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Selecting a Business Entity for a Small Business: Non-Tax Considerations
By Professor Andrew Beckerman-Rodau[1]
Suffolk University Law School
120 Tremont Street
Boston, MA 02108
E-mail: arodau@suffolk.edu
Web Page: www.lawprofessor.org
Copyright 1989 by Andrew Beckerman-Rodau
[Originally published in 93 Dickinson Law Review 519 (1989)]
I. Introduction
Most states allow business enterprises to be organized and operated via a variety of organizational
entities. Typically, both state statutes and common law provide the authority for different forms of
business entities. Choosing the appropriate type of business entity for a small business enterprise is an
important decision that can have profound consequences for a business. Despite the large number of
choices available, proper selection can be accomplished easily once an analysis of the business is
completed. This article will examine the different types of organizational entities available to a small business and the advantages and disadvantages of each. Additionally, this article will examine factors, other
than tax considerations,1 that should be analyzed when determining how a business should be organized.
II. Types of Business Entities
There are over 17 million businesses in the United States.2 The majority of these businesses, about
thirteen million, are sole proprietorships.3 Corporations and partnerships are the next most common types
of businesses.4 It should be noted, however, that numerous other types of business entities are available
which may be appropriate for a particular business. This is especially true for small businesses, since they
are least likely to be organized as corporations.5
A. Common Types of Business Entities
A sole proprietorship, the most common business entity, is also the simplest for a business to use.
This simplicity may account for its widespread use by small businesses.6 A sole proprietorship is a business owned and operated by an individual who has full authority and responsibility for all business
decisions. The sole proprietor owns the business and all the property used in the business.7 No legal
distinction exists between the business and the owner with regard to the assets and liabilities of the
business and the personal assets and liabilities of the owner.8 For example, if Mr. Baker operated a bakery
as a sole proprietorship, he would own the flour, yeast and finished bakery products in the same manner
he owned the food in his home. Additionally, he would own the equipment used in the bakery either
outright or more typically subject to a note and security interest, just as he owned his house or car.
Another common business entity is a general partnership, which is an association of at least two
parties for the purpose of carrying on, as co-owners, a business for profit.10 These parties may be individuals, other partnerships, corporations or other associations. The hallmark of a general partnership is
that two or more distinct legal entities jointly own and operate a profit seeking venture.11 Using the
bakery example above, Mr. Baker may not be able to run the business alone so he may choose to go into
business with Ms. Able. A typical arrangement may delegate the responsibility for all the baking to Baker
and assign to Able all responsibility for retail and wholesale sales of their bakery products. Additionally,
each party may advance half the capital required to open the bakery and any resulting profits would be
split equally among them. Such an arrangement would be viewed as a partnership subject to the Uniform
Partnership Act,l2 regardless of whether the parties agreed to be partners or whether they entered a formal
partnership agreements.13
In its simplest form, a general partnership is an extension of the sole proprietorship entity to
situations involving business enterprises owned by more than one person. It is analogous to a sole
proprietorship in that each partner has a personal joint interest in the partnership business and its assets.14
Additionally, it is similar to a sole proprietorship because there is little distinction between personal and
partnership assets for liability purposes. Under the Uniform Partnership Act, the personal assets of a
partner and their share of the partnership assets are generally available to satisfy the debts of the partnership.l5 The joint liability of partners for partnership debts is based on the presumption that a
partnership, like a sole proprietorship, cannot be viewed as an entity that is separate from the individual
business owners.16
Limited partnerships are special types of partnerships created by statute.l7 A limited partnership must
have one or more general partnersl8 who are typically subject to the same rules as partners of a general
partnership.19 Additionally, a limited partnership must have one or more limited partners20 who have a
restricted role in the operation of the enterprise.21 Limited partners can invest cash, property22 or
services23 in the entity with the expectation that they will receive a return on their investment. Such a
partner's risk of loss is limited to the extent of their personal investment.24 Limited partners, however,
cannot engage in the management or control of the business.25
Limited partnerships are an extension of the general partnership form of business entity. The general
partners operate the limited partnership in a manner similar to that of the partners of a general
partnership. Moreover, the general partners of both limited and general partnerships are jointly liable for
partnership debts to the extent of their partnership and personal assets.26 In contrast, limited partners are
passive investors who provide a means for the partnership to obtain additional capital or services without
surrendering control of the business to additional parties. Referring to the example above, suppose Baker
and Able want to operate the business as a general partnership but they lack adequate capital. They could
set up a limited partnership with each of them being general partners. A third party, Ms. Investor, who
wished to invest in the bakery business but not actually be involved in its operation, could then invest the
necessary capital in exchange for a promised return on her investment. Investor could be made a limited
partner, thereby enabling Baker and Able to have the necessary capital to operate the business as well as
the freedom to run the business on their own.
Corporations represent a distinctly different type of business entity. A corporation is a statutory
creation27 with a legal existence and identity independent of the business owners' identities.28 In reality,
the corporation is a fictional entity that has powers similar to the powers of a natural person.29 The
corporation cannot do anything itself since it is a fictional entity. Nevertheless, the owners and employees
who actually operate the business are legally distinct from the corporation.30 Using the example above,
assume Able and Baker decide to operate the bakery as a corporation. Once the corporation is created it
will own the actual business, including the raw materials and equipment used by the business. Contracts
entered into for the purchase of flour and other items needed by the bakery can be made in the name of
the corporation, with the corporation liable for honoring the contracts and any other obligations of the
business.31 Baker and Able could still own and operate the business. Their ownership interests would be
represented by shares in the corporation that indicate the amount or percentage of each owner's interest
in the business.32 Such shares are the personal property of each owner and can be freely transferred to
other people or entities without affecting the legal existence of the corporation.33 If Baker and Able
actually operate the bakery, they do so as employees of the corporation because the legal existence of the
corporation and its owners are distinct and separate. This legal distinction between a corporation and its
owners is consistently applied by the law. For example, the corporation must file and pay income taxes in
its own name,34 and can be sued civilly35 as well as prosecuted criminally.36
Since shares in a corporation are freely transferable personal property, there is no limit to the number
of owners of a corporation. In some cases, a corporation may have thousands or even millions of owners
that freely buy and sell their shares via public markets such as the New York Stock Exchange.37 Such
corporations are referred to as publicly-held or publicly traded corporations.38 In contrast, all the shares
of a corporation can be owned by a few individuals who also operate the business, such as in the previous
bakery example. This type of corporation is commonly called a close or closely-held corporation.39
Traditionally, the law treats closely-held corporations the same as it treats publicly-held corporations.40
Some states, however, have adopted special statutes for close corporations.41 Typically, these statutes
minimize legal formalities for close corporations42 because little practical distinction exists between the
business, the owners and the employees of such a corporation despite the separate legal status of the
close corporation.43
Another specialized type of corporation, which is commonly recognized statutorily, is the professional
corporation.44 If a business is engaged in providing a service that can only be provided by a licensed
individual, such as a lawyer or doctor, it would be anomalous to allow the business to be incorporated.
As stated earlier, the corporation has a distinct legal existence. To allow a corporation to provide legal or
medical services would amount to the unauthorized practice of law or medicine, since a corporation
cannot earn a license to practice law or medicine.45 Consequently, statutes overcome this problem by
placing certain restrictions on professional corporations. Shareholders46 and employees47 of the
corporation must be personally licensed to provide the professional services offered by the corporation.
The shareholders can only transfer their shares to individuals licensed to provide the service the
corporation renders.48 Additionally, the licensed individual rendering services pursuant to his or her
license remains personally liable for any legal consequences arising from those services.49
B. Other Types of Business Entities
Although one of the common business entities discussed above will be appropriate for most small
businesses, numerous other entities are also available. At least one jurisdiction recognizes a multitude of
entities by both statutory and common law.50 Some of these entities, such as business trusts, partnership
associations, joint stock companies and joint ventures, are used infrequently and may not be permissible
in every state.51 The nature of a particular business, however, may make it appropriate or even mandatory
that an unusual business entity be used.
For example, assume Able and Baker in the previously discussed example are successful in their
bakery venture to the extent that they own and operate a chain of bakeries in a three state area. Disturbed
by the plight of the poor, Able and Baker decide to use money earned from their business to set up a
corporation that will make and sell bread at a very low cost to poor individuals. They decide that the
corporation will be self-supporting and all profits will be used solely to operate the business. In most
jurisdictions, such a corporation would have to be operated as a non-profit corporation in accordance
with a specific statutory scheme that regulates such corporations.52 Assume further that Able and Baker
also establish an organization to raise funds for the poor and homeless. Such a business may also be
subject to a special statutory scheme that controls fund raising organizations.53
III. Selecting the Appropriate Business Entity: Factors to Consider
The determination of the appropriate business entity to use for a particular enterprise depends on an
analysis of the following factors: (1) type of business; (2) number of participants in the business; (3)
desired length of existence of the business; (4) business location; (5) use of the customary form; (6)
potential liability; (7) financing and capital requirements; (8) cost and complexity of formation; (9) ongoing requirements; (10) management and control; and (11) transferability of ownership interests.
The relative importance of each of the above factors is fact dependent since the needs of different
clients, different business goals, differing capital requirements, and different background circumstances
make every business unique. It is important, therefore, to have a clear understanding of the proposed
business enterprise before attempting to choose the appropriate business entity.
IV. Selecting the Appropriate Business Entity: Analysis of the Factors
A. Type of Business
The type of business to be engaged in is an important initial consideration for many reasons. Most
enterprises can be conducted via a variety of organizational forms. Some types of enterprises, however,
are not permitted to be conducted under the guise of certain business entities.54 For example, a non-profit
business cannot be conducted by a general55 or limited partnership.56 A banking or insurance business
cannot be conducted by a limited partnership.57 In at least one jurisdiction that allows limited partnership
associations, such an entity cannot be used to conduct a real estate or banking business.58
If a business is engaged in carrying out a single enterprise or transaction, as opposed to conducting an
ongoing business, a partnership may not be permitted to operate the business. For example, a business
organized solely to develop and build a new shopping mall that will be sold once it is completed, may not
be able to operate as a partnership since it is not an ongoing business.59 The enterprise may be permitted
to operate as, among other things, a joint venture. A joint venture is a common law entity, which is very
similar to a partnership, but not necessarily subject to the Uniform Partnership Act since it does not fall
within the statutory definition of a partnership.60
A corporation can be used for most businesses.61 A non-profit enterprise or a profession, however,
usually is not permitted to be operated as a corporation by most state business corporation statutes.62
Nevertheless, separate corporate statutes governing both nonprofit businesses63 and businesses providing
professional services64 exist that allow these enterprises to be conducted as corporations, provided that
special statutory requirements are satisfied. Additionally, a small business that may otherwise avoid a
corporate form of doing business, due to the formal requirements necessary to operate as a corporation,
may nevertheless choose to operate as a corporation if the jurisdiction in which the business is located has
enacted a close corporation statute. Such a statute eliminates many of the formalities associated with the
creation and operation of a small corporations.65
In addition to the above limitations, it is important to be familiar with any specialized statutes
regulating certain businesses in any jurisdiction in which the business will operate.66 Furthermore, the
impact of any federal statutes on different business entities should be considered. For example, federal tax
statutes subject a business operated as a partnership to different rules than a business operated as a
corporation.67
B. Number of Participants in the Business
The determination of the number of participants who will be involved in the business can dictate certain
choices.68 In the bakery example discussed earlier, if Baker opts to start up the bakery on his own he
could operate as a sole proprietorship. He will be precluded, however, from operating as either a general
or limited partnership because both entities are required statutorily to involve at least two persons.69
Additionally, use of the corporate entity will be dependent on the particular state corporation statute
under which the enterprise is incorporated. In some jurisdictions a corporation involving only one person
can be formed,70 but in other jurisdictions more than one party is required to operate as a corporation.71
Conversely, if both Able and Baker will own and operate the business, a sole proprietorship or limited
partnership would not be feasible.72 On the other hand, if Able only wanted a return on her investment
without any active involvement in the business, a limited partnership could be used with Baker being the
general partner and Able being the limited partner.73 Alternatively, a sole proprietorship could be formed
if Able's investment in the business is structured as a loan either to the business or to Baker, with a
promised repayment from the profits of the business.74
C. Desired Length of Existence of the Business
The desired length of existence for a business may also be a controlling factor in the choice of an
appropriate business form.75 Since most businesses seek an ongoing existence, a perpetual life for the
business is desirable. Nevertheless, some enterprises may have limited objectives.76 An enterprise set up
to operate a one-time entertainment event to raise funds for a charitable cause, or a profit oriented
enterprise engaged in developing and building a shopping mall, which will be sold once it is completed,
are examples of enterprises that only require a business entity with a limited existence.77
A sole proprietorship has perpetual existence.78 Historically corporations had limited lives,79 but
modern corporation statutes typically allow parties to set-up a corporation with either a limited or a
perpetual life.80 A general partnership dissolves when one of the partners ceases to be associated with the
partnership,81 and a limited partnership may dissolve when a general partner ceases to be associated with
the partnership.82 Additionally, other less common business entities may have limitations on their
existence. A joint venture, by definition, ceases to exist once the transaction or enterprise that is the
subject of the joint venture is completed.83 In at least one jurisdiction a limited partnership association is
statutorily limited to a maximum life of twenty years.84
An enterprise desiring perpetual existence can operate as either a sole proprietorship or a
corporation. An enterprise desiring a limited life may also utilize the corporate form, in addition to
operating as a joint venture or a partnership. Since the dissolution of a partnership is triggered when a
partner ceases to be associated with it, a partnership would seem inappropriate for an enterprise desiring
perpetual existence. However, appropriate drafting of the partnership agreement can provide for
continuation of the business even after a partner ceases to be associated with the partnership.85
D. Business Location
The location and operating area of a business are very significant factors to consider in choosing a
business entity, because differing state laws control business activities.86 The initial and projected
activities of the business must be clearly defined. A local intrastate business that intends to expand
nationally will be subject to different concerns than a business that plans to only operate locally. Any of
the available business entities permitted in a particular state are potential choices for an intrastate
business. If the business will be operated as a corporation it can generally be incorporated under the corporation law of any state.87 As a general rule, an intrastate business should be incorporated in the state
where it is located.88 If it is incorporated under the law of another state it will be considered a foreign
corporation in its state of residence.89 Such a designation will entail, in some cases, significant
administrative and financial burdens.90
A foreign corporation usually has to qualify to do business in any jurisdiction other than the one
where it is incorporated.91 Qualification often requires the payment of a fee92 and the filing of a certificate
with the state attorney general. This certificate includes, among other things, the name and address of a
registered agent in the state who can accept service of process on behalf of the foreign corporation, a
statement of the assets and liabilities of the foreign corporation, and a statement detailing the business the
foreign corporation proposes to carry on in the state.93 Additionally, foreign corporations may have to
notify the jurisdictions where they do business of any corporate name changes and of any changes in their
business activities, including mergers or consolidations.94 Foreign corporations may also have to file
annual reports in the jurisdictions where they do business that provide information about the directors and
officers of the corporation, about the corporation's shares and capital structure, and about property
owned in the jurisdiction by the foreign corporation.95
The foreign corporation will have to comply both with the foreign corporation rules for the
jurisdiction where it operates, and the corporation law of its state of incorporation.96 These additional requirements for a foreign corporation are usually not justified for a business that is operated strictly
intrastate. In some cases, however, it may be sufficiently advantageous for the local business to incorporate in a foreign jurisdiction in order to take advantage of a specific statutory provision that is not
available under the corporate law of the home state.97
If a business will operate interstate it may have to qualify to do business in any foreign jurisdiction in
which it operates. The use of a sole proprietorship, a general partnership or a limited partnership could be
problematic for such an interstate business. The qualification requirements for such business entities vary
from state to state and, in some cases, are not statutorily regulated.88 The legal uncertainties that may
arise when an enterprise tries to qualify to carry on business in a foreign jurisdiction can result in
unnecessary legal questions.99 One solution to this problem for partnerships, is to form a separate
partnership in each jurisdiction in which the business operates.l00 Partnership law is reasonably uniform
throughout the United States, so forming a separate partnership in each jurisdiction could be easily
accomplished. An alternate solution is to incorporate. Every jurisdiction has a foreign corporation
qualification statute that sets forth exactly when and how a foreign corporation must qualify to do
business in a particular jurisdiction.l0l Therefore, qualification as a corporation can be accomplished
without much legal uncertainty.
If incorporation is chosen for an interstate business, the most advantageous corporation law should
be selected since the business will be treated as a foreign corporation in any other jurisdictions in which it
operates.l02 Alternatively, if the qualification requirements for a foreign corporation are particularly
onerous in a state where business is conducted, a separate corporation can be formed under that state's
corporation law in order to avoid the burdensome qualification requirements.103
E. Use of the Customary Form
Despite any legal advantages that arise from using a particular form of business entity, the practical
advantages of using a common type of entity should always be considered. Setting-up any business
usually involves dealing with banks, suppliers, customers and a variety of other service providers. The
majority of these parties are accustomed to dealing with corporations, partnerships and sole proprietorships. Conversely, they may not be accustomed to dealing with less commonly used entities, such as
joint stock companies or limited partnership associations. Since many parties will be uncomfortable
dealing with unusual business organizations, using such less common entities can make transactions more
difficult. Additionally, most commercial transactions today are standardized and conducted through the
use of generally accepted, standard documentation. Use of an unusual business entity may prevent the use
of such standard forms and require the extra time and expense of preparing special documentation.l04 A
task as simple as opening a bank account could require the drafting of special forms needed for an
unusual business entity.
The use of an uncommon business form may also raise legal uncertainties for the enterprise since
case law and statutory guidance are limited for many of the less commonly used business entities.
Therefore, absent significant reasons to use non-typical business entities, they should generally be
avoided.
F. Potential Liability
Liability is a major concern of any business enterprise today.l05 Potential liability must be considered in
the choice of a business entity because the extent of liability and the parties liable for obligations of a
business vary with respect to the entity used. When a business is operated as a sole proprietorship, there
is no distinction between the assets of the business and the assets of the business owner.l06 The assets of
the business and the personal assets of the business owner are available to satisfy any obligations arising
from the business. Consequently, the owner's personal liability for obligations of the sole proprietorship is
unlimited.l07
If a business is operated as a general partnership, each partner is both personally and jointly liable for
all debts and obligations of the business.l08 A partner can be liable for a partnership obligation of which he
was not aware, or to which he did not agree. In a general partnership, each general partner is considered
an agent of the partnership.l09 Therefore, any partner can generally bind the partnership with regard to the
usual business affairs of the partnership without the knowledge of the other partners.l10 Partners can also
be held jointly liable for another partner's wrongful acts or breaches of trust, provided the acts or
breaches were caused by a partner acting within the ordinary scope of the partnership business or within
the partner's apparent authority.1ll Just as in a sole proprietorship, partners in a general partnership have
unlimited personal liability for the debts and obligations of the partnership.112
In a limited partnership the general and limited partners have differing levels of liability.ll3 General
partners are jointly and severally liable for all partnership obligations in the same manner as partners in a
general partnership.114 In contrast, limited partners have no personal liability for the debts or obligations
of the partnership. The partnership contribution of each limited partner is available to satisfy the debts and
obligations of the partnership, but once that contribution is exhausted the liability of a limited partner
ends115
Operating a business enterprise as a corporation limits the business owner's personal liability. A
corporation is a separate and distinct entity from the business owner,116 and, therefore, only the corporation's assets are typically available to satisfy the debts and obligations of the business.117 Third parties
will not be able to look to the personal assets of the business owner to satisfy corporate obligations.
However, the limited liability feature does not apply to services provided by a professional corporation.118
In a professional corporation, each service provider is personally liable for any legal obligations or
liabilities arising from the service provided.119 Additionally, just as in a conventional corporation, the
professional corporation's assets are available to satisfy debts and obligations arising from the business.l20
Despite the potential of personal liability for the owner of a professional corporation, this business form
may provide more liability protection than a partnership. In a partnership, a partner's personal assets may
be available to satisfy business obligations even if the partner did not personally incur the obligation.l2l In
a professional corporation, however, individual business owners are not personally responsible for the
malpractice of fellow owners.122
In choosing the appropriate entity several key determinations must be made regarding potential
liability. First, a risk analysis must be performed to ascertain the potential risks for the business enterprise
and the level of risk each business owner finds acceptable. For example, selling shoes clearly carries less
potential risk than selling power tools, because the likelihood of serious consumer injury is higher from
the use of power tools than from the use of shoes. Additionally, if the business has several owners, each
owner may have different liability concerns. Such concerns may be based on the differing personal assets
of each owner and each owner's willingness to accept risk. Second, both the availability and affordability
of insurance for the particular enterprise must be determined. Easily obtainable, low cost insurance may
eliminate any potential concerns with regard to personal liability of the business owners.123 Finally, the
amount of each owner's personal assets are a concern. If an owner has substantial personal assets, he or
she may decide any potential risk to those assets is unacceptable. An owner with minimal assets may also
choose not to risk those assets. As a practical matter, however, the likelihood of a suit against a business
owner increases in proportion to the owner's assets.
Based on the foregoing analysis, a sole proprietorship or a partnership is appropriate if potential
liability is limited or if liability insurance is obtainable for an acceptable cost. If the business is a high risk
venture or if insurance is difficult to obtain or too costly for the enterprise, a corporation is more
appropriate.124 Additionally, if the business has several owners with different liability concerns, a limited
partnership might be appropriate because it allows owners to accept varying levels of risk by choosing to
be either a general or a limited partner.125 Another alternative may be, if feasible, to segregate or isolate
the high risk parts of a business from the rest of the enterprise.126 For example, the business could be
operated as a sole proprietorship or partnership, with the high risk portion of the business separately
incorporated and wholly owned by the sole proprietorship or partnership. This would make the personal
assets of the business owners and some of the assets of the business unavailable to third parties with
claims against the corporation.
Despite the limited liability advantages of a corporation, practical concerns may limit the use of the
corporate form for small businesses. Typically, small businesses have limited assets. Therefore lenders
will not provide capital to small enterprises without the business owners providing personal guarantees or
collateral to secure the loan.127 Consequently, the owners may be personally liable for the capital lent to
the business if the business is unable to repay the loans. A small corporation may also find it difficult to
lease commercial space, to contract for services, or to buy goods and materials from suppliers without the
personal guarantees of the business owners for such obligations.128 In practice, however, lenders tend to
be more cautious than other vendors, and a surprising number of vendors will contract with small
corporations with limited assets, without requiring the business owners to provide personal guarantees or
collateral.129
Another major concern for an enterprise is tort liability arising from the actions of employees of the
business. Employees are personally liable to third parties for their tortious acts that injure third parties.130
Under agency principles, however, an employer is also liable to third parties for injuries caused by
employees acting within the scope of their employment.131 If an enterprise is a corporation, which
conducts its business through employees, the business owners are immune from personal liability for the
tortious acts of employees, because agency principles only render the corporation vicariously liable for
the actions of employees. This immunity from personal liability, however, is illusory for many small
businesses that are operated as corporations. A significant number of small businesses that operate as
corporations are comprised of owners who personally operate the business.132 Consequently, if the
owners commit any tortious acts in operating the business, they are personally liable to third parties for
any resulting injuries.
Despite the general rule that the owners of a corporation are not personally liable for corporate
obligations, a court may ignore this rule in certain equitable cases.133 Well-established case law holds that
a court may disregard the corporate entity and find the business owners personally liable when a contrary
result is inequitable. Such a situation can occur, for example, when a corporation is used to defraud third
parties.134 The disregard of the corporate entity by the courts is especially significant for small businesses
since it is almost exclusively applied to close corporations.135 Additionally, other factors cited by the
courts in disregarding a corporate entity are failure to follow corporate formalities and the failure to make
distinctions between the assets and obligations of the corporation and those of the owners.136 This is a
significant concern for small businesses, because the owners of small corporations frequently conduct
business personally without much regard for legal distinctions between themselves and the corporations.
The potential liability of an enterprise is clearly a significant factor in choosing a business entity. For
small businesses, however, the choice will be narrowed in many cases. As discussed, the limited liability
afforded business owners by incorporating may be illusory for the small business.
G. Financing and Capital Requirements
The amount and source of financing for the initial startup of a business and for the future are both
important considerations in choosing a business entity.137 In selecting the appropriate entity, it is
important to understand the financial needs and resources of the business. It is especially critical to
project future capital requirements of the business, because under-capitalization is a frequent cause of
business failure. Many businesses are started with minimal amounts of capital. Once successful, however,
significant amounts of capital are required to expand the business. Consequently, the business entity
selected should be one which ensures that future capital requirements can be met.
A sole proprietorship provides the fewest financing options. A sole proprietorship is owned by a
single owner, and therefore it can only be capitalized with the owner's personal assets or by debt financing.l38 A partnership also can use debt financing, or it can sell the right to future profits from the
business to raise capital.l39 Additionally, partnership capital can be raised by bringing in new partners who
are required to contribute assets to the business in return for becoming partners.l40 One drawback to
adding partners for the purpose of raising capital is that the percentage of profits received by the other
partners is reduced.141 Each partner added to the business also may reduce the other partners' control of
the business.142 This loss of control can be rectified, however, by converting the partnership into a limited
partnership. Once the conversion is made, any new partners would become limited partners who lack the
right to be involved in controlling the operation of the business.143
Unlike sole proprietorships and partnerships, corporations have a multitude of financing options.144
Corporations can rely on debt financing as do sole proprietorships and partnerships.145 Corporate entities
can also issue a large variety of ownership interests.146 These ownership interests typically take the form
of different classes or types of shares in the corporation.147 For example, shares can have different voting
rights.148 and different dividend preferences.149 Certain shares can have redemption rights. Redemption
rights give the owner the right to have the shares redeemed by the corporation at a predetermined price,
at the option of the owner.150 Other shares can be "called" by the corporation, at its discretion, for a
predetermined price.l5l
If the business enterprise requires limited initial and future capital, or the business owner can easily finance
the business from personal assets or by debt financing, a sole proprietorship, partnership or corporation
are all viable options. If significant outside financing is required either at the inception of the business, or
at a later date, a corporation or limited partnership is preferable. A corporation provides the most options
for raising capital through either debt financing or by issuing ownership interests in the corporation in the
form of shares. However, if passive investors provide the necessary outside capital, a limited partnership
is appropriate since the outside investors can be made limited partners.152
H. Cost and Complexity of Formation
The costs and legal requirements of forming and maintaining a business are significant, especially for
a small business. The simplest entities to utilize are sole proprietorships and general partnerships.
Typically, no special requirements have to be satisfied for an enterprise to operate as either a sole
proprietorship or a general partnership.l53 If an individual establishes and operates a business enterprise
which he or she owns it is a sole proprietorship.154 Likewise, if two or more persons own and operate an
ongoing enterprise in which they share the profits, it is typically a general partnership governed by the
Uniform Partnership Act, without regard to whether the owners intended to be partners.155 A partnership,
however, should always be governed by a written partnership agreement, even though one is not
required. A written partnership agreement is important, because failure to set out the rights and
obligations of the parties in writing will inevitably lead to problems and possible litigation in the future.l56
A partnership agreement can take any form, but typically is written as a contractual agreement between
the parties.157
Formation of limited partnerships and corporations requires compliance with certain formalities. To
form a limited partnership a written agreement executed by members of the partnership must be filed with
state officials.158 This agreement, called a certificate of limited partnership, must set forth the name and
character of the business, the names and addresses of the partners, the contributions of each partner to
the business, and certain rights of the partners.l59
Forming a corporation requires the most documentation. Articles of incorporation, which are
essentially an application for the formation of a corporation, must be filed with state officials.160 Upon
acceptance of the articles by state officials, the corporation comes into existence.161 An organizational
meeting must then be held for the corporation.162 At the organizational meeting, the corporation must, at
a minimum, adopt bylaws and elect officers.163 If a small business is to be operated as a corporation the
business owner may want to operate as a close corporation.l64 In states with special statutory provisions
governing close corporations, a close corporation agreement signed by all the business owners may have
to be prepared.l65
The cost of forming a business entity is directly related to the documentation that must be prepared,
because in most cases an attorney will have to be retained by the business to prepare the documentation.
The amount and complexity of the necessary documentation are both factors to consider. Standard form
documents are available for limited partnerships, for general partnership agreements, and for corporate
documents.l66 Every business deal is unique, however, so standard documents must be modified to reflect
the particular needs of a business. Partnership and limited partnership agreements are the easiest forms to
customize because the Uniform Partnership Act, the Uniform Limited Partnership Act, and the Revised
Uniform Limited Partnership Act are all drafted to provide default provisions that apply unless the
partnership agreement provides otherwise.167 Also a single partnership agreement can be drafted that
contains all rules governing the partnership and all agreements among the partners.168
In contrast, corporation statutes are less flexible because they mandate rules and procedures that
must be followed by the business.169 Moreover, a corporation is governed by several documents as
opposed to the single agreement often governing a partnership.170 For a small business operating as a
close corporation, special shareholder voting agreements may have to be prepared in addition to other
required documentation.171 Consequently, accomplishing the particular goals of the business owners may
require more drafting and therefore more cost if a corporation is used instead of a partnership or limited
partnership.
The extent and complexity of documentation required for a small business operating as a corporation
raises two additional practical considerations. First, the more complex the documentation the greater the
risk of error.172 Second, many small business owners may have difficulty understanding the corporate
documentation as well as the need for all the documentation.173 Therefore, a corporate entity should only
be used for a small business if a sound reason exists to use that type of business entity.
I. Ongoing Requirements
In addition to initial formation requirements, varying ongoing requirements exist for different business
entities. There are generally no ongoing requirements with which a sole proprietorship must comply.174
General and limited partnerships must maintain detailed financial records in order to properly apportion
profits and losses among the partners.175 Limited partnerships must also file an amendment to the
certificate of limited partnership with the state whenever there are any changes in the original certificate,
such as the admission or withdrawal of general or limited partners.176 Limited partners also must avoid
taking an active role in the control or operation of the partnership. Such action could negate the limited
liability that limited partners are normally afforded by statute.177
Corporations in every jurisdiction must comply with ongoing requirements throughout the existence
of the corporation. Corporations must hold annual shareholder meetings178 and may have to prepare
annual financial statements for the shareholders.179 Corporate directors must be periodically elected by the
shareholders.l80 All major corporate action must be conducted by the directors at a board of directors
meeting.181 Careful records must be kept to document all corporate actions.l82 Separate financial records
must be kept for the corporation because a corporation is an entity legally distinct from its owners.l83
In determining which entity to utilize for a business two factual considerations must be evaluated.
First, compliance costs must be determined. A small business often has limited resources. Therefore, the
costs of complying with the ongoing formalities listed above may be a financial strain on the business.
Second, client sophistication should be considered. Many small business owners find the ongoing
formalities required by state corporation statutes to be silly formalities and consequently ignore them.
This is a common problem that arises for two reasons. First, many small business owners do not appreciate the legal distinction between the corporation and the owner, especially when a close corporation
or a one-person corporation is involved. For example, it may be difficult to convince a business owner
who owns all the shares in a corporation, is the only director and officer, and the only employee, that he
or she must comply with the requirements for shareholder and board of director meetings, in addition to
keeping the financial records for the corporation and for the owner separate.l84 Second, many modern
corporation statutes have made it relatively easy to comply with corporate formalities. This ease of
compliance leads many business owners to view the formal requirements as unimportant.l85 Client
sophistication is also a concern with regard to limited partners because failure of a limited partner to
understand their restricted role in the business can render the limited partner personally liable for the
debts of the partnership.l86 Likewise, failure of business owners to comply with ongoing corporate
formalities may cause a court to disregard the distinction between the corporation and the business owner
and find the owner personally liable for the debts of the corporation.l87
J. Management and Control
The various types of business entities are subject to different management structures. This is an
important factor in selecting a business entity because the amount and type of control that business
owners have over the enterprise varies depending on the management structure.
The owner of a sole proprietorship has total control over the business.188 The sole proprietor can
operate the business in virtually any manner without being required to maintain any distinction between
personal and business assets.
In a general partnership all of the partners have a financial stake in the business, and absent an
agreement to the contrary, all partners have an equal voice in the management of the business.l89 If a
business has many partners such an equal distribution of management authority can make carrying on the
business very cumbersome. This is especially true if rapid decision making is necessary. Under the
Uniform Partnership Act the partners may enter a partnership agreement that distributes management
responsibilities in any manner agreed to by the partners.l30 For example, one partner can be responsible for
managing the financial affairs of the business, another partner for outside sales, and a third partner for
supervising personnel employed by the business.191 Regardless of how management authority is
distributed each partner may want to retain some control over the business since all partners are jointly
and severally liable for partnership obligations and debts.192
Additionally, despite the existence of a partnership agreement, the death or incapacity of a partner or
his or her disassociation from the partnership dissolves the partnership.l93 Therefore, each partner retains
substantial leverage over the partnership regardless of how little management power a partner is granted
under the partnership agreement.194 This leverage, however, can be limited by appropriate drafting of the
partnership agreement.l95 Typically, partnership agreements include provisions for buying the interest of
any departing partner and for re-forming the business as a new partnership. Such provisions guarantee the
continuity of the business for the remaining partners.l96
In a limited partnership the general partners typically are treated the same as partners in a general
partnership.l97 Consequently, each general partner usually has some substantial management responsibility
regarding the operation of the business, since each general partner has potentially unlimited personal
liability like a partner in a general partnership.l98 Furthermore, any general partner who ceases to be
associated with the partnership due to death or incapacity or his or her disassociation from the
partnership dissolves the partnership.l99 Dissolution is avoidable, however, if the certificate of limited
partnership allows the remaining general partners to continue the business, or absent such a right, if all
the remaining general and limited partners agree to continue the business.200 In contrast to the general
partners, limited partners are essentially passive investors with no control or management responsibility
over the business. A limited partner's withdrawal from the partnership does not dissolve the partnership,
nor does a limited partner's membership in the partnership generally place any of his or her personal assets
at risk.201
Corporations, unlike partnerships, have rigid management structures that are dictated by statute.202
Corporation statutes require corporations to have shareholders, directors, and officers.203 The
shareholders are the owners of the corporation204 but with only limited control over the management of
the business.205 Typically, shareholders elect directors at annual shareholder meetings called by the
corporation.206 Additionally, shareholder approval is generally required for major changes in the
corporation, such as distribution of corporate assets to shareholders207 or the merger of the corporation
with another corporation.208 Management authority over the business and affairs of the corporation is
vested in the board of directors, which is comprised of the directors elected by the shareholders.209 The
board of directors then elects officers who carry out the day-to-day operation of the corporation.210
The management structure of a corporation results in a distribution of control over the corporation
between the shareholders, directors, and officers.211 Shareholders elect directors212 who in turn elect
officers;213 therefore the shareholders indirectly control the corporation since they determine who is on
the board of directors.214 Consequently, a shareholder with a majority of the outstanding shares can exert
control over the corporation via his or her ability to determine who is elected to the board of directors.2l5
A majority shareholder can even exert direct control over the corporation by electing himself or herself to
the board of directors.216 Ultimately, the distribution of control depends on both the number of outstanding shares and the number of persons who own the outstanding shares. Shares of stock are freely
transferable assets.217 Therefore, when there is large number of shares outstanding there is a greater
opportunity for one shareholder or a group of shareholders to buy enough shares from other shareholders
to acquire a majority of shares. The greater the number of outstanding shares, however, means that a
greater number must be owned to have a majority. Consequently, it may become prohibitively expensive
for a shareholder to obtain a majority if a large number of outstanding shares exist.
In a small business a variety of devices can be used to limit or vary the distribution of control
mandated by corporation statutes. If only a few owners are involved, all shares can be issued to the owners who may then elect themselves as directors and officers of the corporation. Such a scenario effectively
eliminates the distribution of control since the same parties are simultaneously shareholders, directors,
and officers. Each shareholder, however, still remains free to transfer his or her shares to another party.
Therefore, it is possible for one or more shareholders to gain control over the corporation at the expense
of the other shareholders. For example, if three persons form a corporation that issues one share to each
person and which has three directors, each shareholder can elect himself or herself to the board of
directors.218 One of the three shareholders, however, could sell his or her share to one of the other
shareholders. The buying shareholder would then own a majority of the shares and could control who
was elected to the board of directors, thereby negating any control of the corporation by the other
remaining shareholder. In order to prevent such an occurrence the shareholders can enter a contractual
agreement that restricts transfer of the shares or controls how the shareholders vote.219 Additionally, the
shareholders may establish a voting trust.220 A voting trust allows shareholders to retain beneficial
ownership of their shares while conveying the voting rights to a third party who votes in accordance with
the trust agreement.221 Alternatively, some jurisdictions have adopted special statutory provisions for
close corporations that allow the business owners, by agreement, to dispense with the board of directors
and other formalities.222 In some jurisdictions the close corporation agreement may specify how the
corporation is to be managed and how control is to be distributed. These specifications can be so
extensive that the corporation resembles a partnership that is incorporated.223
Two important considerations must be analyzed before the appropriate business entity is chosen.
First, the importance of certain owners maintaining control of the business must be ascertained. If a
business is family oriented the owners may want to maintain family control over the business. The success
of a business sometimes depends on a key person controlling the business and, therefore, it is important
to insure that control remains vested in that key person. Second, the type of investors involved in the
business is a very important consideration. Whether investors require a nominal voice in the business or a
large measure of managerial power influences which entity should be chosen.
If maintaining control of the business is an important consideration to an individual, a sole
proprietorship is an appropriate choice. Such a choice, however, is not appropriate if additional owners
are needed to raise capital for the business.224 A limited partnership is an appropriate choice if one owner
wants to maintain control of the business while maintaining the option to add additional owners to raise
capital. The owner desiring to control the business can be the sole general partner and the additional
owners can be limited partners.225 A limited partnership is viable, however, only if the additional owners
are willing to be passive owners with no right to exert control over the management of the business.226
A general partnership is preferable if a business has several owners who want to maintain control
over the business or if additional investors will only invest if they are entitled to some degree of control
over the business. The partners, via a partnership agreement, can structure the management and control
of the business in any manner they choose.227 Each partner is assured of continuing control of the business
because new partners cannot be freely added to the business without the agreement of all the partners.228
Additionally, any partner can dissolve the partnership by disassociating himself or herself from the
partnership. Therefore, each partner maintains some leverage over the other partners with regard to
control of the business.229
The corporate business entity provides the most options for accommodating different types of investors.230 A
corporation, however, provides the business owners with the least number of options for establishing a
management structure for the business. The usual statutory structure distributes control among various
parties.231 This structure allows any individual who owns a controlling number of shares to alter the
management structure.232 Numerous approaches, as discussed above, can be used to limit the
transferability of shares.233 Additionally, if permitted by statute in the particular jurisdiction, a small
business operated as a close corporation can redistribute control of the business.234 If the business owners
want to be assured of maintaining control over the business, use of a corporation has some drawbacks.
Corporate documents must be custom tailored to insure that certain owners maintain control over the
business. This may entail additional expense depending upon the complexity of the documents.235
Furthermore, if the documents fail to anticipate all possibilities, control over the business can be lost
despite careful drafting.236 Additionally, some jurisdictions have held that majority shareholders of close
corporations owe a fiduciary obligation to minority shareholders. Therefore, the controlling owner of a
close corporation may be limited in his or her control over the business.237
K. Transferability of Ownership Interests
The ability to transfer ownership interests in a business enterprise varies with the type of entity used.
Therefore, it is another significant consideration in choosing an entity. The owner of a sole proprietorship
can freely sell the business enterprise outright.238 Ownership interests in corporations, which take the
form of shares of stock in the corporation, are also freely transferable.239 Ownership interests of partners
in a general or limited partnership, however, are not freely transferable.240
Although the owner of a sole proprietorship can freely sell the entire business, typically the sole
proprietor's ability to sell the enterprise depends on the particular business involved and the facts surrounding the business. For example, certain types of business enterprises are in more demand than others
and, therefore, are more marketable. The length of time a business has operated in a particular location,
its past earnings record, the good will established by the enterprise, the perceived future earning potential
for the enterprise, and the time left on any lease are all factors relevant to the marketability of a business.
As an alternative to the outright sale of the business, a sole proprietor may sell a portion of the business
by converting it into a partnership or a corporation. The former sole proprietor can then become one of
the partners or shareholders, respectively.24l
A partner's ability to transfer his or her ownership interest in the partnership is limited. A partner may
assign rights to his or her share of future profits to a third party but that third party does not
automatically acquire a voice in the operation of the business.242 Such an assignment actually creates an
account receivable for the third party. The substitution of a new partner for an existing partner, or the
addition of a new partner, requires the approval of all existing partners.243 The limitations on the
transferability of partnership interests can be modified, however, by an appropriately drafted partnership
agreement.244
In contrast to partnerships, corporations are free to create and issue shares in almost any variety and
amount.245 Share owners are also free to sell or transfer their shares in any manner they desire.246 Unlike
sole proprietorships, the owner or owners of a business operating as a corporation can sell portions of the
business without changing the character or structure of the business entity.247 Additional shares issued by
a corporation will not effect the existing owners' control of the business, provided that no new
shareholder obtains a majority of the outstanding voting shares. In many small enterprises that are
operated as close corporations, however, voting agreements, close corporation agreements, or other
similar agreements may severely limit the free transferability of shares in the corporations.248
The desired degree of ownership transferability requires balancing the initial business owners' needs
to raise capital against their desire to maintain control over the business. Generally, the ease with which
the ownership interests in a business can be transferred corresponds to the ease with which the business
can raise capital. The more transferable the ownership interests are, however, the harder it is to insure
that the initial owners maintain control. Sole proprietorships and partnerships provide business owners
with the most control over the enterprises. It may be difficult to raise capital for these entities, however,
because a sole proprietor cannot sell interests in the business and partners are not free to sell or transfer
their partnership interests. New partners can only be added and existing partners can only sell their
interests in the business if permitted to do so by the partnership agreement or by the consent of the other
partners. In contrast to partnerships, shares in a corporation are freely transferable absent some
agreement to the contrary among shareholders. Additionally, public markets exist for shares which
provide ready buyers at all times.249 For many small enterprises that are operated as close corporations,
however, the free transferability of corporate shares may be illusory. Shares in close corporations are not
generally traded on any public exchange and, therefore, any sales must be privately arranged.250
V. Conclusion
Numerous business entities exist for the operation of small businesses. Various different business
entities are available in each state. However, the most commonly used entities - partnerships, corporations, and sole proprietorships - are available in every jurisdiction. As a general proposition, one of these
three entities is usually the most appropriate for a small enterprise, although special circumstances may
dictate the use of a less common type of entity for a particular business.
A careful analysis of the business enterprise must be conducted before the appropriate form can be
selected. Objective factors such as the type of business, the location, the desired length of business
existence, and the number of individuals involved in the enterprise may dictate certain choices. A risk
assessment of the enterprise is essential to determine the potential for liability and to ascertain which
business entity best protects the interests of both the business and the business owners. The importance of
owner control over the business must be balanced against any need to freely transfer ownership interests
in the business to determine which consideration is most important. Furthermore, initial and future capital
requirements for a business must be accurately estimated. This factor is especially critical if outside
financing is required because the ability to raise capital varies for different types of business entities. The
amount of capital available to the enterprise is also a consideration because the legal costs involved in
setting up an enterprise depends on the type of entity utilized and the complexity of the documentation
necessary to organize the business. Finally, practical concerns must be evaluated. The more common or
customary a particular type of business entity is, the easier it is to conduct business transactions with
banks and other businesses. Another practical consideration is whether the business owner appreciates the
importance of complying with the ongoing requirements for certain types of entities, such as
corporations. This is a critical factor because failure to follow the requisite formalities can negate the
advantages of using a particular business entity.
FOOTNOTES
1. Tax consequences should always be considered when establishing a new business. In the formation of a typical
small enterprise, however, tax considerations may be a neutral factor. Under the current tax law the maximum
corporate tax rate is 34% while the maximum individual tax rate is 28%. See infra note 33. This discrepancy in tax
rates dictates the use of a sole proprietorship or partnership instead of a corporation because the business owners of
such an entity are individually taxed at individual tax rates that are lower than the corporate tax rate. Additionally,
use of a corporation can result in "double taxation." A corporation, as an entity, pays taxes on its income. Any
dividends then paid by the corporation to shareholders are taxed again to the individual shareholders. See R. DEER,
J. ANDERSON, L. BLACK, M. Scott & R. SIMPSON, THE LAWYER'S BASIC CORPORATE PRACTICE
MANUAL § 1.03, at 7-23 (3d ed. 1984) [hereinafter DEER]. Federal tax laws, however, allow small corporations
to qualify for "Subchapter S" tax treatment. This status allows the shareholders to be taxed at individual tax rates
on income from the corporation. Additionally, the double taxation problem is eliminated for Subchapter S
corporations. Dickman, Small Business and Tax Reform, 73 A.B.A. J. 92 (1987). Therefore, the same tax
treatment may be generally obtained for a small business regardless of whether a sole proprietorship, partnership,
or corporation is used.
Nevertheless, tax considerations are the sole focus of numerous articles. See, e.g., Dickman, Small Business
and Tax Reform, 73 A.B.A. J. 92 (1987); Ackerman, Benefits of S Corporation Election for Closely Held
Corporations Under the Tax Reform Act of 1986, 65 TAXES 372 (1987); Levun, Partnerships The Preferred
Form of Doing Business After the Tax Reform Act of 1986, 65 TAXES 600 (1987); Draneas, S Corp or
Partnership: Which Meets Client's Business and Estate Planning Objectives?, 13 EST. PLAN. 30 (1986). In contrast, few articles have addressed non-tax factors that should be considered in establishing a business and, therefore,
that is the focus of this article. See Haynsworth, Nontax Factors in Selecting the Form of a Small Business Entity,
31 PRAC. LAW. 57 (1985) (one of the few articles that addresses non-tax considerations).
2. R. CLARK, CORPORATE LAW I (1986) [hereinafter CLARK].
3. Id.
4. Id. There are about three million corporations and about one million partnerships. It is interesting to note that
corporations accounted for 89% of business receipts for one year despite the fact that most businesses are not
corporations. Id.
5. Id.
6. H. HENN & J. ALEXANDER, LAWS OF CORPORATIONS 57 (3d ed. 1983) [hereinafter HENN].
7. W KLEIN & J. COFFEE, BUSINESS ORGANIZATION AND FINANCE 1-2 (3d ed. 1988) [hereinafter
KLEIN].
8. Id. at 1-4. See also supra note 6.
9. See KLEIN, supra note 7.
10. U.PA. § 6(1) (1914); Walker Mos by & Calvert, Inc. v. Burgess, 153 Va. 779, 151 U.P.A. 165 (1930).
Partnerships, previously recognized at common law, are primarily governed today by the Uniform Partnership Act
(U.P.A.), which has been adopted in almost every state. See U.P.A., 6 U.L.A. 1-2 (Supp. 1989) (table of
jurisdictions that have adopted the Act). See also HENN, supra note 6, at 63.
11. See Walker, Mosby & Calvert, Inc. v. Burgess, 153 Va. 779, 151 S.E. 165 (1930).
12. U.P.A. §§ 1-45 (1914).
13. See HENN, supra note 6, at 66-67. See also KLEIN, supra note 7, at 61; Raymond S. Roberts, Inc. v.
White, 117 Vt. 573, 97 A.2d 245 (1953) (court found implied partnership from conduct of the parties).
14. U.P.A. § 25 (1914).
15. See KLEIN, supra note 7, at 93; HENN, supra note 6, at 73-75; CLARK, supra note 2, at 6-7. See also
U.P.A. §§ 14-15 (1914).
16. The common law viewed partnerships as an aggregation of the partners' interests rather than as an entity.
R. STEFFAN & T. KERR, AGENCY & Partnership 21 (PARTNERSHIP ed. 1980). Under the U.P.A., partnerships are
treated as entities for some purposes and as an aggregation of interests for other purposes. See, PARTNERSHIP, Is a
Partnership Under the UPS an Aggregate or an Entity?, 16 2ND. L. REV. 377 (1963). See also CLARK,
supra note 2, at 15 & .39. Some disagreement, however, does exist as to whether a partnership is an entity or an
aggregation of interests. Compare Case well v. Maple wood Garage, 84 N.H. 241, 149 A. 746 (1930) (partnership
is an entity) with Morrison's Estate, 343 Pa. 157, 22 A.2d 729 (1942) (partnership is an aggregation of interests).
17. U.L.P.A. §§ 1-31 (1916); R.U.L.P.A. §§ 101-1106 (1985). The Uniform Limited Partnership Act
(U.L.P.A.) is in effect in a minority of jurisdictions, while the Revised Uniform Limited Partnership Act
(R.U.L.P.A.) is in effect in a majority of jurisdictions. See 6 U.L.A. at 172 & 220-21 (Supp. 1989).
18. U.L.P.A. § 1 (1916); R.U.L.P.A. § 101(7) (1985).
19. U.L.P.A. § 9 (1916); R.U.L.P.A. § 403 (1985).
20. See, supra note 18.
21. See, e.g., R.U.L.P.A. § 10 (1916); R.U.L.P.A. § 305 (1985).
22. U.L.P.A. § 4 (1916); R.U.L.P.A. § 501 (1985).
23. R.U.L.P.A. § 501 (1985) (allows services as contributions). But see U.L.P.A. § 4 (1916) (services not
allowed as contributions).
24. U.L.P.A. §§ 7 & 17 (1916); R.U.L.P.A. § 303 (1985).
25. Exercise of control of the business by a limited partner can convert them from a limited partner to a general
partner in regard to their partnership liability to third parties. See U.L.P.A. § 7 (1916); R.U.L.P.A. § 303 (1985).
26. U.L.P.A. § 9 (1916); R.U.L.P.A. § 403 (1985).
27. See HENN, supra note 6, at 125. The states have not adopted a uniform corporation statute. See. e.g.,
DEL. CODE ANN. tit. 8, §§ 101-398 (1983); OHIO REV. CODE ANN. §§ 1701.01-1701.99 (Baldwin 1988).
The American Bar Association Section of Business Law drafted a model corporation statute entitled the Model
Business Corporation Act (M.B.C.A.). The statute has not been adopted in full by any jurisdiction but it has served
as a model for about 35 states and has been influential in several other states. 1 MODEL BUSINESS CORP. ACT
ANN. xxiv (3d ed. 1988). The Section has also drafted a new model corporation statute entitled the Revised Model
Business Corporation Act (R.M.B.C.A.). Virginia has modeled its corporation statute after the Revised Act.
Murphy, The New Virginia Stock Corporation Act: A Primer, 20 U. RICHMOND L. REV. 67, 70 (1985).
28. See HENN, supra note 6, at 125-26. See also CLARK, supra note 2, at 17.
29. See MODEL BUSINESS CORP. ACT § 4 (1979); REV. MODEL BUSINESS CORP. ACT § 3.02
(1984). See also HENN, supra note 6, at 149-52.
30. See HENN, supra note 6, at 127. See also HENN, supra note 1, § 1.01, at 7-21.
31. See KLEIN, supra note 7, at 139.
32. See HENN, supra note 6, at 131; KLEIN, supra note 7, at 118. See also MODEL BUSINESS CORP.
ACT § 2(d) (1979) (statutory definition of shares).
33. See HENN, supra note 6, at 131; KLEIN, supra note 7, at 137.
34. See HENN, supra note 6, at 132-38. Under current federal tax law corporations are subject to different tax
rates than individuals. The maximum individual tax rate is 28% in 1988 while the maximum rate for corporations is
34%. Dickman, Small Business and Tax Reform, 73 A.B.A. J. 92 (1987).
35. Cleveland, Columbus & Cincinnati R.R. Co. v. Keary, 3 Ohio St. 201 (1854).
36. Norris v. State, 25 Ohio St. 217 (1874). See also United States v. Allegheny Bottling Co., 57 U.S.L.W.
2222 (E.D. Va. Sept. 9, 1988) (corporation found guilty of violating federal antitrust laws could be imprisoned and
subjected to a one million dollar fine), aff'd in part, 56 Antitrust & Trade Reg. Rep. (BRA) 77 (Jan. 19, 1989) (the
4th Cir. upheld the fine but found no language in the relevant statute permitting a jail term for a corporation).
37. See HENN, supra note 6, at 696.
38. For a discussion of federal regulation of publicly-held corporations see generally HENN, supra note 6,
785-850.
39. For a discussion of closely-held corporations see generally HENN, supra note 6, at 693-783. A closely-held
corporation is defined as a corporation meeting three requirements: (1) it has a small number of shareholders; (2) a
ready market does not exist for the shares; and (3) the majority shareholders participate substantially in the
management, direction, and operation of the corporation. Donahue v. Rodd Electrotype Co. of New England, Inc.,
367 Mass. 578, 586, 328 N.E.2d 505, 511 (1975).
40. See HENN, supra note 6, at 696, 698.
41. See, e.g., DEL. CODE ANN. tit. 8, §§ 341-56 (1983); OHIO REV. CODE ANN. § 1701.591 (Baldwin
1988).
42. See, e.g., DEL. CODE ANN. tit. 8, §§ 341-56 (1983); OHIO REV. CODE ANN. § 1701.591 (Baldwin
1988) (allows shareholders to eliminate board of directors, to agree to allow any shareholder to dissolve corporation
at will, and to provide limitations on the issuance of shares by the corporation).
43. See, e.g., Romanik v. Lurie Home Supply Center, Inc., 105 111. App. 3d 1118, 435 N.E.2d 712 (111.
App. Ct. 1982) (closely-held corporation in which family members were shareholders, directors, and officers of the
corporation).
44. See, e.g., DEL. CODE ANN. tit. 8, §§ 601-19 (1983); OHIO REV. CODE ANN. §§ 1785.01-1785.08
(Baldwin 1988).
45. Special statutory provisions were necessary to overcome the long-established prohibition against learned
professions operating as corporations. See HENN, supra note 6, at 139.
46. See, e.g., DEL.CODE ANN. tit. 8, § 603(2) (1983).
47. See, e.g., id. at § 607.
48. See, e.g., id. at § 612.
49. See, e.g., id. at § 608.
50. Ohio recognizes, by statute, the following entities: OHIO REV.CODE ANN.§ 1775 (Baldwin 1988)
(general partnership); OHIO REV.CODE ANN.§ 1782 (limited partnership); OHIO REV.CODE ANN.§ 1701
(business corporations); OHIO REV.CODE ANN.§ 1701.591 (closely held corporation); OHIO REV.CODE
ANN.§ 1785 (professional corporation); OHIO REV.CODE ANN.§ 1702 (nonprofit corporation); OHIO
REV.CODE ANN.§ 1703 (foreign corporation); OHIO REV.CODEANN.§ 1711 (agricultural corporation); OHIO
REV.CODE ANN.§ 1713 (educational corporation); OHIO REV.CODE ANN.§ 1715 (religious and benevolent
organization); OHIO REV.CODE ANN.§ 1717 (humane society), OHIO REV.CODE ANN.§ 1719 (charitable
trust); OHIO REV.CODE ANN.§ 1721 (cemetery association); OHIO REV.CODE ANN.§ 1724 (community
improvement corporation); OHIO REV.CODE ANN.§ 1725 (trade association); OHIO REV. CODE ANN.§ 1726
(development corporation), OHIO REV. CODE ANN.§ 1727 (farm laborer's association); OHIO
REV.CODEANN.§ 1728 (community redevelopment corporation); OHIO REV.CODE ANN.§ 1729 (cooperative);
OHIO REV.CODE ANN.§ 1733 (credit union); OHIO REV.CODEANN.§ 1735 (title guarantee and trust
company); OHIO REV.CODE ANN.§ 1736 (prepaid dental plan); OHIO REV.CODE ANN.§ 1737 (medical care
corporation); OHIO REV.CODEANN.§ 1738 (health care corporation); OHIO REV.CODE ANN. § 1740 (dental
care corporation); OHIO REV.CODE ANN.§ 1741 (bridge company); OHIO REV.CODE ANN.§ 1742 (health
maintenance organization); OHIO REV.CODE ANN.§ 1745 (unincorporated association); OHIO REV. CODE
ANN.§ 1746 (business trust); OHIO REV. CODE ANN.§ 1747 (real estate investment trust); OHIO REV.CODE
ANN.§ 1783 (limited partnership association). Ohio also recognizes by common law, the following entities: joint
ventures, joint stock companies, and sole proprietorships.
51. Some states do not recognize partnership associations and may treat them as ordinary partnerships.
Business trusts are also not recognized in all states. Some states treat business trusts as partnerships or joint stock
companies. The federal government views both partnership associations and business trusts as corporations for
federal tax purposes. L. SODERQUIST & A. SOMMER, CORPORATIONS: A PROBLEM APPROACH 5-6
(2d ed. 1986) [hereinafter SODERQUIST]. Business trusts are recognized by statute in some states. See, e.g., S.C.
CODE ANN. §§ 33-53-10 to 33-53-50 (Law. Co-op. 1987); MINN. STAT. ANN. §§ 318.01-648.46 (West 1972
& Supp. 1988); TENN. CODE ANN. §§ 48-1-801 to 71-6-207 (1988). Delaware has recently recognized business
trusts by adopting a new business trust statute. See 9 DEL. CODE ANN. tit. 12, §§ 3801-14 (1988). Partnership
associations are also recognized by statute in some states. See, e.g., OHIO REV. CODE ANN. §§ 1783.01-1783.12 (Baldwin 1988); N.J. STAT. ANN. §§ 42:3-1 to 42:3-30 (1983); MICH. STAT. ANN. §§ 20.91-20.107
(Callaghan 1985). Joint sock companies are common law entities subject to statutory regulation in some states. See,
e.g., OHIO REV. CODE ANN. § 3907.01 (Baldwin 1988); TEX. REV. CIV. STAT. art. 6133 (Vernon 1970).
Joint ventures are also common law entities subject to statutory regulation in some states. See, e.g., MICH. STAT.
ANN. § 20.91 (Callaghan 1985); N.J. STAT. ANN. § 42:3-2 (1983). For a discussion of what constitutes a joint
venture, see generally infra notes 58-59. Joint ventures are sometimes used by two large corporations that want to
jointly engage in a specific business transaction. See, e.g., Chrysler to Distribute Alfa Romeos in U.S., N.Y. Times,
Oct. 7, 1988, at 36 (Fiat and Chrysler announced a joint venture for the purpose of distributing Alpha Romeo
automobiles in the United States and Canada).
52. See, e.g., OHIO REV. CODE ANN. § 1702 (Baldwin 1988).
53. See, e.g., OHIO REV. CODE ANN. § 1716 (Baldwin 1988).
54. Business corporations may be barred from practicing law or from conducting farming operations. National
banks and banks that are members of the Federal Reserve System are barred from using any entity other than a
corporation. See HENN, supra note 6, at 55.
55. See, e.g., OHIO REV. CODE ANN. § 1775.05(1) (Baldwin 1988), see also U.P.A. § 6(1) (1914).
56. See, e.g., OHIO REV. CODE ANN. § 1782.06 (Baldwin 1988); see also U.P.A. § 3 (1916); R.U.L.P.A. §
106 (1985).
57. See, e.g., OHIO REV. CODE ANN. § 1782.06 (Baldwin 1988).
58. See, e.g., OHIO REV. CODE ANN. § 1783.01 (Baldwin 1988).
59. See Walker, Mosby & Calvert, Inc. v. Burgess, 153 Va. 779, 151 S.E. 165 (1930) (partnership applies to
carrying on business for sustained period of time for purpose of earning a living or a profit as distinguished from
carrying on single transaction). See also Tufts v. Mann, 116 Cal. App. 170. 2 P.2d 500 (Cal. Dist. Ct. App. 1931).
60. The U.P.A. states that "[a] partnership is an association of two or more persons to carry on as co-owners a
business for profit." U.P.A. § 6 (1914). This definition does not encompass an enterprise engaged in carrying on a
single transaction. Walker, Mosby & Calvert, Inc. v. Burgess, 153 Va. 779, 151 S.E. 165 (1930). Joint ventures,
also called "joint adventures," are very similar to partnerships and it is often difficult to distinguish them. See
HENN, supra note 6, at 105. One court noted that
[O]ne of the principal distinctions between a partnership and a joint venture lies in the fact that a partnership ,
ordinarily is formed for the transaction of a general business of a particular kind, while a joint venture relates to
a single transaction of a particular kind, although it may continue for years.
Tufts v. Mann, 116 Cal. App. 170, 177, 2 P.2d 500, 503 (Cal. Dist. Ct. App. 1931). See also Easter v. McNabb,
97 Idaho 180, 541 P.2d 604 (1975) (a joint venture is more limited in time and purpose than a partnership);
Keiswetter v. Rubenstein, 235 Mich. 36, 209 N.W. 154 (1926) (a joint adventure is an association of two or more
persons for the purpose of carrying out a single enterprise for profit). Joint ventures are governed by partnership
and agency principles and may even be subject to some of the same rules as partnerships. See HENN, supra note
67, at 107; Eagle-Picher Co. v. Mid-Continent Lead & Zinc Co., 209 F.2d 917, 919 (10th Cir. 1954) (joint
adventure is a partnership limited to a particular enterprise or venture). Since joint ventures are governed by the
common law rather than the U.P.A., they are treated differently than partnerships for certain purposes. For
example, a partner is a general agent of the partnership who can bind the partnership in matters relating to carrying
out the business of the partnership. U.P.A. § 9 (1914). In contrast, a participant in a joint venture lacks authority to
bind the joint venture. Tufts, 116 Cal. App. at 177, 2 P.2d at 503; see also HENN, supra note 6, at 107.
61. See, e.g., OHIO REV. CODE ANN. § 1701.03 (Baldwin 1988). For limitations on the use of corporations,
see infra note 64.
62. See, e.g. OHIO REV. CODE ANN. §§ 1701.01(A) & 1701.03 (Baldwin 1988).
63. See, e.g., OHIO REV. CODE ANN. §§ 1702.01-1702.99 (Baldwin 1988) (nonprofit corporation statute).
64. See, e.g., OHIO REV. CODE ANN. §§ 1785.01-1785.08 (Baldwin 1988) (professional corporation
statute).
65. See, e.g., OHIO REV. CODE ANN. § 1701.591 (Baldwin 1988) (Ohio close corporation statute); MD.
CORPS & Ass NS CODE ANN. §§ 4-101 to 4-603 (1987 Supp.) (Maryland close corporation statute); ILL.
ANN. STAT. ch. 32, para. 1201 (Smith-Hurd Supp. 1988) (the Close Corporation Act); DEL. CODE ANN. tit. 8,
§§ 341-56 (1983) (Delaware close corporation statute).
66. See, e.g., OHIO REV. CODE ANN. §§ 1725.01-1725.06 (Baldwin 1988) (statute affecting incorporated
trade associations); OHIO REV. CODE ANN. §§ 1736.01-1736.28 (Baldwin 1988) (statute affecting prepaid
dental plans).
67. A corporation is treated as an entity for tax purposes. Therefore, the corporation must file a tax return and
pay taxes. Any dividends received by a shareholder from the corporation is then taxable as the individual income of
the shareholder. In contrast, a partnership is not an entity for federal tax purposes. The partnership files an
informational return but each partner is individually taxed for their share of the taxable income of the partnership.
DEER, supra note 1, § 1.03, at 7-23. Different federal tax rates may also apply to partnerships and to
corporations. The top federal tax rates for 1988 are 34% for corporations and 28% for individuals. Therefore, a
partnership may incur less tax liability because the partners are taxed at individual rates. See Dickman, Small
Business and Tax Reform, 73 A.B.A. J. 92(3) (1987).
68. See HENN, supra note 6, at 57.
69. U.P.A. § 6 (1914); R.U.L.P.A. § 2 (1916); R.U.L.P.A. § 101(7) (1985). Limitations exist for other types
of entities also. See. e.g., OHIO REV. CODE ANN. §§ 1783.01-1783.12 (Baldwin 1988) (limited partnership
associations must have at least 3 but no more than 25 persons).
70. See, e.g., OHIO REV. CODE ANN. § 1701.04 (Baldwin 1988); GA. CODE ANN. § 2170 (14-2-170);
ILL. REV. STAT. ch. 32, para. 2.05 (Supp. 1988).
71. ARIZ. REV. STAT. ANN. § 10-053 (1977) (two persons required); Miss. CODE ANN. § 79-3-103
(1973) (two persons required); MASS. GEN. LAWS ANN. ch. 156 § 6 (West 1980) (three persons required).
72. For a discussion of sole proprietorships, see HENN, supra note 6 and KLEIN, supra note 7 and
accompanying text. In a limited partnership, a limited partner does not have the right to engage in the management
or control of the business. Therefore, if Able and Baker formed a limited partnership only one of them would be
entitled to control the operation of the business. See supra notes 17-25 and accompanying text.
73. Id.
74. See HENN, supra note 6, at 57.
75. Haynsworth, Nontax Factors in Selecting the Form of a Small Business Entity, 31 PRAC. LAW. 57, 61
(1985) [hereinafter Haynsworth]. See also HENN, supra note 6, at 53.
76. See Haynsworth, supra note 75, at 62.
77. The importance of permitting an enterprise to have a limited existence in appropriate situations resulted in
the amendment of the Ohio General Corporation Law to allow corporations to be established with either a perpetual
or a limited period of existence. See OHIO REV. CODE ANN. § 1701.04(B)(3) (Baldwin 1988). See also OHIO
REV. CODE ANN. § 1701.04(B)(3) Commentary (Baldwin 1988) (discussing 1955 amendments). Most corporate
statutes allow a corporation to be created with a limited existence. Haynsworth, supra note 75 at 62. See also
MODEL BUSINESS CORP. ACT § 54(b) (1979). Practical reasons may exist for establishing a business
enterprise with a limited period of existence. For example, owners of a business enterprise may desire limited
existence to insure they can liquidate their interests in the enterprise at a certain time. This can be a significant
concern for minority shareholders in a close corporation. Typically a market does not exist for shares in a close
corporation. If the close corporation had perpetual existence a minority shareholder might not be able to liquidate
his or her interest in the business unless the majority shareholder also chose to discontinue the business.
78. The sole proprietorship, however, will end with the death of the business owner. See HENN, supra note 6,
at 59.
79. See KLEIN, supra note 7, at 113-14.
80. See supra note 77.
81. U.P.A. §§ 29 & 31 (1914). See also Haynsworth, supra note 75, at 62.
82. U.L.P.A. § 20 (1916); R.U.L.P.A. § 801 (1985). The loss of a general partner may not dissolve a limited
partnership if at least one general partner is left and the certificate of limited partnership allows the partnership to
continue its business. Additionally, absent a remaining general partner or a provision in the certificate of limited
partnership allowing continuation of the business, the partnership can avoid dissolution if all the remaining general
and limited partners agree to continue the partnership by appointing a new general partner if necessary. Id.
83. See supra note 60.
84. OHIO REV. CODE ANN. § 1783.01 (Baldwin 1988).
85. See HENN, supra note 6, at 77-80; Haynsworth, supra note 75, at 61. See generally, Girard Bank v.
Haley, 460 Pa. 237, 241 & n.2, 332 A.2d 443, 445 & n.2 (1975) (partnership agreement provided that upon death
of any partner remaining partners had option to purchase interest of deceased partner).
86. Many variations exist between the corporation statutes of different states. See HENN, supra note 6, at 176.
See, e.g., supra notes 70 & 71 and accompanying text. In contrast, general partnerships are generally governed by
the U.P.A. Louisiana, however, has not adopted the U.P.A. U.P.A., 6 U.L.A. 1 (Supp. 1988) (table of jurisdictions
that have adopted the Act). Limited partnerships are governed by the U.L.P.A. and the R.U.L.P.A. which are both
uniform statutes each of which has been adopted by different states. See 6 U.L.A. 172, 220-21 (Supp. 1989).
87. C. ROHRLICH, ORGANIZING CORPORATE AND OTHER BUSINESS ENTERPRISES § 4.01
(5th ed. 1985) [hereinafter ROHRLICH].
88. Id. See also HENN, supra note 6, at 176-77.
89. See, e.g., DEL. CODE ANN. tit. 8, § 371(a) (1983); OHIO REV. CODE ANN. § 1701.01(B) (Baldwin
1988); MODEL BUSINESS CORP. ACT § 2(6) (1979); REV. MODEL BUSINESS CORP. ACT § 1.40(10)
(1984).
90. See HENN, supra note 6, at 176-77 & 201-35; ROHRLICH, supra note 87.
91. See, e.g., DEL. CODE ANN. tit. 8, § 371 (1983); MODEL BUSINESS CORP. ACT § 106 (1979); REV.
MODEL BUSINESS CORP. ACT § 15.01 (1984); HENN, supra note 6, at 229-31.
92. The fee can range from $50 in Delaware to $500 in Texas. See DEL. CODE ANN. tit. 8, § 371(b) (1983);
1 CORP. L. GUIDE (CCH) 11850 (1986).
93. See DEL. CODE ANN. tit. 8, § 371 (1983).
94. DEL. CODE ANN. tit. 8, § 372 (1983).
95. DEL. CODE ANN. tit. 8, § 374 (1983).
96. For example, a Delaware business incorporated in Ohio would have to comply with both the Ohio business
corporation statute and the Delaware statute regulating foreign corporations. See OHIO REV. CODE ANN. §§
1701.01-1701.99 (Baldwin 1988); DEL. CODE ANN. tit. 8, §§ 371-85 (1983).
97. For example, some jurisdictions allow one person corporations while other jurisdictions require two or even
three persons for a corporation. See supra notes 70-71 and accompanying text. See generally McGough, Statutory
Limits on a Corporation's Right to Make Distributions to Shareholders: The Law of Distribution in the 1984
Revised Model Business Corporation Act, 21 AKRON L. REV. 27 (1987) (compares different statutory schemes
for regulating corporate distributions under M.B.C.A. and R.M.B.C.A.).
98. See Haynsworth, supra note 75, at 70-71.
99. See Haynsworth, supra note 75, at 71.
100. Id.
101. See Haynsworth, supra note 75, at 70.
102. The Delaware corporate statute is favored by many corporations because of its sympathetic attitude
toward businesses. In contrast, California and New York have the most regulatory corporation statutes. See HENN,
supra note 6, at 178 n.6. For a list of relevant factors for selecting the state of incorporation see 1 G.
HORNSTEIN, CORPORATION LAW AND PRACTICE § 86 (1959); G. SEWARD & W. NAUSS, BASIC
CORPORATE PRACTICE 27-32 (2d ed. 1977); ROHRLICH, supra note 87, at ch. 4; C. ISRAELS & A.
HOFFMAN, CORPORATE PRACTICE 138-47 (3d ed. 1974). For a list of the advantages and disadvantages of
incorporating in Delaware see HENN, supra note 6, at 185-89. For a list of the advantages and disadvantages of
incorporating in New York or California see HENN, supra note 6, at 189-99.
103. See HENN, supra note 6, at 177 & n.4.
104. See Haynsworth, supra note 75, at 58-59, 71 (cost and complexity of documentation to establish and
operate a business is a consideration in choosing an entity).
105. See HENN, supra note 6, at 53.
106. See supra text accompanying note 8.
107. H. REUSCHLEIN & W. GREGORY, AGENCY AND PARTNERSHIP 237 (1979). See also HENN,
supra note 7, at 2-3; KLEIN, supra note 6, at 57.
108. U.P.A. § 15 (1914).
109. Id. at § 9.
110. Id. See also HENN, supra note 6, at 70-71.
111. U.P.A. §§ 13-14 (1914).
112. See HENN, supra note 6, at 73-74.
113. See HENN, supra note 6, at 86.
114. U.L.P.A. § 9 (1916); R.U.L.P.A. § 403 (1985). See also HENN, supra note 6, at 86.
115. U.L.P.A. § 17 (1916); R.U.L.P.A. § 303 (1985).
116. See supra text accompanying note 28. H. HENN & J. ALEXANDER, supra note 6, at 86.
117. See HENN, supra note 6, at 130; DEER, supra note 1, § 1.02(a), at 7-22.
118. See HENN, supra note 6, at 140-41.
119. See, e.g., DEL. CODE ANN. tit. 8, § 608 (1983).
120. Id.
121. See supra notes 109-10 and accompanying text.
122. See, Haynsworth, supra note 75, at 60. See, e.g., OHIO REV. CODE ANN. § 1785.04 (Baldwin 1988);
DEL. CODE ANN. tit. 8, § 608 (1983).
123. See Haynsworth, supra note 75, at 59-60.
124. Haynsworth, supra note 75, at 60 (cost of insurance can be prohibitive in some cases).
125. See supra notes 113- 15 and accompanying text.
126. Haynsworth, supra note 75, at 60.
127. Haynsworth, supra note 75, at 59; DEER, supra note 1, § 1.02(a), at 7-9.
128. Deer, supra note 1, § 1.02(a), at 7-9.
129. See, e.g., Cranson v. Int'l Business Mach. Corp., 234 Md. 477, 200 A.2d 33 (1964) (IBM contracted with
a newly formed business to provide 8 typewriters without requiring the business owners to personally guarantee
payment or pledge collateral; IBM was denied recovery from the business owners when the business was unable to
pay for the typewriters).
130. R. STEFFAN & T. KERR, AGENCY C PARTNERSHIP 211 (4th ed. 1980).
131. Organaso v. Mellow, 356 Mo. 228, 201 S.W.2d 365 (1947); Stockwell v. Morris 46 Wyo. 1, 22 P.2d 189
(1933).
132. See O'Neal, Restrictions on Transfer of Stock in Closely Held Corporations: Planning and Drafting, 65
HARV. L. REV. 773, 773 (1952).
133. See generally E. LATTY, SUBSIDIARIES & AFFILIATED CORPORATIONS 191 (1936).
134. See, e.g., DeWitt Truck Brokers, Inc. v. Ray Flemming Fruit Co., 540 F.2d 681 (4th Cir. 1976).
135. Barber, Piercing the Corporate Veil, 17 WILLAMETTE L. REV. 371, 372 (1981).
136. Id. at 374-75 (lists factors present in cases where courts disregarded corporate entity and found owners
personally liable).
137. The effect of state and federal securities laws must always be considered with regard to the financing of a
business enterprise. Almost any investment in a business, which is made with the expectation of making a profit
principally from the efforts of others, can be classified as a security potentially subject to the securities laws. See 15
U.S.C. § 77b(1) (1982) (definition of security under federal law) see also Smith v. Gross, 604 F.2d 639 (9th Cir.
1979) (investment in earthworm farm held to be a security); McLish v. Harris Farms, Inc., 507 F. Supp. 1075
(E.D. Cal. 1980) (cattle purchase and feeding transaction held to be a security). Additionally, the following
Supreme Court decisions have expanded the definition of security: SEC v. W.J. Howey Co., 328 U.S. 293 (1946);
United Housing Found. v. Forman, 421 U.S. 837 (1975); Int'l Bhd. of Teamsters v. Daniel, 439 U.S. 551 (1979);
Marine Bank v. Weaver, 455 U.S. 551 (1982). See also Schneider, Developments in Defining a "Security", 16
REV. SEC. REG. 981 (1981); Fitzgibbon, What is A Security? A Redefinition Based on Eligibility to Participate
in the Financial Markets, 64 MINN. L. REV. 893 (1980). The effect of securities law is generally a neutral factor
in choosing a business entity since anything that is a security triggers the securities laws without regard to the type
of business entity used. Haynsworth, supra note 75, at 76.
138. Haynsworth, supra note 75, at 66.
139. Id. See also U.P.A. § 27 (1914).
140. See U.P.A. § 18(g) (1914) (addition of new partners requires consent of all existing partners absent
contrary agreement among partners).
141. Id. at § 18(a).
142. Id. at § 18(e).
143. U.L.P.A. § 7 (1916); R.U.L.P.A. § 303 (1985).
144. See Haynsworth, supra note 75, at 66-67. See also DEER, supra note 1, § 1.02(c), at 9-10. Corporations
are often exempt from usury laws and therefore may find it easier to raise capital than other types of business
entities. See, e.g., N.Y. GEN. OBLIG. LAW § 5-521 (McKinney 1977); N.J. STAT. ANN. § 31:1-6 (West 1963
& Supp. 1988); N.D. CENT. CODE § 47-14-09 (1978 & Supp. 1987). See also HENN, supra note 6, at 126;
Sherwood & RobertsOregon, Inc. v. Alexander, 269 Or. 389, 525 P.2d 135 (1974) (corporation used to avoid
usury law).
145. See HENN, supra note 6, at 381.
146. See supra note 144.
147. Id.
148. See, e.g., Zahn v. Transamerica Corp., 162 F.2d 36 (3d Cir. 1947) (corporation issued Class B shares
that had voting rights and Class A shares which only obtained voting rights if four successive quarterly dividends
were not paid to Class A shareholders).
149. Id. at 38 (preferred share entitled to annual dividend of $6; Class A share entitled to annual dividend of
$3.20; Class B share entitled to annual dividend of $1.60).
150. See, e.g., Davis v. Louisville Gas & Elec. Co., 16 Del. Ch. 157, 142 A. 654 (1928) (corporation issued
Class A shares that had no voting rights but which would be redeemed by corporation for $32.50 at option of owner
of the shares).
151. See, e.g., Zahn v. Transamerica Corp., 162 F.2d at 39 (Class A shares callable at option of corporation
for $60 per share plus any outstanding accrued dividends shares entitled to).
152. See supra notes 24-25 and accompanying text.
153. Any business operating under a fictitious name, however, may have to report use of the fictitious name to
state authorities where the business operates. See, e.g., OHIO REV. CODE ANN. § 1329.01(c) (Baldwin 1986).
Additionally, every business may have to comply with applicable business license, tax identification, and worker's
compensation requirements. Haynsworth, supra note 75, at 69.
154. See KLEIN, supra note 7 and accompanying text.
155. See supra notes 10-13 and accompanying text. See also Martin v Peyton, 246 N.Y. 213, 158 N.E. 77
(1927) (court determines if partnership exists based on facts and circumstances; statement in agreement between
parties that partnership does or does not exist is not binding on court); Haynsworth, supra note 75, at 66-67
(partnership can even exist in absence of a written document between the parties).
156. See HENN, supra note 6, at 66-67.
157. See Zajac v. Harris, 241 Ark. 737, 410 S.W. 2d 593 (1967). See also Martin v. Peyton, 246 N.Y. 213,
158 N.E. 77 (1927).
158. See HENN, supra note 6, at 88-89. See also U.L.P.A. § 2 (1916); R.U.L.P.A. § 201 (1985).
159. See HENN, supra note 6, at 88-89. See also U.L.P.A. § 2 (1916); R.U.L.P.A. § 201 (1985).
160. See HENN supra note 6, at 273; MODEL BUSINESS CORP. ACT § 55 (1979); REV. MODEL
BUSINESS CORP. ACT §§ 2.02-.03 (1984). Articles of Incorporation, also called Certificates of Incorporation in
some states, include the name of the corporation, the duration of existence of the corporation, the purposes for
which the corporation is organized, the number and types of authorized shares, the names of directors and
incorporators, the corporation's address, the address of the corporation's registered agent, and, if desired, provisions
regulating the internal affairs of the corporation. MODEL BUSINESS CORP. ACT § 55 (1979), REV. MODEL
BUSINESS CORP. ACT § 2.02 (1984); DEL. CODE ANN. tit. 8, § 102 (1983).
161. MODEL BUSINESS CORP. ACT §§ 55-56 (1979) (once articles of incorporation filed with secretary of
state, secretary of state's office issues certificate of incorporation). See also REV. MODEL BUSINESS CORP.
ACT § 2.03 (1984) (corporation exists once articles of incorporation filed with secretary of state); DEL. CODE
ANN. tit. 8, § 106 (1983) (corporation exists once certificate of incorporation filed with secretary of state).
162. MODEL BUSINESS CORP. ACT § 57 (1979); REV. MODEL BUSINESS CORP. ACT § 2.05 (1984);
DEL. CODE ANN. tit. 8, § 108 (1983).
163. MODEL BUSINESS CORP. ACT § 57 (1979); see also ROHRLICH, supra note 87, at 619 to 6-20
(lists actions that should be taken at organizational meetings in addition to statutory requirements).
164. For the definition of a close corporation see supra note 39 and accompanying text.
165. See, e.g., OHIO REV. CODE ANN. § 1701.591 (Baldwin 1988); see generally DEL. CODE ANN. tit. 8,
§§ 350, 354 (1983). The articles of incorporation of a close corporation may have to include certain mandatory
provisions. ARIZ. REV. STAT. ANN. § 10-203 (1977 & Supp. 1988); MD. CORPS. & ASS NS CODE ANN. §
4-201(b) (1985).
166. See, e.g., 1 BUSINESS FORMS 1-295 (ALI-ABA 1988).
167. Haynsworth, supra note 75, at 72. See, e.g., U.P.A. § 18 (1914) (rules only apply if partners have not
agreed otherwise).
168. See Haynsworth, supra note 75, at 72.
169. Id.
170. See supra notes 160-65 and accompanying text.
171. See Haynsworth, supra note 75, at 72. See, e.g., MODEL BUSINESS CORP. ACT § 55 (1979) (articles
of incorporation); id. at §§ 27 & 57 (by-laws); id. at § 65 (amendments to articles of incorporation); id. at §§ 18 &
54 (shares which represent ownership interests in the corporation). See also Carter, Corporate Minutes: Their
Form. Content, Inspection and Evidentiary Value, 29 PRAC. LAW. 45 (1983) [hereinafter Carter] (corporate
minutes must be kept with regard to actions of the corporations).
172. See Haynsworth, supra note 75, at 72. See, e.g., Jones v. Wallace, 291 Or. 11, 628 P.2d 388 (1981)
(100% quorum requirement for shareholder meeting not effective because included in corporate by-laws instead of
in corporate articles of incorporation).
173. Haynsworth, supra note 75, at 72.
174. If a business operates under a fictitious name and it changes the fictitious name, a notice to this effect may
have to be filed with the secretary of state of the state where the business operates. See, e.g., OHIO REV. CODE
ANN. § 1329.01 (Baldwin 1988).
175. Absent an agreement to apportion, profits and losses are shared equally by the general partners. U.P.A. §
18(a) (1914).
176. U.L.P.A. §§ 8, 24-25 (1916); R.U.L.P.A. §§ 202 & 301 (1985).
177. U.L.P.A. § 7 (1916); R.U.L.P.A. § 303 (1985). See also Holzman v. De Escamilla, 86 Cal. App. 2d 858,
195 P.2d 833 (Cal. Dist. Ct. App. 1948) (limited partners who took part in active control of business treated as
general partners for purposes of liability).
178. See HENN, supra note 6, at 503. See, e.g., DEL. CODE ANN. tit. 8, § 211(b) (1983); MODEL
BUSINESS CORP. ACT § 28 (1979); REV. MODEL BUSINESS CORP. ACT § 7.01 (1984).
179. See, e.g., OHIO REV. CODE ANN. § 1701.38 (Baldwin 1988).
180. See, e.g., DEL. CODE ANN. tit. 8, § 211 (1983); OHIO REV. CODE ANN. § 1701.55 (Baldwin 1988);
MODEL BUSINESS CORP. ACT § 36 (1979); REV. MODEL BUSINESS CORP. ACT § 8.03 (1984).
181. See, e.g., DEL. CODE ANN. tit. 8, § 141 (1983); OHIO REV. CODE ANN. § 1701.59 (Baldwin 1988);
MODEL BUSINESS CORP. ACT § 35 (1979); REV. MODEL BUSINESS CORP. ACT § 8.01 (1984). But see
MODEL BUSINESS CORP. ACT § 44 (1979); REV. MODEL BUSINESS CORP. ACT § 8.21 (1984) (directors
may act without a meeting if they consent in writing to the action to be taken), accord DEL. CODE ANN. tit. 8 §
141(f) (1983). Most states allow board action to be taken without a meeting if the directors unanimously consent to
this in writing. See HENN, supra note 6, at 565.
182. See Carter, supra note 171, at 45-46 (corporate minutes must be kept with regard to actions of the
corporation).
183. See supra notes 28-30, 32 and accompanying text.
184. Such a one person corporation is permitted in Ohio. OHIO REV. CODE ANN. 1701.04(A) (Baldwin
1988).
185. A small corporation, operated as a close corporation, may be able to do away with many corporate
formalities such as eliminating the board of directors. OHIO REV. CODE ANN. § 1701.591(C)(8) (Baldwin
1988). A close corporation, by agreement of the business owners, may even be organized so it is equivalent to a
partnership that is incorporated. See DEL. CODE ANN. tit. 8, § 354 (1983).
186. See U.L.P.A. § 7 (1916); R.U.L.P.A. § 303 (1985).
187. See supra notes 133-36 and accompanying text.
188. SODERQUIST, supra note 51, at 2.
189. U.P.A. § 18(e) (1914).
190. Id. at § 18. See also McAlpine v. Millen, 104 Minn. 289, 116 N.W. 583 (1908). 191. In a large
partnership, management is often delegated to a single partner or to a committee. See HENN, supra note 6, at 70.
192. U.P.A. § 15 (1914).
193. Id. at §§ 30-31.
194. Haynsworth, supra note 75, at 62.
195. Id.
196. See, e.g., I BUSINESS FORMS 147-48 (ALI-ABA 1988) (see clause 16).
197. U.L.P.A. § 9 (1916); R.U.L.P.A. § 403 (1985).
198. See J. CRANE & A. BROMBERG. LAW OF PARTNERSHIP 146 (1968).
199. U.L.P.A. § 20 (1916); RU.L.P.A. §§ 402 & 801 (1985).
200. Id.
201. Freedman v. Tax Review Bd. of Philadelphia, 212 Pa. Super. 442, 243 A.2d 130 (1968). See also
U.L.P.A. § 17 (1916); RU.L.P.A. § 303 (1985).
202. See DEER. supra note 1, § 1.02(d), at 7-10.
203. See H. HENN, Corporations Partnerships - AGENCY TEACHING MATERIALS 267 (2d ed.
1986) [hereinafter TEACHING MATERIALS] (chart shows distribution of management power among
shareholders, directors, and officers).
204. See KLEIN, supra note 7, at 118. See also MODEL BUSINESS CORP. ACT §§ 2(d) & (f) (1979);
REV. MODEL BUSINESS CORP. ACT §§ 1.40(21)-(22) (1984).
205. "The principal functions of the shareholders are to elect (and, under certain circumstances, remove)
directors, and to approve extraordinary corporate actions and transactions." See HENN, supra note 6, at 129
(footnote omitted).
206. See supra note 180 and accompanying text.
207. See, e.g., MODEL BUSINESS CORP. ACT § 46 (1979).
208. See, e.g., MODEL BUSINESS CORP. ACT § 73 (1979); REV. MODEL BUSINESS CORP. ACT §
H.03 (1984); DEL. CODE ANN. tit. 8, § 251 (1983).
209. See, e.g., DEL. CODE ANN. tit. 8, § 141 (1983); OHIO REV. CODE ANN. § 1701.59 (Baldwin 1988);
MODEL BUSINESS CORP. ACT § 35 (1979); REV. MODEL BUSINESS CORP. ACT § 8.01 (1984).
210. See, e.g., MODEL BUSINESS CORP. ACT § 50 (1979); OHIO REV. CODE ANN. § 1701.64
(Baldwin 1988).
211. See TEACHING MATERIALS, supra note 203. See also KLEIN, supra note 7, at 118.
212. See supra note 180 and accompanying text.
213. See supra note 210 and accompanying text.
214. See KLEIN, supra note 7, at 118-19.
215. See MODEL BUSINESS CORP. ACT § 32 (1979); REV. MODEL BUSINESS CORP. ACT § 7.25
(1984); DEL. CODE ANN. tit. 8, § 216 (1983).
216. See KLEIN, supra note 7, at 118.
217. SODERQUIST, supra note 51, at 4; Haynsworth, supra note 75, at 62.
218. Directors normally run for office at large; therefore each shareholder could elect himself or herself as a
director by voting accordingly. See OHIO REV. CODE ANN. § 1701.55(B) (Baldwin 1988).
219. See SODERQUIST, supra note 51, at 299; KLEIN, supra note 7, at 127-28. For a discussion of
shareholder agreements, see generally HENN, supra note 6, at 534-36. Shareholder agreements are statutorily
recognized. See, e.g., MODEL BUSINESS CORP. ACT § 34 (1979); REV MODEL BUSINESS CORP ACT § 7
31 (1984); DEL. CODE ANN. tit. 8, § 218 (1983).
220. SODERQUIST, supra note 51, at 299-301. For a discussion of voting trusts, see generally HENN, supra
note 6, at 528-34. Voting trusts are statutorily recognized. See, e.g., OHIO REV. CODE ANN. § 1701.49
(Baldwin 1988); DEL. CODE ANN. tit. 8, 218 (1983); MODEL BUSINESS CORP. ACT § 34 (1979); REV.
MODEL BUSINESS CORP. ACT § 7.30 (1984).
221. SODERQUIST, supra note 51, at 300.
222. See, e.g., OHIO REV. CODE ANN. § 1701.591 (Baldwin 1988); DEL. CODE ANN. tit. 8, §§ 350-51
(1983).
223. See, e.g., OHIO REV. CODE ANN. § 1701.591 (Baldwin 1988); DEL. CODE ANN. tit. 8, § 354
(1983).
224. A sole proprietorship, by definition, can only have a single owner. See KLEIN. supra note 7 and
accompanying text.
225. See supra notes 17-25 and accompanying text.
226. See U.L.P.A. § 7 (1916); R.U.L.P.A. § 303 (1985).
227. Haynsworth, supra note 75, at 65. See also U.P.A. § 18 (1914) (section specifies rights and duties of
partners but allows them to be altered by agreement of the partners).
228. U.P.A. § 18(g) (1914) (a partner can agree to give up this basic right).
229. Id. at § 31 (grants partner power to dissolve partnership even if such action violates agreement among
partners).
230. See supra notes 144-51 and accompanying text.
231. See supra notes 202-14 and accompanying text.
232. See supra note 217 and accompanying text.
233. See supra notes 219-21 and accompanying text.
234. See supra notes 222-23 and accompanying text.
235. Haynsworth, supra note 75, at 72.
236. In Ringling Bros.-Barnum & Bailey Combined Shows, Inc. v. Ringling, 29 Del. Ch. 610. 53 A.2d 441
(Del. Sup. Ct. 1947), two minority shareholders entered an agreement to vote their shares together at the annual
shareholders meeting. Id. at 613, 53 A.2d at 443. Voting together gave the two minority shareholders control of the
corporation because their shares together gave them a majority of the shares. Id. at 612-15, 53 A.2d at 442-44. One
party breached the agreement, and the court disallowed the vote of the breaching party. Id. at 623, 53 A.2d at 448.
As a consequence, the other shareholder who was a party to the agreement lost control of the corporation because
without specific performance of the shareholder agreement the other shareholder only had a minority interest. Id. at
623-24, 53 A.2d at 448.
237. See, e.g., Donahue v. Rodd Electrotype Co. of New England, Inc., 367 Mass. 578, 328 N.E.2d 505 (1975).
238. See HENN, supra note 6, at 59.
239. See supra text accompanying note 217.
240. See supra text accompanying notes 139-40.
241. See HENS, supra note 6, at 58.
242. U.P.A. § 27 (1914); U.L.P.A. § 19 (1916); R.U.L.P.A. §§ 702 & 704 (1985). See also J. CRANE & A.
BROMBERG, LAW OF PARTNERSHIP 239 40 (1968).
243. U.P.A. § 18(g) (1914). Even if unanimous approval for the admission of new partners is eliminated by
agreement between the partners as permitted by § 18, a single partner who disapproves of the admission of a new
partner can force dissolution of the partnership. U.P.A. § 31 (1914). See also U.L.P.A. § 19 (1916); REV.
U.L.P.A. § 704 (1985); J. CRANE & A. BROMBERG, supra note 243, 239 (1968).
244. See KLEIN, supra note 7, at 98-99.
245. See supra notes 144-51 and accompanying text.
246. See supra note 217.
247. DEER, supra note 1, § 1.02(b), at 9.
248. See supra notes 218-23 and accompanying text.
249. See HENN, supra note 6, at 791-93.
250. See DEER, supra note 1, § 1.02(b), at 9. Free transferability may be illusory for most small businesses
regardless of the entity used for the enterprise, because markets frequently do not exist for interests in such
businesses. Haynsworth, supra note 75, at 63.
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