses) through to individual shareholders.

• To elect “S” status, all shareholders must consent, and the corporation must file with the IRS within the first 75 days of its tax year.


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S-CorporationClaims of S-Corporation’s CreditorsClaims of S-Corporation’s Creditors

S-Corporation’s Assets

S-Corporation’s Assets

Shareholder’sPersonal AssetsShareholder’s



Personal Assets


barrier

Limited Liability Company (LLC)

• Resembles an S Corporation but is not subject to the same restrictions.

• Two documents required: –Articles of organization–Operating agreement


An LLC cannot have more than two of these four corporate characteristics:1. Limited liability2. Continuity of life3. Free transferability of interest4. Centralized management


• An unincorporated business– Combines the most favorable attributes of

general partnerships, limited partnerships, and corporations

• An LLC is a separate legal entity (or legal person) distinct from its members

• Member: An owner of an LLC– Some states refer to members as shareholders

Uniform Limited Liability Company Act (ULLCA)

• A model act that provides comprehensive and uniform laws for the formation, operation, and dissolution of LLCs

• Revised Uniform Limited Liability Company Act (RULLCA): A revision of the ULLCA – Provides comprehensive and uniform laws for the

formation, operation, and dissolution of LLCs

Taxation of LLCs

• An LLC’s income or losses flow through to the members’ individual income tax returns– This avoids double taxation

• Formation of an LLC– An LLC may be organized by one or more persons– It can be organized in only one state– The name of the LLC must contain the words

limited liability company or limited company or the abbreviation L.L.C., LLC, L.C., or LC.

Articles of Organization

• The formal documents that must be filed at the secretary of state’s office of the state of organization of an LLC in order to form the LLC–The LLC is a domestic LLC in the state

in which it is organized–The LLC foreign LLC in any state in

which it wants to conduct business

Operating Agreement• An agreement entered into among

members that governs the affairs and business of the LLC and the relationships among members, managers, and the LLC– Certificate of interest: A document that

evidences a member’s ownership interest in an LLC

– The ULLCA mandates that a member has the right to an equal share in the LLC’s profits• Unless otherwise agreed

Distributional Interest• A member’s ownership interest in an LLC

– Entitles the member to receive distributions of money and property from the LLC

• Liability LLC members– The liability of LLC members for the LLC’s debts,

obligations, and liabilities, which is limited to the extent of their capital contributions

– Members of LLCs are not personally liable for the LLC’s debts, obligations, and liabilities


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Limited Liability Company - LLC

Claims of LLC’s CreditorsClaims of LLC’s Creditors

LLC’s AssetsLLC’s Assets

Member’sPersonal Assets





barrier

Exhibit 4 - Limited Liability Company (LLC)

Liability of Managers• Managers of LLCs are not personally liable for

the debts, obligations, and liabilities of the LLC they manage [ULLCA Section 303(a)]

• Liability of a member tortfeasor– Tortfeasor: A person who intentionally or

unintentionally (negligently) causes injury or death to another person

– A tortfeasor is liable to persons he or she injures and to the heirs of persons who die because of his or her conduct

Management of An LLCType of LLC Description

Member-managed LLC

The members do not designate managers to manage the LLC. The LLC is managed by its members.

Manager-managed LLC

The members designate certain members or nonmembers to manage the LLC. The LLC is managed by the designated managers; nonmanager members have no right to manage the LLC.

Agency Authority to Bind an LLC to ContractsType of LLC Agency Authority

Member-managed LLC

All members have agency authority to bind the LLC to contracts.

Manager-managed LLC

The managers have authority to bind the LLC to contracts; the nonmanager members cannot bind the LLC to contracts.

Duty of Loyalty• A duty owed by a member of a member-managed

LLC and a manager of a manager-managed LLC:– To be honest in his or her dealings with the LLC– To not act adversely to the interests of the LLC

• No fiduciary duty– A member of a manager-managed LLC who is not a

manager: • Owes no fiduciary duty of loyalty or care to the LLC or

its other members

Nature of the Corporation

• A fictitious legal entity that is created according to statutory requirements

• Corporation codes: State statutes that regulate the formation, operation, and dissolution of corporations

Nature of the Corporation• Characteristics of a corporation:

– Free transferability of shares– Perpetual existence– Centralized management– Limited liability of shareholders: A general rule of

corporate law which provides that generally shareholders are liable only to the extent of their capital contributions for the debts and obligations of the corporation and are not personally liable for the debts and obligations of the corporation

Exhibit 5.1 Corporation

Publicly Held and Closely Held Corporations• Publicly held corporation: Has many shareholders -

securities are usually traded on national stock exchanges

• Closely held corporation: A corporation owned by one or a few shareholders

• Revised Model Business Corporation Act: A 1984 revision of the MBCA– Arranges the provisions of the act more logically– Revises the language to be more consistent– Makes substantial changes in the provisions

Incorporation Procedures

• Procedure for incorporating a corporation varies somewhat from state to state

• Domestic corporation: A corporation doing business in the state in which it was formed

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Incorporation Procedures• Articles of incorporation: The basic governing

documents of a corporation, which must be filed with the secretary of state of the state of incorporation – Name of corporation– Number of shares authorized– Address of registered office and agent– Name and address of each incorporator

• Registered agent: A person or corporation that is empowered to accept service of process on behalf of a corporation

Incorporation Procedures• Corporate bylaws: A detailed set of

rules adopted by the board of directors after a corporation is incorporated that contains provisions for managing the business and the affairs of the corporation

• Organizational meeting: A meeting that must be held by the initial directors of a corporation after the articles of incorporation are filed

Incorporation Procedures• S Corporations: A corporation that has

met certain requirements and has elected to be taxed as an S corporation for federal income tax purposes– Pays no federal income tax at the corporate

level– Income or loss flows to the shareholders and

must be reported on the shareholders’ individual income tax returns

Financing the Corporation • Equity securities:

Representation of ownership rights in a corporation

• Equity securities can be:–Common stock–Preferred stock

Common Stock

• An equity security that represents the residual value of a corporation

• Common stockholder: A person who owns common stock

Preferred Stock• Equity security that is given certain

preferences and rights over common stock• Preferred stock may have any or all of the

following preferences, rights, or attributes:– Dividend preference– Liquidation preference– Cumulative dividend right– Right to participate in profits– Conversion right– Redeemable preferred stock

Authorized, Issued, and Outstanding Shares• Authorized shares: The number of

shares provided for in a corporation’s articles of incorporation

• Issued shares: Authorized shares that have been sold by a corporation

Debt Securities• Securities that establish a debtor–

creditor relationship in which the corporation borrows money from the investor to whom a debt security is issued

• Classifications:– Debenture– Bond– Note

Indenture Agreement

• Contract between the corporation and a holder of a debt security

Shareholders

• Owners of a corporation who elect the board of directors and vote on fundamental changes in the corporation

Exhibit 5.2 Shareholders

Shareholders• Shareholders meetings: A meeting

of the shareholders of a corporation that must be held by the corporation to elect directors and to vote on other matters–Annual–Special–Proxy

Shareholders• Quorum: The number of directors

necessary to hold a board meeting or transact business of the board

• Supramajority voting requirement: A requirement that a greater than majority of shares constitutes a quorum of the vote of the shareholders

Shareholders• Straight voting: A system in which each

shareholder votes the number of shares he or she owns on candidates for each of the positions open

• Cumulative voting: A system in which a shareholder can accumulate all of his or her votes and vote them all for one candidate or split them among several candidates

Shareholders• Dividend: A distribution of profits of the

corporation to shareholders

• Piercing the corporate veil: A doctrine that says if a shareholder dominates a corporation and uses it for improper purposes, a court of equity can disregard the corporate entity and hold the shareholder personally liable for the corporation’s debts and obligations

Board of Directors

• A panel of persons who are elected by shareholders to make policy decisions concerning the operation of a corporation –Inside director (executive)–Outside director (non-executive,

independent)

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Exhibit 5.3 Board of Directors

Board of Directors• Regular meetings of a board of

directors are held at the times and places established in the bylaws

• A board can call special meetings of the board of directors as provided in the bylaws

Corporate Officers• Employees of a corporation who

are appointed by the board of directors to manage the day-to-day operations of the corporation

Exhibit 5.4 Corporate Officers

Fiduciary Duties of Directors and Officers• The duties of care and loyalty owed by

directors and officers to their corporation and its shareholders– Duty of loyalty: A duty that directors and officers

have not to act adversely to the interests of the corporation and to subordinate their personal interests to those of the corporation and its shareholders

– Duty of care: A duty of corporate directors and officers to use care and diligence when acting on behalf of the corporation

Sarbanes-Oxley Act• A federal statute enacted by Congress to

improve corporate governance• The goals of the Sarbanes-Oxley Act are

to improve corporate governance rules, eliminate conflicts of interest, and instill confidence in investors and the public that management will run public companies in the best interests of all constituents

Mergers and Acquisitions• A situation in which one corporation

is absorbed into another corporation and ceases to exist

• A merger occurs when one corporation is absorbed into another corporation–Surviving corporation–Merged corporation

Exhibit 5.5 Merger

Dissolution of the Corporation

• Voluntary dissolution• Administrative dissolution • Judicial dissolution• Winding up, liquidation, and

termination

Multinational Corporations

• Multinational corporations operate in more than one country

• Operate in other countries through a variety of means, including the use of agents, branch offices, subsidiary corporations, business alliances, strategic partnerships, franchising, and other arrangements

2.4OTHER FORMS

Limited Liability Partnership (LLP)

• A special form of partnership in which:– All partners are limited partners– There are no general partners

• LLPs enjoy the flow-through tax benefit of other types of partnerships

• Articles of limited liability partnership– The formal documents that must be filed at

the secretary of state’s office of the state of organization of an LLP in order to form the LLP

Limited Liability of Partners

• The liability of LLP partners for the LLP’s debts, obligations, and liabilities, is limited to the extent of their capital contributions–Partners of LLPs are not personally

liable for the LLP’s debts, obligations, and liabilities

Exhibit 5 - Limited Liability Partnership (LLP)

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The Professional Corporation Designed for professions – lawyers,

doctors, dentists, accountants and other professionals

Created in the same manner as a corporation

Identified by the abbreviations: P.C. – Professional Corporation P.A. – Professional Association S.C. – Service Corporation

The Joint Venture

Much like a partnership, but it:

Is formed for a specific purpose

Has a beginning and an end

Conclusion The “right” choice of the form of

ownership is unique to every entrepreneur and their business.

Each form has advantages and disadvantages.

The entrepreneur must be thoughtful and strategic about this important decision.

Exhibit 6 - Franchise

Types of FranchiseType of Franchise Description

Distributorship franchise

A franchise in which the franchisor manufactures a product and licenses a franchisee to distribute the product to the public.

Processing plant franchise

A franchise in which the franchisor provides a secret formula or process to the franchisee, and the franchisee manufactures the product and distributes it to retail dealers.

Chain-style franchise

A franchise in which the franchisor licenses a franchisee to make and sell its products or distribute its services to the public from a retail outlet serving an exclusive territory.

Area franchise

A franchise in which the franchisor authorizes a franchisee to negotiate and sell franchises on its behalf in designated areas. The area franchisee is called a subfranchisor.

Franchise Agreement• An agreement that a franchisor and

franchisee enter into that sets forth the terms and conditions of a franchise

• Liability of franchisors and franchisees– The franchisor deals with the franchisee as an

independent contractor• Franchisees are liable on their own contracts and

are liable for their own torts• Franchisors are liable for their own contracts and

torts

Exhibit 7 - License

CASE DISCUSSION : PREMIER OIL

Casestudy 3 : Premier Oil1. Read and prepare the Casestudy on

Premier Oil (Monks & Minow (2011). Identify the corporate governance issues faced.

2. You are required to:

– Analyse the scenario’s in the case study and plot the resulting risk analysis on an appropriate risk map.

– Map out the stakeholder power/interest issues, and propose the appropriate corporate actions.

Risk Map Action

High

Medium

Low

Low Medium

High

SIGNIFICANCE

PROBABILITY

Requires close

monitoring

Manage and

monitor

Significant focus and

action

Accept but

monitor

Management effort

worthwhile

Manage and

monitor

Accept risks

Accept but periodically

review

Accept but

monitor

Stakeholder mapping

Core Readings• Baron, David P.(2013) Business and its environment, 7th

Edition, Pearson, Ch.14• Cheeseman, Henry R.(2013) Business law, 8th Edition,

Prentice Hall. Ch.14-16• Barringer, Bruce R. & Ireland, R. Duane, 2011

Entrepreneurship – Successfully launching new ventures 4th edition, Pearson.

Next Week’s Ideas for Discussion

• Prem Sikka, (2008),"Enterprise culture and accountancy firms: new masters of the universe", Accounting, Auditing & Accountability Journal, Vol. 21 Iss: 2 pp. 268 - 295

QUESTIONS?