IB Business - Gr11, 1.2 Types of Business Entities

Badru and Anna have three adult children. They have just moved into a new house, and are thinking about converting their antique shop from a partnership to a privately held company. Which of the following is the most likely reason why they are considering this change? 

• It would better secure the continuity of their business.

• They will enjoy greater privacy and confidentiality when it comes to their financial accounts.

• They will be protected by unlimited liability.

• It will be easier for them to grow their business via mergers and acquisitions.

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Answer explanation

For companies (corporations), the death of a shareholder has no impact on the continued functioning of the company. Hence, converting their antique shop into a privately held company would help secure the continuity of their business. On the other hand, it would require greater financial transparency. It is also unlikely that a family-run antique shop would aspire to growth via mergers and acquisitions, as this method usually tends to be used by larger organisations. Companies enjoy limited liability, not unlimited liability.

Limited liability makes it difficult for companies to attract new shareholders.

• True

• False

Answer explanation

Having limited liability is an advantage offered to shareholders and it attracts more investors.

What might be the conflict between the management of a publicly-held company and its owners when deciding how to use the company’s profits? 

• Managers wish to keep profits for personal use.

• Managers do not want to expand the company.

• Owners are not interested in the company’s growth.

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• Manager wishes to reinvest profits in the business while owners aspire to earn higher returns or dividends.

Mo and Sam have made the decision to form a partnership and will be selling second-hand books. Which of the following is an advantage to Mo and Sam of setting up their business as a partnership? 

• Limited liability

• Financial performance remains confidential

• Owner has total control

• Independent legal identity

Answer explanation

As a partnership is not a registered company, the financial performance of the business will remain confidential. This is an advantage as partners are not required to submit annual financial reports. Limited liability and having an independent legal identity are advantages of private and public limited companies rather than partnerships, which are unincorporated and have unlimited liability. Sole traders have the advantage of having total control of the business, whereas partners often have shared decision-making powers.

Which of the following is not a feature of a sole trader?

• Unlimited finance

• The sole trader owns and runs the business

• The sole trader and the business are not legally distinct

• The customers and the business are close to each other

Answer explanation

Unlimited finance is not a feature of a sole trader. A sole trader usually has limited finance because it is funded by the sole trader, family, friends or small bank loans. Due to the fact that start-ups have high failure rates, there is caution in lending funds to a sole trader. All other responses are features of a sole trader.

Key Term: __ is an investor in a partnership but who does not get involved in the daily running and management of the organization.

• Minor Partner

• Limited Partner

• Sleeping partner

• Semi Active Partner

Key Term: __ occurs when an organization sells all or part of its business to shareholders on a public stock exchange for the first time. This changes the legal status of the business to a publicly held company.

• Trading Day

• IPO - Initial Public Offering

• PSI - Public Stock Incorporation

• Initial Shareholder Sale

Key Term: __ This is a business owned by shareholders with limited liability, but the shares cannot be traded on a public Stock Exchange.

• Publicly Held Company

• Privately Held Company

• Public Sector

• Private Sector

Key Term: These organizations are revenue-generating businesses with community (social) objectives at the core of their operations in order to benefit the general public, rather than private shareholders.

• Sole Trader

• Partnership

• Social Enterprise

• Corporation

TRUE OR FALSE? Having limited liability means that owners of a business can only lose the money they have invested, and no more.

• True

• False