- Profit and loss accounts and a balance sheet so that they can be assessed for income tax and national insurance contributions.
- A knowledge of health and safety laws and a willingness to make sure those rules are kept.
Debts
The owner of the business is completely responsible for all the debts of the business – up to the limits of their personal wealth. The owner’s responsibility for the debts of their business is unlimited. The sole trader has unlimited liability which means that the business person can lose all their personal wealth and possessions in order to pay off the debts of their business.
Profits
The owner of the business, the sole proprietor, keeps all the profits from the business. They do not have to share them with anyone else. However, this also applies to the losses of the business. It is the sole responsibility of the owner to pay off debts and cover losses.
Taxes
The business owner has to pay income tax on the profits that the business is making. Sole traders also have to pay VAT if turnover is large enough and they reach the VAT threshold. National Insurance contributions also have to be paid as the sole trader is considered as being self-employed.
Dissolution of Business
The business ends when it ceases to trade or when a different legal form is adopted. There is no legal formality associated when ending the business. The sole trader cannot escape from the responsibility of the debts of their business, as the full extent of the debts have to be repaid even if the business ceases to trade or adopts a different legal form.
Partnership
A Partnership is an agreement between 2 and 20 people to take joint responsibility for the running of a business, to share profits and to share the risks. There are no legal formalities to complete when a partnership is formed.
A partnership means:
- shared liability for debts.
Ownership
The partners own the business equally, unless this is stated as otherwise in the partnership agreement. There has to be a minimum of two partners and, in most cases, a maximum of twenty.
Control
The control of the business is the equal responsibility of all of the partners, unless the partnership agreement says otherwise, and decisions made by one partner are always binding on the others. In many partnerships there is a certain amount of delegation – meaning that particular partners are made responsible for particular jobs.
Finance
Each partner is required to contribute some capital and they share out the profits and the losses between all of the partners, unless stated otherwise in the partnership agreement. The partnership has a greater supply of funds as there are at least two people bringing their personal resources to the business
Establishing the Business
Individuals may enter into a partnership with one another without any real formal written agreement, but in practice they usually draw up a deed of partnership. Essentially this is a set of rules, which will hopefully help avoid disagreements between the partners.
The partnership agreement usually includes the following:
- the amount of capital to be contributed by each partner
- the ratio in which the profits and losses are to be shared. Usually this is worked out in relation to the amount of capital each of the partners has put in. So, in other words, the more capital each partner has
put in, the more profits he or she will be entitled to
- the salaries, if there are any, that are going to be paid to specific partners
- the rules for admitting and expelling partners
- the voting rights of partners - they may have an equal or an unequal share of the decisions making
- the rules for ending the partnership and the distribution of assets once the partnership is dissolved
- the working arrangements of the partnership.
Where one of the partners contributes a disproportionate amount of finance it is doubly important to draw up a deed of partnership. If no deed of partnership is drawn up the arrangements between partners will be subject to the Partnership Act 1890. These are basically that:
profits and losses are shared equally
- all partners have an equal say the running of the business
- all partners must agree before new partners can be admitted.
Debts
In partnerships, all partners have what is known as unlimited liability. This means that any debts incurred by the partnership have to be met by all the partners up to the limits of their personal wealth. Each partner is responsible for the entire debts of the partnership, whether they have caused the debt themselves or not.
Profits
According to the 1890 Partnership Act profits are shared equally. A partnership deed is able to vary this. All the profits go to the owners – the partners.
Taxes
Partners are classed as being self-employed. Thus they pay National Insurance contributions at the self-employed rate, income tax on the profits of the business and VAT, if the turnover is high enough.
Dissolution of Business
When a partnership ends, there are a number of formalities to be observed which are set out in the Partnership Act 1890. Subject to agreement between the partners, a partnership can be dissolved:
- at the end of a previously agreed fixed term
- at the end of what has previously been agreed to be a single undertaking
- by one partner giving notice to all the other partners that they wish to dissolve the partnership.
In addition, a partnership can be dissolved in the following circumstances:
- by death, in a two-partner partnership (in other cases the partnership agreement will normally state the procedure to be followed upon the death of a partner)
- by bankruptcy of one of the partners – although the other partners can agree before the dissolution to continue without the bankrupt partner
- through the occurrence of an event that makes it unlawful for the business of the firm to be carried on
- by order of the court – when a partner becomes in any way permanently incapable of performing their part of the partnership contract
- when one partner is guilty of committing an act that brings discredit or bad publicity to the firm
- where there are wilful or persistent breaches of the partnership agreement
- when the business can only be carried on at a loss
- where circumstances have arisen that, in the opinion of the court, make it just and equitable that the partnership be dissolved
- where a partner becomes so mentally ill as to be no longer capable of managing their affairs.
Once dissolution has been decided, the Partnership Act 1890 set out the rules for the distribution of the assets.
Private Limited Company
Private limited company is one type of limited company. This type of company must include Limited (or Ltd) in its title name. Two to an unlimited number of shareholders owns the company. The capital of the company is divided into shares. Shares can only be transferred ‘privately’ and all shareholders must agree on the transfer – hence the name ‘private’. Shares cannot be advertised for public sale. The private company may restrict share transfer if it wishes by writing a rule into its articles of association requiring members to offer shares to existing shareholders before attempting to sell them to non-members – this way ownership is kept within a particular group of people. A company must have:
- at least one shareholder
- at least one director; and
- a company secretary.
This means that a limited company:
- is owned by shareholders
- has a separate legal identity
- has limited liability.
Ownership
Shareholders own the business. When a firm issues shares, it is as if it is sharing out everything to do with the
business – each share gets an equal slice of ownership and thus an equal slice of the profits and an equal say in the control of the company.
Control
Each share has an equal amount of control. There is one vote with each share meaning that the owners of the business share the control equally.
Finance
The finance for setting up the company comes from selling shares in the company. The money that comes from the sale of shares never has to be repaid to the shareholders. Shareholders can sell their shares on to other people but the company does not have to buy them back. Not all the profits have to be shared amongst shareholders as they can be retained for future investment or expansion, which is a form of finance.
Establishing the Business
The steps to forming a private limited company (see figure 2 forming a limited liability company) are as follows:
- Register with the Registrar of Companies.
-
Draw up a Memorandum of Association. This must include:
• the trading name of the company
• the status of the company i.e. private limited company (Ltd) or public limited company (plc)
• the registered address of the company
• for what purpose the company is established
• the liability of shareholders
• the amount of capital with which the company is to be registered and the manner in which it is to be divided into shares
• a declaration implying that those signing the memorandum wish to form the company and that they are prepared to take up and pay for the number of shares shown on the form by their name. The minimum number of signatories is two.
3. Draw up the Articles of Association which outline the internal rules of the company. These articles can later be changed by shareholders as long as the changes to not conflict with the memorandum of association. The contents of the articles of association include:
• the rights of shareholders
• methods of election of directors
• the manner in which meetings are to be conducted
• division of profits.
- Miscellaneous statements and declarations which include:
• statement of nominal accounts – shows the amount of registered capital and the manner of its division into shares
• declaration – a statement made under oath by the company secretary of a director confirming that all the requirements of the Companies Acts have been met
• directors – the names of the first directors are listed
• statement of consent – signed by each of the proposed directors confirming that they are willing to act in this capacity
• address of registered office – this states the precise address of the company.
5. Obtain a Certificate of Incorporation from the Companies’ Registrar – it is at this point the company becomes a separate legal entity from its owners and a private company can start trading. There are three further steps if the company wishes to become a plc in the future:
• issue a prospectus which details the company’s finances, personnel, business aims, etc, and offers shares for sale
• issue share certificates to shareholders
• obtain a Certificate of Trading from the Companies’ Registrar to start trading.
FORMING A LIMITED LIABILITY COMPANY
Figure 2 Forming a limited liability company
Debts
The directors and shareholders are held responsible but, because of the limited liability, only up to the extent of the money they invested into the company.
Profits
The company for future investment or expansion – a decision that has to be agreed upon by the shareholders – or paid out to the shareholders, either retains the profits. As profits are divided equally amongst the shareholders, this is called a dividend.
Taxes
Corporation tax is like income tax for companies. Just as individuals are taxed on their earnings, so companies are taxed on their profits. Dividend payments are counted as part of the income of shareholders and are therefore taxed as income. If shareholders buy shares at a low price and sell them at a higher one, they have made a ‘capital gain’ and must pay capital gains tax.
Dissolution of Business
There are several forms of company dissolution:
-
Voluntary liquidation – because the members of a company no longer wish to carry on trading
-
Compulsory liquidation – because the company cannot meet its debts
-
Dissolution by the Attorney General – because the objectives of the company are offensive or illegal
-
Dissolution by the Registrar of Companies – because the company has ceased to trade.
When a limited company ceases trading its affairs are ‘wound up’ and its assets are sold to turn them into money. The money is then distributed, firstly to pay off any outstanding taxes and wages and then to pay off other debts of the company. Finally, the remaining money (if there is any) is distributed to shareholders. The winding up may be compulsory – because the company cannot pay its debts or has failed in its legal duties. Alternatively, the winding up may be voluntary – when the shareholders of a company decide that the company will cease trading.
Conclusion
John Smith (self-employed plumber) should form the legal identity as a Sole trader. He would control his own business and keep all the profits made by the business. In this form of business one person provides all the capital and assumes all the risks associated with the business. John runs the business and may employ any number of people to help. Success or failure of the business depends entirely on john’s head. There are no legal formalities involved in setting up in business as a sole trader. However, under the Business Names Act 1985 a business (irrespective of legal form) using a trade name other than that of the owner.
Jane Gregg and Sophia Jenkins (solicitors working together) should form the legal identity as a Partnership. Jane and Sophia can make agreement between themselves to take joint responsibility for the running the business, to share profits and risks. There are no legal formalities to complete when a partnership is formed.
Roger Evans, Mark Cooper and Joanna Sims (Computer Software Designers) should form the legal identity, as a Private limited company is one type of limited company. This type of company must include Limited (or Ltd) in its title name. Two to an unlimited number of shareholders owns the company. The capital of the company is divided into shares. Shares can only be transferred ‘privately’ and all shareholders must agree on the transfer – hence the name ‘private’. Shares cannot be advertised for public sale. The private company may restrict share transfer if it wishes by writing a rule into its articles of association requiring members to offer shares to existing shareholders before attempting to sell them to non-members – this way ownership is kept within a particular group of people.
