Business and Partnership Set-Up Case Study

Report for Supervisor

Summary of the facts:

Rachel wants to set up a technology design business creating augmented reality apps with Clive Watson. Clive owns a Ltd company and is the sole director and shareholder holding £1.00 ordinary share in CW Solutions Ltd (CWS). Clive rents a workshop in Shoreditch under his company’s name which can be used for the new project. Clive does not have employees, but one or two assistants are required and Rachel has people in mind.

The start capital is split as follows: Rachel will invest £400,000 and submitted a business plan to HSRT Bank PLC for additional funding and Clive will invest £200,000.

Advantages and disadvantages of businesses:

1.Sole trader with employees. 

Advantages:

The Client can start this business with very few formalities, and it is extremely flexible.

Disadvantages:

”As a sole trader you would have complete control over the business and all the profits. [..] On the downside , you will be accountable for any debts and liabilities that the business incurs down to the last penny” […] there is no safety net: ultimately all your personal assets,[..]home, could be lost if the business fails”. [1] The tax on a sole trader’s profits and salaries are paid by the sole trader as income tax. The employees will have no decision making unless the Client allows this.

2.Partnership 

Partnership is defined in s1 Partnership Act 1890 as follows:” (1) Partnership is the relation which subsists between persons carrying on a business in common with a view of profit.”[2]

Advantages:

It is very easy to set up a partnership as there are very few formalities, few documentations and it is cheap to run. A partnership agreement can be drawn up but this is not legally required. The main advantage is that both Rachel and Clive can arrange the structure of the partnership however they wish with or without responsibility for decisions so both can be involved in the decision making. This is an implied right by law and each partner is responsible for paying their income tax.

Disadvantages:

The biggest disadvantage is that both Rachel and Clive are equally liable for debts and liabilities of the business without any limits, so Rachel will be in serious financial risk if the business struggles.

3.Limited Liability Partnership

Advantages:

“An LLP has a distinct legal entity much like a company and therefore offers the partners the safety net of limited liability.[3] The business signs the contracts, borrows the money and is responsible for its own debts. This is the best benefit as both Rachel and Clive can only lose the value of their investment but they will not be pursued for debts beyond this amount unlike a general partnership.

It requires a formal set up and registration at the Companies House with a few ongoing requirements for filing and documentation.

Disadvantages:

An LLP must be set formally and with on-going filing. Despite the limit on partner’s liability the lender, Rachel, might guarantee the loan personally. Each partner pays income tax on their share of profits.         

4.Private Limited Company

Advantages:

The same as the LLP, it is a legal entity that needs to be set up formally and registered at the Companies House. Documents include: Articles of Association which set out the rules of how the company will run as agreed by Rachel and Clive. The Company governed by legislation: The Companies Act 2006 and by their own rules. There are ongoing filing requirements and the company owns its own debts and shareholders are not liable for these.

The major advantage is that it protects shareholders financially. Rachel can still have final control.

Disadvantages:

When Rachel borrows capital from the bank it is very likely that personal guarantees are to be required and the public nature of the documentation including accounts and on-going filing can make this expensive as well as lacking in privacy. The company pays its own corporation tax and directors pay their income tax on their salary; shareholders will also pay income tax on dividends.

Suitable business mediums for Rachel:

For Rachel, sole trader is not a best option as only one person will be trading and will own the business so Clive will not be equal in business, though this will allow Rachel to be in control. Also there will be a limitation on raising finance and “ – being unincorporated limits borrowing and prevents the business raising equity finance by issuing shares.” [4]

Partnership is a good alternative in terms of sharing responsibility, ownership and profits but as in the case of a sole trader, it is very risky in terms of sharing the debt and other liabilities especially because these are unlimited as both have no separate legal personality as a business medium and this is not what Rachel wants. She can however obtain what she wants in terms of final say in major decisions by clarifying this in the legally binding partnership agreement. Rachel will be able to start this partnership straight away and can employ people.

“Partners usually raise money for the business out of their own assets[..]although as being unincorporated [..] prevents the business itself from raising equity finance by issuing shares”[5]

An LLP is incorporated and it is good for organising an internal business structure as Rachel wants to retain final say in major decisions via partnership agreement. LLP is governed by rules that are implied by the normal partnership or can be changed in a partnership agreement so it still offers a lot of flexibility. But the LLP does not give the same tax advantage.

Each partner’s liability is limited to the agreed contribution: Rachel 400,000 and Clive to 200,000, though Rachel may be liable for any personal guarantee. LLP has to file some accounts and other information but not as much as the company. This is where Rachel will struggle as she wants the business to give her as much privacy as possible; but also, Rachel mentions in case her business fails she does not want to lose her home and personal assets. So, it depends on what Rachel believes is most important, having privacy in this case a good alternative is a partnership or being protected against unlimited liability where the LLP or Ltd would be the best business choice.The Ltd. company is also incorporated under the Companies Act 2006 and is the most common form of business but it is also the most expensive to run. It is owned by its members, people who invest in the business and it still offers limited liability, similar to the LLP, however, it is much more complicated. And although the structure is set by statute there is some flexibility in relation to directors and shareholders. It looks like there is a lot of flexibility with the sole trader/partnership but as the business grows and more and more people get involved other considerations are more important like risk, separation of ownership and management, protection of liability.

A company can raise finance by issuing shares (equity finance) or borrowing (loan finance).

If Rachel agrees with Clive and for both to subscribe to shares in CWS Ltd and for Rachel to become director of CWS and that both to capitalise by subscribing to CWS shares (Clive -199,999 x £1.00 ordinary shares and Rachel -400,000 £1.00 ordinary shares), they will both become shareholders by increasing the company’s share capital and their own liability will be limited by what they invest and if any personal guarantees are given. In the case Salomon v Salomon[6] the house of Lords held that as long as the company is properly incorporated the court will not pierce the corporate veil (ie. the shareholders are not liable for actions of the company). As in Adams v Cape[7], where there is no evidence of a company being set up to avoid legal obligations the veil will not be pierced.

However, they will not be partners (meaning owners and managers of the business). Their roles will be separated. Rachel and Clive will both be shareholders but only Rachel will be manager (director).As a director, she is an agent of the company but in this capacity she is not the owner of the company and cannot be financially liable for the company’s debts as the company is a separate legal person , responsible for its own debts.

Each share gives a member a right to vote by passing a resolution on important decisions. Rachel as a director of the company will run the company on a day to day basis[8] can hire new staff (Rachel can outvote Clive as majority shareholder) and Clive as a shareholder is involved in important decisions. If Rachel will be the sole director, she will get a vote but also shareholders vote in accordance with the size of the shares.

A company can change its name by passing a special resolution [9]or by permission given in the articles of association, however these will be stipulated in the company articles.  Special resolution requires 75% of majority. So, unless stipulated in the Articles, if Rachel wants to change the name of the company as it stands with the shares, she only has 66% =£400k but if she manages to raise the other capital as a shareholder by borrowing from the bank and reaching 75% she would not need Clive’s permission to change the name of the company to Sheffield TechSol.

As both Rachel and Clive are shareholders, they will receive dividends and as above they can raise capital. Rachel can consider outside investors to make the offer of loan more appealing to the bank. Once the investors they paid the full amount on their shares they won’t be liable for what the company does. Private companies are prohibited from offering their shares to the public.

It is unclear if Clive agrees with the name change of the company or the subsidiary as he suggests that he is but then he mentions that the subsidiary will be the business medium as the capital injected into CWS will be incorporated into this new subsidiary as this will give greater protection from liability and that he says that he will be able to use the same workshop Shoreditch. It is unclear who will be the director of the subsidiary. It looks like the shares will be purchased by the new subsidiary from the company.

“A subsidiary company refers to a legally registered business that is either wholly or partly owned by a larger entity.[..]The entrepreneurs register a subsidiary company “to limit their liability. As long as you ensure all operations are above board, the parent company will not be liable for certain potential costs, such as compensation or legal charges. As long as the parent company holds a certain amount of stock, it will always have control over the subsidiary’s behaviour, yet the subsidiary’s losses will not always be its responsibility, making it a doubly advantageous situation.”[10]

The tenancy agreement should hold: “Where a tenancy is held by a member of a group, occupation by another member of the group, and the carrying on of a business by another member of the group, shall be treated for the purposes of section 23 of this Act as equivalent to occupation or the carrying on of a business by the member of the group holding the tenancy.[11]

In conclusion Clive’s suggestion sounds very appealing however Rachel wants a much simpler business where all her company’s accounts are held privately but where all the liabilities are limited also. It is not possible to have everything as under the partnership even though her counts would remain private, she would be liable for everything and in the limited company /partnership the accounts would public even though the liability is limited. So it will depend on what Rachel would find appropriate. The PLC was not a choice for obvious reasons.

Bibliography

Table of cases:

•   Salomon v Salomon [1897] AC 22, 66 LJ Ch 35.
•  Adams v Cape Industries Plc CA (Civil Division) – [1990] Ch. 433.

Table of Legislation:

• Companies Act 2006
• Companies (Model Articles) Regulations 2008 Schedule 1-MA3.
• Landlord and Tenant Act 1954 c. 56
• The Partnership Act 1890

Secondary Sources:

• BIS, Department for Business Innovation & Skills, A guide to legal forms for business, November 2011-Unincorporated Legal forms, pg 2 <https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/31676/11-1399-guide-legal-forms-for-business.pdf> accessed 13 October 2019.

• Sole trader, partnership or limited company, Gard &Co< http://www.gardandco.com/uploads/Business/Sole-trader-partnership-or-limited-company.pdf> accessed 13 October 2019.

• The advantages of registering a subsidiary company in the United Kingdom

<https://www.coddan.co.uk/private-limited-company-formation/subsidiary-company-registration/advantages-of-registering-subsidiary-company-in-uk > accessed 13 October 2019.

[1]Sole trader, partnership or limited company, Gard &Co

 < http://www.gardandco.com/uploads/Business/Sole-trader-partnership-or-limited-company.pdf> accessed 13 October 2019.

[2] The Partnership Act 1890

<https://uk.practicallaw.thomsonreuters.com/Document/I21CDE1D0E44811DA8D70A0E70A78ED65/View/FullText.html?originationContext=document&transitionType=DocumentItem&contextData=%28sc.Search%29&comp=wluk> accessed 13 October 2019.

[3] Sole trader, partnership or limited company, Gard &Co

 < http://www.gardandco.com/uploads/Business/Sole-trader-partnership-or-limited-company.pdf> accessed 13 October 2019.

[4] BIS, Department for Business Innovation & Skills, A guide to legal forms for business, November 2011-Unincorporated Legal forms, pg 2 <https://assets.publishing.service.gov.uk/government/uploads/system/uploads/attachment_data/file/31676/11-1399-guide-legal-forms-for-business.pdf> accessed 13 October 2019.

[5] Ibid.

[6] Salomon v Salomon [1897] AC 22, 66 LJ Ch 35.

[7]Adams v Cape Industries Plc CA (Civil Division) – [1990] Ch. 433.

[8] Companies (Model Articles)Regulations 2008 Schedule 1-MA3.

[9] S 77(1) Companies Act 2006- a special resolution is required to change the company’s name and S283(1) Companies Act 2006- a special resolution needs no less than 75%of the vote.

[10] The advantages of registering a subsidiary company in the United Kingdom

https://www.coddan.co.uk/private-limited-company-formation/subsidiary-company-registration/advantages-of-registering-subsidiary-company-in-uk/ accessed 13 October 2019

[11] Landlord and Tenant Act 1954 c. 56