1. Business Structures

Question 1

(KF) What are the four principal business structures?

Answer 1

• The four principal business structures are the sole proprietorship, the partnership, the limited liability partnership, and the company.

Question 2

(KF) Sole proprietorships…

Answer 2

.. are the most common business structure and involve little formality, but the liability of the sole proprietor is personal and unlimited.

Question 3

(KF) Partnership…

Answer 3

Two or more persons who wish to conduct business can form an ordinary partnership. Such partnerships are subject to greater regulation than sole proprietorships, but less regulation than limited liability partnerships and companies. The liability of the partners is personal and unlimited.

Question 4

(KF) LLP…

Answer 4

Limited Liability Partnerships were created largely to be a suitable business vehicle for large professional firms. In many respects, limited liability partnerships closely resemble companies.

Question 5

(KF) PLC…

Answer 5

Public Companies are so called because they can offer to sell their shares to the public at large. There are other notable differences between public and private companies.
The vast majority of companies are limited companies, and so their members will usually have limited liability.

Question 6

INTRODUCTION

Answer 6

A person who wishes to engage in some form of business activity will need to do so via some form of business structure, with differing business structures providing different advantages and disadvantages. In the UK, four principal business structures can be identified, namely:
1. The sole proprietorship
2. The partnership
3. The LLP
4. The company
Two of these business structures (the LLP and the company) are created via a process called INCORPORATION and are therefore known as incorporated business structures or, as they are referred to in their respective statuses, as ‘bodies corporate’. The other two structures (namely, the sole proprietorship and the partnership) are not created via incorporation (although the Law Commission has recommended that ordinary partnerships should have corporate personality) and so are known as unincorporated business structures.

Question 7

INTRODUCTION contd.

REVISION TIP!

Answer 7

Although company law focuses on the regulation of companies, it is important that you understand the advantages and disadvantages that companies have when compared to other business structures. Indeed, an essay question may require you to discuss such advantages and disadvantages. Alternatively, a problem question may provide you with a set of facts involving the setting up of a new business, and you might have to advise which business structure would be most suitable for the new business.

Question 8

Sole Proprietorship

Answer 8

The simplest and most popular business structure is the sole proprietorship. A sole proprietor is simply a single natural person carrying on some form of business activity on his own account. Whilst a sole proprietorship will be carried on by an individual for that individual’s benefit, sole proprietors can take on employees, although the vast majority do not. The key point is that the sole proprietorship is not incorporated, nor does the sole proprietor carry on business in partnership with anyone else.

Question 9

Sole Proprietorships come in two forms

Answer 9

1. Where the sole proprietor is a professional (e.g. solicitor, accountant), he will be known as a ‘sole practitioner’
2. Where the sole proprietor is not a professional, he will be known as a ‘sole trader’. Although it is common to refer to all unincorporated single person businesses as sole traders, a sole practitioner is not actually a sole trader.

Question 10

Sole proprietorship: Corporate Personality?

Answer 10

Unlike incorporated structures, there is no separation between a sole proprietor and his business, and sole proprietorships do not have corporate personality. Accordingly, the sole proprietor owns all of the assets of the business and is entitled to all the profit that the business generates.

Question 11

Sole Proprietorship: Formation and Regulation

Answer 11

Commencing business as a sole proprietor is extremely straightforward and involves much less formality than creating a LLP or a company. All that an individual need to do is commence business as a sole proprietor is register himself with HM Revenue & Customs as self-employed. Sole proprietorships are not generally subject to the Companies Act 2006, so do not need to file accounts at Companies House and are subject to much less regulation than companies. However, being self-employed, sole proprietors are required to complete their own tax returns, so sole proprietors should maintain clear and accurate records of all transactions entered into.

Question 12

Sole proprietorship: Finance

Answer 12

In terms of raising finance, sole proprietorships are at a disadvantage when compared to other business structures. Partnerships can raise finance by admitting new partners. Companies, especially public companies, can raise finance by selling shares. Neither of these options is available to a sole proprietor who wishes to remain a sole proprietor. A sole proprietor will either need to invest his own money into the business (and risk losing it should the business fail) or obtain a loan. Given that many sole proprietorships are small affairs, banks are cautious when lending to sole proprietors and obtaining large amounts of debt capital is usually impossible.

Question 13

Sole proprietorship: Liability

Answer 13

The principle disadvantage of carrying on business as a sole proprietorship is that the liability of the sole proprietor is personal and unlimited.. Whereas partnerships and companies can be limited, it is impossible to create a limited sole proprietorship. Accordingly, the sole proprietor’s assets (including personal assets such as his house, car and bank accounts) can be seized and sold in order to satisfy the debts and liabilities of the sole proprietorship. If the sole proprietorship’s debts/liabilities exceed the assets of the sole proprietor, he will likely be declared bankrupt.

Question 14

Partnership

Answer 14

Two or more persons who wish to carry on business together cannot do so as a sole proprietorship for obvious reasons. For such persons, a partnership may be a more appropriate business structure, of which there are three different forms:

1. the ordinary partnership (usually referred to simply as a ‘partnership’)
2. the limited partnership, which is a form of partnership that can be formed under the Limited Partnership Act 1907. Limited partnerships are extremely rare.
3. the limited liability partnership which, being an incorporated business structure, is discussed under LLP.

Question 15

Section 1(1) of the Partnership Act 1890:-
(definition of a partnership)

Answer 15

defines a partnership as ‘the relation which subsists between persons carrying on a business in common with a view to profit’.

Question 16

Partnership: The relationship between the partners

Answer 16

The Partnership Act 1890 lays down detailed rules regarding the relationship between the partners. Many partnerships will have in place a written partnership agreement that sets out the rights ad obligations of the partners. Where a partnership agreement does not exist, ss 24 and 25 of the Partnership Act 1890 imply a number of default terms that will apply to the partnership. In fact, these implied terms will apply even where a written partnership agreement does exist, unless the implied terms are inconsistent with, or are excluded by, the terms of the written agreement. Examples of these implied terms include:

• All of the partners are entitled to share equally in the profits of the firm and must also contribute equally towards the firm’s losses.
• Every partner may take part in the management of the firm.
• No new partners may be admitted to the firm without the consent of all the other partners.
• The agreement between the partners can only be altered with the express consent of all the partners.
• The majority of the partners cannot expel a partner unless an express power to do so has been greed upon by all partners.

Question 17

Partnership: The relationship between partners and third parties

Answer 17

Sections 5-18 of the Partnerships Act 1890 regulate the relationship between the partners and third parties. This includes the extent to which the partners can contractually bind the firm and the other partners to a third party, and the extent to which the firm and the other partners can be liable for the acts or omissions of a single partner that cause a third party to sustain loss.

Question 18

Partnership: The relationship between partners and third parties

Agency

Answer 18

Regarding a partners ability to bind his partnership and co-partners to a third party, the key provision is s 5 of the Partnership Act 1890, which provides that each partner is an agent of the firm and of his co-partners. Accordingly, providing a partner acts within his authority, he is able to contractually bind his firm and his co-partners to a third party. In fact, in certain cases, a binding contract may exist where the partner has exceeded his authority, or even where he has no authority. As each partner had the power to contractually bind his co-partners, it follows that every partner is jointly liable for the debts and obligations of the firm incurred while he is a partner. As with sole proprietorship, the liability of the partners is personal and unlimited.

Question 19

Partnership: The relationship between partners and third parties

Liability for tortious and other wrongful acts

Answer 19

Partners may be held liable in tort or found guilty for the criminal acts of other partners. Section 10 of the Partnership Act 1890 provides that the partnership and each partner is vicariously liable for the wrongful acts or missions of another partner, providing that the partner was actually within his authority, or that the act or omission was done whilst in the ordinary course of the firm’s business.
(Example: Coffey & Sons is a UK-based firm of accountants consisting of 50 partners. One of the firm’s partners, Kirsty, is conducting an audit of BioTech plc, but she conducts the audit negligently. Under s 10, Coffey & Sons and the other 49 partners face liability for Kirsty’s act of negligence.)
Liability under s 10 is joint and several, meaning that the claimant can sue each partner in turn, or all the partners at the same time, until he has recovered the full amount of his loss. Liability is both personal and unlimited.

Question 20

Limited Liability Partnership

Answer 20

With the passing of the Limited Liability Partnerships Act 2000, two or more persons can now form a limited liability partnership (LLP).

Question 21

Limited Liability Partnership

REVISION TIP!

Answer 21

Students often confuse limited liability partnerships with limited partnerships, but the two business structures are very different. A LLP is a body corporate created under the LLPA 2000, whereas a limited partnership is merely a specialised (and extremely rare) type of partnership that can be created under the Limited Partnerships Act 1907. Although both offer limited liability, the limitations placed upon the limited partners of a limited partnership (notably the inability to take part in management) make LLPs a much more attractive option.

Question 22

Limited Liability Partnership: Purpose and functions

Answer 22

In order to understand the purpose and functions of LLPs, it is vital to understand why the LLPA 2000 was enacted. For large professional firms (e.g. accountants and solicitors) who may have thousands of partners worldwide, the joint and several liability of the partners meant that, for example, one partner in London could be personally liable for the unlawful acts of a New York-based partner that he had never met. The largest accountancy firms therefore lobbied the UK government to create a new form of partnership that provided its partners with limited liability similar to that enjoyed by the members of limited companies. The result was the LLPA 2000.

Question 23

Limited Liability Partnership

REVISION TIP!

Answer 23

An essay question in this area might require you to discuss the LLP and the extent of its usefulness. The story of the passing of the LLPA 2000 is significant as it is only professional firms that have expressed a significant interest in adopting LLP status. It is not therefore a business structure of widespread use and it is certainly not a structure designed to cater to the needs of small business. This is demonstrated in that, as of March 2014, there were only 59,327 LLPs incorporated in the UK.

Question 24

Limited Liability Partnership: Characteristics

Answer 24

Some argue that LLPs are hybrid organisations that combine the characteristics of a partnership and a company. Whilst this is true, there is little doubt that LLPs have more in common with registered companies than with partnerships.

• Like a registered company, a LLP is created by by registering documents with the Registrar of Companies at Companies House.
• Like a registered company, a LLP is a body corporate (LLPA 2000, s1(2)) and therefore has corporate personality.
• The LLPA 2000 refers to the partners of a LLP as ‘members’
• The members of a LLP, like the members of most registered companies, will have limited liability.
• Generally, LLPs are regulated by company law, although there are notable areas in which they are regulated by partnership law. Many provisions of the CA 2006 and virtually all the provisions of the Insolvency Act 1986 will therefore apply to LLPs as well as companies.

Question 25

Limited Liability Partnership: Liability

Answer 25

In the event of a partnership being dissolved, the partners are liable for the debts of the firm, with such liability being personal and unlimited. Conversely, the members of a LLP need contribute nothing when it is wound up, although there are several exceptions to this (e.g. the members of a LLP can be found liable for wrongful trading). Accordingly, the LLP remedies the principal weakness of the partnership, namely the personal and unlimited liability of its partners. As the LLP has corporate personality, it follows that the LLP itself will be liable for its debts and can be vicariously liable for the acts of its members, agents, and employees.
It should also be noted that a member of a LLP can be disqualified from acting as a member of a LLP or as a company director under the Company Directors Disqualification Act 1986.

Question 26

Limited Liability Partnership: Differences between an ordinary partnership and a LLP

Answer 26

FORMATION: OP= Can be formed informally by two pr more persons agreeing to carry on business in partnership.
LLP= Formally incorporated by registering certain documents with the Registrar of Companies.
HAS CORPORATE PERSONALITY?
OP= No
LLP=Yes
REGULATED BY?
OP= Regulated by partnership law, notably the PA 1890.
LLP= REgulated by company law, unless the LLPA 2000 states otherwise.
PARTNERS KNOWN AS?
OP= The partners of an ordinary partnership are simply known as ‘partners’.
LLP= The partners of a LLP are known as ‘members’
LIABILITY OF PARTNERS?
OP= The partners of an ordinary partnership are jointly liable for the debts of the partnership and are jointly and severally liable for its liabilities.
LLP= The members of a LLP are not generally liable for the debts and liabilities of a LLP - the LLP itself will be liable.
DISQUALIFICATION
OP= The partners of an ordinary partnership cannot be disqualified from acting as a partner of an ordinary partnership.
LLP= The members of a LLP can be disqualified from acting as a member of a LLP (or as a company director).

Question 27

Company

Answer 27

The processes by which the company can be created and the advantages and disadvantages of conducting business through a company are fundamental issues. The CA 2006 provides for a number of different forms of company that are classifiable by reference to certain characteristics, namely:
- 1. Is the company to to be public or private?
- 2. Is the liability of the company’s members to be limited or unlimited? If liability is to be unlimited, then the company must be private - the law does not allow for the creation of unlimited public companies.
- 3. Does the company have a share capital or not? Public companies must have a share capital, but private companies need not, although the vast majority do. A limited company does not have a share capital will be known as a company ‘limited by guarantee,’ although it is possible for a company limited by guarantee to still have a share capital if the company was created before 22 December 1980.
As companies limited by share capital vastly outnumber companies limited by guarantee. As the focus is on the companies limited by shares, it is the first two characteristics mentioned above that are of crucial importance, beginning with the difference between public and private companies.

Question 28

Company - Public and private companies

Answer 28

When creating a company, the promoters are required to state whether the company is to be registered as a private company or as a public company. A public company is a company limited by shares, or limited by guarantee and having a share capital, whose certificate of incorporation states that it is a public company (CA 2006, s 4 (2)). A private company is simply defined as any company that is not a public company (CA 2006, s 4(1).

Question 29

Company - Public and private companies - Differences

Answer 29

The principal differences between a public company and a private company include:

1. A public company is so called because it may offer to sell its shares to the public at large and, to facilitate this end, it may list its shares on a stock market (such companies are known as listed companies or quoted companies), with the principal market in the UK being the London Stock Exchange. This allows public companies to raise massive amounts of capital very quickly (for example, Facebook’s initial public offering of NASDAQ allowed it to raise over $16 billion in one day through the selling of shares). Private companies are not permitted to offer to sell their shares to the public at large (CA 2006, s 755(1)), nor can they list their shares on a stock exchange (Financial Services and Markets Act 2000, s 74). As a result, private companies can often find it difficult to obtain sufficient levels of capital.
2. Whilst private companies can be created with a trivial amount of capital (e.g. a single 1 pence share), public companies are required to have an allotted share capital of at least £50,000.
3. Both private and public companies can be created with only one member. However, whereas a private company can be formed with only one director, a public company must have at least two directors (CA 2006, s 154).
4. Public companies are required by law to appoint a company secretary (CA 2006, s 271), whereas private companies are not (but may do so if they wish).
5. Private limited companies are required to add the suffix ‘Ltd’ following their name (CA 2006, s 59(1)). Public companies must add the suffix ‘plc’ (CA 2006, s 58(1)).

Question 30

Company - Public and private companies - Differences contd.

Answer 30

NUMBER OF COMPANIES:
PUBLIC: As of March 2014, there were 7,831 public companies registered in the UK (0.3% of the total number of companies)
PRIVATE: As of March 2014, there were 3,214,959 private companies registered in the UK (99.7% of the total number of companies)
REQUIRED TO HAVE SHARE CAPITAL?
PUBLIC: Yes
PRIVATE: No, but the cast majority of private companies do have a share capital.
LIMITED OR UNLIMITED LIABILITY OF MEMBERS?
PUBLIC: Public companies must be limited. It is impossible to create an unlimited public company.
PRIVATE: Can be limited or unlimited, although the vast majority are limited.
CAN OFFER TO SELL SHARES TO THE PUBLIC AT LARGE?
PUBLIC: Yes
PRIVATE: No
CAN LIST SHARES ON A STOCK EXCHANGE?
PUBLIC: Yes, although the majority of public companies do not list their shares.
PRIVATE: No
MINIMAL CAPITAL REQUIREMENT?
PUBLIC: £50,000
PRIVATE: Can be created with a nominal amount of capital.
MINIMUM NUMBER OF DIRECTORS?
PUBLIC: Two
PRIVATE: One
SUFFIX?
PUBLIC: plc
PRIVATE: Ltd
REQUIRED TO APPOINT A COMPANY SECRETARY?
PUBLIC: Yes, public companies must appoint a company secretary.
PRIVATE: No, but may do so if it chooses.
LEVEL OF REGULATION?
The CA 2006 regulates public companies more stringently than private companies. Quoted companies are regulated even more stringently by having to comply with Pt VI of the Financial Services and Markets Act 2000 and the Listing Rules, and having to comply or explain against the recommendations in the UK Corporate Governance Code.

Question 31

Company - Public and private companies

REVISION TIP!

Answer 31

It is vital that you be aware of the differences between public and private companies as the CA 2006 regulates public companies more heavily than private companies. in problem questions, distinguishing between public and private companies will usually be straightforward due to the requirement to state Ltd or plc after the company’s name. Certain public companies are regulated even more strictly by additional rules contained in the Listing Rules.

Question 32

Company - Public and private companies - Listing Regime and the UK Corporate Governance Code

Answer 32

As noted, public companies are able to list their shares on a stock market, and such companies are known as listed companies or quoted companies.

Question 33

Company - Limited and unlimited companies

Answer 33

The terms ‘limited’ and ‘unlimited’ do not actually refer to the company itself, but to the liability of its members. As noted, the liability of the members of a public company must be limited (CA 2006, s 4(2)). Where the promoters decide to form a private company, they will need to decide whether the liability of the company’s members will be limited or unlimited.

Question 34

Company - Limited companies

Answer 34

The vast majority of companies are limited companies. in 2012-13, there were around 2.8 million companies registered in the UK, of which only 4,800 were unlimited companies. Where the liability of a company’s members is limited, the form and extent of the limitation will depend upon whether their liability is limited by guarantee or by shares.
- Where a company is limited by guarantee, the liability of the members is limited to the amount stated in the statement of guarantee (Insolvency Act 1986, s 74(3)).
- Where a company is limited by shares, the liability of the company’s members will usually be limited to the amount that is unpaid on their shares (Insolvency Act 1986, s 74(2)(d)). Members who have fully paid for their shares are generally not liable to contribute any more to the company. The vast majority of limited companies are limited by shares.
EXAMPLE: A newly incorporated company, Spartan plc, issues 100,000 shares, and provides that subscribers can pay fully for their shares immediately, or can pay half now and the remainder at a later date. The shares have a nominal value of £1. Tom decides to buy 1,000 shares and takes advantage of the ability to pay half the amount, therefore paying £500. A few months later, before Tom has paid the remaining amount, Spartan enters liquidation. The liquidator will be able to recover from Tom the remaining £500 (i.e. Tom’s liability is limited to £500). Had Tom paid the full £1,000 prior to liquidation, then the liquidator would not have been able to recover any more money from Tom.
As this example demonstrates, limited liability remedies the principal weakness of sole proprietorships and ordinary partnerships, namely personal and unlimited liability.

Question 35

Company - Unlimited companies

Answer 35

Only 0.2% of all companies are unlimited. The reason why there are so few unlimited companies is simple: in an unlimited company, upon winding up, the liability of the members is personal and unlimited, so their personal assets (e.g. house, car, bank accounts etc.) can be seized and sold to satisfy the company’s debts.