Organizational forms of businesses

How do business forms differ?

Every for-profit business picks a legal organizational form , and the choice decides who runs the business, who bears the losses, who pays the tax and how far it can grow. Law differs by country and the labels vary, so the exam tests the common attributes rather than local names. Five attributes separate the forms.

How forms differ

• Legal identity Memorize separate from the owners, or not
• Owner–manager relationship Memorize owners run it, or hire managers
• Owner liability Memorize can creditors reach personal assets
• Taxation Memorize at the business, the owner, or both
• Access to financing Memorize how far it can grow past the owners' own money

Use these five as a checklist. Almost every comparison question asks you to place a form on one of them, and the wrong answers usually swap two forms on the same attribute.

What are the three families of business form?

There are three families: the sole proprietorship, the partnership and the limited company. The partnership and the limited company each split again.

For-profit businessnames vary by country; the attributes do not

• Sole proprietorship Memorize one owner, no separate identity, unlimited liability
• Partnership Memorize two or more owners pooling capital and skills
  • General partnership Memorize all partners manage, all unlimited
  • Limited partnership Memorize at least one GP (unlimited, manages) plus LPs (limited)
  • Limited liability partnership Memorize no GP; all partners limited
• Limited company Memorize separate legal entity, shares, limited liability
  • Private limited company Memorize owner cap and transfer limits; often pass-through
  • Public limited company Memorize no owner cap; taxed at company and shareholder level

The sole proprietorship

A sole proprietorship is the simplest form: one owner puts in the capital, makes every decision and keeps every dollar of profit. The business has no legal identity apart from the owner, so the owner is personally liable for all its debts. Profit is taxed as the owner’s personal income. Growth is capped by what the owner can save, borrow and manage alone.

Partnerships

A partnership lets several owners pool capital and skills and share risk and return. It rests on an agreement between the partners, though in many places it can arise from conduct alone. A partnership has no legal identity apart from its partners.

In a general partnership , two or more partners share management and every one is liable without limit. If one partner cannot pay a share of the debts, the others must cover it.

A limited partnership needs at least one general partner (GP) , who usually manages and has unlimited liability. Each of the other partners is a limited partner (LP) : their loss is capped at the amount they invested and they take little or no part in management. The GP normally takes a larger share of the profit as pay for carrying more risk.

A limited liability partnership (LLP) has no general partner. Every partner has limited liability and the partners share management. Some countries allow it only for professional firms such as law, accounting or architecture.

Limited companies

A limited company is a separate legal person with limited liability for every owner. Ownership is divided into shares that are easy to transfer. Owners elect a board, and the board appoints professional managers. Two types exist in most places.

A private limited company (a limited liability company, or LLC, in the United States, a GmbH in Germany or a société à responsabilité limitée, or SARL, in France) caps the number of owners and restricts share transfers, and in many places it is taxed as a pass-through business . That means the company pays no income tax and its profit is taxed in the owners’ hands whether or not it is distributed.

A public limited company has no legal cap on owners or on transfers, which suits a company that wants to list its shares. It is the dominant form among large companies. In most countries it is taxed at the company level and again when profit reaches shareholders as dividends. The next lesson covers that.

Exam tip ”Public limited company” is a legal form. “Public company” means listed. A public limited company may stay unlisted.

How do the forms compare side by side?

	Sole proprietorship	General partnership	Limited partnership	Corporation (public limited company)
Legal identity	none; extension of the owner	none; extension of the partners	none; extension of the partners	separate legal entity
Who runs it	owner	partners together	general partner	board and professional managers
Liability	unlimited	shared, unlimited	GP unlimited; LPs limited to their investment	limited for all shareholders
Taxation	pass-through (personal income)	pass-through	pass-through	company taxed; dividends taxed again
Financing	owner’s savings and personal borrowing	partners’ capital	GP and LP capital	widest: unlimited number of owners, debt and equity markets

Read down the table and notice the pattern. As you move right, more outside money can come in, because each step lets an investor take part without being exposed to unlimited loss. The corporation completes the pattern by separating ownership from management and limiting every owner’s liability. The price is the extra layer of tax.

What is a layered structure?

Partnerships are often owned through a company. A listed corporation can act as the general partner of a limited partnership. The corporation, as GP, bears unlimited liability for the partnership, but its own shareholders still have limited liability. Such a structure gives the corporation control and a route to the stock market, while its shareholders are shielded.

To find a shareholder’s effective ownership of the partnership’s assets, multiply the stakes along the chain.

$$E = A \times B$$

Here $A$ is the investor’s share of the GP company and $B$ is the GP company’s share of the partnership.

Go deeper Why funds are limited partnerships, and why managers put a company in the GP seat

A private investment fund is usually a limited partnership: the fund manager is the GP and runs the portfolio, while the investors are LPs who supply capital and accept capped losses. The alternative is a fund set up as a company, with its own board hiring a manager.

Because a GP has unlimited liability, fund managers usually create a wholly owned private limited company to sit in the GP seat. Then a disaster at the fund can reach only that company’s assets, not the manager’s personal wealth. The alternative investments topic returns to this structure.

Go deeper Names change by country, the attributes do not

The same attribute pattern appears under different names: a private limited company is an LLC in the United States, a GmbH in Germany, a SARL in France and a G.K. in Japan. A public limited company is a C corporation in the United States, an AG (Aktiengesellschaft) in Germany and a société anonyme in France. Rules also differ on tax: some countries tax private limited companies as pass-through, others do not. When an exam question names a local form, work out the five attributes from the description.