1. Business Structures Flashcards
(KF) What are the four principal business structures?
- The four principal business structures are the sole proprietorship, the partnership, the limited liability partnership, and the company.
(KF) Sole proprietorships…
.. are the most common business structure and involve little formality, but the liability of the sole proprietor is personal and unlimited.
(KF) Partnership…
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.
(KF) LLP…
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.
(KF) PLC…
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.
INTRODUCTION
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.
INTRODUCTION contd.
REVISION TIP!
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.
Sole Proprietorship
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.
Sole Proprietorships come in two forms
- Where the sole proprietor is a professional (e.g. solicitor, accountant), he will be known as a ‘sole practitioner’
- 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.
Sole proprietorship: Corporate Personality?
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.
Sole Proprietorship: Formation and Regulation
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.
Sole proprietorship: Finance
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.
Sole proprietorship: Liability
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.
Partnership
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:
- the ordinary partnership (usually referred to simply as a ‘partnership’)
- the limited partnership, which is a form of partnership that can be formed under the Limited Partnership Act 1907. Limited partnerships are extremely rare.
- the limited liability partnership which, being an incorporated business structure, is discussed under LLP.
Section 1(1) of the Partnership Act 1890:- (definition of a partnership)
defines a partnership as ‘the relation which subsists between persons carrying on a business in common with a view to profit’.
Partnership: The relationship between the partners
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.
Partnership: The relationship between partners and third parties
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.
Partnership: The relationship between partners and third parties
Agency
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.
Partnership: The relationship between partners and third parties
Liability for tortious and other wrongful acts
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.
Limited Liability Partnership
With the passing of the Limited Liability Partnerships Act 2000, two or more persons can now form a limited liability partnership (LLP).
Limited Liability Partnership
REVISION TIP!
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.
Limited Liability Partnership: Purpose and functions
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.
Limited Liability Partnership
REVISION TIP!
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.
Limited Liability Partnership: Characteristics
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.
