Finance - the Four Types of Firms

The Four Types of Firms:

1.) Sole Proprietorships

a. A business owned and run by one person

b. Usually very small with few, if any, employees

c. All share the following key characteristics:

i. Straightforward to setup – that is why many new businesses use this organizational form

ii. There is no separation between the firm and the owner – this is the principal limitation of this form (there is only one owner, if there are other owners, they cannot hold an ownership stake in the firm)

iii. The owner has unlimited personal liability for any of the firm's debts – if the owner defaults on any debt payment, the lender can (and will) require the owner to repay the loan from their personal assets – if owner cannot repay the loan, then they must declare personal bankruptcy

iv. Life of sole proprietorship is limited to the life of the owner (it is also difficult to transfer ownership of this form)

d. Usually the disadvantages of this form outweigh the advantages

2.) Partnerships

a. Identical to a sole proprietorship except it has more than one owner

b. Key features:

i. All partners are liable for the firm's debt

ii. Partnership ends on the death or withdrawal of any single partner (liquidation can be avoided if the partnership agreement provides for alternatives such as a buyout of a deceased or withdrawn partner)

c. Limited partnership = partnership with two kinds of owners, general partners and limited partners

i. General partners have the same rights and privileges as partners in a partnership – they are personally liable for the firm's debt obligations

ii. Limited partners have limited liability – their liability is limited to their investment (their private property cannot be seized to pay off the firm's outstanding debts) – also, the death or withdrawal of a limited partner does not dissolve the partnership, and a limited partner's interest is transferable – a limited partner has no management authority and cannot legally be involved in the managerial decision making for the business

iii. Examples of industries dominated by limited partnerships = private equity funds and venture capital funds

3.) Limited Liability Companies

a. A limited partnership without a general partner – all the owners have limited liability, but unlike limited partners, they can also run the business

4.) Corporations

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