Partnerships: Formation and Information

Limited Partnerships
LP stands for Limited Partnership which is different from a General Partnership (or just “partnership”). A limited partnership allows for limited partners and general partners. A limited partner is one who invests, does not participate in running the partnership, and is liable only up the amount of his investment. A Limited Partnership must have one or more general partners who manage the business and who are personally liable for partnership debts. Although one partner may be both a limited and a general partner, at all times there must be at least two different partners in a Limited Partnership. A Limited Partnership must file with the state.
General Partnerships
A general partner may or may not invest, participates in running the partnership and is liable for all acts and debts of the partnership and any member of it. A General Partnership does not have limited partners. For a General Partnership, there is no registration with the state or even written agreement necessary for a general partnership to be formed. The legal definition of a partnership is generally stated as “an association of two or more persons to carry on as co-owners a business for profit” (Revised Uniform Partnership Act § 101 [1994]). Although a partnership can be implied by law, if you are forming a partnership you should always have a partnership agreement so that you are not at the mercy of the laws which are implied without one. Most of the law of General Partnerships applies to Limited Partnerships.
In a General Partnership, each of the partners (there can be more than 2) shares in the profits and shares in the liability of the partnership, including losses, unless the partner is a limited partner. A partnership is considered an association of co-owners for tax purposes, and each co-owner is taxed on his or her proportional share of the partnership profits.
Like other businesses, a partnership needs to have a license to do business in towns in which it has offices and may use an assumed name, so that Blow LP or GP could operate as Blow Holes.
All partners must consent in sale of the assets of the partnership. A partner’s interest in a partnership is considered personal property that may be assigned to other persons, but, if transferred, the transferee only receives the financial benefit and does not become a partner.
The death of a partner terminates the partnership, and the filing a dissolution of the partnership with the state also terminates the partnership.
Advantages of Partnership
Partnerships typically have less costs, paperwork and state registrations involved in both formation and upkeep. However, without written documentation, the partnership becomes subject to significant defaults state laws.
With regard to taxes, the partnership is not a separate taxable entity, but instead the profits pass through to the partners who pay for them as income tax.
Disadvantages of Partnerships
In a General Partnership, each partner is liable for the acts of the others and financial losses of the partnership, and there is no protection of personal property as there is with a corporation. Any partner without the other may bind the partnership. Money and property contributed to the partnership becomes owned by the partnership unless otherwise stated and the contributor is not entitled to its return unless stated in the partnership agreement.
Partnerships vary in legal requirements and liabilities by state, do not have the easy of transfer and investment that a corporation structure provides and therefore are regarded as less preferable to other business forms for investment.

Social Networking and Web 2.0

Over the past several months, we have been bombarded with information related to social networking and the advent of Web 2.0, the “interactive web.” Much of the information has been confusing particularly as disparate groups like Facebook, Linkedin and Twitter have fought to shape the process of linking individuals, needs and information. While we have no allusions that we understand all that has been said or done in the name of social networking, it is clear that there is a monumental change taking place in the evolution of the Internet and with that, there will be a dramatic shift in the way business will be done in the future.

Social networking has been defined as, “[A] social structure made of individuals (or organizations) called “nodes,” which are tied (connected) by one or more specific types of interdependency, such as friendship, kinship, financial exchange, dislike, or relationships of beliefs, knowledge or prestige.” Tim O’Reilly, the individual who coined the term “Web 2.0” has described Web 2.0 this way, “Like many important concepts, Web 2.0 doesn’t have a hard boundary, but rather, a gravitational core. You can visualize Web 2.0 as a set of principles and practices that tie together a veritable solar system of sites that demonstrate some or all of those principles, at a varying distance from that core.” In other words, Web 2.0 is the shift from an Internet comprised largely of static web sites and pages to a platform that ties many groups and applications together.

A few statistics are helpful in illustrating the extent that social networking is shaping Internet usage. For example, a no less venerable source than The Nielsen Company has reported the following:

• Between December of 2007 and December of 2008, the amount of Internet usage increased by 17% worldwide. During the same period, however, the amount of time spent on social network sites increased by 63% and during that same period, Facebook usage increased 566%, or from 3.5 billion minutes to 20.5 billion minutes.

• In 2008, minutes spent on social network sites accounted for one out of every fifteen minutes spent online world wide, but in 2009 social network usage accounts for one out of every eleven minutes. In the UK, however, time spent at social networking sites is equal to one out of every six minutes expended online and other parts of the European Union are showing similar results. Even more dramatic is the experience of Brazil where one in four minutes of Internet time is spent at a social networking site.

• Lest anyone think that social networking is a phenomenon reserved for the young, the fastest growing segment of the population joining Facebook constitutes those who are between the ages of 35 to 49 and the addition to Facebook of those between the ages of 50 to 64 is almost double that of the group that is under 18 years of age.

• While a growing percentage of users of social network sites are opposed to advertising on the sites, according to at least one other source, more than 93% of all users believe that a company should have a presence on at least one social networking site.

• Social networking is more important to users than email.

In addition, other sources have reported the following:

• Linkedin has more than 36 million users and is adding a new person every second of every day to their network.

• Twitter’s growth rate of members is annualized at over 750% and the number of unique visitors to Twitter is growing at an astronomical 1380% annual rate.

• Facebook has more than 150 million members and were it a country, it would be the eighth largest in the world.

In interpreting their own data, The Nielsen Company has recommended that businesses who maintain a presence on the web consider some of the following:

• Understand that social networks are an opportunity for everyone

• Tap into what makes social networks meaningful

• Internally, instigate functionality that permits conversations and groups to form within your individual web site

• Externally, participate in other social networking sites like Facebook, Twitter, MySpace and Linkedin

• Think about the mutual relationships between social networks and other media

• Copy what works for others

Over the next months, we will be watching how social networks evolve and will be looking to make the McCarrey Law Group easier to access by your friends and clients and more responsive to your needs and desires. Please let us know what works for you and we will make that information available on our web site, blog, Linkedin site and other places that are easily accessible. We will know that we have arrived when we are in a position to actually Twitter in a meaningful way!

Can You Help a Client of the McCarrey Law Group

BPS Development Group, Inc. – Charter School Development Division: BPS Development is currently working with several Charter School Organizations throughout the Western United States on Built to Suit opportunities. Our most pressing project is a 33,000 SF charter school located in Southern California. We are seeking joint venture and/or equity partners for this current project as well as several other charter school development projects which are coming on-line. We are also structuring a non-profit fund that will focus directly on investing equity into charter school programs. If you have an interest in participating in a single project or in our fund, please let us know and we will provide you with additional details on specific project and potential investment returns. This is truly an opportunity to invest in our children’s future.
Charter Schools: Charter schools are elementary or secondary schools that receive public operating money but have been freed from some of the rules, regulations, and statutes that apply to other public schools in exchange for a promise of increased accountability as set forth in each school’s charter. For example, some charter schools provide a curriculum that specializes in a certain field—e.g. arts, mathematics, etc. Others attempt to provide a better and more efficient general education than nearby public schools. Almost 1.2 million students were enrolled in 4,132 charter schools in 2006–07. During that school year, 410 new charter schools opened.
BPS Charter School Built to Suit Program: Most charter schools do not have the necessary funds or financing means to purchase land and obtain construction financing. BPS’s Built to Suit Program allows BPS and its partners to collaborate with the Charter by permitting the Charter to pick its desired school location, design its school and have the school built and managed by professionals. As part of the development process, the Charter School will execute a lease and acquire an option to purchase the school from the Developer. The Developer will secure equity through our partnerships and secure the construction financing. Once the building is built and occupied by the Charter, the Charter will have the option to purchase the completed School from the Developer at a predetermined price. Our program allows the Charter to do what they do best…teach our Children!

For more information please contact:
Benson P. Sainsbury
BPS Development Group, Inc.
28506 Constellation Road
Valencia, CA 91355
P. 661-714-7655
F. 775-898-5649
E. bps@bpsdg.com
www.bpsdg.com

Corporate Liability Protection

Although an individual can never shield himself from his own tortious or wanton acts throughthe use of a corporation, a properly formed corporation may be used to limit much of the liability associated with the conduct of his business. A corporation is intended to protects its shareholders from the effect of a corporate breach of contract or the wrongful actions of its employees or agents.

Under certain circumstances, however, the law will look through the formality of the corporate structure and attach individual liability to shareholders. This doctrine, sometimes referred to as “alter ego” or “piercing the corporate veil,” permits a court to disregard the corporate structure and to treat shareholders as if there were no corporation. Equitable in nature, the doctrine of alter ego is applied by courts in California when (1) there is such a unity of interest and ownership between the corporation and its shareholders that the separate personalities of each no longer exist and (2) an inequitable result would be reached if the acts complained of were to be treated as those of the corporation alone.

Courts have explicitly detailed which factual situations will warrant the piercing of the corporate veil and which factors, when present, are most heavily weighted towards invoking an alter ego remedy. Factually, courts who invoke the alter ego doctrine generally focus on whether (1) the corporation was properly capitalized at the time of formation, (2) corporate formalities have been maintained and (3) the business affairs and activities of the corporation are kept separate from those of its shareholders.

Often, the corporate veil is peirced when the corporation was under capitalized. Generally, to properly capitalize a new corporation, the shareholders must implement a capitalization plan that will permit the corporation to operate for the forseeable period of time from its creation to the time that it is able to sustain its activities. Courts have not prescribed a formula that details the correct ratio of debt to equity for a new corporation, but the emphasis should be on having as much equity as possible and as little debt as is feasible.

The concept of corporate formalites is broad. For instance, the holding of required meetings and the issuing stock are two of the more common corporate formalities that must be observed. Failure to keep minutes of required corporate meetings or to actually issue stock certificates may be enough for a court to pierce the veil of corporate separateness.

Courts asked to peirce the corporate veil will look closely at whether or not transactions between shareholders and the corporation are done on an “arms length” basis. In essence, the assets of the corporation and the shareholders should not be commingled and all transactions between the corporation and its shareholders should be properly documented. In addition, the California Corporations Code deals specifically with conflict of interest transactions and care must be taken to avoid shareholders acting in their personal best interests to the detriment of those of the corporation.

While it is impossible to delineate all of the possible ways that the existence of the corporation may be disregarded, the following guidelines are intended to help you preserve the protections that you thought you were obtaining when you incorporated your business:

1. Observe corporate formalities by holding the meetings required by the corporations bylaws. At a minimum, these meetings will include required shareholder and director meetings as well as meetings required when significant corporate action is being undertaken.
2. Issue stock certificates to the shareholders when stock is issued. In the process, insure that the consideration to be received by the corporation in return for the stock is in fact received.
3. When creating a corporation, make adequate provision for sufficient capital to conduct the corporation’s business. Make a reasonable plan and provide for the foreseeable obligations of the corporation from the time of its creation to the time of its economic viability.
4. Make sure that all paid in capital committed to the corporation is received by the company in the manner provided.
5. Conduct all transactions between the corporation and its shareholders on an arms length basis and clearly document all such transactions. For instance, a loan from a corporation to a shareholder should be evidenced by a promissory note.
6. File all appropriate tax returns. The failure to file tax returns may result in the state dissolving your corporation.

Limited Liability Companies vs. “S” Corporations

Invariably, when attempting to determine the proper business structure for a new business, one is left to decipher the relative differences and benefits of a limited liability company or an “LLC” versus a so-called “S” corporation. While both entity types are similar in that they are “pass-through” vehicles for federal income tax purposes, each also has significant differences. As pass-through vehicles, income as well as any losses are passed from the entity to its owners and are reported to the IRS on the owner’s tax returns. The effect is to eliminate the double taxation which might otherwise be incurred by the shareholders of a garden variety “C” corporation. Double taxation occurs when the corporate entity is taxed on its income and that same income is taxed again to shareholders at the time that dividends are distributed to them.
To understand which entity is the best for any venture, one must consider some of the key differences between an LLC and an S corporation. Often the decision is the result of the weighing of the relative benefits of the ease and flexibility of operation found in a limited liability company versus the lower employment taxes found in an “S” corporation.
Key Differences between the Two Entity Types
While the following list does not detail all of the differences between a limited liability company and an S corporation some of the key differences are as follows:
1. Ownership. An S Corporation may not have more than 75 shareholders and none of its shareholders can be corporations, limited liability companies or non-resident aliens. None of these restrictions apply to a limited liability company and LLC’s may be owned by individuals, corporations and other limited liability companies.
2. Operation. Generally S corporations are operated in the same manner as conventional corporations and the owners must meet the same record keeping and management formalities required of all corporations. Limited liability companies do not have similar requirements and therefore, LLC’s offer significant flexibility and simplicity in the operation of the entity. While the shareholders and directors of a corporation are required to hold regular meetings after complying with strict notice requirements, similar requirements are not made of limited liability companies. The effect of this is that owners of a S corporation might inadvertently lose liability protection as a result of failing to meet corporate formality requirements while the owners of an LLC generally should not have similar concerns.
3. Management. With an S corporation, directors and officers manage its day to day operations while with limited liability companies, management is performed either by its members or by a manager. If an LLC is “member managed”, the owners of the company manage the business of the company and if it is “manager managed”, management responsibilities are fulfilled by a manager, which may or may not be an owner.
4. Profit Distribution. An S corporation has no flexibility in how its profits are split among owners and profits must be distributed to each owner based upon his percentage ownership of the company. This is the case without taking into account the relative value provided by each of the owners to the corporation. The owners of a limited liability company may, however, distribute profits in almost any manner that they deem appropriate.
5. Employment Tax. One of the major differences between an S corporation and a limited liability company is that an owner of a LLC is deemed to be self employed and therefore liable for the 15.3% self employment tax on all income of the LLC while only the salary paid to an owner/employee of an S corporation is similarly taxed. The remaining amounts that may be distributed to owners are not subject to employment tax. Therefore, an opportunity to limit significant employment taxes may exist with an S corporation.
6. California Tax Law. In the state of California, unlike most other states, in addition to the annual base fee that must be paid by every limited liability company, an additional tax is imposed upon the annual income of each LLC. Although this tax is totally inconsistent with the concept of a pass-through tax entity, the reality of this additional tax must be taken into account when determining whether to create a LLC or an S corporation.
There is no single entity that works for everyone and your individual situation will dictate that which best for you. Please do not hesitate to call us if you have questions about your new business structure.

Shareholder Agreements

A part of business formation that is often overlooked is the drafting of a shareholder agreement or other similar document that governs (i) control and management of the new entity, (ii) ownership and voting rights of the stakeholders and (iii) mechanisms for resolving future disputes that may face the business. These agreements are often neglected in the euphoria of starting a new business or in the misguided belief that the then current relationship of the founders will be sufficiently strong to resist future problems that will inevitably come as the business moves forward.

It is precisely at the time when good will is the very highest that prospective difficulties should be addressed. It is a guaranty that any time initially spent anticipating and providing for the resolution of potential problems will be far less than the energy that will be expended in dealing with foreseeable setbacks when they inescapably arise.

Generally, a shareholder agreement will tackle some of the following issues:

• Restrictions on a shareholder’s ability to sell or encumber his or her ownership interest in the future
• Mechanisms for terminating a non-performing shareholder’s further participation in the entity
• Buy-Sell provisions that may, for example provide rights of first refusal to existing shareholders before an outside third party acquires an interest in the venture
• Mechanisms that permit the company or its shareholders to acquire the ownership interest of someone who dies or is otherwise incapacitated
• Protections for minority shareholders
• Business ethics of the new venture
• Other possible problems that the founders can reasonably foresee at the time the new entity is formed

It is clear that any time spent in successfully addressing predictable problems will increase the likelihood that the business will be successful. If dealt with effectively, future troubles that would otherwise sap energy and time when those commodities are most in demand will be dealt with effectively and efficiently, and all of the needed resources of the company can be directed to the success of the venture.

Is Now the Right Time to Start a New Business?

While it might seem counterintuitive to start a new business in the worst economy of a generation, history shows that many great businesses were founded during the toughest of economic times. For example, almost half of the companies that constitute the basis for the Dow Industrial were created during times of recession or even depression. GE was incorporated during the great downturn of 1873 and HP was formed during the Great Depression. More recently, history has repeated itself with both Microsoft and Disney being started while a recession was raging. During the recession of 1982 when unemployment was then the highest that had been seen since World War II, Sun Microsystems, Adobe, Silicon Graphics and Compaq all started doing business. Downturn does appear to create unique opportunity for the creative and wise entrepreneur.

The past has shown that a great business concept will flourish no matter the then current state of the economy. There is no wrong time for the right idea. Fortune Small Business recently wrote about the perceptions and misconceptions of starting businesses in the world as it exists today. They concluded several things, including:

1. Funding is available. As many of us have seen, while funding has been more difficult to tie down and the freewheeling investing that was the hallmark of the end of the last business cycle has stopped, the fact remains that there is money waiting to be invested. Although investors have become observably more cautious with their investment capital, they are not shying away from good ideas and strong business models.
2. People are available. In fact, due to the large scale downsizing that has taken place, the talent pool appears to be deeper now than it has been for a considerable length of time. Capable and skilled people abound who are looking for opportunity and growth and many experienced and business savvy individuals are willing to invest their time and energy in a start-up company.
3. Recessions make good companies. The fact that capital is more challenging to find and customers and clients are more discriminating in how they spend their resources also causes businesses to budget limited resources more carefully and to aggressively manage business opportunities more wisely. Those businesses that survive and grow in a tough economy will thrive and prosper as economic hardship lessens.

Have any of you started new businesses lately or are you contemplating beginning a new venture? If so, please post your thoughts and ideas about this experience.

Welcome to the new McCarrey Law Group Blog

Dear Friends,

In an effort to better serve our clients and friends and as a means of providing frequent and better communication, we have begun the McCarrey Law Group Blog.  We intend to use our blog as a means of focusing on issues and questions that might arise between regular issues of our McCarrey Law Group Newsletter.   If you have a question or a topic that you would like to see answered or addressed, please post a comment.

As always, it is a pleasure to serve our friends and clients.

The McCarrey Law Group

Pasadena, CA

626.768.0799

lcm@mccarreylaw.com