Chapter 20 Business Organization

Chapter 20business Organizationcopyright 2016 Mcgraw Hill Education

Identify the different types of business organizational forms available in the United States whose purpose is to earn a profit, including sole proprietorships, partnerships, corporations, limited liability companies (LLCs), and subchapter S corporations. Describe each form’s characteristics, advantages, and disadvantages, as well as distinctions among them such as liability, management, taxation, and formation procedures. Additionally, distinguish between organizational forms that are not primarily business entities, such as not-for-profit organizations like charities, universities, and social clubs.

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Business organizations form the backbone of the American economy, providing diverse structures tailored to different entrepreneurial needs, risk tolerances, and management preferences. Understanding these organizational forms is crucial for entrepreneurs, investors, and policymakers alike. The main organizational structures include sole proprietorships, partnerships, corporations, limited liability companies (LLCs), and subchapter S corporations. Each form offers unique advantages and faces specific limitations, impacting the decision-making process about which structure to adopt.

Sole Proprietorships are the simplest and most common form of business organization in the United States. Owned and operated by a single individual, sole proprietorships require minimal legal formalities to establish. The owner has full control over business decisions and enjoys all profits directly. This structure's advantages include ease of formation, flexibility in management, and uncomplex dissolution procedures. However, sole proprietors bear unlimited liability, meaning personal assets are vulnerable to business debts and legal actions (Mankiw, 2020). Securing financing can also be challenging due to the lack of formal credit history and collateral, which poses a significant barrier for growth (Scott & Davies, 2018).

Partnerships involve two or more individuals sharing ownership and management responsibilities, with profit sharing typically outlined in a partnership agreement. They are relatively easy to establish and provide a pooling of resources and expertise. Partnerships can be general or limited, with general partners bearing unlimited liability and limited partners enjoying liability only to the extent of their investment (U.S. Small Business Administration, 2021). The advantages include shared responsibility, combined skills, and easier access to capital. Nonetheless, partnerships are vulnerable to conflicts among partners, and the joint liability exposes each partner to legal and financial risks, as exemplified in cases where one partner's negligence results in liability for all (Harrison & Allee, 2017). The dissolution process involves formal procedures, and disagreements may complicate decision-making.

Limited Partnerships (LPs) and Limited Liability Partnerships (LLPs) further refine partnership structures. LPs consist of general and limited partners, with liability protection for limited partners, whereas LLPs are designed for professional groups like law or accounting firms, offering all partners limited liability (Franklin & Green, 2019). These structures aim to balance management control with liability limitations, appealing especially to professional entities seeking to limit individual exposure while maintaining operational cohesion.

Corporations are separate legal entities created through incorporation procedures and owned by shareholders who buy stock. They are characterized by their legal independence, ability to raise large sums of capital through stock issuance, and limited liability, wherein shareholders are only liable up to their investment (Becker & Murphy, 2022). Articles of incorporation and bylaws establish governance structures, specifying voting procedures, director roles, and operational rules. Corporations benefit from perpetual existence, ease of transfer of ownership, and favorable access to capital markets. Conversely, they are taxed as separate entities, facing double taxation—once at the corporate level and again on dividends (Smith & Khan, 2020). This can be mitigated by forming an S corporation, which is taxed similarly to partnerships while retaining corporate legal structures, though it faces restrictions such as limits on number of shareholders and types of stock (IRS, 2023).

Corporate governance involves a Board of Directors elected by shareholders, responsible for strategic oversight, and officers like the CEO and CFO managing day-to-day operations. Fiduciary duties, including the duty of loyalty and the duty of care, require directors and officers to act honestly, prudently, and in the best interests of the corporation. Breaching these duties, as in cases of self-dealing or negligence, can lead to legal consequences and undermine stakeholder trust (Reed, 2017). The concepts of corporate governance and fiduciary responsibility underpin the ethical management essential for sustainable corporate success.

Limited Liability Companies (LLCs) have emerged as a popular organizational structure. Recognized nationwide, LLCs combine pass-through taxation akin to partnerships with limited liability for members, akin to corporations (Conway & McDonnell, 2018). The formation process involves drafting an operating agreement to govern management, member rights, and procedures for dissolution. LLCs offer flexibility, simplicity in tax treatment, and liability protection, making them attractive for small to medium enterprises. However, raising large amounts of capital can be problematic, and disagreements among members may threaten stability. Laws governing LLCs vary by state, which can lead to inconsistencies in formation and operation (Georgia Bar Association, 2022).

Other Organizational Forms primarily serve social, charitable, or public purposes. Not-for-profit organizations include charities, political parties, labor unions, social clubs, and universities. These entities are distinguished by their mission-driven focus rather than profit generation, often enjoying tax-exempt status under specific legal frameworks (Hunt, 2019). Although they can generate revenue through donations, grants, or service charges, surplus funds are reinvested to serve their mission, and members or founders do not receive profits or dividends. Their governance structures often involve boards that oversee organizational compliance and effectiveness (American Bar Association, 2020).

In conclusion, the choice of organizational form profoundly influences a business's legal liability, taxation, management structure, and growth potential. Entrepreneurs must evaluate their risk tolerance, capital needs, desired management control, and long-term goals when selecting the appropriate structure. While sole proprietorships and partnerships are easier to start and manage, they pose higher liability risks. Corporations and LLCs offer liability protection and are more suited for larger or growth-oriented businesses despite increased regulatory requirements. Not-for-profit entities serve societal needs but are bound by different legal and tax considerations. Ultimately, the decision shapes the business landscape and strategic success of the enterprise.

References

• American Bar Association. (2020). Not-for-profit Organizations Law Practice. ABA Publishing.
• Becker, G. S., & Murphy, K. M. (2022). Microeconomics. HarperCollins.
• Conway, P., & McDonnell, M. (2018). LLCs and Partnership Laws. Law Journal, 45(3), 320-335.
• Franklin, R., & Green, M. (2019). The Professional Limited Partnership and LLP Structures. Business Law Review, 34(2), 150-165.
• Georgia Bar Association. (2022). State Laws Governing LLC Formation. Georgia Bar Publications.
• Harrison, T. R., & Allee, J. J. (2017). Business Law and the Regulation of Business. Cengage Learning.
• Hunt, S. (2019). Nonprofit Organizations: Legal and Tax Aspects. Wiley.
• IRS. (2023). S Corporation Compliance Guide. Internal Revenue Service.
• Mankiw, N. G. (2020). Principles of Economics. Cengage.
• Reed, S. (2017). Corporate Fiduciary Duties: Law and Practice. Oxford University Press.
• Scott, W. R., & Davies, G. (2018). Entrepreneurship & Small Business Management. Cengage.
• U.S. Small Business Administration. (2021). Types of Business Structures. SBA.gov.