Which is the most appropriate legal structure for the business?

Unincorporated business No distinction in law between the individual owner & the business itself Identity of the business & the owner is the same Sole traders or partnerships Unlimited liability If assets cannot pay liabilities, individual will become bankrupt

Unlimited liability A situation in which the owners of a business are liable for all the debts that the business may incur

Incorporated business The business has a legal identity that is separate from the individual owners These organisations can own assets, owe money & enter into contracts in their own right Private Limited Companies (Ltds) & Public Limited Companies (plcs) Limited liability Can become insolvent if liabilities are greater than assets (will first go into liquidation)

Limited liability A situation in which the liability of the owners of a business is limited to the fully paid-up value of the share capital

Sole trader A business owned by one person. The person may operate on his/her own or may employ other people Unincorporated, so unlimited liability Heavily reliant on own personal commitment to make the business a success Most commonly found in provision of local services, e.g. newsagents, plumbers, hairdressers

Partnerships A form of business in which two or more people operate for the common goal of making a profit Usually have unlimited liability, i.e. each partner is liable for the debts of the other partner Partnership agreement sets out rights & responsibilities of each partner – in the absence of an agreement, profits are shared equally More capital put into the business & stress/pressures are shared Ability to raise finance is limited

Limited Partnership Possible since Limited Partnership Act of 1907 At least one partner assumes responsibility for managing & running the business & has unlimited liability Sleeping partner – contributes finance but is not involved in the running of the business. Has limited liability

Limited Liability Partnership Limited Liability Partnership Act of 2000 introduced this new form of business – LLP Created in response to pressure from large professional partnerships concerned about unlimited liability of partners for very large legal claims Designed for professional or trading partnerships Partners actively involved can limit their liability for the partnership’s debts

Private Limited Company (Ltd) Small to medium- sized business that is usually run by the family or the small group of individuals who own it. Can keep affairs reasonably private Funded by shares that cannot be sold without the agreement of other shareholders, i.e. cannot be traded on the Stock Exchange Share capital is typically less than £50k Ltd after company name warns of limited liability

Public limited company (plc) Incorporated business with limited liability Shares are traded on the Stock Exchange Loss of control as becomes responsible to shareholders (shareholders are the owners) Subjects the business to constant scrutiny by financial press May cause the business to focus on short-term profits for shareholders & maintaining share prices in order to avoid takeover pressure – detracts from long-term decision making

Ordinary share capital Ordinary shares are known as risk capital or equity capital – no promises! If business is successful, each shareholders receives a dividend (share of profits) Shareholder gets to vote at the Annual General Meeting If you own 10% of company’s shares, receive 10% of profits distributed (some may be retained profit) & have 10% of the votes No guaranteed dividend level – agreed at the AGM

What if the business goes wrong? Shareholders will only have money invested returned if every debt has been paid in full In case of liquidation, shareholder is protected by the limited liability – can only lose the paid-up value of their shares and cannot be asked to pay any more money

Rights issue To fund expansion, new shares may be sold to existing shareholders This reduces the administrative costs that are an element of issuing ordinary share capital

Advantages of ordinary share capital Limited liability encourages shareholders to invest Not necessary to pay shareholders a dividend if the business cannot afford to (unlike loans where interest MUST be paid) If share capital is provided by business angels or a venture capitalist, also brings their expertise Can be easier to borrow from a bank as share capital can pay for assets that be used as collateral Permanent source of finance – money stays permanently in the business

Disadvantages of ordinary share capital In profitable years, shareholders will expect good dividends & this may be more expensive than interest charged on a loan Original aims of the business may be lost – new shareholders may not have the same values as original owners As the business grows, the % shareholding of the original owner(s) is likely to decline This will lead to a smaller share of the profit & even loss of control of the business

Ownership & Control Sole trader – owner & manager are likely to be the same person In plcs, shareholders vote for a board of directors who appoint managers to control & manage the business – ownership & control are separated

Divorce of ownership & control Shareholders may find it difficult to access information needed to challenge or judge quality of managers’ decisions Shareholders may have too narrow a focus on short-term finance & less understanding than management of the needs of other stakeholders

Stakeholders Any group of individuals with an interest in a business. This includeds:- Employees Customers Shareholders Local community

Corporate governance The systems & mechanisms established by a firm to protect the interests of its owners (shareholders) Board of directors is elected to represent shareholder interests, determine strategy & ensure that the firm acts legally Recommendation from government is that plcs should have more non-executive directors – independent assessors

Not-for-profit organisations Known as the ‘third sector’ – neither commercial nor public Includes voluntary & community organisations, charities, social enterprises, pressure groups,cooperatives, mutual societies & trusts

Common characteristics Non-governmental organisations Have a governing body responsible for managing their affairs Value driven – have social, environmental, community, welfare or cultural aims & objectives Usually established for purposes other than financial gain – profits or surpluses are reinvested into the organisation in order to further its objectives Many use volunteer staff in addition to paid employees

Legal structure – determining factors Need for finance in order to expand Size of the business Level & type of investment required Need for limited liability Degree of control desired by the original owners Nature of the business Level of risk involved