Owners can run their businesses as sole traders, partnerships or limited companies, and they decide on the business ownership form after careful consideration of the business size and nature, liability, capital and the management structure. The simplest ownership form of any business is a sole trader, and when the business expands, management may change the business form and become a limited company. In this article, I will explain the business ownership types, and how they influence a business.
What are the business ownership types?
There are four main ownership types for doing business, namely the sole trader, partnership, limited liability and franchise. The following is a brief description of these various types of ownership:
- Sole trader:
A sole trader is an unlimited-liability business, unincorporated, and owned and controlled by one person. Businesses that provide services, such as plumbers, hairdressers or photographers, are often sole traders. Sole traders do not have a separate legal entity; therefore, the business and the owner are the same, and the owner is liable for any of the firm’s debts and may have to pay them from personal finances. This form of ownership also means unlimited liability by the sole trader, so there is no limit on the amount of money a person would have to repay if the business owed money to stakeholders. The advantages of this business type include easy to set up, require small capital investment and easy to manage. However, the disadvantages are the limitation of resources and unlimited financial liability.
This is like a sole-trader, except that a partnership is a business owned by two or more people. Medical doctors and lawyers are professionals who may enter a partnership company and enjoy their shared expertise. One major advantage of a partnership is that the partners can manage the business together and make joint decisions. The disadvantages are like those of a sole trader and the fact that probable disputes may arise between the partners. Just as with a sole trader, partners have unlimited liability, and thus they are liable for any third-party claims against the company.
A limited company has a special status in the eyes of the law. This type of company is incorporated, which has its own legal identity and separate from the personal finances of the shareholders. Shareholders own a limited company by buying shares in the company’s equity. In limited companies, shareholders are not liable for the firm’s debts, and they instead have limited liability equivalent to their shares in the equity. This benefit is considered a significant advantage for this business legal form, and the owners of a limited company are not necessarily involved in managing the business. A limited company can be private (ltd) or public (plc). The key attributes of both the private (ltd) and public (plc) are limited liability, incorporated firm, challenging to exit, requires a management structure and obligated to declare financial performance. The difference between the private (ltd) and public (plc) is about the financing structure, where the public (plc) is owned by the public and traded in the stock market.
An entrepreneur can set up a new business and turn it successful. One alternative is to purchase an existing business and get the right to use an existing business idea. This type of business is called franchising, which involves a joint agreement between franchisee and franchisor. Many well-known high street shops, such as Subway, are franchises. Opening a franchise is usually less risky than setting up a new business because it already proves the business concept and approaches in the market. Therefore, the franchisee is using a proven business model and selling a tested product in the market.
How ownership type can influence your business?
The key differences between the various ownership types include the level of liability, incorporation, management structure, exit criteria, formal registration, reporting obligation and capital structure. A sole-trader is unlimited liability, unincorporated, owned and run by one person, easy to exit, simple or no obligation to register and no reporting obligation. The partnership type is like the sole trader, except for the number of owners, where two or more owners for the partnership business. For the sole trader and partnership, the business has no legal identity from owners in the eyes of the laws, and the owners are personally liable and countable for any claims made to the business. Banks and other lending institutions hesitate to finance the sole trader and partnership businesses as they will end up offering personal loans with higher risk. Investors are also reluctant to invest in the sole trader and partnership businesses because of an unincorporated business, no equity shares or capital structure and difficult to exit. Public authorities usually require a limited-liability type of business to contract with. Many businesses also impose the condition of limited-liability companies to contract with. Sole traders and partnership have very limited resources to handle bigger projects and grow, and may face difficulties to attract and recruit talented staff. The sole trader and partnership types are easy options to start a new business with, but while the business grows owners must upgrade their businesses to become a limited liability, as this better facilitates sustainability and growth.
This article is extracted from my new book- Mastering Enterprise Skills for Potential Entrepreneurs, which can be found on www.amazon.co.uk. If you want to receive more information about the book and our activities, you can register in our newsletter by using this link.
Munther Al Dawood
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