Question

Assume that you recently graduated and have just reported to work as an investment advisor at the brokerage firm of Balik and Kiefer Inc. One of the firm’s clients is Michelle DellaTorre, a professional tennis player who has just come to the United States from Chile. DellaTorre is a highly ranked tennis player who would like to start a company to produce and market apparel she designs. She also expects to invest substantial amounts of money through Balik and Kiefer. DellaTorre is very bright, and she would like to understand in general terms what will happen to her money. Your boss has developed the following set of questions you must answer to explain the U.S. financial system to DellaTorre.

B. Describe the organizational forms a company might have as it evolves from a start-up to a major corporation. List the advantages and disadvantages of each form.

C. How do corporations go public and continue to grow? What are agency problems? What is corporate governance?

Please don't copy from other sources. Thank you.

Answer 1

B. Starting from a start-up to a major corporation, organizations can take up the form of a sole proprietorship, partnership and a corporation.

Sole proprietorship

In sole proprietorship , the owner (single person) is the investor and there is a merge between the management and the ownership. All the owners personals assets are legally binding in the business in case of debt issues. Sole proprietorship also takes form of LLC ( Limited Liability Corporation), where there can be a restraint on the extent of the owners personal assets that can be responsible for the business. Since LLC is governed by state law and not the federal law, the conditions and terms differ for each state.

Advantage- The owners have direct control and can manage the decisions taken by the firm. There is no conflict of interest among the partners or other owners (investors) of the business.

Disadvantage - The unlimited liability clause makes it a very risky business form in case the business does suffer losses or debt repayment issues

Partnership

Partnership is with two or more partners forming a business. Partnerships helps in combining the expertise, knowledge and investments of qualified individuals excelling in their respective fields. Partnerships again can be unlimited liability or an LLP ( limited liability Partnership ) depending on the contract made by the partners. Unlimited liability makes every partner equally and fully liable for the functioning of the business and responsible for the actions of the other partners. In LLP's, the liabilities of each partner is usually limited to the extent of their investment (involvement) in the business , and will not have need to submit their personal assets for the business.

Advantage - Each partners brings their best knowledge/abilities on the table. Since there is more than one partner , they are able to raise a larger investment. All partners usually work towards the same goal of growing the business.

Disadvantage - A default (mistake) of one partner could result the other partners in being responsible and even being liable to the business. The other partners will need to give their personal assets to pay off the debts and legal obligations of the business and their partners, which makes it extremely risky if the partners do not a mutual trust and cohesive view of the vision of the business.

Corporation

Corporations can be Public Companies as well as Private firms. Public companies have owners who are also shareholders of the business and invest in the company by purchasing shares in the stock market. Private companies do not raise funds form outside public but internally through shareholders deciding by them. Corporations are much larger in size than partnerships and sole-proprietorships , and have a clear distinction in the ownership and management . The companies are managed by the board of directors that are appointed by the shareholders.

Advantage - Larger in size, investment, opportunities and vision. Board of directors are specialized to be making company decisions so the owners who invest their money do not need to look into the aspects of company operations. Their investments are usually well handles by people who are trained in their fields

Disadvantages - Agency problems, the owners who invest their money do not know how their investments are performing an usually do not have a decision power in the companies working. So, its a risky bet for the owners since they could lose their money ( in case of equity) if the company faces loses. No complete guarantee of the return on investment

(C) A company grows and becomes public when it opens its door to raise investment form the public. The capital to be raised is determined and then the price and number of shares it is willing to the sell. The share is then listed on the Public stock exchange of the respective country. With becoming a public company, the owners ( shareholders) of the company grow by a large margin, which makes the pressure for the company to perform well, equally increased, since they are now liable to the large amount of shareholders.

Agency problem usually arises in a corporation where there is a conflict between the principal ( owners/shareholders) and the agents ( corporation employees/managements ). The principal invests and provides money to the agent to take wise decisions for the company to increase the shareholders wealth ultimately. An agency problem arises when there is a conflict of interest between the agent and the principal. The agent has to take decisions not just keeping the interests of the shareholder in mind but also of the companies vision/mission and growth prospects. Every decision that results in corporation expansion ( new companies ) will not results in increase in shareholders wealth ( reduction in dividend for investing in new company). So there always arises an agency problem and the management has to tactfully handle the interest of both the parties.