Business Structures & Corporate Issuers – Comprehensive Study Notes

LOS 1.a – Business Structures: Definitions & Comparative Characteristics

• Business structures describe how companies are formed legally & organisationally.
• Characteristics of business structures include:

• Legal identity – business is a separate legal entity.

• Owner–manager relationship – are owners also managers? How is authority delegated?

• Owner liability – limited (loss capped at investment) vs unlimited (personal assets at risk).

• Taxation – how profits/losses are taxed (personal vs corporate level).

• Access to financing – ease of raising capital, risk-sharing possibilities.

Sole Proprietorship

• Single natural person owns & operates the business.
• Not a separate legal entity ➝ owner and business are legally the same.
• Owner has unlimited liability for debts, lawsuits, taxes, etc.
• Profits taxed once as personal income.
• Scale constrained by owner’s personal ability to raise funds; tends to remain small.
• Maximum managerial control & operational flexibility.

General Partnership

• Two or more people conduct business for profit via a (written, oral, or implied) partnership agreement.
• Partners share management responsibilities unless otherwise agreed.
• Each partner has joint & several unlimited liability for partnership obligations.
• Partner’s share of profit/loss taxed once as personal income.
• Provides larger capital pool & broader expertise than a sole proprietorship but still limited by partners’ resources.

Limited Partnership (LP)

• Two classes of owners: general partners (GPs) and limited partners (LPs).
• GPs manage the firm; retain unlimited liability.
• LPs supply capital only; liability limited to contributed amount; typically cannot hire/fire GPs.
• Profit split specified in partnership agreement (often disproportionally in favour of GPs for management effort).
• Transferability of interests usually restricted; often capped at a small group.
• Income passes through to partners’ personal tax returns.
• Some jurisdictions allow Limited Liability Partnerships (LLPs) where every partner has limited liability—often restricted to professional services (law, accounting) and subject to caps on partner number & equity stake in the US.

Corporation / Limited Company

• Created by filing articles of incorporation with a regulator.
• Separate legal entity: can own property, hire staff, sign contracts, sue/be sued.
• All shareholders enjoy limited liability—maximum loss = share value; no further personal obligation.
• Able to raise large sums via equity & debt; therefore favoured by large enterprises.
• Separation of ownership & control: owners elect a board of directors; board hires senior management; both owe fiduciary duty to act in shareholders’ best interests.
• Profit distribution (dividends) optional; company may retain earnings.
• Potential double taxation (see LOS 1.b).
• Variants:

• Public corporation – shares offered to the public, traded on organised markets (stock exchanges).

• Private limited company – limited number of shareholders, restrictions on share transfer.

LOS 1.b – Key Features of Corporate Issuers

Incorporation & Legal Personality

• Legal existence separate from owners established through statutory filing.
• Corporation can: hire employees, borrow/lend, enter contracts, sue & be sued, own assets.

Equity Securities (Shares)

• Issued to shareholders in exchange for capital.
• Provide:

• Voting rights (elect board, approve major actions).

• Residual claim on earnings & assets after creditors.

• Transferability – especially high if listed.

Board of Directors & Management

• Shareholders ➝ elect board.
• Board ➝ sets strategy, hires/monitors senior management.
• Managers ➝ run day-to-day operations.
• Agency relationship creates potential conflicts; corporate governance mechanisms aim to align interests.

Dividend Policy & Double Taxation

• Profits taxed at corporate level.
• If dividends are paid, shareholders pay personal income tax on distributions: double taxation.
• Burden lighter when company retains earnings instead of paying dividends.

Numerical Illustration – Double Taxation of Dividends (XYZ Ltd)

Given: Pretax earnings $Rs\,10\ \text{Cr}$, corporate tax rate $25\%$, shareholder tax on dividend $20\%$.

(a) 100 % Dividend Payout

• Corporate tax: $10\times0.25 = 2.5\ \text{Cr}$
• Profit after tax (PAT): $7.5\ \text{Cr}$
• Dividend = $7.5\ \text{Cr}$
• Dividend tax: $7.5\times0.20 = 1.5\ \text{Cr}$
• Total tax: $2.5 + 1.5 = 4\ \text{Cr}$
• $\text{Effective Tax Rate} = \frac{4}{10} = 40\%$

(b) 50 % Dividend Payout

• Dividend distributed: $3.75\ \text{Cr}$
• Dividend tax: $3.75\times0.20 = 0.75\ \text{Cr}$
• Total tax: $2.5 + 0.75 = 3.25\ \text{Cr}$
• $\text{Effective Tax Rate} = \frac{3.25}{10} = 32.5\%$

=> When earnings are largely reinvested, effective tax burden declines for shareholders.

LOS 1.c – Public vs Private Corporations

Public (Listed) Companies

• Shares trade on regulated stock exchanges ➝ transparent prices & volumes.
• Widely dispersed ownership; free float = % of outstanding shares not held by insiders/strategic investors.
• Regulators mandate extensive disclosure (financial statements quarterly/half-yearly, insider trades, etc.).
• High liquidity; easy share transferability.
• Possibility of raising additional capital through seasoned offerings.

Private Companies

• Shares not exchange-listed ➝ valuation less observable, sale harder (often illiquid).
• Fewer owners → can focus on long-term strategy without market pressure.
• Lower regulatory & reporting burden.
• Equity capital obtained via private placements to accredited investors (institutions, HNWIs).

Transition Mechanisms – Going Public

• Initial Public Offering (IPO) – new shares issued, underwritten, then listed. Company raises fresh capital; owners can sell in secondary market.
• Direct Listing – existing shares admitted for exchange trading with no new capital or underwriter; faster & cheaper than IPO.
• Special Purpose Acquisition Company (SPAC) – a “blank-cheque” public shell raises funds via IPO, then merges with a private target; trust funds held until acquisition or returned.

Going Private

• An acquirer purchases all outstanding shares of an underperforming public firm; shares delisted.
• Advantages: escape regulatory costs, facilitate restructuring, unlock hidden value.

Additional Comparative Insights & Exam-Relevant Points

• Categories of corporations: for-profit, non-profit, public sector/government-owned. (Note: a non-profit can legally earn profit; restriction is on distribution to members.)
• From issuer’s perspective, bonds are lower-risk than stock because unpaid interest can force bankruptcy whereas dividends are discretionary.
• Bondholders can sometimes become shareholders non-market-wise (e.g., through conversion features or debt-equity swaps).
• Liability hierarchy (from highest liability to lowest):

1. Sole proprietor (unlimited)

2. General partner in GP

3. General partner in LP

4. Limited partner / shareholder (liability limited to investment).
   • Operational simplicity ranks: Sole proprietorship > General partnership > Limited partnership > Corporation (most complex).

Practice Question Quick Answers (for self-check)

1. Incorrect statements: (a) – A nonprofit can generate surplus; restriction is on distribution.

2. Risk of bonds to issuer = (a) lower (fixed obligation but priority).

3. True – bondholders may gain shares via conversion, warrants, restructuring.

4. Least liability holder = a limited partner/shareholder (option c if “general partner” contrasted).

5. Public investors enjoy greater (b) share transferability.

6. Most operationally simple & flexible = sole proprietorship (although not explicitly listed; among given, compare options).