Types of organisation

Sole trader A sole trader is an individual who owns and operates his or her own business, but might employ a small number of people.

Sole trader: advantages There are no legal formalities needed to set up as a sole trader. Any profit made after tax belongs to the owner. The owner is in complete control and is free to make decisions. Independence is one of the key attractions of running a business.

Sole trader: disadvantages A sole trader has unlimited liability. This means that the owner is personally liable for any business debts, so they might be forced to use personal assets to cover debts incurred by the business. Only a limited amount of finance is available. The burden of responsibility is not shared. The owner may have difficulties in taking holidays and running the business during illness.

Partnership A partnership exists when the ownership of a business is shared by at least two people. In most cases, the maximum number of partners is 20, although there are some exceptions, e.g. accountants and solicitors.

There are no legal formalities to complete when forming a partnership. Partners often draw up a deed of partnership. This is a legal document, which states partners’ rights in the event of a dispute. It includes: How much capital each partner will contribute The rate of interest, if any, to be paid on capital invested How profits (and losses) will be shared The procedure for ending the partnership Partners’ salaries.

If no deed of partnership is drawn up, the arrangement between partners is subject to the Partnership Act (1890). This states that: Profits and losses will be shared equally There is no interest to be allowed on capital Interest should not be charged on drawings Salaries are not allowed A partner who contributes more money than the original capital is entitled to receive 5% interest on the additional amount.

Partnership: advantages There are no legal formalities that must be completed when setting up. Partners can specialise. More finance can be raised since there are more contributors. The workload and the burden of responsibility can be shared. For example, partners can share ideas when making decisions.

Partnership: disadvantages Generally, partners have unlimited liability. The more partners there are, the more the profits have to be shared out. Partners might disagree. The amount of capital that can be raised from owners is limited by the number of partners.

Any decision made by one partner is legally binding on all other partners. Partnerships must be wound up when one of the partners dies. Partnerships are unincorporated; partners can be sued by customers.

Limited partnership The Limited Partnership Act (1907) allows a business to become a limited partnership if some partners provide capital but take no part in the management. These partners have limited liability, which means that they can only lose the amount of money that they have invested in the business.

Limited liability partnership The Limited Liability Partnership Act (2000) allows all the partners in a partnership to have limited liability. However, in order to gain this advantage the Act requires that a limited liability partnership (LLP) must comply with a number of regulations, e.g. it must file its annual accounts with the Registrar of Companies.

Limited company The main feature of a limited company is that it has a separate legal identity from that of its owners. The owners of a company all have limited liability. If the company collapses, they cannot be forced to use personal funds to pay off business debts. They only lose the amount that they originally invested in the company.

The capital of a limited company is raised by selling shares. The shareholders are the joint owners of the company. They are entitled to a share of the profit (dividends) and some control over the company (voting rights). Control is exercised through a vote when appointing directors to run the company.

Forming a limited company involves following a set legal procedure. Draw up the Memorandum of Association and the Articles of Association. Register these documents and the names of the directors with the Registrar of Companies to gain legal status.

There are two types of limited company: Private limited company Public limited company.

Private limited company Shares cannot be bought and sold without the agreement of the directors. The company name must end with Ltd or Limited. The directors are often major shareholders and are involved in the running of the business.

Private limited company: advantages Shareholders have limited liability. It is easier to raise capital, as there is no limit to the number of members. Control of the company cannot easily be lost to outsiders. The business can continue even if one member dies, as shares can be transferred to other people.

company: disadvantages Private limited company: disadvantages Financial information must be filed with the registrar of companies. By law, company accounts must be audited. The legal procedures to set up and run a limited company can be complex. In practice, it might be difficult for a shareholder to sell shares.

Public limited company (plc) The name must end in plc. PLCs are allowed to sell shares to the public on the stock market and therefore tend to be larger. Setting up a plc is expensive.

Plc: advantages No limit to the number of owners, so very large amounts of money can be raised from the sale of shares to the public. Because of their size, companies may be able to raise finance cheaply because they are regarded as lower risk than private limited companies.

Plc: disadvantages Floatation costs can be very high. Outsiders can take over ownership if they buy more than 50% of the shares. Plcs have to publish much more detailed financial information than private limited companies. Plcs must comply with a range of company legislation, which is designed to protect shareholders.

Clubs and societies Non-profit making organisations, e.g. sports and social clubs, exist because their members are drawn together by a common interest. The assets of clubs and societies are the property of the members and most income comes from member’s subscriptions. Clubs and societies produce income and expenditure accounts, rather than profit and loss accounts which show either a surplus or deficit of income over expenditure, as they do not aim to make a profit.

Summary The main types of business organisation are: Sole traders Partnerships Limited companies Clubs and societies.

Exam tips Ensure that you understand and can discuss: The principles of ownership and the purpose of each type of organisation The advantages and disadvantages of each type The different types of capital structure.