What happens if the legal structure of a business changes? (Part I)

Think what happens if a sole trader joins partners. The legal structure changes from ‘Sole Trader’ to ‘Partnership’. Initially as a sole trader, a single owner exists. But as soon as a partner(s) is added, the owners will be more (at least two).

Take care. You might take sole trader as an unincorporated business but partnership business as an incorporated business. You might be confused with ‘Partnership Company’ referred in accounting. You got to be clear both are unincorporated.

Let’s go step by step.

First, think a case of a business operating as a sole trader. Say, Laura owns a sole trading business.

As sole trader, Laura might be benefited with her full control over the business. Any changes or any decision including working pattern, working hours or even dissolution of business will be solely her decision. Any profit earned goes to her single pocket. There is no one else to share for her single investment involved in the business. She uses her own skills, ideas or creativity for business success and can reach her full potential. She deals with customers and suppliers personally developing good and direct relationship with them. On early operation, she was not following complex legal formalities. Just informing government about business establishment was enough to run her sole trading business.

On the other hand Laura might be limited by her resources as a sole trader.  Sum of her earnings, savings, money from sale of assets, personal loans etc. might be too small to provide adequate capital for her business. Her profit might be limited as she might not have access to most profitable sector due to lack of proficiency, idea or experience in the most profitable sector. For her pressure on securing her investment and higher return, she might be much absorbed by business works and her family life might be a disaster. She will have to bear unlimited liabilities alone. She is responsible to bear any debt or loss of the business alone even by selling her personal owning. Her business loss or loan will not be considered different than her own as the business has no separate legal entity. Thus, business dies with her if she dies or decides to quit the business.

Next, let’s think a case of a business operating as a partnership business. (Take care. It is still unincorporated one.) Say, Laura, Jim and Harry are operating a partnership business.

Establishment was easy. Laura, Jim and Harry were not to follow complex legal formalities; just informing government about partnership was enough for their business operation. Capital was easier for them as each partner injected some capital in the business. Jim and Harry are from different specific profitable sector to make business access to higher profit. Decision making is also easy. Laura, Jim and Harry analyse from different angles for a problem and better solution can be brought by joint discussion. However, once an opportunity was lost for delayed decision.

On contrary, the trio are responsible to bear unlimited liabilities. Any debt or loss of the business is to be covered selling their personal belongings. Any debt or loss from business is no different than their own as there is no separate legal entity of business. if Laura made mistake and loss appeared, Jim and Harry are equally responsible to pay the (unlimited) liability. Laura might feel advantageous for such shared unlimited liabilities. If Jim or anyone decides to quit the business, the partnership collapses. New agreement is required if remaining partners prefer to continue the business, old partnership no more exists. None of the partners is able to control the overall business alone until partnership goes.

Now, let’s think of the other verse. Laura was operating a sole trading business and now she is offered to join Jim and Harry for partnership. Should she join Jim and Harry or go alone?  

CIE A-level Business prefers to ask such question. If Laura prefers to go partnership, Laura would be benefited by relative advantages of partnership over sole trader. The benefits might be access to profitable sector, more capital for business, better decision making etc.   If Laura prefers to go alone, she would be benefited by relative advantages of sole trader over partnership. The benefits might be monopoly on business control, sole claim on profit, self actualisation etc.

So the clue comes over here. If CIE a-level business asks on conversion of legal structure from sole trader to partnership, the answer should cover only relative matters. There should not be inclusion of benefits or drawbacks common to both legal structures. Both sole trader and partnership are unincorporated business and have common benefits like ‘no complex formalities’ and common drawbacks like ‘discontinuity’. Such issues are not to be included in the answer.  But, sole trader has sole unlimited liabilities that are shared in partnership. Thus, this issue is to be outlined in the answer.

(To be continued... Part II will be posted soon.)