Partnership versus Private Limited Company - Case Study Example

Partnership verses Private Limited Company Customer Inserts His/her Name Customer Inserts Grade Course Customer Inserts Tutor’s Name 19/08/ 2011 Introduction There are major differences between a partnership and a private limited company. This range from legal issues or formalities to the practical issues such as the amount of capital needed and management found in each. Consequently, it is very important for a person or a group of persons intending to open businesses to analyze each of the business type and choose the most viable one under the prevailing conditions. Therefore, Terry and Tessa require an understanding of the features, formalities and implication of each business type. Features of a Partnership A partnership is an agreement between two or more persons to carry on business for profit (Miller and Jentz 2009). In a partnership, the partners are co-owners of the business and have control over the operations of the partnership. Following this, all the partners have the right to share the profits gained out of the partnerships. However, the partners should agree on profit sharing during formation. In addition, partners have the implied authority to perform acts that are reasonably necessary for the purposes of the partnership. Moreover, each partner in a partnership is jointly liable for all the obligations arising from the partnership. This means that each partner is responsible for the decisions made by all other partners. Formalities of setting up a Partnership Parties intending to form a partnership should have a partnership agreement. Although a partnership can be formed by verbal agreement it is important to enter into a written one. A partnership agreement is a written agreement among the parties intending to establish a partnership. Dornseifer (2005 p102) observes that, unlike a private limited company, a partnership whether limited or unlimited does not have Memorandum or Articles of Association. A partnership agreement provides, in a detailed manner, the rules and procedures that guide the ownership and operations in the partnership. These include: the name of the partnership business and of the partners, partner’s capital contribution, the profit-loss sharing ratio and duties and authority of each partner. Gulshan (2005 p1) provides the essentials of partnership as an association of two or more persons, must be as a result of an agreement between these persons, the agreement must be to carry on some business, the agreement must be to share profits of the business and the business must be carried on by all. Advantages and Disadvantages of Partnership It is easy to form a partnership since there are a few legal formalities to be followed compared to a private limited company. A partnership is a good ownership form for people who share as idea for a business and want to cooperate in managing and investing in the business. In addition, there is creation of a pool of resources such as capital and skills. The profit realized in a partnership is shared based on the amount of investment made by a partner hence it is not easy for disputes to arise. Each partner has an equal voice in the management of the partnership unless otherwise stipulated by the partnership agreement. A disadvantage of a partnership is that there may be dormant partners who just make appearances in the partnership business and fail to engage in operations of the partnership. Therefore, if the business partnership realizes profits, the dormant partner will as well be given his or her profit share at the disadvantage of active partners. Another disadvantage is that, if one partner makes the wrong business decisions which results to a critical failure of the business, the other partners lose their investment as well. In addition, if a partner leaves the partnership for any reason the partnership is officially dissolved meaning that the operations must be closed down at the detriment of other partners (Dlabay et al 2005). Another limitation is that each partner is liable to pay his or her income tax obligation on the net profits. Features of a Private Limited Company A private limited company is a corporation whose shares are owned by few persons and cannot be sold to the public. Two or more persons can create a private limited company, but the number is normally limited to fifty persons. There are many legal formalities required for formation of a private limited company compared to the partnership. A major distinction feature of a private limited company is that it provides limited liability for the owners unlike with the partnerships (Harper 2003). This means that, in case the private limited company fails, there will be no taking up of the personal assets of the members in order to recover the loses. However, the members cannot freely transfer their ownership interest. Unlike in partnership where we have the partners, a private limited company comprises of members. Formalities of a Private Limited Company There are two major legal formalities required in the formation of a private limited company. These include: a memorandum of association and articles of association. The articles of incorporation is a written legal document that defines ownership and operating procedures and conditions for the business, in this case a private limited company. In addition to this, the business must establish corporate bylaws that are the operating procedures for the private limited company. The memorandum of association outlines the name of the business; principal address; amount invested; methods of raising additional funds, legal procedures; winding up or dissolution, and other relevant information. The article and memorandum of associations must be filled with the relevant registrar of corporations. When a private limited company is formed, the members decide, in an operating agreement, how the business will be managed and the rules and policies that will apply to the organization as a whole. Generally, it may be managed by members and some non members or by non members only who are also the owners (Miller and Jentz 2009). A private limited company, as a corporation, is treated as an ‘individual’ or ‘a legal person’. This means that it must follow the set laws of the state in which they are found in. One such law is that in forming a private limited company, one must file the articles of association with the appropriate office or department of the government of that state. In addition to this, it must name the board of directors who will make the major policy and financial decisions for the business. A private limited company is authorized to issue shares of stock to the investors and it should provide further details of how extra investments can be made in the articles of association (Dlabay et al 2005). Advantages and disadvantages of a Private Limited Company One major advantage of a private limited company is the fact that the liability of the members and owners are limited to the amount of money invested in the business even if the business experiences losses. In addition investors in the business can make profits without having to take par in the day-to-day management and operations. It is also easy to expand the business and change its ownership through the sale of stocks. According to Chisholm (2009 p140) a private limited company provides a room for the management to improve its performance by offering strong personal incentives. A major drawback of a private limited company is the fact that its control is vested in the board of directors and shareholders or members have limited power in direct management of the corporation, hence they might focus on their personal interests only. In addition, to start a private limited company requires huge initial cash outlay. Moreover, there are numerous legal formalities required hence need for a lot of time and paperwork. On the other hand, there may be a requirement for the person intending to enter in this kind of business to personally cosign any loans or other agreements made on behalf of the business where the capital comprises of borrowed money from banks and other creditors. In addition to this, since a private limited company is regarded as legal entity, it is subject to double taxation (corporate tax and stockholders income tax on dividends. Since private limited companies are not allowed to issue shares to the members of public this means that they cannot trade them in the stock exchange market to raise additional funds in case need be (OECD 2001). Conclusion In the light of the above, Terry and Tessa can choose which the most viable business type is for them. The first consideration is the amount of capital they require on each business type. As observed, formation of a private limited company is costly in terms of time and money compared to the partnership. On the other hand, there are major drawbacks with partnership than with private limited such as unlimited liability. With partnership, Terry’s and Tessa’s personal assets can be taken up in case of business failure. In both business types, stocks cannot be sold to members of public in case there is need to raise additional fund. With partnership, Terry and Tessa will personally pay income taxes on their gains, while with the private limited company they will pay double tax. Therefore, Terry and Tessa should form a partnership rather than a private limited company. References Chisholm, A 2009, An Introduction to International Capital Markets: Products, Strategies, Participants, 2nd Edition, John Wiley and Sons. Dlabay, L, Burrow, JL & Eggland, SA 2005, Intro to Business, 6th Edition, Belmont, Cengage Learning. Dornseifer, F 2005, Corporate Business Forms In Europe: A Compendium of Public And Private Limited Companies in Europe, Sellier. European law publ. Gulshan, SS 2005, Business and Corporate Laws for C. A. Professional Examination-2, New Age International. Harper, SC 2003, The McGraw-Hill Guide to Starting Your Own Business: A Step-By-Step Blueprint for the First-Time Entrepreneur, 2nd Edition, McGraw-Hill Professional. Miller, RL & Jentz, GA 2009, Fundamentals of Business Law: Excerpted Cases, Belmont, Cengage Learning. Organization for Economic Co-operation and Development (OECD) 2001, Behind the Corporate Veil: Using Corporate Entities for Illicit Purposes, OECD Publishing. Read More