The McGee Cake Company
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.
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