Liability

There are a number of factors that need to be taken into consideration as the type of
organisation will have an impact on many things such as:

 whether liability for debts is limited or unlimited

 how the business is governed
 how the business raises funding.

Limited liability
Means the owners liability for debts is limited (usually to how much they’ve invested).

Unlimited liability
Means the owners liability for debts is unlimited. Their personal assets, like any
property that they own, may be at risk if the business cannot pay its debts.

Sole traders
A sole trader is one person running their own business. They are usually small and
are very easy to set up and run as they have very few regulations they must abide
by. Individuals who provide a service such as: hairdressers, photographers,
electricians are often sole traders.
Sole traders have unlimited liability and are responsible for all the debts of the
business. They can take all the profits for themselves.

Partnerships
A partnership is when two or more people start a trade, occupation or profession
together with a view to making a profit.
There are three different types of partnership.

Partnerships. A conventional partnership has unlimited liability. A partnership isn’t

allowed to own property in its own name. It’s governed by the regulations set out in
the Partnership Act (1890). Each partner is taxed individually like a sole trader.

Limited liability partnerships. A limited liability partnership is taxed like a

partnership but must be registered at Companies House. Its liability is limited. It’s
governed by the regulations set out in the Limited Liability Partnerships Act (2000).

Limited partnerships. A limited partnership is formed and regulated under

the Limited Partnership Act (2000). It has one or more partners that have unlimited
liability, and one or more partners that have limited liability. The partner with limited
liability can’t take part in the management of the business. It also needs to be
registered at Companies House.

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Limited companies
The owners of a limited company may be involved in running the business, but they
have no automatic right to be involved. The ownership and management of the
company can be split. Both the company and its owners are taxed separately.

Private limited companies (Ltd). A private limited company is formed under

the Companies Act (2006). It has one or more directors. Provided they have paid for
their shares in full, the owners (shareholders) liability is limited to the amount of their
shares.

Public limited companies (Plc). A public limited company is formed under

the Companies Act (2006). It has two or more directors, two or more shareholders
and must have a qualified company secretary. Provided they have paid for their
shares in full, the owners (shareholders) liability is limited to the amount of their
shares.

Not for profit organisations

Not for profit organisations are found in both the private and public sector.
They have three characteristics:
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1 they don’t have external shareholders (and therefore don’t raise capital in this
way)2
2 they don’t issue dividends (they retain any surplus in the organisation)
3 their objectives include a social, environmental or charitable aspect.

Even though they are called not for profit, this can be misleading as these
organisations do make profits (often called a ‘surplus’) and some of them even have
making a profit or surplus as part of their formal business plans.
A not-for-profit organisation can be either incorporated or unincorporated.

Not for profit organisations: private sector

Not for profit organisations in the private sector include nearly all charities, voluntary
and community organisations.
Sports and housing associations are also common private sector not for profit
organisations.
Most of them don’t have profit as their primary objective and money to pay for the
services is raised through donations, grants and fund raising activities.

Not for profit organisations: public sector

The public sector is made up of the organisations that provide all public services in
the UK, such as emergency services, healthcare, education, housing, refuse
collection, and social care.
Most of them don’t have profit as their primary objective and money to pay for the
services is raised through a variety of taxes.

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Governance and funding
Sole traders
Governance. Sole traders make all the decisions about running a business by
themselves and don’t have to be accountable to anyone else. This can mean it’s
quicker for them to make decisions, but it can also mean they don’t benefit from
diverse viewpoints when making decisions. The owner isn’t a separate legal entity
from the business.

Funding. Sole traders typically raise funding through personal sources; either the
profits of their business that they reinvest, or through loans from family and friends.
Access to funding from banks and lenders can be difficult to obtain – especially as
they’ll typically need a formal business plan.

Partnerships
Governance. A partnership should have a partnership agreement in place to set out
each partner’s rights and responsibilities, how the business will operate on a day to
day basis, and how profits will be shared. A partnership agreement will also set out
what happens in the event of death or retirement of a partner, or the admission of a
new partner into the partnership. Although it isn’t a legal requirement to have a
partnership agreement it can be beneficial, as without it the terms of the Partnership
Act (1890) apply and partners won’t always agree with its provisions. As there are
two or more people in a partnership, there are more viewpoints and skills, but getting
people to agree on a way forward can be challenging.

Funding. Partnerships may find it easier to raise funds than sole traders as banks
are more likely to lend money to a business with more than one owner as it is less
risky for them. The more partners there are, the more that risk is shared. Like for a
sole trader, a partnership isn’t a separate legal entity from its owners.

Limited liability partnerships

Governance. A limited liability partnership (LLP) must have a partnership agreement
or other legal document in place to outline how the organisation will be administered.
This must be registered at Companies House.

Funding. Limited liability partnerships are registered at Companies House, and

unlike a conventional partnership can own property or enter into contracts. This can
make raising finance easier as there is a separate legal entity responsible for assets
and liabilities.

Limited partnerships
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Governance. A limited partnership should also have a partnership agreement in
place which documents the terms of the agreement, including how decisions will be
made and how profits and losses will be shared. This must be registered at
Companies House.

Funding. Limited partnerships registered in Scotland have separate legal personality

from the partners themselves, and have the ability to own property or enter into
contracts. This can make raising finance easier as there is a separate legal entity
responsible for assets and liabilities.

Limited partnerships registered in England and Wales, and Northern Ireland have no
separate legal personality and have no such ability. Finance is raised in the same
way as a traditional partnership.

Private limited companies

Governance. A private limited company must have at least one director. The
company will operate in accordance with its Articles of Association. It is common for
the business owner to be a shareholder and a director (particularly in smaller, family
founded businesses).

Funding. Shares are traded privately – usually between family and friends.

It’s easier to raise funds through banks and other lenders than for sole traders,
especially for larger private limited companies who must have their financial
statements audited.

Public limited companies

Governance. Shareholders may own a public limited company, but the directors
control it. The company will operate in accordance with its Articles of Association.

Most Plcs will have independent non-executive directors as well as executive

directors as this is a specific requirement of the Corporate Governance Code
(although only companies listed on a stock exchange must comply with this code).

Funding. Shares are freely bought and sold on the stock exchange so public limited
companies can use this as a route to raising more financing.

Not for profit organisations

Governance. How they are governed will depend on the structure of the
organisation (as a not-for-profit organisation can be unincorporated or incorporated).

They don’t normally have shareholders but will often have a board of trustees to help
with oversight.

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Funding. Any profit or surplus that a not-for-profit organisation makes is usually
reinvested into the organisation and used as a source of capital.

Public sector
Governance. Public sector organisations are accountable to the government.

Funding. Public sector organisations are funded by the taxpayer. The government
sets a budget and they must operate within that budget.

Under the Companies Act (2006) directors

have seven legal duties that form part of
their responsibilities:
Duty to act within powers
Directors must act in accordance with the company’s constitution; and only exercise
their powers for the purpose they were given.

This means that directors need to understand what is in a company’s constitution: a

company will always have Articles of Association that determine how it is to be
governed, but the specific requirements in the company’s Articles of Association will
not be the same for every company.

Duty to promote the success of the company

Directors must act in the best interest of the company at all times.

There are two elements to this duty; firstly, acting in a way that would be most likely
to promote the benefit of the success of the company for its members, but secondly
giving regard to a number of other factors, including:

 the likely consequences of any decision in the long term

 the interests of the company's employees
 the need to foster the company's business relationships with
suppliers, customers and others
 the impact of the company's operations on the community and the
environment
 the desirability of the company maintaining a reputation for high
standards of business conduct
 the need to act fairly as between members of the company.

This duty therefore requires the director to think about what success means for a
number of stakeholders.

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Duty to exercise independent judgment
Directors mustn’t allow anyone else to control the powers they have as a director.

The purpose of this duty is to ensure that decisions made by directors aren’t affected
by anyone else.

For example, as shareholders appoint directors, this duty aims to prevent a director
being swayed by the opinion of a shareholder that appointed them.

This doesn’t mean that a director can’t take advice from others (for example,
accountants or lawyers) but ultimately their judgment on decisions should be free
from interference.

Duty to exercise reasonable care, skill and diligence

Directors must perform to the best of their ability and must use any relevant
knowledge, skill, or experience they have.

There is a different expectation placed on a director depending on their individual

skillset.

A professionally qualified accountant, for instance, is expected to exercise their

professional knowledge and skills as well as the skills expected of a director.

Duty to avoid conflicts of interest

Directors must avoid situations where their loyalties may be divided and must tell
other directors if they think there may be a conflict of interest.

This duty applies in particular to a director exploiting any property, information or

opportunity.

There is no definition of what constitutes a conflict of interest. A common scenario is

where the director will be a customer or supplier of the company.

As a guide, if the director is able to make a profit through their directorship, then they
should explore whether there is a potential conflict of interest, and if in doubt should
notify the board.

In some circumstances a conflict of interest can be authorised, but for this to happen
it needs to be agreed in advance.

Duty not to accept benefits from third parties

Directors mustn’t accept benefits that are offered to them because they are a
director.

This duty is designed to prevent a director from being bribed to do (or not do)
something.

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Again, there’s no definition of what a benefit is, and this will vary from company to
company. Many companies will have policies for benefits to help guide directors.

Duty to declare interest in proposed transaction or arrangement

Directors must tell other directors if the company is entering into a transaction or
arrangement that might personally benefit the director.

During the course of business, a company may intend to enter into a transaction or
arrangement that might benefit a director.

As soon as the director becomes aware that they will benefit from the transaction
then they should disclose it to the other directors – this must be done before the
company enters into the transaction.

Shareholders rights

The rights of shareholders will differ from organisation to organisation and will
depend on the specific type of shares they hold.
Typically, individual shareholders have:

 the right to inspect company information (for example the register of members
and minutes of general meetings). They aren’t entitled to inspect the
minutes of board meetings
 the right to receive a copy of the company’s annual accounts
 the right to receive dividends. This could be different depending on the class
of shares
 the right to vote at general meetings of the company.
Some shares don’t have the right to receive dividends, and don’t have the right to
vote at meetings.
For other actions to be taken, shareholders collective votes are counted.
For example, if 10% of shareholders request it then a company which would
otherwise be exempt must have an audit.