Unit 1.2: Types of Business Entities - Who Owns What?

Welcome! This chapter is fundamental to understanding how businesses operate legally and financially. Don't worry if the legal terms seem confusing at first; we will break them down using simple analogies.

When someone starts a business, they have to decide what kind of legal structure it will take. This decision is crucial because it affects three main things:

  • Liability (how much personal financial risk the owner takes).
  • Taxation (how the business profits are taxed).
  • Control (who makes the decisions).

The Crucial Concept: Liability

Liability refers to the extent of an owner's financial responsibility for the debts of the business.

Imagine your business runs into major debt. How much of your personal savings (your house, your car, your college fund) are legally required to cover that debt?

The answer depends entirely on whether your entity has Unlimited Liability or Limited Liability.

Unlimited Liability (The Risky Route)

If the business owes money, the owners are personally responsible for repaying those debts. There is no legal distinction between the owner's personal finances and the business's finances.

  • Analogy: The business's wallet and the owner's wallet are the same. If the business wallet is empty, they take money from the owner's personal wallet.
Limited Liability (The Safer Route)

The business is a separate legal entity from the owners. If the business fails, the owners are only liable for the amount they initially invested in the business (the value of their shares). Their personal assets are protected.

  • Analogy: The business has its own wallet, and the owner has theirs. If the business wallet is empty, the bank cannot touch the owner's personal wallet.

Section 1: Unincorporated Entities

Unincorporated entities are business structures where the business and the owner are legally considered the same. These always carry unlimited liability.

1. Sole Trader (Sole Proprietorship)

A sole trader is an individual who owns and runs their own business. It is the simplest and easiest form of business to set up.

Key Features:
  • Ownership: Single owner.
  • Liability: Unlimited Liability (The owner is legally responsible for all business debts).
  • Control: 100% control over all decisions.
  • Capital: Typically raised from personal savings or small bank loans.
Advantages:
  • Easy and cheap to set up (minimal legal hurdles).
  • Owner keeps all the profits.
  • High degree of control and flexibility.
Disadvantages:
  • Unlimited Liability (The biggest risk!).
  • Difficulty raising capital (banks see it as high risk).
  • Heavy workload and pressure on one person.
  • Business ends if the owner dies or retires.

Example: A local freelance web designer, a small coffee cart owner, or a self-employed plumber.

2. Partnership

A partnership involves two or more individuals (partners) who agree to own and run a business together.

Key Features:
  • Ownership: Shared between partners (usually 2 to 20 people).
  • Liability: Usually Unlimited Liability for all partners.
  • Partnership Deed: It is highly recommended that partners sign a legal document outlining their capital contributions, profit sharing, and roles to avoid future disputes.
Advantages:
  • More capital can be raised than by a sole trader.
  • Responsibilities, workload, and expertise are shared.
Disadvantages:
  • Unlimited Liability (If one partner creates massive debt, all partners are liable, even if they didn't cause it!).
  • Potential for disagreements between partners.
  • Profits must be shared.

Example: Law firms, medical practices, or smaller accounting firms often start as partnerships.

Quick Review: Sole traders and partnerships are cheap and easy to start, but they put the owner’s personal assets at risk due to unlimited liability.

Section 2: Incorporated Entities (Companies/Corporations)

Incorporated entities are business structures that legally separate the owners (shareholders) from the business itself. These structures offer limited liability.

These companies are often referred to as 'Corporations' in the US or just 'Companies' in the UK and elsewhere. They are owned by shareholders who buy portions of the company (shares).

The Big Step: Incorporation

When a business becomes incorporated, it gains separate legal entity status. This means the business can be sued, own assets, and incur debts in its own name, not the owner's.

Key Takeaway: Limited Liability

The main reason businesses incorporate is to gain limited liability, protecting the shareholders' personal wealth. If the company goes bankrupt, the most a shareholder can lose is the money they paid for the shares.

1. Private Limited Company (Pte Ltd or Ltd)

A private limited company is a company whose shares are not offered for sale to the general public. They are usually sold privately to family members or close friends.

Key Features:
  • Liability: Limited Liability.
  • Shares: Cannot be sold on a stock exchange. This maintains tight control over ownership.
  • Naming: Often includes "Ltd" or "Pty Ltd" in the name.
Advantages:
  • Limited Liability protects the owners.
  • Easier to raise capital than partnerships (can sell shares privately).
  • Control remains within a small group.
Disadvantages:
  • More complex and expensive to set up than partnerships.
  • Cannot raise capital from the general public.

Example: Many medium-sized family businesses or start-ups that have grown beyond the partnership phase.

2. Public Limited Company (PLC or Inc)

A public limited company is a large business whose shares can be bought and sold by the general public on a stock exchange.

The IPO Process

When a private company decides to "go public" and sell shares for the first time, it does so through an Initial Public Offering (IPO).

Key Features:
  • Liability: Limited Liability.
  • Shares: Can be traded freely on the stock market (e.g., NASDAQ, NYSE).
  • Naming: Often includes "PLC" (UK) or "Inc/Corp" (US) in the name.
Advantages:
  • Ability to raise enormous amounts of capital from the public (investors).
  • Shares are easily bought and sold (high liquidity).
  • Seen as prestigious and trustworthy (high public profile).
Disadvantages:
  • Loss of control (original founders may become minority shareholders).
  • High degree of public scrutiny and regulation (must publish detailed accounts).
  • Very expensive and complicated to set up.

Example: Apple, Toyota, McDonald's.

Mnemonic Aid:

Private Limited = Protected control, Lower capital raised.
Public Limited = Publicly traded, Lots of capital raised.

Section 3: For-Profit vs. Non-Profit Organizations

Not all businesses exist primarily to make money for their owners (shareholders). We categorize organizations based on their primary aims.

1. For-Profit Social Enterprises

These entities operate like traditional businesses (selling goods or services) but they have a primary social mission. They aim to make a profit, but that profit is mostly reinvested back into the business or used to benefit the community.

Example: A company that hires and trains homeless individuals and uses 50% of its profits to run shelters.

2. Non-Profit Organizations (NPOs)

An NPO is an organization that does not aim to make a profit for its owners. Any surplus funds generated are reinvested back into the organization to pursue its main purpose.

Types of Non-Profit Entities:
Non-Governmental Organizations (NGOs)

NGOs are private organizations that typically pursue objectives that benefit society, such as social justice, human rights, or environmental protection. They are independent of the government.

Example: Greenpeace, Doctors Without Borders.

Charities

Charities are a specific form of NPO. They focus on fundraising to support a defined cause (e.g., medical research, disaster relief, education). They are usually granted special tax status.

Example: A local food bank or a national cancer research foundation.

Key Distinction:

While NGOs and Charities are similar, NGOs often operate globally and focus on lobbying/direct intervention (action-focused), whereas Charities typically focus on collecting donations and allocating funds (fund-focused).

Did You Know? The rise of NPOs and NGOs directly relates to the IB concept of Ethics and Sustainability. These organizations are driven by ethical and sustainable goals rather than pure profit maximization.

Quick Review Table: Comparing Key Entities

Entity Type Liability Owner(s) Ability to Raise Large Capital
Sole Trader Unlimited 1 Individual Low
Partnership Unlimited 2+ Individuals Medium-Low
Private Ltd (Ltd) Limited Shareholders (Private) Medium
Public Ltd (PLC) Limited Shareholders (Public) High

Common Mistake to Avoid:

Students often confuse the size of the business with its entity type. A Sole Trader can be very successful and earn millions, but they still have unlimited liability. Conversely, a PLC can be performing poorly but its owners still benefit from limited liability.

The key difference is the legal separation!

You have successfully navigated the legal structures of business! Understanding liability is arguably the most critical component of this chapter, so excellent work if you feel confident in the difference between unlimited and limited liability.