Let's Get Down to Business...

Second-guessing Decisions: The Business Judgment Rule

You're probably curious about a lot of things in the business world.  Here are a couple of head-scratchers.

Have you noticed that most of the big, publicly-held corporations are registered in Delaware?  Why is that?  What put Delaware at the top of the list of best places to register your business? 

And have you also noticed that very few Directors go to jail for the decisions they made (or actions they didn't take) at businesses that committed outlandish crimes?  Why is that?  If a business's shareholder-elected Directors are responsible for its management and the business broke laws or injured someone, shouldn't those Directors be accountable?  Should they bear some personal responsibility? 

Do you think these things are related?  How do you explain what's going on?

And by the way, Enron wasn't a Delaware corporation.  For awhile, Oregon had two, not one, Fortune 500 businesses.  We're very proud of that home-grown shoemaker formerly known as Blue Ribbon Sports and headed up by a former Portland State accounting instructor, but no one brags about Enron also being an Oregon corporation.  Now aren't you really curious about what's going on? 

How did Corporations become "Natural Persons?"

We've learned that corporations have most of the rights and duties of "natural persons."  They can buy and sell property, sue and be sued, engage in protected political speech and are obliged to pay taxes. 

Just about the only unnatural characteristic of a corporation is they have perpetual life; a corporation's shareholders can call for its voluntary demise, but they're otherwise immune to the afflictions of mortal humans.

If you were to browse through the "Oregon Business Corporation Act" (ORS Chapter 60), you would not find any statute authorizing or empowering corporations to do (or not do) any of these things.  And if you were to browse through the laws of the other 49 states, you would come up similarly empty-handed.

So what's going on here?  How can this be?  Sometimes it seems like there's a law, rule, code or ordinance that regulates everything.  How can such a basic question as, "What is a corporation?" go unanswered?

The answer is found in a true story from the nation's past when the wild west was being tamed and conflicts of interest didn't particularly upset anyone.

Taxing Matters

As we discussed, sole proprietorships and general partnerships are, for tax purposes, "flow-through" entities.  That tongue-twisting term means they are not separately taxed by the IRS or any state or other local government.  Income flows through the entities to the proprietor or partners where it is reported on their personal returns and taxed as ordinary income. 

Things are a little more complicated for corporations, but not all that bad.   Going to the Dentist is always worse than income taxes. 

Selecting an Organizational Form: Three Good Questions

Before looking at different approaches and answering the three "good" questions, here are my lecture notes: 

• Download forms_of_business_organization_week_1.ppt 

There are two approaches to studying the topic of organizational forms. 

The traditional approach takes each form and analyzes their key characteristics.  And that's something we'll do as well. 

• It's important to know that the Corporate form includes an advantage of "limited liability" and a disadvantage of "double taxation." 
• General Partnerships are problematic because of the joint and several liability they impose on their partners, but offer great flexibility when it comes to distributing income, expenses and tax-preference items. 
• Sole proprietorships, last but not least, are extraordinarily simple and don't burden the entrepreneur with administrative demands and expenses.

Consider though another approach that starts with the question, "Which organizational form best fits my business?"

Answering this question requires understanding your business's needs.  And it's a better approach to making the right choice.

Form and Structure: They're not the same thing

In order to better understand how organizations work (and to make them work more efficiently), it's important to know the difference between an Organization’s Form and its Structure.

The terms “Form” and “Structure” describe completely opposite aspects of a businesses’ organization. They're not interchangeable and are as different as night and day.

Here's a Big Decision: What should I "Name" my Business?

Starting a business starts with making a very long list of "things-to-do."  And most budding entrepreneurs put naming their new enterprise near the top of that list.

No doubt it's an important thing to do.  First, you'll want your firm's name to be something that's easy for customers to remember. 

You probably will also want the name you pick to be associated with your business's product or service.  Wouldn't it be nice if customers looking for what you sell could easily find you by virtue of the ingenious name you picked?

And last but not least, don't you want to protect your business's name from being misappropriated?  After all, when your new business becomes a roaring success (and there's no doubt this will happen, right?) you'll attract imitators who may try to use your business's name for their own advantage.

There's a short list of rules that corporations registering to do business in Oregon must follow concerning its name. They're important to know and could prove to useful for protecting your business's valuable name.

Using the Right Term

The Business World has its own language.  Knowing when and how to use the right term is essential.

Here are a few key terms you'll need to know as you climb to the top of the corporate ladder.

Is a Shareholder's Liability "Absolutely" Limited?

As we've learned, the principal advantages of corporations are (1) centralized management, (2) perpetual life, (3) free transferability of shares and (4) limited liability for investors.  (Double-taxation is a characteristic but it certainly isn't an advantage!)

The last one (limited liability) is probably the most important.  It explains why corporations "work."  The reason is it solves the "monitoring" problem.  But what's the monitoring problem?

Important Dates and Deadlines

It's likely our course will have a "Wait List." 

One of the most valuable aspects of getting your business education at PSU is small class sizes.  If you were attending Harvard and enrolled in their introductory economics course, the lecture hall would be filled with nearly 900 other students. 

At PSU's Business School, maximum class sizes usually have between 45 and 60 of the best and brightest students in the land.  And I'm stricter-than-most when enforcing that guideline, to the chagrin of the students who don't make the cut. 

We'll reconcile the course's membership during our first meeting and then "true it up" on the following Thursday.  If you're on the Wait List, show up on the first day and see what happens.  If you're not on the Wait List or show up after the course's first session, don't expect to get into the course.

The Last Day you can drop the course without incurring a financial penalty is October 4.  In other words, if you drop the course before then, you'll get all your money back.  Drop the course after that date and you'll get a decreasing amount back.  And the longer you wait, the smaller the refund. The percentage of your hard-earned tuition dollars that will be refunded decreases until November 4.  After that date, all the money you've paid belongs to the University. 

Good luck.

The IRS takes one on the chin. And the crowd roared!

Your textbook calls Limited Liability Companies (LLCs) a type of general partnership (p. 149).  It says that LLCs have "all the favorable features of a typical partnership but also offer limited liability for the partners." 

Limited liability is, as you've learned, a feature of corporations, not partnerships.  A better description for an LLC then might be to call them "hybrids" because they have features of both partnerships and corporations. 

LLCs have become the organizational form of choice for start-ups and small businesses because of this "best of all worlds" treatment:  LLCs are not separately taxed like corporations, but "pass through" their profits and losses to their owner/members.  For tax-filing purposes, LLCs act like partnerships.