Chapter 37: Forms of Business Organizations

The key points in this chapter include:

1. The three major forms of business organizations.

2. The advantages and disadvantages of a partnership and of a corporation.

3. How a limited liability company differs from other business organizations.

4. The characteristics of joint ventures and other business forms.

5. What a franchise is and how a franchising relationship arises.

This chapter sets out features of the major traditional business forms—sole proprietorships, partnerships, and corporations—and other forms for doing business. The chapter includes a discussion of private franchises.

I. SOLE PROPRIETORSHIPS
The simplest form of business—the owner is the business.

A. ADVANTAGES
The proprietor takes all the profits. Easier to start than other kinds of businesses (few legal forms involved); has more flexibility (proprietor is free to make all decisions); owner pays only personal income tax on profits.

B. DISADVANTAGES
The proprietor has all the risk (unlimited liability for all debts); limited opportunity to raise capital; the business dissolves when the owner
dies.

II. PARTNERSHIPS
A partnership arises from an agreement between two or more persons to carry on a business for profit.

A. PARTNERS ARE CO-OWNERS
General partners jointly control the operation and share the profits. No particular form of agreement is necessary to create a general partnership; partners may agree to any terms.

B. PARTNERSHIP IS A LEGAL ENTITY FOR LIMITED
PURPOSES
For example, the partnership name and ownership of property. Partners are subject to personal liability for partnership obligations; partnership is not subject to federal income tax (profit is taxed as individual income to the partners).

III. LIMITED PARTNERSHIPS
Consist of at least one general partner and one or more limited partners. General partners run the business and are subject to personal liability for partnership obligations. Limited partners have limited liability.

IV. CORPORATIONS
Corporations consist of shareholders, who own the business; a board of directors, who are elected by the shareholders to manage the business; and officers, who oversee day-to-day operations (see Chapters 40 through 43).

A. ADVANTAGES
Liability of the owners (shareholders) is usually limited to their investment; corporation can raise capital by selling shares of stock.

B. DISADVANTAGES

1. Corporate Income Is Taxed Twice Once as income to the corporation, and once when distributed to shareholders; this may be avoided by electing to be treated, for tax purposes, as an S corporation, which is not taxed at the corporate level.

2. Incorporation Requirements
A corporation must be set up according to specific statutory procedures, have sufficient capitalization, and pay other costs of incorporation; is subject to more governmental supervision and reporting requirements.

3. Credit Limitations
Because of limited liability, creditors may not be willing to extend credit to a new or small corporation (without a personal guarantee).

V. LIMITED LIABILITY COMPANIES
A limited liability company (LLC) is a hybrid form of business enterprise that offers limited liability of a corporation with tax advantages of a partnership.

A. ADVANTAGES
Taxed as a partnership; liability of members is limited to the amount of their investment; members can participate in management; corporations, partnerships, and foreign investors can be members; no limit on the number of members.

B. DISADVANTAGES
Statutory restrictions on the transfer of ownership; because the LLC is a new form, little case law exists; until uniform statutes are adopted by most states, an LLC with multistate operations may face difficulties.

VI. LIMITED LIABILITY PARTNERSHIPS
Professionals may organize as a limited liability partnership (LLP) to enjoy the tax advantages of a partnership, while avoiding personal liability for the wrongdoing of other partners.

VII. OTHER ORGANIZATIONAL
FORMS

A. JOINT VENTURE

1. Characteristics
Same as a partnership except members have less implied and apparent authority than partners, and the death of a member ordinarily does not terminate the veture.

2. Duration
Depending on the circumstances: members specify a duration, venture terminates when project for which it is formed is completed, or venture is terminable at the will of any of its members.

3. Duties, Rights, and Liabilities among Joint Venturers

a. Duties
Same as partners (see Chapter 38).

b. Conflicts When Members Are Competitors (1) Each may face a choice between disclosing trade secrets to a competitor and breaching the duty to disclose, and (2) there is potential for violation of antitrust laws (see Chapter 47).

c. Rights
Each joint venturer has an equal right to manage the activities of the enterprise (though control may be given to one member).

d. Liability
Each joint venturer is liable to third parties for the actions of the other members in pursuit of the goal of the venture.

B. SYNDICATE
A group of individuals financing a project; may exist as a corporation, a partnership, or no legally recognized form.

C. JOINT STOCK COMPANY
Usually treated like a partnership (formed by agreement, members have personal liability, etc.), but members are not agents of one another, and has many characteristics of a corporation: (1) ownership by shares of stock,
(2) managed by directors and officers, and (3) perpetual existence.

D. BUSINESS TRUST
Legal ownership and management of the property of the business is in one or more trustees; profits are distributed to beneficiaries, who are not personally responsible for the debts of the trust. Resembles a corporation.

E. COOPERATIVE
An association that is organized to provide an economic service without profit to its members (or shareholders).

1. Incorporated Cooperative
Subject to state laws governing nonprofit corporations. Distributes profits to owners on the basis of their transactions with the cooperative rather than on the basis of the amount of capital they contributed.

2. Unincorporated Cooperatives
Often treated like partnerships. The members have joint liability for the cooperative’s acts.

VIII. PRIVATE FRANCHISES
A franchise is any arrangement in which the owner of a trademark, a trade name, or a copyright has licensed others to use it in selling goods or services.

A. TYPES OF FRANCHISES

1. Distributorship
When a manufacturer licenses a dealer to sell its product (such as an automobile dealer). Often covers an exclusive territory.

2. Chain-Style Business Operation
When a franchise operates under a franchisor’s trade name and is identified as a
member of a group of dealers engaged in the franchisor’s business (such as most fast-food chains). The franchisee must follow standardized or prescribed methods of operations, and may be obligated to obtain supplies exclusively from the franchisor.

3. Manufacturing or Processing-Plant Arrangement
When a franchisor transmits to the franchisee the essential ingredients or formula to make a product (such as Coca-Cola), which the franchisee makes and markets according to the franchisor’s standards.

B. LAWS GOVERNING FRANCHISING

1. Federal Protection for Franchises

a. Automobile Dealers’ Franchise Act of 1965 Dealership franchisees are protected from manufacturers’ bad faith termination of their franchises.

b. Petroleum Marketing Practices Act (PMPA) of 1979
Prescribes the grounds and conditions under which a gasoline station franchisor may terminate or decline to renew a franchise.

c. Antitrust Laws
May apply if there is an anticompetitive agreement (Chapter 47).

d. Federal Trade Commission (FTC) Regulations
Franchisors must disclose material facts necessary to a prospective franchisee’s making an informed decision concerning a franchise.

2. State Protection for Franchises
Similar to federal law. State deceptive practices may apply.

C. THE FRANCHISE CONTRACT
A franchise relationship is created by a contract between the franchisor and the
franchisee.

1. Payment for the Franchise
A franchisee pays (1) a fee for the franchise license, (2) fees for products bought from or through the franchisor, (3) a percentage of sales, and (4) a percentage of advertising and administrative costs

2. Location of the Franchise
The franchisor determines the territory to be served and its exclusivity. The agreement may specify whether the premises for the business are leased or purchased and who is to supply equipment and furnishings.

3. Business Organization
A franchisor may specify requirements for the form and capital structure of the business.

4. Price Controls
A franchisor may require a franchisee to buy certain supplies from the franchisor at an established price. A franchisor can suggest retail prices for the goods but cannot insist on them.

5. Quality Controls
A franchisor may specify standards of operation (such as quality standards) and
personnel training methods. Too much control may result in a franchisor’s liability for torts of a franchisee’s employees.

6. Termination of the Franchise
Determined by the parties. Usually, termination must be “for cause” (such as breach of the agreement, etc.) and notice must be given. A franchisee must be given reasonable time to wind up the business.