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Business Organizations
Touro Law School
Graves, Jack M.

3/8/07

Information to know and understand:
– business alone – sole proprietorship
– do nothing – partnership
– file a paper – forms a corporation

To go in to business must raise capital – Two ways to do so: 1) borrow 2) bring in other owners = equity (people coming in in equity usually get stuff)

Investors in new business are venture capitalists. Through brrowing you expand your business then it goes public by selling its shares to the public. Why sell to public? 1) raise more money or 2) cash out initial investors

Once puiblic the shares now trade in a market and it becomes a public corporation.

If the company is sucessful it may sell itself to another, bigger corporation. The point is to make money.

1) Initial formation of business
2) relationship of investors in initial business – directors and shareholders
3) regulation of public companies and corporate governance – directors insiders, shareholders owners outsiders – regulates this relationship

Initial Questions:
1) What kind of business to form?
– corporation
– partnership

Big issue is raising money, this is the initial concern of beginning a business.

Concern initially is what are you willing to risk? Business assets fine, personal assets usually not so the corporate form istheideal form to raise money.

Differences between Corp and Partnerships
– All differences can be changed by contract, these are default rules

1) Limited Liability – essential to raising large amounts of money
– corporation is a separate legal entity – only money put in to the corp is at risk, 30 in 30 on the line if liability is more than that cant get to personal assets of shareholders (except piercing the veil which is rare)
– partnership is an aggregate of sole proprietors – no limited liability, all personal assets are subject to liability liens

2) Centralized Management
– corp is managed by aboard of directors which may be different from the owners
– partnerships are managed by partners

3) Continuity
– if one shareholder dies he is separate from corp nothing happens
– partner dies, partnership dissolves

4) Free Transferability
– shareholders may freely transfer shares in the separate legal entity
– partners not freely transfer interest

5) Taxation

– differences suggest must form corporation to raise large amounts of money from lots of investors.

– everything can change by contract – ex: continuity – if one partner dies has contract that provides for the continuation of the partnership

– Guy wants to start business has 100K needs 10000000 – no bank is going to lend him 9.9 million dollars but if he can get investors to put in 5 million in equity then he can go to a bank and get the other 5 million – banks will do this because they get paid first in bankruptcy. Bring in equity to support debt.

Corporate Formation:

Ultra Vires – beyond power
This doctrine is still alive but rarely used because its easier to start a corporation, corporate purposes may be very broad.
If you have a corp that guarantees a personal loan unconnected with a business you could make a defense of ultra vires but this is very very rare.

Legislature made formation basically automatic – can be formed quite easily. Used to require a minimum amount of equity – now not true.

Restrictions are also less now than before. NJ started this – and corporations flocked to NJ. NJ gets stricter and DE passes less restrictive statute.

Incorporation in a state means that when there are issues about the internal affairs of the corporation are usually governed by the state of incorporation. Internal affairs are rules governing inside operation of the corporation – shareholders etc. DE now dominates how we look at corporate governance issues.

Race to the bottomor Race to the Top?
– Bottom: result is DE has lowered standards and lowered protection of investors and as a result all the other states lower their standards as well
– Top: DE is competeing with other 49 states for corporation – investors wont go to states that don’t protect them so it produces better law.

Reality today is that the law in most states is pretty similar. DE has some protection for investors but companies still go to DE. DE court has a separate chancellary court that deals exclusively with corporate law – all the judges are former corporate lawyers. Litigating before a knowledgable court, history of case law.

Debt/Equity Issue

– companies need capital
– need both debt and equity
– equity supports debt

Public Co:
Debt
– bonds – long term debt secured by an asset – bond holder is a creditor entitled to money on due date and interest. Bonds may go after specific collateral in the company- this gives them an advantage (can grab the air planes)
– debentures – unsecured cant go after specific assets, greater risk than bond but not much still entitled to their money

Equity
– perfered stock – they get paid first out of equity
-common stock – get paid last, most risk

Debt gets paid first, debt interest must be paid, equity gets paid last in aliquidation. Equity gets a dividend they are discretionary from the board not paying them does not force a co in to bankruptcy.

Investment is a trade off – you are concerned with:
1) risk
2) control
– bondholders – K control but not a lot, most control is the common stock because they get to elect the directors (making directors lookout for them). Preferred stock generally doesnt elect board unless they don’t get a dividend after certain time.
3) return
– current
– preferred if dividend paid they get paid first
– common gets paid after preferred
– future
– bondholders have K, get K price company going up doesnt effect them (unless they have convertables)
– debentures same
– preferred same – only get money back don’t get more
– all residual value of a company goes to the common stock

Tradeoff:
– common stock = control, great return, high ri

exchange OR if you have 500 shareholders and 10 million dollars in assets) you are subject to these rules:

1) – Annual report filed with SEC and given to investors (includes financial information) 10K
– Quaterly reports
– If you have significantnewsmust disclose that

2) Federal Proxy Rules
– when asking people to vote you must give them full disclosure

3) Insider Trading Rules

4) Rules governing Tender Offers – someone offers to buy your shares directly from you (in a public company)

Enforced by SEC and criminal law.

Problem in Corporations:
– when you turn your money over to someone somethings happen
1) manage well make money
2) manage poorly lose money
3) they steal it
These things don’t happen when you own manage yourself.
Putting money in to a business creates a potential for bad management and self dealing. Three categories:

1) Closely held Corp (like a marriage) – not a lot of shareholders (xyz) each own 1/3 of business at some point there is a fissure in relationship. In a business the controlling shareholder has all the marbles – How do we protectminority shareholders from actual or potential oppression of minority shareholders.

2) Publicly Traded Companies with dispersed ownership – no dominating owner or controlling shareholder. Problem with majority shareholder is self dealing and take advantage of the company personally. Not a problem here, but the problem is the separation of ownership from control – shareholders don’t control, directors and inside officers do. This creates an opportunity for diversification of portfolios and delegate responsibility for control to specialists who understand that particular business – good if experts are good. Problem is those experts can steal or mismanagement. How do we minimize bad treatment of shareholders?
– cant all control the company
– if system totally corrupt no one would ever buy shares, but need a system to minimize the risk of bad management and stealing
– how do we not over or under regulate
– SOX 2002 – created new fed regulation to protect investors because businesses fund the economy need investor confidence

Ownership of stocks on the market
– 50% individual
– 50% institutional – pension funds banks etc

– To what extent should institutional investors be involved in regulation
– Now think publicly owned co should have independent members of