Types Private Sector Organisations
Most organisations that operate in the private sector do so to make profits for the owners.
Legal structure
When a firm sets up, the basic choice is whether to be an incorporated business or not.
In an unincorporated business, the 'owner is the business', and is legally responsible for everything.
For incorporated firms, the firm is a legal entity, a s if it were a person in the eyes of the law. It has rights and responsibilities, that are separated from those of the owners.
A legal entity means that in law the business is treated as if it were a person If, for instance, someone steals from a company, it is the company itself that prosecutes the offender, not an individual manager.
An important difference between incorporated and unincorporated businesses is that of limited liability.
An incorporated business is owned by shareholders. Every shareholder (owner) has limited liability.
In the event of the business failing, the shareholders can
only lose up to the value of their shares. Their liability for debts is
therefore limited to
the maximum value of the shares they hold. So if a shareholder has $400
of shares in a company, which goes out of business owing large sums of
money, the shareholder can only lose a maximum of the value of the
shares.
In an unincorporated business the owner is responsible for all debts of the business (Unlimited Liability) and if necessary his/her personal possessions (assets), such as their house, can be seized by the authorities to pay business debts.
Businesses which possess limited liability must say so after their name, e.g. 'ABC Limited (in Brazil this is shortened to Ltda - limitada)
This acts as a warning to any individual or organisation that does business with the limited company that, on a liquidation, debts may not be paid. A shareholder's personal possessions cannot be sold to pay for these outstanding debts.
Unincorporated organisations
The business and the owner/owners are seen legally as being one and
the same. If you sue a sole trader for debt, for example, you sue the
individual owner of the business. The owner is entitled to all the
profit, but is also personally liable for all the debts. The owner has unlimited liability
and all of his assets may be sold to pay any outstanding debts after
the business assets have been sold e.g. the owner's house and car could
be seized by legal representatives of the creditors.
Sole traders and partnerships have unlimited liability.
Owners pay personal income tax, at whatever rate the government sets. As the owner's income increases the marginal rate of tax, also increases. There may come a time when the percentage rate of income tax, is higher than the corresponding rate of tax paid by a similar company. This may be an incentive to incorporate.
There are two types of unincorporated businesses:
Sole trader (sole proprietor)
Most new small businesses are set up as sole traders.
- This is the simplest legal structure. It is easy and cheap to set up. There are few formalities, although the sole trader may need to apply for licences or to register the name of the business.
- The income of the business is the sole trader's (owner´s) income and liable for personal income tax.
- Raising finance for
future growth of the business is usually more difficult for a sole
trader than a company, and potentially more expensive as interest is
likely to be higher because of the increased risk. Sole traders will
usually need some security to support borrowing, often their house, and the loan potential is limited.
- They stand to lose everything if the business fails and may become bankrupt. This situation is called unlimited liability. Some businesses, however, stay sole traders for a long time, even when they are large and even international. JCB, the digger firm, operated as a sole proprietorship for many, many years.
- There are no shares or shareholders. Many sole traders are small businesses that sell services such as taxi drivers, plumbers, decorators and electricians. As the business is the owner, a sole tradership ceases to exist when the owner retires or dies; it lacks legal continuity.
Although a sole proprietorship is owned by a single owner, it may have many employees. Never say in an exam that a sole trader is where the business is owned and run by one person.
Sole traders have no shares or shareholders. Do not call them companies!
Summary - You can make flashcards of these
Advantages of a sole trader:
- Cheap and easy to set up with few legal formalities
- The owner receives all the profits
- Decision-making is quick as only one person makes the decisions
- Being 'your own boss' can be motivating (self actualising)
- Privacy and confidentiality as public accounts are not required
- Flexibility and the ability to offer a personal service
Disadvantages:
- Unlimited liability - risks personal assets
- Limited sources of finance
- Limited managerial skills as the owner is responsible for all business functions
- High risks - sole traders have few economies of scale and therefore higher costs. They are vulnerable to competition from larger businesses with lower costs.
- Workload and stress - owners may be 'workaholics' knowing that any profit is down to them
- Lack of legal continuity
- No one to bounce ideas off
Partnership
A Partnership is owned by two or more people. For most ordinary
partnerships, the maximum number of partners is limited by law to
twenty, but like many forms of business structure, this varies from
country to country.
- The ownership, profit and liabilities are shared between partners.
- There is more work necessary to set up a partnership than a sole tradership. Generally, a legal agreement - the Deed of Partnership - must be drawn up by a lawyer.
- There is one major problem of a partnership and that is the responsibility carried by partners. Partners are responsible for losses, 'wholly or severally'. If they all can pay, they will share the debt, but if only one has any assets then this partner will pay all. In other words they still have unlimited liability. A whole section of the law covers partnerships, and they can be difficult to set up and run.
- Many professional firms are partnerships. Most firms of lawyers, accountants, vets and architects are partnerships. They have the necessary skill and knowledge to draw up the correct partnership agreement.
- Partnerships have to be re-established if one partner leaves or dies, as this event invalidates the Deed of Partnership.
Summary - Flashcards
Advantages of a partnership:
- Greater financial strength than sole proprietorship as there are more investors
- The owners receives a share of all the profits
- Decision-making can be shared between partners who may be specialists, allowing for the division of labour
- No responsibility to shareholders
- Privacy and confidentiality as public accounts are not required
Disadvantages:
- Unlimited liability - risks personal assets
- Limited sources of finance compared to companies
- Decision making may be slower than sole proprietorships, as more owner are involved. This may leads to disagreements and conflicts
- High risks - sole traders have few economies of scale and therefore higher costs. They are vulnerable to competition from larger businesses with lower costs.
- Workload and stress - owners may be 'workaholics' knowing that any profit is down to them
- Lack of legal continuity - if one partner dies or leaves the partnership is legally dissolved as the Deed of Partnership is invalid. Redrawing the Deed is expensive.
- A mistake by one partner has legal and financial consequences for all partners.
Unlimited liability, difficulties in raising finance and taxation issues are strong motivators to make businesses change their legal form to become incorporated.
