When we organize a business enterprise, we need to think of more than the great product, innovative service, or brilliant marketing campaigns that will make the business successful. We must also think of the enterprise from the perspective of its legal rights and obligations. Business concerns are established with the objective of making profits. They can be established either by one person or by a group of persons in the private sector by the government or other public bodies in the public sector. The law of business organizations deals with the subject of the specific kinds of organizational structures that the law recognizes. Over time in each legal culture, specific legal entities have been developed and recognized as formats in which to organize and operate a business.
Each business organization format that the law has recognized typically has its own unique characteristics. These characteristics include the following:
- the specific legal steps that must be followed to organize a business in a particular business organization format
- the extent to which the business is treated as a juridical person separately and apart from its owners, managers, and investors
- the nature and extent of the financial risk to which individual owners, managers, and investors are exposed
- the specific legal rights the business will have
- the legal relationship between that business format and the individuals who own the business, manage the business, and/or are investors in the business
- the nature of profit sharing between the business and individual owners, managers, and investors
- the extent to which individual owners, managers, and investors are individually responsible for the debts and other legal liabilities of the business organization
Typically, the three most important factors in choosing between organizing a business as a partnership or a corporation are as follows:
- extent of personal liability
- ownership and control
- ability to raise capital
In a corporation, the liability of the owners (the shareholders) is limited to the amount of their investment in the corporation (e.g., their shareholdings or stockholdings). This is called the corporate veil—a veil that protects the individual assets of the owners.
In contrast to a corporation, a partnership is a business form in which individuals, known as general partners, make capital contributions (e.g., infusions of cash) into the business in return for a share of the partnership. The general partners therefore have equity in the business in proportion to their capital contribution. As the owners of the business, they manage it. In a partnership, the general partners share equally in the earnings as well as the losses of the business—not only to the extent of their capital contributions but also to the extent of their personal net worth.
In a corporation, the shareholders or stockholders are not managers, agents, or representatives of the company. The board of directors hires management for the corporation and elects the officers to lead the corporation. General partners in a partnership serve simultaneously in all three roles, and even their independent actions can bind the partnership under the law of agency.
Corporations can raise capital quickly by selling shares; if they do so publicly, they pay the price of regulatory scrutiny and greater reporting requirements. Partnerships are subject to far less regulation, but they cannot typically raise capital as quickly as a corporation—particularly a publicly traded corporation. Partnerships raise capital by admitting new partners and requiring them to pay a capital contribution or by voting to impose an assessment on current partners.
Characteristics of an Ideal form of Organization
Before we discuss the features, merits and demerits of different forms of organization, let us know the characteristics of an ideal form of organization. The characteristics of an ideal form of organization are found in varying degrees in different forms of organization. The entrepreneur, while selecting a form of organization for his business, should consider the following factors.
- Ease of formation: It should be easy to form the organization. The formation should not involve many legal formalities and it should not be time consuming.
- Adequacy of Capital: The form of organization should facilitate the raising of the required amount of capital at a reasonable cost. If the enterprise requires a large amount of capital, the preconditions for attracting capital from the public are a) safety of investment b) fair return on investment and c) transferability of the holding.
- Limit of Liability: A business enterprise may be organized on the basis of either limited or unlimited liability. From the point of view of risk, limited liability is preferable. It means that the liability of the owner as regards the debts of the business is limited only to the amount of capital agreed to be contributed by him. Unlimited liability means that even the owners’ personal assets will be liable to be attached for the payment of the business debts.
- Direct relationship between Ownership, Control and Management: The responsibility for management must be in the hands of the owners of the firm. If the owners have no control on the management, the firm may not be managed efficiently.
- Continuity and Stability: Stability is essential for any business concern. Uninterrupted existence enables the entrepreneur to formulate long-term plans for the development of the business concern.
- Flexibility of Operations: another ideal characteristic of a good form of organization is flexibility of operations. Changes may take place either in market conditions or the states’ policy toward industry or in the conditions of supply of various factors of production. The nature of organization should be such as to be able to adjust itself to the changes without much difficulty.
This definition of security most closely describes the most common security measures we encounter, which are the shares of stock issued by a publicly traded corporation. The legal definition of security, however, is much broader and can encompass a wide variety of both equity and debt investments (e.g., bonds) with the two fundamental linking characteristics. The security represents value to its holder either in the form of a stake in the business or as representing a debt owed by the business to the security holder, and the security is transferable from the corporation to individuals or other business entities that may transfer the security to other individuals, business entities, or back to the issuing entity itself.
A security is most often a share of a business that:-
- is sold by a corporation to the public.
- is transferable by a buyer to other members of the public.
- gives the owner an equity stake in the corporation.
- qualifies the owner to participate in corporate affairs as a shareholder (such as attendance at the annual meeting that most corporations’ officers and directors hold for shareholder input and comment on their management of the business).
- is expected to increase in value over time as the business grows.
- may carry with it additional profit sharing rights (such as dividends).
- is exchanged in a defined public market for securities.
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