A corporation, also known as a limited company, is a legal entity which is separate and distinct from its owners (shareholders). There are two types of incorporates business organizations – Private Limited Company and Public Limited Company.
Each shareholder in a limited company has limited liability. It means that a creditor with a claim against the assets of the company normally has no rights against its shareholders.
Shares may be transferred without affecting the corporation’s existence or continued operation. It makes ownership interests in a corporation usually easily changed.
The two following characteristics distinguish a limited company from a sole trader or partnership:
– Limited liability – normally no shareholder can be held personally liable for the debts, obligations or acts of the corporation beyond the amount of share capital the members has subscribed.
– Perpetual succession – because the corporation is a separate legal entity, its existence does not depend on the continued membership of any of its members.
Advantages of limited companies
Advantages of limited companies include:
1. Raising money. Companies can raise large amounts of capital by selling shares. There are no interest charges and shareholders are paid only, if the company makes a profit. Shareholders are paid dividends which come from Net Profit After Interest and TAX.
2. Limited liability. As all companies have this, it is easier to attract investors because the risks are relatively low.
3. Continuity. Unlike partnerships and sole traders, the legal difference between the company and its owners means that the limited company can continue operating as a separate entity, even with a change of its owners.
4. Economies of scale. Due to larger size, limited companies can benefit from economies of scale (the firm grows, the average cost of production declines). Because limited companies are less of a financial risk, it is usually cheaper for a company to borrow money than it is for sole traders or partnerships.
5. Productivity. Companies hire directors and managers to run the business as there is no need for the owners to be directly involved in the daily operations. They are also more likely to employ specialist staff such as marketers, lawyers and accountants. Therefore, the sales revenue and productivity levels of limited companies are generally higher than in sole traders or partnerships.
6. TAX benefits. Sole traders or partnerships pay Income TAX on their profits which is usually higher than what limited companies pay which is Corporate TAX on their Net Profit Before Interest and TAX. Companies also benefit from a wider range of allowances and TAX-deductible expenses.
Disadvantages of limited companies
Disadvantages of limited companies include:
1. Loss of control. Whilst sole traders and partnerships retain full control of their businesses, public limited companies face the potential threat of a takeover by a rival company that purchases a majority stake in the business. When owners sell too much of the shares, they may lose the ownership of the business. Shares in public limited companies can be openly traded by anyone on the stock exchange.
2. Added complexities and costs. Running a business as a sole trader or partnership is much cheaper and less bureaucratic than running a limited corporation. For public limited companies, the high costs of complying with the rules and regulations of the stock exchange (compliance costs) add to their running costs. Hosting the annual general meeting is also a huge and expensive task for private limited companies, as well as advertising and promoting the company’s IPO for limited companies going public.
3. Disclosure of information. Financial data about profit or loss, assets and liabilities and the amount of cash must be provided to all shareholders. This can be time consuming and expensive task because professional auditors have to be hired and paid, and annual reports have to be legally accurate, published and distributed. Some of the big consulting companies acting as auditors (solicitors) include Deloitte, KPMG International, PricewaterhouseCoopers (PwC) or Ernst & Young (EY). Privacy no longer exists in limited companies, especially for public limited companies which need to make their financial statements available to the general public, in comparison to that enjoyed by sole traders or partnerships.
4. Communication problems. Quite often, as a company becomes larger, relationships can become more impersonal to both customers and employees. There is far more bureaucracy involved in setting up and running a company as organizational charts with clearly defined accountabilities and responsibilities must be created. The family atmosphere and personalized communication with customers which is a great benefit of sole traders or partnerships fades away too.
