Types of For-Profit (Commercial) Businesses (DP IB Business Management)

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Written by: Lisa Eades

Reviewed by: Steve Vorster

Sole Traders and Partnerships

When an entrepreneur starts a business, they will often start operating as a sole trader
If a group of entrepreneurs set up a business they may choose to operate as a partnership
Over time, they may change the form of business to gain more funding or provide more security for the owners by becoming a private limited company with limited liability

Diagram: ownership for small businesses

For profit business structures include sole traders, partnerships and private limited companies — **The different types of business structures available to small business owners**

Two of the most common forms of business at start up are sole traders and partnerships
Each one of these forms has various advantages and disadvantages associated with the structure

An Explanation of Sole Traders and Partnerships

Sole Trader	A business that has a single owner (although they may still hire employees) Sole traders often run their business alone and require a varied skillset
	Advantages	Disadvantages
	Easy and inexpensive to set up The owner has complete control over the business All profits belong to the owner Simple tax arrangements Decisions can be made very quickly so the business can react swiftly to market change High levels of personal satisfaction	Unlimited liability, meaning the owner is personally responsible for any debts the business incurs Limited access to finance and capital Limited skill sets Difficult to take time off from the business
Partnership	Two or more people join together to form a business Good examples of this type of business include lawyers and accountants A partnership agreement sets out the rules of the partnership such as Dissolution of the partnership How profits are to be distributed between partners Voting rights of partners
	Advantages	Disadvantages
	Easy to set up and inexpensive Shared responsibilities and decision-making More skills and knowledge are available Increased access to finance and capital	Unlimited liability Potential for disputes between partners as decisions need to be agreed Profits are often shared equally, regardless of the contribution It is difficult to transfer ownership

Privately-held Companies

To overcome the personal risks of unlimited liability involved in running a sole trader or partnership, an individual or group of entrepreneurs may choose to form a private limited company
There is a small fee payable to incorporate and register a private limited company (Ltd)
Legal guidance is usually required to draw up the Articles of Association
- These set out the rules of the business including ownership and voting rights of shareholders

An Explanation of Private Limited Companies (Ltd)

Characteristics
The ownership of the business is broken down into a specified number of shares These shares can be sold by the owner, usually to friends and family or to venture capitalists Decision-making often rests with the person appointed to run the company, often called the Managing Director or CEO The business is a separate legal entity to its shareholders and can own assets in its own rights and is responsible for its debts Private limited companies are often family-owned
Advantages	Disadvantages
Limited liability, meaning the owners are not personally responsible for the company's debts Access to greater finance and capital as the company is considered to be more reputable It is easier to transfer ownership by selling shares Can have a professional image and reputation	More expensive and time-consuming to set up More complex legal requirements and regulations than sole traders Annual financial reporting and auditing are required Less privacy as external stakeholders can access some financial data Shareholders have little control over the company as the founder or CEO usually imposes their agenda

The importance of limited liability

Limited liability reduces the responsibility for business debts to the amount a shareholder has invested
- Shareholders cannot be required to sacrifice their personal assets if the business fails
- This lowers the risk to investors and increases the potential for the business to raise finance through the sale of shares

Publicly-held Companies

When a business is growing rapidly it may require a significant amount of capital to fund its expansion
- To secure this funding, it may choose to transition from a private limited company (LTD) to a public limited company (PLC)
This is a complex process with many legal requirements and involves undergoing a stock market flotation

Benefits of Becoming a Public Limited Company (PLC)

Access to Capital	Shared Risks	Increased Liquidity
Significant amounts of capital can be raised very quickly This is often a more cost effective way to raise capital than borrowing money from banks or other lenders	The risks associated with ownership are spread among a larger group of shareholders This reduces the financial risk to any individual	A company's shares become more liquid (they can be bought and sold more easily) on a public stock exchange This can increase the value of the company's shares and make it easier for shareholders to buy/sell shares
Access to Greater Expertise	Greater Public Profile	Succession
The company will have a board of directors made up of independent directors and representatives from major shareholders This can bring in additional expertise/perspectives which can help the company grow and expand	Becoming a PLC can raise a company's public profile and increase its visibility with customers, suppliers, and potential investors This increased visibility can help the company attract new business and grow its customer base	Shareholders can sell their shares, transfer ownership or pass them on to heirs This makes it easier to plan for the long-term continuity of the company

Public limited companies are subject to greater degrees of scrutiny and are expensive to run
- Detailed annual accounts must be made publicly available
- The media often reports on strategy, major decisions and changes in executive structure
- Legal and accounting costs will be significant
The top three initial public offerings as of March 2023 are:
- The Saudi Arabian oil company, Saudi Aramco, raised $29.4 billion in its IPO in December 2019
- The Chinese e-commerce company Alibaba Group raised $25 billion in its IPO in 2014
- The Japanese telecommunications company, SoftBank Corp., raised $23.5 billion in its IPO in 2018

Examiner Tips and Tricks

When evaluating the best form of business to be used in a particular situation (or if a business should change its form), the decision needs to consider any evidence provided about the business owner, the product, the nature and size of the market, the funds required, and the level of profitability.

For example, a business which generates sales of $30k a year is unlikely to be ready to become a public limited company, but it may well benefit from transitioning from a sole trader to a private limited company.

Last updated: 29 October 2024

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