Business Types

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Learning Objectives

Business ownership Individuals Partnerships Companies (corporations)

Comparison of Ownership Types

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Introduction

There are three general ways of owning and operating a business as an individual as a partnership as a limited company

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Individuals

The situation with an individual is fairly straightforward as only one person is involved

That person is the business

That person is often called a sole trader

S/he enters contracts in his/her own name in order to do business

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Partnership

It defines a partnership as “the relation which subsists between two or more persons carrying on a business in common with a view to profit”

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Definition of Partnership

There must be at least 2 people on a partnership and not more than 20 (except in law, medicine and accountancy)A limited company cannot be a partnership, although it can be one partner in a partnershipThe relationship between partners is based on the contract ie the terms of their partnership agreement

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Definition of Partnership (cont.)

To qualify as a partnership, the people must be carrying on a business

Business means any trade, profession or occupation

However, simply sharing in the profits of a business does not make you a partner in that business

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Definition of Partnership (cont.)

The business must be carried out in common

A partnership does not have a separate legal personality from the people who run the business

A partnership is simply a group of people who carry on a business together

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Definition of Partnership (cont.)

Partnerships are not only for carrying on business over a period of time, it is possible to create a partnership for a single event or business venture

The business must be run with the aim of making a profit

However, simply sharing in the gross profits of a business does not make you a partner

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Legal Status of a Partnership

The partnership does not have a separate legal identity from the partners (ie the owners)

As you will see, a limited company does have a separate legal identity from its owners

Because there is no separate legal identity, partners care self-employed and not employees

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Formation of a Partnership

There are no special legal rules for forming a partnership

It is an agreement between individuals

It may be made orally, in writing, or implied from the behaviour of the individuals

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Formation of a Partnership (cont)

However, it is common to have a written partnership agreement which sets out the name of the firm the nature of its business the method for sharing profits the amount of capital to be contributed by each

partner the reasons and method for ending the

partnership

This helps to avoid arguments later

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Liability of Partners

Each partner is liable for the full amount of the firm’s debts and other liabilities

A third party can sue the firm or the partners individually

Where the third party receives payment from one partner, then the other partners must contribute equally to the amount paid by him (indemnify that partner)

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Liability of Partners (cont.)

In order for a firm to be liable in tort, the wrongful act must have been done by a partner in the course of the firm’s business or with the approval of the other partners

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What is a Company?

A company is a body corporate or corporation

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Separate Legal Personality

As companies are a kind of corporation, they have their own separate identity

In law, they are regarded as a person

Although a company is not a natural person (like you or me) the law treats it in the same way in many areas

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Perpetual Succession

Changes in the membership of a company have no effect on the continuation of that companyUnlike a partnership, the death or bankruptcy of a member does not end the companyIn public limited companies, members are free to sell their shares on the stock exchange

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Business Property

Business property is owned by the company and not its shareholders

That means a creditor cannot take action against company assets in respect of a debt due by a member of that company

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Court Actions

A company can sue and be sued in its own name

It can also enter contracts in its own name

The company’s liability for contractual debts is unlimited It is only the members’ liability which is limited

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Liability in Tort and Crime

Companies are vicariously liable for the torts of their employeesCompanies can be guilty of crimes which do not require a mental element (eg intention or recklessness)However, it has been more difficult to prosecute companies where the crime has such an element as it has to be shown that one of the directors of the company had the required mental elementThis can be very difficult in a large company where the directors are not involved in the day to day operation of the business

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Types of Company

Companies can be classified in several ways

Limited and Unlimited

Limited by Shares or by Guarantee

Public and Private

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Limited and Unlimited Companies

Companies are usually formed because of the limited liability for their members

However, it is possible to create a company without limited liability

Such companies do not have disclose their accounts as limited companies do

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Limited by Shares or Guarantee

The most common kind of limited company is one limited by shares

Once the shareholder has paid the full value on his shares then he has no further liability

This is true even if the company does not have enough money to pay its debts

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Limited by Shares or Guarantee (cont)

A company limited by guarantee is usually created for charitable, educational or professional purposes ie it is not a trading company

The liability of members is to pay an agreed amount if the company is wound up

Usually, the amounts are small, so the risk is low

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Public and Private Companies

The main difference between public and private companies is that the shares in a public company may be bought and sold on a stock exchangePublic companies must have at least two directors, whereas a private company can have one

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Public and Private Companies (cont.)

Private companies may purchase their own shares out of capital, whereas public companies cannot

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Comparison of Ownership

It is useful to compare the advantages and disadvantages of the three forms of business Sole trader Partnership Company

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Sole Trader - Advantages

No legal filing requirements or fees and no professional advice is needed to set it up.

You just literally go into business on your own.

Simplicity – one person does not need a complex organisational structure.

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Sole Trader - Disadvantages

The disadvantages are that it is not a particularly useful business form for raising capital (money). For most sole traders the capital will be provided by personal savings or a bank loan.Unlimited liability – the most important point to note in terms of comparing this form to the company in that there is no difference between the sole trading business and the sole trader himself. The profits of the business belong to the sole trader but so do the losses. As a result he has personal liability for all the debts of the business.

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Partnership - Advantages

No formal legal filing requirement involved in becoming a partnership beyond the minimum requirement that there be two members of the partnership.

Easier to obtain capital as there can be up to 20 members of the partnership, all of whom could pool their investment within the partnership.

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Partnership – Advantages (cont.)

If you are aware of the problems the Partnership Act can cause (see disadvantages) then you can draft a partnership agreement to vary these terms of the Act

The partnership agreement can therefore be used to provide a very flexible organisational structure although this usually involves having to pay for legal advice.

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Partnership - Disadvantages

A partnership will end on the death of a partner. The partners are jointly and severally liable for the debts of the partnership. This means that each partner can be sued for the total debts of the partnership

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Company - Advantages

Companies are designed as to make it easy to raise capital.

Companies have the ability to subdivide their capital into small amounts, allowing them to draw in huge numbers of investors who also benefit from the sub-division by being able to sell on small parts of their investment.

Limited liability also minimises the risk for investors and is said to encourage investment.

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Company – Advantages (cont.)

It is also said to allow managers to take greater risk in the knowledge that the shareholders will not lose everything.

The constitution of the company provides a clear organisational structure which is essential in a business venture where you have large numbers of participants.

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Company - Disadvantages

Forming a company and complying with company law is expensive and time consuming.It also appears to be an very complex organisational form for small businesses, where the Board of Directors and the shareholders are often the same people

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Summary (cont.)

Most companies nowadays are formed under the Companies Act 1985

The law regards a company as a legal person

It has a separate identity from its owners (ie its shareholders)

A company is liable for its own debts

Its shareholders are not liable for its debts. They are only liable to pay for their shares