4.3 Corporations and Other Business Entities
3 min read•july 22, 2024
Business entities come in various forms, each with unique characteristics. Corporations offer but face double taxation, while partnerships provide but expose partners to personal liability. LLCs blend features of both, offering flexibility and protection.
Corporate formation involves specific steps, from choosing a name to issuing stock. Governance structures determine who can act on behalf of the company. Limited liability shields owners' personal assets, but exceptions exist for unauthorized actions or breaches of duty.
Types of Business Entities
Types of business entities
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- Corporations exist as separate legal entities from their owners (shareholders) managed by a with perpetual existence but face double taxation at the corporate and shareholder levels
- Partnerships are owned and managed by partners with pass-through taxation at the partner level only
- General partnerships impose unlimited personal liability on partners
- Limited partnerships (LPs) have general partners with unlimited liability and limited partners with limited liability
- Limited Liability Companies (LLCs) combine features of corporations and partnerships offering flexible management structures, default pass-through taxation (can elect corporate taxation), and limited liability for owners
Concept of limited liability
- Limited liability protects owners' personal assets from business debts and liabilities applying to shareholders in corporations and limited partners in LPs
- Encourages investment and risk-taking by shielding personal wealth from business failures
- Facilitates capital formation by attracting investors who might otherwise avoid business ownership due to personal financial risks
Corporate Formation and Governance
Process of corporation formation
- Choose a unique corporate name not already in use
- File with the state including the corporate name, purpose, registered agent, and number of authorized shares
- Adopt bylaws establishing internal rules for the 's management and operations
- Appoint an initial board of directors to oversee the corporation
- Issue stock to shareholders as proof of ownership in the corporation
- Key documents include the articles of incorporation (public document filed with the state creating the legal entity) and bylaws (internal document governing management and operations)
Authority of corporate representatives
- Corporate officers appointed by the board of directors have authority to enter into contracts on behalf of the corporation through actual authority (expressly granted by the board or bylaws) or apparent authority (third party reasonably believes the officer has authority based on position or conduct)
- Corporate agents (employees or individuals acting on behalf of the corporation) have authority to enter into contracts depending on the scope of their agency relationship with the corporation
Personal liability of corporate leaders
- The business judgment rule presumes directors and officers act in good faith and in the best interests of the corporation, protecting them from personal liability for business decisions
- Exceptions to limited liability include:
- when courts disregard the corporate entity and hold shareholders personally liable due to factors like undercapitalization, commingling funds, or failing to observe corporate formalities
- Unauthorized contracts entered into by directors and officers without proper authority
- Breaching fiduciary duties of care and loyalty owed to the corporation through actions like self-dealing or gross negligence
Key Terms to Review (22)
Acquisition Agreement: An acquisition agreement is a legal document that outlines the terms and conditions under which one company agrees to purchase another company’s assets or shares. This agreement is crucial in mergers and acquisitions, as it defines the price, payment methods, and any warranties or representations made by both parties. Understanding this document helps in grasping how corporations and other business entities engage in transactions that can significantly alter their structure and operations.
Articles of Incorporation: Articles of incorporation are legal documents filed with a state government to establish the existence of a corporation. This document serves as the foundation of the corporation and outlines essential details such as the corporation's name, purpose, registered agent, and the number of authorized shares. They play a crucial role in formalizing the business entity and provide important information that governs the corporation's operations and structure.
Board of directors: A board of directors is a group of individuals elected to represent shareholders and oversee the activities of a corporation. This governing body plays a crucial role in making strategic decisions, setting policies, and ensuring that the company adheres to legal and ethical standards, thereby protecting the interests of its stakeholders.
C Corporation: A C Corporation is a legal business entity that is separate from its owners, providing limited liability protection to shareholders while allowing for unlimited growth potential through the sale of stock. This structure enables the corporation to be taxed separately from its owners, which can lead to double taxation on corporate income when profits are distributed as dividends. C Corporations are a popular choice for larger businesses seeking to raise capital and attract investors.
Corporation: A corporation is a legal entity that is separate from its owners, created under state law to conduct business. This structure allows corporations to enter contracts, own assets, incur liabilities, and be sued or sue in their own name. Corporations are designed to limit the personal liability of their shareholders while providing a way to raise capital through the sale of stock.
Debt financing: Debt financing is a method by which businesses raise capital through borrowing, typically by issuing bonds or taking out loans. This form of financing allows companies to obtain necessary funds while maintaining ownership control, as the lenders do not receive equity in the business. Debt financing can be advantageous for corporations and other business entities, as it often provides tax benefits and can be a more cost-effective means of acquiring capital compared to equity financing.
Dissolution process: The dissolution process refers to the formal procedure of legally dissolving a corporation or other business entity, marking the end of its existence as a legal entity. This process often involves settling debts, distributing remaining assets, and filing necessary paperwork with state authorities to officially terminate the business's legal status. It is essential for businesses to follow specific steps to ensure compliance with relevant laws and to protect the interests of creditors and shareholders.
Equity financing: Equity financing is the method of raising capital by selling shares of a company to investors in exchange for ownership stakes. This approach allows companies to gain funds for operations, expansion, and other needs without incurring debt. It is commonly used by corporations and other business entities, as it can provide substantial financial resources while sharing the risk with investors.
Fiduciary duty: Fiduciary duty refers to the legal obligation of one party to act in the best interest of another party. This concept is especially crucial in the context of corporations and other business entities, where individuals in positions of trust, such as directors or officers, must prioritize the interests of the company and its shareholders above their own personal interests. It encompasses a range of responsibilities including loyalty, care, and full disclosure.
General Partnership: A general partnership is a business arrangement where two or more individuals share ownership and operational responsibilities of a business. In this setup, partners collaborate to manage the business and share profits, losses, and liabilities equally unless otherwise specified in a partnership agreement. This form of partnership is characterized by its simplicity and ease of formation, making it a popular choice among small businesses.
Limited liability: Limited liability is a legal structure that protects the personal assets of shareholders and owners in a corporation or business entity, meaning they are only financially responsible for the debts and obligations of the business up to the amount they have invested. This concept allows individuals to invest in a business without risking personal financial ruin, encouraging entrepreneurship and investment in corporations and other business forms. It is a fundamental characteristic of corporations and certain types of partnerships that shapes the relationship between risk and investment.
Limited liability company (LLC): A limited liability company (LLC) is a type of business entity that combines the characteristics of a corporation and a partnership. It provides owners, known as members, with limited liability protection, meaning they are typically not personally responsible for the debts and liabilities of the LLC. This structure allows for flexibility in management and taxation, making it an attractive option for many small businesses.
Limited Partnership (LP): A limited partnership (LP) is a business structure that includes at least one general partner who manages the business and is fully liable for its debts, alongside one or more limited partners whose liability is restricted to their investment in the partnership. This arrangement allows for a separation of management responsibilities and liability, enabling investors to participate in the business while protecting their personal assets.
Merger: A merger is a business transaction where two or more companies combine to form a single entity, typically to enhance their market position, increase efficiency, or expand their operations. This process can involve the unification of assets, liabilities, and management structures, creating new opportunities and challenges for the resulting organization. Mergers are often pursued as strategic moves to leverage synergies, reduce competition, or gain access to new markets and technologies.
Nonprofit corporation: A nonprofit corporation is a type of organization that operates for a purpose other than making a profit, typically focusing on social, charitable, or educational objectives. These entities are granted tax-exempt status by the government, which allows them to receive donations that are often tax-deductible for the donor. Nonprofit corporations are governed by a board of directors and are required to adhere to specific regulations regarding their operations and financial disclosures.
Partnership: A partnership is a business arrangement where two or more individuals share ownership and the responsibilities of managing the business. This collaborative structure allows partners to pool resources, skills, and capital, fostering shared decision-making and risk-sharing. Partnerships can vary in terms of liability and management duties, making them a flexible option for entrepreneurs seeking to combine efforts to achieve common business goals.
Pass-through taxation: Pass-through taxation is a tax structure where the income generated by a business entity is not taxed at the corporate level but instead 'passes through' to the individual owners or shareholders, who then report it on their personal tax returns. This approach is primarily used by entities such as partnerships, limited liability companies (LLCs), and S corporations, allowing owners to avoid double taxation that typically occurs in traditional corporations.
Piercing the Corporate Veil: Piercing the corporate veil is a legal concept that allows courts to hold individual shareholders or directors personally liable for the debts and liabilities of a corporation. This typically occurs when the corporate structure is misused, such as when there is fraud, commingling of assets, or undercapitalization. It serves as a mechanism to prevent individuals from evading liability by hiding behind the protection that corporations provide.
S Corporation: An S Corporation is a special type of corporation that meets specific Internal Revenue Code requirements, allowing it to pass income, losses, deductions, and credits directly to shareholders for federal tax purposes. This structure helps avoid double taxation that typically occurs with regular corporations, where profits are taxed at both the corporate level and again as dividends to shareholders. S Corporations are popular among small business owners who seek the benefits of limited liability while enjoying pass-through taxation.
Securities and Exchange Commission (SEC): The Securities and Exchange Commission (SEC) is a U.S. government agency that oversees and regulates the securities industry, protecting investors, maintaining fair markets, and facilitating capital formation. It plays a crucial role in enforcing federal securities laws and ensuring that public companies provide accurate and timely financial information to investors, which is essential for informed decision-making in the business environment.
Shareholders' agreement: A shareholders' agreement is a contract between the shareholders of a corporation that outlines their rights, obligations, and protections concerning the management of the company and their ownership interests. This agreement helps ensure that all shareholders have a clear understanding of their roles and responsibilities, addressing issues like decision-making processes, transfer of shares, and dispute resolution. It is crucial for maintaining harmony among shareholders and protecting their investments in the corporation.
State corporate law: State corporate law refers to the body of laws enacted by individual states in the U.S. that govern the formation, operation, and dissolution of corporations. This legal framework provides guidelines for corporate governance, shareholder rights, and various operational requirements that differ from one state to another, thus influencing where businesses choose to incorporate.