Question

 

Creating Sunburst: Legal and Organizational Considerations

Ravi, who has a degree from State University in mechanical engineering, was previously employed by a start-up firm in New York City. He worked long hours for little pay, but when the business sold, his stock options paid off. As a result, he now has some time and $100,000 to invest in Sunburst. More importantly, Ravi has the knowledge and know-how to setup and manage production. Tanya, a friend you met through your alumni association, has a degree in marketing and has a few years of experience working in marketing roles. The three of you agree to form the start-up team for Sunburst.

The team estimates that it will take approximately two years to develop Sunburst into a marketable product, but that once the product is on the market, there is excellent growth potential. You know that you will need additional investors and expertise to get the business off the ground. You need to develop a plan for a business form that will be attractive to potential investors and partners, and will address their concerns.

Finance and politics are not your strong suits, and you aren't very interested in the day-to-day business operations of Sunburst—you'd rather spend most of your time inventing new products. The start-up team believes that the business will need someone with finance skills. You also need a visionary CEO. Ideally, this person should have connections and experience in the solar industry. You have asked Elon Helios, a forward-thinking figure in the solar energy field, who is known for being a rainmaker. Helios has expressed some interest, but it will take significant incentives to get him on board.

Although Tanya has little money to invest, she has excellent networking skills, and she has found a potential investor, Carmen Santiago, who thinks that the product may have potential. Santiago does not want to be involved in running the business.

Ravi has identified a good candidate with finance experience. This individual does not want to invest in the company, but he would expect a good salary and benefits.

The team has created a tentative business plan, which has two target stages: The first stage involves local (geographical region) manufacturing with a focus on local solar energy providers; the second stage will begin five years from start-up, at which point the business will expand nationally (or possibly internationally) targeting the market of all potential solar energy customers. The potential investors and participants want to know what legal form the business will take before they agree to participate.

What are the different legal forms of business that you might consider? You remember that there are at least six factors that will influence your choice:

creation and maintenance

continuity

ownership and control

personal liability

compensation and division of profits

taxation

What is your proposed choice for the legal form of business? Include your reasoning based on the preceding six factors and any other relevant factors

Answer 1

The different legal form of business are as follows:

• Sole Proprietorship: A sole proprietorship is a type of business entity that is owned and run by one individual. In this type of entity there is no legal distinction between the owner and the business. It is the most common form of business structure. In this form of business, an individual normally uses its own capital therefore he is entitled to receive all the profits and gains. But he bears all the risk of ownership. He exercises full control over the affairs of the business. This type of business is particularly suitable for businesses which are small in size and where risk and capital involved are not very large.

This type of business has the following features:

1. is simple to form and operate,
2. may enjoy greater flexibility of management,
3. fewer legal controls, and
4. fewer taxes.
5. the business owner is personally liable for all debts incurred by the business.

• General Partnership: A general partnership is an association between two or more people who agree to contribute money, labour, or skill to a business for seeking profit. Each partner shares profits, losses. Each partner is personally and equally liable for the debts of the firm. A general partnership can be formed with little formality but usually an agreement is made containing the terms of the partnership business known as “partnership agreement”.

• Limited Liability Partnership (LLP): This business structure gives benefit of limited liability company and benefit of a partnership firm. In LLP the partners are not personally liable for the negligence of another partner. LLP is a separate legal entity which can continue its existence irrespective of changes in its partners. As it is flexible in its structure and operation, it is useful for small and medium enterprises.

• Limited Partnership: In this type of business there are two types of partners. First is general partner, who manages the business and has unlimited personal liability for the debts of the firm. Second is limited partner, who has limited liability and who cannot participate in the management of the firm. They only share in the profits of the business.

• Limited Liability Company (LLC): A LLC is formed by one or more individuals or entities. A special written agreement is made. The members of the company cannot be held personally liable for the company’s debts or liabilities. LLC has the characteristics of a corporation and a partnership or a sole proprietorship. While the limited liability feature is similar to that of a corporation, the availability of flow-through taxation to the members of an LLC is a feature of partnership.

• Corporation: A corporation is a legal entity that is separate and distinct from its owners. This means that the corporation itself is held legally liable for the actions and debts incurred by the business. The shareholders are not held liable. Corporations are generally suggested for established, larger companies with multiple employees. A Corporation has the following features:

1. It has the right to enter into contracts.
2. It can sue and can be sued.
3. It can hire employees.
4. It can own assets.
5. It has to pay taxes.

My proposed choice for creating Sunburst is LIMITED LIABILTY PARTNERSHIP (LLP)

Factors supporting the choice are as follows:

1. Creation and Maintenance: An LLP is a separate legal entity from its Members. It is required to be registered under the respective law and after successful registration a unique registration number is issued. This registration number will stay the same throughout the life of LLP, even if there is a change in the name of LLP in future years. The cost of formation is low. LLP agreement is required to be formed.
2. Continuity: The continuity of a LLP depends on the partnership agreement. Partnership may be terminated if a partner wants to leave the partnership.
3. Ownership and Control: LLP is owned by the partners who signs the agreement and agrees to be the partners of the business. They are responsible for taking important business decisions and controls how the business will run.
4. Personal Liability: The members of LLP have liability only upto the amount they have contributed to LLP. They cannot be held personally liable but in certain cases personal liability of a member may be extended. They are: a.Negligence due to which third party suffers loss b.Wrongful or fraudulent trading c.Insolvency clawbacks d.Personal guarantees
5. Compensation and Division of Profits: Profit shall be divided among the members in the ratio mentioned in LLP agreement. If there is no agreement, then profit and losses are allocated proportionally based on the partnership interests of each partner.
6. Taxation: LLP is treated as a partnership for tax purpose and the members are taxed as partners. Each member is liable for tax on their share of income or gains of the LLP.