Blog | Entrepreneurship

The History of the Corporation

Why the legal structure of your organization is important

Limited liability is a type of legal structure for an organization where a corporate loss will not exceed the amount invested in a partnership or limited liability company. In other words, investors' and owners' private assets are not at risk if the company fails.

As Robert Kiyosaki learned during his study of admiralty law, corporations came into common usage in the 1500’s to protect investors in maritime ventures. Prior to the popular use of corporations, investors would come together as a partnership, outfit a ship, and send it out for trading purposes. If the ship was lost at sea, the investors could not only lose everything but also be personally seed by various creditors. Of course, this exposure deterred people from risk-taking and discouraged economic activity. Seeing this, the English Crown and courts allowed for the charter of corporations whereby risk and liabilities could be limited to the corporation itself.

The shareholders, the investors, were liable only to the extent of their contribution to the business. This was a significant development in world economic history.

Gradually, governments came to understand that in order to promote economic development, to create jobs and, yes, to collect more taxes, they needed to protect investors. And so the modern day corporation came into its own: an entity that encouraged investment for a larger good by limiting the liability of investors to the amounts contributed.

The corporation was followed by the limited partnership and the limited liability company. Now, all three good entities offer asset protection, shielding owners from personal attacks against their business. Indeed, the good entity is one of the key developments in the history of business. With a good entity, entrepreneurs can pursue opportunities without worry of losing absolutely everything.

Good Entities

It is well recognized that limited liability for shareholders, officers and directors is the number one reason to incorporate.

To succeed in business, to protect your assets and to limit your liability, you want to select from one of the “good” entities, structures that are truly separate legal beings:

• C corporations
• S corporations
• Limited Liability companies (LLCs)
• Limited partnerships (LPs)

Entities are good when they are legally separate from their owners. Corporations, LLCs, and LPs require filing with a state government to obtain a separate identity.

Bad Entities

Sole Proprietorship - is doing business in your name. By operating as a sole proprietorship you have unlimited liability for debts, claims, and obligations of the business. This unlimited liability means that your house and savings and personal assets are exposed to the claim of others.

General Partnership - is twice as bad as a sole proprietorship because you have twice the personal exposure. Whenever two or more persons agree to share profits and losses a partnership has been formed. Even if you never sign a partnership agreement, state law provides that under such circumstances you have formed a general partnership. Each partner is liable for the debts and obligations incurred by all the general partners. And remember, just as with a sole proprietorship, your personal assets are at risk in a general partnership.

Sole proprietorship and general partnerships are bad because there is no separateness to protect you.

Conclusion

Given this evolution to protected entities, why would you use the old fashioned, unprotected variety? If your advisor continues to recommend sole proprietorships and general partnerships perhaps you need a new advisor. And remember, there is no one right answer in all of this. Work with the right advisor to come up with the right entigy mix. Also know that setting up entities is not expensive. Some charge more or less, but don’t worry about asset protection being unaffordable.

Learn more about choosing the right entity for you in my book Start Your Own Corporation: Why The Rich Own Their Own Companies And Everyone Else Works For Them.