FORMS OF BUSINESS OWNERSHIP The following provides descriptions of forms of business structure that can be useful to help businesses that are considering an acquisition. These th descriptions are quoted from: “The Business Reference Guide, 10 Edition, Business Brokerage Press. Concord, MA 2000. Sole Proprietor A sole proprietorship is a business owned by one person having unlimited personal liability for the debts of the business. It is the simplest form of business entity as it is not a separate entity. It is not to be confused with a “one man corporation.” Due to this fact, many small businesses operate as a sole proprietorship. However, it is not advisable if the business has employees and/or significant dealings with customers, vendors, etc., because of liability concerns. Transferability of Interest Generally, the interest of the sole proprietorship is freely transferable, However since a sole proprietorship is not a separate legal entity, the assets comprising the business operated by the sole proprietor must be individually conveyed, unlike the transfer of stock where the business assets do not have to be individually conveyed General Partnership A partnership is defined as an association of 2 or more persons to carry on business for profit as co-owners. A partnership includes a syndicate, group pool joint venture, or other unincorporated organization which caries on any busi-ness, financial operation, or venture, and which is not, for federal income tax purposes, a corporation, trust or estate. With some exceptions, a partnership is not a separate legal entity. Transferability of Interests Partners have three general categories of property rights: 1. rights in specific partnership property; 2. interests in the partnership; and 3. the right to participate in the management of the partnership business. The right to participate in the management of the partnership business is not assignable and may not be attached by a partner‟s creditors. Similarly, a partner‟s rights to specific partnership property are not assignable unless all of the partners assign their rights. However, a partner‟s interest in the partnership (defined as a partner‟s share of profits and surplus) may be assigned. Although the assignee will receive the partner‟s share of profits and of partnership assets on dissolution, the assignee may not take pan in the management of partnership affairs and is not entitled to vote with respect to any matters of the partnership business, unless the assignee becomes a substituted partner with the consent of all the partners, or the partnership agreement provides to the contrary. Limited Partnership A limited partnership is a partnership having one or more genera] partners (who have unlimited liability like partners in a general partnership) and one or more limited partners (each having limited liability). There are no restrictions on the types of partners as in the case of an “S” corporation. Individuals, corporations, partnerships and foreigners can all be either general or limited partners. You can also have different types of partnership interests equivalent to several classes of stock to prefer certain partners over other partners. Transferability of Interests Generally, the interest of a limited partner in a limited partnership may be assigned without the prior consent of the other partners and without the assignment triggering dissolution, unless the limited partnership agreement provides to the Contrary. However, unless the assignee becomes a substituted limited partner (which can only occur with the consent of all the partners or as provided in the limited partnership agreement), the assignee only acquires the right to receive the limited partner‟s share of profits and of assets upon dissolution of the Limited Partnership and has no right to vote as a limited partner, inspect the limited partnership books, or demand an accounting of limited partnership transactions, If all the partners agree or if the limited partnership agreement provides that an assignee becomes a substituted limited partner, the assignee may exercise all of the rights of the assigning limited partner The assignee of a general partner of a limited partnership is not entitled to vote, obtain access to limited partnership books or participate in the conduct of the limited partnership business, unless all the partners agree or if the limited partnership agreement provides to the contrary. Joint Venture A joint venture is really a general partnership organized to carry out a limited or specific purpose rather than a general purpose. The advantages and disadvantages are similar to that of a general partnership as both are governed by the same rules of law. Transferability of Interests The transferability of a joint venture interest is similar to that of a general partnership interest. Corporation A corporation is a separate for-profit legal entity formed in accordance with state corporate laws. It may sue and be sued, hold, convey, and receive property, and enter into contracts in its own name. “C” Corporation A „C” corporation is subject to corporate taxation. It is called a “C” or “regular” corporation because it is taxed under Subchapter C of the Internal Revenue Code. There are no restrictions on the number or types of shareholders of a “C” corporation. You may have individuals, trusts, estates, other corporations, partnerships or foreigners as shareholders. “C” corporations can have one shareholder or hundreds of thousands of shareholders (for example, General Motors). A “C” corporation may own other corporations (“subsidiaries”) or be owned by another corporation (“parent”). A “C” corporation may have several classes of stock (for example, common and preferred). If it is anticipated that the corporation will make money which is to be reinvest m the company and not distributed to its shareholders, then a “C” corporation has the advantage of allowing the company to accumulate retained earnings (after paying corporate tax). This should increase the value of the stock and, when business is sold, the appreciation in the stock will be taxed at capital gains rates. “S” Corporation An “S” corporation is similar to a “C” corporation (both are created in the same manner under state law), except that an “S” corporation is generally not subject to corporate-level taxation it is subject to only one level of taxation on distributions to its shareholders. Upon - election, the entity bears no tax consequences at the corporation level. All income is taxed to the shareholders with few exceptions, regardless of whether the income is actually distributed to the shareholders. It is called an “S” corporation because it is governed by Subchapter S of the Internal Revenue Code. All profits or losses are reported by the shareholders on their individual tax returns in proportion to their stock ownership interest in the corporation. Many small business corporations have elected to be taxed as an “S” corporation to avoid the double taxation problem. Election of “S” status is done by the timely filing of IRS Form 2553 signed by all shareholders. An “S” corporation is commonly used in the early or start-up years when the corporation was more likely to produce tax losses. The shareholders can use these losses as deductions against other income earned during the taxable year up to the amount they had invested or loaned to the corporation. When the corporation starts producing taxable income and the shareholders decide they do not want to be taxed at the individual tax rates on all the corporate income, the “S” corporation status can be revoked and the income is taxed at corporate tax rates. However, all distributions to the shareholders are also subject to taxation. Transferability of Interests Generally the interests of a shareholder in a corporation (usually evidenced by a stock certificate) are freely transferable subject to any restrictions contained in the Articles of Incorporation or Bylaws. In many closely held corporations where there are 2 or more unrelated shareholders, the shareholders agree to restrict the transferability of the shares in a shareholders‟ agreement or buy-sell agreement including granting to the corporation or the other shareholders a right of first refusal if a shareholder desires to sell his or her stock to a third party or a corporation buy back (redemption) upon a shareholders‟ death or disability. If the corporation has elected „S” status, there should also be a restriction that only eligible persons can be a buyer of a shareholder‟s stock so that the corporation does not become ineligible. Limited Liability Company A limited liability company is a relatively new type of entity. Before 1991, only 4 states had adopted limited liability company statutes. Currently, 48 states have now adopted it and the other 2 states (Hawaii and Vermont) are considering it. It has some characteristics of a partnership as well as a corporation and some unique characteristics of its own. A limited liability company is an entity formed under a state law authorizing limited liability companies which provides that each owner‟s (member‟s) liability for the obligations of the entity is limited to the amount invested in the entity. Not many limited liability companies have been formed (as compared to corporations), probably because the concept is relatively new in most states, there had been uncertainty for many years regarding its federal income tax consequences and questions existed as to whether a limited liability company will have limit liability when doing business in other jurisdictions which did not recognize domestic limited liability company. In 1988, the Internal Revenue Service ruled that a Wyoming limited liability company (the first state to adopt the law in 1977) qualified as a partnership for federal tax purposes. There may be cases where you cannot elect “S” corporation status (for example, an ineligible stockholder, 2 classes of stock or more than 35 shareholders), where a limited liability company becomes the possible alternative. A limited liability company affords more flexibility than an “S” corporation in several areas. Unlike an “S” corporation, a limited liability company can include an unlimited number of corporations, partnerships, nonresident aliens, trusts, pension plans, and charitable organizations as members. An “S” corporation may not own 80% or more of another corporation but there is no similar restrictions on a limited liability company. Additionally, the one class of stock restriction and the complex regulations which may deter taxpayers from electing “S” corporation status do not apply to a limited liability company, thereby allowing flexibility in planning distributions and special allocations. Finally, subject to the at-risk rules, a limited liability company may pass through losses and exclude distributions to the extent of member‟s capital contribution plus that member‟s share of limited liability company debt. Generally, members of an “S” corporation cannot use their share of the “S” corporation‟s debt to increase their stock basis and, therefore, their ability to deduct losses and to receive tax-free distributions. In addition, unlike an “S,‟ corporation, there is no special election form which needs to be filed with the Internal Revenue Service to avoid “C” corporation taxation. Unlike a limited partnership, a limited liability company does not require that one of its owners have unlimited liability as does a general partner of a limited partnership. There is no need to form a second entity (corporation) as in many limited partnerships to own the general partnership interest. Also, a limited liability company does not prohibit its members from participating in the control of the limited liability company‟s business in order to maintain their limited liability status as do limited partners of a limited partnership. Transferability of Interests Unless otherwise provided in the Articles of Organization or the Regulations: a. A member‟s interest in a limited liability company is not assignable in whole or in part, unless a majority of the nonassigning members consent to the assignment. b. An assignment of a member‟s interest in a limited liability company does not dissolve a limited liability company or entitle the assignee to become, or to exercise any rights or powers of, a member. c. An assignment entitles the assignee to share in the profits and losses of the limited liability company, to receive such distribution or distributions, and to receive such allocation of income, gain, loss deduction, or credit or similar item to which the assignor was entitled, to the extent assigned. d. A member ceases to be a member and ceases to have the power to exercise any rights or powers of a member upon assignment of his or her entire interest in the limited liability company. The Articles of Organization or the Regulations may provide that a member‟s interest in the limited liability company may be evidenced by a certificate of limited liability company interest issued by a limited liability company and may also provide for the assignment or transfer of any limited liability company interest represented by the certificate and make other provisions with respect to the certificates. Registered Limited Liability Partnership The newest entity to come into existence is a registered limited liability partnership. A registered limited liability partnership is a partnership where all the partners have limited liability. Unlike a general partnership it must be registered with the state. Many states and the District of Columbia currently recognize these entities, and legislation authorizing them is under consideration in virtually all of the other states. A few states, while not having acts for domestic limited liability partnerships, have provisions recognizing foreign registered limited liability partnerships. It is different from (and will probably replace) a general partnership where each partner has joint and several, unlimited liability. It is also different from a limited partnership where at least one partner must be a general partner. It is also different from a limited liability company which is more like a corporation. Not all states have adopted legislation creating this type of entity, so check with your lawyer. Transferability of Interests An interest in a registered limited liability partnership is subject to the rights and restrictions in transferability as are interests in general partnership.