Legal forms of business

Question 1

Why does a business need to raise finances?

Answer 1

○ to purchase premises from which to operate, plant and machinery, stock or raw materials, computer hardware and software in order to be able to manufacture and sell goods, or provide a service;
○ to employ staff to make the goods and/or provide the services to customers;
○ to obtain the advice of professional advisers from time to time, particularly accountants; and
○ to expand and grow, which it may do by acquiring other businesses, carrying out marketing activities

Question 2

How do business raise finances?

Answer 2

• the owners of the business may invest in it by making contributions of capital to the business;
• outside investors may be prepared to make a capital contribution to the business in order to share in its future profits;
• the business may borrow money, for instance, from a bank;
• a proportion of the profit that the business has generated is likely to be retained within the business to help it grow, rather than being distributed to the owners and investors in the business.

Question 3

What are some key considerations when forming a business?

Answer 3

Costs - How much does this business model cost to set up?
Risk - liability
Structure - Does the business model provide a clear organizational structure? Is this flexible?
Formalities - Are there legal formalities that must be followed? How flexible is this business model regarding formalities?
Privacy -
Finance - How can the business raise capital?

Question 4

What are the key characteristics of a partnership?

Answer 4

• No set up costs – there are no formalities, the partnership can start trading straight away.
• Partnerships can be formed without any formal agreement or even intention.
• A partnership is not a separate legal entity. Contracts are formed between third parties and the partners in the partnership as individuals.
• Unlimited personal liability - partners have unlimited liability for the debts and obligations of the partnership incurred while they are partners. This means that their personal assets such as their houses may need to be sold to meet the debts of the business.
• There are no Companies House filing or procedural requirements for running the business.
• Complete privacy – there is no requirement for publicly filed accounts etc.
• Partnerships are governed by the provisions of the Partnership Act 1890 (PA 1890).

Question 5

How can a partnership be formed?

Answer 5

• can be created without any formalities (s1(1) PA1890
• there does not need to be any intention to form a partnership
• S2 PA 1890 contains a list of rules for determining the existence of a partnership. Factors to consider include whether profits and/or losses are shared, whether a loan is made from one partner to another, whether property is held jointly. Evidence of profit sharing will be prima facie evidence of a partnership but not necessarily conclusive evidence.
• A loan of money by one party to another does not of itself create a partnership.

Question 6

Where should the terms of a partnership be written?

Answer 6

Partnership agreement

Question 7

What will the partnership agreement by governed by (default) if one isn’t drawn up?

Answer 7

Partnership Act 1980

• Section 24(1) Profits and losses: Partners are entitled to share equally in the profits of the business, and must share equally in the losses of the business, even where the parties have contributed to the capital unequally. There should therefore be an express provision in the agreement setting out a profit sharing ratio, otherwise both profits and losses are shared equally.
• Section 24(6) Remuneration: Partners are not entitled to a salary.
• Section 24(8) Decision Making: Decisions arising during the ordinary course of the business are decided by a majority, except for any change to the nature of the partnership business which requires unanimity.
• Section 25 Expulsion: A partner cannot be expelled by majority vote unless all of the partners have previously expressly agreed that a majority can do this.

Question 8

What are the key characteristics of a limited partnership (LP)?

Answer 8

• two different types of partners:
  ○ Limited partners who have limited liability. These limited partners must not be involved in the management of the business (they are often called ‘sleeping partners’ eg passive investors). If they do become involved in management, they lose their limited status and become general partners with unlimited personal liability.
  ○ General partners who run the business and have unlimited liability (as in a traditional partnership).
• There must be at least one limited partner and one general partner.
• LPs are governed by the Limited Partnership Act 1907. LPs must be registered at Companies House but have no requirement to file accounts.
• LPs are not commonly used for general business but often used for investment vehicles. They are popular joint venture business structures where an investor (limited partner) puts money into a business run by the general partner.

Question 9

What are the key characteristics of a limited liability partnership (LLP)?

Answer 9

• LLPs were introduced by the Limited Liability Partnership Act 2000 (LLPA 2000).
• LLP has a separate legal personality – it can own property and enter into contracts on its own behalf. However, for tax purposes it is treated as a partnership and the members are taxed as partners, each being liable to pay tax on their shares of the income or gains of the LLP. This is referred to as ‘tax transparency’.
• Section 2(1)(a) LLPA 2000 states that two or more persons associated for carrying on a lawful business with a view to profit can incorporate an LLP. A ‘person’ in this context can be a company as well as an individual.
• All partners in an LLP have limited liability. Their liability to third parties is limited to the amount that they have agreed to pay under the terms of their partnership agreement.
• LLPs are registered at Companies House in the same way as companies and are required to file annual accounts and other information.
• LLPs are in effect a hybrid between a traditional partnership (with procedural flexibility) and a company (with limited liability). Many law and accountancy firms are LLPs.
• The organisational structure of an LLP is very flexible and should be decided between the partners in a formal written Members’ Agreement. In the absence of any such agreement Regulations 7 and 8 of the Limited Liability Partnerships Regulations 2001 (SI 2001/1090) contain default provisions

Question 10

What are the default provisions stated for the organisational structure of an LLP? (Limited Liability Partnerships Regulations 2001)

Answer 10

• Members share equally in capital and profits.
• An LLP must indemnify its members for payments made and personal liabilities incurred by them in the ordinary and proper conduct of the business of the LLP.
• Every member may take part in management but no member is entitled to remuneration for managing the LLP.
• No person can become a member or assign their membership without the consent of all existing members.
• Ordinary decision making may be by the majority of the members. Any proposed change to the nature of the business requires the consent of all the members.
• There is no implied power of expulsion of a member by the majority unless the members have expressly provided for such a power in a Members’ Agreement.