Sole Traders and Partnerships

Posted by Abd. Ghafar ARM

In unit 4 we saw that businesses in the private sector are owned by private individuals. There are two forms of private sector businesses:

1. Unincorporated businesses, which do not exist separately from their owners.

2. Incorporated businesses, which are legally established as separate entities.

The owners of unincorporated businesses mainly have unlimited liability. This means that they are personally responsible for the affairs of the business – including the whole of any debts the business may have. The owners of incorporated businesses are not personally responsible for the affairs of the business, since the business exist as a legal entity in its own right. However, if an incorporated business fails, the owners may loss all the money they put into the business.

In this unit, we will examine unincorporated businesses – sole traders and partnerships. We will look at incorporated businesses, private and public limited companies, in unit 7.

Sole traders

A sole traders (sole proprietor) is someone who owns his or her own business. There is one owner (the sole trader), who makes all the decisions and is responsible for the day-to-day running of the business. While many sole traders are people working on their own, a sole trader can employ others. People who work in the business, apart from the owner, are actually employed by owner. The owner is self-employed.

Typical sole trader businesses are local independent shops, plumbers and similar trades people, freelance artist and other self-employed people.

Setting up as a sole trader

It is very easy to set up as a sole trader, as there are few legal formalities to go through.

The sole trader must tell the tax authorities that they have set up a business and are self-employed. He or she must declare any profit or loss made during the financial year, as this will be their income for tax purposes. Sole traders may be also has to pay other taxes, such as purchase tax or Value Added Tax where these apply. A sole trader must also keep employment records in respect of any employees.

Some businesses, such as hairdressers, employment agencies and businesses dealing with food, must be licensed, and all businesses employing people must comply with laws and health and safety regulations.

Where does the money come from?

Partly because they are small businesses, there are few sources of finance available to sole traders, apart from the personal funds of the owner. These include any saving the owner may have, redundancy payments from previous employment or loans from the bank. In addition, grants may be available from local or national government, and private organizations.

What happens if things go wrong?

A sole trader is an unincorporated business. This means that the business is not considered to be separate from its owner: the affairs of the business are considered the same as the affairs of the trader.

In the case of a sole trader, therefore, it is the owner himself or herself who employs people, owns the property of the business and borrows the money that the business needs. If things go wrong the owner has unlimited liability for any debts the business has. If the business is unable to pay its debts because it has insufficient funds available, the owner must pay the debts in full, even if he or she has to sell all their personal possessions including their house and car to do so.

The advantages and disadvantages of operating as a sole trader:
Advantages:
1. Owner works for him or himself
2. Low start-up costs
3. Few legal requirements
4. Owner keeps all profit
5. Owner has full control of business

Disadvantages:
1. Unlimited liability for the owner
2. Few sources of finance
3. Owner is responsible for all aspect of the business
4. Owner has to take all decisions
5. Usually involves hard work and long hours

Partnerships

A partnership is an unincorporated business that is owned by two or more people (the partners). A partnership can normally have up to twenty partners. Some major professional firms of accountants, such as Ernst and Young which has officer in more than 130 countries throughout the world, and international firms of solicitors such as Linklaters with operations in Asia (including China), Europe and the USA, have several hundred partners, reflecting the large scale and global scope of their operations.

The partners are self-employed. People other than the partners who work in the business are employed by the partners. Typical partnership businesses are local professional firms such as accountants, architects, solicitors and doctor’s practices, shops and similar small businesses that are owned by two or more people.

Setting up a partnership

Although it is not a legal requirement in most countries, many partnerships are established with a Deed of Partnership. This sets out the ‘rules’ of the partnership, including how much money each partner has to put into the business, who is responsible for decisions-making, specific responsibilities of partners and how the profits of the business are to be shared or used, the procedure for removing a partner or introducing a new one to the business and arrangements for dissolving the partnership and ending the business. In the absence of a partnership agreement, any dispute between partners will normally be settled on the basis that each partner shares equally in the management and responsibility for decisions-making in the partnership, as well as any profits of the business and responsibility for debts of the partnership.

What is a limited partnership?

A limited partnership is a special type of partnership in which one or more of the partners have limited liability. This means that the limited partner or partners can only be held liable for the affairs and debts of the partnership to the extent of the money they originally put into the partnership.

Limited partnerships are rare, and there are restrictions on their formation: at least one partner must have unlimited liability; partners with limited liability must not take any part in the management of the business. Some countries require limited partnerships to be registered with the authorities.

Where does the money come from?

As with sole trader businesses, there are few sources of finance available to partnerships, other than partners’ own funds, including savings, and redundancy payments from previous employment, and loans or grants from local or national government. Because there are more owners of the business, however, partnerships my often be set up with more capital than sole trader businesses. In addition, each partner may take out a loan individually, so reducing the amount owned by any one partner.

What happens if things go wrong?

As a partnership is an unincorporated business, the partners, other than limited liability partners, have unlimited liability for any debts of the other partners. Therefore if one partner defaults, the remaining partners are fully responsible for the whole of the debts of the business.

The advantages and disadvantages of partnerships:
Advantages:
1. Owner are self-employed
2. Owners have full control over business and profits
3. Few legal formalities

Disadvantages:
1. Unlimited liability for each of the owners

2. The partners have full responsibility for all aspect of the business

3. Disagreements between partners may cause difficulties with the business

4. The business may not survive the loss of one the partners

Summary

• A sole trader is someone who owns and controls his or her own business.

• A sole trader is the simplest form of business to set up.

• A sole trader makes all the decisions about the business, but has unlimited liability with regard to any debts the business has.

• Partnerships are unincorporated businesses that have more than one owner.

• The rules of a partnership are set out in a Deep of Partnership.

• Partnerships are shared businesses which enabled the owners to share responsibilities, workload and decision-making.

Glossary
Sole trader or sole proprietor: a business that is owned by one person

Self-employed: a person who works for himself or herself rather than for another employer.

Ordinary partnership: an unincorporated business with two or more owners who have unlimited liability.

Deep of partnership: a legal agreement of the terms and conditions of the partnership, signed by all partners.

Limited partnership: an unincorporated business with two or more owners, at least one of whom must have unlimited liability.

Resource: Chris J. Nuttall, IGCSE Business Studies, Cambridge University 2002