QXD 2/4/06 2:08 pm Page 197 Part Three FIRMS 8 Legal structures 9 Size structure of firms 10 Industrial structure 11 Government and business BUEN_C08.QXD 2/4/06 2:08 pm Page 198 BUEN_C08.QXD 2/4/06 2:08 pm Page 199 8 Legal structures Ian Worthington Market-based economies comprise a rich diversity of business organisations, ranging from the very simple enterprise owned and operated by one person, to the huge multinational corporation with production and distribution facilities spread across the globe. Whatever the nature of these organisations or their scale of operation, their existence is invariably subject to legal definition and this will have consequences for the functioning of the organisation. Viewing the business as a legal structure provides an insight into some of the important influences on business operations in both the private and public sectors. Learning Having read this chapter you should be able to: outcomes discuss the legal structure of UK business organisations in both the private and public sectors compare UK business organisations with those in other parts of Europe illustrate the implications of a firm’s legal structure for its operations explain franchising, licensing and joint ventures Key terms Articles of Association Joint venture Public limited company ‘Black economy’ Licensing (PLC) Company Managing director Public sector Company directors Memorandum of organisations Consortium Association Shareholders Consumer societies Nationalised industry Sole trader Executive directors Non-executive directors Stakeholders Franchising Partnership Unlimited personal liability Gearing Private limited company Workers’ co-operatives Golden share Public corporation BUEN_C08.QXD 2/4/06 2:08 pm Page 200 200 Chapter 8 · Legal structures Introduction Business organisations can be classified in a variety of ways, including: size (e.
small, medium, large); type of industry (e. primary, secondary, tertiary); sector (e. private sector, public sector); and legal status (e. sole trader, partnership, and so on).
These classifications help to distinguish one type of organisation from another and to focus attention on the implications of such differences for an individual enterprise. In the discus- sion below, business organisations are examined as legal structures and the consequences of variations in legal status are discussed in some detail. Subsequent chapters in this sec- tion investigate alternative structural perspectives in order to highlight how these too have an important bearing on the environment in which businesses operate. Private sector organisations in the UK The sole trader Many individuals aspire to owning and running their own business – being their own boss, making their own decisions.
For those who decide to turn their dream into a reality, becoming a sole trader (or sole proprietor) offers the simplest and eas- iest method of trading. As the name suggests, a sole trader is a business owned by one individual who is self-employed and who may, in some cases, employ other people on either a full- time or a part-time basis. Normally using personal funds to start the business, the sole trader decides on the type of goods or services to be produced, where the busi- ness is to be located, what capital is required, what staff (if any) to employ, what the target market should be and a host of other aspects concerned with the estab- lishment and running of the enterprise. Where the business proves a success, all profits accrue to the owner and it is common for sole traders to reinvest a consider- able proportion of these in the business and/or use them to reduce past borrowings.
Should losses occur, these too are the responsibility of the sole trader, who has unlimited personal liability for the debts of the business. Despite this substantial disadvantage, sole proprietorship tends to be the most popular form of business organisation numerically. In the United Kingdom, for example, it is estimated that about 80 per cent of all businesses are sole traders and in some sectors – notably personal services, retailing, building – they tend to be the dominant form of business enterprise. Part of the reason for this numerical domi- nance is the relative ease with which an individual can establish a business of this type.
Apart from minor restrictions concerning the use of a business name – if the name of the proprietor is not used – few other legal formalities are required to set up the enterprise, other than the need to register for Value Added Tax if turnover exceeds a certain sum (e. £58 000 in 2004/5) and/or to fulfil any special require- BUEN_C08.QXD 2/4/06 2:08 pm Page 201 Private sector organsations in the UK 201 ments laid down by the local authority prior to trading (e. some businesses require licences). Once established, of course, the sole trader, like other forms of business, will be subject to a variety of legal requirements (e.
contract law, con- sumer law, employment law) – though not the requirement to file information about the business in a public place. For some, this ability to keep the affairs of the enterprise away from public scrutiny provides a further incentive to establishing this form of business organisation – some of which may operate wholly or partly in the ‘black economy’ (i. beyond the gaze of the tax authorities). A further impetus towards sole ownership comes from the ability of the individ- ual to exercise a considerable degree of control over their own destiny.
Business decisions – including the day-to-day operations of the enterprise as well as long- term plans – are in the hands of the owner and many individuals evidently relish the risks and potential rewards associated with entrepreneurial activity, preferring these to the relative ‘safety’ of employment in another organisation. For others less fortunate, the ‘push’ of unemployment rather than the ‘pull’ of the marketplace tends to be more of a deciding factor and one which clearly accounts for some of the growth in the number of small businesses in the United Kingdom in the later part of the twentieth century. Ambitions and commitment alone, however, are not necessarily sufficient to guarantee the survival and success of the enterprise and the high mortality rate among businesses of this kind, particularly during a recession, is well known and well documented. Part of the problem may stem from developments largely outside the control of the enterprise – including bad debts, increased competition, higher interest rates, falling demand – and factors such as these affect businesses of all types and all sizes, not just sole traders.
Other difficulties, such as lack of funds for expansion, poor marketing, lack of research of the marketplace and insufficient management skills are to some extent self-induced and emanate, at least in part, from the decision to become a sole proprietor rather than some other form of busi- ness organisation. Where such constraints exist, the sole trader may be tempted to look to others to share the burdens and the risks by establishing a partnership or co-operative or limited company or by seeking a different approach to the business venture, such as through ‘franchising’. These alternative forms of business organisa- tion are discussed in detail below. The partnership The Partnership Act 1890 defines a partnership as ‘the relation which subsists between persons carrying on a business in common with a view to profit’.
Like the sole trader, this form of business organisation does not have its own distinct legal personality and hence the owners – the partners – have unlimited personal liability both jointly and severally. This means that in the case of debts or bankruptcy of the partnership, each partner is liable in full for the whole debt and each in turn may be sued or their assets seized until the debt is satisfied. Alternatively, all the partners may be joined into the action to recover debts, unless by dint of the Limited Partnership Act 1907, a partner (or partners) has limited liability. Since it tends to be much easier to achieve the same ends by establishing a limited company, limited partnerships are not common; nor can all partners in a partnership have limited BUEN_C08.QXD 2/4/06 2:08 pm Page 202 202 Chapter 8 · Legal structures liability.
Hence in the discussion below, attention is focused on the partnership as an unincorporated association, operating in a market where its liability is effec- tively unlimited. In essence, a partnership comes into being when two or more people establish a business which they own, finance and run jointly for personal gain, irrespective of the degree of formality involved in the relationship. Such a business can range from a husband and wife running a local shop as joint owners, to a very large firm of accountants or solicitors, with in excess of a hundred partners in offices in various locations. Under the law, most partnerships are limited to 20 or less, but some types of business, particularly in the professions, may have a dispensation from this rule (Companies Act 1985, s 716).
This same Act requires businesses which are not exempt from the rule and which have more than 20 partners to register as a company. While it is not necessary for a partnership to have a formal written agreement, most partnerships tend to be formally enacted in a Deed of Partnership or Articles since this makes it much easier to reduce uncertainty and to ascertain intentions when there is a written document to consult. Where this is not done, the Partnership Act 1890 lays down a minimum code which governs the relationship between partners and which provides, amongst other things, for all partners to share equally in the capital and profits of the business and to contribute equally towards its losses. In practice, of course, where a Deed or Articles exist, these will invariably reflect differences in the relative status and contribution of individual partners.
Senior partners, for example, will often have contributed more financially to the partner- ship and not unnaturally will expect to receive a higher proportion of the profits. Other arrangements – including membership, action on dissolution of the partner- ship, management responsibilities and rights, and the basis for allocating salaries – will be outlined in the partnership agreement and as such will provide the legal framework within which the enterprise exists and its co-owners operate. Unlike the sole trader, where management responsibilities devolve on a single individual, partnerships permit the sharing of responsibilities and tasks and it is common in a partnership for individuals to specialise to some degree in particular aspects of the organisation’s work – as in the case of a legal or medical or veterinary practice. Added to this, the fact that more than one person is involved in the own- ership of the business tends to increase the amount of finance available to the organisation, thus permitting expansion to take place without the owners losing control of the enterprise.
These two factors alone tend to make a partnership an attractive proposition for some would-be entrepreneurs; while for others the rules of their professional body – which often prohibits its members from forming a company – effectively provide for the establishment of this type of organisation. On the downside, the sharing of decisions and responsibilities may represent a problem, particularly where partners are unable to agree over the direction the part- nership should take or the amount to be reinvested in the business, unless such matters are clearly specified in a formal agreement. A more intractable problem is the existence of unlimited personal liability – a factor which may inhibit some individuals from considering this form of organisation, particularly given that the actions of any one partner are invariably binding on the other members of the business. To overcome this problem, many individuals, especially in manufacturing and trading, look to the limited company as the type of organisation which can BUEN_C08.QXD 2/4/06 2:08 pm Page 203 Private sector organsations in the UK 203 combine the benefits of joint ownership and limited personal liability – a situation not necessarily always borne out in practice.
It is to this type of business organisa- tion that the discussion now turns.