FAQ

A: Types of business entities and their differences are listed below:

C CORPORATIONS

• The legal and tax structures are independent and separate from their owners to provide protection against personal liability.
• The C Corp must hold annual meetings and record meeting minutes.
• One way to keep personal assets separate from business debts.
• The Corp is governed by By-Laws, a Shareholder Agreement and Buy-Sell Agreement.
• It is formed by filing Articles of Incorporation with the State of Michigan.
• It is managed by Officers and a Board of Directors.
• Profits and losses stay with the Corp.
• The C Corp is taxed on corporate profits and shareholder dividends (double taxation).
• There is no limit to the number of shareholders in a C Corp.
• The C Corp can have different classes of stock and dividend rights.
• Business owners with plans to take a company public or to issue stock to employees are better off selecting a corporation over an LLC.
• Voting is based upon pro rata stock ownership and class of shareholders. Minority shareholders have fewer rights and options.

S CORPORATIONS

• The legal and tax structures are independent and separate from their owners to provide protection against personal liability.
• An S Corp must hold annual meetings and record meeting minutes.
• One way to keep personal assets separate from business debts.
• The Corp is governed by By-Laws. and if necessary, a Shareholder Agreement and Buy-Sell Agreement.
• It is formed by filing Articles of Incorporation with the State of Michigan.
• It is managed by Officers and a Board of Directors.
• It is a pass-thru entity. Owners must report their share of profit and loss in the company on their personal tax returns.
• Limited to 100 shareholders in a S Corp.
• Shareholders must be U.S. citizens or residents with few exceptions.
• S Corps are limited to one class of stock.
• Voting is based upon pro rata stock ownership of shareholders. Minority shareholders have fewer rights and options.

LIMITED LIABILITY COMPANIES

• It offers the liability protection of a corporation with the tax benefits of a partnership.
• The legal and tax structures are independent and separate from their owners to provide protection against personal liability.
• Unlike other entities, one is not required to hold annual meetings or record minutes.
• One way to keep personal assets separate from business debts.
• The LLC is governed by an Operating Agreement, and if needed, a Membership Agreement.
• It is formed by filing Articles of Organization with the State of Michigan.
• Owners can manage themselves (member-managed) or appoint a managing member, and still maintain protection from liability for the entity’s debts.
• If there is one owner, it is taxed similarly to a sole proprietorship.
• If there are multiple owners, it is taxed similarly to a partnership.
• It is a pass-thru entity. Owners must report their share of profit and loss in the company on their personal tax returns.
• There is no limit to the number of owners possible in an LLC, can be owned by non-U.S. citizens and C Corps.
• An LLC can have different class of Members.
• One Member One Vote representation for Members. Members have greater rights and options to make decisions, view financial records, demand accountings, or to initiate a legal action against an LLC and its members for any acts that are illegal, fraudulent, or willfully unfair and oppressive.

PARTNERSHIPS (GENERAL, LIMITED, LLP)

• The partners of a general partnership remain personally liable for the debts of the business. There is no entity protection.
• Limited partners are not liable for the obligations of a limited partnership if they do not “take part in the control of the business” as defined by statute. Instead, the limited partnership names a “General Partner” who is liable for the debts of business.  But typically, as a partnership, management responsibilities are divided between the partners.
• As of August, 2018, the legal and tax structure of an LLP is independent and separate from their owners to provide protection against personal liability similar to an LLC.
• However, a partner in an LLP is still liable for the partner’s own negligence, wrongful acts, omissions, misconduct, or malpractice, or that of any individual who is under the partner’s direct supervision and control.
• State filing is not typically required to form a general partnership but is required for a limited partnership and an LLP.
• A limited partnership is formed by filing a Certificate of Limited Partnership with the State.
• An LLP is formed by filing a Certificate of Co-Partnership with the county clerk, and an Application to Register a Limited Liability Partnership with the State.
• Partnerships are managed by the partners and governed by Partnership Agreements.
• Partnerships are easy to form and operate.
• Partnerships require at least 2 partners.
• It is a pass-thru entity. Owners must report their share of profit and loss in the company on their personal tax returns.
• One Partner One Vote representation for Partner. Except for limited partners, general and LLP partners have greater rights and options to make decisions, view financial records, demand accountings, or to initiate a legal action against other partners for any acts that are illegal, fraudulent, or willfully unfair and oppressive.

SOLE PROPRIETORSHIPS

• Business that has no separate existence from its owner. Not a legal entity.
• In case of a lawsuit filed against the business, the owner remains personally liable.
• There is no state filing required to form a sole proprietorship.
• Sole Proprietorships are easy to form and operate.
• Owners must report business profit and loss on their personal tax return.
• Only assets can be sold or liquidated – there is no entity to sell or transfer.

A: The first question for anyone setting up or running their own company is whether to invite another person to join them in business as a shareholder. Shared ownership, particularly of an owner-managed or family business, will complicate the relationships between people. Before taking this step, the implications (e.g. remuneration, dividend policy, rules on departure, etc.) will need to be carefully thought through. There are also some questions to answer that will help determine whether one needs a Shareholder Agreement.

Are you the controlling shareholder? A controlling shareholder is someone who holds more than 50 percent of the voting shares. (A Shareholders’ Agreement is rarely a protection that a controlling shareholder needs.) A controlling shareholder has a fundamental power in relation to a company: the power to hire and fire the directors of the company.

Since the directors are responsible for the management of the business, this gives the person (or persons) holding 50.1 percent of the votes the ability to control the company. So if, in the opinion of the 50.1 percent controlling shareholders, the directors are not performing, the director(s) concerned can be removed.

So, if you’re establishing a company and retain less than 50.1 percent of the votes, do you need the protection of a Shareholders’ Agreement? “Perhaps” is the best answer.

The reason for wanting a Shareholders’ Agreement generally pertains to retaining the ability to assert veto rights: so the powers of the board to run the business (or the shareholders to exercise their own power) are curtailed.

Of course, the aforementioned may be fine in theory, but the commercial context of the business helps shape the decision. A business seeking new funding may be crucially dependent on a minority investor, regardless of the percentage of ordinary shares initially held.

A particularly difficult area can be the company that is owned 50/50 by two

shareholders. There may be sound reasons dictating it would be better for one of the partners to have a controlling interest, which could be achieved by the holding of one extra share, or by that person’s appointment of an extra director to represent his interests, or to be appointed Chairman of the Board.

Since there’s no “one-size-fits-all” answer, it’s always in your best interest to consult an attorney when drafting articles of incorporation and other company-founding documents.

A: There are two primary ways to structure the sale of a business: an asset sale or a stock sale and the differences between the two may have significant tax and liability consequences.

In a stock sale, the buyer buys a portion (or all) of the outstanding stock of the target business and, as a result, receives the pro rata share of assets, including cash, of the selling company. The buyer also takes on the liabilities, known and unknown, of the target business. It is the liabilities quotient (particularly the “unknown” calculus) that is often cited as a reason buyers refuse to acquire the stock of a small business. Unknown liabilities can include tax liabilities and possible litigation. Another reason buyers usually avoid stock transactions is a lack of favorable tax benefits, which can include higher depreciation for a stepped-up basis of assets and amortization of goodwill.

Although there are situations where a stock sale may be desirable, such as the transfer of certain contracts or a lease, the assumption of all liabilities and unfavorable tax considerations usually pushes most transactions toward an asset sale structure.

In an asset sale, which is typically the way most small and mid-size transactions are structured, only defined assets are acquired and only defined liabilities are assumed. For example, most businesses are sold cash free/debt free, which means the selling entity retains the cash and pays off any debt. Assets that are sold would include tangible assets like furniture, equipment and inventory, as well as intangible assets, including the trade name and goodwill.

One of the desirable aspects of an asset transaction is its flexibility. For example, accounts receivable and/or accounts payable can be included or excluded, by definition, in the purchase contract.

The other attractive attribute of an asset sale is the favorable tax benefits to the buyer. Although sometimes the tax consequences to the seller can be more onerous in an asset sale, most sellers are structured as sole proprietorships, Sub Chapter S Corporations, or LLCs — and the tax “pass through” nature of the entities is manageable from a tax standpoint.

The consequences and complexities of these transactions can be significant to most sellers and buyers, which is why it is beneficial to seek legal counsel early on in the process.

A: Buying a Business: Due Diligence Checklist

When looking to acquire or commit a significant investment in an existing business, there are a host of information items you, your attorney and your financial advisor should request. The following is a fairly robust outline, and some items may not be applicable, but always check with your attorney to request documents that may not be listed.

A.Organization and Good Standing.

• The Company’s Articles of Incorporation, and all amendments thereto.
• The Company’s Bylaws, and all amendments thereto.
• The Company’s minute book, including all minutes and resolutions of shareholders and directors, executive committees, and other governing groups.
• The Company’s organizational chart.
• The Company’s list of shareholders and number of shares held by each.
• Copies of agreements relating to options, voting trusts, warrants, puts, calls, subscriptions, and convertible securities.
• A Certificate of Good Standing from the Secretary of State of the state where the Company is incorporated.
• Copies of active status reports in the state of incorporation for the last three years.
• A list of all states where the Company is authorized to do business and annual reports for the last three years.
• A list of all states, provinces, or countries where the Company owns or leases property, maintains employees, or conducts business.
• A list of all of the Company’s assumed names and copies of registrations thereof.

B. Financial Information.

• Audited financial statements for three years, together with Auditor’s Reports.
• The most recent unaudited statements, with comparable statements to the prior year.
• Auditor’s letters and replies for the past five years.
• The Company’s credit report, if available.
• Any projections, capital budgets and strategic plans.
• Analyst reports, if available.
• A schedule of all indebtedness and contingent liabilities.
• A schedule of inventory.
• A schedule of accounts receivable.
• A schedule of accounts payable.
• A description of depreciation and amortization methods and changes in accounting methods over the past five years.
• Any analysis of fixed and variable expenses.
• Any analysis of gross margins.
• The Company’s general ledger.
• A description of the Company’s internal control procedures.

C. Physical Assets.

• A schedule of fixed assets and the locations thereof.
• All U.C.C. filings.
• All leases of equipment.
• A schedule of sales and purchases of major capital equipment during last three years.

D. Real Estate.

• A schedule of the Company’s business locations.
• Copies of all real estate leases, deeds, mortgages, title policies, surveys, zoning approvals, variances or use permits.

E. Intellectual Property.

• A schedule of domestic and foreign patents and patent applications.
• A schedule of trademark and trade names.
• A schedule of copyrights.
• A description of important technical know-how.
• A description of methods used to protect trade secrets and know-how.
• Any “work for hire” agreements.
• A schedule and copies of all consulting agreements, agreements regarding inventions, and licenses or assignments of intellectual property to or from the Company.
• Any patent clearance documents.
• A schedule and summary of any claims or threatened claims by or against the Company regarding intellectual property.

F. Employees and Employee Benefits.

• A list of employees including positions, current salaries, salaries and bonuses paid during last three years, and years of service.
• All employment, consulting, nondisclosure, non-solicitation or noncompetition agreements between the Company and any of its employees.
• Resumés of key employees.
• The Company’s personnel handbook and a schedule of all employee benefits and holiday, vacation, and sick leave policies.
• Summary plan descriptions of qualified and non-qualified retirement plans.
• Copies of collective bargaining agreements, if any.
• A description of all employee problems within the last three years, including alleged wrongful termination, harassment, and discrimination.
• A description of any labor disputes, requests for arbitration, or grievance procedures currently pending or settled within the last three years.
• A list and description of benefits of all employee health and welfare insurance policies or self-funded arrangements.
• A description of worker’s compensation claim history.
• A description of unemployment insurance claims history.
• Copies of all stock option and stock purchase plans and a schedule of grants thereunder.

G. Licenses and Permits.

• Copies of any governmental licenses, permits or consents.
• Any correspondence or documents relating to any proceedings of any regulatory agency.

H. Environmental Issues.

• Environmental audits, if any, for each property leased by the Company.
• A listing of hazardous substances used in the Company’s operations.
• A description of the Company’s disposal methods.
• A list of environmental permits and licenses.
• Copies of all correspondence, notices and files related to EPA, state, or local regulatory agencies.
• A list identifying and describing any environmental litigation or investigations.
• A list identifying and describing any known superfund exposure.
• A list identifying and describing any contingent environmental liabilities or continuing indemnification obligations.

I. Taxes.

• Federal, state, local, and foreign income tax returns for the last three years.
• States sales tax returns for the last three years.
• Any audit and revenue agency reports.
• Any tax settlement documents for the last three years.
• Employment tax filings for three years.
• Excise tax filings for three years.
• Any tax liens.

J. Material Contracts.

• A schedule of all subsidiary, partnership, or joint venture relationships and obligations, with copies of all related agreements.
• Copies of all contracts between the Company and any officers, directors, 5-percent shareholders or affiliates.
• All loan agreements, bank financing arrangements, line of credit, or promissory notes to which the Company is a party.
• All security agreements, mortgages, indentures, collateral pledges, and similar agreements.
• All guaranties to which the Company is a party.
• Any installment sale agreements.
• Any distribution agreements, sales representative agreements, marketing agreements, and supply agreements.
• Any letters of intent, contracts, and closing transcripts from any mergers, acquisitions, or divestitures within last five years.
• Any options and stock purchase agreements involving interests in other companies.
• The Company’s standard quote, purchase order, invoice and warranty forms.
• All nondisclosure or noncompetition agreements to which the Company is a party.
• All other material contracts.

K. Product or Service Lines.

• A list of all existing products or services and products or services under development.
• Copies of all correspondence and reports related to any regulatory approvals or disapprovals of any Company’s products or services.
• A summary of all complaints or warranty claims.
• A summary of results of all tests, evaluations, studies, surveys and other data regarding existing products, or services and products, or services under development.

L. Customer Information.

• A schedule of the Company’s 12 largest customers (if applicable) in terms of sales thereto and a description of sales thereto over a period of two years.
• Any supply or service agreements.
• A description or copy of the Company’s purchasing policies.
• A description or copy of the Company’s credit policy.
• A schedule of unfilled orders.
• A list and explanation for any major customers lost over the last two years.
• All surveys and market research reports relevant to the Company or its products or services.
• The Company’s current advertising programs, marketing plans and budgets, and printed marketing materials.
• A description of the Company’s major competitors.

M. Litigation.

• A schedule of all pending litigation.
• A description of any threatened litigation.
• Copies of insurance policies possibly providing coverage as to pending or threatened litigation.
• Documents relating to any injunctions, consent decrees, or settlements to which the Company is a party.
• A list of unsatisfied judgments.

N. Insurance Coverage.

• A schedule and copies of the Company’s general liability, personal and real property, product liability, errors and omissions, key-man, directors and officers, worker’s compensation, and other insurance.
• A schedule of the Company’s insurance claims history for past three years.

O. Professionals.

• A schedule of all law firms, accounting firms, consulting firms, and similar professionals engaged by the Company during past five years.

P. Articles and Publicity.

• Copies of all articles and press releases relating to the Company within the past three years.