Chapter 2 - Business Structure
Learning Objective: Structuring an Economy
The economy of a country is made of different sectors of its economy:
The balance of these sectors in the economies of different countries varies substantially. It depends on the level of industrialization in each country:
The growing importance of the secondary sector is called industrialization and the opposite is referred as deindustrialization;
The relative importance of each sector is measured in terms of either employment levels or output levels as a proportion of the whole economy.
To exemplify, let's look at some real case scenarios:
Countries that go through industrialization oftentimes benefit of the process:
The country's GDP raises and as a consequence the average standard of living too;
There can be a lower dependence on import goods and higher exports;
Many jobs are created for manufacturing;
The value of exports increase instead of the export of unprocessed items.
There are, however, many problems that follow an industrialization process:
- Housing and social problems as a consequence of mass movement of people from rural to urban areas;
- Raw material imports increases;
- Multinational companies - which leverage industrialization - can have negative impact on the society and the environment.
When economies go through deindustrialization, there are also many consequences that can arise:
Jobs on the primary and secondary sectors are lost;
Jobs on the tertiary and quaternary sectors are created;
There will probably be a need for training of workers to switch to those sectors.
We now completely understand the different sectors of an economy: primary, secondary, and tertiary. Companies within these different sectors can either be private or public:
Most economies around the world are considered to be mixed economies - in other words, economies that are made out of private and public companies simultaneously. Some countries are close to a free-market economy, a situation in which most economic resources are owned and controlled by the private sector with little intervention of the public sector. Command economies, however, are the opposite of free-market ones.
Public and private businesses are different in their decisions:
Let's dive in to understand Public-Sector Companies:
- These public-sector enterprises usually include health and education services, defense, and public law and order.
- Important strategic industries, such as energy, water supply and public transport, are also owned and controlled by the state as public corporations.
Public-sector business' objectives are based on what most of the population needs. Public companies are not driven by profit but by their social objectives and they are funded by tax income.
In the private-sector, however, the story is different. Businesses are motivated by profit and their ownership is on the hands of one or multiple individuals - not the state. There are many private-sector business structures:
Let's start by understanding sole traders is the most common and the simplest structure a business can have:
Sole Traders are single business owners who may or may not employ additional staff. They are mostly small in size but large in importance for the overall economy.
One of Sole Traders most important characteristics is that they have unlimited liability. This means that if the small business comes to fail the owner/founder is responsible for all of its debts and losses and his/her personal wealth can be used for paying off the debt.
Other disadvantages of a Sole Trader include: the difficulty in raise financing; the intense competition from larger firms; the lack of continuity given the attachment of the business to its owner; and finally
Setting up a Sole Trader structure, however, is simple and quick. The owner/founder has full control over the business and all profits are kept by him/her. A Sole Trader usually chooses to do something that interests him/her and have the ability to choose the patterns of work (e.g. working time). Finally, because they are small businesses, Sole Traders are able to develop closer relationships with customers and staff (if any).
Partnerships are an alternative to Sole Traders as it erases some of its main challenges: raising finance and spreading risks:
Partnerships are formed by two or more 'partners' to carry on a business together. The partners usually share capital investment (easier to raise finance), and responsibilities (less overwhelming). Partners are usually specialized in different aspects of the business (e.g. marketing, finance) bringing an advantage of Sole Traders. The decision-making is also shared making it less stressful.
In Partnerships profits are shared between partners - which is an important disadvantage when compared to Sole Traders.
At the same time, owners do not have independence on decision-making which can bring up conflicts among the people involved in the business.
It is important to notice that Partnerships have unlimited liability too. The difference is that losses (risks) are shared between the partners.
When setting up a partnership it is advisable (although not necessary) to signing a deed of partnership: a document created to divide each of the partners' deeds in the company. It includes:
Voting rights;
Distribution of profits;
Management role of each partner in the firm;
Who has authority to sign contracts.
We will now switch gears from unincorporated (unlimited liability) businesses to talking about limited companies - the businesses with limited liability, legal personality, and continuity:
Limited Companies' ownership is divided into small units (shares) which can be acquired by individuals (shareholders). The more shares a shareholder owns the more influence they have on company's decisions (board of directors). Shareholders with over 50% of a company's share have decision-making power.
A crucial difference between Unincorporated Businesses and Limited Liability Businesses is the LIMITED LIABILITY itself:
In the case of a Limited Liability Corporation (LLC) going bankruptcy shareholders' personal wealth is kept untouched and their only loss is their investment in that particular business. This makes it easier for these businesses to attract investors (less risky) but particularly risky for creditors (suppliers and lenders).
Limited Liability Companies have another special characteristic: Legal Personality:
In other words, the company's legal identity is a complete separate identity from its owners, investors, and shareholders. The business itself is responsible for problems and can even be taken to court. Managers and workers are only responsible for bad faith actions or braking the laws.
Finally, continuity: the fact that a limited company will not be dissolved in case of an investor’s death or sickness.
Now that the 3 mains characteristics (limited liability, legal personality, and continuity) of Limited Companies are clear it is time for us to look at the two different types of Limited Companies:
Private Limited Company is a structured used by small and medium-sized businesses to enjoy of some of the advantages of being a limited company. It doesn't come without its disadvantages, though:
The Public Limited structure is the most common form of legal organization for large businesses because they can have access to large funds for expansion:
Apart from all the benefits of a Private Limited Company, a Public Limited Company can sell shares to the general public through the stock exchange (IPO) leading to an increased ability to raise finance and to shareholders being able to easily and quickly sell their shares. The main problem with such structure is the phenomena of short-termism which commonly happens due to the clear split between ownership and control on these corporations.
It is also important noticing that becoming a Public Limited Company is no easy job: there are many laws regulating this process which can be expensive and time-consuming.
To-Do List:
Term 1, Chapter 2 - Activity 2.2 - Footie Ltd. To Stay Private (p. 25, p. 26)
Chapter 2 - Business Structure
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