Corporate Management

Legal Forms of Business

It is important that the business owner seriously considers the different forms of
business organization – types such as Sole Proprietorship, Partnership,
corporation. Each form of legal organizations has unique characteristics that are
important to consider when starting a business. Which organizational form is most
appropriate can be influenced by tax issues, legal issues, workload, buying or selling
a business, liability issues, financial concerns, and personal concerns? Here I’m
going to explain about the general impression of business organizations.
A Sole Proprietorship, also known as the sole trader or simply proprietorship, is a
type of business entity that is owned and run by one individual and in which there is
no legal distinction between the owner and the business. The owner receives all the
profits (subject to taxation specific to the business) and has unlimited responsibility
for all losses and debts. Every asset of the business is owned by the proprietor and
all debts of the business are the proprietors.
Sole Proprietorships are the most numerous forms of business organization. When
starting a sole proprietorship, one should open it when they are certain they won’t
fail, file a 1040, and must be cautious that if you violate regulation, you may be out of
business because of the government, however they can’t touch your pension.
Terminating a sole proprietorship can be done if the owner chooses to do so or upon
the owner’s death.
There are many advantages and disadvantages to this form of business. The many
advantages are: ease and cost of information, secrecy, distribution and use of
profits, flexibility and control of the business, minimal government regulations, and
easy taxation. The many disadvantages are: unlimited liability, limited sources of
funds (banks don’t like to lend money), limited skills, lack of continuity, lack of
qualified employees, and taxation.
Another form of business organization is Partnership. Partnership is a form of
business organization defined by the uniform partnership act as an ‘association of
two or more person who carry on as co-owners of a business profit.’ Marriages can
be problematic and many of them do fail. There are two kinds of partnerships. A
General Partnership is a partnership that involved a complete sharing in both the
management and liability of the company.
A Limited Partnership is two or more partners united to conduct a business jointly.
And in which one or more of the partners is liable only to extent of the amount of
money the partner has invested. Limited partners do not receive dividends, but enjoy
direct access to the flow of income and expenses. When starting a partnership, one
must file a 1065; then transfer to 1040, but everyone must file separately. Every
company has its own code standard industrial classification system as well.
There are advantages and disadvantages of partnership as well. The many
advantages are: ease and organization, capital and credit, knowledge and skills,
decision making, and regulatory control. The disadvantages are: unlimited liability,
business responsibility, life of the partnership, distribution of profits, and limited
sources of funds. The articles of a partnership are: name, purpose location, duration
of agreement, authority and responsibility of each partner, character of partner,
amount of contribution from each partner, division of profits or losses and salaries of
each partner.
The key of success to a partnership are: keep profit sharing and ownership at 50/50,
honesty is crucial, experience is essential, transparency maintain face to face
communication, family is priority, be realistic, awareness of funding constraints and
limited resources, and partners should have different and complementary skill sets.
The last form of business organization is Corporation. A Corporation is a legal entity
created by the state whose assets and liabilities are separate from its owners.
Corporations generate the largest income, and the most sales. Articles of
incorporation are legal documents filed with basic information about the business
with the appropriate state office. These articles include the name and address of
corporation, objectives of the corporation, classes of stock, and financial capital
required at time of incorporation. There are many types of corporations such as
domestic corporation, foreign corporation, alien corporation, private corporation,
public corporation, initial public offering, quasi-public corporation and non-profit
corporation. The elements of corporation include: board of directors, preferred stock,
and common stock.
Shares in a corporation are easily transferable to a new shareholder and the
shareholders liability is limited to their investment amount of the company. Lastly, if a
shareholder dies or withdraws from the company, unlike a sole proprietorship, there
is no impact to the continuity of the corporation.
There are many advantages and disadvantages of corporations. The advantages
are: limited liability, transfer of ownership, perpetual life, external sources or funds,
and expansion potential. The disadvantages are: double taxation, forming a
corporation, disclosure of information, and employee-owner separation.
Other types of business ownership include; a joint venture which is a partnership
established for a specific project for a limited time. S-Corporation which is a
corporation taxed as though it were a partnership (no double taxation) with restriction
on shareholders. LLC which is flexible form of enterprise that blends elements of
partnership and corporate structures. Co-op which is an organization of individuals or
small businesses that have banded together to reap the benefits of belonging to a
larger organization. Mergers which is the combination of two companies to form a
new company.
Forward Integration which is when a manufacturer buys the wholesalers and
retailers, in control all their intermediaries and distribution. Backwards Integration
which is when the retailers buys the wholesalers and manufacturer. Acquisition
which is the purchase of one company by another, usually by buying its stock and/or
assuming its debts and Leverage buyout which is a purchase, in which a group of
investors borrows money from banks and other institutions to acquire a company,
using the assets of the purchased company to guarantee payment of the loan.
Hybrid forms of the business societies
How would you like a legal form of organization that provides the attractive features
of the three common forms of organization (corporation, sole proprietorship and
partnership) and avoids the unattractive features of these three organization forms?
It sounds very appealing. This is what was accomplished with the creation of two
hybrid forms of organization: S-corporation and limited-liability company. These
hybrid-organization forms provide business owners with limited liability (the attractive
feature of corporations) and no “double taxation” (the attractive feature of sole
proprietorships and partnerships). They avoid double taxation (the unattractive
feature of corporations) and unlimited liability (the unattractive feature of sole
proprietorships and partnerships). We’ll now look at these two hybrids in more detail.
S-Corporation
In 1970, Karen and Mike Tocci, avid go-kart racing fans, bought a parcel of land in
New Hampshire so their son, Rob, and his son’s friends could drag race in a safe
environment. The Tocci’s continued interest in racing resulted in their starting a
family-run business called Shannon Dragway. Over time, the business expanded to
include a speedway track and a go-kart track and was renamed New Hampshire
Motorsports Complex. In selecting their organization form, the Tocci’s wanted to
accomplish two main goals: (1) limit their personal liability; and (2) avoid having their
earnings taxed twice, first at the corporate level and again at the personal level. An
S-corporation form of business achieved these goals. They found they were able to
meet the following S-corporation eligibility criteria:
 The company has no more than 100 shareholders
 All shareholders are individuals, estates, or certain nonprofits or trusts
 All shareholders are U.S. citizens and permanent residents of the U.S.
 The business is not a bank or insurance company
 All shareholders concur with the decision to form an S-corporation
Deciding to operate as an S-corporation presented the Tocci’s with some
disadvantages: They had no flexibility in the way profits were divided among the
owners. In an S-corporation, profits must be allocated based on percentage
ownership. So, if an owner/shareholder holds 25 percent of the stock in the S-
corporation, 25 percent of the company profits are allocated to this shareholder
regardless of the amount of effort he or she exerts in running the business.
Additionally, the owners had to follow a number of formal procedures, such as
electing a board of directors and holding annual meetings. Finally, they were
subjected to heavy recordkeeping requirements. Despite these disadvantages, the
Tocci’s concluded that on balance the S-corporation was the best form of
organization for their business.
Limited Liability Company
In 1977, Wyoming was the first state to allow businesses to operate as limited-
liability companies. Twenty years later, in 1997, Hawaii was the last state to give its
approval to the new organization form. Since then, the limited-liability company has
increased in popularity. Its rapid growth was fueled in part by changes in state
statutes that permit a limited-liability company to have just one member. The trend to
LLCs can be witnessed by reading company names on the side of trucks or on
storefronts in your city. It is common to see names such as Jim Evans Tree Care,
LLC, and For-Cats-Only Veterinary Clinic, LLC. But LLCs are not limited to small
businesses. Companies such as Crayola, Domino’s Pizza, Ritz-Carlton Hotel
Company, and iSold It (which helps people sell their unwanted belongings on eBay)
are operating under the limited-liability form of organization.
In many ways, a limited-liability company looks a lot like an S-corporation. Its owners
(called members rather than shareholders) are not personally liable for debts of the
company, and its earnings are taxed only once, at the personal level (thereby
eliminating double taxation). But there are important differences between the two
forms of organizations. For example, an LLC:
1. Has fewer ownership restrictions. It can have as many members as it wants—
it is not restricted to a maximum of 100 shareholders.
2. Its members don’t have to be U.S. residents or citizens.
3. Profits do not have to be allocated to owners based on percentage ownership.
Members can distribute profits in any way they want.
4. Is easier to operate because it doesn’t have as many rules and restrictions as
does an S-corporation. It doesn’t have to elect a board of directors, hold
annual meetings, or contend with a heavy record-keeping burden.
Cooperatives
A cooperative (also known as a co-op) is a business owned and controlled by those
who use its services. Individuals and firms who belong to the cooperative join
together to market products, purchase supplies, and provide services for its
members. If run correctly, cooperatives increase profits for its producer-members
and lower costs for its consumer-members. Cooperatives are common in the
agricultural community. For example, some 750 cranberry and grapefruit member
growers market their cranberry sauce, fruit juices, and dried cranberries through the
Ocean Spray Cooperative (Ocean Spray History, company website, “about us,”
history, accessed June 19, 2008). More than three hundred thousand farmers obtain
products they need for production—feed, seed, fertilizer, farm supplies, fuel—
through the Southern States Cooperative. (Corporate information, Southern States
Cooperative, accessed June 19, 2008). Co-ops also exist outside agriculture. For
example, REI (Recreational Equipment Incorporated), which sells quality outdoor
gear, is the largest consumer cooperative in the United States with more than three
million active members. The company shares its financial success each year with its
members, who get a refund each year based on their eligible purchases (2006 REI
Stewardship Report, accessed June 19, 2008).
Not-for-Profit Corporations
A not-for-profit corporation (sometimes called a nonprofit) is an organization formed
to serve some public purpose rather than for financial gain. As long as the
organization’s activity is for charitable, religious, educational, scientific, or literary
purposes, it should be exempt from paying income taxes. Additionally, individuals
and other organizations that contribute to the not-for-profit corporation can take a tax
deduction for those contributions. The types of groups that normally apply for
nonprofit status vary widely and include churches, synagogues, mosques, and other
places of worship; museums; schools; and conservation groups.

There are more than 1.5 million not-for-profit organizations in the United States
(“Number of Nonprofit Organizations in the United States, 1999–2009,” Urban
Institute, National Center for Charitable Statistics, accessed August 27, 2011). Some
are extremely well funded, such as the Bill and Melinda Gates Foundation, which
has an endowment of approximately $38 billion and has given away $25.36 billion
since its inception (“Foundation Fact Sheet,” The Bill and Melinda Gates Foundation,
June 30, 2011, accessed August 27, 2011). Others are nationally recognized, such
as United Way, Goodwill Industries, Habitat for Humanity, and the Red Cross. The
vast majority is neither rich nor famous but nevertheless makes significant
contributions to society.
Benefit Corporations
More companies are registering as benefit corporations which can more freely divert
profits to their community and the environment, instead of focusing on maximizing
shareholder profits.

Wasiq Farooq.
Business Administration (BIA).