ARE 5.0(Architect Registration Examination): ARE 5.0 PREP Self-Study #4

ARE 5.0 (Architect Registration Examination)

 ARE 5.0 Self-Study: Day #4 

"Practice Management"

Business operations for Architecture Firms

Business Organization: the legal structure of an architecture firm

Office Organization: the way the firm organizes to complete its work

Ethical Standards: the accepted principles of correct professional conduct

Human Resources: the practices and legal responsibilities pertaining to employing other. 

Business development: the use of marketing and public relations to increase business.

Business Organization

There are a number of different ways in which an architectural firm can be structured, and each structure has different legal and financial consequences. 

• Sole Proprietorship

• General or Limited partnership

• Corporation

• Limited liability company or Limited liability partnership

• Joint Venture

Each has advantages and disadvantages and may be more or less appropriate depending on the number

of people in the firm, the type of practice, the size of the business, the level of risk the owner or owners

want to take, the laws of the state or states where the firm is doing business, and the requirements of the

state licensing board or boards in regard to the participation of licensed architects in firm management.

Sole Proprietorship

The simplest business type is the sole proprietorship. In this structure, the business is owned by an individual. The business may operate under the owner’s name or under a company name.

 

Setting up a sole proprietorship requires only a name and location for the business, company stationery, whatever electronic communications systems are needed, and the business licenses required by the local jurisdiction. If employees are hired, state and local requirements must also be met.

 

The advantages of a sole proprietorship include ease of setup, total management control by the owner, and possible tax advantages to the owner because business expenses and losses may be deducted from the gross income of the business. The main disadvantage is that the owner is personally liable for the company’s debts and losses. If a client sues the company, the owner’s personal income, personal property (possibly including

property co-owned with a spouse), and other assets can be seized to pay any judgments.

 

Another possible disadvantage is that raising capital and establishing credit will depend entirely on the owner’s personal credit rating and assets. Similarly, because success or failure depends mainly on the work and personal reputation of its owner, it may be difficult to sell even a successful sole proprietorship to others. When the owner stops practicing, the firm will usually cease to exist.

Partnerships

In a general partnership, two or more people, called general partners, share in the management, profits, and risks of the business. Income is shared among the general partners and is reported on personal tax forms. Each general partner is also personally liable for business debts and liabilities.

 

A limited partnership is similar, but has at least one general partner and at least one limited partner. As with a general partnership, the general partners invest in the business, manage it, and are financially responsible for it. The limited partners are investors who receive a portion of the profits, but who have no say in the management of the company and are liable only to the extent of their investment. The limited partnership has largely been superseded by the limited liability company, described later in this section.

 

 

A partnership is relatively easy to form. A partnership agreement is usually advisable. The additional requirements are similar to those of a sole proprietorship. Where a sole proprietorship depends mainly on a single person, a partnership brings together the skills of several people. Most partnerships are formed because each partner brings to the business a particular talent, such as business development, design ability, or technical knowledge.

 

The primary disadvantage of a partnership is that all the partners are responsible and liable for the actions of the others. As with a sole proprietorship, the personal assets of any of the partners are vulnerable

to lawsuits and other claims. Income is taxed at individual rates, another disadvantage of the partnership form. On a personal level, the partners may eventually disagree on how to run the business. If one partner wants to withdraw, the partnership is usually dissolved.

Corporations

A corporation, sometimes called a C corporation, is an association of individuals that exists as a legal entity apart from its members. A corporation can be created only in accordance with statutory requirements.

To form a corporation, formal articles of incorporation must be drawn up by an attorney and filed with the appropriate state office. The specific regulations and requirements are governed by state law.

 

Corporations have three levels of participants. Stockholders are owners of the corporation in proportion to the number of shares they own. They elect the directors. The directors have the fiduciary duty to act in the best interest of the stockholders and are responsible for broad policy decisions. The directors, in turn, elect the officers who carry out the day-to-day management of the corporation.

 

A corporation is financially and legally independent from its shareholders. Each shareholder is financially liable only for the amount of money he or she has invested in the corporation. If the corporation is sued, the personal assets of the shareholders are not at risk. This is the greatest advantage of the corporation. Additionally, a corporation has a continuity that is independent of any changes in shareholders, directors, and principals.

It is also relatively easy to raise capital for corporations through the sale of stock.

 

Corporations are generally taxed at lower rates than individuals, which can result in considerable savings over a partnership or sole proprietorship. As the corporation and the shareholders are separate legal entities, however, they are also taxed separately, the corporation on its profits and the shareholders on their dividends. In this way, corporate income is, in effect, taxed twice.

 

The primary disadvantages of a corporation are the initial cost to establish the business and the continuing paperwork and formal requirements necessary to maintain it. These, however, are usually outweighed by the

reduced liability and tax benefits.

 

An S corporation does not retain profits and pay out dividends in the usual manner. Instead, an S corporation chooses to allocate its income and losses directly to shareholders in proportion to their holdings. Shareholders report their shares of the business’s income and losses on their personal federal tax returns and are assessed tax at their individual rates. This avoids the tax on corporate income, and can also be advantageous when the business loses money or when tax rates favor the individual over the corporation; in addition, an S corporation offers all the advantages of a standard corporation. S corporation status, however, is limited to small business corporations as defined in Chap. 1, Subsection S, of the Internal Revenue Code. To qualify for S corporation status, a corporation must be a domestic company with no more than 100 shareholders; there are other restrictions as well.

Many states allow the formation of a professional corporation for professionals such as architects, lawyers, doctors, accountants, and interior designers. This form of business is similar to other corporations except that liability for malpractice is generally limited to the person responsible for the act. However, each state has its own laws regarding the burden of liability in a professional corporation.

Limited liability company or Limited liability partnership

The limited liability company (LLC) and the limited liability partnership (LLP) are similar business structures that combine the advantages of a partnership or sole proprietorship with the limited liability of a corporation. Each is formed like a partnership. Those who invest are called members, and those who manage are called managers. Unlike a partnership, however, it is possible for a non-member to be a manager.

The main advantage to these types of organizations is that liability is limited to a member’s investment; a member has no personal liability. An LLC is not a separate entity in the eyes of the federal government, so the business itself is not taxed. Accordingly, profits and losses are passed through the business to each member who must report a profit or loss on his or her personal federal tax return. However, some states may tax the LLC. In addition, members of an LLC are considered to be self-employed, so they must report and pay self-employment tax for Social Security and Medicare. In some cases, the members of an LLC can elect to be classified as an S corporation; the organization remains an LLC from a legal standpoint but is taxed as an S corporation. Generally, an LLC is easier to set up and operate than a corporation.

Joint Venture

A joint venture is a temporary association of two or more persons or firms for the purpose of completing a specific project or achieving a specific goal. This business arrangement is typically used by architectural firms when a project is too large or complex to be completed by one firm alone, or when one firm needs the expertise in a particular area that another firm can offer. The joint venture is typically dissolved when the project is completed or the goal is reached.

 

A joint venture should be based on a formal, written agreement that describes the duties and responsibilities of each firm, how profits and losses will be divided, and how the work will be completed. The joint venture is treated like a partnership; it is not itself a legal entity independent from its members, and it cannot be sued as a corporation can. Depending on the laws in the state in which the joint venture operates, profits may be taxed as a partnership, or the individual members of the joint venture may be taxed separately.

 

Before a joint venture is formed, a teaming agreement (also called a memorandum of understanding) should be developed that defines the roles, responsibilities, and contractual relationships that will be established if the firms are awarded the project and the joint venture is formed. A teaming agreement is not a formal business organization, but it can be used to market the team and forms the basis of a joint venture. A teaming agreement can also be used if a firm wants to form a prime-consultant agreement.