Chapter 12: Sole Prop., Partnerships, Corporations Sole Proprietorship Sole Proprietorship and Section 27.1 Sole Proprietorship Chapter 27 Partnership Section 27.1 Sole Proprietorship Section 27.2 The Partnership Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship What You’ll Learn How to define sole proprietorship (p. 584) How to create a sole proprietorship (p. 584) Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship What You’ll Learn How to identify the advantages of a sole proprietorship (p. 585) How to identify the disadvantages of a sole proprietorship (p. 587) Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Why It’s Important Understanding the nature of a sole proprietorship will help you decide when to form that type of business association rather than the other associations that are available in the market today. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Legal Terms sole proprietorship (p. 584) fictitious name (p. 584) employer identification number (p. 585) unlimited liability (p. 587) Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section Outline Creation and Operation of a Sole Proprietorship Advantages of a Sole Proprietorship Disadvantages of a Sole Proprietorship Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Pre-Learning Question What is a sole proprietorship? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Creation and Operation of a Sole Proprietorship A sole proprietorship is a form of business that is owned and operated by one person. However, that owner may have any number of agents or employees. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Creation and Operation of a Sole Proprietorship A sole proprietorship is the most common type of business and the easiest to form. Examples include: Repair shops Small retail stores Service organizations Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Creation and Operation of a Sole Proprietorship A person who goes into business as a sole proprietor can choose to operate under his or her own name or can make up a name. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Creation and Operation of a Sole Proprietorship If a sole proprietor uses anything but his or her own name, the law calls the made-up name a fictitious name. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Creation and Operation of a Sole Proprietorship In selecting a fictitious name, sole proprietors must not choose a company name already in use. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Creation and Operation of a Sole Proprietorship There usually are few formal requirements in establishing a sole proprietorship. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Creation and Operation of a Sole Proprietorship Some may be required to have Licenses to legally operate as businesses Occupational licenses Certain types of liability insurance Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Creation and Operation of a Sole Proprietorship Some states require a formal filing when a sole proprietorship begins or if the sole proprietorship chooses to use a fictitious name. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Advantages of a Sole Proprietorship Ease of creation Total control Retention of profits Freedom from excessive governmental control One-time taxation of profits Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Ease of Creation A sole proprietorship is the easiest form of business association to form. To create a sole proprietorship, a person needs only to begin the operation of the business. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Ease of Creation When a sole proprietor decides to hire workers, he or she will have to contact the Internal Revenue Service to obtain an employer identification number, which is assigned for income tax purposes. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Total Control In a sole proprietorship, while the sole proprietor is free to seek the advice of experts, such as accountants, attorneys, and financial planners, all decisions are up to the sole proprietor. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Retention of Profits Sole proprietors get to keep all of the profits that the firm makes. They must, of course, pay taxes on those profits. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Freedom from Excessive Governmental Control The regulations a sole proprietor must follow are much less cumbersome than the regulations required of other types of business ownership, such as limited partners and corporations. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship One-Time Taxation of Profits Sole proprietorships do not pay taxes as a business. Rather, the individual sole proprietor who owns the business pays taxes based upon his or her income, which includes any profits made by the business. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Disadvantages of a Sole Proprietorship Limited capital Unlimited liability Limited human resources Limited lifetime Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Limited Capital All money used to finance the business must come from the proprietor’s savings or income, or from loans obtained by the proprietor. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Unlimited Liability Unlimited liability means that the business owner is responsible for all losses experienced by the business. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Limited Human Resources As the only person responsible for the decisions that affect the business, a sole proprietor is subject to tremendous stress. Even if he or she consults experts, the decision-making responsibility still falls upon the owner. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Limited Lifetime Unlike a corporation, which has perpetual existence, a sole proprietorship lasts only as long as the proprietor. When the proprietor dies or sells or closes the business, the company no longer exists. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Amira wants to start her own business. She really doesn’t like the idea of working for someone else— she wants work to suit her own schedule and she has very definite ideas about how a business should be run. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Her idea is to open a slushee and fruit juice stand near the city park. However, she estimates the stand will cost about $7,500 to open and she has only saved $4,000. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Given Amira’s circumstances, name one advantage Amira would find to having a sole proprietorship. Name one disadvantage. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship ANSWER Advantage—total control; disadvantage—limited capital. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.1 Assessment Reviewing What You Learned 1. What is a sole proprietorship? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.1 Assessment Reviewing What You Learned Answer A form of business that is owned and operated by one person. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.1 Assessment Reviewing What You Learned 2. How does a sole proprietorship begin? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.1 Assessment Reviewing What You Learned Answer To create a sole proprietorship, a person needs only to begin the operation of the business. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.1 Assessment Reviewing What You Learned 3. What are the advantages of a sole proprietorship? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.1 Assessment Reviewing What You Learned Answer Ease of creation, total control, retention of profits, freedom from excessive governmental control, and one-time taxation of profits. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.1 Assessment Reviewing What You Learned 4. What are the disadvantages of a sole proprietorship? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.1 Assessment Reviewing What You Learned Answer Limited capital, unlimited liability, limited human resources, and limited lifetime. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.1 Assessment Critical Thinking Activity Licensing Requirements Why does the government interfere in the formation and regulation of some sole proprietorships by creating licensing requirements? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.1 Assessment Critical Thinking Activity Answer Licensing Requirements Answers will vary but could recognize that licensing requirements may be necessary for public safety. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.1 Assessment Legal Skills in Action The Responsibilities of a Sole Proprietor Your Aunt Matilda, a sole proprietor, owns a store called Scrapbook Heaven. She has decided to hire you and your friend Ted to work in the store on the weekends. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.1 Assessment Legal Skills in Action The Responsibilities of a Sole Proprietor Aunt Matilda is convinced that hiring you and Ted will not involve any new entanglement with the government. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.1 Assessment Legal Skills in Action The Responsibilities of a Sole Proprietor Send Aunt Matilda an e-mail message that explains the responsibilities of a sole proprietor who hires additional workers. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.1 Assessment Legal Skills in Action Answer The Responsibilities of a Sole Proprietor E-mails will vary, but should include that once Aunt Matilda hires you and Ted, she will have to contact the Internal Revenue Service to obtain employer identification numbers. Understanding Business and Personal Law Sole Proprietorship and Partnership End of Section 27.1 Sole Proprietorship Section 27.2 Sole Proprietorship Section 27.1 Sole Proprietorship What You’ll Learn How to define general partnership (p. 588) How to identify the ways that a partnership can be created (p. 588) Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship What You’ll Learn How to identify partnership rights in relation to property (p. 593) How to explain the effects of the dissolution of a partnership (p. 597) Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Why It’s Important Understanding the nature of a partnership will help you decide when to form that type of business association. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Legal Terms general partnership (p. 588) articles of partnership (p. 588) partnership by proof of existence (p. 590) partnership by estoppel (p. 591) tenancy in partnership (p. 593) Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Legal Terms joint liability (p. 596) dissolution (p. 597) registered limited liability partnership (p. 598) limited partnership (p. 599) Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section Outline The Nature of Partnership Forming a General Partnership Types of Partners Partnership Property Property Rights of Partners Duties of the Partners Liability of the Partners Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section Outline Dissolving a Partnership Effects of Dissolution Distribution of Assets Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section Outline The Revised Uniform Partnership Act Registered Limited Liability Partnerships Limited Partnerships Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Pre-Learning Question What is a partnership? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship The Nature of Partnership Partnership law is largely found in the Uniform Partnership Act (UPA). The UPA defines partnership as “an association of two or more persons to carry on a business for profit.” Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Advantages of Partnerships More capital and credit available. Burden of work is shared. Responsibility for losses shared. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Disadvantages of Partnerships Partners share in the liabilities. Each partner is responsible for the others’ actions. Must share profits. Disagreements among partners. Death of a partner dissolves the partnership. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Forming a General Partnership When two or more competent parties combine their money, labor, and skills for the purpose of carrying on a lawful business, they create a general partnership. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Forming a General Partnership General partnerships can be formed in one of three ways: 1. By agreement 2. By proof of existence 3. By estoppel Understanding Business and Personal Law Sole Proprietorship and Partnership 27.2 27.1 Sole Proprietorship Section Partnership Formation Partnership by contract Express agreement drawn up by partners Articles of partnership Partnership by proof of existence Individuals form partnership because of their method of doing business Sharing of profits is prima facie evidence Partnership by estoppel Third party led to believe a partnership exists No true partnership created Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship By Agreement Forming a general partnership by agreement requires the valid assent of all parties. Such an agreement is usually express and may be written or oral. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship By Agreement Under the Statue of Frauds, if a partnership is to last more than a year or if the partnership is formed to sell, buy, or lease real property, it must be evidenced in writing. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship By Agreement The partnership agreement is known as the articles of partnership, or as the articles of copartnership. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Important Points Covered in an Agreement Parties to the agreement Specific nature, scope, and limits of the business Planned duration of the business Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Important Points Covered in an Agreement Amount of each partner’s original investment and procedure for future investments Provisions regarding salaries, withdrawal of funds, and the division of profits Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Important Points Covered in an Agreement Terms under which a partner may withdraw from the partnership Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship By Proof of Existence Sometimes a partnership can be formed because of the way that two or more people conduct their business together. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship By Proof of Existence Such a partnership, which forms regardless of the label given to the enterprise or the intent of the parties involved, is termed a partnership by proof of existence. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship By Estoppel If someone does or says something that leads a third party to believe that a partnership exists, then a court may treat the arrangement as a partnership by estoppel. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship By Estoppel This type of partnership is not a real partnership. It is a way for the court to prevent injustice because someone has relied on the words or actions of another party and has acted accordingly. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Types of Partners There are five types of partners: 1. General 2. Secret 3. Silent 4. Dormant 5. Limited Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Types of Partners Each of these partners is a co-owner of the business and has some liability for the debts of the firm. Understanding Business and Personal Law Sole Proprietorship and Partnership 27.2 27.1 Sole Proprietorship Section Types of Partners Type of Partner Participation in the Business Relationship to the Public Degree of Liability General Active Known Unlimited Secret Active Unknown Unlimited Silent Not active Known Unlimited Dormant Not active Unknown Unlimited Limited Not active Known Limited Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Partnership Property It is important to distinguish between property that belongs to the partnership and property that belongs to individual partners. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Partnership Property Is property contributed directly to the partnership when the partnership is created. Is property that is bought with partnership funds. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Partnership Property In addition, the court may ask certain questions to determine whether or not certain property belongs to the partnership. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Property Rights of the Partners Certain rights arise regarding property that belongs to the partnership. These include: The right to use the property The right to manage the firm The right to share in the profits Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Right to Use Property Partners are co-owners of all the real and personal property included in the partnership. This co-ownership is called tenancy in partnership by the UPA. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Right to Use Property As a result, the partners can use the property for partnership business; however, there are limitations. For example, a partner cannot, on his or her own, transfer ownership of the property. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Right to Manage the Firm Unless a partner’s rights are limited in the partnership agreement, each partner has an equal voice in managing the partnership’s business. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Right to Share in the Profits Unless there is an agreement to the contrary, partners share equally in the profits, regardless of their initial capital contribution or the time devoted by each partner to the business. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Duties to the Partners Partners must trust one another. Each partner is an agent of the other partner and has duties comparable to those of an agent. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Duties to the Partners 1. To always act in good faith and in the best interests of the firm. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Duties to the Partners 2. To always use their best skill and judgment in looking after the firm’s affairs. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Duties to the Partners 3. To be loyal to the firm and put the firm’s interests first. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Liability of the Partners Partners have unlimited liability for all of the debts of the partnership incurred while they are partners, even to the extent of their personal assets. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Liability of the Partners Partners are liable to other members of the firm for their share of the firm’s debts. Partners share losses in the same proportion that they share profits. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Liability of the Partners Partners are jointly liable with their partners on contracts entered into by any member of the firm acting within the actual or apparent scope of the firm’s business. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Liability of the Partners Joint liability means that in the event of a lawsuit, all the partners must be sued together. Partners are jointly and severally (separately) liable for torts committed within the scope of the firm’s business. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Pre-Learning Question How do partnerships come to an end? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Dissolving a Partnership A dissolution is a legal detachment. The dissolution of a partnership is a change in the relationship of the partners that occurs when any partner stops being associated with the business. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Effects of Dissolution Dissolution does not necessarily bring the business to an end. Other partners may want to continue in business together. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Effects of Dissolution If so, New financial arrangements need to be made. A new agreement must be drawn up. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Effects of Dissolution Public notice is usually given to relieve retiring partners from liability for any new debts. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Distribution of Assets Upon dissolution, an accounting of the firm’s financial affairs is necessary to determine how the firm’s assets will be distributed or divided. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Distribution of Assets Liabilities are paid in this order: 1. Money owed to creditors other than partners. 2. Money lent by partners to the firm. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Distribution of Assets 3. The original money paid into the partnership by each partner. 4. The surplus, if any, owed to the partners. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Distribution of Assets If the business is insolvent: Assets are sold to pay the creditors. Partners are individually liable for any unpaid balance that the sale of the assets will not cover. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship When Jess and Joe’s Café closed, they had $38,000 and owed $25,000 to creditors. Neither Jess nor Joe had any outstanding loans to the business, but each had paid $5,000 into the business to start it. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Will Jess and Joe get their money back? Will there be any additional money left over? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship ANSWER Yes, Jess and Joe will get their money back. There will $3,000 left over. $38,000 – 25,000 = 13,000 –10,000 = $3,000. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Pre-Learning Question What is the Revised Uniform Partnership Act? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship The Revised Uniform Partnership Act Since the UPA was written in 1914, it has undergone extensive revision. This new variation of the act is referred to as the Revised Uniform Partnership Act (RUPA). Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Pre-Learning Question What is a registered limited liability partnership? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Registered Limited Liability Partnerships A registered limited liability partnership (RLLP) is a new type of partnership designed to eliminate a major disadvantage of the general partnership—joint and several liability. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Registered Limited Liability Partnerships Partners of an RLLP can escape joint and several liability for the torts, wrongful acts, negligence, or misconduct of other partners by registering with the appropriate state office. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Pre-Learning Question What is a limited partnership? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Limited Partnership According to RUPA, a limited partnership is “a partnership formed by two or more persons. . . having one or more general partners and one or more limited partners.” Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Limited Partnership Limited partnerships are often used in real estate ventures and tax shelter investments. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.2 Assessment Reviewing What You Learned 1. What is a general partnership? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.2 Assessment Reviewing What You Learned Answer An association of two or more persons to carry on a business for profit. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.2 Assessment Reviewing What You Learned 2. How can a partnership be created? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.2 Assessment Reviewing What You Learned Answer By agreement, by proof of existence, and by estoppel. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.2 Assessment Reviewing What You Learned 3. What are the partner’s rights in relation to property? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.2 Assessment Reviewing What You Learned Answer The right to use partnership property, the right to manage the firm, and the right to share profits. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.2 Assessment Reviewing What You Learned 4. What are the effects of the dissolution of a partnership? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.2 Assessment Reviewing What You Learned Answer Dissolution need not end a partnership. Other partners may wish to continue the business. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.2 Assessment Reviewing What You Learned Answer New financial arrangements must be made in regard to the new firm. A new agreement must be drawn up regarding the conduct of the new firm. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 27.2 Assessment Reviewing What You Learned Answer Public notice must usually be given in order to relieve the retiring partners from liability for any new debts created by the new firm. Understanding Business and Personal Law Sole Proprietorship and Partnership End of Section 27.2 Sole Proprietorship Section 28.1 Sole Proprietorship Section 27.1 Sole Proprietorship What You’ll Learn How to define corporation (p. 606) How to distinguish among various types of corporations (p. 607) How to create a corporation (p. 608) Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship What You’ll Learn How to finance a corporation (p. 614) How to distinguish between a corporation and a limited liability company (p. 616) Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Why It’s Important Understanding the nature of a corporation will help you decide when to form one rather than the other associations that are available. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Legal Terms corporation (p. 606) shareholder (p. 606) share (p. 606) promoter (p. 608) articles of incorporation (p. 610) Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Legal Terms certificate of incorporation (p. 612) common stock (p. 614) dividends (p. 614) preferred stock (p. 614) limited liability company (p. 616) Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section Outline The Nature of a Corporation Advantages of a Corporation Disadvantages of a Corporation Types of Corporations Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section Outline Forming a Corporation The Incorporation Process Corporate Financing Forming a Limited Liability Company Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section Outline Incorporation Problems De Facto Corporation Corporation by Estoppel Piercing the Corporate Veil Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Pre-Learning Question What is a corporation? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship The Nature of a Corporation A corporation is a body formed and authorized by law to act as a single person, distinct from its members or owners. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship The Nature of a Corporation About 90 percent of all business in the United States is done by corporations. Not all corporations are large businesses. Approximately 40 percent of all corporations employ fewer than five employees. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship The Nature of a Corporation An individual who owns shares of a corporation is called a shareholder or a stockholder. A share is a single unit of ownership of a corporation. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship The Nature of a Corporation Each shareholder has one vote for each share of stock that he or she owns. Shareholders cast their votes to elect a board of directors whose duty is to direct the corporation’s business. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Advantages of a Corporation Selling shares enables a corporation to tap into a large source of capital. Shareholder’s liability is limited to the amount of money he or she paid for shares in the corporation. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Advantages of a Corporation It is a legal entity and has the power to make contracts, buy and sell goods, and sue and be sued. It has continuity of existence, regardless of the lifespans of founders, shareholders, and directors. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Disadvantages of a Corporation A corporation’s income may be taxed more than once. First as the company profits; then shareholders’ dividends become part of their taxable income. Large corporations face extensive government regulation. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Disadvantages of a Corporation Original founders can lose not only control but also actual ownership. Because of the prominence of some corporations, business decisions may be subject to close scrutiny. Understanding Business and Personal Law Sole Proprietorship and Partnership 28.1 27.1 Sole Proprietorship Section Types of Corporations Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Pre-Learning Question How is a corporation formed? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Forming a Corporation Each state has its own version of corporate law. States may use: The Model Business Corporation Act (MBCA) The Revised Model Business Corporation Act (RMBCA) Their own statutes Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship The Incorporation Process 1. A promoter carries out the incorporation process by taking the initial steps to organize and finance a business. 2. Promoters choose a corporate name. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship The Incorporation Process 3. Promoters are responsible for drawing up and filing the articles of incorporation, an application for incorporation of a business that describes a corporation’s organization, powers, and authority. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship The Incorporation Process 4. A filing fee completes the application. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship The Incorporation Process 5. After the application is approved by the secretary of state, the corporation receives a certificate of incorporation, its official authorization to do business in the state (also called a charter). Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship The Incorporation Process 6. Initial shareholders elect a board of directors who replace the original incorporators. 7. Directors elect a chairman and top corporate officers to manage the company. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Articles of Incorporation The articles of incorporation usually include the following information: Name of the corporation, including the words company, incorporated, or corporation or appropriate abbreviations. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Articles of Incorporation Proposed duration of the corporation. Purpose(s) of the corporation. Number, classes, and value of corporate shares. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Articles of Incorporation Shareholders’ rights in relation to shares, classes of shares, and special shares. Address of the original registered or statutory agent. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Articles of Incorporation Names and signature of the initial directors. Names and signatures of the incorporators. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Corporate Financing A corporation may choose to issue several different kinds of stock. Along with each share of stock come certain rights. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Types of Stock Common stock is the basic form of corporation ownership. Owners have voting rights. It pays dividends, or profits, to the shareholders based on the corporation’s performance. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Types of Stock Preferred stock is the second type of stock issued by a corporation. Owners have no voting rights. But do receive a fixed dividend. Preferred stock dividends are paid before common stock dividends. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Draw a flow chart that describes the relationship between the following people. Board of directors Initial shareholders Chairperson Top corporate officers Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship ANSWER Initial shareholders hire board of directors who elect the chairperson and top corporate officers. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Pre-Learning Question What is a limited liability company? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Forming a Limited Liability Company A limited liability company (LLC) is a new type of business enterprise that has been adopted by all states. It is a combination of a partnership and a corporation. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Forming a Limited Liability Company LLCs offer limited liability to its owners. Like the partners in a partnership, the owners of an LLC escape double taxation. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Forming a Limited Liability Company LLCs are statutory entities—they can be formed only if owners follow the legal steps required—and must also have a statutory agent for service of process. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Pre-Learning Question How does the law deal with incorporation problems? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Incorporation Problems The courts have developed two doctrines—de facto corporations and corporation by estoppel—to deal with incorporation problems. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship De Facto Corporation Even when making a good faith attempt to incorporate, promoters sometimes inadvertently make an error in filing, or fail to complete the incorporation. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship De Facto Corporation The laws says that, although the corporation does not exist in law (de jure), it does exist in fact (de facto). This type of corporation is called a de facto corporation. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Corporation by Estoppel Like other estoppel doctrines, corporation by estoppel stops people from denying the consequences of their own actions. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Corporation by Estoppel Corporation by estoppel usually occurs when some party has been willing to treat a person or a group of people as a corporation, generally reaping some benefit from the relationship. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Corporation by Estoppel When this happens, the court will not allow that party to then deny the existence of the corporation because doing so would be unfair. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Piercing the Corporate Veil Sometimes there are extreme circumstances in which the courts will deny shareholders the benefits of limited liability and hold them personally liable. This is known as piercing the corporate veil. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 28.1 Assessment Reviewing What You Learned 1. What is a corporation? Who are its owners? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 28.1 Assessment Reviewing What You Learned Answer An artificial person created by law owned by shareholders or stockholders. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 28.1 Assessment Reviewing What You Learned 2. What are the two main types of corporations? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 28.1 Assessment Reviewing What You Learned Answer Public and private. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 28.1 Assessment Reviewing What You Learned 3. What are the steps necessary to form a corporation? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 28.1 Assessment Reviewing What You Learned Answer Promoters choose a corporate name, draw up and file articles of incorporation with the office of the secretary of state, pay the filing fee, and receive the certificate of incorporation; Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 28.1 Assessment Reviewing What You Learned Answer initial shareholders elect a board of directors; and directors elect a chairman and top officers to manage the corporation. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 28.1 Assessment Reviewing What You Learned 4. How are corporations financed? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 28.1 Assessment Reviewing What You Learned Answer By selling shares of stock in the corporation. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 28.1 Assessment Reviewing What You Learned 5. What is the difference between a corporation and a limited liability company? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 28.1 Assessment Reviewing What You Learned Answer A limited liability company is a combination of a partnership and a corporation. Like a corporation, it offers limited liability to its owners. Like a partnership, the owners escape double taxation. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 28.1 Assessment Critical Thinking Activity Advantages and Disadvantages of a Corporation If you had a chain of very successful restaurants in a large city, why might you decide to incorporate the business? Why might you decide not to incorporate? Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 28.1 Assessment Critical Thinking Activity Answer Advantages and Disadvantages of a Corporation Answers will vary, but could include raising capital for further expansion as an advantage and additional government regulation as a disadvantage. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 28.1 Assessment Legal Skills in Action Forming a Corporation Your brother, Dirk, wants to start a business manufacturing playground equipment using recyclable materials, such as plastics and old tires. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 28.1 Assessment Legal Skills in Action Forming a Corporation He wants to organize his company as a corporation in order to raise capital to build his manufacturing plant, but he isn’t sure how to go about it. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 28.1 Assessment Legal Skills in Action Forming a Corporation Write a letter to Dirk outlining the steps he should take to incorporate his business. Understanding Business and Personal Law Sole Proprietorship and Partnership Section 27.1 Sole Proprietorship Section 28.1 Assessment Legal Skills in Action Answer Forming a Corporation Letters will vary, but should include contacting the secretary of state’s office in Dirk’s state. Understanding Business and Personal Law Sole Proprietorship and Partnership End of Section 28.1 Sole Proprietorship