Business Notes, August 2011
Choosing the correct form of business organization is important. It can have far reaching consequences, some that are not anticipated at the time a new business is organized. There are income tax options available when a business is organized. The business can report and pay tax on its profits (typically a C Corporation) or the owner(s) can individually report the income and pay the tax for a pass-through entity (typically a sole proprietorship, partnership, LLC, LLP, Subchapter S corporation or similar entity).
However, taxes should not be the only consideration when forming a business. Business organizational documents create important differences for day-to-day management, dispute resolution, death or withdrawal of an owner, and dissolution. A recent Wisconsin Supreme Court case involved Press Enter, a business which provided computer and internet services and was organized as a limited liability partnership. The court’s ultimate decision was controlled by the absence of important organizational documents. Press Enter did not have buy-sell or dissolution provisions in its organizational documents.
Except for a sole proprietorship, Wisconsin statutes provide detailed rules that govern the organization, operation and dissolution of business entities. Within those rules, organizers of a business are given considerable latitude regarding the organization and operation of the business. Selecting the appropriate options is an important process. But, selecting the right business entity and making informed decisions about the available options is only the first step. The most important step, and the one that most frequently causes problems, is to wrap up all the details. With the hope, anticipation and excitement of a new business, many do not pay attention to the documents that can anticipate and resolve potential future problems.
In any business with multiple owners, the key documents are those that deal with the four Ds: Death, Disability, Divorce and Disagreement. Many, if not most, closely-held businesses do not have documents that address these issues. Sometimes the omission is the result of a lack of information about the importance of those documents. In other cases, the owners do not want to incur the expense of negotiating and drafting the documents. If there is never an auto accident, seat belts and air bags are unimportant. Similarly, if a business never experiences one of the four Ds, the owners need not worry about the lack of documentation. But, accidents happen and businesses experience unanticipated problems.
That was the Press Enter situation. The partners never got around to drafting a buy-sell or dissolution agreement. In the absence of an agreement and failed settlement proposals, the courtroom and lawyers were the only option. We can only guess at the time, effort and expense involved in a trial, an appeal to the Wisconsin Court of Appeals and then an appeal to the Wisconsin Supreme Court. Not only that, but, in the absence of an agreement, the law imposed a result that most of us, including the Supreme Court, view as inequitable.