What Form Should the Business Take?
WHAT DOES 'LEGAL STRUCTURE' MEAN?
An organisation's 'legal structure' consists of two elements. Its legal status, for example as a Limited Company or an Industrial and Provident Society (IPS), determines how it will be treated for legal, administrative, taxation and other purposes. Its constitution identifies the type of venture that it is to be (for example, a co-operative, a charity, or a community business). The constitution of a limited company consists of two documents, officially called the Memorandum of Association, but generally known as the "Mem and Arts". The constitution of an IPS is called simply the Rules. The Rules or the Mem and Arts set out such aspects as:- the objects of the organisation (the scope of its activities)
- eligibility to membership of the organisation
- how (in general) the organisation is to be managed
- how profits are to be used
- how the assets of the organisation are to be used, if it is wound up
- by seeking the personal guarantees of the firm's directors for a portion of the liability
- by taking a debenture, securing the loan against the assets of the company, and giving the holder a prior claim or 'change' (which may be fixed or floating) on these assets in the event of the company's failure
- trade creditors may sell goods to a company subject to 'retention of title', so that ownership passes only on payment
The constitution also sets the ground rules for the establishment and development of a business. It imposes obligations on the directors, and places limits on their powers.
LIMITED LIABILITY
The great majority of businesses of more than one person trade as limited companies, either public or private. Although many firms are still run as sole proprietorships or partnerships, this form is generally appropriate only for very small, or for professional concerns. Specifically, it is suitable for businesses that do not require significant capital investment, or where the risk of failure is negligible.
The problems faced by the members of an unincorporated firm are that they bear full personal responsibility for the liabilities of the business. Such a business finds it hard to raise capital and is therefore likely to remain small. If the assets of a partnership are insufficient to meet the claims of its creditors, then the creditors can look to the members' personal assets for repayment.
This unlimited liability is generally sufficient to prevent outside investors from taking a share in the business. The risks are too great, whatever the potential rewards.
Investors in a limited company, by contracts, risk only the sums they have agreed to invest. Banks and other creditors can look only to the company's assets for repayment of outstanding claims. An incorporated business thus reduces the risk to investors of equity capital by increasing the exposure of lending institutions and other creditors. Creditors may protect themselves when dealing with limited companies in a number of ways:
SEPARATE LEGAL ENTITY
A limited company or an IPS is a legal entity (or 'person') in its own right, separate from its members. It is the company that enters into contracts, and incurs liabilities under these contracts. The incorporated company continues in existence until liquidated, irrespective of the death or change to its members. Company law gives the creditors some protection by requiring that the company's capital is preserved intact.
REGISTRATION
A limited company or IPS is formed (or 'incorporated') by the straightforward procedure of registration, either with the Registrar of Companies or with the Financial Services Authority. Various documents must be filed, most importantly the Mem and Arts or Rules. To simplify the process of registration, various sets of Model Rules for co-operative and community businesses have been drawn up by ICOM. These consist of Rules suitable for various types of business, into which individual details can be easily inserted, saving the expense of drawing up a constitution from scratch.
WORKERS' CO-OPERATIVES
Workers' Co-operatives have constitutions that enshrine a number of fundamental principles. Most importantly, they determine that all workers - and in most cases only workers - should be entitled to membership, and that ultimate control of the business rests with the General Meeting of the co-operative at which each member has one vote. Voting rights (and therefore control) depend upon participation in the business not upon investment. Co-operatives are therefore unable to raise money by selling shares in the way that a conventional company can.
The constitution of a Co-operative does not specify in detail how the business is to be run. The members are perfectly entitled to delegate to a managing director the responsibility of devising and carrying out a business plan, if that is what they want. More commonly, at least in the UK, members are closely involved with the management of the business at every level.
SOCIAL ENTERPRISE
A social enterprise is a business with a social aim, find out more about them in the social enterprise section.
COMMON OWNERSHIP
Because co-operatives do not allow equity shareholding, either by members or by outsiders, the assets of the business must instead be built up slowly by the re-investment of profits. Founder members of the co-operative contribute what is sometimes called 'sweat equity'. That is, they forego a portion of profits that might otherwise be distributed as bonuses in order to improve the capital base of the business. It is clear that under these circumstances it would not be fair if a later group of members, once the business is well established could benefit from selling it or winding it up.
The constitution of a Common Ownership Co-operative therefore rules that residual assets cannot be distributed to members, but must go to another co-operative or to a charity. Members are not asked to make a financial contribution when they join the co-operative, nor do they take any part of the assets of the business with them when they leave. Although technically its 'owners'- the members of the co-operative at any point are in fact simply the stewards of its assets. They control these assets while they work for the c o-operative, but they pass them on to future members when they leave.
COMMUNITY BUSINESSES
A Community Business (or Community Enterprise) is also owned and controlled by its members. In this case, however, the members are not the organisation's employees (though these may be members as well) but individual members of the community in which the organisation is based. Members of the community have a right to membership of the community business. But the members of the community business control it for the benefit of the whole community.
The concept of stewardship applies even more thoroughly here, for a community business's profits cannot be distributed among members at all, but must be reinvested, either in the organisation itself, or elsewhere in the community. Community businesses benefit the community principally by offering employment and training opportunities for local residents and by providing services needed by the community (although it is not restricted to the community market). The community may also benefit from the fact that a community business provides an acceptable channel for central and local government funding.
The members of a community business elect a Board of Directors from amongst themselves. Directors are not rewarded for their work. They represent the members who elected them, and as a Board they act to ensure that the business is run legally and efficiently to the benefit of the community. Depending on the number, scale, and nature of the individual businesses set up, a Community Enterprise may adopt a variety of structures. In some cases, a number of different trading ventures are run by a single organisation. In others, the Community Enterprise acts as a central 'holding company', co-ordinating the activities of a series of more or less independent community-based 'subsidiaries'.