Chapter 13 Choice of Business Entity Sole Proprietorship

Sole Proprietorships n Ease of formation and maintenance makes this entity a popular choice. n Sole proprietorships are typically capitalized using a proprietor’s personal resources or through a private or commercial loan that is secured by the proprietor’s personal assets. 2

General Partnerships n Unlike most business entities, general partnerships are not created by filing a form with a government agency. n Instead, the law recognizes two or more principals as being a general partnership if they have demonstrated an intent to carry on as co-owners of a business for profit. 3

Liability of the Partners n General partners have no protection of their personal assets for unpaid debts and liabilities of the partnership. n The RUPA imposes additional liability on general partners who are jointly and severally liable. n This means that general partners’ personal assets are at risk both together (jointly) and separately (severally) for all debts and liabilities of the partnership regardless of the source of the debt or liability. 4

Taxation of Partnership and Principals n Just as in the case of a sole proprietorship, a partnership is a pass-through entity. n This means that the partnership entity pays no level of corporate tax. n Rather, profits are taxed after they pass through the business and are distributed to the individual partners. 5

Capitalization n General partnerships are generally funded through debt (borrowing money), or n Selling of equity (selling a percentage of ownership rights in the partnership). n Partnerships may not, however, sell ownership rights (stock) through the public markets. 6

Operation and Management of the Partnership n Absent an agreement by the parties, the RUPA governs certain internal operations of the general partnership. For example, unless the parties agree otherwise: q q q each partner receives an equal share of the partnership profit payments regardless of the partner’s involvement in the success of the business, the same rule applies to losses, general partners have the general power to bind the partnership to a contractual obligation. 7

Limited Partnerships n An entity that exists by a state statute that recognizes one or more principals as general partners managing the business enterprise with unlimited liability. n Limited partners normally participate only in terms of contributing capital or property, and have limited liability. 8

Personal Liability of Principals n Each general partner in a limited partnership is personally liable for all of the partnership’s debts and liabilities. n Limited partners do not have the same automatic personal liability of a general partner, it is limited to whatever the limited partner contributed to the partnership. 9

Management and Operation of LP n Under the RULPA, limited partners may engage in consulting and contribute expertise, but may not engage in management activities such as supervision of employees. 10

Partner Dissociation and Dissolution of the Partnership n When a partner no longer wishes to be a principal in the partnership, she may choose to leave the partnership. n The RUPA uses the term dissociation to describe this act of separation while the RULPA uses the term withdrawal. 11

Withdrawal under RULPA n RULPA sets down default rules for withdrawal of partners if no written agreement. n A general partner may withdraw provided that the partnership still has at least one remaining general partner, and the partners (both general and limited) agree in writing to continue. n Limited partners are subject to restrictions on withdrawal. 12

learning outcomes checklist n 13 - 1 Articulate the factors that business owners should consider when selecting a business entity. n 13 - 2 List the elements required to form a general partnership and the statutory requirements forming a limited partnership. 13

learning outcomes checklist n 13 - 3 Recognize the effect and role of the RUPA for general partnerships and the RULPA for limited partnerships. n 13 - 4 Identify methods through which sole proprietorships and partnerships may be capitalized (funded). 14

learning outcomes checklist n 13 - 5 Distinguish between personal liability for general partners and limited partners. n 13 - 6 Explain the concept of pass-through taxation. n 13 - 7 Articulate the consequences of partner separation and dissolution. 15