Study Notes: Types of Business Organisation (Setting up a New Enterprise)

Welcome to Section 2 of the course! This chapter is incredibly important because before you even launch your enterprise project, you need to decide on its legal identity. This choice affects how much risk you take, how you get funding, and how much control you have.


Don't worry if the legal terms seem confusing—we will break down the differences between being fully responsible for all debts (unlimited liability) and protecting your personal belongings (limited liability). Think of choosing a business type like choosing your gear for an adventure!


2.2 Types of Business Organisation

Every enterprise needs a legal structure. This structure defines the ownership, control, and, most importantly, the financial responsibility (liability) of the owners.


Key Concept Check: What is Liability?

Liability refers to the extent to which the owners of the business are legally responsible for the debts of the business.

  • Unlimited Liability: The owner(s) are personally responsible for all business debts. If the business fails, their personal assets (house, car, savings) can be taken to repay the creditors.
  • Limited Liability: The business is a separate legal entity. The owner's financial responsibility is limited only to the amount they invested in the business. Their personal assets are safe.

1. Sole Trader

This is the simplest and most common form of ownership for a new, small enterprise.


Definition: A business owned and controlled by one single person.


Legal Status:
  • The business and the owner are legally considered one entity.
  • The owner has Unlimited Liability.
👍 Advantages (Why choose this for a new enterprise?):
  • Easy to set up: Minimal paperwork and legal requirements. You can start trading almost immediately.
  • Full Control: The owner makes all the decisions and doesn't have to consult anyone.
  • Keeps all Profit: All profits belong entirely to the owner after tax is paid.
  • Secrecy: Financial details are kept private (no need to publish accounts).
👎 Disadvantages:
  • Unlimited Liability: This is the biggest risk! If the business goes bankrupt, the owner loses personal assets.
  • Hard to raise finance: Banks see this as riskier, and there are no partners to contribute capital.
  • Heavy Workload: The owner must manage all aspects (production, marketing, finance) alone.
  • Lack of Continuity: If the owner dies or retires, the business usually ends.

Quick Review: Think of a student who starts a small tutoring business or sells handmade jewellery. They are usually Sole Traders. They have total freedom, but if things go wrong, their savings are on the line.


2. Partnership

This structure is very similar to a sole trader, but involves more people.


Definition: A business owned and controlled by two or more people (usually up to 20), who share the risks, responsibilities, and profits.


Partnerships often establish a formal document called the Deed of Partnership. This crucial document sets out how much capital each partner contributes, how profits will be shared, and how the partnership is managed.


Legal Status:
  • Partnerships are generally considered Unlimited Liability.
  • Every partner is jointly and individually responsible for the entire debt of the partnership.
👍 Advantages:
  • Shared Risk and Workload: Responsibilities are spread out, reducing stress.
  • More Capital: Each partner brings money into the business, making it easier to start or expand.
  • Diverse Skills: Partners often have different expertise (e.g., one is good at marketing, the other at finance).
👎 Disadvantages:
  • Unlimited Liability: You are liable for your partners' actions! If one partner incurs a huge debt, all partners are responsible.
  • Shared Profits: Profits must be divided according to the Deed of Partnership.
  • Potential for Conflict: Disagreements between partners can lead to slow or poor decision-making.
  • Lack of Continuity: If one partner leaves, the partnership usually has to be formally dissolved and reformed.

Did you know? Many professional services, like small legal or accounting firms, start out as partnerships because they rely heavily on the shared expertise of the owners.


3. Limited Company

This is where the business becomes a separate legal 'person'.


Definition: A business organisation that is legally separate from its owners (shareholders).


Legal Status:
  • The company has a separate legal identity (often called 'incorporation').
  • The owners (shareholders) benefit from Limited Liability.

Limited Liability Explained: If Acme Co. Ltd owes money, creditors can only claim the assets belonging to Acme Co. Ltd. They cannot claim the personal assets of the owners (shareholders). The owners only lose the money they invested in buying shares.


👍 Advantages:
  • Limited Liability: Protects the personal wealth of the owners—a huge benefit for a risk-taker!
  • Easier to raise capital: Money can be raised by selling shares (part ownership) to investors.
  • Perceived as Reliable: Often seen as more stable and professional by customers and suppliers.
  • Continuity: The company continues to exist even if shareholders die or change.
👎 Disadvantages:
  • Complex Setup: Involves extensive legal paperwork (Memorandum of Association, Articles of Association).
  • Administrative Costs: Higher setup and ongoing legal and accounting fees.
  • Lack of Secrecy: Financial accounts must be published and made public.
  • Loss of Control: As more shares are sold, the original owner might lose some control over decisions.

Common Mistake to Avoid: A Sole Trader is NOT a limited company. If you see 'Ltd' or 'PLC' after a name, it means the owners have limited liability. If you see neither, assume they have unlimited liability (like a sole trader or most partnerships).


4. Co-operative

Co-operatives focus on democratic control and meeting the needs of their members, not just profit maximization.


Definition: A business owned by its members, who share control, and whose primary goal is to meet the common economic, social, and cultural needs of those members.


Legal Status:
  • Usually incorporated, meaning they enjoy Limited Liability.
👍 Advantages:
  • Democratic: Each member gets one vote, regardless of how much capital they invested, leading to high engagement.
  • Strong Loyalty: Members are also the owners (or employees/customers), leading to high motivation and loyalty.
  • Profits Shared: Profits are distributed fairly among members (based on usage or contribution, not just investment).
👎 Disadvantages:
  • Slow Decision Making: Achieving consensus among many members can be time-consuming.
  • Limited Capital: Difficult to attract large-scale capital investment, as the goal is not to maximise return for external investors.

Example: Farmer co-ops allow small farmers to combine their resources to market their products more effectively, ensuring better prices for all members.


5. Franchise

A franchise is a special type of business agreement, not strictly a standalone legal structure, but a common path for new enterprises.


Definition: An entrepreneur (the franchisee) buys the right to use the brand name, products, and operating methods of an existing business (the franchisor).


Legal Status:
  • The franchisee decides whether to operate their individual unit as a Sole Trader or a Limited Company.
  • The relationship is governed by the Franchise Agreement.
👍 Advantages (For the new entrepreneur/franchisee):
  • Proven Success: The business model is already tested and recognized (e.g., buying a pizza franchise).
  • Brand Recognition: Immediate customer trust and awareness.
  • Support and Training: The franchisor provides training, marketing materials, and assistance, lowering the risk of starting from scratch.
👎 Disadvantages:
  • Lack of Freedom: The franchisee must strictly follow the franchisor's rules (product recipes, decor, suppliers). You cannot be very creative.
  • High Costs: Requires a large initial lump sum payment (franchise fee) and ongoing percentage of revenue (royalties).
  • Reputation Risk: If another franchisee in a different town performs poorly, it can damage the reputation of your unit.

6. Social Enterprise (Charities and Not-for-Profit Organisations)

Some enterprises are set up not to make money for owners, but to serve a purpose.


Definition: Organisations that trade goods or services to meet a social, environmental, or community objective, rather than to make a profit for private owners.


Legal Status:
  • They are often incorporated (separate legal entity) and registered as Charities or Not-for-profit organisations.
  • They have strict rules ensuring that any surplus revenue is reinvested into the cause.
👍 Advantages:
  • Access to Grants: Can qualify for government or private grants that standard profit-making companies cannot access.
  • Motivated Staff: Attracts volunteers and employees dedicated to the social mission.
  • Tax Relief: Often benefit from lower taxes or are exempt entirely (Charities).
👎 Disadvantages:
  • Profit Restrictions: Cannot distribute profits to owners/shareholders.
  • Limited Finance: Cannot raise capital by selling shares on a stock exchange.
  • Bureaucracy: Must comply with strict regulations regarding fundraising and how money is spent.
✅ Key Takeaway Review for New Enterprises

When starting your own enterprise, the choice comes down to these trade-offs:

  1. Do you prioritize simplicity and total control? Choose Sole Trader (but accept Unlimited Liability).
  2. Do you need more capital and skills, but still want to keep things simple? Choose Partnership (but accept Unlimited Liability).
  3. Do you want to protect your personal assets and look professional? Choose Limited Company (but accept complex legal setup and less secrecy).
  4. Are you focused on a cause more than profit? Choose a Social Enterprise structure.