Q1: What are the advantages and disadvantages of changing the company organization from a sole proprietorship to an LLC? Since the company’s inception, the McGee’s have operated The McGee Cake Company as a sole proprietorship which has provided them with several key advantages. The first among these advantages is the relative ease with which the McGee’s likely experienced in starting their business where essentially they were only required to secure the necessary licenses, tax identification numbers, and certifications to begin conducting business. In contrast, the requirements to start a LLC are quite a bit more extensive. Although less extensive than other corporate entities, establishing and maintaining an LLC requires that the owner form and register the LLC entity with the appropriate state agency. Next, the owner must draft and file articles of organization with secretary of state’s office along with paying a substantial filing fee that can be on the upwards of several hundred dollars.
This LLC filing will have to include the LLC’s name, principal office’s location, the owner’s name or names, the expected term of the LLC, and any other state mandated information. Additionally, since the McGee’s would operate as co-owners of the company, they would be required to draft an operating agreement which details the each of their duties, capital contributions, and rights to profits. Another key advantage of the sole proprietorship is the owner’s freedom to make decisions and direct the course of action for the future of the business. Up to this point, the only deliberation on major decisions has been amongst the McGee’s themselves; however, this freedom has come at a cost. Due to some favorable exposure in the media, the McGee’s have experienced an explosion in demand, and despite their best efforts, they have fallen short of meeting this demand due to cash flow and operating capacity problems. As a sole proprietorship, the McGee’s ability to raise the necessary capital to expand their business is limited to their own personal wealth.
On the other hand, reorganizing as an LLC could open new channels for acquiring capital by bringing in new members or outside investors; however, by doing so would result in relinquishing some of their ownership rights, and by extension, a portion of freedom in making decisions. Finally, the last key advantage of a sole proprietorship is its distribution of profits. Under a sole proprietorship, the McGee’s have enjoyed the benefit of keeping all the company profits for themselves while only being taxed on an individual income tax return. Should the McGee’s choose to bring in outside investors as an LLC; the profits will divided up amongst members based on their capital investment. At the same time, the profits will be subjected to the same tax guidelines as sole proprietorships. Still, the sole proprietorship is not without disadvantages, the most notable of which is its unlimited liability.
As a sole proprietor, the McGee’s are responsible for all business debts and should they default on their debt obligations, their creditors could claim their personal assets such as their personal automobiles, home, savings account, and investments. However, this unlimited liability isn’t just limited to business debts. It also applies in legal matters as well. Should an employee get injured on the job or injure another party while on the job, the injured party could go after the McGee’s personal assets should the company’s asset fail to coverage the damages rewarded in the lawsuit.
Q2: What are the advantages and disadvantages of changing the company organization from a sole proprietorship to a corporation? A corporation has the same advantages as forming a LLC, however they are significantly more rules and regulations involved. Additionally, a corporation is often taxed twice on earnings.
Q3: Ultimately, what action do you recommend the company undertake? Why? In the final analysis, my recommendation for the McGee’s would be to change their organization from a sole proprietorship to a limited liability corporation. In spite of its relative more complex paperwork requirements, organizing as a LLC will create new opportunities to raise capital for expansion to meet the growing demand while also limiting their personal liability on future losses should demand decline and exposure to potential lawsuits. That said, it may prove advantageous to proceed with caution before entering into any future contracts with large supermarket chains and especially with large restaurant chains without using The McGee Cake Company brand name.
The bakery industry in the United States is a $30 billion industry highly dominated by commercial bakeries such as Hostess. Often times, the large supermarket chains force suppliers to delivery their products at such low prices making it extremely challenging to turn a reasonable profit. Nonetheless, the amount of brand exposure one could achieve by such a contract alone would trump any marketing efforts on an individual level therefore it’s imperative to carefully weigh the costs and benefits before any decision. A company is as only as good as it identity therefore every company must create a strategy to protect its brand which is why I highly advise against allowing a restaurant chain to sell The McGee Cakes without a brand name.