Week 5 Legal Structures PDF

LEGAL STRUCTURES  Types of Organizations How to organize the firm to handle the operations Two perspectives – Legal – Management Legal structure in commercial undertaking is an important issue  Why Legal Structure is Important Dictates tax provisions Distributi...

LEGAL STRUCTURES  Types of Organizations How to organize the firm to handle the operations Two perspectives – Legal – Management Legal structure in commercial undertaking is an important issue  Why Legal Structure is Important Dictates tax provisions Distribution of liability Ability to raise capital  Legal Structure Which type of legal structure should be used when one wants to start a company. Types of legal structure: – Proprietorship – Partnership – Corporations Publicly held Corporation Closely held Corporation Subchapter Corporation – Joint Ventures  Proprietorship Simplest form of legal structure One individual owns, operates and controls the firm Income of the firm= Personal income of the owner Losses of the firm accrue directly to owner The owner is taxed as an individual, no separate tax for the firm  Proprietorship Liabilities incurred by the firm are the owner’s personal liabilities and the owner must cover them from personal fortune Ability of the firm to generate capital is limited by the personal assets of the owner Life of the proprietorship corresponds to the life of the owner  Example: Proprietorship Entrepreneur owns a truck and acts as a free agent (or sub) in hauling earthworks or materials  Partnership- General Partners Ownership of the firm is shared by partners to a degree defined in the initial charter of the partnership Assets= Personal assets of all partners Control of the firm is divided among general partners Profit and losses divided proportionally  Partnership- General Partners Liability of each partner is not limited. One partner may carry more liability in case of a major loss Example: Partner Personal Fortune Ownership A $1,400,000 40% B $800,000 30% C $100,000 30%  Liability in Partnership If the firm is liable for $1,000,000 the proportional shares of each would be A $400,000 B $300,000 C $300,000 Since the personal worth of C is only $100,000 C won’t be able to pay the share of the loss. Therefore, C pays $100,000 and the remaining $900,000 is paid by A and B. A share now= 4/7 *(900,000)= $514,286  Share of Partners In case of profit, partners share proportionally- for example: A gets 40%... Division of ownership would be based on the capital assets contributed by each partner, and/ or other contributions like expertise, trademark, name recognition, intellectual property (e.g. Patent)  Limited Partners This form of partnership allows a person to enter a partnership with limited liability Limited partners have no control over the management of the firm Limited partners share the profit and losses with other partners proportionally to participation Liability is limited to the capital investment by the limited partner (similar to shareholders in a stock company)  Partnership Every partnership must have at least one general partner In the event of death of one of the partners the partnership would terminate. Provision can be made to provide for continuity of the firm The action of any partner is binding on all other partners  Corporations A corporation is a separate legal entity, and is created as such under the law in a state in which it is chartered Only those assets that belong to the firm would be used for settlement of claims in the event of bankruptcy or damage suits Mostly established by applying to the office of the Secretary of State  Corporations The Secretary of State issues a chartering document and approves the initial issuance of stock in the corporation Stocks establish the levels of ownership of initial stock holders Corporation – Stockholders – Board of Directors – Officers  Corporations Closely held corporations: all stock held by a small number of persons Publicly held corporations: allows its stock to be bought and sold freely in the market Upon establishment of a Corporation, a number of stocks are issued with an arbitrary value Book Value= Net Worth/ No. of Shares Market Value= What buyers will pay  Corporations In a corporate structure the company can sell stock to raise capital Limitation of liability Double taxation feature: tax is collected on the profit of the company. After the profit is distributed to shareholders, the same profit is taxed as personal income  Corporations Level of stockholder control is reduced Life of the corporation is perpetual Good for raising capital  The selection of appropriate legal structure depends on: Taxation Establishing costs Risk and liability Continuity of the firm Administrative flexibility and impact of structure on decision making Laws constraining operations Attraction of capital Comparison of Legal Structures