So we’ve been talking in the last two classes about different ways that we could categorize businesses.

We started out with the idea of looking at businesses by how big they are and specifically by how many employees they have.

Then we took a look at a way to categorize business by the type of work that they do. And specifically we talked about Sectors and Industries and we learned about the classification system for Sectors and Industries—the NAICS codes.

This class we’re going to look at yet another way that we can understand different kinds of businesses—by their legal structure.

This can get a little more technical and I’m going to do my best to keep it interesting.

Because it is pretty interesting and I promise you, it’s important to understand this stuff.

The legal structures of businesses have major implications for how they work and for how our whole society and economy work.

But before we go any further, I want to stop for a minute and quickly review what we discussed when we were looking at businesses by size.

Remember, the vast majority of businesses have no employees.

Of the businesses that have employees, most have less than 500 employees

And then some had a lot of employees—1000s of or even more than a million.

So let’s think about that for a second.

If I have my own business, if I’m the only owner of a business, that business is basically an extension of me.

I own the business, but I also make all of the decisions about the business.

If the business needs more printer paper, I buy more printer paper.

If the business needs to enter into a contract with a supplier, I can enter into a contract with a supplier.

But what about a bigger business?

Let’s say a business that has hundreds of people working in it.

There needs to be a way for that business to do things.

Buying supplies sure, but also... Entering into contracts. Hiring people. Firing people. Borrowing money. Paying taxes. Maybe suing another company or an individual….

How does that work?

It sounds like the company can basically operate like a person—but it’s not a person it’s a big group of people.

The employees, but the mangers and the investors who own the company.

This is what we’re going to talk about in this class.

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The legal structure of businesses that allows them to do all of the stuff that they need to do to function.

The legal structures that allow many people to come together and to operate a business as an entity that has certain rights and responsibilities.

The first thing to know—and this won’t be surprising to you—is that most businesses…about 75% or 3 out of 4 of them…are sole proprietorships.

They have one owner and as we just said that owner gets to make all of the decisions about that business.

Then we have other businesses that are partnerships.

This is when two or more people get together in a business.

They don’t necessarily have equal ownership of the business.

They don’t have to be “50-50 partners” right?

Maybe you own 95% of the business and I own only 5% of the business, but we’re still partners.

And for your information, there are about 4.5 million partnerships in the US.

So, so far we have sole proprietorships and we have partnerships.

Sole proprietors have one owner and partnerships have many owners.

But I said we were going to talk about legal structures and so far we’ve only talked about how many owners the business has.

And this is where things start to get a little more interesting.

Have you ever seen “Inc.” at the end of a company’s name and wondered what it meant?

You see it all over the place, right?

EXAMPLES:

Apple, Inc.

Amazon.com, Inc.

American Eagle Outfitters, Inc.

Anheuser-Busch Companies, Inc.

Bed Bath & Beyond Inc.

Berkshire Hathaway Inc.

Coca-Cola Enterprises Inc.

Dollar Tree Stores, Inc.

E*Trade Group, Inc.

And there are others letters we see as well…

Corp.

Co.

LLC.

LLP.

And this gets us to a very important idea:

Some businesses are incorporated and some are unincorporated.

Those letters at the end of a business’ name tell you that the business is incorporated and what kind of corporation it is.

What does that mean? Incorporated? “In corporation”?

The word Corporate is from the same Latin root as the word “body”

And it literally means "united in one body”

So when a business is united in one body it is considered a separate and distinct legal entity.

It’s a thing that is different from—separate from—the people who own that thing or work in that thing or manage that thing.

And that “thingness” means that businesses that are incorporated have certain advantages.

Certain things that they are legally allowed to do.

And those things turn out to be extremely powerful.

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As legal entities, corporations have certain legal rights.

They can enter into contracts, loan and borrow money, sue and be sued, hire employees, own assets, including other businesses, and pay taxes.

Technically an unincorporated businesses can do those things too but with an unincorporated business it’s the owners who are doing those things—not the business itself.  

And that’s an extremely important difference.

For one thing, having a company be a separate legal entity—a separate “thing”—makes it easier to sell pieces or “shares” of that company to investors.

I can tell you that I will give you 10% of the equity—the ownership—of my business if you invest $10,000.

You give the company the money and in exchange you become a shareholder who owns 10% of the business.

Some companies are “private”—which means that you need to be invited to buy part of the business.

And some are “public” which means that anyone can buy or sell shares on an exchange like the NASDAQ or the NYSE.

Another advantage of having a company as a separate entity is that it limits the liability of the owners of the business.

Maybe you’ve heard that term “limited liability”…as in a “Limited Liability Company”.

It means that the owners of the business—the shareholders or investors—are not responsible for paying debts that the company might incur.

Let’s say when you invested in my company right you put in $10k and you got 10% of the business.

But we’re doing a terrible job managing the business, the business borrows millions of dollars and the company goes bankrupt.

Or maybe the business gets sued for a lot of money and loses and is forced to close.

In that case, you’ll lose your investment—the $10k—but that’s it.

Even though you own 10% of the company, you are not responsible for 10% of its debts.  

The company owes the money not you—so your personal money is safe.  

You can see how that would encourage people to invest in businesses that might be too risky otherwise.

Another advantage of incorporation is that because they are separate legal entities, they outlive the people who start them.

As long as there is someone to manage the business, it can keep doing business after the people who started it leave to do something else or die.

Incorporated businesses can last for 100s of years—the oldest companies in the world are over 1000 years old.

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There are few different types of corporate structures.

They have different advantages in terms of what they are allowed to do, but they also have different levels of complexity in terms of how hard they are to manage.

And they also have different tax structures.

Most US businesses don’t pay taxes – they pass the profits onto the owners—you’ll hear them call “pass-through” entities—and the owners reports the income on their personal taxes.

This is true for sole proprietorships, partnerships, Limited Liability Companies (LLCs), and S Corps (small business corporations governed by Subchapter S of the Internal Revenue Code)

C-corps—which is what most big companies are--pay their own taxes—albeit at a lower rate than most individuals pay.

We tend to think of corporations as for-profit businesses but important to keep in mind that there are for-profit and non-profit corporations.

Nonprofits are corporations that are set up to have a social impact rather than to make a profit. They can include charities, political organizations, schools, hospitals, churches, foundations, and cooperatives.

For the last 15 years, we’ve also had “benefit corporations” which now exist in 36 states.

Benefits corporations or “B corps” are for profit corporation that also seek to have social or environmental impact…

You can think about them as a kind of a hybrid between for and nonprofit models.

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That was a lot to absorb. Don’t feel like you need to remember all of it.

The important things to remember are that some companies are incorporated as some are unincorporated.

Being incorporated—"or unity in a body”—means that a company exists as a legal entity with it’s own rights and responsibilities.

And finally that there are several different types of corporations—each with its own advantages and costs.

The final thing I’ll say is that until a 125 years ago, it was very hard to create a corporation—you basically needed Congress to allow it.

It wasn’t until the end of the 19th century that any individual or group could create a corporation simply by registering it with the government.

That was a very radical idea…And it’s one that has had a major impact on how we live and how our economies work.

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