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Corporate Finance/ All Chapter 19.05.2016Corporate Finance
Chapter 1
The Corporation
1.1 The Types of Firms
A sole proprietorship is a business owned and run by one person. Sole proprietorships are usually very small
with few, if any employees. They share the following key characteristics:
Sole proprietorships have the advantage of being straightforward to set up. Consequently, many new
businesses use this organizational form.
The principal limitation of a sole proprietorship is that there is no separation between the firm and the
owner – the firm can have only one owner who runs the business. If there are are other investors, they
cannot hold an ownership stake of the firm.
The owner has unlimited personal liability for the firm’s debts. That is, if the firm defaults on any debts
payment, the lender can (and will) require the owner to repay the loan from personal assets. An owner
who cannot afford to repay the loan must declare personal bankruptcy.
The life of a sole proprietorship is limited to the life of the owner. It is also difficult to transfer ownership
of a sole proprietorship.
A partnership is identical to a sole proprietorship expect it has more than one owner. Here are some key
characteristics:
All partners are liable for the firm’s debt. That is, a lender can require any partner to repay all the firm’s
outstanding debts.
The partnership ends on the death or withdrawal of any single partner.
Partners can avoid liquidation if the partnership agreement provides for alternatives such as a buyout
of deceased or withdrawn partner.
Often these firms are the types of firms in which the owners’ personal reputations are the basis for the
businesses.
A limited partnership is a partnership with two kinds of owners, general partners and limited partners. In this
case, the general partners have the same rights and privileges as partner in a (general) partnership – they
personally liable for the firm’s debt obligations.
Limited partners, have limited liability – that is, their liability is limited to their investment. Their private property
cannot be seized to pay off the firm’s outstanding debts. Furthermore, the death or withdrawal of a limited
partner does not dissolve the partnership, and limited partner’s interest is transferable. However, a limited
partner has no management authority and cannot be legally be involved in the managerial decisions making for
the business.
A limited liability company or corporation limits the owners’ liability to their investment, which means the
owners cannot be held personally liable for the company’s debt. The are two types of limited liability company:
private companies and public companies. The owners of private limited companies are not allowed to trade their
shares on an organized exchange.
The distinguishing feature of a corporation (or company) is that it is a legally defined, artificial being (a judicial
person or legal entity), separate from its owners.
Formation of a Corporation. Corporations must be legally formed, which means that a legal document (known
as a corporate charter in the United States) is created upon the formation of the company. Setting up a
corporation is therefore considerably costlier than setting up a sole proprietorship. The corporate charter
specifies the initial rules that govern how the corporation is run.
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