Pre-Reading Flashcards
(36 cards)
How do businesses raise finance?
There are four basic ways in which a business can raise money:
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; and
as already mentioned, 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.
Key considerations when forming a business
Costs - How much does this business model cost to set up?
Risk - Will the participants in the business have personal liability for debts of the business?
Structure - Does the business model provide a clear organizational structure? Is this flexible?
Formalities - Are there legal formalities that must be followed in running the business? How flexible is this business model regarding formalities?
Privacy - To what extent is information about the business required to be publicly disclosed?
Finance - How can the business raise capital?
Sole traders – Key characteristics
No set up costs – there are no formalities, the sole trader can start trading straight away.
A sole trader is not a separate legal entity – contracts are formed between the individual themselves and third parties.
Unlimited personal liability – the sole trader’s personal assets such as their home and cars are potentially liable to be sold to meet the debts of the business.
No formal structure - the individual can choose how they wish to run their business.
No Companies House filing or procedural requirements for running the business.
Complete privacy – no need for publicly filed accounts etc.
Partnerships – Key characteristics
- 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. See the next page for more detail on formation of partnerships.
- 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 joint (in contract) or joint and several (in tort) 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).
Partnership - Formation
Partnerships can be created without any formalities.
There does not need to be any intention to form a partnership – two or more people working together with a view to profit automatically form a partnership.
Limited Partnerships (LP) – Key characteristics
A LP has 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 (as amended). 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. Note that on 6 April 2017 a new sub-category of limited partnership called a private fund limited partnership was created. These are now commonly used for investment vehicles.
Limited Liability Partnership (LLP) – Key Characteristics (1)
The key difference between LLPs and sole traders, partnerships or LPs is that an 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.
Limited Liability Partnership (LLP) – Key Characteristics (2)
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 as follows:
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.
Companies – Key characteristics
company is a separate legal entity – companies are distinct from their owners (known as shareholders or members). This means that the company owns property, enters into contracts and can sue and be sued in its own name. Profits and losses belong to the company and not the shareholders and it is the company that is therefore liable for its own debts, not the shareholders.
Limited liability – the liability of shareholders is limited to the amount unpaid on their shares (if any). This protects shareholders and facilitates investment.
Companies are governed by the Companies Act 2006 (which superseded the Companies Act 1985) which contains detailed requirements regulating how companies are run and the filings and disclosures that must be made by all companies at Companies House.
However, these formal procedural requirements can be onerous, especially for small private companies where the shareholders and directors are often the same individuals.
Private companies
Private companies limited by shares (Ltd)
Most common type of company
No minimum share capital requirements
Prohibited from offering shares to the public
Can be formed by one person
Section 4(1) CA 2006 states that ‘a private company is any company that is not a public company’. Private companies’ names end with the word ‘Limited’ or ‘Ltd’ (s 59(1)). The vast majority of companies in England and Wales are private companies, and it is this type of company that this module focuses on.
Private companies limited by guarantee
No share capital
Liability of members is limited to the amount that they agreed to contribute in the event of a winding up
Membership is not transferable
These companies are relatively rare
Unlimited companies
The liability of the members is unlimited.
These companies are rare
Public companies limited by shares (Plc)
Can offer their shares to the public
Need a minimum of 2 directors
Minimum share capital requirement of £50,000 (s763 CA 2006)
Requires a trading certificate before it can trade (s761 CA 2006)
Listed companies
Only public companies can be listed.
Not all public companies are listed.
‘Listed’ means admitted on a regulated investment exchange such as the London Stock Exchange
Principal differences between a private and a public company
Name
As already mentioned, the name of a private company will end in ‘Limited’ or ‘Ltd’ and the name of a public company will end in ‘Public Limited Company’ or ‘Plc’.
Share capital
There is no requirement for a private company to have any specified minimum amount of share capital. A private company could be incorporated with just one share of 1p. In practice many companies are incorporated with a share capital of £1, that is with one share that has a nominal value of £1.
A public company must have a share capital with a nominal value of at least £50,000 (or the euro equivalent), of which at least one quarter must be paid up (this means paid at the time of purchase) (s 586 and s 763 CA 2006).
Number of directors
A private company need only have one director, and a public company must have a minimum of two directors (s 154 CA 2006).
Company secretary
A private company may choose to have a company secretary but it is not obliged to have one (s 270(1) CA 2006). If a private company does not have a company secretary, the directors (or any person the directors authorise) may do anything that the secretary is required or authorised to do (s 270(3)(b) CA 2006).
A public company must have a company secretary (s 271 CA 2006), and the person appointed to that post must have the requisite knowledge and experience and hold one of the qualifications specified in s 273(2) CA 2006.
Annual general meetings
A public company is required to have one annual general meeting (AGM) each year (s 336 CA 2006). Private companies are no longer required to hold an AGM, although they may do so if they wish.
An AGM provides members who are not directors with an opportunity to question directors, particularly on the issue of a company’s finances.
Regulation
Public companies are potentially able to offer their shares to the public. For this reason they are subject to a higher level of regulation than private companies. As well as the requirements of the CA 2006, further legislation governs public companies.
What constitutional documents are required for a company?
CA 1985 required companies to have two constitutional documents: the Articles of Association and the Memorandum.
Under s 17 CA 2006 the memorandum no longer forms part of the company’s constitution - it is only required as part of the procedure to register a company at Companies House. The memorandum of a company incorporated under CA 2006 simply amounts to a declaration on the part of the company’s subscribers ie that the first members of the company wish to form a company and agree to become members of that company (s 8 CA 2006).
Purpose of Memorandum
Under the Companies Act 1985 (CA 1985) the memorandum was a more complex document and formed part of the company’s constitution. Companies could set out constitutional restrictions in their memorandum and were required to include an objects clause setting out the purposes for which the company has been formed. Acting outside of this purpose was described as acting ultra vires or outside the company’s capacity.
Companies formed under CA 2006 have unrestricted objects (s 31 CA 2006) unless the objects are specifically restricted in the company’s Articles. So the ultra vires rule is not applicable to a 2006 Act company unless it has chosen to insert an objects clause into its Articles. You will learn more about this in the next Topic.
For older companies that were incorporated under the CA 1985, s 28 CA 2006 provides that any provisions in a memorandum must be treated as provisions of the company’s Articles. This includes the objects clauses included in the memoranda of all CA 1985-incorporated companies. Under CA 2006, therefore, the objects clause of an older company continues in force, operating as a limitation on that company’s capacity unless and until the Articles of that company are amended to remove its objects clause.
Contents of Articles of Association
All companies must have articles of association (Articles) (s 18 CA 2006). Under CA 2006, the Articles form the main constitutional document of a company. The purpose of the Articles is to regulate the relationship between the shareholders, the directors and the company.
Examples of the types of provisions which are included in the Articles of a company are:
- the number of directors required to transact business (both to form a quorum at board meetings and to take decisions at board meetings);
- the method of appointment of directors;
- the powers of directors;
- how board meetings are to be conducted;
- any special rights attaching to shares;
- how shareholder meetings are to be conducted; and
- how and to whom shareholders may transfer their shares.
How can a company amend the articles and what is the basic rule for the amendments?
Through a special resolution
The basic rule is that, to be valid, any alteration must be made bona fide in the interests of the company as a whole
Legal effect of the Articles
The generally established rule is that the Articles evidence a contract between the company and its members in their capacity as members and with respect to their rights and obligations as members
2 Ways of forming a company
Incorporation from scratch ( by submitting relevant information to Companies House/ online)
Shelf company conversion ( purchase of shelf company followed by formalities to enable necessary changes)
Under s 9 CA 2006, the following must be delivered to the Registrar of Companies at Companies House for a company to be registered:
Memorandum
Articles
The fee
Form IN01
A statement of capital and initial shareholdings
A statement of the company’s proposed officers (directors, secretary)
If company is limited by guarantee, details of guarantee
A statement of compliance stating that the requirements of CA 2006 have been complied with.
Once the Registrar of Companies has approved the application for incorporation of the company, the company is sent a certificate of incorporation authenticated by the Registrar’s official seal. The certificate sets out:
- the name of the company (although this may be changed at a later date);
- the company’s registered number. The company’s registered number will never change and must therefore be used when drafting any legal agreements to which the company is a party to ensure that the company can be correctly identified following future changes to its name; and
- the date of incorporation
Advantage of shelf company
conversion of a shelf company retains the advantage of being an available option all the time on every day of the year, whereas online incorporation can only take place during Companies House opening hours.
