Explain the legal forms a business can take and what each means for its owners
The idea
A sole proprietorship offers full control and unlimited personal liability, with profits taxed once as the owner's income. A general partnership spreads capital and labour but leaves each partner liable for the whole; a limited partnership confines that exposure to the limited partners' contributions while the general partner retains it. A corporation gives shareholders limited liability, perpetual existence and transferable ownership, at the cost of separating ownership from control and, in many jurisdictions, double taxation of distributed profits.
A practice question
What is the principal liability feature of a corporation for its shareholders?
- Shareholders are liable for corporate debts in proportion to their holdingsWhy not: That describes a partnership. Limited liability is the defining protection of the corporate form.
- Liability is limited to the amount invested — correct
- Liability is unlimited but capped by law at ten times the investmentWhy not: No such multiple exists in any major jurisdiction.
Limited liability is the defining feature: the most a shareholder can lose is the capital committed, which is what makes widely dispersed ownership possible.
A harder one
Which cost does the corporate form introduce that a sole proprietorship avoids?
- Separation of ownership from control, and double tax — correct
- Unlimited liability for all of the ownersWhy not: The proprietor bears it and the shareholder does not, so the corporate form avoids this rather than introducing it.
- The inability to raise any external capitalWhy not: The corporation's access to outside capital is among its main advantages.
Managers run the company on shareholders' behalf, which creates the agency problem governance exists to address, and corporate profits are often taxed again as dividends.
The hardest tier
In a limited partnership, how does the general partner's position differ from the limited partners'?
- The general partner contributes no capitalWhy not: They usually contribute capital as well as management, and the defining feature is the liability they carry.
- The general partner's liability is capped at their contribution while limited partners' is notWhy not: Exactly inverted: the cap belongs to the limited partners.
- The general partner manages and bears unlimited liability — correct
The structure trades control for exposure: limited partners give up management rights in return for a capped downside, and the general partner accepts unlimited liability in return for running the business.
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