Choosing the Right Legal Structure for Business
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sirtmkhanChoosing the Right Legal Structure for Business
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sirtmkhanWHAT DOES A BUSINESS NEED FROM ITS LEGAL
FORM?
Christopher Riley
Lecture Transcript
What does a business need from its legal form?
This lecture tries to help us begin to understand why so many businesses choose to operate as
companies. The company can be described as a ‘legal vehicle’ through which a business may
operate, so we’ll start by understanding what we mean by a legal vehicle.
We’ll then move on to consider the sorts of issues that confront those who are starting a new
business – the sorts of things they’ll be concerned about – and from that, we’ll start to see what
sort of issues a legal vehicle must address.
Imagine that, as you’re sitting listening to this lecture, you had one of those light-bulb moments. In
a flash of inspiration, you suddenly think of some wonderful new thing you can make and sell, or
some brilliant new service that you can provide. You’re convinced that this business is going to
make you a fortune, and you want to become an entrepreneur and start your business as quickly
as you can.
Now, even though you may think of this as ‘your business’, it’s very unlikely you, and you alone,
will be able to do, and supply, everything that will be necessary to make your business a success.
Entrepreneurs, like you, will almost certainly need to deal with, and involve, lots of others. This
image captures just some of the people you will need to co-operate with. You may need to borrow
from a bank, or to employ one or more people, to rent some premises from a landlord, buy in
supplies of raw materials, and so on. And you may need to get more capital than you alone can
provide, or your bank is willing to lend, and so may be looking for another investor.
To get your business going, you will need to think about all these practical things, involving lots of
other people or other businesses.
But, in addition to these very practical steps, you will also need to decide on a legal structure for
your business. And we generally call the alternative legal structures you could adopt to run your
business - ‘legal vehicles’.
What do we mean when we say that you’ll need a legal vehicle to run your business?
We’ve just seen how a business involves lots of relationships with others. The legal vehicle you
adopt will provide some of the legal rules that will govern these relationships – with your fellow
investors, with your employees, suppliers, and so on. By choosing one legal vehicle rather than
another, you are, in a real sense, ‘buying into’ the package of legal rules that make up the vehicle
that you have chosen. Some of these rules may be ‘mandatory’ – meaning they cannot be
changed or excluded. Others may only be ‘default rules’ – meaning that they can be changed.
Different vehicles may vary in terms of the balance the strike between their mandatory and their
default rules – some vehicles may have lots more defaults than mandatory rules – making them
more ‘flexible’ for any business that chooses them.
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Having talked about legal vehicles in abstract, we can now make things a bit more concrete, by
identifying the actual vehicles that exist for business. Simplifying a little, you, as an entrepreneur,
have a choice between three major types. Here, we’ll just identify the main types. The first, and
most simple and straightforward, is to operate as a ‘sole trader’.
The second option is to operate through a partnership – although in fact, in the UK there are three
different types of partnership you could choose between: each of these three types comprises a
slightly different package of rules.
And third, you could, as most businesses in fact do, operate as a company – with, again, a number
of different types of company to choose between.
So, what sort of issues will you be concerned about for your business?
One key concern will be about the risk that you’re taking on by running your business. You hope
it’s going to be a success, but what if it isn’t? What liabilities might you incur to those your
business is dealing with – to employees, banks, landlords, and so on? Who will lose if the business
fails? Could you lose everything that you own?
A second concern might be about the continuity of the business: will the business enjoy an
existence that is separate from you, so that you can leave – for example, retire – and pass on the
business to someone else – by selling it, or leaving it to your children? Or will the business always
be just you, so that if you stop being involved, it will inevitably come to an end?
Third, who is going to manage the business? Who will get to decide what it does? Will you be
allowed to run it, free from interference by others? Or perhaps you will want others to join you in
the management – how easily will you be able to do that?
Fourth, how will those who invest in the business get their money back – not just you, but any other
investors you persuade to join you? Making it easy for them to recover their money will make it
easier for you to persuade them to join you in the first place. But if it’s very easy for them to
demand their money back in the future, then the business may suddenly be left without sufficient
capital.
Fifth, how heavily will the business be regulated? Will there be lots of rules about how the
business must be run, how decisions have to be taken, what information the business has to make
available – the greater the regulation, the more costs will be imposed on the business.
Sixth, and finally, how much will it cost to acquire – or create – the business vehicle you choose.
Again, if it is expensive to set up this vehicle, or takes a long time to do so, then this may make it
less attractive to you, however well it otherwise deals with the issues identified above.
So, we now have some idea of the sorts of issues that an entrepreneur, starting a business, is
concerned about - things that will matter as they decide what legal structure to adopt for their
business. In our next lectures, we’ll see how the different legal vehicles that are available deal with
these issues.
Thank you.
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