Sole Proprietorships and Partnerships Slides developed by Les
Sole Proprietorships and Partnerships Slides developed by Les Wiletzky and Associates Copyright © 2006 by Pearson Prentice-Hall. All rights reserved.
Entrepreneur A person who forms and operates a new business either by him- or herself or with others. Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 2
Entrepreneurial Forms of Conducting Business Sole Proprietorship General Partnership Limited Liability Company Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Corporation 25 - 3
Sole Proprietorship n A form of business where the owner is actually the business n The business is not a separate legal entity n Sole proprietorships are the most common form of business organization in the United States Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 4
Advantages of a Sole Proprietorship (1 of 2) n The ease and low cost of formation n The owner’s right to make all management decisions concerning the business n Including those involving hiring and firing employees n The sole proprietor owns all of the business and has the right to receive all of the business’s profits Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 5
Advantages of a Sole Proprietorship (2 of 2) n A sole proprietorship can be easily transferred or sold if and when the owner desires to do so n No other approval (such as from partners or shareholders) is necessary Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 6
Disadvantages of a Sole Proprietorship n The sole proprietor’s access to capital is limited to personal funds plus any loans he or she can obtain n The sole proprietor is legally responsible for the business’s contracts and the torts committed by the proprietor and his or her employees in the course of employment Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 7
Creation of a Sole Proprietorship (1 of 2) n There are no formalities n No federal or state government approval is required n Some local governments require all businesses (including sole proprietorships) to obtain a license to do business within the city n A sole proprietorship can operate under the name of the sole proprietor or a trade name Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 8
Creation of a Sole Proprietorship (2 of 2) n A sole proprietorship is not a separate tax- paying entity for federal income tax purposes n A sole proprietor need not file an informational return with the Internal Revenue Service (IRS) n Income and losses are reported on the sole proprietor’s personal income tax return Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 9
Personal Liability of a Sole Proprietor (1 of 2) n The sole proprietor bears the risk of loss of the business n The owner will lose his or her entire capital contribution if the business fails n The sole proprietor has unlimited personal liability Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 10
Personal Liability of a Sole Proprietor (2 of 2) n Creditors may recover claims against the business from the sole proprietor’s personal assets n The law holds that a sole proprietorship is not a distinct legal entity n The sole proprietorship and the sole proprietor are one and the same Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 11
Sole Proprietorship Sole Proprietorsh ip Debt or obligation owed Third Party Capital investment Sole Proprieto r (Owner) Personal liability for sole proprietorship’s debts and obligations Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 12
General Partnership n A voluntary association of two or more persons for carrying on a business as coowners for profit n Also called a partnership n General partners, partners or partners are personally liable for the debts and obligations of the partnership Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 13
General Partnership General Partnersh ip Debt or obligation owed Third Party Capital investment General Partner Personal liability for partnership’s debts and obligations Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 14
Uniform Partnership Act (UPA) n Model act that codifies partnership law n Most states have adopted the UPA in whole or part n The UPA covers most problems that arise in the formation, operation, and dissolution of ordinary partnerships Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 15
Right to Participate in Management n Unless otherwise agreed, each partner: n Has a right to participate in the management of the partnership, and n Has an equal vote on partnership matters n Under the UPA, a simple majority decides most ordinary partnership matters Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 16
Right to an Accounting n A formal judicial proceeding in which the court is authorized to: Review the partnership and the partners’ transactions; and n Award each partner his or her share of the partnership assets n Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 17
Tort Liability of Partnerships and Partners n The partnership is liable if the tortious act of a partner or an employee or agent of the partnership is committed while the person is acting within the ordinary course of partnership business or with the authority of his or her co-partners Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 18
Joint and Several Tort Liability n Partners are jointly and severally liable for tort liability of the partnership i. e. , the plaintiff can sue one or more of the partners separately n If successful, the plaintiff can recover the entire amount of the judgment from any or all of the defendant-partners n Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 19
Summary: Personal Liability of General Partners Issue Joint Liability Joint and Several Liability Type of lawsuit Contract action Tort action Defendants Plaintiff must name all Plaintiff can sue partners as defendants individually Recovery If successful, the plaintiff can recover the judgment against all or any of the defendants Indemnificat Partner who pays ion judgment can recover contribution from other partners for their share Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. If successful, the plaintiff can recover the judgment against all or any of the named defendants Partner who pays judgment can recover contribution from other partners for their share of the judgment 25 - 20
Liability of Incoming Partners n A new partner who is admitted to the partnership is liable for the existing debts and obligations (antecedent debts) debts of the partnership only to the extent of his or her capital contribution n The new partner is personally liable for debts and obligations incurred by the partnership after becoming a partner Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 21
Dissolution of Partnerships (1 of 3) n Partnership for a term n A partnership for a fixed duration n Partnership at will n A partnership with no fixed duration n A partner has the power to withdraw and dissolve the partnership at any time, but he or she may not have the right to do so Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 22
Dissolution of Partnerships (2 of 3) n Wrongful dissolution n When a partner withdraws from a partnership without having the right to do so at that time n The partner is liable for damages caused by the wrongful dissolution of the partnership n Notice of dissolution must be given to certain third parties n The degree of notice depends on the relationship of the third person with the partnership Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 23
Dissolution of Partnerships (3 of 3) n Continuation of a partnership after dissolution n The surviving or remaining partners have the right to continue the partnership after dissolution n Liability of outgoing partners n The dissolution of a partnership does not itself discharge the liability of outgoing partners for existing partnership debts and obligations Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 24
Limited Partnership n A type of partnership that has two types of partners: n General Partners – who invest capital, manage the business, and are personally liable for partnership debts n Limited Partners – who invest capital but do not participate in management and are not personally liable for partnership debts beyond their capital contribution Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 25
The Revised Uniform Limited Partnership Act (RULPA) n A 1976 revision of the ULPA n Provides a more modern comprehensive law for the formation, operation, and dissolution of limited partnerships Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. n A majority of states 25 - 26 Uniform Limited Partnership Act (ULPA) of 1916 n Contained a uniform set of provisions for the formation, operation, and dissolution of limited partnerships n Most states originally enacted this law
Limited Partnership Limited Partnersh ip Debt or obligation owed Third Party Capital investment Limite Gener d d al al Partne r r Liability limited to capital No personal liability for contribution Personal liability for partnership’s debts and obligations Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. obligations 25 - 27
Formation of Limited Partnerships (1 of 2) n The creation of limited partnerships is formal and requires public disclosure n The entity must comply with the statutory requirements of the RULPA or other state statute n Certificate of Limited Partnership – a document that two or more persons must execute and sign that makes the limited partnership legal and binding Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 28
Formation of Limited Partnerships (2 of 2) n Limited Partnership Agreement – a document that sets forth: The rights and duties of the general and limited partners; and n The terms and conditions regarding the operation, dissolution, and termination of the limited partnership n Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 29
Summary: Liability of Limited Partners General Rule Limited partners are not individually liable for the obligations or conduct of the partnership beyond the amount of their capital contribution. Exceptions to the General Rule Limited partners are individually liable for the debt, obligations, and tortious acts of the partnership in three situations: 1. Defective Formation 2. Participation in Management 3. Personal Guarantee Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 30
Defective Formation Occurs when: 1. A certificate of limited partnership is not properly filed, 2. There are defects in a certificate that is filed, or 3. Some other statutory requirement for the creation of a limited partnership is not met Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 31
Limited Liability Partnership (LLP) (1 of 4) n A special form of partnership where all partners are limited partners and there are no general partners n None of the partners is personally liable for the debts and obligations of the partnership beyond his or her capital contribution Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 32
Limited Liability Partnership (LLP) (2 of 4) Limited Liability Partnershi p (LLP) Debt or obligation owed Third Party Capital investment Limite d Partne r Limite d d Partne r r Liability limited to capital No personal liability for contribution partnership’s debts and obligations Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. Limite d Partne r 25 - 33
Limited Liability Partnership (LLP) (3 of 4) n The LLP is taxed as a partnership n Each partner’s share of the income or loss from the partnership is reported on his or her individual income tax return n The LLP is required to file an informational income tax return with the IRS n LLPs are mainly used by professionals such as accountants and lawyers Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 34
Limited Liability Partnership (LLP) (4 of 4) n Many state laws require LLPs to carry a minimum of $1 million of liability insurance that covers negligence, wrongful acts, and misconduct by partners or employees of the LLP n This requirement guarantees that injured third parties will have compensation to recover for their injuries Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 35
LLP: Articles of Partnership n Must be filed with the secretary of state of the state in which the LLP is organized n The LLP is a domestic LLP in the state in which it is organized n The LLP must register as a foreign LLP in any other state in which it wants to conduct business Copyright © 2006 by Pearson Prentice-Hall. All rights reserved. 25 - 36
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