structure of business organisation

Structure of Business Organisation

We focus on the corporate form because it is the predominant structure of business organization in the United States. Corporations issue a variety of financial securities, many of which are publicly traded. This section discusses the advantages of the corporate form over the primary alternative forms.

The Corporate Form

There are three basic forms of business organization; sole proprietorship, partnership and corporation. In a sole proprietorship, a single individual owns all the company's assets directly and is directly responsible for all its liabilities. The sole proprietor has unlimited liability. That is the sole proprietor's entire personal wealth is at risk. But a sole proprietorship is not a taxable entity. Instead, the proprietorship's income is added to the owner's other income to determine income taxes due. Most small businesses are set up as proprietorship because they are easy to organize.

A partnership is similar to a sole proprietorship except that there are two or more owners. In a general partnership, all partners have unlimited liability, including unlimited liability for actions taken entirely by other general partners. The partners share in profits and losses, often in proportion to their respective capital contributions to the partnership. As with a proprietorship, the income from the business is taxed directly to the general partners, a partnership does not pay income taxes. Oil and gas ventures and real estate ventures are often organized as partnerships because tax laws.

The partnership form has another disadvantage besides unlimited liability. If a general partner leaves the partnership or dies, the partnership must be dissolved. This is very inconvenient if there are many partners. Many states permit limited partnerships, in which there are one or more limited partners in addition to the general partners. The general partners run the partnership with unlimited liability. The limited partners contribute capital and share in partnership profit or losses. But a limited partner's liability is limited to the invested capital. Limited partners are typically allowed to withdraw by selling their partnership interests, which avoids the need to dissolve the partnership when someone dies or wishes to withdraw. 

A corporation is legally a "person" that is separate and distinct from its owners, who age its shareholders. A corporation is allowed to own assets, incur liabilities, and sell securities to raise capital, among other things. The corporation's officers are agents who are authorized to act for the corporation.

The corporate form of organization has four major advantages over sole proprietorships and partnerships.

1. Limited Liability:  Shareholders liability for corporate obligations is limited to the loss of the shares. If a corporation goes bankrupt or loses a large product liability suit the most its shareholders can lose is their respective investments. In a sole proprietorship or a general partnership, the owners can lose considerably more in the extreme case, virtually everything they own.
2. Permanency: A corporation's legal existence is not affected when some of its shareholders die or sell their shares. So it's more permanent than a proprietorship or a partnership.
3. Transferability of Ownership: Selling Shares in a corporation is normally easier than selling a proprietorship or a general partnership intrest.
4. Better Access to External Sources of Capital:  Because of its permanency and its ability to borrow money or to sell additional shares, a corporation has greater financing flexibility.

The corporate form does have a significant drawback, however. A corporation must pay taxes on its income. Operating income paid to shareholders through organizations, fraternal organizations, not for profit corporations and many kinds of governmental organizations. Although we focus mostly on profit making corporations the principles of finance apply equally well to other forms of organizations.

Ownership Rights

A corporation's shareholders, its owners, can have the following four types of rights:

1. Dividend Rights: Shareholders get an identical per share amount of any dividends. However, the decision to pay dividends is made by the company's board of directors and is subject to legal and other restrictions.
2. Voting Rights: Shareholders have the right to vote on certain matters, such as the annual election of directors. In most Cases, each share of common stock entitles its holder to one vote. A corporation's articles of incorporation typically specify either of two voting procedures, majority voting or cumulative voting. Under majority voting, with one vote per share, shareholders vote for each director separately, casting one vote per share for each director they support. The candidates receiving the  largest numbers of votes are elected to the board. Alternatively, under cumulative voting, the directors are voted on jointly, and a shareholder can cast all his votes in favor of a single candidate. Cumulative voting makes it easier for a minority shareholder group to elect a particular representative to the board.
3. Liquidation Rights: Shareholders have the right to a proportional share of the company's residual value in the event of liquidation. The residual value is what remains after all the corporation's other obligations have been settled.
4. Preemptive Rights: In some corporations, shareholders have the right to subscribe proportionally to any new issue of the corporation's shares. Such offerings are called rights offerings.

When a company has two or more classes of common stock with differences in dividend, voting, liquidation or preemptive rights the different classes of stock will usually trade at different prices, with the prices reflecting the differential rights.

The Goal of a Business

Many people say a company's goal is to maximize profit. More carefully stated, according to the investment vehicle model a company's goal is to maximize shareholder wealth. Shareholder wealth maximization is a more specific form of profit maximization.

Why Not Profit Maximization?

There are at least three important reasons why profit maximization is not an operational goal. First, profit maximization is vague. Profit has many different definitions. Do we mean accounting profits or economic profits . Are we measuring private profits or social profits, which include any impacts on all parts of society, not just owners? Are we maximizing short run profits or long run profits?

Second, profit maximization ignores differences in when we get the money. The longer you have to wait to get the money the less it's worth. Such timing differences are called the time value of money. Profit maximization does not clearly distinguish between getting a dollar today and getting a dollar in the future, such as a year from today. When costs and benefits extend over time, such as a few years profit measures fail to properly adjust for the effect that timing differences have on value.

Third, profit maximization ignores risk differences between alternative courses of action. When given a choice between two alternatives that have the same return but different risk, most people will take the less risky one. This makes the less risky alternative more valuable. Profit maximization ignores such differences in value.

Shareholder Wealth Maximization

Shareholder wealth maximization focuses the profit motive squarely on the owners. By maximizing shareholder wealth we are directly addressing the problems of profit maximization. First, shareholder wealth is unambiguous. It is based on the future cash flows that are expected to come to the shareholder, rather than an ambiguous notion of profit or other revenues. A cash flow is a transfer of money from one party to another. Second, Shareholder wealth depends explicitly on the timing of future cash flows. Finally, our process for measuring shareholder wealth accounts for risk differences. If structure of business organisation is a famous and good than every shareholder wealth maximization profit is most attractive.