In early 2001, Doc and Lyn McGee formed the McGee Cake Company. The company produced a full line of cakes, and its specialties included chess cake, lemon pound cake, and double-iced, double-chocolate cake. The couple formed the company as an outside interest, and both continued to work at their current jobs. Doc did all the baking, and Lyn handled the marketing and distribution. With good product quality and a sound marketing plan, the company grew rapidly. In early 2006, the company was featured in a widely distributed entrepreneurial magazine. Later that year, the company was featured in Gourmet Desserts, a leading specialty food magazine. After the article appeared in Gourmet Desserts, sales exploded, and the company began receiving orders from all over the world. Because of the increased sales, Doc left his other job, followed shortly by Lyn. The company hired additional workers to meet demand. Unfortunately, the fast growth experienced by the company led to cash flow and capacity problems.
The company is currently producing as many cakes as possible with the assets it owns, but demand for its cakes is still growing. Further, the company has been approached by a national supermarket chain with a proposal to put four of its cakes in all of the chain’s stores, and a national restaurant chain has contacted the company about selling McGee cakes in its restaurants. The restaurant would sell the cakes without a brand name. Doc and Lyn have operated the company as a sole proprietorship. They have approached you to help manage and direct the company’s growth. Specifically, they have asked you to answer the following questions:
What are the advantages and disadvantages of changing the company organization from a sole proprietorship to an LLC? Essence ***The McGee Cake Company, currently operating as a sole proprietorship, may benefit from forming a limited liability company (LLC). An LLC is a comparatively new type of business entity. With an LLC there are reduced legal formalities in comparison to setting up a corporation. In addition, unlike a corporation, the McGees could set up an LLC yet remain the sole owners of the company. Another advantage as the owners of an LLC, the McGees are taxable only for personal income and not for the income of your LLC. Therefore, they would not pay double income tax. An LLC also has a long existence it will exist forever, irrespective of the owner’s death or retirement. Some negatives for the McGees to consider are the expense.
Although setting up an LLC is less expensive and hectic than setting up a corporation, the cost incurred in setting up an LLC is definitely more than that of a sole proprietary firm or a partnership firm. If they chose to convert their sole proprietorship to an LLC, they may be taxed on appreciated assets. If their LLC exists in multiple states, it may be difficult to handle, as the nature of rules and regulations differs from state to state.*** *** The first advantage of changing the McGee Cake Company from a sole proprietorship to an LLC is that the owners will be protected from liability for debts of the company.
This is very important because if Doc and Lyn keep McGee sole proprietorship and for some reasons, the company went bankrupt, everything will show up on Doc and Lyn’s personal credit report. Changing to LLC will protect Doc and Lyn from paying back the debt with their personal funds. However, there are some disadvantages with doing this. The paperwork won’t be simple as it was when the company was sole proprietorship. There’s going to be a fee and registration required. And the last thing is there has to be annual reporting requirements.
What are the advantages and disadvantages of changing the company organization from a sole proprietorship to a corporation? Maria A corporation is defined as a legal entity independent of its owners, shareholders or the management personnel running it. As owners of the corporation the McGees will enjoy limited liability and they are not completely responsible for the profits and losses of the corporation. Instead, their scope of liability remains confined to their investment in the venture. There are many advantages to changing the company organization from a sole proprietorship to a Corporation. Ownership is separated from Management of the company so transfer of ownership is much easier through the sale of stock.
On the other hand, under a Sole Proprietorship the life of the business is limited to the life of the owner and the equity that can be raised is limited to the amount of the proprietor’s personal wealth and credit line. Besides the ease of the transfer of ownership a corporation can raise money through Initial Public offerings of stock as well as borrow money under the corporate name and the owners of a corporation would only have limited liability to the debt protecting their personal assets. The main disadvantage of converting to the corporation is being subject to double taxation. Corporate profits are taxed twice once when the profits are earned and once when profits are paid out such as dividends.
Another disadvantage to corporations is having to answer to the Stock holders which all they care about is making money on the stock which may consistent with the goals of the company. Under a Sole Proprietorship profits are only taxed once but the owner of a Sole Proprietorship has unlimited liability. With this the credibility that they can get is bountiful, it’s easier to raise capital anytime they feel like they need to expand or open new factories. The couple can feel safe about McGee Cake Company and its continuous life.
Ultimately, what action would you recommend the company undertake? Why? Essence and Maria I would recommend McGee Cake Company to go corporation. Not any company can go from sole proprietorship to corporation. It’s all about the size and the reputation of the company. McGee already went international with orders from all over the world, and it also appears on the best food magazines. Many people will see the potential of the company and therefore they will put their money in, buy its stocks and expand this cake factory, make it one of the best cake factories in the world. The profit will be huge.