Organizational Forms, Corporate Issuer Features, and Ownership: formula sheet

Key formulas

Sole proprietorship

1 owner | unlimited liability | income taxed once at owner level

Owner and business are not separate legally. Limited capital access.

General partnership

2+ owners | all unlimited liability | pass-through taxation

Partners share management, profit and loss. Liability can extend beyond the amount invested.

Limited partnership

General partner(s): unlimited liability, manage | Limited partner(s): liability limited to investment, passive

Limited partners who take part in management may risk their protection.

LLC

Members | limited liability | typically pass-through taxation

Flexible structure. Treatment varies by jurisdiction.

Corporation

Separate legal entity | shareholders' liability limited | double taxation | easiest to raise capital

Ownership transferable through shares. Heaviest regulation and disclosure.

Shareholder maximum loss

Maximum loss = amount invested in shares

Limited liability. Holds absent personal guarantees or other separate obligations.

Separate legal identity

Company owns assets and owes debts; owners do not

Source of limited liability, contracting in its own name and perpetual life.

Residual claim

Shareholders' claim = assets − creditors' claims

Creditors are paid first; shareholders receive what remains.

Double taxation

Profit taxed at company level, then dividends taxed to shareholders

Applies in many jurisdictions, not all. Pass-through forms avoid it.

Agency costs

Agency costs = monitoring costs + bonding costs + residual loss

Monitoring is borne by the principal; bonding by the agent; residual loss is value lost despite both.

Agency relationship

Principal (owner) → hires → Agent (manager) who acts on the principal's behalf

Conflict arises from differing goals and information asymmetry.

Shareholder-creditor conflict

Shareholders: residual claim with upside; creditors: fixed claim with downside

Risk-shifting, extra debt and large dividends benefit shareholders at creditors' expense.

Controlling vs minority conflict

Control rights ≠ cash-flow rights can allow private benefits of control

Minority holders bear the cost when controllers extract private benefits.

Quick revision

• A sole proprietorship has one owner who has unlimited personal liability.
• A general partnership has partners with joint and unlimited liability.
• A limited partnership has at least one general partner with unlimited liability and limited partners whose loss is capped at their investment.
• An LLC combines limited liability with flexible, partnership-like management and taxation, depending on the jurisdiction.
• A corporation is a separate legal entity, so shareholders have limited liability and can transfer shares more easily.
• Public corporations have shares traded on an exchange, more disclosure and easier access to capital markets.
• Private corporations have fewer owners, less disclosure and lower reporting costs, but shares are harder to sell.
• Shareholders hold a residual claim, while creditors hold contractual claims with priority in a failure.
• An agency problem arises when the agent's interests differ from the principal's.
• Shareholders may prefer risk that transfers value from creditors, so creditors use covenants.
• Aligning pay with long-term results and strong independent boards help reduce manager-shareholder conflict.
• Controlling shareholders may act against minority shareholders, which is a separate conflict from manager-shareholder conflict.

Common mistakes

• Saying all partners in a limited partnership have limited liability. Fix: Remember there must be at least one general partner with unlimited liability. Only limited partners are protected up to their investment.
• Stating that an LLC is taxed like a corporation with double taxation. Fix: Link tax to structure: LLC income typically passes through to members, as in a partnership. Treatment can vary by jurisdiction.
• Saying private companies have no disclosure duties at all. Fix: Say private firms face much lighter requirements. They still report to owners, lenders and tax authorities.
• Thinking going public always lowers the cost of capital. Fix: Access and liquidity can help, but listing adds ongoing costs. Treat lower cost of capital as a possible benefit, not a guarantee.
• Saying limited liability means shareholders can never lose more than expected or that creditors are never repaid. Fix: Limited liability caps the shareholder's loss at the amount invested. Creditors can still lose if assets are insufficient.
• Confusing separate legal identity with limited liability. Fix: Separate identity is the cause: the company is its own legal person. Limited liability is one consequence for owners.
• Mixing up monitoring costs and bonding costs. Fix: Remember who pays: the principal pays monitoring costs; the agent pays bonding costs.
• Treating residual loss as a cost that can be fully removed. Fix: Residual loss is what remains after monitoring and bonding. It is the leftover divergence in interests.

Exam tips

• Link each form to three attributes: liability, tax and capital access. Most questions test one of the three.
• Watch the word 'general' versus 'limited' in partnership questions. The liability answer changes completely.
• Double taxation points to corporation. If the stem says tax is paid only by owners, rule it out.
• With no penalty for wrong answers, never leave a blank. Eliminate the option that breaks a clue and choose between the remaining two.
• Memorize the direction of each feature for both forms. Most questions test whether you can spot a reversed statement.
• Watch for scenario wording: a need for large capital points to public; a need for privacy or control points to private.
• Remember that illiquidity and valuation difficulty are the main drawbacks for private investors.
• Do not confuse private companies with private equity funds or private placements; read the stem carefully.