D1 Change in Ownership of the Enterprise
In order to finance the growth of an enterprise, the owner may decide to change the ownership type. Two options are partnership and limited company.
A partnership is a business that is owned by two or more people. The partners sign a partnership agreement to outline expectations and how profit will be shared.
A limited company is a business that is owned by its shareholders. It has gone through a process of incorporation which legally separates it from its owners. This means that the business is seen as a separate entity to its shareholder in the eyes of the law.
Benefits and Drawbacks of Partnerships to Finance Growth
Easier to Raise Capital
Partners can combine their finance, making it simpler to business resources and invest in growth. It can also help in obtaining outside funding such as bank loans as partnerships are seen as less risky than sole traders.
For example, Remi left her job in banking to set up a coffee shop with her savings. She has built a successful brand and would like to expand by investing in her own coffee roasting equipment. The bank will not lend her the money as they are not confident she will have the means to pay it back. By taking on a partner, she may benefit from the investment they bring but also increase the bank’s confidence in their ability to pack back loans.
Shared Knowledge and Skills
Partnerships bring together different skills and expertise. Each partner's unique strengths contribute to more innovative solutions as they focus on their specialist area and better overall performance.
For example, Eva has set up an online make up brand. Her products have had some popularity through her social media account but she is concerned about the complications of the paperwork and legal requirements as her business grows. She decided to form a partnership with her friend Renee who has just graduated from Business school. Eva can now focus on product development while Renee will enure take care of finance and administration.
Shared Workload
Partners can share responsibilities and tasks, easing the workload for each individual. This division of labor boosts efficiency and productivity within the business. Also if one partner needs to take time off for sickness or holiday, the other partner can manage the business.
For example, Thomas left his job as an investment banker to set up a pizza parlour. His pizzas are very popular and an opportunity has arised for him to expand into the shop next door. However, he is concerned about his workload. Despite employing staff in his pizza parlour, he is working every evening and weekend to oversee operations. He is considering forming a partnership to share this responsibility if he expands.
Unlimited Liability
Ordinary partnerships have unlimited liability just like sole traders. This means that if the business runs into financial difficulties, the personal assets of the owners are still at risk until the debt has been paid.
For example, if Remi and her partner take out a bank loan to buy coffee roasting equipment and the expansion is not successful, the loan will still need to be repaid. As they have unlimited liability, the bank will not recognise them as separate entities to the business. They will therefore have to find the money personally to pay it back. This may mean using personal savings, selling an asset such as a car, remortgaging their house or asking family members for help.
Conflict
Multiple decision-makers in a partnership can lead to conflicts over business strategies, profit sharing, and operations. However, as partners share profits, they are all invested in decisions that impact the company's profitability, aligning their interests and motivating them to resolve disagreements effectively.
For example, Eva may want to expand by introducing a premium product line and Renee may want to expand by using cheaper raw materials to reduce costs and targeting the mass market. Both partners may perceive their recommendation as the best strategy which can lead to disagreements between the partners.
Decision Making Takes Longer
As all partners are now key decision makers in the business, decisions may take longer as more people are involved in discussions. Where disagreements take place, it may take a long time to agree on a course of action.
For example, prior to forming a partnership, Thomas could make changes to the menu quickly based on customer demand. However, once he forms a partnership, they will both need to agree on decisions like this. This means he will need to find time to discuss with his partner before this change can be made.
Benefits and Drawbacks of Limited Companies to Finance Growth
Limited liability
Limited liability means that owners and shareholders are not personally responsible for a company's debts. If the company gets into financial difficulty, the shareholders can only lose what they already invested in the company and will not have to sell off any personal property to repay debts.
Ability to Raise Capital
A limited company can raise funds by issuing shares. A share is a unit of ownership in a company meaning the shareholder has a claim to the company’s assets and profits. This gives an additional source of finance for expansion than a sole trader, who cannot sell shares.
Increased credibility
A limited company may be seen as more stable and credible by stakeholders such as lenders, suppliers and investors because they have gone through a legal process to establish the company. This could potentially attract more business opportunities such as favourable deals with suppliers and easier access to finance such as bank loans in the future.
Reduced Decision Making Power
In a limited company, shares are owned by multiple shareholders. This shared ownership means big decisions need agreement from all, which can make the process slower and reduce the control the original entrepreneur has over the direction of the company.
Compliance Costs
Setting up a limited company is an expensive process due to registration, accountancy and legal fees. Running costs are also likely to increase in order to comply with changes such as more complex accounting regulations.
Increased Management Complexity
Starting a limited company means dealing with more paperwork and rules, like filing annual accounts and keeping accurate records. This can be challenging for someone who was a sole trader. Directors have specific legal duties, and failing to meet these can result in penalties or disqualification, increasing the pressure of the role.
