When setting up a business, one of the most important considerations is what form that business should take. The three main options are:
1) Sole trader;
A sole trader is someone who is in business on his own as a self-employed person. There are no formalities for setting up the business.
A sole trader is personally liable for all the debts of the business, and so could be made bankrupt if the business is not successful.
This is defined as “the relation which subsists between persons carrying on a business in common with a view to profit” – s.1 (1) Partnership Act 1890.
The advantages of a partnership are that it has no:
1) formality in setting it up;
2) memorandum and articles;
4) publicly available accounts;
5) need for a written agreement, although many choose to have a partnership agreement;
6) huge set of rules to adhere to, unlike the Companies Act 2006;
7) prescribed roles of “director” or “member” so internal management is fluid.
However, the major disadvantage of the partnership is unlimited liability for the debts of the partnership. The partners’ assets and personal possessions may be at risk if the partnership is unable to pay its debts.
A partnership may also find it harder to raise capital as it cannot issue debentures and other forms of finance security.
There is also the option of a ‘limited liability partnership’, created by the Limited Liability Partnership Act 2000. An LLP is a hybrid between a partnership and a limited company. The intention was to offer the protection from liability of a limited company and the informality of a partnership.
Therefore, although both the sole trader and the partnership are easy to set up, the main risk is that liability is unlimited – participants stand to lose not only their investment but also the rest of their property if things go wrong.
This served to act as a disincentive to start up a business. As a result, there was a demand for some form of business entity which would encourage investment by offering limited liability to its participants – essentially, that investors would, at worst, only lose what they had invested in the business venture.
The solution was the company.
A public company is defined as:
“a company limited by shares or limited by guarantee and having a share capital (a) whose certificate of incorporation states that it is a public company, and (b) in relation to which the requirements of this Act, or the former Companies Acts, as to registration or re-registration as a public company have been complied with on or after the relevant date.” [Companies Act 2006, s. 4(2)]
Typically, a public limited company:
1) must have at least two members and two directors;
2) must have the words ‘public limited company’ or ‘Plc’ at the end of its name;
3) must have £50,000 of authorized capital before they can start trading;
4) has an unrestricted right to offer shares to the public and these shares may be floated on the stock market.
A private company is not defined, except to the extent that it is “any company that is not a public company.” [Companies Act 2006, s. 4(1)]
Typically, a private limited company:
1) can have just one member;
2) must have the word ‘Limited’ or ‘Ltd’ at the end of its name;
3) has no minimum capital requirement;
4) cannot offer shares publicly and does not float its shares on the stock market.
Advantages and disadvantages of the company
1) Limited liability, which protects members from personal insolvency;
2) It is the company that sues or is sued, rather than its members;
3) The assets are in the name of the company;
4) Members obtain shares and receive dividends;
5) Perpetual succession, which allows the company to continue as members come and go over time;
6) Increased methods of raising finance;
7) Some tax advantages.
1) There is far more regulation and less flexibility than sole trader or partnership;
2) Public inspection of accounts meaning loss of privacy;
3) Various administrative costs, for instance filing fees for documents.