Issues In Establishing a Construction Business - Essay Example

Running Head: ABBREVIATED OF YOUR CHOICE (all caps) and Section # of Issues in establishing a construction business This paper discusses various issues regarding setting up a construction business. Because the scale of business activity in construction is large, the issues pertaining to this form of business are also significant and must be resolved in order to ensure smooth and profitable operation of the business. This is a study of the main legal and financial issues involved and evaluates the alternatives available. Introduction In order to establish a construction business, some legal and financial issues need to be addressed in totality. The first most important thing for the business is, what kind of legal entity will it be. The construction business has some significant legal concerns as well, such as liquidated damages issue that should be taken into account. The business then requires finance for its operations and means of obtaining these finances are to be evaluated. It is important for the owners to study these matters to understand whether this business is well suited to them and to understand what kind of management skills, legal and financial expertise they should have in the enterprise for it to successfully turn it into a successful, profitable venture. Legal form of business When considering the legal form of business formation, the choices available to a business include sole proprietorship, partnership, corporation, and the newest form of business formation, the limited liability company (LLC). These forms of business may be compared in terms of ownership, liability of owners, continuity of business, and transferability of interest, among others. Since construction is a business with a potential for personal injury where employees and customers can experience a fall or some other injury at the construction site, it is best to select the form of business entity that provides liability protection for the business owners. Liability protection is also an important consideration because in times of financial adversity, it allows the owners to be accountable only to the extent of their share in the business and no charge is placed on their personal assets. The two options that provide protection of personal liability are corporation and LLC. Corporations are further classified into C Corporations and S Corporations. Typically the term 'Corporation' refers to a C Corporation, whereas the S Corporation is a special type of corporation that combines tax advantages of the partnership and the corporation. The LLC is a new alternative brought about by the new regulation and has gained much popularity because of its acceptance in all states and amendments in several states making it more attractive. (Hisrich, Peters, Shepherd, 2004) The LLC is considered a partnership-corporation hybrid because of its characteristics. Like partnerships have partners and corporations have shareholders, the LLC has members. These members do not own shares but rather an interest in the business. As mentioned earlier, the LLC allows owners to have limited liability protection, which would benefit the owners of a construction business by offering them protection from. The taxation for an LLC does not take place on the business level, instead the income, profit or loss is passed on to the owners and is treated as their personal income and reported in the owner's personal tax return. Liquidated Damages The construction industry is one in which legal issues arise very often. Breaches of contracts and failures to perform have to be dealt with by the employer as well as the contractor. Because this paper discusses considerations for owners of a construction business, we will look at the legal matters that can arise, from the viewpoint of the employer who assigns the task of constructing a particular project to the contractor. The relationship of an employer and contractor is such that According to the American Law Encyclopedia Vol. 6, liquidated damages refer to monetary compensation for a loss, detriment, or injury to a person or a person's rights or property, awarded by a court judgment or by a contract stipulation regarding breach of contract. Most contracts having money as consideration or the promise of performance contain a liquidated damages stipulation. Through this stipulation a predetermined sum is established that must be paid if there is a failure to perform by the party. Like any other contract, construction contracts between the employer and contractor carry with them a risk of a breach. In fact, in the construction industry, breaches of contract are a commonplace to the point of being routine. It is therefore a common commercial practice for parties to include provisions for dealing with most likely breaches in their contracts. In the construction industry, standard forms usually contain detailed clauses for procedures and the recovery process for specified breaches of the contract (Eggleston B., 1997). The employer must take special about matters that may cause a breach. Late instructions or unclear information, failure to give full possession of the construction site and so on will result in a delay, disruption or extra costs and expenses from the end of the contractor. If the contractor can prove the loss or extra cost and expense incurred, the contractual remedy will allow the recovery of the same to the contractor and, under certain conditions, an extension of the time for completion of the project. From the contractor's side, the breaches of contract most commonly include failure to proceed with due diligence, inability to complete on time and failure to meet specified standards. The contractual remedy available with the employer in the event of a breach from the contractor will usually be the right to terminate the contractor's employment or demand reconstruction. Only in the event of inability to complete on time by the contractor will the employer have a financial contractual remedy (Eggleston B., 1997). The position of the employer is therefore very different from that of the contractor. The employer has a financial remedy only in the event that the contractor fails to complete on time whereas the contractor has a financial remedy for most breaches by the employer. Finance Every business requires finance. When it comes from internal sources, i.e. from the owner's contributions to the business, it is known as the equity or capital of the business and when it comes from external sources i.e. from some form of borrowing, it is known as the portion of debt in the business. The question of whether the business should have more equity or debt actually depends upon the risk taking stance of the owners and the management of the business. If the major part of the business funds is owner's equity, it will have the ability to absorb more financial shocks and allow the business to sail through in poor financial conditions. In contrast, if the business has undertaken a lot of borrowings to finance its operations, it will have to pay them back to the lenders when they come due, and if the business fails to pay, its assets can be charged. However financing the business through debt does turn out to be very profitable for the business that is why a certain amount of borrowings should be present in the business to reach high profitability. Also, businesses such as construction require very large amounts of finance, which cannot normally be contributed by the owners alone. This brings us to discuss the options available for construction business owners to finance their business activities. The main activity of such a business would be undertaking construction projects, for which it will require funds. Since a construction company does not require a production facility to manufacture a product or the like, the main land ownership in the business would be that of an office. However, the construction company might need to own some machines for the business including cranes, lifters, bulldozers and mixers. For both of the aforementioned, finance will be required. Loans To finance its projects, the construction company can obtain a loan. The kinds of loans commonly available for this purpose include construction loans (or development loans) and permanent loans. As defined by businessdictionary a construction loan is short-term (usually 3 years) real estate financing secured by a mortgage on the property being financed. This loan is meant to cover the cost of land development and building construction, and is disbursed (1) as needed, (2) as each stage is completed, (3) according to a prearranged schedule, or (4) when some condition is met. A permanent loan (also known as permanent financing) is defined as a long-term (maturity period 15 to 30 years) mortgage loan or bond issue for the purpose of repaying the construction loan. The amount of financing required at each stage of the construction process is large such that one loan is used to pay off the other. The most common type of loan in the business is known as a construction loan. This type of loan provides the construction company finance to build the project in plans. It provides cash funds for materials, labor and other expenses such as land development, throughout the period of construction. Construction loans are paid off from the proceeds of permanent financing (usually for 20 to 30 years), which in turn is repaid from the cash flow generated by the completed building, and is arranged before the construction loan is disbursed. Lease As defined by investorwords a lease is a written agreement under which a property owner allows a tenant to use the property for a specified period of time and rent. Conclusion This paper discussed few of the major issues surrounding business set up of a construction company. Legal matters of business formation and liquidated damages were discussed. The LLC form of business entity was evaluated and found to have many favorable characteristics. The owners should also be aware of the legality of liquidated damages so as to know the contractor's legal position as well as their own. Once the legal matters of the business were addressed, we moved on to discuss the financial ones. The means of obtaining finances for the business by way of the combination of construction loan and permanent loan was discussed, and lease arrangements for the office References American Law Encyclopedia Vol. 6,. Retrieved 02-26-2009, from http://law.jrank.org/pages/8310/Liquidated-Damages.html Business Dictionary Retrieved 02-26-2009, from http://www.businessdictionary.com/definition/construction-loan.html Eggleston B. (1997) Liquidated Damages and Extensions of Time in Construction Contracts: In Construction Contracts. Blackwell Publishing Hisrich R. D., Peters M.P., Shepherd D.A. (2004). Entrepreneurship. Australia: McGraw Hill Professional. Investor Words Retrieved 02-26-2009, from http://www.investorwords.com/2749/lease.html Read More