TB - starting a new business - types of business medium

Question 1

what are the two types of business medium

Answer 1

• unincorporated businesses (sole traders/partnerships)
• incorporated businesses (private and public limited companies/limited liability partnerships)

Question 2

what is the fundamental distinction between unincorporated businesses and incorporated businesses

Answer 2

an incorporated business has its own legal identity or separate personality and needs to be reg with CH

it’s an artificial ‘person’ created by law and is legally distinct from those who own and run the business

Question 3

key term - unincorporated business (does it have its own legal identity)

Answer 3

an unincorporated business doesn’t have its own legal identity (or separate personality) - there’s no legal distinction between the business and its owners and managers

Question 4

key term - incorporated business (does it have its own legal identity)

Answer 4

it has its own legal identity (or separate personality)
there’s a legal distinction between the business and its owners and managers

Question 5

practice q - Niamh is the only director and shareholder of a plc. the company has entered into a contract with your client, Linda, and failed to perform its obligations. should Linda consider legal action against Niamh, the limited company or both

Answer 5

Linda should consider legal action against the limited company only - as a separate (artificial) legal person, it owes the contractual obligations to her

Question 6

what is a sole trader/proprietor

Answer 6

someone who’s self employed and owns and runs their own unincorporated business

Question 7

can a sole trader have employees

Answer 7

yes but they are still the sole owner of the business

Question 8

sole traders may be involved in any trade, business or profession and can be anything from window cleaners and hairdressers, to accountants and solicitors - what does the term sole practitioner sometimes refer to

Answer 8

sole traders/proprietors who have a profession (eg dentist) rather than a trade (eg shopkeeper)

Question 9

as an unincorporated business, there’s no legal separation between the business and the sole traders personal affairs/assets - what is an advantage and disadvantage to this

Answer 9

advantage - keeping ownership and management simple

disadvantage - sole traders have unlimited liability

Question 10

key term - unlimited liability

Answer 10

a business owner is personally and directly responsible for all debts and liabilities incurred

Question 11

unlimited liability - a business owners personal assets (eg any property they own or money held in bank accounts even if unrelated to the business) will be at risk, and they can be made bankrupt if the business is unsuccessful - true or false

Answer 11

true

the concept of unlimited liability is a key disadvantage of carrying on business as a sole trader and its implications can have serious consequences

Question 12

practice example

katrina set up business as a hairdresser several years ago, but the liabilities of the business now exceed its assets by over £100k . K has savings of 50k and a house worth 200k.
the realisable assets of the business amount to 20k - how would you advise K

Answer 12

as a sole trader K will be personally liable for the debts of the business
the business is unincorporated so doesn’t have its own legal identity (or separate personality)
there’s no legal distinction between the business and its owner/manager
therefore K’s personal assets will be at risk (including her home) if she’s unable to satisfy the debts of her business

Question 13

although unlimited liability can be a sig disadvantage of being a sole trader, a key advantage is that there’s no specific formalities or legal processes required to set up the business - do self employed people need to register with HMRC

Answer 13

self employed people do need to register with HMRC and some sole traders may be required to register for VAT
however the additional costs of forming a company are avoided

Question 14

are there onerous ongoing formality, decision making, filing and disclosure requirements for sole traders

Answer 14

no (unlike companies)

this can make being a sole trader more attractive, private and less expensive

Question 15

sole traders pay income tax on their trading profits and capital gains tax on their capital gains - true or false

Answer 15

true - they will usually obtain tax advice when deciding on the type of business medium

Question 16

practice example

R wants to set up his own business as a business cleaner. His funds are modest and his liabilities and financial investment will be low. He’s keen to keep things simple and not to incur substantial expense. How would you advise R with regard to the most suitable business medium for him

Answer 16

although the benefits of limited liability may be sig for those investing large sums and taking sig risk, it would appear that the costs and administrative burden of setting up a limited company would not be appropriate here. therefore in this situation it would be advisable for R to operate his business as a sole trader

Question 17

key term - partnership

Answer 17

an unincorporated business with at least two owners

an unincorporated business that exists when two or more people carry on a business in common with a view of profit
s1 Partnership Act 1890

Question 18

partnerships under the PA must be distinguished from limited liability partnerships (which are incorporated businesses) - true or false

Answer 18

true

Question 19

as with sole traders, although the partners in partnerships may have employees, will they still be the owners

Answer 19

yes

Question 20

practice example - N and D are friends. they make and sell cakes in the town where they live and split the money they receive 50-50. they think that as the arrangements are purely informal and there’s nothing in writing, this isn’t a partnership - is this correct

Answer 20

they are mistaken - as N and D are carrying on a business in common with a view of profit, this is a partnership as defined by s1 PA. there’s clearly agreement between the parties (whether oral or implied by conduct) as to how the business is run

Question 21

are there any specific formalities required to set up a partnership business

Answer 21

no

Question 22

a partnership can arise through oral agreement or through conduct - true or false

Answer 22

true

Question 23

if the parties are actually carrying on business together with a view of profit - does a partnership exist

Answer 23

yes

Question 24

although no specific formalities or legal processes are required to set up a partnership, is it desirable to have a formal partnership agreement, setting out the terms of the partnership

Answer 24

yes because many of the provisions of the PA will apply, in the absence of an express or implied agreement to the contrary (the so called default provisions - many of the default provisions can have undesirable consequences)

Question 25

as an unincorporated business, is there a legal separation between the business and the partners personal affairs/assets

Answer 25

no

Question 26

as an unincorporated business, there is no legal separation between the business and the partners personal affairs/assets - so are they personally and directly responsible for all debts and liabilities incurred whilst they’re partners

Answer 26

yes - S9 PA

their personal assets are at risk and they may be made bankrupt if the business is unsuccessful

Question 27

under the PA for partnerships there’s no separation of ownership and control (s5 PA) - every partner may act for the purposes of the partnership business and the acts of any one partner may bind the partnership - true or false

Answer 27

true (this can make management more straightforward than with companies)

Question 28

do partners need to register with HMRC and is it true that they may be required to register for VAT

Answer 28

yes they do need to register with HMRC and they may be required to register for VAT

Question 29

in partnerships what are the additional costs that are avoided due to the nature of partnerships

Answer 29

the additional costs of forming a company are avoided

Question 30

there are no onerous ongoing formality, decision making, filing and disclosure requirements - how is this an advantage for partnerships

Answer 30

it makes being in a partnership more attractive, private and less expensive

Question 31

what do individuals in partnerships pay income tax on

Answer 31

on their share of the trading profits and capital gains tax on their share of the capital gains for the partnership

they will usually obtain tax advice when deciding on the type of business medium

Question 32

is a company an incorporated business or unincorporated business

Answer 32

incorporated business

Question 33

does a company have separate legal personality

Answer 33

yes

Question 34

do the owners (members) in a company usually have limited liability or unlimited liability

Answer 34

limited liability

Question 35

the company may be limited by shares or guarantee and can be public or private - true or false

Answer 35

true

Question 36

key term - company

Answer 36

an incorporated business with separate legal personality, where its members can have limited liability

Question 37

can a company exist without the involvement of companies house

Answer 37

no - unlike sole traders and partnerships, a company is the creation of a legal process and docs must be file at companies house in order for a company to be born

Question 38

note

Answer 38

companies may be involved in any trade, business or profession, they range from v small private companies with just one director and one member/shareholder to v large listed public companies (whose shares are traded on a stock exchange)

Question 39

exam warning

Answer 39

for purposes of sqe1 focus on private companies limited by shares and only those public companies whose shares aren’t traded on a stock exchange (ie unlisted public companies)

Question 40

what are the two key hallmarks

Answer 40

• separate legal personality
• limited liability

Question 41

which case was the principle of separate legal personality enshrined in

Answer 41

Salomon v A Salomon and Co Ltd [1897] AC 22

Question 42

what was held in the case of Salomon v A Salomon and Co Ltd [1897] AC 22

Answer 42

it was not fraud to set up a limited company in order to create a separate legal person, to avoid personal responsibility for debts

Question 43

cases where the court will disregard the fundamental principle found in the Salomon case and impose personal liability are very rare - true or false

Answer 43

true

Question 44

key term - separate legal personality

Answer 44

the company is a person separate from its members/shareholders and directors

as a separate legal person, it can own property, enter into contracts and be a party to legal proceedings (by suing or being sued)

it is a key advantage of incorporation and as an artificial person, it can have perpetual succession (can continue indefinitely)

Question 45

is a company the agent of its shareholders

Answer 45

no - unlike sole traders and partnerships

not even a one person company with one director and one member/shareholder

Question 46

key term - shareholders

Answer 46

the shareholders own the shares in the company

sometimes shareholders are referred to as members

Question 47

key term - directors

Answer 47

the directors have general management powers to control what the company does on a day to day basis - they run the company

Question 48

can directors and shareholders be the same people

Answer 48

yes - often the case with smaller companies

Question 49

is the separation of membership (ownership) and management an advantage or disadvantage of incorporation

Answer 49

it is a key advantage

but can also be unnecessarily cumbersome for smaller businesses (eg a one member, one director company)

Question 50

how is a sale/transfer of a company or any interest in it made more straighftorward

Answer 50

as this can be done through the transfer of shares as an alternative to the transfer of the assets themselves

Question 51

what are the two ways that liability may be limited

Answer 51

it may be limited by shares (more commonly) or by guarantee (usually for non profit making entities)

Question 52

key term - limited liability

Answer 52

limited liability means members have a limit on their liability to contribute towards the company’s debts

Question 53

limited by shares meaning

Answer 53

the liability of members (shareholders) is limited to any amount unpaid on their shares

Question 54

limited by guarantee meaning

Answer 54

the liability of members is limited to any amount they promise to pay in the event that the company is wound up
ie when it’s brought to an end and ceases to exist

Question 55

is limited liability a significant advantage or disadvantage of incorporation

Answer 55

advantage

Question 56

practice example - K subscribes and pays for 100 £1 shares in a private limited company. the company is subsequently wound up - what is K’s liability

Answer 56

K will have no further liability as he held fully paid shares - had payment not been made, or only partially made, he would be liable for the balance

Question 57

what are the two most significant advantages of incorporation

Answer 57

• separate personality
• limited liability

Question 58

having a company can be perceived as being more prestigious to both owners and clients/customers - it’s the main format for most big businesses and they’re recognised internationally - true or false

Answer 58

true

Question 59

companies can grant floating and fixed charges - what is the advantage of a floating charge

Answer 59

it is a more flexible form of security, which can improve the banking facilities available to companies

Question 60

what is a disadvantage for companies when it comes to commercial secrecy

Answer 60

most info kept at companies house becomes public - this may not be attractive to those who value commercial secrecy

Question 61

what do companies pay corporation tax on

Answer 61

their income profits and their capital gains

Question 62

private limited company characteristics

Answer 62

• a company that’s not a public company (s4(1) Companies Act 2006 (CA))
• may be limited by shares or by guarantee
• shares cannot be offered to the general public (s 755 CA)
• no minimum capital requirements

Question 63

public limited company characteristics

Answer 63

• certificate of incorporation states that it’s a public limited company
• may be limited by shares
• general public can be invited to subscribe for shares
• min capital requirements £50k (ss 761 and 763 CA.. shares must be at least one quarter paid up (s586 CA)
• subject to more stringent/onerous rules (particularly on disclosure) as public money is involved
• comp may apply for shares to be officially listed for trading on a recognised investment exchange (eg london stock exchange or alternative investment market)
• officially listed companies are subject to additional disclosure rules

Question 64

which act is a limited liability partnership formed under

Answer 64

the Limited Liability Partnerships Act 2000

Question 65

a limited liability partnership is a type of incorporated business and is formed by sending which form to companies house

Answer 65

form LLIN01

Question 66

key term - limited liability partnership

Answer 66

a cross between a company and a partnership, formed under the LLPA

Question 67

an LLP has a combination of the features of both partnerships and limited companies - true or false

Answer 67

true

for eg they’re available for persons carrying on a lawful business with a view to profit s2(1)(a) LLPA and every member is deemed to be an agent of the LLP (s6 LLPA)

Question 68

when a limited liability partnership is registered at companies house - does it have separate personality and do the members have limited or unlimited libaility

Answer 68

it has separate personality s1(2)LLPA and members have limited liability/aren’t directly responsible for its debts s1(4) and (5) LLPA

Question 69

like the PA the Limited Liability Partnerships Regulations 2001 provide provisions that apply between the partners in default of express or implied agreement to the contrary - does this grant less or more flexibility

Answer 69

more flexibility with regard to management than companies, which have stricter separation of powers

Question 70

can LLPs grant fixed and floating charges over their assets

Answer 70

yes

Question 71

companies are subject to ongoing administrative and reporting requirements - is this the same for LLPs

Answer 71

yes

Question 72

what is a key disadvantage of LLPs

Answer 72

they are not as well recognised internationally as limited companies

Question 73

what do LLP members pay income tax on

Answer 73

their share of the trading profits

Question 74

what do LLP members pay capital gains tax on

Answer 74

their share of the capital gains for the partnership