Chapter

McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved.

11Corporate Governance And Corporate Governance And

Business OrganizationsBusiness Organizations

11-2

Corporate GovernanceHow Business How Business

Organizations Are Organizations Are Operated, Led, Operated, Led, GovernedGoverned

How Law Provides How Law Provides Regulation Of Business Regulation Of Business OrganizationsOrganizations

REGULATIONS

11-3

Size Of OwnershipClosely Held- Family Closely Held- Family

And/Or FriendsAnd/Or Friends

Publicly Held- Traded Publicly Held- Traded On Public Stock On Public Stock ExchangesExchanges

11-4

Selecting a FormSole

Proprietorship

Forms of Legal Organization of Business Entities

Partnership

Corporation

General Partnership

Limited Partnership

Regular CCorporation

Subchapter SCorporation

Limited LiabilityCompany

Limited LiabilityPartnership

Starting a Business

Some Other FormsSome Other Forms• Joint VentureJoint Venture• Strategic AllianceStrategic Alliance• FranchiseFranchise• CooperativesCooperatives• Master Limited Partnerships Master Limited Partnerships

(M.L.P.) in some states, similar to (M.L.P.) in some states, similar to L.L.CsL.L.Cs

Starting a Business

Sole ProprietorshipSole Proprietorship• Business is operated as own personal propertyBusiness is operated as own personal property• Unlimited personal liability for all debts/obligations Unlimited personal liability for all debts/obligations

of the businessof the business• Over 2/3 of U.S. businesses are sole Over 2/3 of U.S. businesses are sole

proprietorshipsproprietorships• They are usually small, about 99% have revenues of They are usually small, about 99% have revenues of

less than $1,000,000.00 per yearless than $1,000,000.00 per year• Sole Proprietors are allowed to establish tax-Sole Proprietors are allowed to establish tax-

exempt retirement accounts (e.g. Keough plans)exempt retirement accounts (e.g. Keough plans)

11-7

Sole Proprietorship

AdvantagesAdvantages Ease of start/endEase of start/end

Be your own bossBe your own boss

Pride of ownershipPride of ownership

Retain profitRetain profit

No special taxesNo special taxes

DisadvantagesDisadvantages Unlimited liabilityUnlimited liability Limited financial Limited financial

resourcesresources Difficulty in mgmt.Difficulty in mgmt. Time commitmentTime commitment Few fringe benefitsFew fringe benefits Limited growthLimited growth Limited life spanLimited life span

Starting a Business

PartnershipPartnership• Voluntary AssociationVoluntary Association• Between 2 or more legal competent personsBetween 2 or more legal competent persons• No Express Agreement RequiredNo Express Agreement Required• Typically governed by statutory law (e.g. Uniform Partnership Typically governed by statutory law (e.g. Uniform Partnership

Act, except Louisiana)Act, except Louisiana)• Sharing profits and losses = prima facie evidence of Sharing profits and losses = prima facie evidence of

partnershippartnership• States differ on whether a partnership is viewed as a legal States differ on whether a partnership is viewed as a legal

entity or aggregate of individuals for the purpose of entity or aggregate of individuals for the purpose of participating in legal actionsparticipating in legal actions

• Extent and Nature of personal liability variesExtent and Nature of personal liability varies• General v.LimitedGeneral v.Limited

11-9

Types of PartnershipsGeneraGenerall

GPGP

GPGP

GPGP

GPGP

LimiteLimitedd

GPGP

PassivePassiveInvestorInvestor

PassivePassiveInvestoInvestorr

PassivePassiveInvestorInvestor

11-10

Partnership

AdvantagesAdvantages DisadvantagesDisadvantages

More financial resources

Shared mgmt.

Longer survival

Unlimited liability

Division of profits

Disagreements among partners

Difficult to terminate

11-11

Sharing Workload

Sharing FinancialBurden

Sharing EmotionalBurden

Procuring ExecutiveTalent

Companionship

InterpersonalConflicts

Dilution of Equity

Dissatisfactionwith Partner

Absence of OneClear Leader

Frustration of NotCalling Own Shots

Advantages Disadvantages

Advantages and

Disadvantages of

Partnerships

11-12

Small Business Management, 11th editionLongenecker, Moore, and Petty© 2000South-Western College Publishing

An Opinion Survey About the Pros and Cons of Partnerships

Why is apartnershipgood?

Why is apartnershipbad?

Spreads the workloadSpreads the emotional burdenBuys executive talent not otherwise affordableSpreads the financial burdenMakes company building less lonely

Personal conflicts outweigh the benefitsPartners never live up to one another’s expectationsCompanies function better with one clear leaderDilutes equity too muchYou can’t call your own shots

5541403326

605953 6 6

Question Perceived Pros and Cons Percentage Responding

Source: “The Inc. Fax Poll: Are Partners Bad for Business?” Inc., Vol. 14, No. 2 (February 1992), p. 24.

Partnerships

• Choose your partners wisely!!!Choose your partners wisely!!!• A partnership is like a A partnership is like a

marriage, easy to get into, marriage, easy to get into, sometimes difficult to sometimes difficult to maintain, and generally messy maintain, and generally messy to get out of!to get out of!

Partnerships A voluntary agreement by two or more persons to carry on, as A voluntary agreement by two or more persons to carry on, as

co-owners, a business for profit.co-owners, a business for profit. ““Persons” may be natural or artificial (e.g. corporations)Persons” may be natural or artificial (e.g. corporations) Requires intent to become partners (Tarnavsky v. Tarnavsky, 8th Requires intent to become partners (Tarnavsky v. Tarnavsky, 8th

Circuit, 1998 147 F.3d 674. And In Re Nielsen, 2002 Cal.App. Circuit, 1998 147 F.3d 674. And In Re Nielsen, 2002 Cal.App. Unpub, LEXIS 5621 (Cal. Ct. App., 2d Dist., Div.3 2002))Unpub, LEXIS 5621 (Cal. Ct. App., 2d Dist., Div.3 2002))• Intent can be express or implied (based on words or actions)Intent can be express or implied (based on words or actions)• Though their must be an intent to carry on a business “for Though their must be an intent to carry on a business “for

profit” the business does not have to actually make a profit to profit” the business does not have to actually make a profit to be considered a partnership.be considered a partnership.

Partnership by estoppel may be found where one holds himself Partnership by estoppel may be found where one holds himself out as, creates a reliance upon, or fails to dispel a known out as, creates a reliance upon, or fails to dispel a known misrepresentationmisrepresentation

Partnerships Is There a Partnership?Is There a Partnership? A father and son each owned land and raised seed potatoes. A father and son each owned land and raised seed potatoes.

They each used their own equipment. Each raised about the They each used their own equipment. Each raised about the same amount of potatoes, and they were stored together and same amount of potatoes, and they were stored together and advertised for sale by Wilbur Kimm and Son. A loss arose. advertised for sale by Wilbur Kimm and Son. A loss arose. Issue: Are the father and son partners such that they must share Issue: Are the father and son partners such that they must share this loss? Held: Yes. They were partners and must share the this loss? Held: Yes. They were partners and must share the loss. Although intent of parties is a major factor, if facts bring loss. Although intent of parties is a major factor, if facts bring arrangement within definition of a partnership, parties cannot arrangement within definition of a partnership, parties cannot escape liability incident to that relationship merely by saying that escape liability incident to that relationship merely by saying that no such relationship exists. If intended action of parties creates no such relationship exists. If intended action of parties creates a partnership in fact, what parties call their arrangement or a partnership in fact, what parties call their arrangement or intend their arrangement to be is irrelevant. The fact that the intend their arrangement to be is irrelevant. The fact that the father and son split profits in a joint account that contained father and son split profits in a joint account that contained proceeds from their sale of seed potatoes was prima facie proceeds from their sale of seed potatoes was prima facie evidence that a partnership existed between father and son. evidence that a partnership existed between father and son. Truck Ins. Exchange v. Industrial Indem. Co., 688 P.2d 1243 Truck Ins. Exchange v. Industrial Indem. Co., 688 P.2d 1243 (Mont. 1984). (Mont. 1984).

Partnerships Sharing in profits or losses is prima facie Sharing in profits or losses is prima facie

evidence of participation in a partnership evidence of participation in a partnership but receipt of funds:but receipt of funds:• in repayment of a debt orin repayment of a debt or• as interest on a debt oras interest on a debt or• as wages oras wages or• as rent oras rent or• as an annuity to heirs of a deceased partner oras an annuity to heirs of a deceased partner or• as consideration for the sale of goodwillas consideration for the sale of goodwill

does not constitute evidence of does not constitute evidence of participation in a partnership.participation in a partnership.

Partnerships

Co-owners must register with Co-owners must register with the state.the state.

Co-owners may need an Co-owners may need an occupational license.occupational license.

Limited Partnerships Partnership consisting of one or Partnership consisting of one or

more more general partnersgeneral partners (who manage (who manage the business and are liable to the the business and are liable to the full extent of their personal assets full extent of their personal assets for debts of the partnership) & one for debts of the partnership) & one or more or more limitedlimited partnerspartners (who (who contribute only assets and are liable contribute only assets and are liable only up to the amount contributed only up to the amount contributed by them).by them).

Limited Partnerships General PartnerGeneral Partner - In a limited partnership, a partner - In a limited partnership, a partner

who assumes responsibility for the management of who assumes responsibility for the management of the partnership and liability for all partnership debts.the partnership and liability for all partnership debts.

Limited PartnerLimited Partner - In a limited partnership, a partner - In a limited partnership, a partner who contributes capital to the partnership but has who contributes capital to the partnership but has no right to participate in the management and no right to participate in the management and operation of the business. The limited partner operation of the business. The limited partner assumes no liability for partnership debts beyond assumes no liability for partnership debts beyond the capital contributed.the capital contributed.

Note: Failure to comply with statutory requirements Note: Failure to comply with statutory requirements in forming a limited partnership results in the in forming a limited partnership results in the creation of a general partnership.creation of a general partnership.

Limited Partnerships The exercise of substantial control The exercise of substantial control

by a limited partner may result in by a limited partner may result in his being declared a general his being declared a general partner.partner.

Limited Partnerships

Not equal exercise of substantial Not equal exercise of substantial control if only:control if only:• Contractor for an agent or employee of the Contractor for an agent or employee of the

partnershippartnership• Consulting/AdvisingConsulting/Advising• Acting as a suretyActing as a surety• Approving or disapproving an amendment Approving or disapproving an amendment

to a partnership agreementto a partnership agreement• VotingVoting

11-22

Partnerships

Partnership Agreements (Sometimes called Partnership Agreements (Sometimes called Articles of Partnership)- An agreement listing Articles of Partnership)- An agreement listing and explaining the terms of the partnership.and explaining the terms of the partnership.• Critical for preventing and resolving potential disputesCritical for preventing and resolving potential disputes• Should state (at least)Should state (at least)

Who will make final decisions.Who will make final decisions. What each partner’s duties are.What each partner’s duties are. How much each partner will invest.How much each partner will invest. How profits and losses will be How profits and losses will be

apportioned to each partner.apportioned to each partner. Methods for dispute resolution (e.g. arbitration)Methods for dispute resolution (e.g. arbitration) How the partnership can be How the partnership can be

expanded or dissolved.expanded or dissolved.

11-23

PartnershipsThe Uniform Partnership Act, as The Uniform Partnership Act, as

enacted by a particular enacted by a particular jurisdiction, has default rules jurisdiction, has default rules covering matters not addressed covering matters not addressed in partnership agreementsin partnership agreements

Partnerships - Management/Authority

General rule giving equal voice to all partners in General rule giving equal voice to all partners in management (even if differing contributions)management (even if differing contributions)• Can be altered by agreementCan be altered by agreement

Why alter?Why alter? In large/complex partnership may be In large/complex partnership may be

cumbersome/inefficientcumbersome/inefficient Decisions that significantly impact the nature of the Decisions that significantly impact the nature of the

partnership generally require unanimous consentpartnership generally require unanimous consent Partnerships are generally not liable for agreements of Partnerships are generally not liable for agreements of

individual partners acting outside of scope of the individual partners acting outside of scope of the partnership’s normal business, unless ratify, expressly partnership’s normal business, unless ratify, expressly or implicitly or implicitly

Partnerships

Partnership PropertyPartnership Property• All property originally contributed toAll property originally contributed to• All property purchased on behalf ofAll property purchased on behalf of• Purchasing property with partnership funds Purchasing property with partnership funds

implies that it becomes partnership property implies that it becomes partnership property (unless contrary intention can be proved)(unless contrary intention can be proved)

• Any conveyance to the partnership by nameAny conveyance to the partnership by name

Partnerships

3 rules for liability in a partnership are:3 rules for liability in a partnership are:• 1. Every partner is liable for his or her 1. Every partner is liable for his or her

own actions.own actions.• 2. Every partner is liable for the 2. Every partner is liable for the

actions of the other partners (in actions of the other partners (in course of business)course of business)

• 3. Every partner is liable for the 3. Every partner is liable for the actions of the employees of the actions of the employees of the business (in course of business)business (in course of business)

Partnerships Distribution of partnership incomeDistribution of partnership income

• How should the shares of partnership How should the shares of partnership income be distributed?income be distributed?Pro-rata?Pro-rata?Based on financial contribution?Based on financial contribution?Based on work performed on behalf Based on work performed on behalf

of?of?• Usually determined by written Usually determined by written

agreementagreement

PartnershipsCreditors RightsCreditors Rights

• Can obtain the debtor’s share of the Can obtain the debtor’s share of the income of a partnership, or in some income of a partnership, or in some cases can get the court to order the cases can get the court to order the sale of the debtor’s share (Charging sale of the debtor’s share (Charging Order)Order)

• This does not give the creditor a voice This does not give the creditor a voice in the management of the partnershipin the management of the partnership

• This does not give the creditor the right This does not give the creditor the right to dissolve the partnershipto dissolve the partnership

11-29

Partnership Duties

DutiesDuties• Loyalty/Good FaithLoyalty/Good Faith• Care in PartnershipCare in Partnership• To Inform/AccountTo Inform/Account

Note: However, partners can be Note: However, partners can be compelled to sign confidentiality compelled to sign confidentiality agreements (Madison Ave. Investment agreements (Madison Ave. Investment Partners, L.L.C. v. American First Real Partners, L.L.C. v. American First Real Estate Investment Partners, L.P., 2002 Estate Investment Partners, L.P., 2002 Del. Ch. LEXIS 97 (Del. Ch. New Castle Del. Ch. LEXIS 97 (Del. Ch. New Castle 2002)2002)

Partnerships - Dissolution Dissolution methodsDissolution methods

• Automatically after an agreed upon period of timeAutomatically after an agreed upon period of time• Automatically when set objective has been attainedAutomatically when set objective has been attained• By mutual agreementBy mutual agreement• By unilateral decision of any partner (if at will)By unilateral decision of any partner (if at will)• By court order (including by Bankruptcy)By court order (including by Bankruptcy)• By death or incompetence of a partnerBy death or incompetence of a partner• By disability of a partner that substantially impairs By disability of a partner that substantially impairs

his ability to carry on dutieshis ability to carry on duties• By wilful breach of a partnership agreementBy wilful breach of a partnership agreement• By illegal acts of the partnership businessBy illegal acts of the partnership business

Partnerships - Dissolution Dissolution of a partnership does not Dissolution of a partnership does not

necessarily end the operation of a necessarily end the operation of a business (e.g. it may continue as a sole business (e.g. it may continue as a sole proprietorship, etc.)proprietorship, etc.)

The value of interests at dissolution is The value of interests at dissolution is usually determined by settlement usually determined by settlement agreementsagreements

There are notice requirements upon There are notice requirements upon dissolution (Phillip Lithographing Co. V. dissolution (Phillip Lithographing Co. V. Babich, 135 NW.2nd 343 (Wis. 1965))Babich, 135 NW.2nd 343 (Wis. 1965))

11-32

Distribution of AssetsOrder/PriorityOrder/Priority

• Outside CreditorsOutside Creditors• Debts to Partners for Debts to Partners for

Loans/Capital AdvanceLoans/Capital Advance• Capital ContributionCapital Contribution• Remaining Assets According Remaining Assets According

to Partnership Agreementto Partnership Agreement

11-33

Seven Trigger Points That Can Destroy a Partnership

1. A partner that is going through a divorce.

2. A partnership that is experiencing growing pains due to rapid growth.

3. A partner brings a spouse or a relative into the business.

4. A partner that wants to withdraw more money from the business.

5. A partner makes sexual advances toward another partner.

6. A partner experiences serious medical problems.

7. A partner begins doing business on the side with the partnership’s customers.

Source: Used with permission, Inc. magazine, February 2001. Copyright 1998 by Gruner + Jahr USA Publishing, 38 Commercial Wharf, Boston, MA 02110. Inc. is a registered trademark of Gruner + Jahr Printing and Publishing.

Corporations

A legal entity formed in A legal entity formed in compliance with state compliance with state statutory requirements. The statutory requirements. The entity is treated as a legal entity is treated as a legal “person”, distinct from its “person”, distinct from its shareholders.shareholders.

Starting a Business

CorporationCorporation• Separate Legal EntitySeparate Legal Entity• Ongoing Enterprise/LifecycleOngoing Enterprise/Lifecycle• Limited LiabilityLimited Liability• Close v.PublicClose v.Public• ““C” v.“S” C” v.“S” • Profit v.Non-ProfitProfit v.Non-Profit• Domestic, Foreign, AlienDomestic, Foreign, Alien• De Jure v. De FactoDe Jure v. De Facto

11-36

Corporation

AdvantagesAdvantages DisadvantagesDisadvantagesMore money for investmentLimited liabilitySeparation of ownership/mgmt.Ease of ownership changePerpetual lifeSize

Initial cost

Paperwork

Two tax returns

Termination difficult

Double taxation

Corporations A Corporation is “an A Corporation is “an

artificial being, invisible, artificial being, invisible, intangible, and existing intangible, and existing only in the contemplation only in the contemplation of law. Being the mere of law. Being the mere creature of law, it creature of law, it possesses only those possesses only those properties which the properties which the charter of creation confers charter of creation confers upon it, either expressly or upon it, either expressly or incidental to its very incidental to its very existence.” - Chief Justice existence.” - Chief Justice Marshall, Dartmouth v. Marshall, Dartmouth v. Woodard (1819)Woodard (1819)

Corporations Historical OriginsHistorical Origins

• Roman royal fiat. Roman royal fiat. • 17th century English Royal Charter.17th century English Royal Charter.• 1814, Francis Cabot Lowell, a Boston Merchant, 1814, Francis Cabot Lowell, a Boston Merchant,

founded the first publicly traded company in founded the first publicly traded company in America, a textile company. Lowell had smuggled a America, a textile company. Lowell had smuggled a plan for a power loom out of England and planned plan for a power loom out of England and planned to compete with the British Lancashire Mills. Since to compete with the British Lancashire Mills. Since he personally lacked the capital to build and install he personally lacked the capital to build and install the machinery, he sold shares in the company to 10 the machinery, he sold shares in the company to 10 other people.other people.

• The publicly traded company model also played a The publicly traded company model also played a key part in the financing of America’s railroads.key part in the financing of America’s railroads.

Corporations Close corporationClose corporation——a corporation a corporation

whose stock is owned by a whose stock is owned by a relatively few people and is not sold relatively few people and is not sold to the general public. to the general public.

Public/Open corporationPublic/Open corporation——a a corporation whose stock is bought corporation whose stock is bought and sold on security exchanges and and sold on security exchanges and can be purchased by any individual.can be purchased by any individual.

Corporations TypesTypes

• For ProfitFor Profit• Non-Profit (e.g. Hospitals, Non-Profit (e.g. Hospitals,

Charities, Some Insurance Co.) - Charities, Some Insurance Co.) - exempt from Corp. income taxexempt from Corp. income tax

• Municipal (e.g. Sewer Authority) Municipal (e.g. Sewer Authority) (often have tax authority)(often have tax authority)

11-41

Close Corporations ShareholdersShareholders

• FewFew• Live Near Each Other Know One Another & Live Near Each Other Know One Another &

SkillsSkills• Active in BusinessActive in Business• No Market for SharesNo Market for Shares

Transferability of SharesTransferability of Shares• Right of First RefusalRight of First Refusal• Buy/Sell AgreementBuy/Sell Agreement• Consent RestraintConsent Restraint

11-42

Corporations

• Types by place of incorporationTypes by place of incorporationDomestic corporationDomestic corporation - a business - a business

incorporated in a stateincorporated in a stateForeign corporationForeign corporation—a business —a business

incorporated outside of the state.incorporated outside of the state.Alien corporationAlien corporation—a business —a business

incorporated in a foreign country incorporated in a foreign country and operating in the United States.and operating in the United States.

Corporations- “S” Corp

““S” CorporationS” Corporation• A Federal Tax ElectionA Federal Tax Election• Owners have limited liability, but are Owners have limited liability, but are

taxed as if the firm were a partnershiptaxed as if the firm were a partnership

Corporations- “S” Corp ““S” Corporation RequirementsS” Corporation Requirements

• Firm has 75 or fewer ownersFirm has 75 or fewer owners• All stockholders must be individuals, estates, All stockholders must be individuals, estates,

or certain trusts (not other corporations)or certain trusts (not other corporations)• Only one class of stock outstandingOnly one class of stock outstanding• Must be a domestic corporationMust be a domestic corporation• Must operate on a calendar year basisMust operate on a calendar year basis• No nonresident alien stockholdersNo nonresident alien stockholders• All shareholders must consent to having the All shareholders must consent to having the

corporation taxed as a partnershipcorporation taxed as a partnership

Corporations- “S” Corp Tax Reasons for “S” Corp.Tax Reasons for “S” Corp.

• Corporation is losing moneyCorporation is losing money- Valuable to have losses - Valuable to have losses flow through to individual tax return, but only flow through to individual tax return, but only valuable if have other personal income to offset valuable if have other personal income to offset against. Losses are limited to basis. Basis is stock against. Losses are limited to basis. Basis is stock investment and loans to corporation investment and loans to corporation

• Corporation is highly profitableCorporation is highly profitable - Although double - Although double taxation rarely applies, there is always the risk the taxation rarely applies, there is always the risk the IRS will deem salaries “excessive”. Excess salaries IRS will deem salaries “excessive”. Excess salaries are treated as dividends. Issue of salary vs. are treated as dividends. Issue of salary vs. dividend doesn’t matter with S corp., since no dividend doesn’t matter with S corp., since no corporate level taxcorporate level tax

Corporations- Preincorporation

PromotersPromoters (also called Preincorporators) - persons (also called Preincorporators) - persons who bring the corporation into being by pre-who bring the corporation into being by pre-incorporation actionsincorporation actions• Has personal liability for pre-incorporation Has personal liability for pre-incorporation

contracts (corporations may later adopt same)contracts (corporations may later adopt same)• Not agents of corporation or shareholdersNot agents of corporation or shareholders• But have fiduciary duties to both (e.g. full disclose, But have fiduciary duties to both (e.g. full disclose,

dealing in good faith, etc.)dealing in good faith, etc.)• May be paid for reasonable chargesMay be paid for reasonable charges• May be paid with sharesMay be paid with shares

Corporations-Preincorporation

IncorporatorsIncorporators - those who sign - those who sign the articles of incorporation the articles of incorporation and deliver them to the state and deliver them to the state • May be a single personMay be a single person• May be an attorneyMay be an attorney

Corporations-PreincorporationShareholder Agreements should Shareholder Agreements should

address:address:• Conflicts of InterestConflicts of Interest• Key Man (e.g. Life Insurance)Key Man (e.g. Life Insurance)• Buy/Sell (e.g. Right of First Buy/Sell (e.g. Right of First

Refusal to Purchase Shares)Refusal to Purchase Shares)• Profit AllocationProfit Allocation• IndemnificationIndemnification

11-49

IncorporationStepsSteps

• Select Where to IncorporateSelect Where to Incorporate• Prepare ArticlesPrepare Articles• Sign/Authenticate ArticlesSign/Authenticate Articles• File ArticlesFile Articles• Receive CertificateReceive Certificate• Hold Initial MeetingHold Initial Meeting

11-50

Corporations-Incorporation Where to incorporateWhere to incorporate

• Businesses can incorporate in any state Businesses can incorporate in any state they choose.they choose.

• Some states offer fewer restrictions, lower Some states offer fewer restrictions, lower taxes & fees, and other benefits to attract taxes & fees, and other benefits to attract businesses to incorporate with their state.businesses to incorporate with their state.

• Internet businesses present a sales tax Internet businesses present a sales tax collection problem for states in which these collection problem for states in which these businesses have no physical presence.businesses have no physical presence.

11-51

Corporations-Incorporation Issues to Consider when Selecting a State of Inc.Issues to Consider when Selecting a State of Inc.

• How many incorporators are required by the state, and whether How many incorporators are required by the state, and whether the incorporator itself can be a corporation.the incorporator itself can be a corporation.

• The minimum number of people required to form the The minimum number of people required to form the corporation.corporation.

• The minimum capital requirement, if any.The minimum capital requirement, if any.• The state's fees for filing the articles of incorporation.The state's fees for filing the articles of incorporation.• The state's annual corporate franchise tax.The state's annual corporate franchise tax.• The state's corporate income tax and whether earnings from The state's corporate income tax and whether earnings from

operations outside the state are taxable. The State of Delaware operations outside the state are taxable. The State of Delaware taxes non-Delaware resident shareholders of S corporations on taxes non-Delaware resident shareholders of S corporations on their distributive share of S Corporation income based on the their distributive share of S Corporation income based on the percentage of that income derived from Delaware sources. If a percentage of that income derived from Delaware sources. If a Delaware corporation has no Delaware source income, these Delaware corporation has no Delaware source income, these taxes should not be an issue.taxes should not be an issue.

11-52

Corporations-Incorporation Issues to Consider when Selecting a State of Inc. (Cont.)Issues to Consider when Selecting a State of Inc. (Cont.)

• Whether the corporation is allowed to keep its books and Whether the corporation is allowed to keep its books and records outside the state.records outside the state.

• The state's court system's reputation of fairness in business The state's court system's reputation of fairness in business cases.cases.

• Whether the corporation is allowed to have its principal place Whether the corporation is allowed to have its principal place of business outside the state.of business outside the state.

• Whether there is a state inheritance tax on non-resident Whether there is a state inheritance tax on non-resident shareholders.shareholders.

• Disclosure/privacy - whether the state requires public Disclosure/privacy - whether the state requires public disclosure of the names of shareholders.disclosure of the names of shareholders.

• Whether the state requires a corporate bank account in that Whether the state requires a corporate bank account in that state (Delaware does not).state (Delaware does not).

11-53

Corporations-Incorporation DelawareDelaware- Delaware often is the preferred state of incorporation. - Delaware often is the preferred state of incorporation.

Initially, Delaware gave management better rights in the event of Initially, Delaware gave management better rights in the event of a takeover, so in the 1940's and 1950's many corporations a takeover, so in the 1940's and 1950's many corporations moved there. Delaware set up a court system that has expertise moved there. Delaware set up a court system that has expertise in commercial transactions and well-developed corporate law in commercial transactions and well-developed corporate law (equals predictability). Other states improved their corporate (equals predictability). Other states improved their corporate legal systems, but virtually every corporate attorney is familiar legal systems, but virtually every corporate attorney is familiar with Delaware law. Delaware also has the Delaware Asset with Delaware law. Delaware also has the Delaware Asset Protection Trust, which permits one to set up a trust that cannot Protection Trust, which permits one to set up a trust that cannot be touched by creditors but that allows one to get one's money. be touched by creditors but that allows one to get one's money. Most other states require irrevocable trusts that prevent one Most other states require irrevocable trusts that prevent one from accessing one's money once it is in the trust. The state of from accessing one's money once it is in the trust. The state of Alaska responded with a similar trust, but added spouses and Alaska responded with a similar trust, but added spouses and children to the list of creditors that could not get at the money children to the list of creditors that could not get at the money in the trust. Delaware responded likewise.in the trust. Delaware responded likewise.

11-54

Corporations-Incorporation

Delaware v. Nevada-Delaware v. Nevada-• Taxes on corporate earnings:Taxes on corporate earnings: Delaware taxes the proportion of Delaware taxes the proportion of

corporate profits earned in Delaware. Nevada is tax-free, regardless of corporate profits earned in Delaware. Nevada is tax-free, regardless of where the profits are earned.where the profits are earned.

• Annual franchise tax:Annual franchise tax: Delaware and most other states have an annual Delaware and most other states have an annual franchise tax on corporations. Nevada does not.franchise tax on corporations. Nevada does not.

• Annual disclosure:Annual disclosure: Delaware requires an annual report of stockholder Delaware requires an annual report of stockholder meeting dates, business locations outside of Delaware, and the meeting dates, business locations outside of Delaware, and the number and value of shares issued. Nevada requires only the current number and value of shares issued. Nevada requires only the current list of officers and directors. In both Delaware and Nevada, the officers list of officers and directors. In both Delaware and Nevada, the officers and directors can be one person.and directors can be one person.

• Protection of officers and directors:Protection of officers and directors: Nevada provides broader Nevada provides broader protection against personal liability of officers and directors than does protection against personal liability of officers and directors than does Delaware.Delaware.

11-55

Corporations-Incorporation Delaware v. Nevada- (Cont.)Delaware v. Nevada- (Cont.)

• Shareholder disclosure:Shareholder disclosure: Nevada and Wyoming are two states that allow bearer Nevada and Wyoming are two states that allow bearer shares. When corporations first came into existence, their stock certificates were shares. When corporations first came into existence, their stock certificates were like cash in the sense that whoever was holding them at the moment legally was like cash in the sense that whoever was holding them at the moment legally was the owner. However, in order to protect their shareholders against theft of the the owner. However, in order to protect their shareholders against theft of the stock certificates, corporations began to maintain a stock ledger listing the stock certificates, corporations began to maintain a stock ledger listing the shareholders. Eventually, the stock ledger became the authoritative record of the shareholders. Eventually, the stock ledger became the authoritative record of the shareholders, and when stock was transferred it would have to be recorded in the shareholders, and when stock was transferred it would have to be recorded in the corporation's stock transfer ledger. Most U.S. states no longer permit bearer corporation's stock transfer ledger. Most U.S. states no longer permit bearer shares, with the notable exceptions of Nevada and Wyoming. Since bearer shares shares, with the notable exceptions of Nevada and Wyoming. Since bearer shares legally belong to the person holding them at the moment, the holder of bearer legally belong to the person holding them at the moment, the holder of bearer shares truthfully can deny ownership in the corporation if he or she does not hold shares truthfully can deny ownership in the corporation if he or she does not hold the certificates. Bearer shares often are used for illegal purposes, such as tax the certificates. Bearer shares often are used for illegal purposes, such as tax evasion. They also are used for asset protection, which by itself is not illegal, but evasion. They also are used for asset protection, which by itself is not illegal, but which often results in illegal actions when bearer shares are involved. For which often results in illegal actions when bearer shares are involved. For example, if you hand your bearer shares over to somebody else so that you can example, if you hand your bearer shares over to somebody else so that you can truthfully deny owning them in the future, gift tax is due on the transaction. truthfully deny owning them in the future, gift tax is due on the transaction. Furthermore, when the other person ultimately hands them back to you, gift taxes Furthermore, when the other person ultimately hands them back to you, gift taxes are due again. While bearer shares might have a few legitimate uses, in general it are due again. While bearer shares might have a few legitimate uses, in general it is best to avoid them, so whether or not a state permits them probably should not is best to avoid them, so whether or not a state permits them probably should not be a major criterion in the decision of where to incorporate.be a major criterion in the decision of where to incorporate.

11-56

Corporations-Incorporation Delaware v. Nevada (Cont.)Delaware v. Nevada (Cont.)

• Disclosure to IRS:Disclosure to IRS: Delaware and most other states share tax Delaware and most other states share tax information with the IRS. Nevada does not. As with bearer shares, information with the IRS. Nevada does not. As with bearer shares, non-disclosure to the IRS attracts those seeking to illegally evade non-disclosure to the IRS attracts those seeking to illegally evade taxes, so this should not be a criterion for legitimate business taxes, so this should not be a criterion for legitimate business purposes.purposes.

• Note: There is a flip side to some of Nevada's perceived Note: There is a flip side to some of Nevada's perceived advantages. Some companies attempt to take advantage of advantages. Some companies attempt to take advantage of Nevada's laws in order to evade taxes. As a result, Nevada Nevada's laws in order to evade taxes. As a result, Nevada corporations are more frequently audited by the IRS than are corporations are more frequently audited by the IRS than are corporations in other states. In this regard, however, the state of corporations in other states. In this regard, however, the state of Wyoming has most if not all of the advantages that Nevada has, but Wyoming has most if not all of the advantages that Nevada has, but a lower audit rate, at least for now. There also are other intangibles a lower audit rate, at least for now. There also are other intangibles to consider. For example, if you incorporate in Delaware instead of to consider. For example, if you incorporate in Delaware instead of Nevada, your corporation may be seen as having slightly more Nevada, your corporation may be seen as having slightly more credibility in the eyes of those who know about Nevada's credibility in the eyes of those who know about Nevada's corporation laws. This issue may have little or no ground, but it at corporation laws. This issue may have little or no ground, but it at least is worth considering.least is worth considering.

11-57

Corporations-Incorporation Advantage of Incorporating in One's Own StateAdvantage of Incorporating in One's Own State

• If the company does not plan to obtain venture If the company does not plan to obtain venture capital funding, it may be best to incorporate in the capital funding, it may be best to incorporate in the state in which the company plans to do business. state in which the company plans to do business. Doing so has the following advantages:Doing so has the following advantages:

• Local attorneys are familiar with the local lawLocal attorneys are familiar with the local law• One can have an intrastate securities law One can have an intrastate securities law

exemption.exemption.• There is the convenience of geographical There is the convenience of geographical

proximity.proximity.• The corporation does not need to register as a The corporation does not need to register as a

"foreign" corporation in the state of operation if it is "foreign" corporation in the state of operation if it is incorporated there.incorporated there.

11-58

Articles of Incorporation- Contents

Mandatory ElementsMandatory Elements• Name of CorporationName of Corporation• # Shares of Capital Stock Authorized to # Shares of Capital Stock Authorized to

IssueIssue• Address of Registered Office/Name Address of Registered Office/Name

Registered Agent (for service of process)Registered Agent (for service of process)• Name/Address of IncorporatorName/Address of Incorporator

See N.C. Blank FormSee N.C. Blank Form Generally should keep to a minimum because Generally should keep to a minimum because

must file amendments to changemust file amendments to change

Corporations - Incorporation

Other RequirementsOther Requirements• MeetingsMeetings• Corporate SealCorporate Seal• BylawsBylaws

Corporations - Defective Incorporation

De Jure v. De FactoDe Jure v. De Facto• Substantial compliance with all Substantial compliance with all

steps of the incorporation steps of the incorporation process = De Jureprocess = De Jure

• If serious defect, but good faith If serious defect, but good faith effort and exercise of powers, effort and exercise of powers, may be found to be De Facto.may be found to be De Facto.

Corporations - Duties Ultra vires doctrineUltra vires doctrine: shareholders could : shareholders could

sue managers for embarking on projects sue managers for embarking on projects contrary to the corporate purpose.contrary to the corporate purpose.

However this doctrine is in decline However this doctrine is in decline because of the broad interpretation of because of the broad interpretation of the the Business Judgement RuleBusiness Judgement Rule which which shields some managerial actions from shields some managerial actions from substantive review by courts (especially substantive review by courts (especially in Delaware)in Delaware)

11-62

Corporations- Dissolution

Types of Voluntary DissolutionTypes of Voluntary Dissolution• End at specified time found in Articles End at specified time found in Articles • Written consent of all shareholdersWritten consent of all shareholders• Majority Vote of shareholders at a Majority Vote of shareholders at a

special meetingspecial meeting• Merger or consolidationMerger or consolidation• Vote of majority of incorporators if Vote of majority of incorporators if

corporation has not begun businesscorporation has not begun business

11-63

Board of Directors Powers/DutiesPowers/Duties

• GeneralGeneral• Actions Requiring Actions Requiring

InitiativeInitiative

Online Online CommunicationsCommunications

Powers/Rights of Powers/Rights of Director as an Director as an IndividualIndividual

CompensationCompensation

ElectionElection• NumberNumber• QualificationsQualifications• NominationNomination• TermTerm• VacanciesVacancies

RemovalRemoval MeetingsMeetings

Board of Directors In most jurisdictions, the board acting In most jurisdictions, the board acting

alone can:alone can:• Declare a dividendDeclare a dividend• Establish the price for sale of sharesEstablish the price for sale of shares• Elect and remove officersElect and remove officers• Fill vacancies on the BoardFill vacancies on the Board• Sell, lease or mortgage assets outside Sell, lease or mortgage assets outside

the normal course of businessthe normal course of business

Board of Directors

Actions by Actions by Board InitiativeBoard Initiative are are regarded as proposals for regarded as proposals for shareholder approvalshareholder approval

Shareholders must all approve Shareholders must all approve certain extraordinary actions such certain extraordinary actions such as amendment of articles, mergers, as amendment of articles, mergers, sale or lease of substantially all sale or lease of substantially all assets or dissolutionassets or dissolution

Board of Directors

Recent statutes in many Recent statutes in many jurisdictions now allow directors to jurisdictions now allow directors to communicate and conduct business communicate and conduct business electronically.electronically.• But , not allow electronic board But , not allow electronic board

meetingsmeetingsWhy the distinction?Why the distinction?

Board of Directors

There are statutory and/or bylaw There are statutory and/or bylaw requirements for qualification, requirements for qualification, nomination, election, term, nomination, election, term, vacancy filling, removal or vacancy filling, removal or directors and officers as well as directors and officers as well as for meeting frequency, notice, for meeting frequency, notice, formality, quorumformality, quorum

Board of Directors

Is it realistic to expect Is it realistic to expect directors to “manage” the directors to “manage” the corporation, or should their corporation, or should their role be viewed as one of role be viewed as one of more of more of monitoring/evaluating the monitoring/evaluating the actions of corporate officers?actions of corporate officers?

Board of Directors The Board only has authority to act for The Board only has authority to act for

the corporation the corporation as a groupas a group Most state law mandates directors must Most state law mandates directors must

act in the best interests of the act in the best interests of the corporation and its shareholderscorporation and its shareholders• Courts have generally interpreted this Courts have generally interpreted this

to mean maximizing share price.to mean maximizing share price.• Is what’s best for the share price Is what’s best for the share price

always what’s best for the company?always what’s best for the company?

11-70

Officers of Corporation

PowersPowersPresident/Chairman- President/Chairman- ex ex

officioofficioVice PresidentVice PresidentCorporate SecretaryCorporate SecretaryTreasurerTreasurer

Officers

Ex-officio authority = Ex-officio authority = authority by virtue of officeauthority by virtue of office

Often a good idea to have an Often a good idea to have an Assistant Treasurer and/or Assistant Treasurer and/or Assistant Secretary for Assistant Secretary for reasons of expediencyreasons of expediency

11-72

Duties Directors/Officers Act Within Act Within

AuthorityAuthority Due Care and Due Care and

DiligenceDiligence• Prudent PersonPrudent Person• Business Business

JudgmentJudgment• Increased Increased

Director LiabilityDirector Liability

Loyalty/Good Loyalty/Good FaithFaith• Self-DealingSelf-Dealing• UsurpUsurp• Freeze-Outs, Freeze-Outs,

etc.etc.• Inside Inside

InformationInformation Right to DissentRight to Dissent

11-73

Duties Directors/OfficersOptional limitations on liabilityOptional limitations on liability

• Charter Option Statute (breach of duty)Charter Option Statute (breach of duty)• Self-Executing Statute (willful or Self-Executing Statute (willful or

reckless)reckless)• Cap on Money DamagesCap on Money Damages

Why should the law permit any of Why should the law permit any of these?these?

11-74

Duties Directors/Officers

IndemnificationIndemnification• MandatoryMandatory (acting in good faith, pre- (acting in good faith, pre-

existing agreement)existing agreement)• PermissiblePermissible (good faith, believed best (good faith, believed best

interest, unaware illegal, disinterested interest, unaware illegal, disinterested agree)agree)

• ImpermissibleImpermissible (liable or bad faith or (liable or bad faith or violate fed. Securities law)violate fed. Securities law)

Corporate Governance ““Directors can be out of touch with a Directors can be out of touch with a

company's business and can fall prey to the company's business and can fall prey to the temptation to simply be polite to a chief temptation to simply be polite to a chief executive while Rome is burning. A code of executive while Rome is burning. A code of silence develops in the boardroom. By the silence develops in the boardroom. By the time someone is willing to speak up, the time someone is willing to speak up, the company is in deep trouble.” - Bill George, company is in deep trouble.” - Bill George, Former CEO, Medtronic Corp. in "Authentic Former CEO, Medtronic Corp. in "Authentic Leadership: Rediscovering the Secrets to Leadership: Rediscovering the Secrets to Creating Lasting Value," Jossey-Bass/Wiley, Creating Lasting Value," Jossey-Bass/Wiley, 2003.2003.

Corporate Governance The Board of Directors of The Board of Directors of

Worldcom reportedly allowed Worldcom reportedly allowed CEO Bernie Ebbers to rule CEO Bernie Ebbers to rule “practically unchecked”, “practically unchecked”, generally “rubber-stamping” generally “rubber-stamping” his decisions. Their audits his decisions. Their audits “rarely scratched below the “rarely scratched below the surface” and they approved surface” and they approved multibillion dollar mergers multibillion dollar mergers and acquisitions “with little and acquisitions “with little discussion.” (Report: discussion.” (Report: Worldcom board passive, Jim Worldcom board passive, Jim Hopkins, Hopkins, USA TodayUSA Today, June , June 10, 2003, p. 3B)10, 2003, p. 3B)

Corporate Governance

First Board usually appointed First Board usually appointed by incorporatorsby incorporators

Who nominates/elects the Who nominates/elects the board thereafter?board thereafter?• Typically the Executive Typically the Executive

Officers by Proxy ElectionsOfficers by Proxy Elections

11-78

Make-up of Corporate Boards

Retired officer of another firmRetired officer of another firm 89%89% CEO at another companyCEO at another company 87%87% Major company shareholderMajor company shareholder 73%73% Ex-government officialEx-government official 53%53% AcademiciansAcademicians50%50%

Corporate boards average 11 Corporate boards average 11 Directors. Directors. Most Directors by Most Directors by

percentage are:percentage are:

Corporate Governance But, on April 14, 2003, the SEC said it But, on April 14, 2003, the SEC said it

would review rules that make it tough for would review rules that make it tough for shareholders to nominate directors to shareholders to nominate directors to corporate boards. SEC Chairman William corporate boards. SEC Chairman William Donaldson asked staffers to come with Donaldson asked staffers to come with recommendations to make it easier for recommendations to make it easier for shareholders to run their own shareholders to run their own candidates. Changes may be adopted in candidates. Changes may be adopted in time for the 2004 proxy season.time for the 2004 proxy season.

Corporate Governance Criteria for Who should sit on the Board of Criteria for Who should sit on the Board of

Directors?Directors?• Competence?Competence?• Knowledge of/Experience in, the industry?Knowledge of/Experience in, the industry?• General business knowledge/experience?General business knowledge/experience?• Note: One of the requirements of Sarbanes-Note: One of the requirements of Sarbanes-

Oxley is that a company must have Oxley is that a company must have individuals who are certified financial individuals who are certified financial experts on the board.experts on the board.

Corporate Governance

Independence?Independence?• Inside vs. OutsideInside vs. Outside

Self-Interest (Good or Bad?)Self-Interest (Good or Bad?)Some corporate bylaws require Some corporate bylaws require

board members to be shareholdersboard members to be shareholdersShould the company maintain a Should the company maintain a

certain % of independent directors? certain % of independent directors? If so, what %?If so, what %?

Corporate Governance Independence?Independence?

• In Britain, the 1992 Cadbury In Britain, the 1992 Cadbury Committee report recommended Committee report recommended that boards of directors of public that boards of directors of public companies include at least 3 companies include at least 3 outside directors as members and outside directors as members and that the CEO and chairman posts that the CEO and chairman posts be held by different individuals. be held by different individuals.

Corporate Governance Should There be Should There be PluralismPluralism on on

Board (interest group reps. e.g. Board (interest group reps. e.g. Labor, Environmental, Labor, Environmental, Consumer Watchdogs, etc.)?Consumer Watchdogs, etc.)?• e.g. Volkswagon’s “Group Works” e.g. Volkswagon’s “Group Works”

CouncilCouncil

Corporate GovernanceEthical Orientation?Ethical Orientation? - C-bridge, - C-bridge,

a rapidly emerging leader a rapidly emerging leader among Internet-based business among Internet-based business solution providers, appointed to solution providers, appointed to Joseph L. Badaracco, Jr., Joseph L. Badaracco, Jr., Professor of Business Ethics at Professor of Business Ethics at the Harvard Business School to the Harvard Business School to its Board.its Board.

Corporate Governance Should a Chairman of the Board & CEO be the same Should a Chairman of the Board & CEO be the same

person?person?• In the UK, the role of chairman of the board and In the UK, the role of chairman of the board and

CEO are now generally held by different people, CEO are now generally held by different people, unlike the U.S., where it is estimated that in 70-80% unlike the U.S., where it is estimated that in 70-80% of companies in the Standard and Poor’s 500, one of companies in the Standard and Poor’s 500, one person wears the hats of both CEO and chairman.person wears the hats of both CEO and chairman.

• However, recent studies suggest that companies in However, recent studies suggest that companies in which the chairman and CEO positions are held by which the chairman and CEO positions are held by two different people perform no better than two different people perform no better than companies in which the roles are combined. In companies in which the roles are combined. In other words, it’s no guarantee against future other words, it’s no guarantee against future scandals.scandals.

Executive Compensation

Is CEO Is CEO CompensaCompensation Fair?tion Fair?

Executive Compensation The traditional argument is that executive The traditional argument is that executive

responsibilities and skills call for higher responsibilities and skills call for higher salaries (e.g. Michael Capellas recently salaries (e.g. Michael Capellas recently received judicial approval for “scaled down” received judicial approval for “scaled down” $20 million 3 year pay package. This was 23% $20 million 3 year pay package. This was 23% below originally proposed package. The judge below originally proposed package. The judge called the package “fair and eminently called the package “fair and eminently reasonable”. The company had difficulty reasonable”. The company had difficulty attracting candidates. Capellas will make less attracting candidates. Capellas will make less than could have earned elsewhere.)than could have earned elsewhere.)

Executive Compensation According to the judge, the package According to the judge, the package

was “Quite startling in its was “Quite startling in its magnitude but reasonable for a magnitude but reasonable for a management challenge that was management challenge that was unprecedented. The challenge, to unprecedented. The challenge, to save tens of thousands of jobs and save tens of thousands of jobs and satisfy tens of millions of satisfy tens of millions of customers.”customers.”

Executive Compensation According to Richard Lambert, Accounting According to Richard Lambert, Accounting

Professor at Wharton Business School, if the Professor at Wharton Business School, if the level of executive compensation is put in the level of executive compensation is put in the context of overall company finances, it seems context of overall company finances, it seems less of a problem. Compared with the value of less of a problem. Compared with the value of most public companies, the amount of money most public companies, the amount of money being given to executives is not that large. being given to executives is not that large. “Even if you cut the CEO’s salary in half, the “Even if you cut the CEO’s salary in half, the effect on shareholder wealth would be very effect on shareholder wealth would be very small.”small.”

Executive Compensation If a company does well or poorly, to If a company does well or poorly, to

what extent is the CEO responsible for what extent is the CEO responsible for this?this?• It's clear that CEOs' pay has risen far It's clear that CEOs' pay has risen far

faster than the corporate profits faster than the corporate profits they're paid to generate. Profits rose they're paid to generate. Profits rose 78% in the last decade, much less than 78% in the last decade, much less than the 212% increase in CEO pay over the the 212% increase in CEO pay over the same period.same period.

Executive Compensation The chief executives at 23 corporations The chief executives at 23 corporations

under investigation for improper under investigation for improper accounting pocketed $1.4 billion, or an accounting pocketed $1.4 billion, or an average of $62 million each, in the last average of $62 million each, in the last three years. Meanwhile, their companies' three years. Meanwhile, their companies' stock values plunged $530 billion, or stock values plunged $530 billion, or about 73% of their total value, and their about 73% of their total value, and their companies laid off a total of 162,000 companies laid off a total of 162,000 workers.workers.

Executive Compensation The The Financial TimesFinancial Times recently reported on a recently reported on a

study of what they called “The Barons of study of what they called “The Barons of Bankruptcy” – a privileged group of top Bankruptcy” – a privileged group of top business leaders who made extraordinary business leaders who made extraordinary fortunes even as their companies were fortunes even as their companies were heading for disaster. They examined the heading for disaster. They examined the largest 25 business collapses since the start largest 25 business collapses since the start of last year and, according to their figures, the of last year and, according to their figures, the executives and directors of these doomed executives and directors of these doomed companies walked away with over $3.3 billion companies walked away with over $3.3 billion in compensation and proceeds from stock in compensation and proceeds from stock sales.sales.

Executive Compensation Revenue at Tyco's electronics unit fell Revenue at Tyco's electronics unit fell

from $13.6 billion in fiscal 2001 to $10.5 from $13.6 billion in fiscal 2001 to $10.5 billion in the following year. billion in the following year. Nevertheless, division president Juergen Nevertheless, division president Juergen W. Gromer earned a bonus of almost W. Gromer earned a bonus of almost $3.4 million. Gromer's salary was $3.4 million. Gromer's salary was increased by $35,500, to $695,500. In the increased by $35,500, to $695,500. In the previous year, Gromer earned a bonus previous year, Gromer earned a bonus of $6.85 million.of $6.85 million.

Executive Compensation Former Kmart CEO Charles Former Kmart CEO Charles

Conaway received nearly $23 Conaway received nearly $23 million in compensation during his million in compensation during his 2-year tenure. When Kmart filed for 2-year tenure. When Kmart filed for bankruptcy in 2002, 283 stores were bankruptcy in 2002, 283 stores were closed and 22,000 employees lost closed and 22,000 employees lost their jobs. Their total severance their jobs. Their total severance pay: $0.pay: $0.

Executive Compensation In 2002, the total compensation of In 2002, the total compensation of

CEO Scott McNealy of Sun CEO Scott McNealy of Sun Microsystems, rose 31% to $31.7 Microsystems, rose 31% to $31.7 million while his shareholders’ million while his shareholders’ return plunged 74.7%, according to return plunged 74.7%, according to Equilar, an independent provider of Equilar, an independent provider of compensation data.compensation data.

Executive Compensation

At Honeywell, CEO David Cote At Honeywell, CEO David Cote made $68.5 million, about 80% of made $68.5 million, about 80% of which was a sign-on bonus for which was a sign-on bonus for taking over the top job in February taking over the top job in February 2002. Meanwhile, Honeywell 2002. Meanwhile, Honeywell shareholders saw the value of their shareholders saw the value of their investments slide by 27.3%. investments slide by 27.3%.

Executive Compensation Steve Jobs of Apple Computer, Steve Jobs of Apple Computer,

pulled in $78.1 million while his pulled in $78.1 million while his investors’ return slumped by 34.6%.investors’ return slumped by 34.6%.

In 2002, while the S&P 500 plunged In 2002, while the S&P 500 plunged 22%, median CEO compensation 22%, median CEO compensation rose 14% . rose 14% .

Bottom Line: Bottom Line: There is little correlation There is little correlation between pay and performance, no between pay and performance, no linkagelinkage

Executive Compensation Executive vs. Worker Pay DisparityExecutive vs. Worker Pay Disparity

• 20 years ago the CEO got about 20 years ago the CEO got about 40 times what the average worker 40 times what the average worker did. It's now, according to them, did. It's now, according to them, 541 times.541 times.

• The earnings of CEO's have The earnings of CEO's have grown 10 times faster than those grown 10 times faster than those of the average worker. of the average worker.

Executive Compensation Executive vs. Worker Pay DisparityExecutive vs. Worker Pay Disparity

• Among Fortune 500 companies CEOs earn more Among Fortune 500 companies CEOs earn more than 100 times the average employee’s salary.than 100 times the average employee’s salary.

• Compensation for CEO’s rose at 27 out of 30 Compensation for CEO’s rose at 27 out of 30 companies in 1993 with the largest staff reductions.companies in 1993 with the largest staff reductions.

• 60% of managers recently surveyed said CEOs 60% of managers recently surveyed said CEOs make too much.make too much.

• 64% of respondents to a recent SHRM online poll 64% of respondents to a recent SHRM online poll indicated that they did not believe that executive indicated that they did not believe that executive pay in their organization was in line in comparison pay in their organization was in line in comparison to pay in the rest of the organization.to pay in the rest of the organization.

Executive Compensation Executive vs. Worker Pay DisparityExecutive vs. Worker Pay Disparity

• Hershey CEO Richard Lenny was paid more Hershey CEO Richard Lenny was paid more than $22 million last year. An average union than $22 million last year. An average union worker at Hershey makes $18 per hour, worker at Hershey makes $18 per hour, about $37,440 a year. Lenny's compensation about $37,440 a year. Lenny's compensation could support 598 of these average workers. could support 598 of these average workers. Hershey employees went on strike earlier Hershey employees went on strike earlier this year when management doubled the this year when management doubled the cost of co-payments for health care.cost of co-payments for health care.

Executive Compensation Executive vs. Worker Pay DisparityExecutive vs. Worker Pay Disparity

• Gaps between exec/worker increasing.Gaps between exec/worker increasing.• The growing disparity between executive The growing disparity between executive

compensation and that of other employees compensation and that of other employees is leading to a trust gap, which threatens to is leading to a trust gap, which threatens to seriously impair morale.seriously impair morale.

• Bottom Line: When executive pay increases Bottom Line: When executive pay increases faster than the economy other people's faster than the economy other people's share decreases.share decreases.

Executive Compensation Perks/Other non-salary compensationPerks/Other non-salary compensation

• Stock OptionsStock OptionsOptions allow executives to buy their Options allow executives to buy their

company's stock in the future at the company's stock in the future at the current price.current price.

After less than six months on the job, After less than six months on the job, Tyco International Ltd.'s chief executive Tyco International Ltd.'s chief executive Ed Breen earned $49 million in paper Ed Breen earned $49 million in paper profits just in his Tyco stock options, profits just in his Tyco stock options, according to the company's proxy according to the company's proxy statement.statement.

Executive Compensation

Qwest's CEO Joseph Nacchio, Qwest's CEO Joseph Nacchio, cashed out $300 million in cashed out $300 million in stock options while the stock options while the company's stock dropped company's stock dropped from $51 a share to $8. At the from $51 a share to $8. At the same time he fired 17,000 same time he fired 17,000 employees and shut down a employees and shut down a $25 million charity program.$25 million charity program.

Executive Compensation Life insurance, pension plan, Life insurance, pension plan,

IRA, club memberships, car IRA, club memberships, car allowances, stock options.allowances, stock options.

Jack Welch from GE got luxury Jack Welch from GE got luxury apartment, entertainment and a apartment, entertainment and a private jet.private jet.

““Golden parachutes”Golden parachutes”

Executive Compensation

Under his current contract, if Under his current contract, if Home Depot CEO Robert Home Depot CEO Robert Nardelli is fired he will Nardelli is fired he will receive an $82 million receive an $82 million severance package (Fortune severance package (Fortune Magazine)Magazine)

Executive Compensation SERP (supplemental executive-retirement plan) is a SERP (supplemental executive-retirement plan) is a

steroid-enhanced version of the traditional defined-steroid-enhanced version of the traditional defined-benefit pension plan, in which a company sets aside a benefit pension plan, in which a company sets aside a given % of an executive's pay every year to produce a given % of an executive's pay every year to produce a guaranteed payout. SERPs are now offered by about guaranteed payout. SERPs are now offered by about 1/2 of all big publicly traded companies, usually only 1/2 of all big publicly traded companies, usually only to the CEO and the next dozen or so officers. And to the CEO and the next dozen or so officers. And while the combination of a collapsing stock market while the combination of a collapsing stock market and low interest rates have placed pension plans for and low interest rates have placed pension plans for ordinary Joes in jeopardy that's not the case for top ordinary Joes in jeopardy that's not the case for top execs. In fact, now that the stock market bubble has execs. In fact, now that the stock market bubble has burst, compensation experts predict that companies burst, compensation experts predict that companies will actually increase their use of SERPs to pick up the will actually increase their use of SERPs to pick up the slack. ” (Fortune, April 28, 2003)slack. ” (Fortune, April 28, 2003)

Executive Compensation How did this happen?How did this happen?

• Who usually decides on compensation Who usually decides on compensation packages?packages?Compensation Committees of Corporate Compensation Committees of Corporate

BoardsBoards• Based on what?Based on what?

Fair Market Value as demonstrated by Fair Market Value as demonstrated by disclosed information, recommendations disclosed information, recommendations of of executive search firmsexecutive search firms and “other” and “other” factors.factors.

Executive Compensation Collusion?Collusion?

• When most big companies name outside When most big companies name outside directors they tend to draw from a familiar directors they tend to draw from a familiar pool of corporate luminaries close to home.pool of corporate luminaries close to home.

• A University of Michigan Business School A University of Michigan Business School study determined that there is about 4.6 study determined that there is about 4.6 degrees of separation on average on degrees of separation on average on corporate boards. Business is run by the corporate boards. Business is run by the “connected few”.“connected few”.

Executive Compensation What about the shareholders, What about the shareholders,

the supposed “owners” of the the supposed “owners” of the corporations?corporations?• Vodafone recently put executive Vodafone recently put executive

compensation up for a compensation up for a shareholder vote.shareholder vote.

• Good idea?Good idea?• This is highly unusual.This is highly unusual.

Starting a Business Limited Liability Company (L.L.C.)Limited Liability Company (L.L.C.)

• A hybrid form of business enterprise that offers the A hybrid form of business enterprise that offers the limited liability of the corporation but the tax limited liability of the corporation but the tax advantages of a partnershipadvantages of a partnership

• 47 States permit (including N.C.)47 States permit (including N.C.)• Separate Legal Entity like corporationSeparate Legal Entity like corporation• Require filing Articles of IncorporationRequire filing Articles of Incorporation• All investors able to share in managementAll investors able to share in management• No restrictions on number or types of membersNo restrictions on number or types of members• No one member has liability for wrongful acts of No one member has liability for wrongful acts of

others (makes attractive to doctors, lawyers, etc.)others (makes attractive to doctors, lawyers, etc.)

Starting a Business Limited Liability Partnership (L.L.P.)Limited Liability Partnership (L.L.P.)

• Similar to L.L.C., but designed for Similar to L.L.C., but designed for professional groups who normally do professional groups who normally do business as partnersbusiness as partners

• Started to shield uninvolved Started to shield uninvolved professionals’ personal assets from professionals’ personal assets from malpractice claimsmalpractice claims

• Must maintain adequate professional Must maintain adequate professional liability insuranceliability insurance

Starting a Business

Joint VentureJoint Venture• A joint undertaking of a specific commercial A joint undertaking of a specific commercial

enterprise by an association of persons (.e.g. enterprise by an association of persons (.e.g. construction of a tunnel, Wheatley v. Halvoson, 323 construction of a tunnel, Wheatley v. Halvoson, 323 P2d 49 (Ore. 1958) P2d 49 (Ore. 1958)

• A joint venture is normally not a legal entity and is A joint venture is normally not a legal entity and is treated like a partnership for federal income tax treated like a partnership for federal income tax purposespurposes

• Normally lasts until venture is completed or Normally lasts until venture is completed or becomes impossible to completebecomes impossible to complete

Starting a Business

Strategic AllianceStrategic Alliance• A strategic alliance is an A strategic alliance is an

organizational relationship that organizational relationship that links two or more independent links two or more independent business entities in a common business entities in a common endeavorendeavor

Starting a Business

FranchiseFranchise• Business owner (franchisor), usually a corporation, Business owner (franchisor), usually a corporation,

allows another (the franchisee) to use its allows another (the franchisee) to use its trademark, trade name, or copyright, under trademark, trade name, or copyright, under specified conditions.specified conditions.

• Each franchise operates as an independent Each franchise operates as an independent business.business.

• Franchise Agreements are often viewed as one-Franchise Agreements are often viewed as one-sided or “Contracts of Adhesion” (Body Shop sided or “Contracts of Adhesion” (Body Shop Example)Example)

• Clayton Act “tie-in sales” questionsClayton Act “tie-in sales” questions• Sherman Act price control questionsSherman Act price control questions

Starting a Business

Franchise (Cont.)Franchise (Cont.)• Government disclosure requirementsGovernment disclosure requirements• Law of state of franchisor typically controls in Law of state of franchisor typically controls in

contract disputes (e.g. Burger King, Florida)contract disputes (e.g. Burger King, Florida)• Often “turn-key” operationsOften “turn-key” operations• Typically owned by a sole proprietor. Typically owned by a sole proprietor. • Examples (McDonald's, Dairy Queen)Examples (McDonald's, Dairy Queen)• Advantages - Proven management style, Name Advantages - Proven management style, Name

recognition, Strong marketing resources, Often recognition, Strong marketing resources, Often involve financial supportinvolve financial support

• Beware, overblown or “fly-by-night” franchises!Beware, overblown or “fly-by-night” franchises!

Starting a Business

Types of FranchisesTypes of Franchises• DistributorshipDistributorship- Dealer is allowed to sell a - Dealer is allowed to sell a

product produced by a manufacturer.product produced by a manufacturer.• Chain-Style BusinessChain-Style Business - Firm is allowed to use - Firm is allowed to use

the trade name of a company and follows the trade name of a company and follows guidelines related to the pricing and sale of guidelines related to the pricing and sale of the product.the product.

• Manufacturing ArrangementManufacturing Arrangement- Firm is allowed - Firm is allowed to manufacture a product using the formula to manufacture a product using the formula provided by the franchisorprovided by the franchisor

Starting a Business

CooperativesCooperatives• Group of 2 or more independent Group of 2 or more independent

persons that cooperate for a common persons that cooperate for a common objective (e.g. farmers pooling objective (e.g. farmers pooling produce for sale)produce for sale)

Starting a Business

Factors in Selecting a FormFactors in Selecting a Form• LiabilityLiability• Tax TreatmentTax Treatment• Formalities/ComplexityFormalities/Complexity• Access to Funds/FinancingAccess to Funds/Financing• Distribution of Profits/LossesDistribution of Profits/Losses• Management/ControlManagement/Control• LifecycleLifecycle• Liquidity/Ease of TransferLiquidity/Ease of Transfer• PrivacyPrivacy• Fringe BenefitsFringe Benefits

Starting a Business

LiabilityLiability• Why Limit Liability?Why Limit Liability?

Incentive to InvestIncentive to InvestLawsuitsLawsuits

• Can’t insurance cover liability?Can’t insurance cover liability?• Personal Guarantees/Co-Signing Can Personal Guarantees/Co-Signing Can

Expand/Reimpose Liability (Often required Expand/Reimpose Liability (Often required by lenders, especially with new, small by lenders, especially with new, small companies)companies)

Starting a Business LiabilityLiability

• Sole ProprietorSole Proprietor Sole and complete unlimited liabilitySole and complete unlimited liability

• General PartnershipGeneral Partnership Joint liability for debts and contracts (“in the Joint liability for debts and contracts (“in the

ordinary course of business”, Help instill v. ordinary course of business”, Help instill v. Regions Bank, Texas Court of Appeals, 2000, 33 Regions Bank, Texas Court of Appeals, 2000, 33 S.W.3d 401)S.W.3d 401)

Joint and several unlimited liability for torts Joint and several unlimited liability for torts (unless “marshalling” requirement(unless “marshalling” requirement

• Marshalling = liabilities first paid out of the Marshalling = liabilities first paid out of the partnership assetspartnership assets

Starting a Business Partnership LiabilityPartnership Liability Orel Koelling was a partner in a partnership Orel Koelling was a partner in a partnership

that employed Martin Martinez. Mr. Martinez that employed Martin Martinez. Mr. Martinez died as the result of an accident which died as the result of an accident which occurred in the course of the partnership's occurred in the course of the partnership's business. Mrs. Martinez filed suit against business. Mrs. Martinez filed suit against Koelling to recover for her husband's death. Koelling to recover for her husband's death. Koelling moved for summary judgment on the Koelling moved for summary judgment on the grounds that the partnership was the employer grounds that the partnership was the employer and liable, if anyone was. Issue: Should and liable, if anyone was. Issue: Should Koelling be dismissed from this litigation? Koelling be dismissed from this litigation? Held: No. Partners are jointly and severally Held: No. Partners are jointly and severally liable for the actions of the partnership. Thus, liable for the actions of the partnership. Thus, Koelling, as a partner, was a proper defendant. Koelling, as a partner, was a proper defendant. Martinez v. Koelling, 421 N.W.2d 1 (Neb. 1988). Martinez v. Koelling, 421 N.W.2d 1 (Neb. 1988).

Starting a Business Liability (Cont.)Liability (Cont.)

• Limited PartnershipLimited Partnership Some partners have personal liability that is limited Some partners have personal liability that is limited

to the cash or property they invested in the firm. to the cash or property they invested in the firm. One or more general partners who actively manage One or more general partners who actively manage the business, receive a salary, share in profits and the business, receive a salary, share in profits and losses, have unlimited liability. losses, have unlimited liability.

• Limited Liability PartnershipLimited Liability Partnership Unlimited liability for general obligations, limited for Unlimited liability for general obligations, limited for

malpracticemalpractice• Corporation, S Corporation, Limited Liability Corporation, S Corporation, Limited Liability

Corporation Corporation Liability limited to the assets of the CorporationLiability limited to the assets of the Corporation

Starting a Business TaxationTaxation

• Sole ProprietorSole Proprietor Reports profits on personal income tax returnReports profits on personal income tax return

• Partnership/”S”Corp./L.L.C./L.L.P.Partnership/”S”Corp./L.L.C./L.L.P. Pass through (not taxed at business entity level) - Personal Pass through (not taxed at business entity level) - Personal

earnings received from the partnership are subject to earnings received from the partnership are subject to personal income taxes.personal income taxes.

• ““C” CorporationC” Corporation ““Double Taxation” - Corporation pays tax on its income and Double Taxation” - Corporation pays tax on its income and

Shareholders pay income tax on dividends (Possible Shareholders pay income tax on dividends (Possible solution: Don’t pay dividends. Profits can be paid out as solution: Don’t pay dividends. Profits can be paid out as salary or other forms of deductible compensation)salary or other forms of deductible compensation)

• ““Income Splitting”Income Splitting” Always good idea to seek advice of Accountant or Tax Attorney on Always good idea to seek advice of Accountant or Tax Attorney on

this!this!

Starting a Business

Formalities/ComplexityFormalities/Complexity• Sole ProprietorSole Proprietor

Least formalities/complexityLeast formalities/complexity• PartnershipPartnership

Formalities/complexity variesFormalities/complexity varies

Starting a Business Formalities/Complexity (Cont.)Formalities/Complexity (Cont.)

• Limited Partnership, L.L.P., S Corporation, L.L.C., CorporationsLimited Partnership, L.L.P., S Corporation, L.L.C., Corporations All have statutory requirements and require written All have statutory requirements and require written

agreements.agreements.• Corporation has the most required formalities/complexity Corporation has the most required formalities/complexity

(Must file Articles of Incorporation, Adopt Bylaws, Hold (Must file Articles of Incorporation, Adopt Bylaws, Hold periodic meetings, Keep Minutes, etc.) (Failure to periodic meetings, Keep Minutes, etc.) (Failure to maintain formalities may result in involuntary dissolution maintain formalities may result in involuntary dissolution and thus a loss of limited liability! Burlington v. Palangio, and thus a loss of limited liability! Burlington v. Palangio, Arkansas Supreme Court, 2001, 345 Ark. 320, 45 S.W3rd Arkansas Supreme Court, 2001, 345 Ark. 320, 45 S.W3rd 834)834)

• Limited Partnerships covered under N.C.G.S. 59Limited Partnerships covered under N.C.G.S. 59• L.L.C.s are covered under N.C.G.S. 57CL.L.C.s are covered under N.C.G.S. 57C• Corporations covered under N.C.G.S. Chapter 55 Corporations covered under N.C.G.S. Chapter 55

(Professionals under, 55B Non-Profits, under 55A)(Professionals under, 55B Non-Profits, under 55A)

Starting a Business

Access to Funds/FinancingAccess to Funds/Financing• Sole ProprietorSole Proprietor

Generally has the least access to Generally has the least access to funds/financingfunds/financing

• PartnershipPartnership Generally has a greater access to Generally has a greater access to

funds/financing than Sole Proprietorshipfunds/financing than Sole Proprietorship• L.L.P’s, S CorporationsL.L.P’s, S Corporations

Generally somewhat better access to fundsGenerally somewhat better access to funds

Starting a Business

Access to Funds/FinancingAccess to Funds/Financing• Limited Partnerships and L.L.C.sLimited Partnerships and L.L.C.s

Generally better access to fundsGenerally better access to funds Note: Limited Partnerships often offer the best Note: Limited Partnerships often offer the best

tax shelters for investors!tax shelters for investors!• CorporationCorporation

Generally has greatest access to funds/financing Generally has greatest access to funds/financing (e.g. Can sell equity/debt securities (stocks & (e.g. Can sell equity/debt securities (stocks & bonds),, limited liability encourages investors, bonds),, limited liability encourages investors, stock can be offered as collateral, etc.)stock can be offered as collateral, etc.)

Starting a Business Distribution of Profits/LossesDistribution of Profits/Losses

• Sole ProprietorSole ProprietorGains all profits, suffers all lossesGains all profits, suffers all losses

• PartnershipPartnershipDistribution of profits and losses Distribution of profits and losses

generally set by agreement or pro-ratagenerally set by agreement or pro-rata• CorporationCorporation

Distribution of profits determined by Distribution of profits determined by management/market, received as management/market, received as dividends or increased value of stock.dividends or increased value of stock.

Starting a Business

Management/ControlManagement/Control• Sole ProprietorSole Proprietor

Sole & complete management/controlSole & complete management/control• PartnershipPartnership

Management/control determined by Management/control determined by agreementagreement

Partnership books and records must be Partnership books and records must be kept accessible to all partnerskept accessible to all partners

Starting a Business

Management/Control (Cont.)Management/Control (Cont.)• CorporationCorporation

Nature of control/management determined by bylaws, Nature of control/management determined by bylaws, actual persons in control determined by vote.actual persons in control determined by vote.

Corporate shareholder have no management authority Corporate shareholder have no management authority unless elected to board or as officerunless elected to board or as officer

““Freeze-outs” are a common problem in Close Freeze-outs” are a common problem in Close CorporationsCorporations

• L.L.P.L.L.P. Management shared unless altered by agreementManagement shared unless altered by agreement Purchasing an existing members interest does not Purchasing an existing members interest does not

automatically confer managerial authority. Other partners automatically confer managerial authority. Other partners must unanimously agree to.must unanimously agree to.

Starting a Business

LiquidityLiquidity• Sole ProprietorshipSole Proprietorship

Poor liquidityPoor liquidity• Limited partnershipLimited partnership

Interest sales are technically easy, but generally Interest sales are technically easy, but generally not particularly attractivenot particularly attractive

• General partnershipGeneral partnership Interest sales are difficult, requiring agreement of Interest sales are difficult, requiring agreement of

other partnersother partners

Starting a Business

Liquidity (Cont.)Liquidity (Cont.)• ““S” CorporationS” Corporation

Fair liquidity, but it may be restrictedFair liquidity, but it may be restricted• CorporationCorporation

Easy transfer, sell shares (note: minority interest Easy transfer, sell shares (note: minority interest shares less attractive in close corporation)shares less attractive in close corporation)

• L.L.C.L.L.C. Transfer restrictionsTransfer restrictions

Starting a Business

LifecycleLifecycle• Sole ProprietorshipSole Proprietorship

Often ends with the death or incapacity of the sole Often ends with the death or incapacity of the sole proprietorproprietor

• CorporationCorporation Continues to function unless/until formally Continues to function unless/until formally

dissolved, voluntarily or involuntarily, regardless dissolved, voluntarily or involuntarily, regardless of the death or incapacity of individual of the death or incapacity of individual shareholders (makes easier to preserve goodwill)shareholders (makes easier to preserve goodwill)

• L.L.C.L.L.C. Often required to have a stated durationOften required to have a stated duration

Starting a Business

LifecycleLifecycleGeneral Partnerships, L.L.P.’s, L.L.C.’sGeneral Partnerships, L.L.P.’s, L.L.C.’s

Often dissolved by loss of any member, but Often dissolved by loss of any member, but remaining members can unanimously agree to remaining members can unanimously agree to continue operationscontinue operations

• Limited PartnershipsLimited Partnerships Often dissolved by loss of a general partner, but Often dissolved by loss of a general partner, but

remaining members can unanimously agree to remaining members can unanimously agree to continue operationscontinue operations

Life Insurance, especially for a “key man” can Life Insurance, especially for a “key man” can be a key factor in maintaining operations!be a key factor in maintaining operations!

Starting a Business

PrivacyPrivacy• Sole Proprietorships, Partnerships and Sole Proprietorships, Partnerships and

Close CorporationsClose CorporationsHave very limited requirements for Have very limited requirements for

disclosure of private/financial disclosure of private/financial information.information.

• Public CorporationsPublic CorporationsHave extensive requirements for Have extensive requirements for

disclosure of private/financial disclosure of private/financial information.information.

Starting a Business

Fringe BenefitsFringe Benefits• Historically, fringe benefit laws Historically, fringe benefit laws

have favored “C” corporationshave favored “C” corporationsFor example, generally, health For example, generally, health insurance is fully deductible for a insurance is fully deductible for a “C” corporation, partially “C” corporation, partially deductible for sole proprietor, not deductible for sole proprietor, not deductible for partners or for an deductible for partners or for an “S” corporation“S” corporation

11-137

Organizational ChoicesTypeType CreationCreation ContinuityContinuity ControlControl LiabilityLiability TaxTax

ProprietorshipProprietorship Do It!Do It! ProprietorProprietor ProprietorProprietor Unl’dUnl’d SingleSingle

PartnershipPartnership AgreementAgreementEasilyEasily

DissolvedDissolved(Buy/Sell)(Buy/Sell)

EqualEqualAmongAmong

PartnersPartners Unl’dUnl’d SingleSingle

LimitedLimitedPartnershipPartnership

Agree & Agree & RegisterRegister

GeneralGeneralPartnerPartner

GeneralGeneralPartnerPartner

Gen’l- Unl’dGen’l- Unl’dLtd.- Ltd.Ltd.- Ltd. SingleSingle

LLPLLP Articles &Articles &RegistrationRegistration

EasilyEasilyDissolvedDissolved

EqualEqualPartnersPartners LimitedLimited SingleSingle

LLCLLC Articles &Articles &RegistrationRegistration

DissolvedDissolved(90 Days)(90 Days)

EqualEqualMembersMembers LimitedLimited SingleSingle

S CorporationS CorporationArticlesArticles

(<75 People)(<75 People)PerpetualPerpetual

(Ease Of (Ease Of Transfer)Transfer)

ShareholdersShareholdersDirectorsDirectorsOfficersOfficers

LimitedLimited SingleSingle

CorporationCorporationArticles OfArticles Of

IncorporationIncorporationPerpetualPerpetual

(Ease Of (Ease Of Transfer)Transfer)

ShareholdersShareholdersDirectorsDirectorsOfficersOfficers

LimitedLimited DoubleDouble

11-138

Basic Forms of Ownership

Sole ProprietorshipSole Proprietorship

PartnershipPartnership

CorporationCorporation

NumberNumber SalesSales74%74% 5%5%

8%8% 5%5%

18%18% 90%90%

11-139

Basic Forms of Ownership

18%5%

74%

5%8%

90%

0%10%20%30%40%50%60%70%80%90%

100%

Number Sales

Sole ProprietorshipPartnershipCorporation

11-140

Relative Percentages of Sole Proprietorships, Partnerships, and Corporations in the U.S.

Sole proprietorships16,955,000

73.0%

Corporations4,631,00019.9%

Partnerships1,654,0007.1%

Sole proprietorships, the most widespread form of business ownership, are most common in retailing, agriculture, and the service industries.

Source: U.S. Bureau of the Census, Statistical Abstract of the United States, 119th ed., Washington, D.C., 1999, p. 545.

Changing Popularity of Business Forms

02000400060008000

10000120001400016000

S. Prop C Corp S Corp Part.

19801992

Corporations

0

500

1000

1500

2000

2500

C Corp S Corp

19801992

Some Form Trends Historically, maximum individual tax rate > Historically, maximum individual tax rate >

than maximum corporate rate created than maximum corporate rate created incentive to keep income in corporate formincentive to keep income in corporate form

1986 Tax Act made maximum individual rate < 1986 Tax Act made maximum individual rate < maximum corporate rate & companies became maximum corporate rate & companies became ” S” corps in droves” S” corps in droves

But 1993 Tax Act increased individual rates, But 1993 Tax Act increased individual rates, thus, “S” corps no longer as advantageousthus, “S” corps no longer as advantageous

New kid on block - L.L.C., more flexible than New kid on block - L.L.C., more flexible than “S” Corp and better that L..L.P. in that not “S” Corp and better that L..L.P. in that not require a general partnerrequire a general partner

11-144

Aspects of Business That May Require Legal Help

1. Choosing either the sole proprietorship, partnership, or corporate form of ownership

2. Constructing a partnership agreement 3. Establishing a corporation 4. Registering a corporation’s stock 5. Obtaining a trademark, patent, or copyright 6. Filing for licenses or permits at the local, state, and

federal levels 7. Purchasing an existing business or real estate 8. Leasing real estate or equipment 9. Hiring employees and independent contractors

10. Handling labor disputes and customer lawsuits 11. Extending credit and collecting debts 12. Handling bankruptcy and reorganization

Source: Adapted from Seth Godin, ed., 1997 Business Almanac. Copyright © 1996 by Houghton Mifflin Company.

Naming a Business

Some Key QuestionsSome Key Questions• Statutory requirements?Statutory requirements?• Is your proposed business name Is your proposed business name

available?available?• Will your business name receive Will your business name receive

trademark protection?trademark protection?• If your business will have a website, If your business will have a website,

is a similar domain name available?is a similar domain name available?

Naming a Business If you're starting a corporation, LLC or If you're starting a corporation, LLC or

limited partnership, you must comply limited partnership, you must comply with statutory requirements for naming with statutory requirements for naming your businessyour business

Naming Convention for Corporations Naming Convention for Corporations (Incorporated, Inc., Corporation, Corp., (Incorporated, Inc., Corporation, Corp., Company, Co.)Company, Co.)

L.L.P. or L.LC. (Limited or Ltd..)L.L.P. or L.LC. (Limited or Ltd..) Fictitious/Assumed/Trade Name (or dba)Fictitious/Assumed/Trade Name (or dba)

Naming a Business

Name available?Name available?• Corporate/L.L.C./Limited Partnership Name Corporate/L.L.C./Limited Partnership Name

Search – Secretary of StateSearch – Secretary of State• Fictitious/Assumed Name Search – Register Fictitious/Assumed Name Search – Register

of Deedsof Deeds• Trademark Search – U.S. Patent OfficeTrademark Search – U.S. Patent Office

Basic ConcernsBasic Concerns• Is it the same?Is it the same?• Is it similar enough to cause confusion?Is it similar enough to cause confusion?

Naming a Business

TrademarkTrademark• A trademark (sometimes called simply a "mark") is A trademark (sometimes called simply a "mark") is

any word, phrase, design or symbol used to market a any word, phrase, design or symbol used to market a product or service.product or service.

• Technically, a mark used to market a service, rather Technically, a mark used to market a service, rather than a product, is called a service mark, though the than a product, is called a service mark, though the term "trademark" is commonly used for both types term "trademark" is commonly used for both types of marks because they refer to the same group of of marks because they refer to the same group of legal protections.legal protections.

• Owners of trademarks have rights under both federal Owners of trademarks have rights under both federal and state law that give them the power in many and state law that give them the power in many cases to prevent others from using the same or cases to prevent others from using the same or confusingly similar trademarks.confusingly similar trademarks.

Naming a Business Trademark (Cont.)Trademark (Cont.)

• When picking a business name, take When picking a business name, take care to choose a name that will be likely care to choose a name that will be likely to receive trademark protectionto receive trademark protection

• There are specific steps to protect your There are specific steps to protect your business name as a trademarkbusiness name as a trademark

• Document first & continuous useDocument first & continuous use• Aggressively warn/sue potential Aggressively warn/sue potential

infringers (see Victor’s Little Secret infringers (see Victor’s Little Secret case)case)

Naming a Business

Trademark (Cont.)Trademark (Cont.)• On the flip side, to make sure your business On the flip side, to make sure your business

name won't step on someone else's rights name won't step on someone else's rights to an existing trademark, you'll have to do a to an existing trademark, you'll have to do a trademark search.trademark search.

• If your business is anything but a small, If your business is anything but a small, local service business or retailer, such as a local service business or retailer, such as a dry cleaners or a fabric store, you'll dry cleaners or a fabric store, you'll probably want to take advantage of probably want to take advantage of trademark protection.trademark protection.

Naming a Business Trademark (Cont.)Trademark (Cont.)

• Allowing businesses to have exclusive use of their Allowing businesses to have exclusive use of their names helps consumers identify and recognize goods in names helps consumers identify and recognize goods in the marketplace.the marketplace.

• By allowing just one company to use a name, trademark By allowing just one company to use a name, trademark law helps that company to build customer trust and law helps that company to build customer trust and goodwill.goodwill.

• Any business name you use to market and identify your Any business name you use to market and identify your products or services is a potential trademark. For products or services is a potential trademark. For example, McDonald's uses its business name to market example, McDonald's uses its business name to market its hamburgers.its hamburgers.

• To qualify for trademark protection, your business name To qualify for trademark protection, your business name should be what trademark law considers "distinctive."should be what trademark law considers "distinctive."

Naming a Business

Distinctive NamesDistinctive Names• Examples of Distinctive Names Examples of Distinctive Names

(likely to receive trademark (likely to receive trademark protection): Xerox, protection): Xerox, Amazon.ComAmazon.Com

• Not: Joe’s HardwareNot: Joe’s Hardware• One Theory - Make a new wordOne Theory - Make a new word

11-153

Agency DutiesLoyaltyLoyaltyKeep Principal InformedKeep Principal InformedObey InstructionsObey InstructionsAccount For MoneyAccount For MoneyPartnership Liability- Each Partnership Liability- Each

Partner Is Agent Partner Is Agent AndAnd Principal Principal

11-154

Creation of AgencyNature of Agency- One Nature of Agency- One

Party (Agent) Acting for Party (Agent) Acting for Another (Principal)Another (Principal)• Usually formed by Usually formed by

contract, but may be oralcontract, but may be oral

11-155

Creation of Agency• De facto agency may be found by court De facto agency may be found by court

even where no intent to createeven where no intent to createKeys:Keys:

• Indication/manifestation of Indication/manifestation of consent by principalconsent by principal

• Agent acceptance to act on behalf Agent acceptance to act on behalf of principalof principal

• Understanding of principal controlUnderstanding of principal controlEvidence: Word’s, Actions, Evidence: Word’s, Actions,

CircumstancesCircumstances

11-156

Creation of AgencyCapacity to Be PrincipalCapacity to Be Principal

• Generally same capacity Generally same capacity to act as principalto act as principal

Capacity to Be AgentCapacity to Be Agent• Generally unrestrictedGenerally unrestricted

11-157

Duties of Agents Some Duties of Principal may be non-Some Duties of Principal may be non-

delegable (e.g. provide safe work delegable (e.g. provide safe work environment, etc.)environment, etc.)

LoyaltyLoyalty• HonestyHonesty• Full discloseFull disclose• Notification and surrender of special Notification and surrender of special

compensationcompensation• No seizure of principal opportunitiesNo seizure of principal opportunities

11-158

Duties of Agents LoyaltyLoyalty

• Conflict of Interest AvoidanceConflict of Interest AvoidanceEven in re: the appearance of a Even in re: the appearance of a

conflictconflictDual role generally o.k. with full Dual role generally o.k. with full

consent & disclosureconsent & disclosure

11-159

Duties of Agents Those Specified by Contract, if any Those Specified by Contract, if any FiduciaryFiduciary

• Strongly enforced by courtsStrongly enforced by courts Obey InstructionsObey Instructions

• Reasonable Belief ExceptionReasonable Belief Exception Exercise Care and SkillExercise Care and Skill

• Gratuitous Agent Factor (reduced expectations)Gratuitous Agent Factor (reduced expectations) Communicate “Relevant” Information Affecting Communicate “Relevant” Information Affecting

a “Material Interest”a “Material Interest” Protect Confidential InformationProtect Confidential Information Not Perform Illegal ActsNot Perform Illegal Acts

11-160

Duties of Agents

Account for Funds/PropertyAccount for Funds/Property• Keep Accurate RecordsKeep Accurate Records• Permit InspectionPermit Inspection• Not Commingle FundsNot Commingle Funds• Not embezzleNot embezzle• Not convert for own useNot convert for own use

11-161

Duties of PrincipalsCompensateCompensate

• Contingent Compensation (e.g. Contingency Contingent Compensation (e.g. Contingency Fee or Commission)Fee or Commission)

• Procuring Cause - when agent primary causeProcuring Cause - when agent primary cause• Duration of Employment - Where no set time, Duration of Employment - Where no set time,

“reasonable time” to recover costs“reasonable time” to recover costs• Real Estate Commissions - Received at Real Estate Commissions - Received at

“closing”“closing”• Insurance Commissions - On premiums paidInsurance Commissions - On premiums paid

11-162

Duties of Principals

Reimburse/Indemnify - Reimburse/Indemnify - for expenses on for expenses on behalf of Principal, behalf of Principal, where no faultwhere no fault

Keep AccountsKeep Accounts

11-163

Enforcement of Liabilities Breach of Duty by AgentBreach of Duty by Agent

• may reduce/eliminate may reduce/eliminate compensationcompensation

• may be grounds for termination may be grounds for termination of agencyof agency

Breach of Duty by PrincipalBreach of Duty by Principal• May create basis for lien of held May create basis for lien of held

property or cause for legal actionproperty or cause for legal action

11-164

Termination of Agency By Will of Parties - As specified per By Will of Parties - As specified per

agreementagreement Agency at Will- Power by either to Agency at Will- Power by either to

terminate at any timeterminate at any time• Exceptions:Exceptions:

Agency Coupled With Interest - Agency Coupled With Interest - power given as securitypower given as security

Legislative RestrictionsLegislative Restrictions

11-165

Termination of AgencyBy Operation of LawBy Operation of Law

• Death or insanityDeath or insanity• Bankruptcy affectingBankruptcy affecting• IllegalityIllegality• ImpossibilityImpossibility• Destruction of subject matterDestruction of subject matter• Material change in business Material change in business

conditionsconditions

11-166

Termination of AgencyNotice to 3Notice to 3rdrd Persons Persons

• ActualActual• Constructive (e.g. in Constructive (e.g. in

newspaper of general newspaper of general circulation in the area)circulation in the area)

• Failure may = apparent Failure may = apparent authorityauthority

11-167

Agent’s Authority to Bind Principal

Actual AuthorityActual Authority• Express- Specifically DescribedExpress- Specifically Described

Attorney-in-Fact if Power of Attorney-in-Fact if Power of Attorney (General or Limited) Attorney (General or Limited) (Statutory Limitations)(Statutory Limitations)

• Implied- Necessary to Complete Task Implied- Necessary to Complete Task (Custom, Justifiable Belief of Agent, (Custom, Justifiable Belief of Agent, Emergency)Emergency)

11-168

Agent’s Authority to Bind Principal

Apparent Authority- Apparent Authority- Reasonable Belief/Perception Reasonable Belief/Perception by 3by 3rdrd Party Party• Based on conduct of principalBased on conduct of principal• Justifiable Belief of 3rd Party Justifiable Belief of 3rd Party

TestTest• Duty of 3Duty of 3rdrd Persons Persons

11-169

Agent’s Authority to Bind Principal

Apparent AuthorityApparent Authority The shareholders of a closely held family The shareholders of a closely held family

corporation filed suit to set aside a mortgage on corporation filed suit to set aside a mortgage on certain real property. Held: The corporate president certain real property. Held: The corporate president had apparent authority to mortgage the property of had apparent authority to mortgage the property of the corporation, and the bank relied on that the corporation, and the bank relied on that authority. The mortgage was proper because the authority. The mortgage was proper because the family corporation had left the president in a virtually family corporation had left the president in a virtually unfettered managerial position of control. Their unfettered managerial position of control. Their actions caused the bank to believe that the president actions caused the bank to believe that the president had authority to bind the corporation. Lettieri v. had authority to bind the corporation. Lettieri v. American Sav. Bank, 437 A.2d 822 (Conn. 1980). American Sav. Bank, 437 A.2d 822 (Conn. 1980).

11-170

Ratification Could be where exceeded authority or no authorityCould be where exceeded authority or no authority Intent may be express or implied by words or Intent may be express or implied by words or

actionsactions RequirementsRequirements

• Principal must have had legal capacity both when Principal must have had legal capacity both when act occurred and ratifiedact occurred and ratified

• Affirm Act in its entiretyAffirm Act in its entirety• Knowledge of All Material Facts (Though not Knowledge of All Material Facts (Though not

necessarily understanding)necessarily understanding) Effect - Releases Agent of Liability to 3rd PartyEffect - Releases Agent of Liability to 3rd Party

11-171

Principal’s Contractual Liability

Liability for Agent Representation- Limited by Liability for Agent Representation- Limited by Exculpatory ClauseExculpatory Clause

Liability for Notice/Payment to AgentLiability for Notice/Payment to Agent• Generally Notice to Agent = Notice to Generally Notice to Agent = Notice to

Principal, wherein scope of agent’s Principal, wherein scope of agent’s authorityauthority

• Generally Payment to Agent = Payment to Generally Payment to Agent = Payment to PrincipalPrincipal

• A conflicts of interest may negate a A conflicts of interest may negate a principal’s liabilityprincipal’s liability

11-172

Principal’s Liability for Acts of Subagents

Agent’s Authority to Appoint Agent’s Authority to Appoint Subagents - Implied unless Subagents - Implied unless expressly excludedexpressly excluded• Agent ultimately liableAgent ultimately liable

Agent’s May Have Employees- Agent’s May Have Employees- Ministerial Acts - Principal boundMinisterial Acts - Principal bound• Concept: Liable as if agent had Concept: Liable as if agent had

performedperformed

11-173

Agent’s Contractual Liability Only If:

Unauthorized ActionsUnauthorized Actions• Implied Warranty of AuthorityImplied Warranty of Authority• Intent, Knowledge & Good Faith of Agent Intent, Knowledge & Good Faith of Agent

ImmaterialImmaterial Nonexistent/Incompetent PrincipalNonexistent/Incompetent Principal Agreement to Assume LiabilityAgreement to Assume Liability

• Agent Should Fully Disclose I.D. of PrincipalAgent Should Fully Disclose I.D. of Principal• Agent Should Clearly Indicate Capacity as AgentAgent Should Clearly Indicate Capacity as Agent

Undisclosed/Partially Disclosed PrincipalUndisclosed/Partially Disclosed Principal• Frequently used in controversial real estate/stock Frequently used in controversial real estate/stock

acquisitionsacquisitions• Creates expectation of liabilityCreates expectation of liability

11-174

Liability for Torts Direct Liability vs. Direct Liability vs. Respondeat SuperiorRespondeat Superior (Let the (Let the

master respond, i.e., master is responsible for master respond, i.e., master is responsible for servant.) = vicarious liabilityservant.) = vicarious liability

Employee vs. Independent ContractorEmployee vs. Independent Contractor• Within actual or apparent scope of employmentWithin actual or apparent scope of employment

Focus on words/actions/consent of principalFocus on words/actions/consent of principal• ““mere deviation” not take outside of scopemere deviation” not take outside of scope

• Degree of Control over “Methods”Degree of Control over “Methods”• Loaned/Borrowed Employee - Whether “loaned” Loaned/Borrowed Employee - Whether “loaned”

employee within scope for original employer or employee within scope for original employer or other depends upon degree of controlother depends upon degree of control

11-175

Liability for Torts

Intentional Torts by Agent - Intentional Torts by Agent - Generally = not within scope Generally = not within scope of employment, unless of employment, unless encouraged by principalencouraged by principal

Agent Generally Still Liable Agent Generally Still Liable even if acting with scope even if acting with scope (though may be indemnified)(though may be indemnified)

11-176

Employee vs. Independent Contractor

EmployeeEmployeeWorks ForWorks ForReceives Payment Receives Payment

FromFromControlled Working Controlled Working

Conditions/MethodsConditions/MethodsEmployer Liable forEmployer Liable for

ActsActsOmissionsOmissions

Independent ContractorIndependent ContractorWorks ForWorks ForReceives Payment Receives Payment

FromFromUncontrolled Working Uncontrolled Working

Conditions/MethodsConditions/MethodsEmployer Not LiableEmployer Not Liable

11-177

Liability for Crimes Agent -LiableAgent -Liable Principal - Old rule, hard to impose Principal - Old rule, hard to impose

liability, but changing in some liability, but changing in some jurisdictionsjurisdictions

Foreign Representatives (varies with Foreign Representatives (varies with jurisdiction)jurisdiction)• Dependent Agents - greater Dependent Agents - greater

liabilityliability• Independent Agents - lesser Independent Agents - lesser

liabilityliability