Understanding Corporate Structures and Ownership | CFA Level I Corporate Issuers
Welcome to our lesson on corporate structures and ownership! We’ll be covering the basics of the most common forms of business organizations. So, buckle up and let’s dive in!
Four Common Business Structures
In this lesson, we’ll explore the following four business structures:
We’ll focus on their legal relationships, owner-operator relationships, liability, and tax treatments.
1. Sole Proprietorship
The sole proprietorship is the simplest structure, where an individual owns and operates the business. Key aspects include:
- Legal relationship: The owner personally funds the business and has full control.
- Liability: The owner has unlimited liability for the business’s actions and debts.
- Tax treatment: Profits are taxed as personal income.
These businesses tend to be small due to limited financing options.
2. General Partnership
- Legal relationship: The partnership agreement specifies each partner’s roles and responsibilities.
- Liability: Unlimited shared liability for the business’s actions and debts.
- Tax treatment: Profits are shared and taxed as personal income for each partner.
3. Limited Partnership
- Legal relationship: The general partner manages the business, while limited partners invest but don’t manage.
- Liability: General partners have unlimited liability, while limited partners have limited liability.
- Tax treatment: Profits are divided according to the partnership agreement and taxed as personal income.
Examples include private equity firms, hedge funds, and some law firms.
A corporation is a legal entity separate from its owners and managers. Key aspects include:
- Legal relationship: Shareholders own the corporation, while managers operate it.
- Liability: Shareholders have limited liability.
- Tax treatment: Profits may be subject to double taxation (corporate and personal).
Corporations can be not-for-profit, for-profit, public, or private. Not-for-profit corporations focus on a social or philanthropic mission without the intent of distributing profits to shareholders, while for-profit corporations aim to generate profits for shareholders. Private corporations are typically owned by a limited number of shareholders, and their shares are not publicly traded on organized exchanges. Public corporations, on the other hand, have shares listed on stock exchanges, allowing a broader group of investors to buy and sell shares. The distinction between these types of corporations lies in their purpose, ownership structure, and the accessibility of their shares to the investing public.
Private Companies: Starting Out & Raising Capital
Most corporations begin as private companies, raising equity capital through private placements to accredited investors such as institutions or high-net-worth individuals. The terms and risks of these investments are outlined in a legal document called the private placement memorandum (PPM).
Shares of private companies can’t be traded on organized exchanges, so there’s no visible market price. Instead, shareholders must find another accredited investor and negotiate a price for transferring the shares. Because of these restrictions and a lack of liquidity, investments in private companies generally require higher returns and longer investment horizons than public companies.
Going Public: IPOs, Direct Listings & SPACs
Private companies can go public through:
- Initial Public Offerings (IPOs): Issuing shares to retail investors, with stringent disclosure requirements.
- Direct Listings: Stock exchanges agreeing to list existing shares, without raising new capital.
- Special Purpose Acquisition Companies (SPACs): Corporate structures designed to acquire a private company in the future, raising capital through their own IPOs without identifying a specific target.