Forms of business 1.5.4

Question 1

What is a business form?

Answer 1

The legal structure of a business determines the financial impact on the business owners if something were to go wrong, and affects the ease of the business financing growth.

Question 2

What is unlimited liability?

Answer 2

There is one legal identity for the owner and the business, so if the business goes into debt the owner could have to repay using both business and personal assets, putting the owner at risk of personal bankruptcy as well as business bankruptcy.

Question 3

What is a sole trader

Answer 3

This is an individual who owns and operates their own business. There may be one or two employees but the final decisions are made by the owner. They are the only ones to benefit financially from success but they have to face the burden of failure themselves too. They have unlimited liability, meaning that if a sole trader cannot pay the bills for the business the banks have the right to take personal assets as repayment. If this is still not enough to repay the debt the individual is declared officially bankrupt.

Question 4

What are the advantages of a sole trader?

Answer 4

1. Owner keeps all profit.
2. Simple to set up.
3. Owner has complete control.
4. There are no administrative costs involved.
5. Complete confidentiality can be maintained because accounts are not published.

Question 5

What are the disadvantages of a sole trader?

Answer 5

1. Unlimited liability.
2. No economies of scale.
3. Long hours for the owner.

The main disadvantages facing sole traders are the fact that there are only limited sources of finances available, there are long working hours, and if they are unwell running the business whilst in ill health can be difficult to do.

Question 6

What is a partnership?

Answer 6

These are formed when 2 or more people start a business together but they do not form an official company. They also have unlimited liability, so their personal assets are at risk as well as business assets if the business goes into debt. Because people are working together in this, and both are risking their personal assets as well as business assets it is absolutely crucial that the partners trust each other with their money. As a result, this legal structure is often found in professions such as medicine and law. The main difference between a partnership and a sole trader is the number of owners involved.

Question 7

What are the advantages of a partnership?

Answer 7

1. Easy to set up.
2. Shared burden of running the business.
3. More owners = more capital.

Question 8

What are the disadvantages of a partnership

Answer 8

1. Unlimited liability.
2. Profits have to be shared.
3. Disagreements.

Question 9

What is a limited partnership?

Answer 9

Rare, ‘sleeping partner’ - provide capital but take no part in management of the business.

Question 10

What are the disadvantages of a limited partnership?

Answer 10

Require that the general partner have unlimited liability. They are responsible for 100% of management control but also are on the hook for any debts or mishandling of business dealings. As well, limited partners are only allowed limited involvement in operations.

Question 11

What is limited liability?

Answer 11

The owner of the business has a separate legal identity for their personal life and their business, so if the business goes into debt the owner would only have to pay the bank back from the business assets, not personal assets.

Question 12

What is a limited company?

Answer 12

Limited liability means that no matter how much debt the business is in, it cannot take personal assets as payment, and this is because the business has a separate legal identity from the business. This means that, if the business were to lose £1 million, the owners would owe the money but they would not be forced to pay the money back in personal assets. If there is still not enough money the business would be closed down, but the owners and shareholders have no liability for any remaining debts from it.

They must go through a legal process to become an official company. The process of incorporation creates a separate legal identity for the business, so in the eyes of the law, the business and the owners are 2 different identities. The business would be able to take legal action against others and have legal action taken against it. In order to get this, the company must be registered with the Registrar of Companies.

Question 13

What are the advantages of a limited company?

Answer 13

• Shareholders experience the benefits of limited liability - including the confidence to expand.
• A limited company is able to gain access to a wider range of borrowing opportunities than a sole trader or partnership.

Question 14

What are the disadvantages of a limited company?

Answer 14

More Expensive to Set Up. There are a few key disadvantages of setting up a limited company.
More Paperwork.
Difficult to change the company structure.
Records Are Publicly Available.
Additional Reporting.
- Limited companies must make financial information available to the public.
- Limited companies have to follow more and more expensive rules than unlimited companies.

Question 15

What is a private limited company?

Answer 15

Small to medium-sized company, owned by shareholders who have limited liability. The company cannot sell its shares to the general public. They do not operate on the public stock markets.

Question 16

What are the advantages of an Ltd?

Answer 16

1. Large amounts of capital can be raised through shares.
2. Economies of scale.
3. Large business = can dominate markets.
4. Limited liability.
5. Capital can be raised through shares.
6. Control of business cannot be lost to outsiders.
7. As limited liability protects the shareholders from business debts, ‘cowboys’ can be attracted by the status and therefore take advantage of this - which is why many places say they do not accept business cheques.

Question 17

What are the disadvantages of an Ltd?

Answer 17

1. Shares can’t be sold to the general public.
2. Profits shared amongst more people.
3. More complex and expensive to set up - Ltds must be registered at companies house.
4. Accounts must be disclosed to shareholders.
5. Limitations on capital.

Question 18

What is franchising?

Answer 18

A contractual agreement between a franchisor and a franchisee that allows the franchisee to operate a business using a name and format developed and supported by the franchisor.

An arrangement in which one business (the franchiser) sells the rights to the name and the brand, and certain business operations, to another smaller business (the franchisee).

Question 19

What is a franchisor?

Answer 19

A business that sells the rights to the brand name, trademark, brand, and certain business operations to another smaller business.

Question 20

What is a franchisee?

Answer 20

An independent, small business that has bought the rights to use a better-known business’s brand name, trademark, brand, and certain business trading operations within a specific area.

Question 21

What are the advantages of franchising?

Answer 21

1. Lower risk.
2. Predictable set - up costs.
3. Support from the franchisor.
4. Benefit from national marketing campaigns.
5. Franchises find finance easier and cheaper to get, especially as the interest rates for the franchise would be lower than they would be for an independent business.

Question 22

What are the disadvantages of franchising?

Answer 22

1. Profit shared with the franchisor.
2. Contract + strict operating rules = lack of independence.
3. Expensive way to set up a business.
4. There are some dubious franchises out there that promise training and advertising support, but they give very little once they have been paid the franchising fee, which makes careful research into the franchiser essential. It is also important to consider that the franchiser’s share in the income can make it difficult to make a good amount of profit for the franchisee.

Question 23

What is social enterprise?

Answer 23

A business with mainly social objectives reinvests most of its profits into benefiting society rather than maximising returns to owners.

When a business is set up by an individual with the aim to solve a community problem, willing to take on the risk and effort needed to make a positive difference in the community.

Question 24

What are lifestyle businesses?

Answer 24

A business that aims to make enough money and provide the flexibility needed to support a particular lifestyle for the owner.

A business that has been set up based on the needs of their own or their family’s needs.

Question 25

What is stock market flotation?

Answer 25

The process of changing a business to a public limited company (PLC) by issuing shares for sale on a stock exchange.

• When a company has expanded to the point in which it has a share capital of more than £50 000 it can convert to a Public Limited Company (PLC). This then means it can be floated onto the stock market and members of the general public can buy shares in the company. This increases the company’s access to share capital and therefore makes it able to expand considerably. The key differences between a ‘PLC’ and an ‘Ltd’ are as follows:

Question 26

What are advantages of stock market flotation?

Answer 26

• Giving access to new capital to develop the business.
• Making it easier for you and other investors - including venture capitalists - to realise their investment.
• Allowing you to offer employees extra incentives by granting share options.
• Can encourage and motivate your employees to work towards long-term goals.
• Placing value on your business.
• Increasing your public profile, and providing reassurance to your customers and suppliers.
• Allowing you to do business - eg acquisitions - by using quoted shares as currency.
• Creating a market for the company’s shares.

Question 27

What are the disadvantages of stock market floatation?

Answer 27

• Beyond your control - including market sentiment, economic conditions or developments in your sector.
• It can be complicated and expensive and there is the possibility of losing control, as anyone can buy shares.
• Cost - the costs of flotation can be substantial and there are also ongoing costs of being a public company, such as higher professional fees.
• Responsibilities to shareholders - in return for their capital, you will have to consider shareholders’ interests when running the company - which may differ from your own objectives.
• The need for transparency - public companies must comply with a wide range of additional regulatory requirements and meet accepted standards of corporate governance including transparency, and needing to make announcements about new developments.
• Demands on the management team - managers could be distracted from running the business during the flotation process and through needing to deal with investors afterwards.
• Investor relations - to maximise the benefits of being a public company and attract further investor interest in shares, you will need to keep investors informed.

Question 28

What are the key differences between a PLC and an ltd?

Answer 28

• A public company can raise capital from the general public, but a private company cannot do so.
• The minimum capital requirement of a public company is £50 000, but there is no minimum for a private company.
• Public companies must publish far more detailed accounts than private companies.
• Most large businesses are PLCs, but the process of converting from private to the public can be extensive and difficult. Usually, successful small firms grow steadily, sometimes at a rate of 10% per year. The problem with floating onto the stock market is that it provides a sudden huge input of cash into the business - this forces the business to try and grow faster in order to appease shareholders.

Question 29

What does bankrupt mean?

Answer 29

When an individual or business is unable to meet personal or business liabilities, which can be a result of business activities.

Question 30

What is an online business?

Answer 30

A business that has been set up to be solely operated online, with free choice as to whether they have limited or unlimited liability. With an online business, the financial investment usually happens more gradually over time, so they have more time to evaluate the risk before putting it out to risk capital. As well as this, the scale of the business is normally limitless. With an online business, the financial risks are lower and the potential rewards are higher.

Question 31

What are debtors?

What are creditors?

Answer 31

Those who owe money to a business, such as companies that give bonds.

The people who are owed money by a business, such as bankers or suppliers.

Question 32

What is incorporation?

Answer 32

Establishing a business that has a separate legal identity to the owner and therefore giving the owners limited liability.

Question 33

What is a registrar of companies?

Answer 33

The government can allow a business to become an incorporated business.