Business and Organisational Characteristics

1. Introduction — Incorporated v Unincorporated

The starting point for advising a business client is to identify whether the business is incorporated or unincorporated. This single distinction determines whether there is a separate legal entity, how the owners are taxed, the extent of their liability, and whether shares can be traded.

An incorporated business operates as a distinct legal entity, separate from its owners. Its formation occurs when the individuals wishing to establish it adhere to the various legal prerequisites for incorporation. The characteristics of an incorporated business include the payment of business tax on profits, the ability to trade shares, and the general exemption of owners from business liabilities.

Conversely, unincorporated businesses are enterprises conducted by individuals who have not established a separate legal entity to manage the business. These individuals bear full personal liability for the business's debts and pay income tax on profits. The trading of shares in these businesses is not permissible.

2. Sole Trader

The simplest business medium is the sole trader: a single self-employed individual carrying on an unincorporated business with no formalities and unlimited personal liability.

A primary advantage of being a sole trader is that the individual earns income from the money received from customers or clients and retains all the profit once expenses have been paid. The profits and benefits are therefore enjoyed 'solely' by one person. Sole traders pay income tax as self-employed individuals.

There are no formal requirements to begin a business as a sole trader, because there is no dedicated piece of legislation governing businesses run by a sole trader. While the law will govern the sole trader's activities, it does so through various pieces of legislation that apply to individuals or businesses in general.

3. Partnership

A partnership is the principal unincorporated vehicle for two or more people in business together. It is governed by the Partnership Act 1890 ('PA 1890'), which supplies a comprehensive default code where the partners have not agreed otherwise.

2.2.1 Formation of a Partnership

A partnership is where two or more people run and own a business together, and it can be formed orally, in writing, or even impliedly by conduct. It is created when the definition in s. 1 PA 1890 is satisfied — the relation which subsists between persons carrying on a business in common with a view of profit.

2.2.2 Characteristics of a Partnership

Like a sole trader, a partnership is an unincorporated business, and partnerships can engage in any trade or profession. The difference is that a partnership involves more than one person managing the business. Its advantage lies in its governance by statute, which provides enhanced protection for partners. Partners have unlimited liability for the partnership's debts, and their personal assets are at risk if there is not enough money in the business to pay creditors.

2.2.3 Management and Decisions

All partners have the right to participate in the management of the business. Day-to-day decisions are typically made by a majority, but certain situations require unanimity.

Introduction of a new partner — requires unanimity (s. 24(7) PA 1890).

Changing the nature of the partnership business — requires unanimity (s. 24(8) PA 1890).

Changing the terms of the partnership agreement — requires unanimity (s. 19 PA 1890).

2.2.4 Duty of Good Faith

Partners are required to act in good faith towards each other. They must disclose information about the business to each other, account for any benefit gained from using partnership property or its name, and account for any profit made from a competing business.

2.2.5 Finance and Taxation

Partnerships can be financed by the partners, by bank borrowing, and by the retention of profits. Partners can invest by way of capital or by lending. Such capital may be in the form of assets or cash and is treated as a debt owed to the partner, usually repaid only on dissolution or the departure of the partner. The partners divide the profits or losses of the business between them.

2.2.6 Duration and Dissolution

Most partnerships are 'at will', meaning they have no set duration and will continue until dissolved unless otherwise agreed. The PA 1890 provides a default partnership agreement for the partners: they may enter into an agreement which disapplies some of its provisions, but if they do not, the PA 1890 applies and its provisions are implied.

2.2.6.1 Fixed Term

The expiry of a fixed term will dissolve the partnership unless the agreement provides that it shall continue beyond that date. Where it continues, the partnership carries on as a partnership 'at will' on the same terms (s. 27 PA 1890).

2.2.6.2 Notice

If the partnership was entered into for an undefined period, it may be terminated by notice at any time by one partner giving notice to all the others. The notice takes immediate effect and need not be in writing unless the partnership was made by deed (s. 26(2) PA 1890).

2.2.6.3 Death or Bankruptcy

The death or bankruptcy of any of the partners will dissolve the partnership automatically.

2.2.6.4 Illegality

If an event occurs that makes it unlawful for the business of the firm to be carried on, or for the members of the firm to carry it on in partnership, the partnership is automatically terminated.

2.2.6.5 Court Order

A court may order the dissolution of the partnership on the following grounds:

A partner becomes incapable of performing his duties (s. 35(b) PA 1890).

Conduct that prejudicially affects the carrying on of the business (s. 35(c) PA 1890).

Breach of the partnership agreement (s. 35(d) PA 1890).

When the partnership can only be carried on at a loss (s. 35(e) PA 1890).

When the court considers it just and equitable to dissolve it (s. 35(f) PA 1890).

2.2.7 Limited Partnerships (LPs)

Limited partnerships ('LPs') are not widely used. An LP is similar to an ordinary partnership in that there must be at least one general partner with unlimited liability and at least one limited partner whose liability is limited to the amount they initially invested in the business. This limited liability is conditional: the limited partner must not —

Control or manage the LP;

Have the power to make binding decisions on behalf of the LP; or

Withdraw their contribution to the LP for as long as it is in business.

LPs were originally created to encourage entrepreneurs to establish businesses by mitigating some of the effects of the unlimited liability arising from an ordinary partnership. Over time, the limited company became the business format of choice as it offers even greater protection. Nowadays, LPs have regained popularity for specialist financial businesses, such as investment funds and venture capital funds.

4. Limited Liability Partnership (LLP)

The limited liability partnership ('LLP') is a hybrid between an ordinary partnership and a limited company. It was created by the Limited Liability Partnerships Act 2000 ('LLPA 2000') in response to pressure from professional firms for greater protection from liability than was available under existing partnership law.

2.3.1 Formation and Registration

An LLP is required by s. 8 LLPA 2000 to have at least two 'designated members', who are responsible for sending documents to Companies House. An LLP is registered by sending two forms to Companies House, but there is no need to send a copy of any partnership agreement or other constitutional document. The main form is generally equivalent to that used for a company and is called the 'incorporation document', which must contain (s. 2(2) LLPA 2000) the name of the LLP and the country where the registered office is situated.

2.3.2 Legal Personality and Liability

The LLP has a legal personality separate from that of its members. Thus it is the LLP that carries the duties and liabilities of the business owed to outsiders. Unlike the position with a partnership, the existence of the LLP is separate from that of its members. Partners in an LLP ('members') have full limited liability. The LLP is a corporate body with a separate identity from its members, and the provisions of the Insolvency Act 1986 (IA 1986) and the Company Directors Disqualification Act 1986 (CDDA 1986) apply to LLPs.

2.3.3 Authority of a Member to Bind the LLP

Every member of an LLP is the agent of the LLP (s. 6(1) LLPA 2000). Section 6(2) provides for limitations to be placed on a member's actual authority: an LLP is not bound if the member has no authority to act for the LLP in that matter and the third party knows that fact. The LLP agreement, if there is one, should provide for limits on the authority of members. However, this still leaves open the question of apparent authority.

2.3.4 Owning Property and Granting Charges

An LLP can issue debentures and grant fixed or floating charges. Every LLP must keep a copy of every charge requiring registration at its registered office (s. 859P CA 2006). These must be open for inspection by any LLP creditor or member without paying a fee.

2.3.5 Taxation

For most tax purposes an LLP is treated as 'transparent', so that any tax liability arising from the business is assessed not against the LLP as a whole but against each member individually. This includes trading profits, capital profits, and inheritance tax on transfers of value made by the partnership as a whole or by the individual partner.

5. Companies

The company is the most widely recognised business medium. In the United Kingdom a company is established by registering specific documents with the Registrar of Companies in accordance with the Companies Act 2006 ('CA 2006'). Unlike sole traders and partnerships, which can commence trading immediately, a company requires a formal setup before it can begin operations.

Companies can be categorised as private or public and further classified as limited by shares or by guarantee. Under the CA 2006, shareholders' liability is limited to the value of their respective shareholdings. A 'private company' is defined as any company that is not a public company. Most companies in the UK are private limited companies (LTDs), which are separate legal entities with their own assets, profits and liabilities.

2.4.1 Private Companies

A private company (limited company) is a business entity owned by non-governmental organisations or a relatively small number of shareholders or company members. It does not offer or trade its shares to the general public on the stock market exchanges; rather, the company's stock is offered, owned and traded privately.

Limited companies must have at least one director, who must be a natural person, and may optionally have a secretary. Directors, often the primary shareholders, have various legal duties, including delivering an annual confirmation statement to Companies House (s. 853A CA 2006, which replaced the former annual return).

In terms of decision-making, the company, as a legal person, requires human agents to make decisions on its behalf. These decisions are made by the company's directors or shareholders: the directors run the company, while the shareholders provide the capital in return for shares. This division of responsibility introduces a degree of formality not typically present in partnerships.

2.4.2 Public Limited Companies (PLCs)

Public limited companies (PLCs) are similar to LTDs in that they are legally distinct entities with their own assets, profits and liabilities. However, shares in a public company can be freely sold and traded to the general public and may be listed on a stock exchange. PLCs are the only type of company allowed to raise capital from this type of public investment.

To qualify as a public company under UK law, a company must meet several specific criteria:

Constitutional declaration — the company's constitution (the governing document setting out the rules and regulations of the company) must explicitly state that the entity is a public company.

Naming convention — the company's name must end with 'public limited company' or the abbreviation 'plc' (the Welsh equivalent may be used for companies based in Wales).

Minimum share capital — shareholders must invest the 'authorised minimum', currently £50,000 (ss. 761 and 763 CA 2006). Each allotted share must be paid up to at least one quarter of its nominal value, in addition to the whole of any premium on it (s. 586 CA 2006).

Operating as a plc offers several advantages:

Prestige — being a plc can enhance a company's reputation and credibility, which can help attract customers, suppliers and potential employees.

Raising capital — unlike private companies, public companies can raise funds by offering shares to the general public, accessing a far larger pool of capital. Private companies are prohibited from offering their shares to the public (s. 755 CA 2006); s. 756 defines what counts as an 'offer to the public'.

Stock market access — public companies can apply to join the UK stock market, such as the London Stock Exchange's Main Market or the Alternative Investment Market (AIM), enabling them to raise large sums quickly. A company cannot start as a publicly traded company; it becomes an option only once the business reaches a certain size, reputation or level of growth.

While these advantages are significant, public companies are subject to more regulation than private companies, because they offer shares to the public at large. Additional measures are needed to protect the public, who can easily invest in a listed company and are at risk if it does not perform well financially.

2.4.3 Unlisted Public Companies

An unlisted public company is a public company that is not listed on any stock exchange. Although its shares are not traded on a formal exchange, the company must still comply with the same regulations as a listed company, such as filing financial reports with Companies House.

Unlisted public companies can have more shareholders than private companies, allowing them to raise more capital. However, because their shares are not listed on a public exchange, it can be harder for shareholders to sell their shares.

6. Key Notes (Chapter Summary)

The following summary table consolidates every business medium examined in this chapter together with its governing statute. Treat it as a revision checklist — you should be able to define each row from memory and identify its liability and taxation position.

7. MCQ Practice — SQE-Style Questions

Each of the following questions mirrors the style, length and difficulty of the SQE1 FLK1 single best answer questions. Attempt each question closed-book, write down your answer, then turn to the answer key. The answer key explains why each option is correct or incorrect — read every explanation in full.

A. A public company must appoint a company secretary, whereas a private company is not required to appoint a company secretary.

B. A private company must be formed with one director, whereas a public company must have at least two directors.

C. Private companies can be created with a trivial amount of capital, whereas public companies must have an allotted minimum share capital of £50,000.

D. Public companies may offer their shares to the public, whereas private companies may not.

E. A public company must have at least two members, whereas a private company need only have one member.

A. The client's best option would be a partnership because the process is informal, there is no obvious need to limit liability, and there is no need to grant a floating charge.

B. The client's best option would be a company because shareholders' liability for debts would be limited, the company can grant floating charges to attract finance, and the company is a widely recognised business medium worldwide.

C. The client's best option would be an LLP because the members' liability would be limited, LLPs can grant floating charges to attract finance, and the LLP is a widely recognised business medium worldwide.

D. The client's best option would be either an LLP or a partnership because there will only be two partners and there is no need to incur the legal and administrative burden of a company.

E. The client's best option would be a company or an LLP because this enables a more organised structure, whereas partnerships are run more informally as no partnership agreement is necessary.

A. One.

B. Two.

C. Five.

D. Ten.

E. Twenty.