LAW 101 SEU Business Entity Formation that Fits Ahmed Concerns Case Study Analysis

Case Study

Ahmad and his friend, A.G. Pennypacker, have come up with a great idea: they have developed a fluoroelastomer liner (a rubber lining) for oil tankers. With this innovation, they believe they can eliminate most oil spills that result from tanker accidents. The liner is highly resistant to fluctuations in temperature as well as physical punctures.

Ahmad wants to set up a company, but is unsure of his options and has come to you for advice for the type of business entity formation he should select. He has the following concerns:

He does not want his other business concerns being held liable should there be a lawsuit arising from use/sale of this product.

He wants an entity form that will minimize his tax liability.

Based on the entity forms detailed in Chapter 35, select one you feel satisfies his concerns. Make sure to explain why it is the best for Ahmad and Pennypacker.

Chapter 35
Forms of Business
Organizations
McGraw-Hill/Irwin
Copyright © 2012 by The McGraw-Hill Companies, Inc. All rights reserved.
Chapter 35 Ethical Dilemma
As this chapter indicates, a corporation is a legal construct with an identity
separate and apart from its owner(s). The primary legal advantage to converting
one’s business from an unincorporated enterprise to the corporate form is the
ability to avoid personal liability for the business’s financial obligations. Since the
corporation is distinguishable from its owner, the owner’s personal assets cannot
be seized to satisfy business indebtedness. This effectively means that an owner
can “crash and burn” a corporation financially, bankrupt the business, and walk
away from the “flaming wreckage” of the corporation without personal obligation
for business debts.
Is it ethical for an owner to use the corporate entity to avoid personal obligation for
business debts?
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Chapter 35 Case Hypothetical
Allison Seizer has a very wealthy father, entrepreneur Warren Seizer of “Chimichonga Chime” restaurant
fame, although her family pedigree was not what attracted Blake Patterson to his girlfriend of three years;
instead, it was “love at first sight.” Blake proposes to Allison, and the two are married with the blessing of
Warren Seizer.
Warren wants the best for his daughter and son-in-law, so he offers a “Chimichonga Chime” franchise to
Blake, with a prime location in the center of the Elmwood business district. After one year, it is clear that
the newest “Chimichonga Chime” is and will be a tremendous business success. In fact, sales, revenue
and profit goals for the restaurant are shattered in its first year of operation, and Blake would like to think
that his “hands-on” ownership and operation of the restaurant was an important part of the store’s success.
Unfortunately, the couple’s relationship has suffered over the year, and the term “irreconciliable
differences” creeps into marriage conversations. Blake asks for his freedom, and Allison obliges. Wedding
bells have been replaced by divorce attorneys.
Warren Seizer is furious. He is firmly convinced that Blake Patterson is to blame for the marriage’s
dissolution, because there is no conceivable way (at least in his mind) that his “darling angel,” his
“precious daughter,” could be responsible for the divorce. The creative genius behind “Chimichonga
Chime” plots justice for his daughter and himself, although some may call it revenge.
On September 1, Warren Seizer personally delivers a Notice of Termination of Franchise to Blake
Patterson. The document states that Patterson’s franchise agreement has been terminated for cause, and
that he must either close the restaurant, or cease and desist from using the name “Chimichonga Chime,”
advertising the franchise chime logo, and selling all franchise-related products, within 30 days.
Who wins: The “ex-father-in-law,” or the “ex-son-in-law?”
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Major Forms of Business Organizations
■
Sole Proprietorship
■
General Partnership
■
Limited Partnership
■
Corporation
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Sole Proprietorship
■
Definition: Unincorporated business owned by one person
■
Owner has total control
■
Owner has unlimited liability
■
Profits taxed directly as income to sole proprietor
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Advantages and Disadvantages of Sole
Proprietorship
■
■
Advantages
■
Ease of creation (“start-up”)
■
Owner has total managerial control
■
Owner retains profits
Disadvantages
■
Personal liability for all business debts/obligations
■
Funding limited to personal contributions and loans
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General Partnership
■
Definition: Unincorporated business owned and operated by
two or more persons
■
Each partner has equal control of business
■
Each partner has unlimited, personal liability for business
debts/obligations
■
Profits taxed as income to partners
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Advantages and Disadvantages of Partnership
■
■
Advantages
■
Ease of creation (“start-up”)
■
Partnership income is partner income
■
Business losses qualify for tax deduction
Disadvantages
■
Personal liability for all business debts/obligations, including those
incurred by other partners on behalf of partnership
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Limited Partnership
■
Definition: Unincorporated business with at least one general
partner, and one limited partner
■
General partner in limited partnership has
managerial/operational control over business
■
Limited partner’s liability limited to extent of his/her capital
contributions
■
Limited partner has no managerial/operational control over
business
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Corporation
■
Definition: State-sanctioned business with legal identity separate
and apart from its owners (shareholders)
■
Owners’ (shareholders’) liability limited to amount of investment
in corporation
■
Profits taxed as income to corporation, plus income to
owners/shareholders (“double-taxation”)
■
“S” Corporation can avoid double-taxation
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Advantages and Disadvantages of Corporation
■
■
Advantages
■
Limited liability for shareholders
■
Ease of raising capital by issuing (selling) stock
Disadvantages
■
“Double-taxation”
■
Formalities required in establishing and maintaining corporate existence
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“S” Corporation
■
Definition: Business organization formed under federal tax law
that is considered corporation, yet taxed like a partnership
■
Formed under federal law
■
No more than seventy-five shareholders
■
Shareholders must report income on their personal income tax
forms
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Limited Liability Company (LLC)
■
Definition: Business organization with limited liability of a
corporation, yet taxed like partnership
■
Formed under state law
■
Owners of LLC (“members”) pay personal income taxes on
shares they report
■
No limitation on number of owners permitted in LLC
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Specialized Forms of Business Organizations
■
Cooperative—Organization formed by individuals to market products
■
Joint stock company—Partnership agreement in which company members hold
transferable shares, while all company goods are held in names of partners
■
Business Trust—Business organization governed by group of trustees, who operate
trust for beneficiaries
■
Syndicate—Investment group that forms for purpose of financing specific large
project
■
Joint Venture—Relationship between two or more persons/corporations created for
specific business undertaking
■
Franchise—Agreement between “franchisor” (owner of trade name/trademark) and
“franchisee” (person who, by specific terms of agreement, sells goods/services under
trade name/trademark)
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Advantages and Disadvantages of Franchise
(To Franchisee)
■
■
Advantages
■
Assistance from franchisor in starting franchise
■
Trade name/trademark recognition
■
Franchisor advertising
Disadvantages
■
Must meet contractual requirements, or possibly lose franchise
■
Little/no creative control over business
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Advantages and Disadvantages of Franchise (To
Franchisor)
■
■
Advantages
■
Low risk in starting franchise
■
Increased income from franchises
Disadvantages
■
Little control (except contractually) over individual franchise
■
Can become liable for franchise, if franchisor exerts too much control
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Types of Franchises
■
“Chain-Style” Business Operation
■
■
Distributorship
■
■
Franchisor helps franchisee establish a business (using franchisor’s
business name, and franchisor’s standard “methods and practices”)
Franchisor licenses franchisee to sell franchisor’s product in specific area
Manufacturing Arrangement
■
Franchisor provides franchisee with technical knowledge to manufacture
franchisor’s product
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Top Ten Global Franchises (2009)
■
Subway
■
Ace Hardware Corp.
■
McDonald’s
■
Pizza Hut
■
Liberty Tax Service
■
UPS Store
■
Sonic Drive In Restaurants
■
Circle K
■
Intercontinental Hotels
Group
■
Papa John’s International,
Inc.
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