In the next few minutes:
We'll follow one business as it grows: Meera's bakery.
An organizational form is how a business is set up legally. To compare forms, ask five questions:
Meera starts the bakery on her own. That's a sole proprietorship: owned and operated by one person.
To open a second shop, Meera teams up with Arjun. Together they form a general partnership.
A partnership agreement sets each partner's duties and share of profits or losses. It can be written, verbal, or implied by how the partners act.
Everything else looks like the sole proprietorship: both partners have unlimited liability, and each partner's share of profit is taxed as personal income.
Now an investor, Kabir, wants in, but he won't run the shops or risk his house. A limited partnership has two tiers:
General partners usually get a larger profit share for running the business. Profits are still taxed as personal income.
Some jurisdictions allow a limited liability partnership (LLP). There's no general partner: every partner has limited liability.
In the United States, LLPs are allowed only for professional services such as law and accounting, with limits on the number of partners and the equity invested.
What sets a corporation (or limited company) apart is that it is a legal entity separate from its owners and managers.
Check yourself
The partners incorporate as Meera Foods Ltd. A corporation is formed by filing articles of incorporation with a regulatory body.
As a legal entity, it has many of an individual's rights and responsibilities. It can hire employees, enter contracts, and borrow and lend money in its own name.
Meera Foods issues shares to its owners, the shareholders. Shares let a corporation raise large amounts of capital, and they're easy to transfer if they trade on an exchange.
Shareholders don't run the day-to-day business. They use their voting rights to elect a board of directors. The board hires senior managers and may declare dividends from earnings. The board and managers must act in shareholders' interests.
This is the separation of ownership and control.
In many countries the company pays tax on its earnings. Then, when it pays a dividend (a distribution of earnings to owners), shareholders pay personal tax on it.
The same profit is taxed twice. This is double taxation.
Partnerships and sole proprietorships avoid it: their profits are taxed once, as the owners' personal income.
If all after-tax profit is paid out as dividends:
If only part is paid out, multiply the second term by the payout ratio :
Pretax profit is INR 1,000. Corporate tax is 30% and dividend tax is 20%.
Check with the formula: 30% + 0.5 × 70% × 20% = 37%.
Slide the payout ratio for Meera Foods. Profits that are reinvested escape the second layer of tax, for now.
Pretax profit INR 1,000; corporate tax 30%; dividend tax 20%.
Check yourself
A public limited company's shares are sold to the public. Most are listed: shares trade on a stock exchange, a rules-based open market with price and volume transparency.
Free float is the shares actually available to trade, excluding those held by insiders, strategic investors or sponsors. It's usually quoted as a percentage of shares outstanding.
Public companies must file quarterly or annual financial reports with a regulator and disclose material changes in their business or ownership.
After listing, Meera Foods has 100 million shares outstanding.
Only 30 million shares are actively traded, so the free float is 30%.
A private limited company has a limited number of shareholders and restrictions on transferring shares. Its shares don't trade on an exchange.
It raises equity through private placements, usually restricted to accredited investors: corporate and institutional investors or high-net-worth individuals.
A SPAC needn't name its target at its IPO, so it's called a blank check company.
It can also run the other way. An acquirer buys all the outstanding shares of a public company, and the company is delisted.
This is often done to restructure an underperforming company and unlock its value. The benefits include a lower regulatory burden and the cost savings that come with it.
Check yourself
That's the reading.
Now test it on exam-style questions while it's fresh.