Business forms: Understanding the issues

MARIA SOOKDEO, ACCA Business development Manager

In the second part of ACCA's business forms series, we provide professionals in practice a guide to help advise their entrepreneurial customers when choosing the best business form for their enterprise. The goals and visions may differ, but the drive of every small business founder is success. Helping them find the right legal form for a business can be the critical success factor.

The first part of the business forms series gave an overview of the different options available when it comes to legal forms. This follow-up guide dives deeper into the areas perceived as most important by both advisers and entrepreneurs, highlighting aspects which might weigh more heavily on the minds of the novice founder than the experienced expert.

Practice professionals and business advisors have a key role to play in supporting entrepreneurs, providing them with expert advice on what can, should and must be done when it comes to starting business venture.

The first crucial step is to advise the business founder on the legal form they should adopt for their business. An open and honest conversation about what the implications are, informed by an understanding of likely preconceptions, will help set the foundations of an enduring and successful advisory relationship.

The characteristics of different business forms

In order to help structure the analysis and conversations with clients, the characteristics of business forms have been split into four broad chapters, considering in turn:

• Realising the returns

• Investing into the business

• Legal characteristics

• Administrative requirements

While there is inevitably some overlap and interaction between those broad headings, and a number of further considerations must be taken into account, results from the survey confirm that addressing these factors and identifying the correct balance between them will be essential to ensuring that the business is operating through the format best suited to its current needs.

Realising the returns

Establishing what form "value" takes for the business, and then how best to ensure that the value ends up where it is supposed to be, is perhaps the most important consideration when deciding on form. In order to offer appropriate advice, it will be important for the adviser to understand the owners/founders’ goals, their approach to achieving those goals, and any compromises they may be prepared to make along the way. Some structures favour regular extraction of accrued profits; others allow for the sale of a share, and future returns on that share, to a third party. A number of cooperative and charitable forms, by contrast, deliver their value entirely in the form of returns to society or indirectly to the members, and do not allow for any cumulative return on capital invested. Understanding the founders’ intentions, and exploring how they can best be reflected by the outcomes available from the form chosen is an essential element in good advice.

Investing into the business

One of the most fundamental considerations is whether or not the owners need to raise money beyond their own resources to develop the business. If the founders need more start-up funding than they personally have available, then the simplest way to introduce money to the business is often to borrow it, which will involve paying interest. Typically, the cost will be based on how much is borrowed, regardless of the predicted proportional return on that sum.

One aspect of investing to develop the business that can be hard to assess is the time and effort needed to establish networks of customers and suppliers. The difficulties faced were captured by a comment from one survey respondent: "Two of the biggest problems for any new SME are where to find clients, and where to find capital. Hence, if government wants to engage in meaningful support activities, I would see them concentrate efforts on promoting truly working business exchanges, trade associations’ membership support, making government contracts more accessible, supporting funding efforts through some sort of (government) guarantees for qualifying business projects that would allow the owners to draw credit from commercial banks."

Legal characteristics

The defining legal characteristic of a business form will be whether the business has a separate legal identity from its owner(s). Deciding whether the enterprise will need its own identity, and the capacity to own things in its own right, or can simply exist as an extension of the legal name(s) of the owner(s) goes to the heart of its relationships with the outside world, and where liability will fall for any issues that arise. Companies and other "bodies corporate" exist as independent legal entities, able to enter into contracts and enforce (or be subject to) rights and liabilities. That contrasts with the sole trader’s position, where everything is done directly in the name of the individual responsible. In addition, use of a separate legal personality can greatly simplify selling, or transferring, part or all of the business. At the same time, it will impose restrictions on the legal power of the owners and/or managers to deal with the assets of the business, or enter into contracts on its behalf.

Administrative requirements

These are often driven by the legal characteristics and tend to fall into two categories – occasional requirements, such as the formalities governing the initial start-up or major transactions such as a sale of the business, and regular requirements such as preparing and filing or publishing accounting information, or observing certain formalities around transactions, for example dealings between the investors and other stakeholders, such as managers or employees.

Starting the business is something that happens only once. The legal form adopted by the business should be based on long-term factors, not just the ease of the start-up process. It is important, nonetheless, to understand what needs to be done, how long it will take and what it might cost. This is particularly the case in those jurisdictions where the formalities of the incorporation process are more burdensome.