>> The type of business organization often determines
the role and impact finance plays in an organization.
Since this is true,
we probably ought to become familiar with
the three basic forms of business organizations and
also some of the special types of organizations which
are often subsets of partnerships and corporations.
A sole proprietorship is
the easiest and cheapest type of business organization to create.
In fact it's likely that some of you are currently operating
a sole proprietorship since it's any business owned by an individual.
Some other characteristics are that the assets and profits are entirely the sole owner.
The sole owner has unlimited liability against lawsuits and other claims,
so all business and personal assets could be
forfeited if they're on the wrong side of a legal claim.
They're also very easy to end.
Finally, all the business income is passed
through to the owner's personal income tax filing,
so sole proprietorships do not pay separate business income tax.
There are two types of partnerships;
general partnerships and limited liability partnerships.
Let's learn about the characteristics of a general partnership first.
Partnerships are businesses owned by two or more people.
All partners co-own assets and share in profits and losses.
All partners are fully responsible for the liabilities incurred by the partnership.
Any partner can bind,
via contract, all partners in the partnership.
This is called mutual agency.
Just like a sole proprietorship,
all of the business income is passed through to the partner's personal tax filings.
So partnerships do not pay separate business income tax.
A limited liability partnership is similar to a general partnership except it
has two types of partners; general partners and limited liability partners.
For general partners, in a limited liability partnership,
nothing really changes from what we just learned about a general partnership.
The characteristics are the same.
However, a limited partner has very different characteristics.
They act mostly as investors in a partnership and do not
and cannot participate in the management and decisions of a business,
thus their liability, should the partnership be sued,
is limited to their investment.
They can lose all they invested but their personal assets are safe.
Corporations and specifically C Corps,
are the most common type of business organization you've heard
of; Apple, Nike, Microsoft,
Ford, Starbucks, McDonald's, etc,
these are all C Corp type corporations.
They function as separate legal entities from their owners,
meaning corporations can be sued, sue others,
purchase, sell, and own property independent of their owners.
The owners of corporations are called shareholders or stockholders.
They directly elect a board of directors,
who direct the policies and directions of a company by instructing the CEO.
Shareholders have limited liability,
similar to a limited partner.
They could lose all they invested but their personal assets are safe.
Finally, corporations have unlimited lives
which protects company direction and investors wealth,
otherwise Coca-Cola wouldn't still be in business a 120 years after its founding.
The corporate form is
the most common business organization for
large businesses and there are good reasons they choose it,
but there are trade-offs.
Some of the benefits are limited liabilities for its owners,
ease to transfer ownership,
and it's easier to raise capital,
and, of course, the unlimited life.
There are some drawbacks however.
Secrecy of information, including proprietary information,
is harder to maintain.
Decision-making is often slow and may
delay or otherwise miss out on business opportunities.
They have higher regulation and reporting standards,
these are time consuming and costly.
Finally, a big one,
corporations have the drawback of double taxation,
meaning corporations pay tax on their income and then the
owner's pay tax on the same income once it's passed down in the form of dividends.
Here's a simple double taxation example.
Assume corporate earnings before tax is $1,000.
If federal tax is 25 percent,
then the corporation pays $250 in income tax.
After tax income available for distribution to the shareholders is $750.
If the corporation distributes these profits as dividends to shareholders,
the shareholders will be taxed again.
Assuming dividends are taxed at 15 percent,
the dividend tax is 15 percent of $750 or a $112.50.
Thus the total tax on the $1,000 is $250 plus
$112.50 which equals $362.50 or 36.25 percent.
The $750 distributed to the shareholders was taxed twice.
C Corps aren't the only type of corporations,
just the most common type.
S Corp is another type of corporation.
It is a little bit like a hybrid between corporations and
partnerships and they are often small businesses.
They have similar benefits that partnerships have in
that they have unlimited liability for their owners and they do not have double taxation.
But there are some limitations including who can
be an owner and how many owners it can have.
The final type of business organization is a very popular one for small businesses.
In fact, small businesses choose the limited liability company or
LLC form of business organization over sole proprietorship and partnership form.
The benefits are the same as the S Corp,
although without restrictions on ownership.
There are some drawbacks.
States have different rules and regulations for this type of business organization,
but again it varies a state to state.
Finally, regardless of the business organization chosen,
the goal of the firm is still the same,
to maximize the value for its owners.
For C Corp corporations,
which will be our focus in this course,
this means maximizing the market price for common stock.