Forms of Business
Organization
Every person who starts a new business
faces tough choices about how to best organize and manage their fledgling
enterprise. The law establishes certain rules about the formation, internal
operation, taxation, and legal liability that applies to each form of business
organization. With the help of an attorney, each new business owner must select
the organizational form that will promote the most efficiency and profitability
while minimizing the various risks. This process involves weighing the benefits
and detriments associated with each business form. An uninformed decision about
how to organize and manage a business may mean the difference between the
enterprise's ultimate success and failure.
Agency law governs many aspects of the
relationships that exist within all forms of doing business and the
relationships between the firm and third parties. An agency relationship exists
whenever the owner-principal delegates authority to another person (i. e., an
agent) to act on his behalf for the good of the enterprise. Agents may be
cloaked with express authority to act on behalf of the principal, or the
authority may be implied or apparent.
Under the law of agency, agents, who may
be employees, corporate directors or officers, or partners, owe their
principals several duties, including the duties of loyalty and obedience, to
exercise skill and care, to inform, and to account. Principals are bound by all
contracts entered into by their agents, unless the agent exceeded the scope of
his or her authority. Additionally, under the doctrine of respondeat superior,
principals are responsible for all torts committed by agent when they act
within the scope of their agency.
Agency law applies to all forms of
organizing a business. In addition, each type of business organization is also
subject to specific laws. The most common forms of doing business are sole
proprietorships, partnerships, and corporations.
The biggest advantage of sole proprietorships,
which are the most common type of business enterprise in the United States, is
that they are easy to start-up and easy to dissolve. Unless a license is
needed, sole proprietorships are created by simply beginning to do business.
The sole proprietorship's owner owns the firm and all of its assets, and,
therefore, he has the unilateral right to make all significant business
decisions.
The sole proprietor is personally liable
for all business debts and other legal obligations. In addition, a sole proprietorship's
ability to raise capital depends upon the sole proprietor's personal credit
rating. Lending institutions consider loans to sole proprietorships to be quite
risky, because only the owner's personal assets are available to enforce
recovery in the event of a default.
Partnerships are an alternative form of
organizing a business. They allow several owners to pool their resources and
expertise to create and manage a new enterprise. Many partnerships are formed
by professionals, such as lawyers, doctors, or accountants, for the purpose of
offering their services to the public. While it is not legally necessary for
partners to enter into a written agreement as a prerequisite to creating a
partnership, it is common practice to do so. Usually, the partnership agreement
spells out the partner's respective rights with regard to management and
profits and how the enterprise's dissolution will be handled. Partnerships
dissolve automatically upon the occurrence of certain events, such as a
partner's death, insanity, bankruptcy, withdrawal or expulsion unless the
partnership agreement expressly states otherwise.
As with sole proprietorships, the chief
disadvantage of partnerships is that general partners are personally liable for
all business debts and obligations. However, limited partners, who do not have
the right to participate in the firm's management, are only personally liable
to the extent of their investment in the partnership. Finally, it is somewhat
easier for partnerships to raise capital than sole proprietorships, because the
personal assets of more than one person are at stake.
Corporations are the most complex form of
business organization. They can be (1) foreign or domestic, (2) closely or
publicly held, (3) an S corporation or (4) business or nonprofit. Nonprofit
corporations may be further subdivided according to the source of financing and
the type of control group. The hallmark of' a nonprofit corporation is that it
does not distribute profits to its owner.
A business corporation is comprised of
shareholders, who contribute capital and receive a share of the profits;
directors, who run the corporate board; and officers, who carry out corporate
policy. There are two principal advantages to organizing as a corporation. First,
business corporations can raise capital with relative ease by selling shares of
its stock. Second, shareholders-the corporation's owners-are not personally
liable for corporate debts, although banks often require the owners of small
corporations to guarantee business loans personally.
On the down side, the formation of a
corporation is quite complicated and requires the preparation of several legal
documents. In addition, corporations are required to pay taxes and are subject
to a myriad of government regulations. Finally, there is a separation of
ownership and control in most large modern corporations, because the
shareholders, who own it, are not usually involved in corporate
decision-making. This situation is problematic because the interests of' the
corporation's officers, who wind up making the lion's share of decisions, are
not always in accord with the interests of the corporation as a whole. If this
conflict becomes acute, shareholders may bring a shareholders derivative action
against directors or officers on the ground that they violated their duty of
loyalty by putting their self-interest above that of the corporation. "
