Company formation and management
There are many different types of business associations that exist around the world in order to suit different needs. Different countries allow various types of business associations to be formed, each requiring different documents for formation. Some of the main considerations when choosing which business form to use are: (i) the types of products or services; (ii) tax issues; (iii) control and management objectives; (iv) liability risks; (v) business risks; (vi) financial, growth and investment goals; (vii) owner and employee compensation and benefit goals; and (viii) scope of the intended geographic market for products and services. This section will summarize briefly the main types of business associations that exist, as well as their formation documents and other requirements.
Types of entities
A sole proprietorship exists when one person (the “sole proprietor”) carries on a business without forming a separate company. That person is the sole owner of the business. The sole proprietor may employ others as employees but such employees are not otherwise involved in the management of the business. All of the income, losses, assets and liabilities of the business are also those of the sole proprietor (i.e., the person is not a separate legal entity from the business). The sole proprietor may, however, limit personal liability by purchasing insurance. There are obviously few legal formalities in forming or operating a sole proprietorship and thus many small businesses choose to be so organised.
A partnership exists when two or more persons (called “partners”) carry on a business together with a view to profit. These persons can be either individuals or corporations (corporations are viewed as “legal persons” under the law). Partnerships are generally preferable to corporations from a tax standpoint in that they are said to have “pass-through” or “flow-through” taxation. In other words, the profits of the partnership pass through the entity to the partners themselves. As a result, partnerships are only taxed once via the partners´ income tax (unlike a corporation which is subject to double taxation of corporate profits and shareholders´ income).
Partnerships are a common form of business organisation, used often by lawyers and chartered accountants, but also by small businesses and large commercial projects. Normally, partners will have a kind of partnership agreement (which is a contract between the partners, often called “Articles of Partnership”), which lays out certain aspects of the partnership, such as who the partners are, when the partnership commences, its planned duration or how it is to be managed (Appendix 1 contains a sample partnership agreement).
The corporate law of many countries often permits different forms of partnerships. A “general partnership” is one in which the liability of each partner for the debts and other obligations of the partnership is unlimited, which means that all partners can be held responsible for re-payment of all of the partnership’s debts. On the other hand, in a “limited partnership” (or “LP”), the liability of “general partners” is unlimited, but the liability of “limited partners” is restricted to the amount that the limited partner contributed or agreed to contribute to the partnership. In exchange for this limited liability, a limited partner is often required to be a passive investor rather than an active participant in the operation of the limited partnership.
A common business form for law firms in the US, the UK, Japan and Canada is the “limited liability partnership” or “LLP”. In this form, all partners have a limited liability (rather than just the limited partners like in the limited partnership) regardless of whether they manage the business directly. A LLP is often appropriate when all partners wish to take an active role in management of the business. This business form, however, is generally only available for law firms, accounting firms and other professional organizations.
A company or corporation is the business entity most often used when carrying on business activities. The word “company” is often preferred in the UK whereas the word “corporation” is generally used in the US.
A company is a separate legal entity from its owners. Some of the consequences of this are that it can sue and be sued and is taxed in its own name. The owners of a company are its “shareholders”. These are people who provide the company with money, property or services, which then belong to the company. A company may own property, carry on business, possess rights and incur liabilities in its own name while the shareholders own the company through the ownership of “shares” or “stock” in the company.
Although shareholders are described as the company’s “owners”, they do not personally own the business or the property of the company. Likewise, the rights and liabilities of the company are separate from those of the shareholders. Shareholders thus have “limited liability” since their liability is restricted to the value of their shares, and they can never lose more than the amount they paid for their shares even if the company should end up with liabilities in excess of its assets. A company thus allows “owners” to invest in a business without exposing their other assets, including personal assets, to the creditors of the business.
Other important participants in a company are the directors and officers. Directors are primarily charged with the responsibility of managing the business. They often sit together as a “board” and are referred to as the “board of directors” of a company. They are usually elected by the shareholders at the annual meeting of the shareholders called the “annual general meeting” or “AGM” or the “annual meeting”. The directors usually then choose “officers” who are responsible for the day-to-day management of the business.
Another characteristic of a company is that it has perpetual existence. The assets and the structure of the company last beyond the lifetime or withdrawal of an owner/shareholder. In order for a company to be “dissolved”, a majority of shareholders must resolve that it should be, a court must order it, or the relevant government official may dissolve the company if the company is in breach of applicable legislation or it has been inactive.
Companies in different jurisdictions
Registration for all companies must be done through Companies House. The overwhelming majority of companies are limited companies, where the responsibility of shareholders is restricted in some way (depending on the type of limited company). There are three types of limited company:
(i) Public limited company (“plc”) – the shares of the company may be offered for sale to the general public. Liability is limited to the amount unpaid on shares held by shareholders. There is a minimum amount of share capital which must be issued in order to establish this kind of company (presently £50,000). Many of the large multinational companies are incorporated as PLCs in the UK, such as Cadbury Schweppes plc, Rolls-Royce plc, Tesco plc, Unilever plc, Vodafone Group plc, and British Airways plc.
(ii) Private company limited by shares (“Ltd”, “Ltd.”, “Limited”, “Incorporated” or “inc.”) – liability is limited to the capital invested, in other words, the sale of shares. Unlike in a public limited company, shares may not, however, be offered to the general public and therefore cannot be traded on a public exchange. There is a maximum and minimum number of people that can hold shares (presently in the UK, the maximum is 50 and the minimum is two). Most UK companies, especially smaller ones, are private companies limited by shares.
(iii) Private company limited by guarantee – no shares are issued but the company is instead guaranteed by its “members” who agree to pay a fixed amount in case of liquidation/bankruptcy. Charities and political parties often use this kind of company. For all of these types of companies, one must send a memorandum of association, articles of association and two other forms, together with registration fees to the Companies House in order to register the company.
In the US, several forms of corporations exist since each state has jurisdiction over the formation, management, operation and termination of corporations. Many of the states follow the same general format for company law as found in the Model Business Corporation Act, which was originally developed by the American Bar Association (ABA). It is not law, but rather it simply provides guidance for State governments to develop their corporate laws. However many companies are formed in the state of Delaware (about half of Fortune 500 companies), which does not follow the Model Business Corporation Act. Law students therefore generally study both models of companies in law school and some other states (such as New York, California, Texas, Illinois) combine both of these two model laws. There are generally two types of corporations in the US. The “C Corporation” is one which files its own tax returns and pays its own taxes, rather than passing this liability onto its owners. An “S Corporation”, on the other hand, is taxed like a partnership and the profits and losses of such a corporation flow through to its owners in proportion to their stock ownership. Stockholders are still protected from the liabilities of the business, however, in an S Corporation. The S Corporation is often preferred by small businesses, especially when stockholders are often also employees of the corporation or are otherwise involved in the day-to-day operations of the corporation. Many companies choose to incorporate in the state of Delaware for many reasons, including its sophisticated and flexible corporate law and their separate commercial law courts with judges who are knowledgeable and experienced in corporate law matters. A company does not have to have its headquarters in Delaware, but it must have at least a registered agent there. Loosely equivalent to the UK’s limited liability company, another business form in the US is the “limited liability company” or “LLC” which differs from both a corporation and a partnership in its formation, management and tax responsibilities (note: the correct term is limited liability company and not limited liability corporation). One may wish to form an LLC because it combines the limited liability features of the corporation with the tax efficiencies of a partnership. Some of the small differences in company formation include that while shareholders own a corporation, “members” own a LLC. Members establish a general operating agreement which empowers managers to manage the affairs of the business. Ownership percentages, profit and loss distribution and voting rights are determined by the “Articles of Organization” rather than by stock ownership. In addition, LLCs are treated as partnerships for tax purposes and there is also no requirement for directors or officers.
Full text may be found at http://www.abanet.org/buslaw/library/onlinepublications/mbca2002.pdf (last visited 2006-11-23).
The EU has developed a new form of European company called the “Societas Europaea” or “SE”. This is a public limited company which may be created through registration in any one of the member states of the European Economic Area. An SE is to be treated as if it is a public limited company according to the law of the member state in which it has its registered office. The reasoning behind the development of a SE is to allow companies incorporated in different member states to merge or join together in some other manner while avoiding the legal and practical constraints arising from compliance with all of the different laws of the different member states in which they are doing business. For tax purposes, an SE company is treated like any other multinational company according to the law of the member state in which it has its registered office.
A company usually requires founding documents (which one can liken to a “constitution”) which defines the existence of the company and regulates the structure and control of the company. Sometimes, this is composed of two documents. The first specifies the company’s objects and powers and its authorized share capital. In the US, this is called the charter (or the “articles of incorporation”) and in the UK, this is called the “memorandum of association”. The second document outlines the company rules for internal affairs and management, such as procedures for board meetings and annual shareholder meetings. In the US, this is called the “bylaws” and in the UK, this is called the “articles of association”. Companies will often have “shareholder agreements” which normally do not have to be made publicly available. There are different types of shareholder agreements but they are all contracts either between shareholders or between shareholders and the company. One common one is the “unanimous shareholder agreement (“USA”) in which all shareholders of a company agree on certain ways of exercising their rights and agree to the management of the business of the company by the directors and officers. All the shareholders of a company must sign the USA for it to be valid, however a valid one may, in some jurisdictions, supersede the company’s articles of incorporation/memorandum of association (Appendix 2 contains an example of articles of incorporation).
Company law in practice
Corporate or company lawyers advise companies and other legal entities on a wide range of issues. Lawyers advise on company law matters, such as which type of business association is most appropriate, how to set up a company, how the company is managed (corporate governance), employment law matters and duties of directors, and draft documents needed in the running of the company, such as minutes of meetings, the constitutional documents of the company, the shareholders agreement, and contracts with suppliers and customers. Some documents are also required by law to be filed with the companies registration office. Companies will either engage law firms to provide this type of legal assistance or use lawyers who work “in-house” at the company. Larger companies often have a legal department containing a number of in-house counsel because their advice is required on a daily basis. In-house counsel are also sometimes involved in the running of the business, including sitting as a member of the board of directors.
Lawyers also advise on transactional work. Lawyers at larger commercial law firms in particular will often be retained to negotiate, and draft documentation for, transactions, such as the acquisition of another company. This may require extensive work, including conducting due diligence on the target company and negotiating and drafting the sale and purchase agreement (SPA). The company may also wish to raise capital by issuing shares to existing or new shareholders, which will require a lawyer to ensure these procedures are conducted correctly and to draft relevant documents (see section on Company Law: Capitalisation).
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