Advantages of Companies
Accounting (Year 12) - Characteristics of Companies
Limit of Owners Liability
As explained earlier, the extent of the shareholders' liability in repaying the company's debts is limited to the amount of capital invested on the basis of the number of shares owned by the shareholder. The shareholders' personal assets are not at risk to repay the company's debts. The shareholder is known to have 'Limited Liability'.
In unincorporated organisations (sole trader and partnerships), the owner and partners have unlimited liability since the business does not exist as a separate legal entity. Therefore, the owners' personal assets are at risk to repay the debts. Forming a company is advantageous as it will allow owners to protect themselves from businesses losses.
Lenders are aware of this protection to company owners and often require shareholders to guarantee them (personally pay the company's interest on loans or secure personal assets to repay the loan) to enhance the security on their loans.
Capacity to contract in the business name
Since an unincorporated business does not legally exist separately from its owner, it cannot enter into contracts or hold assets under its own name.
This has to be done personally under the owners' name and causes significant inconvenience when assets such as land have to be held under several names in a partnership, and when motor vehicles that can only be registered under one name are registered under one partner only and not the others. Incorporating the business avoids these difficulties.
Transfer of ownership
In sole traders and partnerships the transfer of business ownership requires the transfer of assets such as land, property and vehicles individually, making the process complicated and costly. Furthermore, loans taken by the current business owners must be fully settled prior to the transfer of ownership. This creates a significant issue when one partner wants to leave or sell their portion of ownership to someone else as all assets would need to be revalued and transferred to the new owners, and all liabilities have to be settled.
This is how having an incorporated business is advantageous as all that is needed is the transfer of shares in full or a portion, as all other assets and liabilities are held under the company's name. Public companies also have the added benefit of being listed on a share-market, where the sale and buying of shares transactions between anyone can take place.
Continuity of existence
If a sole trader dies, their business comes to an end. If a partner in a partnership dies or wishes to not be a part of the business anymore, the original partnership agreement comes to an end and a new agreement would need to be made between the new partners.
A company's running would not be affected upon the death of a shareholder, or a shareholder wishing to leave the company and selling their shares. The shares of a shareholder who has died will be passed onto their beneficiaries. If a shareholder wishes to leave the company, they can sell their shares to another buyer on the public share market. These two circumstances do NOT affect the functioning of a company.
In some circumstances, having a company is advantageous from a tax standpoint. Companies pay a flat rate of 30% tax on profit. Sole traders pay personal income tax on their profits, and partners after splitting their portion of the business profits pay personal income tax rates as well.
In circumstances where a sole trader or partner in a partnership is very wealthy, they may have a high marginal personal tax rate. For example, if a partner is effectively paying 31% income tax, it would be more advantageous from a tax perspective to have a company. However, if the profits rate low and the personal income tax rate is 20%, it would be more advantageous to stay as a sole trader or partnership. This depends on certain circumstances.
Access to capital
Public companies are able to have an unlimited number of shareholders, therefore the ability to raise large amounts of capital through the issuing of shares to the public.
Companies can issue debentures- which is effectively borrowing money from the public. Proprietary companies can have a maximum of 50 shareholders, but they are still able to raise more capital than a partnership which have a maximum of 20 partners. Proprietary companies cannot issue debentures to the public.