Business Entity
Formations
Nema Koohmaraie and Matt Hinrikus
UNL College of Law – Entrepreneurship Legal Clinic
Disclaimer
• The content of this presentation is intended solely as a brief
summary of entity choices available to individuals starting a
business operation. The information provided during this
presentation shall not be construed as legal advice
• We are not tax experts. Consult your accountant or tax
attorneys to supplement the tax considerations
Discussion Points
• Overview of Business Entity Structures
• Benefits & Values of Entity Formation
• Types of Entities
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Sole Proprietorship
Partnership – General or Limited
Corporation – C-Corp. or S-Corp.
Limited Liability Company (LLC)
• Differences
Benefits of Entity Formation
• Corporate Shield – a.k.a., liability protection
• Appearance of Legitimacy
• Means to raise capital from outside investors
• Method of combining valuable assets
• E.g., intellectual property
• Business continuity and planning
Sole Proprietorship
• Composed of one individual who owns and operates a
business – Default entity
• No separation or distinction as between the owner and the
business
• No statutory requirements to create
• Trade Name Application if going to conduct business in something
other than the name of the owner
• Applicable licenses or permits
Sole Proprietorship
• Taxation
• Owner of the business reports income or loss directly on his or
her personal income tax return
• Liability of Owner
• Owner of the business is personally liable for debts & obligations
of business and for negligent acts committed by themselves and
their employees if acting within the scope of employment
Partnerships
• An association of two or more persons to carry on a business
for profit as co-owners
• Two Types
• General Partnership
• Limited Partnership
General Partnership
• Partnership Formation
• Default entity
• Automatically forms when two or more individuals are carrying
on a business for profit as co-owners
• Operations
• Partnership Agreement; OR
• Revised Uniform Partnership Act (governing law)
General Partnership
• Taxation
• Partnership files an informational income tax return, but the
Partnership itself does not pay income taxes
• Pass-Through Entity
• Income or loss is attributed to the owners/partners equally
• Note: Sharing of profits or losses can be determined by the
Partnership Agreement
General Partnership
• Liability of Owners/Partners
• Shared liability by all partners
• Joint and Several
• Any one partner can bind other partners
• Contract
• Negligence
General Partnership
• Advantages
• Simple and Inexpensive to create
• Partners report their share of profits or losses on their own
income tax return
• Disadvantages
• Partners are personally liable for debts & obligations of the
business
Limited Partnership
• Formation
• Must file a Certificate of Limited Partnership with Secretary of
State
• Operations – Two Types of Partners
• General Partners: Active investor and actively involved in the day
to day operations and management
• Limited Partners: Do not participate in day to day operations and
management – passive investors
Limited Partnership
• Taxation
• Based on value of individual contributions
• Tax liability is not equal among partners
• Liability of Owners/Partners
• General Partners: Subject to personal liability for debts &
obligations of business (similar to General Partnership)
• Limited Partners: Not subject to personal liability for debts &
obligations of business
Limited Partnership
• Advantages
• Limited partners are not personally liable for business debts
(generally)
• General partner can raise capital from the passive investors
(limited partners) without giving up management in business
• Disadvantages
• General Partners are personally liable for business debts
Alternatives
• Is there a way to limit the liability of all owners while allowing
easy transferability of ownership interests?
• YES – Corporations or Limited Liability Companies
Limited Liability Entities
• Our purpose today  Corporations or LLCs
• Legal entity, separate & distinct from the owners
• Created by statutory law
• Limited liability of business owners
• Not liable for debts incurred by the business
• Unless exceptions apply – Piercing Corporate Veil
Requirements
• Must file with the Nebraska Secretary of State
• Articles of Incorporation (Corporations)
• Certificate of Organization (LLCs)
• Must draft and execute – governing document
• Corporate Bylaws (Corporations)
• Operating Agreement (LLCs)
Limited Liability Entity or Not
• Increased Likelihood of incurring liability
• Selling products or services
• Hiring more employees
• Entering into contracts – e.g., leases, loans, sales
• Multiple owners
• Additional investors
Corporation or LLC
• Things to Consider:
• Financing needs
• Investors, Venture Capitalists, Angel Capitalists tend to prefer
corporation status
• Management
• Board of Directors & Officers (Corporations); OR
• Member- or Manager-Managed (LLCs)
• Tax & Liability
Corporations
• Corporate law is state law
• Approx. 50% of corporations incorporate in Delaware
• Internal Affairs Rule: the laws of the state of incorporation
govern internal corporate affairs
• Foreign Business Rule: if incorporated in a state other than
where conducting business, must qualify/register to operate
business in the “foreign” jurisdiction
Corporations
• Operations
• Shares of Stock = Ownership Interest = Shareholder
• Board of Directors = primary decision makers
• Election process is established in the Articles or Bylaws
• Can reserve certain decision-marking authority to Shareholders
• Officers = day to day decision makers
• Elected by Board of Directors
• President, VP, Secretary, Treasurer, etc.
Corporations
• Liability of Owners/Shareholders
• Separate legal entity, distinct from Owner/Shareholders
• General Rule: Entity is liable for corporate debts & obligations
• Exceptions:
• Piercing the Corporate Veil (PCV)
• Personal Contractual Guarantees
Corporations
• Two Choices:
• C-Corporations (C-Corp.)
• S-Corporations (S-Corp.)
C-Corporation
• Taxation
• Double Taxation
• First, taxed at the corporate level – corporation reports and pays
income taxes
• Second, taxed at the individual level – shareholders report and pay
income tax on any distributions paid out to them
S-Corporation
• Corporation that makes a valid election to be taxed under
Subchapter S of Chapter 1 of the Internal Revenue Code
• File Form 2553
• Taxation
• Pass-Through
• No taxation at corporate level
• Only taxed at individual level if shareholders are paid distributions
S-Corporation
• Restrictions on S-Corporation
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Domestic Corporation
Allowed only 1 class of stock
Maximum of 100 shareholders
Shareholders must be U.S. citizens or residents
Profits and Losses allocated proportionately
Limited Liability Company
• Flexible structure: Can take the form of a General Partnership,
but provides the limited liability of a corporation
• Formation
• Must file Certificate of Organization with Nebraska Secretary of
State
Limited Liability Company
• Operations
• Operating Agreement (governing contract)
• Nebraska Limited Liability Company ct (governing law)
• Management Structure
• Member-Managed – Default
• All members (owners) have decision-making authority in day to day
operations of business
• Manager-Managed
• Must be elected in the Operating Agreement
• Decision-making authority is given to one or more persons
Limited Liability Company
• Taxation – various possibilities
• Default: Pass-Through entity
• Election
• C-Corporation treatment: taxed at corporate and individual levels;
OR
• S-Corporation treatment: Pass-Through entity
• Liability
• Neither members or managers are subject to personal liability for
debts & obligations of business
Limited Liability Company
• Advantages
• Owners have limited liability for business debts even if they
participate in management of the business
• Profit and Loss can be allocated differently than ownership
interest
• Choice of taxation structure
• Disadvantages
• More expensive to create than a Partnership or Sole
Proprietorship
Summary
• Business Entity Formation matters greatly
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Tax Implications
Liability of Owners
Future Financing & Investor Preference
Internal Operations
Default Rules
Contact Us
• Write us:
Entrepreneurship Legal Clinic
University of Nebraska College of Law
7 McCollum Hall
Lincoln, NE 68583-0902
• Give us a call:
402-472-1680
• Visit our website:
http://law.unl.edu/eclinic