Organization Forms, Corporate Issuer Features, and Ownership

Generally, there are three major organizations in market economies, each with specific reasons, stakeholders, and a governing legal framework. They include:

1. For-profit organizations (businesses or companies)
2. Not-for-profit, non-governmental organizations (non-profits)
3. Governments.

Under for-profits or simply businesses, there are three business structures:

1. Sole trader or sole proprietorship.
2. Partnership.
3. Limited company.

We concentrate on the for-profits in the subsequent discussions.

Organizational Forms of Business

A business structure describes how a business is organized, influencing day-to-day operations. Five factors determine a business structure:

1. Legal Identity: Describes the legal relationship between the owner(s) and the business.
2. Owner Liability: Indicates the level of liability an individual assumes dues to a business’ actions or debts. The levels of liability can be described as limited or unlimited.
3. Owner-manager Relationship: Describes the relationship between a business’s owner(s) and the management.
4. Taxation: Describes the tax regime applicable to a business structure.
5. Access to financing: A firm’s ability to raise capital and distribute risk.

Types of Business Structures

Considering the above factors, we now discuss the following business structures:

1. Sole Proprietorship (or Sole Trader) In a proprietorship, the owner raises the business capital and fully controls business operations. Moreover, the owner benefits fully from financial returns and assumes all the business risks.In most jurisdictions, sole proprietorship does not require formal legal registration. The sole trader is dissolved when the owner stops business operations.A good example would be a plumber.General Features of Sole Trader
   • The owner operates it.
   • The business is not a legal identity. Hence it is considered as an extension of the owner.
   • The owner keeps all the financial returns and bears all risks.
   • Profits generated by the business are taxed as personal income.
   • It is simple and flexible to operate.
   • Financing is solely from the owner.
   • Business growth depends on the financial ability and risk appetite of the owner.
2. Partnerships In partnership business structures, multiple owners contribute resources and share business risk and return. There are two types of partnerships: General partnerships and imited partnerships.
   1. General Partnership In the general partnership business structure, at least two owners (partners) whose roles and responsibilities are stated in the partnership agreement. However, partnerships can also be initiated verbally or incidentally.Unlike a sole proprietorship, there are multiple sources of funds, and the returns and risks are shared.Good examples are professional service businesses such as law and accounting firms.General Features of General Partnership
      • Partners operate the business.
      • It has no legal identity since ownership is set in the partnership agreement.
      • The partners share all business risks and business liabilities.
      • The partners share business returns, and profits are taxed like personal income.
      • Capital and expertise are provided to the partners.
      • Business growth depends on the ability of the partners to finance and the level of their risk appetite.
   2. Limited Partnership In a limited partnership, partners are divided into two:
      1. At least one general partner (GP) has unlimited liability and is responsible for managing the business.
      2. Limited partners (LPs) have, as the name suggests, limited liability. This means their losses are capped at their investment amounts in the limited partnership.

      The limited partners earn a share profit that is usually lower than that of the general partners. General partners earn more, given their managerial position in the business.

      Limited partnerships include private equity funds, real estate, and hedge funds.

      General Features of Limited Partnerships

      • The partners provide capital contributions and expertise.
      • The general partner manages the business and has unlimited liability.
      • Limited partners do not have business control and have limited liability.
      • All partners are entitled to a share in returns, where profits are taxed as personal income.
      • Business growth depends on the financial capabilities of the GPs and LPs, risk appetite, and the competence and integrity of the GP(s).

      A limited liability partnership (LLP) is a unique form of limited partnership existing in certain jurisdictions. An LLP does not have a general partner; it consists of only limited partners. All partners bear limited liability and share management responsibilities.

      Commonly, one or more partners are voted in as managing partners. For example, in the USA, LLPs include service firms such as law and accounting firms.

   Limited Companies

   A limited company is similar to a limited partnership, except that a limited company incorporates more features that facilitate more access to capital and skills that promote growth.

   Limited companies are categorized into:

   1. Private limited company
   2. Public limited company

   Private Limited Company

   A private limited company is like a limited partnership. However, in a limited company, all owners bear limited liability, ownership can be easily transferred using shares, and owners and managers are separated.

   The owners called the shareholders, elect the board of directors to oversee the company and approve the distribution of profits to the owners. On the other hand, the board of directors appoints various managers.

   A private limited company goes by different names depending on the jurisdiction within which it operates. For instance, it is referred to as a limited company in the UK and a limited liability company (LLC) in the US. In the US, LLCs are legally restricted to a certain number of shareholders, and taxation is applied at the shareholder level only.

   Public Limited Companies (Corporations)

   A public limited company (corporation) is similar to a private limited company, except that in many jurisdictions, there is no legal restriction on the number of owners or transfer of ownership.

   General Features of a Corporation

   • A corporation is a separate legal entity.
   • Dividends (distributions) paid to the owners are taxed as personal income.
   • Corporations have unlimited opportunities to access capital, hence unlimited capital potential.
   • Owner-operator separation allows for higher and more diverse resourcing with significant risk control.
   • In some countries, corporations are tax disadvantaged due to double taxation of corporate profits.
   • Business liability is shared among multiple owners with limited liability.

   Given the features of a corporation, it is the most appropriate form of company that wishes to go public and have a substantial global organizational form in terms of revenues and asset values.

   Question

   Which of the following statements is most likely correct regarding business structures?

   1. Sole trader and general partnerships business structures both have a legal identity.
   2. The taxation regimes for sole traders and corporations are different.
   3. Corporate bondholders and shareholders have different claims on a corporation in exchange for the capital they provide.

   Solution

   The correct answer is C.

   Corporate bondholders and shareholders are the capital providers of a corporation. Corporate bondholders provide debt capital, while the shareholders provide equity capital. The bondholders provide debt capital in exchange for issued debt securities with no ownership entitlement. On the other hand, aside from returns, shareholders are entitled to the company’s ownership.

   A is incorrect. Sole traders (sole proprietorships) and general partnerships do not have a legal identity. The business structures are considered an extension of the owner (sole proprietorship) or partnership agreement (general partnerships).

   B is incorrect. The tax structures in both sole trader and corporation are comparable because, in both business structures, profits are taxed as personal income.