Business Organisations

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Introduction:

One of the early decisions that have to be taken by entrepreneurs looking to set up a business is what type of organisation they want to be.

For many small businesses there are three main options:

• A sole trader
• A private limited company
• A franchise

The decision on which to choose as the appropriate form of organisation depends on many factors, including the aims of the entrepreneur(s), type of business, level of finance needed and, crucially, the attitude of the entrepreneur to the risk involved.

This resource provides a series of questions and information to help build your understanding of the decisions that entrepreneurs have to take when deciding on the type of organisation to set up as.

Business Organisations

When setting up a new business, one of the things that an entrepreneur has consider is risk. Any business venture involves risk, and any decision an entrepreneur takes will involve a risk of some sort. What type of organisation to set up as is one of the main decisions an entrepreneur has to take early on, and it can be a very important decision. The entrepreneur needs to weigh up the risk against the reward. If the risk seems greater than the reward, the decision may need to be changed and another route followed.

Assessing risk is not an exact science. Different entrepreneurs may see risk in different ways, and some may be prepared to take more risks than others. The crucial point is that taking an important decision like what sort of business organisation to become without considering the risks and the rewards involved is not a good idea!

The different types of business organisation available to most small businesses each have advantages and disadvantages. The advantages and disadvantages reflect different degrees of risk. An entrepreneur should be fully aware of the advantages and disadvantages so that they can weigh up the risks to them and also the rewards.

The main options available are:

Sole trader:

This is the simplest form of organisation. The owner and the business are one and the same person in the eyes of the law: there is no distinction between the individual and the business. This is important. It means that if legal action were taken against the business, the individual – who remember, is not seen as being different to the business – is responsible. There is one owner (hence the name 'sole trader') but the owner may employ other workers.

The main features of setting up as a sole trader are:

• Setting up is simple: you just have to decide on your business, register with Her Majesty's Revenue and Customs (HMRC), and you are ready to begin trading
• The one owner takes all the decisions
• The owner has to accept all the responsibility
• Any profits made go to the owner alone
• The owner is responsible for all the debts of the business – if the business failed and debts were owed, the owner would have to pay these debts
• To pay off debts the owner may be forced to sell off personal possessions. This might include cars, houses, property, etc.
• This is called 'unlimited liability'. It means that the liability (responsibility) for the debts of the business are unlimited – if the sole trader has debts of £50,000 then they have to be paid off somehow
• The fact that the owner can be legally forced to pay off debts means that some suppliers are happier to enter into agreements to supply because the risk to them of losing money is less
• You would be the owner and take all responsibility – and also all the risks. If you make profits, you take them all; but if you make losses, you have to pay for them
• There are few formal processes to go through to set up apart from registering your business with Her Majesty's Revenue and Customs (HMRC) for tax purposes
• The owner is responsible for meeting all the legal and tax requirements of the business – they have to make sure they pay the right amount of income tax and National Insurance Contributions (NICs), for example, as well as meeting health and safety laws, employment laws, etc.
• Because the sole trader is the sole owner, the pressures of running the business can be very high.
• Running the business on your own can be time-consuming.
• Many sole traders find it difficult to get time away from the business – holidays may be a luxury!
• If the business is successful then there can be huge satisfaction to the owner knowing that they have done it all themselves.

Limited company:

A limited company is a more formal type of organisation. There are a number of legal processes that are required to set it up. In this type of organisation, the owner is legally separated from the business. This means that if legal action is taken against the business then it is the business that is answerable, not any individual in the business. It is the business, NOT an individual, who can sue and be sued.

Private limited companies generally have more than one owner although there is something called a 'single owner limited company' that now exists. As a general rule, there is more than one owner who each owns a share of the business. They are, therefore, called 'shareholders'. Each owner is called a shareholder because they agree to buy a share in the ownership of the business and they have a claim to a share of the profits the business might make. A small family business, for example, may have two owners with 50% of the shares each; others may have five owners with one dominant shareholder with 75% of the shares and the others owning only a small amount each. Shares can be bought and sold but only with the agreement of all the shareholders, and may not be sold to the general public. The shares in this type of organisation are not sold on the stock exchange. The business has to lodge its accounts with Companies House, and its financial details can be viewed by anyone (a small fee is required to do this).

Each shareholder will have invested a certain amount of money into the business. If the business got into trouble and had to close, they would risk losing all that money. However, when a business has to close, often it has debts which it cannot pay – payments to suppliers for goods, tax bills to pay, loans to pay off, etc.

We saw above how sole traders were fully responsible for these kinds of debts and how legal action could be taken against them by those who are owed money to get the debts paid. The sole trader runs the risk of having to sacrifice personal possessions in order to pay off these debts – their liability is unlimited.

With a private limited company, the situation is different. If there are debts when the business closes, the shareholders could lose the money they have invested. But if this money is not sufficient to cover the debts of the business then they cannot be forced to sell off their personal possessions to pay off the debts. Their responsibility for the debts of the business are therefore limited. The owners of a private limited company are said to have 'limited liability'. This is an important difference between the two types of business organisation. Having limited liability does not mean there is no risk to running the business – far from it. What it means, however, is that the owners know what the extent of the risk might be if things do not go as they hoped.

The name of this type of business organisation must have 'Ltd' or 'Limited' at the end to show that it is a limited company, for example, Jones and Son Plumbers Ltd, Northern Hotels Ltd, Dairy Farms Cheese Ltd.

A private limited company is popular for small businesses because of limited liability. However, some credit organisations and suppliers are reluctant to deal with some private limited companies for this very reason.

Franchises:

Some people want to run their own business but either they do not believe they have a good enough idea or lack experience in running a business. In addition, they might feel that running a business either as a sole trader or as a private limited company is too risky. There is one other option that might be considered and that is to set up as a franchise. There are a large number of businesses that are franchises – probably far more than you might realise.

A franchise is where an individual buys the right to operate under another business's name. The individual pays a fee to the franchise owner, and in return the owner provides the licence to trade under their business name, use marketing materials and provide training and equipment to set up. The franchise owner may also provide a degree of support for the individual, to help make sure that the business gets the best chance of being successful.

The franchise owner often takes a portion of any profits made and does have some say in how the business is run. Many McDonald's, KFC, Prontaprint, Timpson, Dominos Pizza, Toni&Guy, The Body Shop outlets, etc. are franchises.

The main benefit of operating as a franchise is that the individual gets the experience of running their own business, but with the added knowledge that the business model they are running has already been likely to be successful. (Although there are a growing number of small businesses who are trying to grow quickly through offering franchises who have not yet proved they are successful!).