Legal Structure

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