1The idea in one paragraph

Every business has a legal form, and the form answers four questions: who owns it, who controls it, who pays if it fails, and where the surplus goes. Sole traders and partnerships are owned and run by one or a few people who carry unlimited liability: if the business cannot pay its debts, the owners must, from their own pockets. Companies, privately held or publicly held, are separate legal persons owned by shareholders whose limited liability caps their loss at what they invested; in exchange, companies cost more to set up, must publish more, and in the publicly held case the founders can lose control. Social enterprises use trading to pursue a social or environmental purpose: some are for-profit (private sector companies, public sector companies, cooperatives), and one is non-profit (the NGO). Choosing a form is always a trade between capital, control, risk and purpose.

2The private sector and the public sector

The economy is split into two sectors by who owns and controls the organisation. (These are not the four sectors of 1.1, which sort businesses by what they do; these sort them by who owns them.)

• The private sector is made up of organisations owned and controlled by private individuals and groups: sole traders, partnerships, companies, cooperatives and NGOs. Most aim for profit, but not all.
• The public sector is made up of organisations owned and controlled by the government, national or local. It provides services that the government has decided everyone should have, or that private firms would not provide well: defence, policing, state schools and hospitals, roads, often public transport and water. It is financed mainly through taxation, with charges for some services.

Figure 1 places every entity the guide names in one of the two columns, and in one of three rows by purpose.

Read the caption twice. A publicly held company is in the private sector: "publicly" means only that anyone can buy its shares on a stock exchange. A public sector company is owned by the state. Students often swap them, and a question that turns on the difference is an easy four marks for the student who does not.

Organisations can move between the sectors. Privatisation is the sale of a public sector organisation to private owners, usually to raise money for the government and to make the business more efficient through competition and the profit motive. Nationalisation is the reverse: the government takes a private business into public ownership, for example to rescue a failing firm whose service the country cannot do without. Either move changes the organisation's objectives, and that is where the exam question usually sits.

3Five features that separate one form from another

Before the forms themselves, learn the five features that distinguish them. An answer that compares forms on these five, applied to the case, is an answer that scores.

Ownership. Who owns the business: one person, several partners, shareholders, members, or nobody at all (an NGO has no owners who take profit).

Control. Who makes the decisions. In small forms the owners control directly. In companies, shareholders elect a board of directors to run the business, so ownership and control can separate.

Liability. Who pays the debts if the business cannot. With unlimited liability the owners are personally responsible for all the business's debts, without limit. With limited liability the owners' loss is limited to the money they have invested in the business; their personal possessions are safe.

Legal identity. An unincorporated business, such as a sole trader or an ordinary partnership, has no legal existence separate from its owners: the business's debts are the owners' debts. An incorporated business, a company, is a separate legal entity: it can own property, sign contracts, sue and be sued in its own name, and it carries on existing when its owners change. Limited liability follows directly from incorporation.

Finance and disclosure. The more people who can buy a stake, the more capital a business can raise, and the more information the law requires it to publish so that those people are protected.

Figure 2 puts the liability difference into numbers. Two failed businesses each owe €60,000 and raise €22,000 by selling everything they own. €38,000 is still owed.

In panel (a) the owner is a sole trader, so the creditors can pursue the €38,000 from the owner's savings, car, and in the worst case home. In panel (b) the business is a company. The company is a separate legal person, so the debt belongs to it, not to the shareholders. The creditors lose the €38,000; each shareholder loses what they paid for their shares, €10,000 here, and nothing more.

Limited liability: the owners' loss is limited to what they invested. It exists because a company is a separate legal person from its owners.

4Sole traders

A sole trader is a business owned by one person, who has unlimited liability. The owner may employ other people; "sole" refers to ownership, not to working alone. It is the commonest form of small business in many countries: hairdressers, plumbers, market traders, tutors, freelance designers.

Take Farah Nasser, who runs Studio Farah, an invented hair salon with two employees.

The evaluative point: the sole trader form suits a small, low-risk business where the owner values control. It becomes a problem when the business needs more capital than one person can raise, or when the risk grows large enough that unlimited liability becomes frightening.

5Partnerships

A partnership is a business owned by two or more people who share the capital, the decisions and the profits. Some countries limit the number of partners an ordinary partnership may have. The form is common among professionals: architects, lawyers, doctors, accountants.

Partners usually sign a deed of partnership, a legal agreement that sets out how much capital each puts in, how profits and losses are shared, who does what, how decisions are made, and what happens if a partner leaves or dies. Without one, disputes are hard to settle.

In an ordinary partnership every partner has unlimited liability, and it is joint: each partner can be made to pay the whole firm's debts, including debts run up by the other partners. Some countries allow a partner who invests but takes no part in running the firm, a sleeping partner (or silent partner), to have limited liability, and some allow limited liability partnerships. Name the form in the case and do not assume.

Take Mbeki & Lund, two invented architects who joined forces to bid for larger contracts.

6Companies: privately held and publicly held

A company is an incorporated business owned by shareholders. Each share is a small piece of ownership. Shareholders have limited liability, may receive part of the profit as dividends, and vote, usually one vote per share, to elect the board of directors that runs the company. There are two kinds, and the difference is who is allowed to buy the shares.

A privately held company sells its shares privately, to people the existing owners choose: family, friends, employees, private investors. Its shares are not traded on a stock exchange, and a shareholder usually cannot sell without the agreement of the others. Many are family firms. (In the UK such a firm carries "Ltd" after its name; the label varies by country.)

A publicly held company has its shares traded on a stock exchange, so anyone can buy them. A company becomes publicly held through a flotation, or initial public offering (IPO): it offers shares to the public for the first time. (In the UK such a firm carries "plc".)

Both kinds share the advantages of incorporation: limited liability, which makes investors willing to put money in; continuity, since the company outlives any one shareholder; and a status that makes lenders and suppliers more willing to deal with it. Both share the costs too: registration, legal requirements, and accounts that must be filed.

What floating does to control. Figure 3 shows the trade you make as you move from left to right across the four forms.

The loss of control is the part candidates state and rarely show. Halden Foods is an invented privately held company with 1,000,000 shares, of which the Halden family own 600,000. To fund a new factory it floats and issues 500,000 new shares to the public.

The family did not sell a single share, yet its stake fell from a majority to a minority, as Figure 4 shows. That is dilution. With 60% the family could outvote everyone; with 40% it can be outvoted if the other shareholders act together, and a rival could try to buy the 60% it does not own. Publicly held companies also show a divorce of ownership and control: the thousands of shareholders who own the company leave the running of it to professional directors and managers, whose interests may not be the same as theirs.

7For-profit social enterprises

A social enterprise is a business that trades to achieve a social or environmental purpose, and that uses most of its surplus to pursue that purpose rather than to reward owners. It judges itself on more than profit: on the triple bottom line of people, planet and profit that the guide uses to define sustainability. The guide names three for-profit forms.

Private sector companies (with a social purpose). A company owned privately, with limited liability, whose stated purpose is social or environmental. It makes a profit and may pay a limited dividend, but reinvests most of it in the mission. Some countries have created special legal forms for such companies; others use an ordinary company with the purpose written into its founding documents. Thread Forward Ltd (invented) makes workwear and deliberately employs and trains refugees, putting most of its profit into training places.

• Strengths: limited liability; can sell shares to impact investors, who want a social return as well as a financial one; customers and staff are drawn to the purpose.
• Weaknesses: mission drift, the risk that the need to stay profitable slowly pushes the purpose aside; ordinary investors may see a capped dividend as unattractive; the business must prove its social claims or be accused of using them as marketing.

Public sector companies. A company owned by the government that sells goods or services, covers as much of its costs as it can from sales, and pursues a social aim set by the state. State-owned railways, postal services, water and energy companies are common examples around the world. Metro Norte (invented) is a city-owned bus company that charges fares but keeps running unprofitable routes to outlying villages because the council wants every village connected.

• Strengths: provides services that private firms would drop as unprofitable; can keep prices affordable; profits, if any, return to the public.
• Weaknesses: losses are covered by taxpayers; without competition or a profit motive there may be little pressure to be efficient; managers may face political interference, and decisions may follow the electoral calendar rather than the business's needs.

Cooperatives. A business owned and controlled by its members, who are the people who use it or work in it, and run for their benefit. Each member has one vote, however much money they have put in, and profits are shared among members, usually in proportion to how much they buy from, sell to or work for the cooperative. There are three common types: worker cooperatives, owned by their employees; consumer (retail) cooperatives, owned by their customers; and producer cooperatives, owned by producers who pool their output. Valle Verde (invented) is a producer cooperative of 40 dairy farmers who share a bottling plant and sell their milk together.

• Strengths: a small farmer alone has no bargaining power against a supermarket chain, but 40 selling together do; members share costs, such as one bottling plant instead of forty; members are motivated because they own the business; decisions are democratic, and profit stays in the community.
• Weaknesses: one member, one vote can make decisions slow; outsiders cannot buy a stake, so raising large sums is hard; members may lack management skills and be reluctant to pay for professional managers; disagreement between members about the balance of profit and purpose.

8The non-profit social enterprise: NGOs

A non-governmental organization (NGO) is a non-profit organisation, independent of government, that pursues a social, environmental or humanitarian purpose. "Non-profit" does not mean it never makes a surplus. It means no owner or member takes one: every surplus is put back into the cause. Many NGOs are registered charities, though the two words are not identical.

Clearwell (invented) is an NGO that installs and maintains water filters in villages without safe drinking water. It is funded by:

• donations from individuals and companies
• grants from governments, international bodies and foundations
• trading income, for example selling filters at cost to schools that can afford them
• volunteers, whose time replaces paid labour

It is run by a board, often called trustees, who must make sure the money is used for the stated purpose.

• Strengths: public trust, which attracts donations and volunteers; freedom to act where governments and profit-seeking firms do not; in many countries, tax advantages on income and on donations.
• Weaknesses: income is unpredictable, rising and falling with donors' moods and the economy; a large grant can come with conditions that pull the NGO away from its own priorities; donors want to see money spent on the cause, so the NGO may underinvest in the systems and staff it needs; it competes with other NGOs for the same donors; it must account publicly for every euro, and one scandal damages trust in the whole organisation.

Figure 1's bottom row is short for a reason: the NGO is the only non-profit form the guide names. The table below sets the four social enterprise forms side by side.

9Choosing the right form

Every exam question on this subtopic that says discuss, evaluate or recommend comes down to a trade. Weigh these for the business in the case.

• How much capital does it need? More capital pushes the business to the right of Figure 3.
• How much risk is there? A risky venture makes limited liability worth its cost.
• How much do the owners value control and privacy? Founders who want to keep control stay private.
• What is the purpose? If the purpose is social, a social enterprise form tells customers, staff and investors so, and may unlock finance that an ordinary company cannot reach.
• What can it afford to run? Flotation and reporting cost money that a small firm does not have.

There is rarely one right answer. The marks go to the answer that picks one, shows why it beats the alternative for this business, and says what would change the decision.