Business Entity FormationsNema Koohmaraie and Matt HinrikusUNL College of Law – Entrepreneurship Legal Clinic

Disclaimer• The content of this presentation is intended solely as a brief

summary of entity choices available to individuals starting a business operation. The information provided during this presentation shall not be construed as legal advice

• We are not tax experts. Consult your accountant or tax attorneys to supplement the tax considerations

Discussion Points• Overview of Business Entity Structures• Benefits & Values of Entity Formation• Types of Entities

• Sole Proprietorship• Partnership – General or Limited• Corporation – C-Corp. or S-Corp. • Limited Liability Company (LLC)

• Differences

Benefits of Entity Formation• Corporate Shield – a.k.a., liability protection

• Appearance of Legitimacy

• Means to raise capital from outside investors

• Method of combining valuable assets• E.g., intellectual property

• Business continuity and planning

Sole Proprietorship• Composed of one individual who owns and operates a

business – Default entity

• No separation or distinction as between the owner and the business

• No statutory requirements to create• Trade Name Application if going to conduct business in

something other than the name of the owner• Applicable licenses or permits

Sole Proprietorship• Taxation• Owner of the business reports income or loss directly on his or

her personal income tax return

• Liability of Owner• Owner of the business is personally liable for debts & obligations

of business and for negligent acts committed by themselves and their employees if acting within the scope of employment

Partnerships• An association of two or more persons to carry on a business

for profit as co-owners

• Two Types• General Partnership• Limited Partnership

General Partnership• Partnership Formation• Default entity• Automatically forms when two or more individuals are carrying

on a business for profit as co-owners

• Operations• Partnership Agreement; OR• Revised Uniform Partnership Act (governing law)

General Partnership• Taxation• Partnership files an informational income tax return, but the

Partnership itself does not pay income taxes• Pass-Through Entity

• Income or loss is attributed to the owners/partners equally

• Note: Sharing of profits or losses can be determined by the Partnership Agreement

General Partnership• Liability of Owners/Partners• Shared liability by all partners

• Joint and Several

• Any one partner can bind other partners• Contract• Negligence

General Partnership• Advantages• Simple and Inexpensive to create• Partners report their share of profits or losses on their own

income tax return

• Disadvantages• Partners are personally liable for debts & obligations of the

business

Limited Partnership• Formation• Must file a Certificate of Limited Partnership with Secretary of

State

• Operations – Two Types of Partners• General Partners: Active investor and actively involved in the day

to day operations and management• Limited Partners: Do not participate in day to day operations and

management – passive investors

Limited Partnership• Taxation• Based on value of individual contributions• Tax liability is not equal among partners

• Liability of Owners/Partners• General Partners: Subject to personal liability for debts &

obligations of business (similar to General Partnership)• Limited Partners: Not subject to personal liability for debts &

obligations of business

Limited Partnership• Advantages• Limited partners are not personally liable for business debts

(generally)• General partner can raise capital from the passive investors

(limited partners) without giving up management in business

• Disadvantages• General Partners are personally liable for business debts

Alternatives• Is there a way to limit the liability of all owners while allowing

easy transferability of ownership interests?• YES – Corporations or Limited Liability Companies

Limited Liability Entities• Our purpose today Corporations or LLCs

• Legal entity, separate & distinct from the owners• Created by statutory law

• Limited liability of business owners• Not liable for debts incurred by the business

• Unless exceptions apply – Piercing Corporate Veil

Requirements• Must file with the Nebraska Secretary of State• Articles of Incorporation (Corporations)• Certificate of Organization (LLCs)

• Must draft and execute – governing document• Corporate Bylaws (Corporations)• Operating Agreement (LLCs)

Limited Liability Entity or Not• Increased Likelihood of incurring liability• Selling products or services• Hiring more employees• Entering into contracts – e.g., leases, loans, sales

• Multiple owners

• Additional investors

Corporation or LLC• Things to Consider:• Financing needs

• Investors, Venture Capitalists, Angel Capitalists tend to prefer corporation status

• Management • Board of Directors & Officers (Corporations); OR• Member- or Manager-Managed (LLCs)

• Tax & Liability

Corporations• Corporate law is state law• Approx. 50% of corporations incorporate in Delaware

• Internal Affairs Rule: the laws of the state of incorporation govern internal corporate affairs

• Foreign Business Rule: if incorporated in a state other than where conducting business, must qualify/register to operate business in the “foreign” jurisdiction

Corporations• Operations• Shares of Stock = Ownership Interest = Shareholder

• Board of Directors = primary decision makers• Election process is established in the Articles or Bylaws• Can reserve certain decision-marking authority to Shareholders

• Officers = day to day decision makers• Elected by Board of Directors• President, VP, Secretary, Treasurer, etc.

Corporations• Liability of Owners/Shareholders• Separate legal entity, distinct from Owner/Shareholders

• General Rule: Entity is liable for corporate debts & obligations

• Exceptions:• Piercing the Corporate Veil (PCV)• Personal Contractual Guarantees

Corporations• Two Choices:• C-Corporations (C-Corp.)

• S-Corporations (S-Corp.)

C-Corporation• Taxation• Double Taxation

• First, taxed at the corporate level – corporation reports and pays income taxes

• Second, taxed at the individual level – shareholders report and pay income tax on any distributions paid out to them

S-Corporation• Corporation that makes a valid election to be taxed under

Subchapter S of Chapter 1 of the Internal Revenue Code• File Form 2553

• Taxation• Pass-Through

• No taxation at corporate level• Only taxed at individual level if shareholders are paid distributions

S-Corporation• Restrictions on S-Corporation • Domestic Corporation• Allowed only 1 class of stock• Maximum of 100 shareholders• Shareholders must be U.S. citizens or residents• Profits and Losses allocated proportionately

Limited Liability Company• Flexible structure: Can take the form of a General Partnership,

but provides the limited liability of a corporation

• Formation• Must file Certificate of Organization with Nebraska Secretary of

State

Limited Liability Company• Operations• Operating Agreement (governing contract)• Nebraska Limited Liability Company ct (governing law)

• Management Structure• Member-Managed – Default

• All members (owners) have decision-making authority in day to day operations of business

• Manager-Managed• Must be elected in the Operating Agreement• Decision-making authority is given to one or more persons

Limited Liability Company• Taxation – various possibilities• Default: Pass-Through entity• Election

• C-Corporation treatment: taxed at corporate and individual levels; OR• S-Corporation treatment: Pass-Through entity

• Liability• Neither members or managers are subject to personal liability for

debts & obligations of business

Limited Liability Company• Advantages• Owners have limited liability for business debts even if they

participate in management of the business• Profit and Loss can be allocated differently than ownership

interest• Choice of taxation structure

• Disadvantages• More expensive to create than a Partnership or Sole

Proprietorship

Summary• Business Entity Formation matters greatly• Tax Implications• Liability of Owners• Future Financing & Investor Preference• Internal Operations• Default Rules

Contact Us• Write us:

Entrepreneurship Legal Clinic University of Nebraska College of Law7 McCollum HallLincoln, NE 68583-0902

• Give us a call:402-472-1680

• Visit our website:http://law.unl.edu/eclinic