Types of business entity

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Cambridge International AS & A Level Accounting 9706

Types of Business Entity

The big idea: The legal form of a business decides who owns it, who runs it, who carries the risk when it fails and how easily it can raise money. Each form suits a different stage of growth, and each has its own sources of finance.

Summary — What This Chapter Covers

A sole trader is owned and controlled by one person, who has unlimited liability for the debts of the business.
A partnership has two or more owners who share control, profits and (normally) unlimited liability.
A limited company is a separate legal entity owned by shareholders with limited liability and run by directors. A public limited company (plc) may offer its shares to the public.
Each type has advantages and disadvantages for the owners and for other stakeholders such as lenders, suppliers and employees.
Sources of finance include secured and unsecured loans, bank overdrafts, payment by instalments, renting or leasing, trade credit and, for companies, share and debenture issues.
Choosing a source means matching it to the purpose: short-term needs with short-term finance, long-term assets with long-term finance.

1. The Three Types of Business Entity

Syllabus 1.1.1 · AS Level · Papers 1 & 2

Legal form, ownership, management and control

The syllabus compares three legal forms. The important differences are who owns the business, who manages it day to day, who controls the big decisions, and whether the business is a separate legal person from its owners.

	Sole trader	Partnership	Limited company
Owners	One person	Two or more partners	Shareholders (members)
Management and control	The owner makes every decision	The partners, as set out in the partnership agreement	Directors run the company; shareholders vote at general meetings and elect the directors
Legal identity	Not separate from the owner	Not separate from the partners	A separate legal entity: it can own assets, sue and be sued in its own name
Liability for debts	Unlimited	Unlimited (each partner can be made to pay all the debts)	Limited to the amount paid or unpaid on the shares
Capital comes from	The owner’s savings and loans	The partners’ capital and loans	Issues of shares and debentures
Financial statements	Private	Private	Must be published and filed; a plc’s are usually audited and widely available
Continuity	Ends when the owner dies or retires	A change of partner ends the old partnership	Continues whoever owns the shares

A private limited company (Ltd) cannot offer its shares to the general public; its shares are usually held by a family or a small group. A public limited company (plc) can offer shares to the public and may have them traded on a stock exchange, which lets it raise very large amounts of capital but brings much stricter rules on disclosure.

Limited liability partnerships

The syllabus states that questions on limited liability partnerships will not be set. Treat every partnership in an exam as having unlimited liability.

Practice Question 1

Rania is a sole trader. A customer sues the business for $90,000 and wins. The business has net assets of only $35,000. Explain what happens to Rania, and what would have happened if the business had been a limited company of which she held all the shares.

2. Advantages and Disadvantages

Memorise

Ltd v plc

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For the owners and for other stakeholders
Match the finance to the purpose
Lease, borrow, pay by instalments or pay cash?

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Types of business entity