Chapter 13

Choice of
Business
Entity,
Sole
Proprietorship,
and
Partnerships
McGraw-Hill/Irwin Copyright © 2011 by The McGraw-Hill Companies, Inc. All rights reserved.
Sole Proprietorships

 Ease of formation and maintenance makes

this entity a popular choice.

 Sole proprietorships are typically capitalized

using a proprietor’s personal resources or
through a private or commercial loan that is
secured by the proprietor’s personal assets.

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General Partnerships

 Unlike most business entities, general

partnerships are not created by filing a form
with a government agency.

 Instead, the law recognizes two or more

principals as being a general partnership if
they have demonstrated an intent to carry on
as co-owners of a business for profit.

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Liability of the Partners

 General partners have no protection of their personal assets for

unpaid debts and liabilities of the partnership.

 The RUPA imposes additional liability on general partners who

are jointly and severally liable.

 This means that general partners’ personal assets are at risk

both together (jointly) and separately (severally) for all debts and
liabilities of the partnership regardless of the source of the debt
or liability.

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Taxation of Partnership and Principals

 Just as in the case of a sole proprietorship, a

partnership is a pass-through entity.

 This means that the partnership entity pays no level

of corporate tax.

 Rather, profits are taxed after they pass through the

business and are distributed to the individual
partners.

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Capitalization

 General partnerships are generally funded

through debt (borrowing money), or

 Selling of equity (selling a percentage of

ownership rights in the partnership).

 Partnerships may not, however, sell

ownership rights (stock) through the public
markets .

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Operation and Management of the
Partnership
 Absent an agreement by the parties, the RUPA
governs certain internal operations of the general
partnership. For example, unless the parties agree
otherwise:
 each partner receives an equal share of the partnership
profit payments regardless of the partner’s involvement in
the success of the business,
 the same rule applies to losses,
 general partners have the general power to bind the
partnership to a contractual obligation.

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Limited Partnerships

 An entity that exists by a state statute that

recognizes one or more principals as general
partners managing the business enterprise
with unlimited liability.

 Limited partners normally participate only in

terms of contributing capital or property, and
have limited liability.

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Personal Liability of Principals

 Each general partner in a limited partnership

is personally liable for all of the partnership’s
debts and liabilities.

 Limited partners do not have the same

automatic personal liability of a general
partner, it is limited to whatever the limited
partner contributed to the partnership.

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Management and Operation of LP

 Under the RULPA, limited partners may

engage in consulting and contribute
expertise, but may not engage in
management activities such as supervision of
employees.

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Partner Dissociation and Dissolution of
the Partnership
 When a partner no longer wishes to be a
principal in the partnership, she may choose
to leave the partnership.

 The RUPA uses the term dissociation to

describe this act of separation while the
RULPA uses the term withdrawal.

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Withdrawal under RULPA

 RULPA sets down default rules for withdrawal of

partners if no written agreement.

 A general partner may withdraw provided that the

partnership still has at least one remaining general
partner, and the partners (both general and limited)
agree in writing to continue.

 Limited partners are subject to restrictions on

withdrawal.

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learning outcomes checklist

 13 - 1 Articulate the factors that business

owners should consider when selecting a
business entity.

 13- 2 List the elements required to form a

general partnership and the statutory
requirements for forming a limited
partnership.

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learning outcomes checklist

 13- 3 Recognize the effect and role of the

RUPA for general partnerships and the
RULPA for limited partnerships.

 13- 4 Identify methods through which sole

proprietorships and partnerships may be
capitalized (funded).

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learning outcomes checklist

 13- 5 Distinguish between personal liability

for general partners and limited partners.

 13- 6 Explain the concept of pass-through

taxation.

 13- 7 Articulate the consequences of partner

separation and dissolution.

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