T1.2 Different business forms

Question 1

Different business forms

Answer 1

• Sole traders
• Partnerships
• Private limited companies and public limited companies
• Private and public sector organisations
• Non-profit organisations

Question 2

Business structure
Unlimited liability

Answer 2

• Unlimited liability: finances of the business are treated as inseparable from the finances of the business owners
  –>If company loses £1m, people owed money (creditors) can get the courts to force individual owners to pay up
  –>If the owner cant pay, they’re made personally bankrupt
• Two types of businesses have unlimited liability: sole traders, partnerships

Question 3

Unlimited liability:
Sole traders

Answer 3

• An individual who owns and operates their own business.
• They’re the only ones that benefit from the business’ success but also face the burden of failure.
• They have unlimited liability for any debts that result from running the firm.
• If a sole trader cannot pay their bills, the courts can allow personal assets to be seized by creditors in order to meet outstanding debts. Without paying back, they’re declared bankrupt.
• Theyre the most common form of legal structure in UK
• Include: shopkeepers, plumbers, contractors
• There are no formal rules to follow when establishing as a sole trader or administrative costs to pay. Complete confidentiality can be maintained because accounts aren’t published.
• Main disadvantages are the limited source of finances, long hours of work and difficulty of running business in ill health

Question 4

Partnerships

Answer 4

• When two or more people start a business without forming a company
• Like sole traders they have unlimited liability for any debts run by the business
• Often found in professions, such as law and medicine

Question 5

Limited liability

Answer 5

• Give protection to owners of companies through a ‘limited’ structure
• Means owners of business are only financially liable up to value of their share capital
• Company itself is liable for the rest because in law the business has a separate legal identity from its owners

Question 6

Process of becoming limited

Answer 6

• Needs its own identity in the eyes of the law. It has to go through a process of incorporation which involves:
  ◦ Producing legal documents
  ◦ Registering the company
  ◦ Deciding on the number of shares and shareholders
• In order to get separate legal status a company must be registered with the Registrar of Companies

Question 7

Limited liability:
Advantages and disadvantages

Answer 7

Advantages:
- Shareholders experience benefits of limited liability, including confidence to expand
- A limited company to gain access into wider range of borrowing opportunities than a sole trader or partnership
- Other advantages: easier to make money, owner not personally liable, customer confidence, tax breakers, pre-pack administration
Disadvantages:
- Limited companies must make financial information available publically at Companies House. Small firms arent required to make full disclosure of their company accounts but still have to reveal more than sole traders
- They have to follow more, and more expensive rules than unlimited liability businesses, for example producing audited accounts and holdings
- Other disadvantages: paperwork, payments to accountant, less confidentiality because reports and accounts are published, rules and reguations

Question 8

Pre-pack administration

Answer 8

• Process that allows a limited company that gets into debts to go into administration, but allows the business to continue trading under a different corporate identity.
  –>Its good in some ways as it saves jobs and customer orders can be fulfilled, however because the debts of the old company are written off, the creditors who are owed money are unlikely to receive payments

Question 9

Limited company:
Private limited company (Ltd.)

Answer 9

• Most popular because its relatively easy to set up and manage. It offers potential for growth because additional shares can be issued in the future to raise more capital
  –> Business has limited liability
  –> Why are business start-ups run by small groups/families… attracted to this? It has potential to grow, security of limited liability

Question 10

Public limited companies (plcs)

Answer 10

• Normally large businesses that require a lot of capital investment and they get this from selling shares to the public
  –> Shares are sold through stock exchange
  –> Plc company cant control who buys shares
  –> Sainsbury’s, Kingfisher, Boots are plcs
  –> A plc must have share capital worth more than £50,000
  –> Shareholders want a return on their investment, so some of the profits are distributed to them as dividends. This is why plcs are often pressured to go for short- to medium- term success rather than to take a long-term view

Question 11

Stockmarket

Answer 11

• Made up of buyers and sellers of shares. Shares are normally issued for sales through stockmarket. Shareprices and quantity of shares traded are determined buy demand and supply

Question 12

Public limited companies:
Advantages and disadvantages

Answer 12

Advantages:
* Can sell shares publically, potential raise huge amounts of money
* Can publically advertise their shares, newspapers, radios…
Disadvantages:
* Expensive to form, many legal documents are required
* Management is crucial, position making can be slow and disagreements between employees
* Shareholders own company

Question 13

Public sector organisations

Answer 13

• Public sector organisations are owned and run by central or local government and their main aim is to provide services to the general public. They include NHS, Police, welfare, roads and education
  –> Usually involve a lot of investment, they’re controlled by government and do not trade for profit
  –> Services are funded through taxes and everyone in the country has access to them. Their main objective is social provision but if they do make profit they have to be reinvested or given back into the treasury

Question 14

Non-profit making organisations:
Mutuals
Charities and non-charitable voluntary bodies

Answer 14

• Mutuals: two most well known are John Lewis Partnership and Co-op. They run for the benefit of their ‘members’ who are staff for JL and customers for Co-op
  –> JL is the largest employee owned business in the UK, with a workforce of over 80,000 ‘partners’
• Charities must wire in the public interest and show they do something that benefits the community like relieve poverty. They do this by raising money through donations and using it to do good work
  –> Some are non charitable voluntary bodies like Greenpeace or Friends of the Earth. They cant be classed as charities because a charity cannot be involved in political activity
• Charities ensures that those who fund the charity are not liable for my debts. It provides significant tax benefits. These include pressure groups such as Greenpeace and Friends of the Earth, or conventional charities such as Oxfam and Save the Children

Question 15

Co-operatives

Answer 15

• Can be worker owned like JL or Waitrose, or customer owned like Co-op. Co-operatives have the potential to offer a more united cause for the workforce than the profit of the shareholders. Workers at JL can enjoy 20% of their salary, as their share of company profits. Co-op has been less

Question 16

Not-for-profit organisations

Answer 16

• They’re mutual businesses, including many building societies and mutual life assurance business, have no shareholders and no owners. They exist solely for the best interests of members: its customers

Question 17

Shareholders

Answer 17

• Shareholder is any person who owns shares in a limited company and is entitled to a share of the profit. They have a right to vote on decisions about the business
• One of the roles of the board of directors is to get the best return on investment for shareholders
• Shareholders who have a lot of shares are very powerful and can use their voting rights to change the direction of the business
• Shareholders invest because they want to see money grow. Buy when share prices are low, sell when they are high. Shareholders also get dividends, which are payouts when company does well

Question 18

Dividends

Answer 18

• Dividends paid to shareholders out of company’s profit. Directors decide how much will be paid out and how much profit to keep and invest back into the business
• Number of shares you own determines the amount of dividends you get, as dividends are paid out per share
• Shares are issued to owners when it is incorporated, in return for capital investment
• Sometimes no dividend is paid, this could be because:
  –> Company has had a bad trading period
  –> It might need surplus cash to invest in development, for example updating equipment to improve efficiency
• Dividends are annual rewards for shareholders for their investment in the business. They represent an income to the shareholders. If companies grow, dividends grow
• This guarantees a rising income as the years go by while interest rates in banks go up and down, with no upward trend.

Question 19

Dividend cover

Answer 19

• Important issue with dividends is that there is a trade-off. The higher the dividend payout agreed by the directors, the lower the amount of retained capital available for reinvestment in the business. This can be measured by looking at the dividend cover
  –> If dividend cover is 1, it means business is paying out everything to shareholders and retaining 0. At 2, half is paid out and half retained
• If a firm has a low dividend cover, you can wonder:
  –> Why pay out high dividends when they’re not making much?
  –> Will they be able to go on if they continue?
  –> Are directors propping up shareprices in a short-terminist way? Meaning they pay high dividends now at the cost of future growth prospects, or survival prospects of the company

Question 20

Market capitalisation, or market cap

Answer 20

• Market cap is the market value of a company’s issued share capital. In other words it is the number of shares multiplied by the current price of shares on the stock market
  –> If company has issued 50,000 shares and they’re being traded at £7, then market cap is £350,000
• Important because it tells you the value of the company and allows you to compare it to another company of a similar size to see who is doing best
  –> If you were considering a takeover, it would be this you look at to find out how much you would need to raise to make a bid

Question 21

Supply and demand

Answer 21

• Shareprices are influenced by supply and demand
• When people are desperate to buy more shares the price normally goes up because the demand is high and supply is low. In this case the seller has the upper hand
• If a company’s share price is good and its performance is predicted to improve it can raise money through borrowing

Question 22

Rights issue

Answer 22

• sometimes companies raise money by issuing new shares to existing shareholders. Shareholders are offered shares in proportion to their current stock holding at a discount but only for a specific period
  –> This way of raising money is called a rights issue
• Shareholders don’t always like rights issue because the company is giving them the choice of finding more cash or seeing their shareholding’s diluted
  –> Therefore it is important for the company to explain to its shareholders the reason for the rights issue and why business needs money

Question 23

External environment

Answer 23

• Shareprices are also affected by external influences like recession, the actions of competitors or the government
  –> Companies associated with housing market saw their shareprices fall when UK house prices crashed. This can lead to some shareholders trying to sell their shares before they hit the bottom price

Question 24

Good or bad news in terms of progress

Answer 24

• Prices rise when companies announce good news like expanding into new markets or winning a government contract, and fall when they announce that they wont meet the performance expected of them or that they’ve lost an important contract
  –> Good news for company isnt always good news for investors because too much publicity can drive the value of the company only to see it fall quickly and take a long time to recover

Question 25

What influences the price of shares?
Value investors

Answer 25

• The value investors place on a share depends on the profit after tax the company makes (known in UK as ‘earnings’) multiplied by the value investors place on those earnings
  –> If investors have a great deal of confidence about the future of the business they’ll pay a higher multiple

Question 26

Effects of ownership on a business:
Sole trader or partnership

Answer 26

• day to day management of the business is in the hands of the owner, therefore the ownership control sits with the same people which can make business easier to manage
• Family businesses often experience disagreement on the continuing of a business or the progress of it for the future
  –> This makes the stock market cautious of small family businesses that want to expand
• Even small businesses need to decide on their objectives because, once they’re agreed, everyone knows what the are setting out to achieve, eg survival, growth, cash flow…
  –> They also need to decide whether they’re taking a short term or longer term perspective
• In the case of inter generational partnership, the younger partner needs to maximise profit whereas the older partner wants to re-invest in the business

Question 27

Effects of ownership on a business:
Private limited companies

Answer 27

• shareholders are likely to be the owners as well as working in and managing the business. This will raise similar issues to those discussed for sole traders and partnership
• Difference is that owners have gone through legal process of setting it up so they may have a business plan and longer term vision for the business
  –> They often have a more formal management structure than an unlimited company deciding what role each shareholder will play
• They also have a tighter control on performance of business because they will be keeping formal accounts so can easily see how the business is doing and the adjustments in response to market changes

Question 28

Effects of ownership on a business:
Public limited companies

Answer 28

• Often are accused of short-Terminism- because there are powerful shareholders whose priority is a return on their investment and not the long term future of the organisation
• When things go well the people who manage organisations are left to get on with it. But when value of company starts to fall, shareholders can use their power to remove CEO or other board members.
  –> This is seen during recessions with large plcs
• Shareholders rarely have emotional connections this means the people working in the organisation can see a sudden change in objectives and focus when market cap falls
  –> Short term goal is to maximise profit rather than the long term plan
• Leads to fundamental problems: whatever the mission statement says, staff will soon learn the real priorities of senior management
• Staff that rises up the ladder are the best ones to respond to the real mission, not the stated one. Real one might be to get a profit rise
  –> Person with cost cutting ideas will be valued more than one that reduces greenhouse emissions

Question 29

Effects of ownership on the public and not-for-profit organisations

Answer 29

• Public sector will be affected by ownership, changes in government shapes their objectives and decisions and some political parties are interested in financial accountability than other
  –> Parties on the right want them run more like commercial businesses and parties on the left see them as public service
  –> This makes managing public sectors difficult because they are subject to sudden changes in priorities and directions. Decision making can also be slow
• Not-for-profit organisations also has its own issues with objectives, decisions and performance. Mutuals tend to take a long-term and ethical approach to business, which gives them stability and pays off
  –> Not-for-profit voluntary bodies like Greenpeace have a difficult trend because they become too political- alienating their supporters
• Charities are run by trustees and because their objectives have to be stated by law, they tend to have a clear idea of what they are setting out to achieve
  –> Their stakeholders are primarily their diners and beneficiaries so they do not have the pressure of people wanting a return on investment
  –> They dont need professional leadership because raising donations to do good work wile keeping cost low is their measure of success