Forms of Business Organizations and Corporate Governance

Chapter
McGraw-Hill/Irwin Copyright © 2005 by The McGraw-Hill Companies, Inc. All rights reserved.
11
Corporate Governance AndCorporate Governance And
Business OrganizationsBusiness Organizations

11-2
Corporate Governance
How BusinessHow Business
Organizations AreOrganizations Are
Operated, Led,Operated, Led,
GovernedGoverned
How Law ProvidesHow Law Provides
Regulation Of BusinessRegulation Of Business
OrganizationsOrganizations
REGULATIONS

11-3
Size Of Ownership
Closely Held- FamilyClosely Held- Family
And/Or FriendsAnd/Or Friends
Publicly Held- TradedPublicly Held- Traded
On Public StockOn Public Stock
ExchangesExchanges

11-4
Selecting a Form
Sole
Proprietorship
Forms of Legal
Organization of
Business Entities
Partnership
Corporation
General
Partnership
Limited
Partnership
Regular C
Corporation
Subchapter S
Corporation
Limited Liability
Company
Limited Liability
Company
Limited Liability
Partnership
Limited Liability
Partnership

Starting a Business
Some Other FormsSome Other Forms
• Joint VentureJoint Venture
• Strategic AllianceStrategic Alliance
• FranchiseFranchise
• CooperativesCooperatives
• Master Limited PartnershipsMaster Limited Partnerships
(M.L.P.) in some states, similar to(M.L.P.) in some states, similar to
L.L.CsL.L.Cs

Starting a Business
Sole ProprietorshipSole Proprietorship
• Business is operated as own personal propertyBusiness is operated as own personal property
• Unlimited personal liability for all debts/obligationsUnlimited personal liability for all debts/obligations
of the businessof the business
• Over 2/3 of U.S. businesses are soleOver 2/3 of U.S. businesses are sole
proprietorshipsproprietorships
• They are usually small, about 99% have revenues ofThey are usually small, about 99% have revenues of
less than $1,000,000.00 per yearless than $1,000,000.00 per year
• Sole Proprietors are allowed to establish tax-Sole Proprietors are allowed to establish tax-
exempt retirement accounts (e.g. Keough plans)exempt retirement accounts (e.g. Keough plans)

11-7
Sole ProprietorshipSole Proprietorship
AdvantagesAdvantages
 Ease of start/endEase of start/end
 Be your own bossBe your own boss
 Pride of ownershipPride of ownership
 Retain profitRetain profit
 No special taxesNo special taxes
DisadvantagesDisadvantages
 Unlimited liabilityUnlimited liability
 Limited financialLimited financial
resourcesresources
 Difficulty in mgmt.Difficulty in mgmt.
 Time commitmentTime commitment
 Few fringe benefitsFew fringe benefits
 Limited growthLimited growth
 Limited life spanLimited life span

Starting a Business
PartnershipPartnership
• Voluntary AssociationVoluntary Association
• Between 2 or more legal competent personsBetween 2 or more legal competent persons
• No Express Agreement RequiredNo Express Agreement Required
• Typically governed by statutory law (e.g. Uniform PartnershipTypically governed by statutory law (e.g. Uniform Partnership
Act, except Louisiana)Act, except Louisiana)
• Sharing profits and losses = prima facie evidence ofSharing profits and losses = prima facie evidence of
partnershippartnership
• States differ on whether a partnership is viewed as a legalStates differ on whether a partnership is viewed as a legal
entity or aggregate of individuals for the purpose ofentity or aggregate of individuals for the purpose of
participating in legal actionsparticipating in legal actions
• Extent and Nature of personal liability variesExtent and Nature of personal liability varies
• General v.LimitedGeneral v.Limited

11-9
Types of Partnerships
GeneralGeneral
GPGP
GPGP
GPGP
GPGP
LimitedLimited
GPGP
PassivePassive
InvestorInvestor
PassivePassive
InvestorInvestor
PassivePassive
InvestorInvestor

11-10
PartnershipPartnership
AdvantagesAdvantages DisadvantagesDisadvantages
More financial
resources
Shared mgmt.
Longer survival
Unlimited liability
Division of profits
Disagreements
among partners
Difficult to
terminate

11-11
Sharing Workload
Sharing Financial
Burden
Sharing Emotional
Burden
Procuring Executive
Talent
Companionship
Interpersonal
Conflicts
Dilution of Equity
Dissatisfaction
with Partner
Absence of One
Clear Leader
Frustration of Not
Calling Own Shots
Advantages Disadvantages
Advantages
and
Disadvantages
of
Partnerships

11-12
Small Business Management, 11th edition
Longenecker, Moore, and Petty
© 2000
South-Western College Publishing
An Opinion Survey About the
Pros and Cons of Partnerships
Why is a
partnership
good?
Why is a
partnership
bad?
Spreads the workload
Spreads the emotional burden
Buys executive talent not otherwise affordable
Spreads the financial burden
Makes company building less lonely
Personal conflicts outweigh the benefits
Partners never live up to one another’s expectations
Companies function better with one clear leader
Dilutes equity too much
You can’t call your own shots
55
41
40
33
26
60
59
53
6
6
Question Perceived Pros and Cons Percentage Responding
Source: “The Inc. Fax Poll: Are Partners Bad for Business?” Inc., Vol. 14, No. 2 (February 1992), p. 24.

Partnerships
• Choose your partners wisely!!!Choose your partners wisely!!!
• A partnership is like aA partnership is like a
marriage, easy to get into,marriage, easy to get into,
sometimes difficult tosometimes difficult to
maintain, and generally messymaintain, and generally messy
to get out of!to get out of!

Partnerships
 A voluntary agreement by two or more persons to carry on, asA voluntary agreement by two or more persons to carry on, as
co-owners, a business for profit.co-owners, a business for profit.
 ““Persons” may be natural or artificial (e.g. corporations)Persons” may be natural or artificial (e.g. corporations)
 Requires intent to become partners (Tarnavsky v. Tarnavsky, 8thRequires intent to become partners (Tarnavsky v. Tarnavsky, 8th
Circuit, 1998 147 F.3d 674. And In Re Nielsen, 2002 Cal.App.Circuit, 1998 147 F.3d 674. And In Re Nielsen, 2002 Cal.App.
Unpub, LEXIS 5621 (Cal. Ct. App., 2d Dist., Div.3 2002))Unpub, LEXIS 5621 (Cal. Ct. App., 2d Dist., Div.3 2002))
• Intent can be express or implied (based on words or actions)Intent can be express or implied (based on words or actions)
• Though their must be an intent to carry on a business “forThough their must be an intent to carry on a business “for
profit” the business does not have to actually make a profit toprofit” the business does not have to actually make a profit to
be considered a partnership.be considered a partnership.
 Partnership by estoppel may be found where one holds himselfPartnership by estoppel may be found where one holds himself
out as, creates a reliance upon, or fails to dispel a knownout as, creates a reliance upon, or fails to dispel a known
misrepresentationmisrepresentation

Partnerships
 Is There a Partnership?Is There a Partnership?
 A father and son each owned land and raised seed potatoes.A father and son each owned land and raised seed potatoes.
They each used their own equipment. Each raised about theThey each used their own equipment. Each raised about the
same amount of potatoes, and they were stored together andsame amount of potatoes, and they were stored together and
advertised for sale by Wilbur Kimm and Son. A loss arose.advertised for sale by Wilbur Kimm and Son. A loss arose.
Issue: Are the father and son partners such that they must shareIssue: Are the father and son partners such that they must share
this loss? Held: Yes. They were partners and must share thethis loss? Held: Yes. They were partners and must share the
loss. Although intent of parties is a major factor, if facts bringloss. Although intent of parties is a major factor, if facts bring
arrangement within definition of a partnership, parties cannotarrangement within definition of a partnership, parties cannot
escape liability incident to that relationship merely by saying thatescape liability incident to that relationship merely by saying that
no such relationship exists. If intended action of parties createsno such relationship exists. If intended action of parties creates
a partnership in fact, what parties call their arrangement ora partnership in fact, what parties call their arrangement or
intend their arrangement to be is irrelevant. The fact that theintend their arrangement to be is irrelevant. The fact that the
father and son split profits in a joint account that containedfather and son split profits in a joint account that contained
proceeds from their sale of seed potatoes was prima facieproceeds from their sale of seed potatoes was prima facie
evidence that a partnership existed between father and son.evidence that a partnership existed between father and son.
Truck Ins. Exchange v. Industrial Indem. Co., 688 P.2d 1243Truck Ins. Exchange v. Industrial Indem. Co., 688 P.2d 1243
(Mont. 1984).(Mont. 1984).

Partnerships
 Sharing in profits or losses is primaSharing in profits or losses is prima
facie evidence of participation in afacie evidence of participation in a
partnership but receipt of funds:partnership but receipt of funds:
• in repayment of a debt orin repayment of a debt or
• as interest on a debt oras interest on a debt or
• as wages oras wages or
• as rent oras rent or
• as an annuity to heirs of a deceased partner oras an annuity to heirs of a deceased partner or
• as consideration for the sale of goodwillas consideration for the sale of goodwill
 does not constitute evidence ofdoes not constitute evidence of
participation in a partnership.participation in a partnership.

Partnerships
Co-owners must register withCo-owners must register with
the state.the state.
Co-owners may need anCo-owners may need an
occupational license.occupational license.

Limited Partnerships
 Partnership consisting of one orPartnership consisting of one or
moremore general partnersgeneral partners (who manage(who manage
the business and are liable to thethe business and are liable to the
full extent of their personal assetsfull extent of their personal assets
for debts of the partnership) & onefor debts of the partnership) & one
or moreor more limitedlimited partnerspartners (who(who
contribute only assets and are liablecontribute only assets and are liable
only up to the amount contributedonly up to the amount contributed
by them).by them).

 General PartnerGeneral Partner - In a limited partnership, a partner- In a limited partnership, a partner
who assumes responsibility for the management ofwho assumes responsibility for the management of
the partnership and liability for all partnership debts.the partnership and liability for all partnership debts.
 Limited PartnerLimited Partner - In a limited partnership, a partner- In a limited partnership, a partner
who contributes capital to the partnership but haswho contributes capital to the partnership but has
no right to participate in the management andno right to participate in the management and
operation of the business. The limited partneroperation of the business. The limited partner
assumes no liability for partnership debts beyondassumes no liability for partnership debts beyond
the capital contributed.the capital contributed.
 Note: Failure to comply with statutory requirementsNote: Failure to comply with statutory requirements
in forming a limited partnership results in thein forming a limited partnership results in the
creation of a general partnership.creation of a general partnership.

 The exercise of substantial controlThe exercise of substantial control
by a limited partner may result inby a limited partner may result in
his being declared a generalhis being declared a general
partner.partner.

Not equal exercise of substantialNot equal exercise of substantial
control if only:control if only:
• Contractor for an agent or employee of theContractor for an agent or employee of the
partnershippartnership
• Consulting/AdvisingConsulting/Advising
• Acting as a suretyActing as a surety
• Approving or disapproving an amendmentApproving or disapproving an amendment
to a partnership agreementto a partnership agreement
• VotingVoting

11-22
Partnerships
 Partnership Agreements (Sometimes calledPartnership Agreements (Sometimes called
Articles of Partnership)- An agreement listingArticles of Partnership)- An agreement listing
and explaining the terms of the partnership.and explaining the terms of the partnership.
• Critical for preventing and resolving potential disputesCritical for preventing and resolving potential disputes
• Should state (at least)Should state (at least)
 Who will make final decisions.Who will make final decisions.
 What each partner’s duties are.What each partner’s duties are.
 How much each partner will invest.How much each partner will invest.
 How profits and losses will beHow profits and losses will be
apportioned to each partner.apportioned to each partner.
 Methods for dispute resolution (e.g. arbitration)Methods for dispute resolution (e.g. arbitration)
 How the partnership can beHow the partnership can be
expanded or dissolved.expanded or dissolved.

11-23
Partnerships
The Uniform Partnership Act, asThe Uniform Partnership Act, as
enacted by a particularenacted by a particular
jurisdiction, has default rulesjurisdiction, has default rules
covering matters not addressedcovering matters not addressed
in partnership agreementsin partnership agreements

Partnerships -
Management/Authority
 General rule giving equal voice to all partners inGeneral rule giving equal voice to all partners in
management (even if differing contributions)management (even if differing contributions)
• Can be altered by agreementCan be altered by agreement
 Why alter?Why alter?
 In large/complex partnership may beIn large/complex partnership may be
cumbersome/inefficientcumbersome/inefficient
 Decisions that significantly impact the nature of theDecisions that significantly impact the nature of the
partnership generally require unanimous consentpartnership generally require unanimous consent
 Partnerships are generally not liable for agreements ofPartnerships are generally not liable for agreements of
individual partners acting outside of scope of theindividual partners acting outside of scope of the
partnership’s normal business, unless ratify,partnership’s normal business, unless ratify,
expressly or implicitlyexpressly or implicitly

Partnerships
Partnership PropertyPartnership Property
• All property originally contributed toAll property originally contributed to
• All property purchased on behalf ofAll property purchased on behalf of
• Purchasing property with partnership fundsPurchasing property with partnership funds
implies that it becomes partnership propertyimplies that it becomes partnership property
(unless contrary intention can be proved)(unless contrary intention can be proved)
• Any conveyance to the partnership by nameAny conveyance to the partnership by name

Partnerships
 3 rules for liability in a partnership are:3 rules for liability in a partnership are:
• 1. Every partner is liable for his or her1. Every partner is liable for his or her
own actions.own actions.
• 2. Every partner is liable for the2. Every partner is liable for the
actions of the other partners (inactions of the other partners (in
course of business)course of business)
• 3. Every partner is liable for the3. Every partner is liable for the
actions of the employees of theactions of the employees of the
business (in course of business)business (in course of business)

Partnerships
 Distribution of partnership incomeDistribution of partnership income
• How should the shares of partnershipHow should the shares of partnership
income be distributed?income be distributed?
Pro-rata?Pro-rata?
Based on financial contribution?Based on financial contribution?
Based on work performed on behalfBased on work performed on behalf
of?of?
• Usually determined by writtenUsually determined by written
agreementagreement

Partnerships
Creditors RightsCreditors Rights
• Can obtain the debtor’s share of theCan obtain the debtor’s share of the
income of a partnership, or in someincome of a partnership, or in some
cases can get the court to order thecases can get the court to order the
sale of the debtor’s share (Chargingsale of the debtor’s share (Charging
Order)Order)
• This does not give the creditor a voiceThis does not give the creditor a voice
in the management of the partnershipin the management of the partnership
• This does not give the creditor theThis does not give the creditor the
right to dissolve the partnershipright to dissolve the partnership

11-29
Partnership DutiesPartnership Duties
 DutiesDuties
• Loyalty/Good FaithLoyalty/Good Faith
• Care in PartnershipCare in Partnership
• To Inform/AccountTo Inform/Account
Note: However, partners can beNote: However, partners can be
compelled to sign confidentialitycompelled to sign confidentiality
agreements (Madison Ave. Investmentagreements (Madison Ave. Investment
Partners, L.L.C. v. American First RealPartners, L.L.C. v. American First Real
Estate Investment Partners, L.P., 2002Estate Investment Partners, L.P., 2002
Del. Ch. LEXIS 97 (Del. Ch. New CastleDel. Ch. LEXIS 97 (Del. Ch. New Castle
2002)2002)
 DutiesDuties
• Loyalty/Good FaithLoyalty/Good Faith
• Care in PartnershipCare in Partnership
• To Inform/AccountTo Inform/Account
Note: However, partners can beNote: However, partners can be
compelled to sign confidentialitycompelled to sign confidentiality
agreements (Madison Ave. Investmentagreements (Madison Ave. Investment
Partners, L.L.C. v. American First RealPartners, L.L.C. v. American First Real
Estate Investment Partners, L.P., 2002Estate Investment Partners, L.P., 2002
Del. Ch. LEXIS 97 (Del. Ch. New CastleDel. Ch. LEXIS 97 (Del. Ch. New Castle
2002)2002)

Partnerships - Dissolution
 Dissolution methodsDissolution methods
• Automatically after an agreed upon period of timeAutomatically after an agreed upon period of time
• Automatically when set objective has been attainedAutomatically when set objective has been attained
• By mutual agreementBy mutual agreement
• By unilateral decision of any partner (if at will)By unilateral decision of any partner (if at will)
• By court order (including by Bankruptcy)By court order (including by Bankruptcy)
• By death or incompetence of a partnerBy death or incompetence of a partner
• By disability of a partner that substantially impairsBy disability of a partner that substantially impairs
his ability to carry on dutieshis ability to carry on duties
• By wilful breach of a partnership agreementBy wilful breach of a partnership agreement
• By illegal acts of the partnership businessBy illegal acts of the partnership business

Partnerships - Dissolution
 Dissolution of a partnership does notDissolution of a partnership does not
necessarily end the operation of anecessarily end the operation of a
business (e.g. it may continue as a solebusiness (e.g. it may continue as a sole
proprietorship, etc.)proprietorship, etc.)
 The value of interests at dissolution isThe value of interests at dissolution is
usually determined by settlementusually determined by settlement
agreementsagreements
 There are notice requirements uponThere are notice requirements upon
dissolution (Phillip Lithographing Co. V.dissolution (Phillip Lithographing Co. V.
Babich, 135 NW.2nd 343 (Wis. 1965))Babich, 135 NW.2nd 343 (Wis. 1965))

11-32
Distribution of AssetsDistribution of Assets
Order/PriorityOrder/Priority
• Outside CreditorsOutside Creditors
• Debts to Partners forDebts to Partners for
Loans/Capital AdvanceLoans/Capital Advance
• Capital ContributionCapital Contribution
• Remaining Assets AccordingRemaining Assets According
to Partnership Agreementto Partnership Agreement
Order/PriorityOrder/Priority
• Outside CreditorsOutside Creditors
• Debts to Partners forDebts to Partners for
Loans/Capital AdvanceLoans/Capital Advance
• Capital ContributionCapital Contribution
• Remaining Assets AccordingRemaining Assets According
to Partnership Agreementto Partnership Agreement

11-33
Seven Trigger Points That Can Destroy a
Partnership
1. A partner that is going through a divorce.
2. A partnership that is experiencing growing pains due to rapid growth.
3. A partner brings a spouse or a relative into the business.
4. A partner that wants to withdraw more money from the business.
5. A partner makes sexual advances toward another partner.
6. A partner experiences serious medical problems.
7. A partner begins doing business on the side with the partnership’s
customers.
Source: Used with permission, Inc. magazine, February 2001. Copyright 1998
by Gruner + Jahr USA Publishing, 38 Commercial Wharf, Boston, MA 02110.
Inc. is a registered trademark of Gruner + Jahr Printing and Publishing.

Corporations
A legal entity formed inA legal entity formed in
compliance with statecompliance with state
statutory requirements. Thestatutory requirements. The
entity is treated as a legalentity is treated as a legal
“person”, distinct from its“person”, distinct from its
shareholders.shareholders.

Starting a Business
CorporationCorporation
• Separate Legal EntitySeparate Legal Entity
• Ongoing Enterprise/LifecycleOngoing Enterprise/Lifecycle
• Limited LiabilityLimited Liability
• Close v.PublicClose v.Public
• ““C” v.“S”C” v.“S”
• Profit v.Non-ProfitProfit v.Non-Profit
• Domestic, Foreign, AlienDomestic, Foreign, Alien
• De Jure v. De FactoDe Jure v. De Facto

11-36
CorporationCorporation
AdvantagesAdvantages DisadvantagesDisadvantages
More money for
investment
Limited liability
Separation of
ownership/mgmt.
Ease of ownership
change
Perpetual life
Size
Initial cost
Paperwork
Two tax returns
Termination
difficult
Double taxation

Corporations
 A Corporation is “anA Corporation is “an
artificial being, invisible,artificial being, invisible,
intangible, and existingintangible, and existing
only in the contemplationonly in the contemplation
of law. Being the mereof law. Being the mere
creature of law, itcreature of law, it
possesses only thosepossesses only those
properties which theproperties which the
charter of creation conferscharter of creation confers
upon it, either expressly orupon it, either expressly or
incidental to its veryincidental to its very
existence.” - Chief Justiceexistence.” - Chief Justice
Marshall, Dartmouth v.Marshall, Dartmouth v.
Woodard (1819)Woodard (1819)

Corporations
 Historical OriginsHistorical Origins
• Roman royal fiat.Roman royal fiat.
• 17th century English Royal Charter.17th century English Royal Charter.
• 1814, Francis Cabot Lowell, a Boston Merchant,1814, Francis Cabot Lowell, a Boston Merchant,
founded the first publicly traded company infounded the first publicly traded company in
America, a textile company. Lowell had smuggled aAmerica, a textile company. Lowell had smuggled a
plan for a power loom out of England and plannedplan for a power loom out of England and planned
to compete with the British Lancashire Mills. Sinceto compete with the British Lancashire Mills. Since
he personally lacked the capital to build and installhe personally lacked the capital to build and install
the machinery, he sold shares in the company to 10the machinery, he sold shares in the company to 10
other people.other people.
• The publicly traded company model also played aThe publicly traded company model also played a
key part in the financing of America’s railroads.key part in the financing of America’s railroads.

Corporations
 Close corporationClose corporation——a corporationa corporation
whose stock is owned by awhose stock is owned by a
relatively few people and is not soldrelatively few people and is not sold
to the general public.to the general public.
 Public/Open corporationPublic/Open corporation——aa
corporation whose stock is boughtcorporation whose stock is bought
and sold on security exchanges andand sold on security exchanges and
can be purchased by any individual.can be purchased by any individual.

Corporations
 TypesTypes
• For ProfitFor Profit
• Non-Profit (e.g. Hospitals,Non-Profit (e.g. Hospitals,
Charities, Some Insurance Co.) -Charities, Some Insurance Co.) -
exempt from Corp. income taxexempt from Corp. income tax
• Municipal (e.g. Sewer Authority)Municipal (e.g. Sewer Authority)
(often have tax authority)(often have tax authority)

11-41
Close CorporationsClose Corporations
 ShareholdersShareholders
• FewFew
• Live Near Each Other Know One Another &Live Near Each Other Know One Another &
SkillsSkills
• Active in BusinessActive in Business
• No Market for SharesNo Market for Shares
 Transferability of SharesTransferability of Shares
• Right of First RefusalRight of First Refusal
• Buy/Sell AgreementBuy/Sell Agreement
• Consent RestraintConsent Restraint
 ShareholdersShareholders
• FewFew
• Live Near Each Other Know One Another &Live Near Each Other Know One Another &
SkillsSkills
• Active in BusinessActive in Business
• No Market for SharesNo Market for Shares
 Transferability of SharesTransferability of Shares
• Right of First RefusalRight of First Refusal
• Buy/Sell AgreementBuy/Sell Agreement
• Consent RestraintConsent Restraint

11-42
Corporations
• Types by place of incorporationTypes by place of incorporation
Domestic corporationDomestic corporation - a business- a business
incorporated in a stateincorporated in a state
Foreign corporationForeign corporation—a business—a business
incorporated outside of the state.incorporated outside of the state.
Alien corporationAlien corporation—a business—a business
incorporated in a foreign countryincorporated in a foreign country
and operating in the United States.and operating in the United States.

Corporations- “S” Corp
““S” CorporationS” Corporation
• A Federal Tax ElectionA Federal Tax Election
• Owners have limited liability, but areOwners have limited liability, but are
taxed as if the firm were a partnershiptaxed as if the firm were a partnership

 ““S” Corporation RequirementsS” Corporation Requirements
• Firm has 75 or fewer ownersFirm has 75 or fewer owners
• All stockholders must be individuals,All stockholders must be individuals,
estates, or certain trusts (not otherestates, or certain trusts (not other
corporations)corporations)
• Only one class of stock outstandingOnly one class of stock outstanding
• Must be a domestic corporationMust be a domestic corporation
• Must operate on a calendar year basisMust operate on a calendar year basis
• No nonresident alien stockholdersNo nonresident alien stockholders
• All shareholders must consent to havingAll shareholders must consent to having
the corporation taxed as a partnershipthe corporation taxed as a partnership

 Tax Reasons for “S” Corp.Tax Reasons for “S” Corp.
• Corporation is losing moneyCorporation is losing money- Valuable to have losses- Valuable to have losses
flow through to individual tax return, but onlyflow through to individual tax return, but only
valuable if have other personal income to offsetvaluable if have other personal income to offset
against. Losses are limited to basis. Basis is stockagainst. Losses are limited to basis. Basis is stock
investment and loans to corporationinvestment and loans to corporation
• Corporation is highly profitableCorporation is highly profitable - Although double- Although double
taxation rarely applies, there is always the risk thetaxation rarely applies, there is always the risk the
IRS will deem salaries “excessive”. Excess salariesIRS will deem salaries “excessive”. Excess salaries
are treated as dividends. Issue of salary vs.are treated as dividends. Issue of salary vs.
dividend doesn’t matter with S corp., since nodividend doesn’t matter with S corp., since no
corporate level taxcorporate level tax

Corporations- Preincorporation
 PromotersPromoters (also called Preincorporators) - persons(also called Preincorporators) - persons
who bring the corporation into being by pre-who bring the corporation into being by pre-
incorporation actionsincorporation actions
• Has personal liability for pre-incorporationHas personal liability for pre-incorporation
contracts (corporations may later adopt same)contracts (corporations may later adopt same)
• Not agents of corporation or shareholdersNot agents of corporation or shareholders
• But have fiduciary duties to both (e.g. full disclose,But have fiduciary duties to both (e.g. full disclose,
dealing in good faith, etc.)dealing in good faith, etc.)
• May be paid for reasonable chargesMay be paid for reasonable charges
• May be paid with sharesMay be paid with shares

Corporations-Preincorporation
IncorporatorsIncorporators - those who sign- those who sign
the articles of incorporationthe articles of incorporation
and deliver them to the stateand deliver them to the state
• May be a single personMay be a single person
• May be an attorneyMay be an attorney

Corporations-Preincorporation
Shareholder Agreements shouldShareholder Agreements should
address:address:
• Conflicts of InterestConflicts of Interest
• Key Man (e.g. Life Insurance)Key Man (e.g. Life Insurance)
• Buy/Sell (e.g. Right of FirstBuy/Sell (e.g. Right of First
Refusal to Purchase Shares)Refusal to Purchase Shares)
• Profit AllocationProfit Allocation
• IndemnificationIndemnification

11-49
IncorporationIncorporation
StepsSteps
• Select Where to IncorporateSelect Where to Incorporate
• Prepare ArticlesPrepare Articles
• Sign/Authenticate ArticlesSign/Authenticate Articles
• File ArticlesFile Articles
• Receive CertificateReceive Certificate
• Hold Initial MeetingHold Initial Meeting
StepsSteps
• Select Where to IncorporateSelect Where to Incorporate
• Prepare ArticlesPrepare Articles
• Sign/Authenticate ArticlesSign/Authenticate Articles
• File ArticlesFile Articles
• Receive CertificateReceive Certificate
• Hold Initial MeetingHold Initial Meeting

11-50
Corporations-Incorporation
 Where to incorporateWhere to incorporate
• Businesses can incorporate in any stateBusinesses can incorporate in any state
they choose.they choose.
• Some states offer fewer restrictions, lowerSome states offer fewer restrictions, lower
taxes & fees, and other benefits to attracttaxes & fees, and other benefits to attract
businesses to incorporate with their state.businesses to incorporate with their state.
• Internet businesses present a sales taxInternet businesses present a sales tax
collection problem for states in which thesecollection problem for states in which these
businesses have no physical presence.businesses have no physical presence.

11-51
 Issues to Consider when Selecting a State of Inc.Issues to Consider when Selecting a State of Inc.
• How many incorporators are required by the state, and whetherHow many incorporators are required by the state, and whether
the incorporator itself can be a corporation.the incorporator itself can be a corporation.
• The minimum number of people required to form theThe minimum number of people required to form the
corporation.corporation.
• The minimum capital requirement, if any.The minimum capital requirement, if any.
• The state's fees for filing the articles of incorporation.The state's fees for filing the articles of incorporation.
• The state's annual corporate franchise tax.The state's annual corporate franchise tax.
• The state's corporate income tax and whether earnings fromThe state's corporate income tax and whether earnings from
operations outside the state are taxable. The State of Delawareoperations outside the state are taxable. The State of Delaware
taxes non-Delaware resident shareholders of S corporations ontaxes non-Delaware resident shareholders of S corporations on
their distributive share of S Corporation income based on thetheir distributive share of S Corporation income based on the
percentage of that income derived from Delaware sources. If apercentage of that income derived from Delaware sources. If a
Delaware corporation has no Delaware source income, theseDelaware corporation has no Delaware source income, these
taxes should not be an issue.taxes should not be an issue.

11-52
 Issues to Consider when Selecting a State of Inc. (Cont.)Issues to Consider when Selecting a State of Inc. (Cont.)
• Whether the corporation is allowed to keep its books andWhether the corporation is allowed to keep its books and
records outside the state.records outside the state.
• The state's court system's reputation of fairness in businessThe state's court system's reputation of fairness in business
cases.cases.
• Whether the corporation is allowed to have its principal placeWhether the corporation is allowed to have its principal place
of business outside the state.of business outside the state.
• Whether there is a state inheritance tax on non-residentWhether there is a state inheritance tax on non-resident
shareholders.shareholders.
• Disclosure/privacy - whether the state requires publicDisclosure/privacy - whether the state requires public
disclosure of the names of shareholders.disclosure of the names of shareholders.
• Whether the state requires a corporate bank account in thatWhether the state requires a corporate bank account in that
state (Delaware does not).state (Delaware does not).

11-53
 DelawareDelaware- Delaware often is the preferred state of incorporation.- Delaware often is the preferred state of incorporation.
Initially, Delaware gave management better rights in the event ofInitially, Delaware gave management better rights in the event of
a takeover, so in the 1940's and 1950's many corporationsa takeover, so in the 1940's and 1950's many corporations
moved there. Delaware set up a court system that has expertisemoved there. Delaware set up a court system that has expertise
in commercial transactions and well-developed corporate lawin commercial transactions and well-developed corporate law
(equals predictability). Other states improved their corporate(equals predictability). Other states improved their corporate
legal systems, but virtually every corporate attorney is familiarlegal systems, but virtually every corporate attorney is familiar
with Delaware law. Delaware also has the Delaware Assetwith Delaware law. Delaware also has the Delaware Asset
Protection Trust, which permits one to set up a trust that cannotProtection Trust, which permits one to set up a trust that cannot
be touched by creditors but that allows one to get one's money.be touched by creditors but that allows one to get one's money.
Most other states require irrevocable trusts that prevent oneMost other states require irrevocable trusts that prevent one
from accessing one's money once it is in the trust. The state offrom accessing one's money once it is in the trust. The state of
Alaska responded with a similar trust, but added spouses andAlaska responded with a similar trust, but added spouses and
children to the list of creditors that could not get at the moneychildren to the list of creditors that could not get at the money
in the trust. Delaware responded likewise.in the trust. Delaware responded likewise.

11-54
 Delaware v. Nevada-Delaware v. Nevada-
• Taxes on corporate earnings:Taxes on corporate earnings: Delaware taxes the proportion ofDelaware taxes the proportion of
corporate profits earned in Delaware. Nevada is tax-free, regardless ofcorporate profits earned in Delaware. Nevada is tax-free, regardless of
where the profits are earned.where the profits are earned.
• Annual franchise tax:Annual franchise tax: Delaware and most other states have an annualDelaware and most other states have an annual
franchise tax on corporations. Nevada does not.franchise tax on corporations. Nevada does not.
• Annual disclosure:Annual disclosure: Delaware requires an annual report of stockholderDelaware requires an annual report of stockholder
meeting dates, business locations outside of Delaware, and themeeting dates, business locations outside of Delaware, and the
number and value of shares issued. Nevada requires only the currentnumber and value of shares issued. Nevada requires only the current
list of officers and directors. In both Delaware and Nevada, the officerslist of officers and directors. In both Delaware and Nevada, the officers
and directors can be one person.and directors can be one person.
• Protection of officers and directors:Protection of officers and directors: Nevada provides broaderNevada provides broader
protection against personal liability of officers and directors than doesprotection against personal liability of officers and directors than does
Delaware.Delaware.

11-55
 Delaware v. Nevada- (Cont.)Delaware v. Nevada- (Cont.)
• Shareholder disclosure:Shareholder disclosure: Nevada and Wyoming are two states that allow bearerNevada and Wyoming are two states that allow bearer
shares. When corporations first came into existence, their stock certificates wereshares. When corporations first came into existence, their stock certificates were
like cash in the sense that whoever was holding them at the moment legally waslike cash in the sense that whoever was holding them at the moment legally was
the owner. However, in order to protect their shareholders against theft of thethe owner. However, in order to protect their shareholders against theft of the
stock certificates, corporations began to maintain a stock ledger listing thestock certificates, corporations began to maintain a stock ledger listing the
shareholders. Eventually, the stock ledger became the authoritative record of theshareholders. Eventually, the stock ledger became the authoritative record of the
shareholders, and when stock was transferred it would have to be recorded in theshareholders, and when stock was transferred it would have to be recorded in the
corporation's stock transfer ledger. Most U.S. states no longer permit bearercorporation's stock transfer ledger. Most U.S. states no longer permit bearer
shares, with the notable exceptions of Nevada and Wyoming. Since bearer sharesshares, with the notable exceptions of Nevada and Wyoming. Since bearer shares
legally belong to the person holding them at the moment, the holder of bearerlegally belong to the person holding them at the moment, the holder of bearer
shares truthfully can deny ownership in the corporation if he or she does not holdshares truthfully can deny ownership in the corporation if he or she does not hold
the certificates. Bearer shares often are used for illegal purposes, such as taxthe certificates. Bearer shares often are used for illegal purposes, such as tax
evasion. They also are used for asset protection, which by itself is not illegal, butevasion. They also are used for asset protection, which by itself is not illegal, but
which often results in illegal actions when bearer shares are involved. Forwhich often results in illegal actions when bearer shares are involved. For
example, if you hand your bearer shares over to somebody else so that you canexample, if you hand your bearer shares over to somebody else so that you can
truthfully deny owning them in the future, gift tax is due on the transaction.truthfully deny owning them in the future, gift tax is due on the transaction.
Furthermore, when the other person ultimately hands them back to you, gift taxesFurthermore, when the other person ultimately hands them back to you, gift taxes
are due again. While bearer shares might have a few legitimate uses, in general itare due again. While bearer shares might have a few legitimate uses, in general it
is best to avoid them, so whether or not a state permits them probably should notis best to avoid them, so whether or not a state permits them probably should not
be a major criterion in the decision of where to incorporate.be a major criterion in the decision of where to incorporate.

11-56
 Delaware v. Nevada (Cont.)Delaware v. Nevada (Cont.)
• Disclosure to IRS:Disclosure to IRS: Delaware and most other states share taxDelaware and most other states share tax
information with the IRS. Nevada does not. As with bearer shares,information with the IRS. Nevada does not. As with bearer shares,
non-disclosure to the IRS attracts those seeking to illegally evadenon-disclosure to the IRS attracts those seeking to illegally evade
taxes, so this should not be a criterion for legitimate businesstaxes, so this should not be a criterion for legitimate business
purposes.purposes.
• Note: There is a flip side to some of Nevada's perceivedNote: There is a flip side to some of Nevada's perceived
advantages. Some companies attempt to take advantage ofadvantages. Some companies attempt to take advantage of
Nevada's laws in order to evade taxes. As a result, NevadaNevada's laws in order to evade taxes. As a result, Nevada
corporations are more frequently audited by the IRS than arecorporations are more frequently audited by the IRS than are
corporations in other states. In this regard, however, the state ofcorporations in other states. In this regard, however, the state of
Wyoming has most if not all of the advantages that Nevada has, butWyoming has most if not all of the advantages that Nevada has, but
a lower audit rate, at least for now. There also are other intangiblesa lower audit rate, at least for now. There also are other intangibles
to consider. For example, if you incorporate in Delaware instead ofto consider. For example, if you incorporate in Delaware instead of
Nevada, your corporation may be seen as having slightly moreNevada, your corporation may be seen as having slightly more
credibility in the eyes of those who know about Nevada'scredibility in the eyes of those who know about Nevada's
corporation laws. This issue may have little or no ground, but it atcorporation laws. This issue may have little or no ground, but it at
least is worth considering.least is worth considering.

11-57
 Advantage of Incorporating in One's Own StateAdvantage of Incorporating in One's Own State
• If the company does not plan to obtain ventureIf the company does not plan to obtain venture
capital funding, it may be best to incorporate in thecapital funding, it may be best to incorporate in the
state in which the company plans to do business.state in which the company plans to do business.
Doing so has the following advantages:Doing so has the following advantages:
• Local attorneys are familiar with the local lawLocal attorneys are familiar with the local law
• One can have an intrastate securities lawOne can have an intrastate securities law
exemption.exemption.
• There is the convenience of geographicalThere is the convenience of geographical
proximity.proximity.
• The corporation does not need to register as aThe corporation does not need to register as a
"foreign" corporation in the state of operation if it is"foreign" corporation in the state of operation if it is
incorporated there.incorporated there.

11-58
Articles of Incorporation- ContentsArticles of Incorporation- Contents
 Mandatory ElementsMandatory Elements
• Name of CorporationName of Corporation
• # Shares of Capital Stock Authorized to# Shares of Capital Stock Authorized to
IssueIssue
• Address of Registered Office/NameAddress of Registered Office/Name
Registered Agent (for service of process)Registered Agent (for service of process)
• Name/Address of IncorporatorName/Address of Incorporator
 See N.C. Blank FormSee N.C. Blank Form
 Generally should keep to a minimum becauseGenerally should keep to a minimum because
must file amendments to changemust file amendments to change
 Mandatory ElementsMandatory Elements
• Name of CorporationName of Corporation
• # Shares of Capital Stock Authorized to# Shares of Capital Stock Authorized to
IssueIssue
• Address of Registered Office/NameAddress of Registered Office/Name
Registered Agent (for service of process)Registered Agent (for service of process)
• Name/Address of IncorporatorName/Address of Incorporator
 See N.C. Blank FormSee N.C. Blank Form
 Generally should keep to a minimum becauseGenerally should keep to a minimum because
must file amendments to changemust file amendments to change

Corporations - Incorporation
Other RequirementsOther Requirements
• MeetingsMeetings
• Corporate SealCorporate Seal
• BylawsBylaws

Corporations - Defective
Incorporation
De Jure v. De FactoDe Jure v. De Facto
• Substantial compliance withSubstantial compliance with
all steps of the incorporationall steps of the incorporation
process = De Jureprocess = De Jure
• If serious defect, but goodIf serious defect, but good
faith effort and exercise offaith effort and exercise of
powers, may be found to be Depowers, may be found to be De
Facto.Facto.

Corporations - Duties
 Ultra vires doctrineUltra vires doctrine: shareholders could: shareholders could
sue managers for embarking on projectssue managers for embarking on projects
contrary to the corporate purpose.contrary to the corporate purpose.
 However this doctrine is in declineHowever this doctrine is in decline
because of the broad interpretation ofbecause of the broad interpretation of
thethe Business Judgement RuleBusiness Judgement Rule whichwhich
shields some managerial actions fromshields some managerial actions from
substantive review by courts (especiallysubstantive review by courts (especially
in Delaware)in Delaware)

11-62
Corporations- Dissolution
 Types of Voluntary DissolutionTypes of Voluntary Dissolution
• End at specified time found in ArticlesEnd at specified time found in Articles
• Written consent of all shareholdersWritten consent of all shareholders
• Majority Vote of shareholders at aMajority Vote of shareholders at a
special meetingspecial meeting
• Merger or consolidationMerger or consolidation
• Vote of majority of incorporators ifVote of majority of incorporators if
corporation has not begun businesscorporation has not begun business

11-63
Board of DirectorsBoard of Directors
 Powers/DutiesPowers/Duties
• GeneralGeneral
• Actions RequiringActions Requiring
InitiativeInitiative
 OnlineOnline
CommunicationsCommunications
 Powers/Rights ofPowers/Rights of
Director as anDirector as an
IndividualIndividual
 CompensationCompensation
 Powers/DutiesPowers/Duties
• GeneralGeneral
• Actions RequiringActions Requiring
InitiativeInitiative
 OnlineOnline
CommunicationsCommunications
 Powers/Rights ofPowers/Rights of
Director as anDirector as an
IndividualIndividual
 CompensationCompensation
 ElectionElection
• NumberNumber
• QualificationsQualifications
• NominationNomination
• TermTerm
• VacanciesVacancies
 RemovalRemoval
 MeetingsMeetings

Board of Directors
 In most jurisdictions, the board actingIn most jurisdictions, the board acting
alone can:alone can:
• Declare a dividendDeclare a dividend
• Establish the price for sale of sharesEstablish the price for sale of shares
• Elect and remove officersElect and remove officers
• Fill vacancies on the BoardFill vacancies on the Board
• Sell, lease or mortgage assets outsideSell, lease or mortgage assets outside
the normal course of businessthe normal course of business

Board of Directors
 Actions byActions by Board InitiativeBoard Initiative areare
regarded as proposals forregarded as proposals for
shareholder approvalshareholder approval
 Shareholders must all approveShareholders must all approve
certain extraordinary actions suchcertain extraordinary actions such
as amendment of articles, mergers,as amendment of articles, mergers,
sale or lease of substantially allsale or lease of substantially all
assets or dissolutionassets or dissolution

Board of Directors
 Recent statutes in manyRecent statutes in many
jurisdictions now allow directors tojurisdictions now allow directors to
communicate and conduct businesscommunicate and conduct business
electronically.electronically.
• But , not allow electronic boardBut , not allow electronic board
meetingsmeetings
Why the distinction?Why the distinction?

Board of Directors
There are statutory and/or bylawThere are statutory and/or bylaw
requirements for qualification,requirements for qualification,
nomination, election, term,nomination, election, term,
vacancy filling, removal orvacancy filling, removal or
directors and officers as well asdirectors and officers as well as
for meeting frequency, notice,for meeting frequency, notice,
formality, quorumformality, quorum

Board of Directors
Is it realistic to expectIs it realistic to expect
directors to “manage” thedirectors to “manage” the
corporation, or should theircorporation, or should their
role be viewed as one ofrole be viewed as one of
more ofmore of
monitoring/evaluating themonitoring/evaluating the
actions of corporate officers?actions of corporate officers?

Board of Directors
 The Board only has authority to act forThe Board only has authority to act for
the corporationthe corporation as a groupas a group
 Most state law mandates directors mustMost state law mandates directors must
act in the best interests of theact in the best interests of the
corporation and its shareholderscorporation and its shareholders
• Courts have generally interpreted thisCourts have generally interpreted this
to mean maximizing share price.to mean maximizing share price.
• Is what’s best for the share priceIs what’s best for the share price
always what’s best for the company?always what’s best for the company?

11-70
Officers of
Corporation
Officers of
Corporation
PowersPowers
President/Chairman-President/Chairman- exex
officioofficio
Vice PresidentVice President
Corporate SecretaryCorporate Secretary
TreasurerTreasurer
PowersPowers
President/Chairman-President/Chairman- exex
officioofficio
Vice PresidentVice President
Corporate SecretaryCorporate Secretary
TreasurerTreasurer

Officers
Ex-officio authority =Ex-officio authority =
authority by virtue of officeauthority by virtue of office
Often a good idea to have anOften a good idea to have an
Assistant Treasurer and/orAssistant Treasurer and/or
Assistant Secretary forAssistant Secretary for
reasons of expediencyreasons of expediency

11-72
Duties Directors/OfficersDuties Directors/Officers
 Act WithinAct Within
AuthorityAuthority
 Due Care andDue Care and
DiligenceDiligence
• Prudent PersonPrudent Person
• BusinessBusiness
JudgmentJudgment
• IncreasedIncreased
Director LiabilityDirector Liability
 Act WithinAct Within
AuthorityAuthority
 Due Care andDue Care and
DiligenceDiligence
• Prudent PersonPrudent Person
• BusinessBusiness
JudgmentJudgment
• IncreasedIncreased
Director LiabilityDirector Liability
 Loyalty/GoodLoyalty/Good
FaithFaith
• Self-DealingSelf-Dealing
• UsurpUsurp
• Freeze-Outs,Freeze-Outs,
etc.etc.
• InsideInside
InformationInformation
 Right to DissentRight to Dissent

11-73
Optional limitations onOptional limitations on
liabilityliability
• Charter Option Statute (breachCharter Option Statute (breach
of duty)of duty)
• Self-Executing Statute (willfulSelf-Executing Statute (willful
or reckless)or reckless)
• Cap on Money DamagesCap on Money Damages
Optional limitations onOptional limitations on
liabilityliability
• Charter Option Statute (breachCharter Option Statute (breach
of duty)of duty)
• Self-Executing Statute (willfulSelf-Executing Statute (willful
or reckless)or reckless)
• Cap on Money DamagesCap on Money Damages

11-74
 IndemnificationIndemnification
• MandatoryMandatory (acting in good faith, pre-(acting in good faith, pre-
existing agreement)existing agreement)
• PermissiblePermissible (good faith, believed best(good faith, believed best
interest, unaware illegal, disinterestedinterest, unaware illegal, disinterested
agree)agree)
• ImpermissibleImpermissible (liable or bad faith or(liable or bad faith or
violate fed. Securities law)violate fed. Securities law)
 IndemnificationIndemnification
• MandatoryMandatory (acting in good faith, pre-(acting in good faith, pre-
existing agreement)existing agreement)
• PermissiblePermissible (good faith, believed best(good faith, believed best
interest, unaware illegal, disinterestedinterest, unaware illegal, disinterested
agree)agree)
• ImpermissibleImpermissible (liable or bad faith or(liable or bad faith or
violate fed. Securities law)violate fed. Securities law)

 ““Directors can be out of touch with aDirectors can be out of touch with a
company's business and can fall prey to thecompany's business and can fall prey to the
temptation to simply be polite to a chieftemptation to simply be polite to a chief
executive while Rome is burning. A code ofexecutive while Rome is burning. A code of
silence develops in the boardroom. By thesilence develops in the boardroom. By the
time someone is willing to speak up, thetime someone is willing to speak up, the
company is in deep trouble.” - Bill George,company is in deep trouble.” - Bill George,
Former CEO, Medtronic Corp. in "AuthenticFormer CEO, Medtronic Corp. in "Authentic
Leadership: Rediscovering the Secrets toLeadership: Rediscovering the Secrets to
Creating Lasting Value," Jossey-Bass/Wiley,Creating Lasting Value," Jossey-Bass/Wiley,
2003.2003.

 The Board of Directors ofThe Board of Directors of
Worldcom reportedly allowedWorldcom reportedly allowed
CEO Bernie Ebbers to ruleCEO Bernie Ebbers to rule
“practically unchecked”,“practically unchecked”,
generally “rubber-stamping”generally “rubber-stamping”
his decisions. Their auditshis decisions. Their audits
“rarely scratched below the“rarely scratched below the
surface” and they approvedsurface” and they approved
multibillion dollar mergersmultibillion dollar mergers
and acquisitions “with littleand acquisitions “with little
discussion.” (Report:discussion.” (Report:
Worldcom board passive, JimWorldcom board passive, Jim
Hopkins,Hopkins, USA TodayUSA Today, June, June
10, 2003, p. 3B)10, 2003, p. 3B)

First Board usually appointedFirst Board usually appointed
by incorporatorsby incorporators
Who nominates/elects theWho nominates/elects the
board thereafter?board thereafter?
• Typically the ExecutiveTypically the Executive
Officers by Proxy ElectionsOfficers by Proxy Elections

11-78
Make-up of
Corporate Boards
 Retired officer of another firmRetired officer of another firm 89%89%
 CEO at another companyCEO at another company 87%87%
 Major company shareholderMajor company shareholder 73%73%
 Ex-government officialEx-government official 53%53%
 AcademiciansAcademicians 50%50%
Corporate boards average 11Corporate boards average 11
Directors.Directors. Most Directors byMost Directors by
percentage are:percentage are:

 But, on April 14, 2003, the SEC said itBut, on April 14, 2003, the SEC said it
would review rules that make it tough forwould review rules that make it tough for
shareholders to nominate directors toshareholders to nominate directors to
corporate boards. SEC Chairmancorporate boards. SEC Chairman
William Donaldson asked staffers toWilliam Donaldson asked staffers to
come with recommendations to make itcome with recommendations to make it
easier for shareholders to run their owneasier for shareholders to run their own
candidates. Changes may be adopted incandidates. Changes may be adopted in
time for the 2004 proxy season.time for the 2004 proxy season.

 Criteria for Who should sit on the Board ofCriteria for Who should sit on the Board of
Directors?Directors?
• Competence?Competence?
• Knowledge of/Experience in, the industry?Knowledge of/Experience in, the industry?
• General business knowledge/experience?General business knowledge/experience?
• Note: One of the requirements of Sarbanes-Note: One of the requirements of Sarbanes-
Oxley is that a company must haveOxley is that a company must have
individuals who are certified financialindividuals who are certified financial
experts on the board.experts on the board.

Independence?Independence?
• Inside vs. OutsideInside vs. Outside
Self-Interest (Good or Bad?)Self-Interest (Good or Bad?)
Some corporate bylaws requireSome corporate bylaws require
board members to be shareholdersboard members to be shareholders
Should the company maintain aShould the company maintain a
certain % of independent directors?certain % of independent directors?
If so, what %?If so, what %?

Independence?Independence?
• In Britain, the 1992 CadburyIn Britain, the 1992 Cadbury
Committee report recommendedCommittee report recommended
that boards of directors of publicthat boards of directors of public
companies include at least 3companies include at least 3
outside directors as members andoutside directors as members and
that the CEO and chairman poststhat the CEO and chairman posts
be held by different individuals.be held by different individuals.

Should There beShould There be PluralismPluralism onon
Board (interest group reps. e.g.Board (interest group reps. e.g.
Labor, Environmental,Labor, Environmental,
Consumer Watchdogs, etc.)?Consumer Watchdogs, etc.)?
• e.g. Volkswagon’s “Group Works”e.g. Volkswagon’s “Group Works”
CouncilCouncil

Ethical Orientation?Ethical Orientation? - C-bridge,- C-bridge,
a rapidly emerging leadera rapidly emerging leader
among Internet-based businessamong Internet-based business
solution providers, appointed tosolution providers, appointed to
Joseph L. Badaracco, Jr.,Joseph L. Badaracco, Jr.,
Professor of Business Ethics atProfessor of Business Ethics at
the Harvard Business School tothe Harvard Business School to
its Board.its Board.

 Should a Chairman of the Board & CEO be the sameShould a Chairman of the Board & CEO be the same
person?person?
• In the UK, the role of chairman of the board andIn the UK, the role of chairman of the board and
CEO are now generally held by different people,CEO are now generally held by different people,
unlike the U.S., where it is estimated that in 70-80%unlike the U.S., where it is estimated that in 70-80%
of companies in the Standard and Poor’s 500, oneof companies in the Standard and Poor’s 500, one
person wears the hats of both CEO and chairman.person wears the hats of both CEO and chairman.
• However, recent studies suggest that companies inHowever, recent studies suggest that companies in
which the chairman and CEO positions are held bywhich the chairman and CEO positions are held by
two different people perform no better thantwo different people perform no better than
companies in which the roles are combined. Incompanies in which the roles are combined. In
other words, it’s no guarantee against futureother words, it’s no guarantee against future
scandals.scandals.

Executive Compensation
Is CEOIs CEO
CompensaCompensa
tion Fair?tion Fair?

 The traditional argument is that executiveThe traditional argument is that executive
responsibilities and skills call for higherresponsibilities and skills call for higher
salaries (e.g. Michael Capellas recentlysalaries (e.g. Michael Capellas recently
received judicial approval for “scaled down”received judicial approval for “scaled down”
$20 million 3 year pay package. This was 23%$20 million 3 year pay package. This was 23%
below originally proposed package. The judgebelow originally proposed package. The judge
called the package “fair and eminentlycalled the package “fair and eminently
reasonable”. The company had difficultyreasonable”. The company had difficulty
attracting candidates. Capellas will make lessattracting candidates. Capellas will make less
than could have earned elsewhere.)than could have earned elsewhere.)

 According to the judge, the packageAccording to the judge, the package
was “Quite startling in itswas “Quite startling in its
magnitude but reasonable for amagnitude but reasonable for a
management challenge that wasmanagement challenge that was
unprecedented. The challenge, tounprecedented. The challenge, to
save tens of thousands of jobs andsave tens of thousands of jobs and
satisfy tens of millions ofsatisfy tens of millions of
customers.”customers.”

 According to Richard Lambert, AccountingAccording to Richard Lambert, Accounting
Professor at Wharton Business School, if theProfessor at Wharton Business School, if the
level of executive compensation is put in thelevel of executive compensation is put in the
context of overall company finances, it seemscontext of overall company finances, it seems
less of a problem. Compared with the value ofless of a problem. Compared with the value of
most public companies, the amount of moneymost public companies, the amount of money
being given to executives is not that large.being given to executives is not that large.
“Even if you cut the CEO’s salary in half, the“Even if you cut the CEO’s salary in half, the
effect on shareholder wealth would be veryeffect on shareholder wealth would be very
small.”small.”

 If a company does well or poorly, toIf a company does well or poorly, to
what extent is the CEO responsible forwhat extent is the CEO responsible for
this?this?
• It's clear that CEOs' pay has risen farIt's clear that CEOs' pay has risen far
faster than the corporate profitsfaster than the corporate profits
they're paid to generate. Profits rosethey're paid to generate. Profits rose
78% in the last decade, much less than78% in the last decade, much less than
the 212% increase in CEO pay over thethe 212% increase in CEO pay over the
same period.same period.

 The chief executives at 23 corporationsThe chief executives at 23 corporations
under investigation for improperunder investigation for improper
accounting pocketed $1.4 billion, or anaccounting pocketed $1.4 billion, or an
average of $62 million each, in the lastaverage of $62 million each, in the last
three years. Meanwhile, their companies'three years. Meanwhile, their companies'
stock values plunged $530 billion, orstock values plunged $530 billion, or
about 73% of their total value, and theirabout 73% of their total value, and their
companies laid off a total of 162,000companies laid off a total of 162,000
workers.workers.

 TheThe Financial TimesFinancial Times recently reported on arecently reported on a
study of what they called “The Barons ofstudy of what they called “The Barons of
Bankruptcy” – a privileged group of topBankruptcy” – a privileged group of top
business leaders who made extraordinarybusiness leaders who made extraordinary
fortunes even as their companies werefortunes even as their companies were
heading for disaster. They examined theheading for disaster. They examined the
largest 25 business collapses since the startlargest 25 business collapses since the start
of last year and, according to their figures, theof last year and, according to their figures, the
executives and directors of these doomedexecutives and directors of these doomed
companies walked away with over $3.3 billioncompanies walked away with over $3.3 billion
in compensation and proceeds from stockin compensation and proceeds from stock
sales.sales.

 Revenue at Tyco's electronics unit fellRevenue at Tyco's electronics unit fell
from $13.6 billion in fiscal 2001 to $10.5from $13.6 billion in fiscal 2001 to $10.5
billion in the following year.billion in the following year.
Nevertheless, division presidentNevertheless, division president
Juergen W. Gromer earned a bonus ofJuergen W. Gromer earned a bonus of
almost $3.4 million. Gromer's salary wasalmost $3.4 million. Gromer's salary was
increased by $35,500, to $695,500. In theincreased by $35,500, to $695,500. In the
previous year, Gromer earned a bonusprevious year, Gromer earned a bonus
of $6.85 million.of $6.85 million.

 Former Kmart CEO CharlesFormer Kmart CEO Charles
Conaway received nearly $23Conaway received nearly $23
million in compensation during hismillion in compensation during his
2-year tenure. When Kmart filed for2-year tenure. When Kmart filed for
bankruptcy in 2002, 283 stores werebankruptcy in 2002, 283 stores were
closed and 22,000 employees lostclosed and 22,000 employees lost
their jobs. Their total severancetheir jobs. Their total severance
pay: $0.pay: $0.

 In 2002, the total compensation ofIn 2002, the total compensation of
CEO Scott McNealy of SunCEO Scott McNealy of Sun
Microsystems, rose 31% to $31.7Microsystems, rose 31% to $31.7
million while his shareholders’million while his shareholders’
return plunged 74.7%, according toreturn plunged 74.7%, according to
Equilar, an independent provider ofEquilar, an independent provider of
compensation data.compensation data.

 At Honeywell, CEO David CoteAt Honeywell, CEO David Cote
made $68.5 million, about 80% ofmade $68.5 million, about 80% of
which was a sign-on bonus forwhich was a sign-on bonus for
taking over the top job in Februarytaking over the top job in February
2002. Meanwhile, Honeywell2002. Meanwhile, Honeywell
shareholders saw the value of theirshareholders saw the value of their
investments slide by 27.3%.investments slide by 27.3%.

 Steve Jobs of Apple Computer,Steve Jobs of Apple Computer,
pulled in $78.1 million while hispulled in $78.1 million while his
investors’ return slumped by 34.6%.investors’ return slumped by 34.6%.
 In 2002, while the S&P 500 plungedIn 2002, while the S&P 500 plunged
22%, median CEO compensation22%, median CEO compensation
rose 14% .rose 14% .
 Bottom Line:Bottom Line: There is little correlationThere is little correlation
between pay and performance, nobetween pay and performance, no
linkagelinkage

 Executive vs. Worker Pay DisparityExecutive vs. Worker Pay Disparity
• 20 years ago the CEO got about20 years ago the CEO got about
40 times what the average worker40 times what the average worker
did. It's now, according to them,did. It's now, according to them,
541 times.541 times.
• The earnings of CEO's haveThe earnings of CEO's have
grown 10 times faster than thosegrown 10 times faster than those
of the average worker.of the average worker.

• Among Fortune 500 companies CEOs earn moreAmong Fortune 500 companies CEOs earn more
than 100 times the average employee’s salary.than 100 times the average employee’s salary.
• Compensation for CEO’s rose at 27 out of 30Compensation for CEO’s rose at 27 out of 30
companies in 1993 with the largest staff reductions.companies in 1993 with the largest staff reductions.
• 60% of managers recently surveyed said CEOs60% of managers recently surveyed said CEOs
make too much.make too much.
• 64% of respondents to a recent SHRM online poll64% of respondents to a recent SHRM online poll
indicated that they did not believe that executiveindicated that they did not believe that executive
pay in their organization was in line in comparisonpay in their organization was in line in comparison
to pay in the rest of the organization.to pay in the rest of the organization.

• Hershey CEO Richard Lenny was paid moreHershey CEO Richard Lenny was paid more
than $22 million last year. An average unionthan $22 million last year. An average union
worker at Hershey makes $18 per hour,worker at Hershey makes $18 per hour,
about $37,440 a year. Lenny's compensationabout $37,440 a year. Lenny's compensation
could support 598 of these averagecould support 598 of these average
workers. Hershey employees went on strikeworkers. Hershey employees went on strike
earlier this year when management doubledearlier this year when management doubled
the cost of co-payments for health care.the cost of co-payments for health care.

• Gaps between exec/worker increasing.Gaps between exec/worker increasing.
• The growing disparity between executiveThe growing disparity between executive
compensation and that of other employeescompensation and that of other employees
is leading to a trust gap, which threatens tois leading to a trust gap, which threatens to
seriously impair morale.seriously impair morale.
• Bottom Line: When executive pay increasesBottom Line: When executive pay increases
faster than the economy other people'sfaster than the economy other people's
share decreases.share decreases.

 Perks/Other non-salary compensationPerks/Other non-salary compensation
• Stock OptionsStock Options
Options allow executives to buy theirOptions allow executives to buy their
company's stock in the future at thecompany's stock in the future at the
current price.current price.
After less than six months on the job,After less than six months on the job,
Tyco International Ltd.'s chief executiveTyco International Ltd.'s chief executive
Ed Breen earned $49 million in paperEd Breen earned $49 million in paper
profits just in his Tyco stock options,profits just in his Tyco stock options,
according to the company's proxyaccording to the company's proxy
statement.statement.

Qwest's CEO JosephQwest's CEO Joseph
Nacchio, cashed out $300Nacchio, cashed out $300
million in stock options whilemillion in stock options while
the company's stock droppedthe company's stock dropped
from $51 a share to $8. At thefrom $51 a share to $8. At the
same time he fired 17,000same time he fired 17,000
employees and shut down aemployees and shut down a
$25 million charity program.$25 million charity program.

Life insurance, pension plan,Life insurance, pension plan,
IRA, club memberships, carIRA, club memberships, car
allowances, stock options.allowances, stock options.
Jack Welch from GE got luxuryJack Welch from GE got luxury
apartment, entertainment and aapartment, entertainment and a
private jet.private jet.
““Golden parachutes”Golden parachutes”

Under his current contract, ifUnder his current contract, if
Home Depot CEO RobertHome Depot CEO Robert
Nardelli is fired he willNardelli is fired he will
receive an $82 millionreceive an $82 million
severance package (Fortuneseverance package (Fortune
Magazine)Magazine)

 SERP (supplemental executive-retirement plan) is aSERP (supplemental executive-retirement plan) is a
steroid-enhanced version of the traditional defined-steroid-enhanced version of the traditional defined-
benefit pension plan, in which a company sets aside abenefit pension plan, in which a company sets aside a
given % of an executive's pay every year to produce agiven % of an executive's pay every year to produce a
guaranteed payout. SERPs are now offered by aboutguaranteed payout. SERPs are now offered by about
1/2 of all big publicly traded companies, usually only1/2 of all big publicly traded companies, usually only
to the CEO and the next dozen or so officers. Andto the CEO and the next dozen or so officers. And
while the combination of a collapsing stock marketwhile the combination of a collapsing stock market
and low interest rates have placed pension plans forand low interest rates have placed pension plans for
ordinary Joes in jeopardy that's not the case for topordinary Joes in jeopardy that's not the case for top
execs. In fact, now that the stock market bubble hasexecs. In fact, now that the stock market bubble has
burst, compensation experts predict that companiesburst, compensation experts predict that companies
will actually increase their use of SERPs to pick up thewill actually increase their use of SERPs to pick up the
slack. ” (Fortune, April 28, 2003)slack. ” (Fortune, April 28, 2003)

 How did this happen?How did this happen?
• Who usually decides on compensationWho usually decides on compensation
packages?packages?
Compensation Committees of CorporateCompensation Committees of Corporate
BoardsBoards
• Based on what?Based on what?
Fair Market Value as demonstrated byFair Market Value as demonstrated by
disclosed information, recommendationsdisclosed information, recommendations
ofof executive search firmsexecutive search firms and “other”and “other”
factors.factors.

 Collusion?Collusion?
• When most big companies name outsideWhen most big companies name outside
directors they tend to draw from a familiardirectors they tend to draw from a familiar
pool of corporate luminaries close to home.pool of corporate luminaries close to home.
• A University of Michigan Business SchoolA University of Michigan Business School
study determined that there is about 4.6study determined that there is about 4.6
degrees of separation on average ondegrees of separation on average on
corporate boards. Business is run by thecorporate boards. Business is run by the
“connected few”.“connected few”.

What about the shareholders,What about the shareholders,
the supposed “owners” of thethe supposed “owners” of the
corporations?corporations?
• Vodafone recently putVodafone recently put
executive compensation up forexecutive compensation up for
a shareholder vote.a shareholder vote.
• Good idea?Good idea?
• This is highly unusual.This is highly unusual.

Starting a Business
 Limited Liability Company (L.L.C.)Limited Liability Company (L.L.C.)
• A hybrid form of business enterprise that offers theA hybrid form of business enterprise that offers the
limited liability of the corporation but the taxlimited liability of the corporation but the tax
advantages of a partnershipadvantages of a partnership
• 47 States permit (including N.C.)47 States permit (including N.C.)
• Separate Legal Entity like corporationSeparate Legal Entity like corporation
• Require filing Articles of IncorporationRequire filing Articles of Incorporation
• All investors able to share in managementAll investors able to share in management
• No restrictions on number or types of membersNo restrictions on number or types of members
• No one member has liability for wrongful acts ofNo one member has liability for wrongful acts of
others (makes attractive to doctors, lawyers, etc.)others (makes attractive to doctors, lawyers, etc.)

Starting a Business
 Limited Liability Partnership (L.L.P.)Limited Liability Partnership (L.L.P.)
• Similar to L.L.C., but designed forSimilar to L.L.C., but designed for
professional groups who normally doprofessional groups who normally do
business as partnersbusiness as partners
• Started to shield uninvolvedStarted to shield uninvolved
professionals’ personal assets fromprofessionals’ personal assets from
malpractice claimsmalpractice claims
• Must maintain adequate professionalMust maintain adequate professional
liability insuranceliability insurance

Starting a Business
Joint VentureJoint Venture
• A joint undertaking of a specific commercialA joint undertaking of a specific commercial
enterprise by an association of persons (.e.g.enterprise by an association of persons (.e.g.
construction of a tunnel, Wheatley v. Halvoson, 323construction of a tunnel, Wheatley v. Halvoson, 323
P2d 49 (Ore. 1958)P2d 49 (Ore. 1958)
• A joint venture is normally not a legal entity and isA joint venture is normally not a legal entity and is
treated like a partnership for federal income taxtreated like a partnership for federal income tax
purposespurposes
• Normally lasts until venture is completed orNormally lasts until venture is completed or
becomes impossible to completebecomes impossible to complete

Starting a Business
Strategic AllianceStrategic Alliance
• A strategic alliance is anA strategic alliance is an
organizational relationship thatorganizational relationship that
links two or more independentlinks two or more independent
business entities in a commonbusiness entities in a common
endeavorendeavor

Starting a Business
FranchiseFranchise
• Business owner (franchisor), usually a corporation,Business owner (franchisor), usually a corporation,
allows another (the franchisee) to use itsallows another (the franchisee) to use its
trademark, trade name, or copyright, undertrademark, trade name, or copyright, under
specified conditions.specified conditions.
• Each franchise operates as an independentEach franchise operates as an independent
business.business.
• Franchise Agreements are often viewed as one-Franchise Agreements are often viewed as one-
sided or “Contracts of Adhesion” (Body Shopsided or “Contracts of Adhesion” (Body Shop
Example)Example)
• Clayton Act “tie-in sales” questionsClayton Act “tie-in sales” questions
• Sherman Act price control questionsSherman Act price control questions

Starting a Business
Franchise (Cont.)Franchise (Cont.)
• Government disclosure requirementsGovernment disclosure requirements
• Law of state of franchisor typically controls inLaw of state of franchisor typically controls in
contract disputes (e.g. Burger King, Florida)contract disputes (e.g. Burger King, Florida)
• Often “turn-key” operationsOften “turn-key” operations
• Typically owned by a sole proprietor.Typically owned by a sole proprietor.
• Examples (McDonald's, Dairy Queen)Examples (McDonald's, Dairy Queen)
• Advantages - Proven management style, NameAdvantages - Proven management style, Name
recognition, Strong marketing resources, Oftenrecognition, Strong marketing resources, Often
involve financial supportinvolve financial support
• Beware, overblown or “fly-by-night” franchises!Beware, overblown or “fly-by-night” franchises!

Starting a Business
Types of FranchisesTypes of Franchises
• DistributorshipDistributorship- Dealer is allowed to sell a- Dealer is allowed to sell a
product produced by a manufacturer.product produced by a manufacturer.
• Chain-Style BusinessChain-Style Business - Firm is allowed to use- Firm is allowed to use
the trade name of a company and followsthe trade name of a company and follows
guidelines related to the pricing and sale ofguidelines related to the pricing and sale of
the product.the product.
• Manufacturing ArrangementManufacturing Arrangement- Firm is allowed- Firm is allowed
to manufacture a product using the formulato manufacture a product using the formula
provided by the franchisorprovided by the franchisor

Starting a Business
CooperativesCooperatives
• Group of 2 or more independentGroup of 2 or more independent
persons that cooperate for a commonpersons that cooperate for a common
objective (e.g. farmers poolingobjective (e.g. farmers pooling
produce for sale)produce for sale)

Starting a Business
 Factors in Selecting a FormFactors in Selecting a Form
• LiabilityLiability
• Tax TreatmentTax Treatment
• Formalities/ComplexityFormalities/Complexity
• Access to Funds/FinancingAccess to Funds/Financing
• Distribution of Profits/LossesDistribution of Profits/Losses
• Management/ControlManagement/Control
• LifecycleLifecycle
• Liquidity/Ease of TransferLiquidity/Ease of Transfer
• PrivacyPrivacy
• Fringe BenefitsFringe Benefits

Starting a Business
LiabilityLiability
• Why Limit Liability?Why Limit Liability?
Incentive to InvestIncentive to Invest
LawsuitsLawsuits
• Can’t insurance cover liability?Can’t insurance cover liability?
• Personal Guarantees/Co-Signing CanPersonal Guarantees/Co-Signing Can
Expand/Reimpose Liability (Often requiredExpand/Reimpose Liability (Often required
by lenders, especially with new, smallby lenders, especially with new, small
companies)companies)

Starting a Business
 LiabilityLiability
• Sole ProprietorSole Proprietor
 Sole and complete unlimited liabilitySole and complete unlimited liability
• General PartnershipGeneral Partnership
 Joint liability for debts and contracts (“in theJoint liability for debts and contracts (“in the
ordinary course of business”, Help instill v.ordinary course of business”, Help instill v.
Regions Bank, Texas Court of Appeals, 2000, 33Regions Bank, Texas Court of Appeals, 2000, 33
S.W.3d 401)S.W.3d 401)
 Joint and several unlimited liability for tortsJoint and several unlimited liability for torts
(unless “marshalling” requirement(unless “marshalling” requirement
• Marshalling = liabilities first paid out of theMarshalling = liabilities first paid out of the
partnership assetspartnership assets

Starting a Business
 Partnership LiabilityPartnership Liability
 Orel Koelling was a partner in a partnershipOrel Koelling was a partner in a partnership
that employed Martin Martinez. Mr. Martinezthat employed Martin Martinez. Mr. Martinez
died as the result of an accident whichdied as the result of an accident which
occurred in the course of the partnership'soccurred in the course of the partnership's
business. Mrs. Martinez filed suit againstbusiness. Mrs. Martinez filed suit against
Koelling to recover for her husband's death.Koelling to recover for her husband's death.
Koelling moved for summary judgment on theKoelling moved for summary judgment on the
grounds that the partnership was the employergrounds that the partnership was the employer
and liable, if anyone was. Issue: Shouldand liable, if anyone was. Issue: Should
Koelling be dismissed from this litigation?Koelling be dismissed from this litigation?
Held: No. Partners are jointly and severallyHeld: No. Partners are jointly and severally
liable for the actions of the partnership. Thus,liable for the actions of the partnership. Thus,
Koelling, as a partner, was a proper defendant.Koelling, as a partner, was a proper defendant.
Martinez v. Koelling, 421 N.W.2d 1 (Neb. 1988).Martinez v. Koelling, 421 N.W.2d 1 (Neb. 1988).

Starting a Business
 Liability (Cont.)Liability (Cont.)
• Limited PartnershipLimited Partnership
 Some partners have personal liability that is limitedSome partners have personal liability that is limited
to the cash or property they invested in the firm.to the cash or property they invested in the firm.
One or more general partners who actively manageOne or more general partners who actively manage
the business, receive a salary, share in profits andthe business, receive a salary, share in profits and
losses, have unlimited liability.losses, have unlimited liability.
• Limited Liability PartnershipLimited Liability Partnership
 Unlimited liability for general obligations, limited forUnlimited liability for general obligations, limited for
malpracticemalpractice
• Corporation, S Corporation, Limited LiabilityCorporation, S Corporation, Limited Liability
CorporationCorporation
 Liability limited to the assets of the CorporationLiability limited to the assets of the Corporation

Starting a Business
 TaxationTaxation
 Reports profits on personal income tax returnReports profits on personal income tax return
• Partnership/”S”Corp./L.L.C./L.L.P.Partnership/”S”Corp./L.L.C./L.L.P.
 Pass through (not taxed at business entity level) -Pass through (not taxed at business entity level) -
Personal earnings received from the partnership arePersonal earnings received from the partnership are
subject to personal income taxes.subject to personal income taxes.
• ““C” CorporationC” Corporation
 ““Double Taxation” - Corporation pays tax on its incomeDouble Taxation” - Corporation pays tax on its income
and Shareholders pay income tax on dividends (Possibleand Shareholders pay income tax on dividends (Possible
solution: Don’t pay dividends. Profits can be paid out assolution: Don’t pay dividends. Profits can be paid out as
salary or other forms of deductible compensation)salary or other forms of deductible compensation)
• ““Income Splitting”Income Splitting”
 Always good idea to seek advice of Accountant or Tax AttorneyAlways good idea to seek advice of Accountant or Tax Attorney
on this!on this!

Starting a Business
Formalities/ComplexityFormalities/Complexity
Least formalities/complexityLeast formalities/complexity
• PartnershipPartnership
Formalities/complexity variesFormalities/complexity varies

Starting a Business
 Formalities/Complexity (Cont.)Formalities/Complexity (Cont.)
• Limited Partnership, L.L.P., S Corporation, L.L.C., CorporationsLimited Partnership, L.L.P., S Corporation, L.L.C., Corporations
 All have statutory requirements and require writtenAll have statutory requirements and require written
agreements.agreements.
• Corporation has the most required formalities/complexityCorporation has the most required formalities/complexity
(Must file Articles of Incorporation, Adopt Bylaws, Hold(Must file Articles of Incorporation, Adopt Bylaws, Hold
periodic meetings, Keep Minutes, etc.) (Failure toperiodic meetings, Keep Minutes, etc.) (Failure to
maintain formalities may result in involuntary dissolutionmaintain formalities may result in involuntary dissolution
and thus a loss of limited liability! Burlington v. Palangio,and thus a loss of limited liability! Burlington v. Palangio,
Arkansas Supreme Court, 2001, 345 Ark. 320, 45 S.W3rdArkansas Supreme Court, 2001, 345 Ark. 320, 45 S.W3rd
834)834)
• Limited Partnerships covered under N.C.G.S. 59Limited Partnerships covered under N.C.G.S. 59
• L.L.C.s are covered under N.C.G.S. 57CL.L.C.s are covered under N.C.G.S. 57C
• Corporations covered under N.C.G.S. Chapter 55Corporations covered under N.C.G.S. Chapter 55
(Professionals under, 55B Non-Profits, under 55A)(Professionals under, 55B Non-Profits, under 55A)

Starting a Business
 Access to Funds/FinancingAccess to Funds/Financing
 Generally has the least access toGenerally has the least access to
funds/financingfunds/financing
 Generally has a greater access toGenerally has a greater access to
funds/financing than Sole Proprietorshipfunds/financing than Sole Proprietorship
• L.L.P’s, S CorporationsL.L.P’s, S Corporations
 Generally somewhat better access to fundsGenerally somewhat better access to funds

Starting a Business
 Access to Funds/FinancingAccess to Funds/Financing
• Limited Partnerships and L.L.C.sLimited Partnerships and L.L.C.s
 Generally better access to fundsGenerally better access to funds
 Note: Limited Partnerships often offer the bestNote: Limited Partnerships often offer the best
tax shelters for investors!tax shelters for investors!
• CorporationCorporation
 Generally has greatest access to funds/financingGenerally has greatest access to funds/financing
(e.g. Can sell equity/debt securities (stocks &(e.g. Can sell equity/debt securities (stocks &
bonds),, limited liability encourages investors,bonds),, limited liability encourages investors,
stock can be offered as collateral, etc.)stock can be offered as collateral, etc.)

Starting a Business
 Distribution of Profits/LossesDistribution of Profits/Losses
Gains all profits, suffers all lossesGains all profits, suffers all losses
Distribution of profits and lossesDistribution of profits and losses
generally set by agreement or pro-ratagenerally set by agreement or pro-rata
Distribution of profits determined byDistribution of profits determined by
management/market, received asmanagement/market, received as
dividends or increased value of stock.dividends or increased value of stock.

Starting a Business
Management/ControlManagement/Control
Sole & complete management/controlSole & complete management/control
Management/control determined byManagement/control determined by
agreementagreement
Partnership books and records must bePartnership books and records must be
kept accessible to all partnerskept accessible to all partners

Starting a Business
Management/Control (Cont.)Management/Control (Cont.)
 Nature of control/management determined by bylaws,Nature of control/management determined by bylaws,
actual persons in control determined by vote.actual persons in control determined by vote.
 Corporate shareholder have no management authorityCorporate shareholder have no management authority
unless elected to board or as officerunless elected to board or as officer
 ““Freeze-outs” are a common problem in CloseFreeze-outs” are a common problem in Close
CorporationsCorporations
• L.L.P.L.L.P.
 Management shared unless altered by agreementManagement shared unless altered by agreement
 Purchasing an existing members interest does notPurchasing an existing members interest does not
automatically confer managerial authority. Other partnersautomatically confer managerial authority. Other partners
must unanimously agree to.must unanimously agree to.

Starting a Business
LiquidityLiquidity
• Sole ProprietorshipSole Proprietorship
 Poor liquidityPoor liquidity
• Limited partnershipLimited partnership
 Interest sales are technically easy, but generallyInterest sales are technically easy, but generally
not particularly attractivenot particularly attractive
• General partnershipGeneral partnership
 Interest sales are difficult, requiring agreement ofInterest sales are difficult, requiring agreement of
other partnersother partners

Starting a Business
Liquidity (Cont.)Liquidity (Cont.)
• ““S” CorporationS” Corporation
 Fair liquidity, but it may be restrictedFair liquidity, but it may be restricted
 Easy transfer, sell shares (note: minority interestEasy transfer, sell shares (note: minority interest
shares less attractive in close corporation)shares less attractive in close corporation)
• L.L.C.L.L.C.
 Transfer restrictionsTransfer restrictions

Starting a Business
LifecycleLifecycle
• Sole ProprietorshipSole Proprietorship
 Often ends with the death or incapacity of theOften ends with the death or incapacity of the
sole proprietorsole proprietor
 Continues to function unless/until formallyContinues to function unless/until formally
dissolved, voluntarily or involuntarily, regardlessdissolved, voluntarily or involuntarily, regardless
of the death or incapacity of individualof the death or incapacity of individual
shareholders (makes easier to preserve goodwill)shareholders (makes easier to preserve goodwill)
• L.L.C.L.L.C.
 Often required to have a stated durationOften required to have a stated duration

Starting a Business
LifecycleLifecycle
General Partnerships, L.L.P.’s, L.L.C.’sGeneral Partnerships, L.L.P.’s, L.L.C.’s
 Often dissolved by loss of any member, butOften dissolved by loss of any member, but
remaining members can unanimously agree toremaining members can unanimously agree to
continue operationscontinue operations
• Limited PartnershipsLimited Partnerships
 Often dissolved by loss of a general partner, butOften dissolved by loss of a general partner, but
remaining members can unanimously agree toremaining members can unanimously agree to
continue operationscontinue operations
 Life Insurance, especially for a “key man” canLife Insurance, especially for a “key man” can
be a key factor in maintaining operations!be a key factor in maintaining operations!

Starting a Business
PrivacyPrivacy
• Sole Proprietorships, Partnerships andSole Proprietorships, Partnerships and
Close CorporationsClose Corporations
Have very limited requirements forHave very limited requirements for
disclosure of private/financialdisclosure of private/financial
information.information.
• Public CorporationsPublic Corporations
Have extensive requirements forHave extensive requirements for
disclosure of private/financialdisclosure of private/financial
information.information.

Starting a Business
Fringe BenefitsFringe Benefits
• Historically, fringe benefit lawsHistorically, fringe benefit laws
have favored “C” corporationshave favored “C” corporations
For example, generally, healthFor example, generally, health
insurance is fully deductible forinsurance is fully deductible for
a “C” corporation, partiallya “C” corporation, partially
deductible for sole proprietor,deductible for sole proprietor,
not deductible for partners ornot deductible for partners or
for an “S” corporationfor an “S” corporation

11-137
Organizational Choices
TypeType CreationCreation ContinuityContinuity ControlControl LiabilityLiability TaxTax
ProprietorshipProprietorship Do It!Do It! ProprietorProprietor ProprietorProprietor Unl’dUnl’d SingleSingle
AgreementAgreement
EasilyEasily
DissolvedDissolved
(Buy/Sell)(Buy/Sell)
EqualEqual
AmongAmong
PartnersPartners
Unl’dUnl’d
SingleSingle
LimitedLimited
Agree &Agree &
RegisterRegister
GeneralGeneral
PartnerPartner
GeneralGeneral
PartnerPartner
Gen’l- Unl’dGen’l- Unl’d
Ltd.- Ltd.Ltd.- Ltd.
SingleSingle
LLPLLP Articles &Articles &
RegistrationRegistration
EasilyEasily
DissolvedDissolved
EqualEqual
PartnersPartners
LimitedLimited SingleSingle
LLCLLC Articles &Articles &
RegistrationRegistration
DissolvedDissolved
(90 Days)(90 Days)
EqualEqual
MembersMembers
S CorporationS Corporation ArticlesArticles
(<75 People)(<75 People)
PerpetualPerpetual
(Ease Of(Ease Of
Transfer)Transfer)
ShareholdersShareholders
DirectorsDirectors
OfficersOfficers
CorporationCorporation Articles OfArticles Of
IncorporationIncorporation
PerpetualPerpetual
(Ease Of(Ease Of
Transfer)Transfer)
ShareholdersShareholders
DirectorsDirectors
OfficersOfficers
LimitedLimited DoubleDouble

11-138
Basic Forms of Ownership
 Sole ProprietorshipSole Proprietorship
 PartnershipPartnership
 CorporationCorporation
NumberNumber SalesSales
74%74% 5%5%
8%8% 5%5%
18%18% 90%90%

11-139
Basic Forms
of Ownership
Basic Forms
of Ownership
18%
5%
74%
5%8%
90%
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Number Sales
Sole Proprietorship
Partnership
Corporation

11-140
Relative Percentages of Sole Proprietorships,
Partnerships, and Corporations in the U.S.
Sole proprietorships
16,955,000
73.0%
Corporations
4,631,000
19.9%
Partnerships
1,654,000
7.1%
Sole proprietorships, the
most widespread form of
business ownership, are
most common in retailing,
agriculture, and the service
industries.
Source: U.S. Bureau of the Census, Statistical Abstract of the
United States, 119th ed., Washington, D.C., 1999, p. 545.

Changing Popularity of Business
Forms
0
2000
4000
6000
8000
10000
12000
14000
16000
S. Prop C Corp S Corp Part.
1980
1992

Corporations
0
500
1000
1500
2000
2500
C Corp S Corp
1980
1992

Some Form Trends
 Historically, maximum individual tax rate >Historically, maximum individual tax rate >
than maximum corporate rate createdthan maximum corporate rate created
incentive to keep income in corporate formincentive to keep income in corporate form
 1986 Tax Act made maximum individual rate <1986 Tax Act made maximum individual rate <
maximum corporate rate & companies becamemaximum corporate rate & companies became
” S” corps in droves” S” corps in droves
 But 1993 Tax Act increased individual rates,But 1993 Tax Act increased individual rates,
thus, “S” corps no longer as advantageousthus, “S” corps no longer as advantageous
 New kid on block - L.L.C., more flexible thanNew kid on block - L.L.C., more flexible than
“S” Corp and better that L..L.P. in that not“S” Corp and better that L..L.P. in that not
require a general partnerrequire a general partner

Forms of Business Organizations and Corporate Governance

Forms of Business Organizations and Corporate Governance

Empfohlen

Empfohlen

Weitere ähnliche Inhalte

Was ist angesagt?

Was ist angesagt? (13)

Ähnlich wie Forms of Business Organizations and Corporate Governance

Ähnlich wie Forms of Business Organizations and Corporate Governance (20)

Kürzlich hochgeladen

Kürzlich hochgeladen (20)

Forms of Business Organizations and Corporate Governance