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C H A P T E R 19
FORMS OF BUSINESS ORGANIZATIONS
One of the first questions facing any entrepreneur wishing to start a business is which form of
business organization will best suit the enterprise. This decision comes in the earliest stages in
the life of a business, but it is nonetheless a crucial one. This chapter discusses the most
frequently used forms of business organization, and their basic tax treatments.
I. SOLE PROPRIETORSHIPS. Can be a fictitious business name; income is ordinary income
on 1040, schedule c.
II. GENERAL PARTNERSHIPS. Advantages and Disadvantages: Profit earned “passes
III. JOINT VENTUREs terminate when the project is completed.
IV. LIMITED LIABILITY PARTNERSHIPS insulate partners from vicarious liability arising
from the malpractice.
VI. CORPORATIONS operate under state charter with limited powers to achieve specific
purposes and has various legal advantages.
A. “C” Corporations. Two levels of taxation.
VII. LIMITED LIABILITY COMPANIES combine the tax advantages of a pass-through entity
with the limited liability advantages of a corporation.
CASE 19.1 Fisk Ventures, LLC v. Segal, 2008 WL 1961156 (Del. Ch. May 7, 2008).
Segal founded Genitrix, LLC with three classes of membership. Segal
transferred his patent and received 55% of Class A stock with a capital
BAGLEY, MANAGERS AND THE LEGAL ENVIRONMENT 7TH ED—INSTRUCTOR’S MANUAL
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contribution worth $500,000. Fisk contributed $843,000 in return for
sizeable percentage of Class B stock, with Fisk Ventures and Stephen
VIII. BENEFIT CORPORATIONS. A new and developing type of business organization. A “B”
corporation is a for-profit corporation that uses the power of business to solve social and
IX. INCOME TAX CONSIDERATIONS.
A. Comparing Separate Taxable Entities with Pass-Through Entities.
1. Property Transfers.
2. Cash Distribution.
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CHOICE OF BUSINESS ENTITIES: PROS AND CONS
C
Corp.
S
Corp.
General
Partnershi
p
Limited
Partnersh
ip
Limited
Liability
Compan
y
Limited Liability
Yes
Yes
No
Yes (A)
Yes
Flow-through
Taxation
No
Yes
Yes
Yes
Yes
Ability to Raise
Venture Capital
Yes
No
No
No
No
Ability to Take
Public
Yes
Yes (C)
No (D)
No (D)
No (D)
Flexible Charter
Documents
No
No
Yes
Yes
Yes
Ability to Change
Structure
without Tax
No
No
Yes
Yes
Yes
options)
Gains
Special
Allocations
Limitations on
Eligibility
Limitations on
No
BAGLEY, MANAGERS AND THE LEGAL ENVIRONMENT 7TH ED—INSTRUCTOR’S MANUAL
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Distributions
(A) Limited liability for limited partners only; a limited partnership must have at least one general partner with
unlimited liability.
(B) Partners in LLPs generally are protected from liability for malpractice and other wrongful conduct of
fellow partners; states are split on whether LLP partners can be held individually liable for other
partnership liabilities, such as commercial debt.
X. AGENCY LAW AND LIMITED LIABILITY. To avoid personal liability, an individual
should disclose whether they are acting on their own or as agents for a third party. If a
person signs a contract without designating he is acting as an agent, he will be personally
liable for the terms and conditions of that contract, if the undisclosed principal fails to
perform.
CASE 19.2 Estate of Countryman v. Farmers Cooperative Association of Keota,
679 N.W.2d 598 (Iowa 2004). In 1999, a propane tank explosion killed
XI. PARTNERSHIP MECHANICS.
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A. Formation of a General Partnership. Can be created with a handshake and general
understanding between the partners to share profits and losses.
1. Without a Written Agreement, state laws govern.
CASE 19.3 Holmes v. Lerner, 88 Cal. Rptr. 2d 130 (Cal. Ct. App.
1999). Sandra Lerner was wealthy entrepreneur. She met
Holmes and the two talked about setting up a cosmetics
business, Urban Decay. Holmes received assurances from
2. With a Written Agreement.
B. Operation of a General Partnership may be informal. But partners must discharge
their duties to each other in accordance with good faith and fair dealing.
C. Dissolution, Winding Up, and Termination of a General Partnership.
1. Dissolution occurs when the partners no longer carry on the business
together.
XII. LIMITED PARTNERSHIP REQUIREMENTS.
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XIII. INCORPORATION. A corporation can do business as a foreign corporation in another
state by filing documents with the appropriate secretary of state and tax authorities.
A. Where to Incorporate.
B. How to Incorporate. The minimum steps are: (1) select a corporate name and
C. Defective Incorporation.
1. De Jure Corporation the entity is a corporation by right and cannot be
challenged.
XIV. PIERCING THE VEIL OF A CORPORATION OR LLC. Generally, shareholders and
members enjoy a “veil” of limited liability from third-party claims. However, a court
will pierce this veil under certain conditions.
A. Alter Ego Theory.
1. Domination of the Controlling Shareholder.
B. Undercapitalization Theory.
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CASE 19.4 Walkovszky v. Carlton, 223 N.E.2d 6 (N.Y. 1966), Defendant was
a shareholder in the cab company, Seon, responsible for hitting
C. Tort versus Contract.
D. Reverse Piercing. In some circumstances, a corporation may be liable for the
debts of a shareholder.
XV. MANAGEMENT OF THE CORPORATION.
A. Directors. Typically corporations have a board of directors, which selects a chief
executive officer (who may also be a member of the board).
C. Shareholders.
1. Voting Rights: Cumulative vs. Straight Voting, Class voting.
CASE 19.5 Business Roundtable v. SEC, 647 F.3d 1144 (D.C. Cir. 2011).
Plaintiffs challenged the validity of Rule 14a-11, alleging the
4. Majority Voting.
BAGLEY, MANAGERS AND THE LEGAL ENVIRONMENT 7TH ED—INSTRUCTOR’S MANUAL
5. Shareholder Inspection Rights and Access to the Shareholder List.
6. Shareholder Suits: (a) against the CEO, for mismanagement; or (b) a
derivative suit, on behalf of the corporation.
XVI. STRUCTURAL CHANGES IN A CORPORATION.
A. Merger. Combination of two or more corporations into a surviving corporation,
with the other corporation(s) “disappearing.” Can be cash or non-cash (stock or
assets).
XVII. TENDER OFFERS AND STOCK REPURCHASES
A. Tender Offers.
THE RESPONSIBLE MANAGER: TEACHING SUGGESTIONS
1. Begin a discussion with a hypothetical business idea and move the discussion to which of
the business organizations will best serve the needs of the ‘founders.’ The students should lay
out goals and a business plan in conjunction with the proper type of business organization. What
written documents must be developed to reduce future liability and problems of the new
business?
2. Discuss franchises and the following considerations for the legally astute manager to
consider: Advantages and Disadvantages, Definition and Formation, The Marketing Plan
CHAPTER 19 FORMS OF BUSINESS ORGANIZATIONS
3. Discuss how cumulative voting could help minority shareholders?