DISTRIBUTION OF PROFITS AND LOSSES
Profits and Losses
The sole proprietor receives all the profits from the business, and bears all the losses, which may exceed the proprietor’s investment in the business.
In the general partnership, the limited liability partnership, the limited liability limited partnership and the limited partnership, profits and losses are passed through to the partners as specified in the partnership agreement. If left unspecified, profits and losses are shared equally among the partners.
In a C corporation, profits and losses belong to the corporation. Profits may be distributed to shareholders in the form of dividends, or they may be reinvested or retained (within limits) by the corporation. Losses by the corporation are not claimed by individual shareholders. Shareholders include dividends and the gain or loss on the sale of stock or liquidation of stock in the corporation as income.
In an S corporation, corporate income and losses flow through and are taxed to the shareholders in proportion to their shareholdings. Shareholders also include their gain or loss on the sale of stock or liquidation of stock as income. Generally, cash distributions (dividends) received from the S corporation are not included in income to the extent the shareholder has basis in his or her stock.
Limited Liability Company
Profits and losses of a limited liability company flow are taxed in the same manner as those of a sole proprietorship, partnership, S corporation, or C corporation depending on how the entity has chosen to be treated for federal income tax purposes. The governing statute, articles of organization, or the operating agreement will specify how these are allocated among the members.
Management Control and Decision Making
The sole proprietor has full and complete authority to manage and control the business. There are no partners or shareholders to consult before making decisions. This form of organization gives the proprietor maximum freedom to run the business and respond quickly to day-to-day business needs. The disadvantage of this form is that the sole proprietor, as just one person, will have limited time, energy and expertise to devote to the business. His or her experiences may not provide the breadth of skills and knowledge necessary to deal with all phases of the business. Further, because the sole proprietor is the only person authorized to act on behalf of the business, he or she may be unable to leave the business for extended periods of time without jeopardizing its operations. As the business expands, the proprietor may be able to hire managers to perform some of these functions and provide additional expertise, but in the early years of the business, the sole proprietor often will perform many of these tasks alone.
The general rule of management is that in both a general partnership and a limited liability partnership, all partners share equally in the right, and responsibility, to manage and control the business. The partnership agreement may centralize some management decisions in a smaller group of partners, but all partners continue to share ultimate responsibility for these decisions. By statute, unless a partnership agreement provides otherwise, certain management decisions require unanimous consent of the partners. Other decisions may be made by consent of a majority of the partners. The right to share equally in decisions can make the decision-making process cumbersome, and the risk of major disagreements can impair effective operation of the business. An advantage of the partnership that is not present in a sole proprietorship is that the partnership, with its several owners, can bring a broader range of skills, abilities and resources to the business. The owners’ combined experiences also can promote more informed decision making. In addition, the workload can be shared to lessen the physical and other demands on the individual owners.
In addition, under the Revised Uniform Partnership Act (RUPA), a system of formal filings has been established that allows partnerships to limit the authority of certain partners to third parties as well as to limit the liability of partners for partnership obligations purportedly incurred by a partner after the partner has left the firm. In order to use this system, the partnership must first file with the Secretary of State an assumed name certificate or limited liability partnership statement of qualification. After that filing has been made, the partnership may again file any of the following statements with the Secretary of State:
Statement of Partnership Authority. This allows the partnership to either restrict or specifically expand the authority of particular partners to conduct various transactions, particularly real estate transactions.
Statement of Denial. This allows a partner to deny partnership status or the conferral of authority upon the partners by a Statement of Partnership Authority.
Statement of Dissociation. This allows a partner who is withdrawing from the partnership to avoid liability for obligations for the partnership incurred after the partner has withdrawn, and also allows the partnership to eliminate the authority of that partner to bind the partnership.
Statement of Dissolution. This allows the partnership to notify the world that it is dissolving and that partners will no longer have authority to act on behalf of the partnership.
The following are also permitted:
Statement of Merger. This allows partnerships and limited partnerships to merge with each other.
Statement of Qualification. This statement establishes a Minnesota limited liability partnership under Minn. Stat. Chapter 323A.
Statement of Foreign Qualification. This statement registers a non-Minnesota limited liability partnership.
Any of these seven statements may also be amended or cancelled.
In order for any Statement to have an effect on real property transactions, a certified copy of the Statement, obtained from the Secretary of State, must be recorded in the office where land records for the county in which the real property is located, and, if applicable, has been memorialized on the certificate of title for that real property.
In a limited partnership in Minnesota, limited partners may participate in the management and control of the partnership but may not act for or bind the partnership (unless this is provided for in the limited partnership agreement or another agreement between the limited partner and the limited partnership). Those functions generally are performed by general partners.
The rules for corporate decision making are established by statute, but many rules may be modified by the articles of incorporation or bylaws. Shareholders elect the board of directors, which in turn manages the operation of the business. The corporation also must have one or more natural persons exercising the functions of chief executive officer and chief financial officer. Except in very small corporations in which the shareholders are also the directors, shareholders as a group generally will not directly participate in management decisions. This concentration of decision making in a relatively few individuals promotes flexibility in decision making, but also can result in overruling of minority interests or in some cases manipulation or exploitation of minority shareholders. To resolve this problem, corporations may adopt provisions in the articles of incorporation or bylaws to give minority shareholders a stronger voice in management decisions. Decision-making authority also may be delegated by the shareholders and/or directors to hired managers, who may or may not be shareholders. This delegation further removes decision-making authority from the shareholders. Like a partnership, the corporation can draw on the skills and expertise of more than one individual in running the business. This can broaden the base of information for decision making and reduce workload demands on individual managers.
The articles of incorporation, bylaws or state business corporation act establish procedures and criteria for decision making, such as meeting and quorum requirements, voting margins, and the like, which may make decision malting in the corporation more cumbersome than in a sole proprietorship or partnership.
Limited Liability Company
Minn. Stat. Chapter 322C, which governs limited liability companies takes more of a partnership approach to limited liability companies than did the older law, which was based on Minnesota’s business corporations act. firm. Stat. Chapter 322C permits management by the members, management by one or more managers, and management by a board (Minn. Stat. § 322C.0407). The default structure is member management. Unless the operating agreement provides otherwise, each member has equal rights in the management and conduct of the limited liability company’s activities — i.e., per capita, not in proportion to their capital contributions. Differences as to matters in the ordinary course of the limited liability company’s activities maybe decided by a majority of the members, while acts outside the ordinary course may be undertaken only with the consent of all members. Additional agents (who can be referred to as officers) may be appointed by the members, managers, or board. As with a corporation, the rules governing the management of a limited liability company are often specified in a written operating agreement. If not otherwise specified in an operating agreement, the default rules of the limited liability company statute will control.
In addition, the Revised Uniform Limited Liability Act as adopted in Minnesota (Minn. Stat. Chapter 322C), provides for a system of formal filings similar to those under the Minnesota Revised Uniform Partnership Act. These allow limited liability companies to put of record the authority or limitations on authority of persons holding any position that exists in or with respect to the company to execute an instrument transferring real property held in the name of the company or enter into other transactions on behalf o1, or otherwise act for or bind, the limited liability company. Such statements affect only the power of a person to bind a limited liability company to persons that are riot members. Any such statement also may be amended or cancelled. Filing a statement of dissolution automatically cancels all previously filed statements. The types of statements and their effects may be found in the statute (Minn. Stat. § 322C.0302.)
In the case of real property transactions, if an effective statement containing a limitation on the authority to transfer real property held in the name of a limited liability company is certified by the Secretary of State and is recorded in the real property records, all persons are deemed to know of the limitation. An effective statement of authority that grants authority to transfer real property held in the name of the limited liability company, is conclusive in favor of a person that gives value in reliance on the grant without knowledge to the contrary, whether or not a certified copy of the statement was recorded in the real property records, unless, when the person gave value, (a) the statement had been canceled or restrictively amended under and a certified copy of the cancellation or restrictive amendment had been recorded in the real property records, or (b) a limitation on the grant was contained in another statement of authority that became effective after the statement containing the grant became effective and a certified copy of the later effective statement was recorded in the real property records.
CREDITS: This is an excerpt from A Guide to Starting a Business in Minnesota, provided by the Minnesota Department of Employment and Economic Development, Small Business Assistance Office, Thirty-fourth Edition, January 2016, written by Charles A. Schaffer, Madeline Harris, and Mark Simmer. Copies are available without charge from the Minnesota Department of Employment and Economic Development, Small Business Assistance Office.