A sole trader (also known as a sole proprietor) is a commercial for-profit business owned by a single person. Although this person can employ as many people as needed, the sole trader is the only owner of the business.

 Advantages of sole traders / sole proprietors

The advantages of setting up a business as a sole trader (or sole proprietor) as a type of for-profit (commercial) organization include:

• It is the quickest and easiest type of business to set up. Sole traders can avoid complicated and costly set-up procedures.

• The owner receives all of the profits if the business succeeds.

• Sole traders are likely to be highly motivated as the owners have a sense of achievement from running their own business and can keep all of the profits made.

• The sole trader (owner) has complete control without having to consult with or be accountable to others.

• Hence, decision-making is also swift as the owner does not have to consult anyone else and seek their permission to execute a decision.

• The sole trader enjoys privacy as it only needs to publish its financial accounts to the tax authorities (rather than to the general public like a publicly held company). For example, sole traders in Hong Kong only need to submit paperwork for the Inland Revenue if their annual sales revenue exceed HK$2m (around US$260,000). Similarly, sole proprietors in the UK are able to complete their own business tax returns without the formal requirement of final accounts being externally audited.

• The owner can benefit from tax advantages. As a small business, many sole traders work from home, so can claim tax concessions by using part of their home for business purposes.

 Disadvantages of sole traders / sole proprietors

However, there are some potentially significant disadvantages of being a sole trader too. These include:

• The finance to set up and run the business is generally provided by the owner (from personal savings) as s/he cannot easily access external sources of finance.

• The sole trader accepts all the risks of owning and running their own business, including any losses made or even the collapse of the organization.

• The workload for a sole trader can be extremely high. There is no one else to share ideas or to ask questions, so all pressures, burdens and responsibilities fall on the owner. This means the sole trader often has to work very long hours.

• Legally, a sole trader is treated as the same legal entity as the business, i.e. it is an unincorporated business. This means the sole trader has unlimited liability so is responsible for any debt owed to other individuals or organizations, even if this requires the owner to pay the debts from their personal belongings and assets.

• There is a lack of continuity in the operations of the business if the owner is unwell, wishes to take a holiday or wants to retire. The latter is a main reason why many sole trader businesses struggle to continue.

• As sole proprietorships are usually small businesses (such as a small convenience store owner), they are unlikely to be able to gain any economies of scale, perhaps because they cannot buy their materials or stocks (inventory) in bulk. This means sole traders pay more for their goods, their prices charged to customers also tend to be higher. By contrast, larger business (such as supermarket chains) gain these cost-saving benefits, so are able to charge much lower prices due to their ability to exploit economies of scale.

• Since access to external finance is difficult for most sold traders (because they represent a high degree of risk), expansion of the business is difficult.

 To review your understanding of this topic, watch this informative video about sole proprietorships.

 Exam Practice Question - Flowers by Cam

Flowers by Cam is a small business in London, UK. It was set up as a sole trader in 2010 by Cam Tran. At the time, she had three young school-aged children, and operated her business from home and a small stall that she rented at a local market.

The business relies on repeat customers in the local area, but also prepares bespoke flower arrangements for weddings, funerals, graduations, and special occasions. Sales fluctuate on a weekly basis, but she enjoys the flexibility of being able to work from home when needed. Now that her children have graduated from high school and university, she is keen to expand the business. However, with the devastation of the coronavirus pandemic in the UK, her business has struggled with liquidity issues and she is seeking to borrow a significant amount of money from her bank. Valentine's Day should have been her busiest day of the year in 2021, but with national lockdowns still in force, sales were the lowest they have been since she set up Flowers by Cam.

(a)	Define the term sole trader.	[2 marks]
(b)	Explain one advantage and one disadvantage of establishing Flowers by Cam as a sole trader.	[4 marks]

 Teacher only box

Answers

(a)  Define the term sole trader.  [2 marks]

A sole trader (or sole proprietor) is a type of business structure that is owned and run (controlled) by one person, although s/he can employ staff. Hence, all profits made by the business (if any) belongs to the owner.  There is no legal distinction between the owner and the business itself, so the owner has unlimited liability (legal and financial responsibility for all losses and debts).

Award [1 mark] for an answer that shows some understanding of the term sole trader.

Award [2 marks] for an answer that shows good understanding of the term sole trader, similar to the example above.

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(b)  Explain one advantage and one disadvantage of establishing Flowers by Cam as a sole trader. [4 marks]

The advantages of setting up the business as a sole trader could include:

• It is the quickest and easiest type of business for Cam Tran to set up. She can avoid complicated and costly set-up procedures, especially because at the time she had to also care for her three young children.

• Cam Tran gets to receive all of the profits of the business during prosperous trading times.

• She is likely to be highly motivated as the owner of Flowers by Cam, and gains a sense of achievement / high self esteem from owning and running her personal business.

• She is her own boss - that is, she maintains complete control of the business, without having to consult with or be accountable to others. Decision-making is swift as Cam Tran does not have to consult anyone else and seek their permission to execute a decision.

• She can enjoy privacy the financial accounts only need to be shared with the Inland Revenue (UK tax authorities) rather than with the general public as there are no shareholders.

• Cam Tran may also benefit from tax advantages as she operates some of her work from home, so can claim tax concessions from using part of their home for commercial purposes.

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The disadvantages of setting up the business as a sole trader could include:

• She must accept all the risks of owning and running her own business, including any losses made or even the possible collapse of the business (given the aftermath of the coronavirus pandemic on local, small businesses).

• The workload for the owner can be extremely high. There is no one else to share her ideas with or to ask questions, so all pressures, burdens and responsibilities fall on the owner herself. This means Cam Tran often has to work very long hours, especially when preparing her bespoke flower arrangements for weddings and funerals.

• Legally, a sole trader is treated as the same legal entity as the business itself, so as an unincorporated business Cam Tran has unlimited liability. This means she is legally responsible for any debt owed to her suppliers or lenders, even if this requires her to pay the debts from their personal belongings.

• There is a lack of continuity in the operations of the business if the owner is unwell, wishes to take a holiday or wants to retire.

• As a sole trader, Flowers by Cam operates on a small scale, there are limited opportunities to exploit economies of scale. This means that Cam Tran will not be able to gain cost-saving benefits compared to larger florists, resulting in her having to charge higher prices to their customers.

• The finance to set up and run the business is generally provided by Cam Tran herself (from her personal savings) as she cannot easily access external sources of finance from commercial banks.

• Similarly, access to external finance is difficult for Cam Tran as a sole trader, because she represents a high degree of risk, especially with volatile sales revenue throughout the year. Hence, expansion of the business is difficult.

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Mark as a 2 + 2

Award [1 mark] for a suitable advantage, and [1 mark] for a suitable explanation written in the context of the case study.

Award [1 mark] for a suitable disadvantage, and [1 mark] for a suitable explanation written in the context of the case study.

A partnership is a commercial business that strives to earn a profit for its owners. It is owned by two or more people.

For an ordinary partnership, the maximum number of partners is usually capped at twenty owners, although this does vary from one country to another. Some organizations can have more than 20 partners, such as law firms and health clinics. Highly specialised professional service providers (such as doctors, solicitors, dentists and accountants) are usually set up as partnerships. Many family-run businesses are also established as partnerships. The owners of a partnership are called partners.

The vast majority of partnerships are unincorporated businesses, so at least one of the owners must have unlimited liability. In practice, it is usual for all the partners to share responsibility for any liabilities made by the partnership. In some countries, it is possible to have a limited liability partnership (LLP). Setting up an LLP protects each individual partner from being responsible or liable for another partner’s misconduct or shortcomings.

Most partnerships sign a Deed of Partnership (or Partnership Agreement) as this helps to resolve potential misunderstandings and disagreements. stating their responsibilities, voting rights, and how profits are to be shared between the owners.

 Advantages of partnerships

The advantages of partnerships as a type of for-profit (commercial) business organization include:

• Partnerships can raise far more finance than sole traders, especially as there can be up to 20 partners (subject to the laws in different countries) in the business. Silent partners (also known as sleeping partners) can provide additional capital without having any role in the actual running of the business.

• Having partners enables the firm to benefit from having more ideas and different skills and expertise.

• Unlike a sole trader, partners can share the burden of their workload and responsibilities.

• Hence, unlike a sole trader, partnerships benefit from continuity as the partnership can remain in operation if a partner is unwell or wants to go on a family vacation.

• Partnerships can benefit from specialization and the division of labour. For example, a law firm might have partners who specialize in different specialisms, such as criminal law, civil law, business law and tax law.

• As with sole traders, business affairs of a partnership are kept confidential, so only the tax authorities need to know about the financial position of the partnership.

 Disadvantages of partnership

However, there are limitations to setting up a business as a partnership. These potential drawbacks include:

• As the business has more than one owner, this can easily lead to disagreements and conflict between the owners, which can seriously damage the running of the partnership.

• Decision making is slower than with sole traders because there are more owners involved. This can also lead to disagreements and conflicts between the owners

• Unlike with a sole trade, the profits made by a partnership must be shared between all the owners.

• In general, partners have unlimited liability so are liable for any debts, fines, penalties or law suits against the business, even if this these were caused by another partner in the firm. However, sleeping partners are exempt from unlimited liability.

• Compared to limited liability companies, access to finance is restricted to the finances available from the different partners in the firm. There is no maximum number of owners in limited liability companies, so they can raise finance through their shareholders.

• There is no continuity if a partner decides to leave the firm or if one of the partners die. This is because such cases would void the Deed of Partnership. There would be a time delay in setting up a new partnership agreement.

 To review your understanding of this topic, watch this informative video about partnerships (the IB syllabus does not require you to know about limited liability partnerships).

Companies (also known as corporation) are commercial for-profit businesses owned by shareholders. Hence, the profits of a company belong to and are shared among the various owners. As incorporated businesses, the owners have limited liability. Limited liability protects shareholders who cannot lose more than the amount they invested in the business. This is because shareholders are not personally liable for the debts of the company should it go into debt or bankruptcy.

In legal terms, there is a divorce of ownership and control as the owners (shareholders) are treated as separate legal entities from those who control and run the business (the board of directors and CEO). It is the board of directors and the CEO (or managing director) who are responsible for the strategic direction of the company.

There are two categories of companies: privately held companies and publicly held companies.

Features of privately held companies

• The shares of privately held companies cannot be advertised for sale nor sold via a stock exchange. Shares are not available on an open stock exchange such as the New York Stock Exchange.

• Most privately held companies (sometimes referred to as private limited companies) are small businesses, with shares typically owned by family, relatives, and friends.

• The company and its owners are separate legal entities, i.e., there is a legal divorce (separation) of ownership and control, with the owners (shareholders) appointing a board of directors to run the company on their behalf.

• Owners have limited liability, so if the business experiences a financial collapse, then the owners will only be liable for the capital they invested in the company.

• The number of shareholders in a privately held company may be limited. In some countries, the maximum number is 50 (Turkey) and in others it is 200 (India). In other countries, like the UK and Switzerland, there is no maximum (source: DLA Piper).

• There is usually no legal requirement for the company to publish detailed financial accounts for the general public (this is only needed for corporate tax purposes).

Examples of well-known privately held companies include:

 Advantages of privately held companies

The advantages of establishing a business as a privately held companies as a type of for-profit (commercial) organization include the following points:

• There is better control of a privately rather than publicly held company, as shares in a privately held company cannot be bought or sold without the agreement of existing shareholders.

• Significantly more finance can be raised compared with a sole trader (one owner) or a partnership (up to 20 owners).

• Privately held companies have greater privacy compared to publicly held companies; the latter must make their final accounts available to the general public.

• Shareholders have limited liability, so cannot lose more than what they invest in the company. Owners are protected against any misconduct or misjudgments of those who run the company.

• Unlike a sole trader or partnership, a privately held company can enjoy continuity in the event of the death of a major shareholder.

 Disadvantages of privately held companies

However, the potential limitations of being a privately held company include the following :

• Privately held companies can only sell their shares to family, friends, and employees, with the approval of the majority of existing shareholders. This can make it difficult to buy and sell shares in the company.

• They are more expensive to operate than a sole trader or partnership. For example, there are higher legal fees and auditing fees (for checking and approving of the financial accounts).

• A privately held company can become a target for a takeover by a larger company which purchases a majority stake, although other owners have to agree to the sale of the company.

• Companies (also known as corporation) are commercial for-profit businesses owned by shareholders.

• A Deed of Partnership (or partnership deed) is a formal partnership agreement or contract between the owners, which includes legal agreements such as the formal responsibilities of each owner, their voting rights, and how profits are to be shared between the partners.

• An ordinary partnership has a minimum of 2 partners and up to twenty owners (although this does vary from one country to another).

• Partners are the co-owners of a partnership business.

• A partnership is a commercial (for-profit) business that strives to earn a profit for its owners.

• Privately held companies are limited liability companies owned by shareholders but the shares in the business cannot be advertised or traded on a stock exchange.

• Publicly held companies (or joint-stock companies) are limited liability companies owned by shareholders with the shares in the business being traded (bought and/or sold) on a public stock exchange (or stock market).

• Shareholders are the owners of a limited liability company.

• Silent partners (also known as sleeping partners) are inactive owners of a partnership business, who provide additional capital without having any role in the actual running of the organization.

• A sole trader (or sole proprietor) is the single owner of a business organization, so makes all the decisions and takes all the risks in running the enterprise.

• A stock exchange (or stock market) is a marketplace where shares in publicly held companies can be bought and/or sold, such as the New York Stock Exchange (NYSE).

• Unlimited liability means that if the sole proprietorship fails, the sole trader is personally held responsible for all the debts of the business. As there is no limit to the amount of losses, this means that the sole trader could lose their personal possessions to pay for the organization's debts.