Types of Business Organisation (i): Sole Proprietors, Partnerships and LLPs

Before a business can trade, its owners must choose the legal form it will take. The choice decides who owns the business, who answers for its debts, how it raises money, what records it must keep and whether it can outlive its owners.

The Institute of Chartered Accountants of Nigeria (ICAN) syllabus asks you to explain the characteristics, purposes, merits and demerits of each form, so this is a topic to learn in full.

This part covers the three unincorporated or partly incorporated forms: the sole proprietorship, the partnership and the limited liability partnership (LLP). Part (ii) covers companies, non-governmental organisations, public sector bodies, alliances, cooperatives and joint ventures.

The nature and objectives of business

A business is an organised activity in which people produce and distribute goods or services, usually to earn a profit, under conditions of uncertainty. Four things distinguish a business from a one-off sale: the activity is continuous, it aims at profit, capital is invested in it and it carries risk. Selling your old television once is not a business. Selling televisions regularly is.

Types of business by what they do

• Service businesses offer skills and expertise, such as accounting, law, hairdressing and banking. Their product is intangible.
• Merchandising businesses buy goods and sell them on without changing them, such as supermarkets and pharmacies.
• Manufacturing businesses buy materials and turn them into new products, such as bakeries, bottlers and textile mills.

Objectives of business

Sole proprietorship

A sole proprietorship is a business owned, managed and controlled by one individual. It is the simplest, oldest and most common form of business in Nigeria, and it is typical of retail and wholesale trade, professional practice and construction.

Features

• One owner takes the decisions from experience and judgement, without consulting anyone.
• One person carries the risk and keeps all the profit.
• No separate legal existence. The business and its owner are the same person in law.
• Unlimited liability. If the business cannot pay its debts, the owner’s personal assets, such as a house or a car, can be used.
• Secrecy. The owner keeps the business’s affairs private.
• Little regulation and no written agreement needed to form it.
• Limited continuity. The death of the owner may end the business.

Partnership

A partnership is a business owned by two or more persons who agree to carry it on together with a view to profit. They contribute capital and skills and share the profit on agreed terms. Law, accountancy, medicine and insurance often use it. The syllabus puts the number of partners at a minimum of two and a maximum of twenty for an ordinary partnership.

Features

• Agreement. The terms are set out in a partnership deed.
• Sharing of profit and loss in the agreed proportions.
• Agency. Each partner acts for the others, so each partner can bind the firm by what he or she does in the ordinary course of business.
• Unlimited liability. Partners answer for the firm’s debts from their private assets.
• Common management. Every partner has a right to take part in running the business.
• Restricted transfer of interest. A partner cannot hand over his or her share without the consent of all the others.
• Registration with the Corporate Affairs Commission.
• No board of directors and no duty to publish information to the public.

The partnership deed

The deed is the written contract between the partners. It prevents disputes by settling the main questions in advance. It usually states:

• the firm’s name, address and the nature of the business;
• the names of the partners and the capital each will contribute;
• how profits and losses are shared, and any salary or interest on capital;
• each partner’s role, rights and limits on liability;
• how decisions are made, for example by majority vote;
• how a new partner is admitted;
• rules on withdrawals and further investment;
• how long the partnership will last; and
• what happens on the death, incapacity or withdrawal of a partner, and how the firm is dissolved.

Types of partner

Dissolution of a partnership

A partnership comes to an end by court order, by technical insolvency, by agreement between the partners, when the task for which it was formed is complete, on the death of a partner, or when the partners decide that its objectives have been met.

Limited liability partnership (LLP)

A limited liability partnership is provided for in Part C of the Companies and Allied Matters Act 2020. Unlike an ordinary partnership, an LLP is a body corporate with its own legal personality.

• Separate legal entity. It can own property, sue and be sued in its own name.
• Limited liability. A partner’s liability is limited to the amount he or she agreed to contribute.
• Perpetual succession. A change of partners does not affect its existence, rights or liabilities.
• Partners. At least two at all times, with no maximum. Individuals or bodies corporate may be partners, but not a person of unsound mind or an undischarged bankrupt.
• Designated partners. At least two designated partners who are individuals, at least one of them resident in Nigeria.
• Registration with the Corporate Affairs Commission.
• Winding up voluntarily by the partners or by the court.
• Tax. The syllabus notes that the tax treatment of LLPs is still being clarified, with the view that partners are taxed on their shares of profit.

The forms compared

Worked example: choosing a form

1. Rule out the sole proprietorship. There are three owners, so a sole proprietorship does not fit.
2. Consider a general partnership. It is quick and cheap and suits professionals. But liability is unlimited, and each partner can bind the others, which is exactly their worry.
3. Consider an LLP. It limits each partner’s liability to the contribution, has its own legal personality and continues if a partner leaves. It is more formal and must be registered.
4. Recommend. Form an LLP under CAMA 2020 with a written agreement setting out roles, profit shares and how a partner leaves. It answers their worry about unlimited liability while keeping the partnership style of working.
5. State the cost. Registration and compliance are more demanding than for a plain partnership.

The three forms examined further

Why a person chooses each form

• Sole proprietorship. The owner keeps all the profit and all the control, makes decisions quickly and can keep the affairs private. The price is unlimited liability: creditors may take the owner’s personal property, such as a car or a house, and the business is limited by what one person can raise and manage. It also ends or is disrupted if the owner dies or falls ill.
• General partnership. Partners can pool capital, skills and contacts, share the workload and spread risk. The cost is that each partner is an agent of the others, so one partner’s dishonest or careless act within the business can bind everyone, and each is liable without limit. Disagreements can be costly, which is why a partnership deed matters.
• Limited liability partnership. It keeps the partnership’s flexibility but gives the partners protection, because the firm is a legal person and the partners are not personally liable for its debts. That is why professionals such as accountants and lawyers often prefer it. It brings more formality, registration and filing duties.

The partnership deed: why each clause matters

A deed that states the capital each partner contributes, the profit-sharing ratio, salaries or interest if any, powers and limits of each partner, how new partners are admitted, how a retiring or deceased partner is paid out and how disputes are settled turns arguments into rules. Where a deed is silent, the law supplies default terms.

Under those terms profits and losses are shared equally whatever the capital contributed, no partner is paid for working, and a new partner needs everyone’s agreement. A deed lets the partners choose terms that fit their real arrangement.

Dissolution: the reasons

A partnership ends when its term or its single venture ends, when a partner gives notice in an open-ended partnership, on the death or bankruptcy of a partner, when the business becomes illegal, or by order of the court on grounds such as a partner’s incapacity, serious misconduct or persistent breach of the agreement.

After dissolution the assets are sold and applied first to outside creditors, then to partners’ loans, then to partners’ capital, with any surplus shared in the profit ratio.

A comparison of risk: one set of figures

Suppose a business fails owing ₦12,000,000, and its assets realise ₦4,000,000, leaving ₦8,000,000 unpaid. A sole proprietor is personally liable for the whole ₦8,000,000. In a general partnership of Ade, Bisi and Chidi, creditors may pursue all three personally for the ₦8,000,000, and if Chidi has no assets the others must make up his share.

In an LLP, the partners are not personally liable for the shortfall, except for their own fraud, and lose only what they invested.

Everything the syllabus says: complete notes

The nature of business: seven integral elements

A business is more than a place that sells things. The syllabus breaks the idea into seven elements that together describe what a business is.

Three types of business by what they provide

Objectives of business, in full

A business objective is a goal, where the business wants to be in the future, such as opening a franchise in another state within three years. Objectives are the driving force and cornerstone of a business, and without them a business is ‘like a car without headlights driving blind’. They aim to secure survival, growth and success through profitability, increased market share, customer satisfaction and employee well-being. They fall into two groups.

Economic objectives

• Profit earning. Profit is the excess of income over expenses. A business cannot survive without it, as a plant cannot survive without water. Profit pays for modernisation and growth and shows the stability, efficiency and progress of the business.
• Market share and the creation of customers. Drucker said the only valid definition of business purpose is to create a customer. Profit comes from satisfying customers, and long-run survival depends on the market share the business captures. It must supply good quality and value for money.
• Innovation and use of resources. Innovation means changing processes or creating better processes, products and ideas, so large firms invest heavily in research and development. Use of resources means using workforce, raw materials, capital and technology properly, since resources are limited.
• Increasing productivity. Productivity measures the efficiency of business activity by its output. It is achieved by cutting waste and making efficient use of machines, supplies, people and cash.

Social objectives

As Dayton Hudson put it, the business of business is serving society, not just making money. A business cannot thrive without society’s resources, so it must attend to social factors:

• Providing goods and services at reasonable prices. It is the first and major social objective, since business exists to satisfy society’s needs.
• Employment generation, by offering beneficial jobs.
• Fair remuneration to employees, including a share of profit, which motivates higher productivity.
• Community service, part of corporate social responsibility: libraries, hospitals, schools, and support for NGOs such as the Red Cross.

Sole proprietorship: the complete picture

It is the simplest, most common and oldest form of ownership, and the most common in Nigeria. The business is owned, managed and controlled by one individual who is entitled to all the profit and bears all the loss. He raises the capital from personal resources, friends, relatives and banks. It is common in retail and wholesale trading, professional practice and construction.

It can be formed without a written agreement or charter, and it is not a legal entity, so it is not distinct from its owner.

Partnership: the complete picture

A partnership arises when two or more individuals agree to organise and run an enterprise jointly with profit as the motive. They contribute capital and services. The legal basis is contractual, setting out the duties and rights of the partners. It is common in law, insurance, finance and accountancy.

Characteristics

Features

1. Basis of agreement, with terms stated in the deed.
2. Sharing of profit and loss.
3. Agency relationship. Each partner may act for the others, so every partner can bind the firm.
4. Unlimited liability. If the firm’s assets are not enough, partners’ private property can be taken.
5. Common management. Every partner may take part. A partner who does not should be consulted before strategic decisions.
6. Restricted transfer of interest. No partner can transfer his interest without the consent of all the others.
7. Registration. The syllabus says registration with the Corporate Affairs Commission is compulsory. Under CAMA a partnership that carries on business in its partners’ own names need not register a business name, so be careful: say what the syllabus says, and add that registration is required where a business name is used.
8. Deed of partnership strictly guides the activities.

The types of partner in the syllabus

The contents of a partnership deed (the article of partnership)

The deed is a written contract that guides the day-to-day running of the business and avoids disputes. It states each partner’s rights and responsibilities, how decisions will be made if the partners cannot agree, and each partner’s share of profit and loss.

It may contain:

• the name of the firm
• the names of the partners
• the place of business
• the nature of the business
• the capital each partner will contribute
• the role of each partner
• how profit and loss are shared
• compensation, if any, for services
• the partners’ rights
• the duration of the partnership
• how matters are to be decided, by majority or not
• provision for new partners
• the limit of liability of one or more partners
• arrangements for withdrawals or extra investment
• arrangements for dissolution on death, incompetence or other withdrawal

Once all partners sign, it is a legally enforceable contract. It may also describe the business practices, such as the fiscal year, the accounting system and the amount that may be withdrawn in a given period.

Advantages, disadvantages and dissolution

Limited liability partnership in the syllabus

An LLP is provided for in Part C of CAMA 2020. A general partnership is not a legal entity and is dissolved by the death of a partner. An LLP, however, is a body corporate and a legal entity separate from its partners, with perpetual succession, so a change in partners does not affect its existence, rights or liabilities.

Any individual or body corporate may be a partner, but not a person of unsound mind found so by a court in Nigeria or elsewhere, nor an undischarged bankrupt. It must have at least two partners at all times and has no maximum. It may be wound up voluntarily by the partners or by the court, and then dissolved.

Notice that the syllabus’s ‘advantages of LLPs’ and ‘disadvantages of LLPs’ are written in terms of a company with shareholders. Learn them as given if a question asks for the advantages of a limited liability form.

The limited liability company in the syllabus

An LLC is an association of individuals who pool their capital to start and own a business that is distinct from its owners. It is a hybrid structure meant to give the limited liability of a corporation with the tax efficiency and flexibility of a partnership. Its formation is more complex and formal than a general partnership. Owners are called members, not shareholders.

Documents used in forming a company

1. Memorandum of association. States the relationship between the company and the outside world. It contains the name, the location of the registered office, the objectives, the proposed registered capital, a statement of the shareholders’ liability, and the regulations that guide the company and its members.
2. Articles of association. The internal rules for organisation and management. They contain the duties, rights and position of each member; how directors are appointed and removed; the rights and powers of directors; how dividends are shared; how general meetings are held and their procedure; how directors are elected and voting rights at elections; how the accounts are audited; the procedure for issuing and transferring shares; and the rights and responsibilities of shareholders.
3. Statutory declaration. A statement that the promoters have complied with the requirements of CAMA.
4. Prospectus. An invitation to the public to subscribe for or buy shares or debentures, issued by a public company to raise capital. A copy must be filed with the Registrar after approval by the stock exchange, so the public is not misled. It contains the names and addresses of the directors; the types of shares; when and how shares may be bought; the minimum and maximum number a subscriber may apply for; the cost of shares; the financial history of the company; and the possible value of its assets and liabilities.
5. Certificate of incorporation. Issued by the Registrar after scrutinising the memorandum and articles. It confers legal status on the company.
6. Certificate of trading. Issued to a public company so that it may begin business and exercise borrowing powers. It is issued only if the Registrar is satisfied that the minimum capital has been raised from the public and each director has paid for his shares.

Winding up of a limited liability company

Winding up brings the existence of a company to an end. The conditions that can lead to it are: expiry of the agreed life span; undue delay in starting business, about a year from incorporation; membership falling below the minimum of two for a private company or seven for a public company; default in filing statutory reports; events beyond the owners’ control; a court order; and bankruptcy.

Unlimited liability

Unlimited liability is the legal obligation of the founders and owners to repay in full the debts and other financial obligations of the business. It generally applies to sole proprietorships and general partnerships, where each owner is equally responsible. It means owners are personally responsible for all the business’s debts and may lose personal assets if it fails.

Questions that could be asked on this topic, and how to answer them

Exam focus: nature and objectives of business, and the features of sole proprietorships and partnerships

Nature of business

Business is an activity carried on to earn profit by producing and distributing goods and services under uncertain market conditions. The nature of business is a company’s main activities in creating, marketing and selling a product or service. Its core components are purpose, activities, scale, stakeholders, economic contribution, risks and challenges, and legal structure.

Objectives of business

Objectives are broadly economic, financial and human, aimed at survival, growth and success. The syllabus groups them into two categories.

• Economic objectives. Profit earning, the main objective, which funds growth and modernisation. Market share or creation of customers, since Drucker said the only valid purpose of business is to create a customer. Innovation and utilisation of resources. Increasing productivity, by cutting waste and using machines, staff and cash well.
• Social objectives. Providing goods and services at reasonable prices; generating employment; fair remuneration to employees, including a share of profits; and community service through corporate social responsibility, such as schools, hospitals and support for NGOs.

Sole proprietorship: key features

Individual initiative dominates, with the owner using his own judgement. The owner bears all the risk and takes all the profit. He manages and controls the business, and any manager has little real power. Liability is unlimited. Secrecy is easy to keep, and government regulation is minimal.

Partnership: key features

Types of partner include the active (general or working) partner, the inactive (dormant or sleeping) partner, the nominal or passive partner, the silent partner, the secret partner and the limited partner.

Exam focus: the deed of partnership and more on the sole proprietorship

Contents of a deed of partnership

A deed contains some or all of the following:

• the name of the firm
• the names of the partners
• the place of business
• the nature of the business
• the capital each partner will contribute
• the role of each partner
• the method of sharing profits and losses
• any pay partners get for services
• the rights of partners
• the duration of the partnership
• how matters are decided, by majority vote or otherwise
• admission of new partners
• the limit of liability of any partner
• arrangements for withdrawals or extra investment
• arrangements for dissolution on death, incompetence or withdrawal of a partner

More features of a sole proprietorship

• It is owned by one person and is not a separate legal entity from the owner.
• It is the most common form of business ownership in Nigeria.
• The owner is responsible for losses and liabilities and may have to sell personal assets if capital runs short.
• The death of the owner may end the business, since continuity is not guaranteed.

Common mistakes in the exam

• Saying that a partnership is a legal person. It is not. An LLP is.
• Confusing silent, secret, dormant and nominal partners. Silent partners are known to the public. Secret partners are active but unknown.
• Forgetting that every general partner can bind the firm.
• Stating the limited partner’s rights wrongly. A limited partner has limited liability but may not manage.
• Giving advantages without disadvantages when the question says ‘discuss’ or ‘evaluate’.
• Describing business objectives as profit only. The syllabus lists economic and social objectives.

Quick revision

• Business: continuous, profit-seeking, capital invested, risk. Types by activity: service, merchandising and manufacturing.
• Sole proprietorship: one owner, unlimited liability, no separate legal existence.
• Partnership: two to twenty, partnership deed, unlimited liability, agency, registration with the Corporate Affairs Commission.
• Know the types of partner and what the deed contains.
• Dissolution: court order, insolvency, agreement, task done, death of a partner, objectives met.
• LLP: body corporate, limited liability, perpetual succession, at least two partners, at least two designated partners and one resident in Nigeria.

Practice questions

These are original questions written in the style of the ICAN exam. Try each one before you open the answer.

Section A style: multiple choice

Section B style: written questions

A further written question

Model answers

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