1.5.4 Forms of Business

Forms of Business

Key Definitions

Business Form: The legal structure of a business that determines the financial impact on the business owners if something were to go wrong, and affects the ease the of the business financing growth.

Unlimited Liability: There is one legal identity for the owner and the business, so if the business goes into debt the owner could have to repay using both business and personal assets, putting the owner at risk of personal bankruptcy as well as business bankruptcy. 

Limited Liability: The owner of the business has a separate legal identity for their personal life and their business, so if the business goes into debt the owner would only have to pay the bank back from the business assets, not personal assets. 

Sole Trader: A form of business involving just one person with unlimited liability, such as a window washer or a cleaner. 

Partnerships: A form of business involving 2 or more people who share management and profit between them, these can have either limited or unlimited liability, it depends on the type of partnership. 

Private Limited Company: A form of business with limited liability that does not operate on the public stock markets. 

Franchising: An arrangement in which one business (the franchiser) sells the rights to the name and the brand, and certain business operations, to another smaller business (the franchisee).

Franchiser: A business that sells the rights to the brand name, trademark, brand, and certain business operations to another smaller business. 

Franchisee: An independent, small business that has bought the rights to use a better-known business's brand name, trademark, brand, and certain business trading operations within a specific area. 

Social Enterprise: When a business is set up by an individual with the aim to solve a community problem, willing to take on the risk and effort needed to make a positive difference in the community.

Lifestyle Business: A business that has been set up based on the needs of their own or their family's needs.

Online Business: A business that has been set up to be solely operated online, with free choice as to whether they have limited or unlimited liability. 

Bankrupt: When an individual or business is unable to meet personal or business liabilities, which can be a result of business activities.

Creditors: The people who are owed money by a business, such as bankers or suppliers. 

Debtors: Those who owe money to a business, such as companies that give bonds.

Incorporation: Establishing a business that has a separate legal identity to the owner and therefore giving the owners limited liability. 

Registrar of Companies: The government that can allow a business to become an incorporated business. 

Short-Termism: When a business chooses to focus on the short term situation instead of planning ahead for the long term. 

Businesses with Unlimited Liability

This is when the finances of the business are treated as something inseparable to the personal finances of the business owners. This means that, if the business were to lose £1 million, the owners would also owe the money and could be forced to pay the money back in personal assets as well as business assets. This could result in the owners becoming bankrupt as well. Two types of businesses tend to have unlimited liability:

1. Sole Trader

This is an individual who owns and operates their own business. There may be one or two employees but the final decisions are made by the owner. They are the only one to benefit financially from success but they have to face the burden of failure themselves too. They have unlimited liability, meaning that if a sole trader cannot pay the bills for the business the banks have the right to take personal assets as repayment. If this is still not enough to repay the debt the individual is declared officially bankrupt. 

The sole trader is the most common form of legal business structure adopted by UK businesses, even though it has the greatest financial risk involved. In some areas of the economy this structure is the dominant structure, especially in fields where little finance is needed to set up and run the business, and customers demand a more personal service. There are no formal rules to follow when establishing a sole trader, and there are no administrative costs involved. Complete confidentiality can be maintained because accounts are not published. 

The main disadvantages facing sole traders is the fact that there are only limited sources of finances available, there are long working hours, and if they are unwell running the business whilst in ill health can be difficult to do. 

2. Partnerships

These are formed when 2 or more people start a business together but they do not form an official company. They also have unlimited liability, so their personal assets are at risk as well as business assets if the business goes into debt. Because people are working together in this, and both are risking their personal assets as well as business assets it is absolutely crucial that the partners trust each other with their money. As a result, this legal structure is often found in professions such as medicine and law. The main difference between a partnership and a sole trader is the number of owners involved. 

Businesses with Limited Liability

Limited liability means that no matter how much debt the business is in, they cannot take personal assets as payment, and this is because the business has a separate legal identity to the business. This means that, if the business were to lose £1 million, the owners would owe the money but they would not be forced to pay the money back in personal assets. If there is still not enough money the business would be closed down, but the owners and shareholders have no liability for any remaining debts from it. 

To benefit from limited liability the business must go through a legal process to become an official company. The process of incorporation creates a separate legal identity for the business, so in the eyes of the law the business and the owners are 2 different identities. The business would be able to take legal action against others and have legal action taken against it. In order to get this, the company must be registered with the Registrar of Companies. 

Advantages of Forming a Limited Company

• Shareholders experience the benefits of limited liability - including the confidence to expand.
• A limited company is able to gain access to a wider range of borrowing opportunities than a sole trader or partnership.

Disadvantages of Forming a Limited Company

• Limited companies must make financial information avaliable to the public.
• Limited companies have to follow more and more expensive rules than unlimited companies.

Private Limited Companies

The shares of a private limited company cannot be bought and sold without the agreement of the other directors or managers in the company. This means that the company is not listed on the public stock market, making it possible for the managers to maintain close control over how the business is run. This is typically run by a family or a small group of friends. It may be very profit focused, or it could have completely different objectives than profit maximisation. 

All private limited companies must have 'Ltd' after the company name to warn those dealing with the business that they are relatively small and has limited liability. As limited liability protects the shareholders from business debts, 'cowboys' can be attracted by the status and therefore take advantage of this - which is why many places say they do not accept business cheques. 

Growth to PLC and Stock Market Flotation

When a company has expanded to the point in which it has share capital of more than £50 000 it can convert to a Public Limited Company (PLC). This then means it can be floated onto the stock market and members of the general public can buy shares in the company. This increases the company's access to share capital and therefore makes it able to expand considerably. The key differences between a 'PLC' and an 'Ltd' are as follows:

• A public company can raise capital from the general public, but a private company cannot do so.
• The minimum capital requirement of a public company is £50 000, but there is no minimum for a private company.
• Public companies must publish far more detailed accounts than private companies.

Most large businesses are PLCs, but the process of converting from private to public can be extensive and difficult. Usually, successful small firms grow steadily, sometimes at a rate of 10% per year. The problem with floating onto the stock market is that it provides a sudden huge input of cash into the business - this forces the business to try and grow faster in order to appease shareholders. 

Other Forms of Business

Franchising

Starting a new business with a new idea needs a massive amount of planning, and sometimes also luck. Many of the problems involved with this can be avoided through the use of a franchise, which can be considered as a 'half-way house' towards the running of their own business for new business owners. If an independent business were to be set up, the owner would need to do all of the work on design, systems creation, promotion etc. on their own, whereas if they were to adopt a franchise this would all be done for them. The franchise owner also provides and handles all of the necessary staff training. 

Advantages of Running a Franchise

A young businessperson could treat being part of a franchise as a good source of training towards becoming a full entrepreneur. Few people have the range of skills required to be an independent business owner, which is why the failure rate for new independent businesses is higher than for franchise businesses - and because of this the attitude of bankers is very different when business owners seek finance for a franchise start-up. Franchises find finance easier and cheaper to get, especially as the interest rates for the franchise would be lower than it would be for an independent business. 

Disadvantages of Running a Franchise

Independent-minded hate being a franchise owner, as they often want to be their own boss. A franchisee is the boss of their own business, but without the normal freedoms of decision making as an independent business owner - this can be very frustrating for them. It is also important to choose the right franchise. There are some dubious franchises out there that promise training and advertising support, but they give very little once they have been paid the franchising fee, which makes the careful research into the franchiser essential. It is also important to consider that the franchiser's share in the income can make it difficult to make a good amount of profits for the franchisee. 

Social Enterprise

Where 'private limited company' is a legal term with specific rules that need to be followed, 'social enterprise' sounds great but actually promises little in return. The term 'social enterprise' means nothing more than the idea that the business claims to do good, but for whom the 'good' is for is not actually stated. A specific type of potentially social enterprise is the co-operative, such as John Lewis, which is a worker-owned co-operative, or the retail Co-op, which is a customer-owned co-operative. These have the potential to offer a more united cause for the workforce than the profit of shareholders. 

Lifestyle Businesses

Some entrepreneurs start a business based on the needs of their own or their family's needs. For example, a young couple might start a surf school by the sea in order to earn money whilst enjoying their love of surfing. With a lifestyle business the usual rules about objectives and strategies may not apply - the surfer entrepreneurs may target plenty of customers above plenty of revenue so they may set lower prices than a profit seeking business would. 

Online Businesses

Online businesses are so common nowadays that they barely need a separate category. Like any other business, they have to decide on a limited or unlimited liability business structure. The only thing that makes an online business different is that there is a different balance between risk and reward. Ordinary 'brick' businesses, such as a restaurant, there has to be a heavy financial investment before the business can begin to trade. With an online business, the financial investment usually happens more gradually over time, so they have more time to evaluate the risk before putting it out to risk capital. As well as this, the scale of the business is normally limitless. With an online business the financial risks are lower and the potential rewards are higher.