Introduction to Other Business Forms

Terms:

Capitalization: When a company forms, it requires funding in order to obtain the cash and property that are required to get its operation under way. This process of initial infusions of cash is known as capitalization. Capital can be sourced from a variety of places, but for early-stage companies, it typically comes from the founders, their friends and family, banks, and contacts obtained from friends, family and business associates.

Introduction:

This chapter will discuss the other major business forms that are prevalent today. As these various forms are reviewed, we will discover that there are certain advantages and disadvantages to each form, and that selecting the appropriate kind of entity is a matter of balancing the relevant interests of the company and its constituents. Keep in mind that there is virtually never a single business form that meets the needs of all of the people involved in the company. Rather, selecting the appropriate business form is a matter of weighing each of the relevant factors and identifying the company's needs at the time.

Additionally, one should keep in mind that the best business form at one point in a company's lifecycle may not be the best form for the entire course of the firm's existence. Early on, ease of formation and flexibility as to management may be optimal. Further along, needs for added capital and flexibility in ownership structure may be the controlling factors.

One added concern is that it is not always easy to move from one form to another. For these reasons, the company's organizers, its attorneys, and you as a paralegal, need to understand and address these concerns when selecting the business entity that meets the company's needs now and in the future.

EXAMPLE: Tammy, who is forming her new business building MP3 players, is in a conundrum. She feels that the company can grow steadily for its first two years based solely on her savings and early earnings. During this period, she expects that she will be the sole individual in charge of the company. After that, she expects that she will need venture funding, either from a professional venture capital firm or from wealthy independent investors. Given her experience in the field, she knows that either of these types of investors will want to be involved in managing and owning the company, and will have certain concerns about their tax and liability obligations from their involvement in the firm. Ultimately, if all goes according to plan, she hopes to take the company public several years down the road 1 and she knows that she will face a whole new set of concerns.

Ultimately, it would be impossible for Tammy to choose one business form that will perfectly suit all of these business needs. While the corporation, as we learned before, is probably her best bet, any one of the concerns above, if big enough, might suggest that Tammy select a different business form or change her choice of form as the business progresses.

Factors:

The following are some of the factors to consider when choosing a business form. These concerns will be addressed further in subsequent chapters.

• Ownership:

Certain business forms have virtually no restraints on ownership. That means that for such firms, anyone, from a nine-year-old child to a ninety-year-old billionaire, may own an interest in the company. Conversely, some firms have extremely strict controls on ownership. In some instances, a cap on the number of owners is placed on the business. For other business forms, there may be restrictions on ownership that allow only those people who work for the company to own an interest. In addition, one needs to be aware of the interaction between ownership and control in certain business forms, as in some businesses, those who own the business may not necessarily control the day-to-day functioning of the business, and vice versa.

• Liability:

A major factor relevant to the selection of a business form is the corresponding liabilities, or limits on liability, that attach to the business, its owners and its employees. As we discussed previously in the introductory section on the corporate form, the potential liability of the company's owners and managers is a serious issue for the company. Moreover, in several of the business forms to be discussed in this chapter, there may not necessarily be an equal sharing of potential liability on the part of the company's owners and its managers. As such, the firm must weigh the power and potential liability of the company's managers, as opposed to its owners, and determine what is most pressing at the time of formation.

• Taxation:

A major concern at any point in the firm's lifecycle is what percentage of the firm's earnings will be subject to taxation. A corresponding issue that is at least as important is who is responsible for paying that tax. In other words, will a new company have any profits to even raise the potential of having a tax to pay, or will it be operating at a loss for its first few years? In another situation, should the taxes be paid by the company itself, perhaps at a preferential rate, or should it be paid by the company's owners at their individual tax rates?

• Capitalization and Fund Raising:

Certain business forms allow for easy means of raising initial (or capitalizing) funds. However, those business forms may not provide the same ease and flexibility when it comes to raising additional money to fund the company's continued operations in the future. Thus, in determining the optimum business form, the company needs to determine where it will source from at creation and keep in mind from where it will raise operating cash in the future.

• Formation and Operation:

While the well-heeled firm may not mind a $5,000 legal bill just to create the business as a 2 legal entity, certain companies operating on a low budget may not be so willing to pay an attorney just to form the company. Additionally, as the company grows and evolves, it may require added flexibility in deciding how the business is run, rather than having a great many of its management and operating decisions provided for it by the law. Certain business forms leave management and control almost wholly within the sole domain of its owners. For other businesses, they may find that those companies that have come before have set all the rules for how they will be required to conform their conduct.

• Liquidity:

Apart from raising funds, certain business forms provide more flexibility for the owners to sell or transfer their ownership interests. As with the public corporation, certain business forms provide a public or semi-public market for the securities that represent ownership of the firm. For other business entities, ownership in the company may be so tied up (illiquid) as to make the security nontransferable. In the extreme case, inflexible ownership rules in the face of changed circumstances may trigger a required liquidation of the firm.

Other Business Forms:

The major forms of businesses that we will discuss in this chapter are as follows:

• Sole Proprietorship • Partnership (General Partnership) • Limited Liability Partnership • Limited Liability Company • Professional Company • S Corporation (as opposed to the traditional C Corporation)

As we discuss each of these business forms, we will look to the factors above to distinguish the various characteristics of each. It is important that you keep these traits in mind as they will help you identify potential trouble spots for the companies with whom you are working.