1.2.1 Unincorporated businesses

Unincorporated businesses

1. The two unincorporated structures are the sole trader and the partnership, and between them they account for most UK businesses.
2. Because there is no legal separation, the money the business owes is money the owner personally owes, which is unlimited liability.

Sole traders

1. Easy and cheap to set up: the owner registers with HMRC and can start trading within days, with low start-up costs.
   1. Greggs started this way in 1939, when John Gregg delivered eggs and yeast to homes around Newcastle by bicycle as a one-man business.
2. Makes all the decisions: one person decides everything, so the business reacts quickly, but there is nobody to share the workload or challenge a bad decision.
3. Keeps all the profit: there are no partners or shareholders to share it with, so every pound of profit after tax belongs to the owner.
4. Flexible working hours: the owner sets their own hours, which is why this structure suits somebody fitting work around family commitments.
5. Privacy: accounts are not published, so competitors cannot look up what the business earns.
6. Limited sources of finance: a sole trader cannot sell shares, so money comes from savings, family, a bank loan, an overdraft or retained profit.
   1. Banks lend cautiously because the business owns few assets to offer as security.
7. Unlimited liability: personal possessions such as the owner's car or home can be sold to pay business debts.
8. No continuity: the business has no legal life of its own, so it ends when the owner retires, sells up or dies.

Partnerships

1. More capital: every partner can invest, so a partnership usually starts with more money than a sole trader could raise alone.
2. Shared workload and expertise: partners bring different specialisms and can cover for each other, so the business can offer more than one person could.
3. Shared control: decisions have to be agreed, which slows them down, and partners who disagree can stall the business with no boss to break the tie.
4. Shared profit: profit is split between the partners, so each owner earns less from the same total than a sole trader would.
5. Unlimited liability, shared: debts run up by one partner can be claimed from the others, which makes choosing a partner a financial decision as much as a personal one.
6. Disrupted continuity: if a partner leaves or dies the partnership normally has to be dissolved and reformed, which can interrupt trading.

What a deed of partnership covers

1. How profits are shared between the partners, and what salary each one takes.
2. How much capital each partner has invested, and how liability is shared.
3. Voting rights, and who decides important matters such as which products to sell.
4. How the workload is divided, and the rules for admitting a new partner or for a partner retiring.
5. A deed is not compulsory, but without one a disagreement over money has nothing to settle it.

Deciding whether to take on a partner

1. Ask first whether the partner brings capital, because a partner who invests money solves a finance problem that a bank loan would otherwise have to solve.
2. A partner who brings no money is a much weaker case, because they take a share of the profit for doing work a paid employee could have done.
3. Weigh the shared workload and specialist skills against slower decisions, possible conflict and the loss of sole control.
4. Then judge it against how profitable the business already is, because giving away half of a healthy profit costs far more than giving away half of a struggling one.

1.2.1b Incorporated and not-for-profit organisations

Incorporated businesses

1. An incorporated business can own property, borrow money and be taken to court in its own name, separately from its owners.
2. Because the company owes its own debts, shareholders have limited liability and can only lose the money they invested.
3. The company also carries on trading even when owners sell their shares or die, which a sole trader cannot do.
4. The cost is more paperwork and less privacy, because a company files annual accounts that anybody, including a competitor, can look up.

Private limited companies

1. Owned by a few shareholders: shares go to family, friends and invited investors, and existing shareholders normally have to agree before anybody sells theirs on.
2. Control is maintained. Because shares cannot be sold to just anybody, the founding owners keep decision-making inside the group.
3. More finance than a sole trader: selling shares raises money the owner could not raise alone, and banks lend more readily to a company.
4. Limited liability: a failure costs shareholders their investment rather than their home.
5. Profit is shared as dividends. Shareholders receive a dividend in proportion to the shares they hold, but because there are few of them more profit can be kept back to fund growth than in a plc.
6. Accounts are not private. Unlike a sole trader, a company must publish its accounts, and there are set-up and accountancy costs to meet.

Public limited companies

1. It can issue shares to the public. Selling shares on a stock exchange such as the London Stock Exchange raises sums no other structure can reach.
2. Limited liability: a shareholder in a plc risks only what they paid for their shares, which is what persuades thousands of strangers to put money into a business they will never run.
3. Borrowing is easier. Lenders can see the company's value and its published accounts, so loans are larger and cheaper.
4. Control can be lost. Anybody can buy the shares, so the original owners can be outvoted and a rival can mount a takeover.
5. Shareholders expect dividends. Profit is spread across many shareholders who want a payout each year, which can push the board towards short-term decisions.
6. Scrutiny and cost: detailed accounts are published and reported on, and floating on a stock exchange is expensive in legal and advisory fees.

Not-for-profit organisations

1. Aims: success is measured by the difference made rather than by profit, such as meals served, habitat protected or people housed.
2. Control: charities and similar bodies are run by trustees or a committee rather than by owners taking profit out, so decisions are made in the interest of the cause.
3. Finance: the money comes from donations, grants, fundraising and legacies alongside revenue from trading.
   1. That mix can be less reliable than sales, because donations fall when household incomes are squeezed and grants can be withdrawn.
4. Distribution of any surplus: nothing is paid out to owners, because the surplus goes back into the work the organisation exists to do.
5. The commercial reality: it still has to cover its costs and still closes if the money runs out, so the National Trust charges for entry and runs shops and cafés to fund its conservation work.

1.2.2 Benefits and drawbacks of legal structures

The four issues every structure is compared on

1. Management and control, meaning who makes the decisions and how quickly they can be made.
2. Sources of finance available, meaning where the money to start and grow the business can come from.
3. Liability, meaning how much of their own money the owners stand to lose if the business fails.
4. Distribution of profits, meaning who the profit is shared between and how much each owner keeps.
5. One pattern runs through all four, because as ownership spreads across more people the business can raise more money but each owner controls less of it and keeps a smaller share.

The five structures side by side

Management and control

1. A sole trader has total control, so a decision to change prices on Monday can be in force by Tuesday, but there is nobody to share the load or challenge a bad call.
2. In a partnership control is shared, which brings in more skills but makes agreement slower and disagreement possible.
3. In a private limited company the shares are held by people the owners invited, so the business can raise money without handing control to strangers.
4. In a public limited company anybody can buy shares, so the founders can be outvoted and a rival with enough money can take the company over.
5. In a not-for-profit, trustees or a committee decide, and they are bound to act in the interest of the cause rather than of any owner.

Sources of finance

1. A sole trader is limited to savings, family, a bank loan, an overdraft and retained profit, and lenders are cautious because the business owns few assets to offer as security.
2. A partnership can draw capital from every partner, which is why professional practices needing expensive equipment often take this form.
3. A private limited company can sell shares to invited investors and borrows more easily, because it has a separate legal identity and published accounts a bank can check.
4. A public limited company can raise sums no other structure can reach, and unlike a loan that share capital never has to be repaid.
5. A not-for-profit draws on donations, grants and fundraising as well as trading, which brings in money no ordinary firm could ask for but is less predictable than sales.
6. Finance is usually what forces a change of structure, because a business normally changes form when it cannot fund the next step any other way.

Liability and distribution of profits

1. Sole traders and partnerships have unlimited liability, so a failed business can take the owner's savings, car and home with it.
2. Private and public limited companies have limited liability, so a shareholder who put in £5,000 can lose £5,000 and no more.
3. Liability changes behaviour as well as risk, because an owner whose home is at stake turns down contracts that a company would take on.
4. On profit, a sole trader keeps everything after tax, partners split it as the deed sets out, and shareholders receive dividends in proportion to their holding.
5. A plc spreads dividends across thousands of shareholders who expect a payout each year, which leaves less profit to reinvest than a family-owned Ltd can keep back.
6. A not-for-profit distributes nothing, because the surplus is reinvested in the cause the organisation exists to serve.

1.2.3 Limited liability and choosing a structure

Unlimited liability

1. An unincorporated business has no legal identity of its own, so its debts are simply the owner's debts.
2. If the business cannot pay, a court can order the owner's savings, car and even their home to be sold to settle what is owed.
3. It applies to sole traders and partnerships, and in a partnership debts run up by one partner can be recovered from the others.
4. The effect on behaviour is real, because an owner whose house is at stake turns down the risky contract and grows more slowly than they otherwise might.

Limited liability

1. It applies to private limited companies and public limited companies, the two incorporated structures.
2. Shareholders' personal possessions are protected, because they are not liable for the debts of the business.
3. There is a guaranteed limit to their losses, since only the amount paid for the shares can be lost.
4. Knowing the worst case in advance is what makes outside investment possible, because somebody will risk £5,000 on a stranger's business when they would never risk their house on it.
5. The people who carry the risk instead are the suppliers and lenders, who may go unpaid when a limited company fails.

Choosing a structure for a new start-up

1. Most new businesses start as sole traders, because it is quick, cheap, private and needs no accounts to be published.
2. That suits a start-up whose risks and costs are small, such as a private tutor or a freelance designer, where the worst case is a few hundred pounds of unsold time.
3. A partnership makes sense when the start-up needs more capital or skills than one person has, though joint unlimited liability means the partners must trust each other.
4. Incorporating from day one is worth the extra cost when the business will borrow heavily or work in a sector where a single mistake is expensive, such as food manufacturing or construction.
5. So for a start-up the decision turns on how much could go wrong and how much money is needed, not on how ambitious the owner feels.

Choosing a structure for a large established business

1. A large business almost always needs limited liability, because the sums it owes at any moment are far beyond what any individual could cover.
2. A private limited company suits an established firm that wants the protection and the extra finance while keeping decisions inside the family.
3. A public limited company suits a firm that needs sums only the stock market can supply, and whose owners accept outside shareholders as the price.
4. The drawbacks of floating are real, since the founders can be outvoted, a rival can mount a takeover, the accounts are public, and floating itself costs a large sum in fees.

Recommending a structure

1. When you are asked to advise a business on changing structure, build the answer on four things rather than listing every feature you know.
2. Control and decision making, because moving from sole trader to Ltd means sharing decisions that used to be one person's.
3. Liability, because incorporating protects the owner's home and that protection is worth more the riskier the sector is.
4. Finance and access to capital, because share capital does not have to be repaid whereas a loan does.
5. Growth potential, because the structure has to fit where the business is trying to get to, not just where it is now.
6. Then weigh the loss of control against the ability to raise finance that never has to be repaid, and commit to an answer rather than leaving both sides open.