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Unformatted text preview: ro rata liability in the event the partnership goes
bankrupt, the remaining partners must make good on
the unsatisfied claims, drawing on their personal
assets to the extent necessary.
The first three disadvantages—unlimited liability,
impermanence of the organization, and difficulty of
transferring ownership—lead to the fourth, the difficulty
partnerships have in attracting substantial amounts of
capital. This is generally not a problem for a slow-growing
business, but if a business’s products or services really
catch on, and if it needs to raise large amounts of capital
to capitalize on its opportunities, the difficulty in attracting
capital becomes a real drawback. Thus, growth companies such as Hewlett-Packard and
Microsoft generally begin life as a proprietorship or
partnership, but at some point their founders find it
necessary to convert to a corporation.
necessary A corporation is a legal entity created by a state, and it
is separate and distinct from its owners and managers.
This separateness gives the corporation three major
advantages: (1) Unlimited life. A corporation can continue
after its original owners and managers are deceased. 18 8
1 (2) Easy transferability of ownership interest.
Ownership interests can be divided into shares of
stock, which, in turn, can be transferred far more
easily than can proprietorship or partnership interests.
(3) Limited liability: Losses are limited to the actual
For instance, if you invested $10,000 in the stock of a
corporation that then went bankrupt, your potential
loss on the investment would be limited to your
These three factors—unlimited life, easy transferability
of ownership interest, and limited liability—make it
much easier for corporations than for proprietorships
or partnerships to raise money in the capital markets.
or The value of any business other than a very small one will
probably be maximized if it is organized as a corporation for
these three reasons:
1. Limited liability reduces the risks borne by investors, and,
other things held constant, the lower the firm’s risk, the higher
2. A firm’s value depends on its growth opportunities, which, in
turn, depend on the firm’s ability to attract capital. Because
corporations can attract capital more easily than unincorporated
businesses, they are better able to take advantage of growth
3. The value of an asset also depends on its liquidity, which
means the ease of selling the asset and converting it to cash at
a “fair market value.” Because the stock of a corporation is
much more liquid than a similar investment in a proprietorship
or partnership, this too enhances the value of a corporation. 0 Disadvantages of Corporations
Cost and complexity to start. A corporation is more difficult and
costly to set up than are other forms of business organization.
In the United States, a corporation is incorporated in a specific
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This note was uploaded on 02/11/2014 for the course FIN 9891 taught by Professor Wu during the Fall '11 term at Kazakhstan Institute of Management, Economics and Strategic Research.
- Fall '11