Level 1 CFA® Exam:
There are several different business structures that business owners can choose from for their business. The most common business structures are:
- sole proprietorship,
- general partnership,
- limited partnership, and
Each business structure has its advantages and disadvantages that business owners need to consider when deciding which structure is right for them.
A sole proprietorship is the simplest and most common business structure. In a sole proprietorship, the business owner is the only owner of the business and is personally liable for all debts and obligations of the business. The sole proprietor also has complete control over the business and can make all decisions about the business without having to consult any other partners or shareholders.
One of the main disadvantages of a sole proprietorship is that the business owner is personally liable for all debts and obligations of the business, which means that if the business fails, the business owner’s personal assets are at risk.
A general partnership is a partnership between two or more partners who have agreed to share in the profits and losses of the business. In a general partnership, each partner is personally liable for all debts and obligations of the business.
One of the main advantages of a general partnership is that it is relatively easy to form and there are few formalities. Another advantage is that the partners can pool their resources and expertise to grow the business.
One of the main disadvantages of a general partnership is that the partners are personally liable for all debts and obligations of the business.
A corporation (limited company; limited liability company; LLC) is a legal entity that is owned by shareholders (! nonprofit corporations – see below). The shareholders receive profit in the form of a dividend but they are not personally liable for the debts and obligations of the business and they can only lose the amount they invested in the shares of the corporation. The shareholders elect the board of directors that makes decisions about the business. The board of directors appoints managers to run the day-to-day operations of the business.
Exception: Nonprofit corporations don’t issue shares and don’t pay dividends because their goal is other than increasing the value for the shareholders.
Because a corporation is a legal person, it can do things a human person can do, e.g., it can enter into contracts, sue others, own property, employ people, etc.
The 2 main sources of financing for corporations are:
- equity capital, and
- debt capital.
In return for the capital provided, debtholders receive interest and the return of capital in the future. On the other hand, holding equity gives voting rights and the right to a dividend but there is no legal obligation of returning the capital invested. However, equity owners have a residual claim to the company's net assets after all liabilities have been settled.
In the case of a liquidation event, debtholders have a prior legal claim over the claim of equity owners.
Public Corporation vs Private Corporation
Generally, a public company is a company whose shares are traded on a stock exchange. However, in some countries also companies with a large number of shareholders (e.g., more than 50) are treated like public companies, even if the company is not listed.
In the case of public companies, we are dealing with more demanding regulatory and disclosure requirements, e.g., a public company has to publish financial statements on a regular basis. This is usually not required from private companies.
There are 3 types of corporations:
- private nonprofit,
- private for-profit,
- public for-profit.
- The most common business structures are: sole proprietorship, general partnership, limited partnership, and corporation.
- In a sole proprietorship, the business owner is the only owner of the business and is personally liable for all debts and obligations of the business.
- A general partnership is a partnership between two or more partners who have agreed to share in the profits and losses of the business.
- A limited partnership includes at least one general partner and limited partners (usually more than one).
- A corporation (limited company; limited liability company; LLC) is a legal entity that is owned by shareholders.
- There are 3 types of corporations: private nonprofit, private for-profit, and public for-profit.