Page 55 - Cambridge IGCSE Business Studies

4: Types of business organisation

Risk, ownership and limited liability

Unincorporated business ownership has greater legal and financial risks for owners
than incorporated businesses. This is because:

■ Owners and the business have the same legal identity. If, for example, a customer
is injured as a result of using a faulty product made by the business, then the
owners of the business are legally responsible and may be sued for damages.
■ Owners have unlimited liability for business debts. If the business fails and has
unpaid debts, then the owners may have to use their personal wealth to pay
these debts.

These risks are removed for the owners of incorporated businesses such as private

and public limited companies because:
■ Owners and the company have separate legal identities. If a customer is injured
by a product made by an incorporated business then they sue the company for
damages and not the owners.
■ Owners have limited liability for business debts. This means that if the company
fails, the owners do not have to use their personal wealth to pay any debts. The
only financial risk that owners of incorporated businesses have is that they can lose
all of the money they paid for their shares.
Choosing the type of business organisation
You have already learned, earlier in this chapter, that it is much easier to set up an
unincorporated business than an incorporated business. This explains why sole 53

traders and partnerships are the most popular form of business organisation in
most countries.
Private limited companies, and especially public limited companies, are more

complex to set up. They have many more legal controls than unincorporated busi-
nesses; for example they must produce more detailed financial statements every year.

Most businesses start small and often as a sole trader or partnership. However,

as a business grows, the original owners may decide to incorporate – become a
private or public limited company. They may decide to do this for a number of

reasons, such as:
■ To reduce the legal and financial risk to owners. Incorporation has the benefit of
separating legal identity between the business and the owners, and providing
owners with limited liability.
■ Separate legal identity also has the benefit of business continuity. If one or more
owner leaves, then the business is still able to continue.
■ The business may want to raise additional capital to invest in growth plans. This
may be easier to achieve by becoming a limited company and selling shares in the
business.

When setting up a new business, the choice of which form of business organisation
to use will depend on several factors.
■ The number of owners. A sole trader can only have one owner. If there is more
than one owner then the choice will usually be between a partnership and an
incorporated business. The larger the number of owners the more likely it is that
owners will choose an incorporated business organisation.