LIMITED LIABILITY COMPANIES

Limited Liability companies came into existence because of the growth in the size of business
enterprises and the need for more people to invest in the business who would not be able to
participate in the running of the business. Partnerships are unsuitable for such businesses
because of limitation in the number of partners and also due to unlimited liability. The form of
business organization, which is free from the above-mentioned hindrances of growth, is the
limited liability company, popularly known as Limited Company.

Features of Limited Companies:

1. A company is an artificial person created by law

2. Its life is perpetual
3. It is a separate entity from its owners
4. Finance is obtained by sale of shares
5. Shareholders control the business
6. Profits are distributed as dividends on the basis of capital held
7. Shareholders enjoy limited liability.

Partnerships and Limited Companies:

1. A partnership can be formed between two and twenty persons, except for professional
partnerships, where as a public limited company can have unlimited membership.
2. The liability of shareholders of a limited company is limited but the liability of partners in
a partnership is unlimited.
3. A limited company has a separate legal entity whereas a partnership does not have a
separate legal entity; its existence is linked to that of the partners.
4. A limited company raises capital by selling shares but a partnership raises capital by the
contribution of the partners.
5. A partnership is owned and also controlled directly by the partners themselves, while a
limited company is owned by shareholders and controlled by Board of Directors.

Private Limited Company:

A private limited company is a type of privately held small business entity. These are closely held
businesses usually by family, friends and relatives. Private limited company issue share and have
shareholders, but those shares are not available to the general public to buy and sell on a
recognised stock exchange. The shareholders enjoy Limited Liability. Shareholders may not be
able to sell their shares without the agreement of the other shareholders.

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 Advantages

1. Limited Liability: This means that if the company experience financial distress because of normal
business activity, the personal assets of shareholders will not be at risk of being seized by
creditors.
2. Continuity of existence: The continuity of the business not affected by the status of the
shareholder.
3. Minimum number of shareholders need to start the business are only 2 persons.
4. More capital can be raised as the maximum number of shareholders allowed is 50.
5. Scope of expansion is higher because easy to raise capital from financial institutions and the
advantage of limited liability.
6. Provides more privacy of information than an public limited company
Disadvantages

1. Growth may be limited because maximum shareholders allowed are only 50.
2. The shares in a private limited company cannot be sold or transferred to anyone else without the
agreement of other shareholders

Public Limited Company

A public limited company is a form of business organization that operates as a separate legal
entity from its owners. It is formed and owned by shareholders. Shares of a public limited
company are listed and traded at a stock exchange market freely. Shareholders of a public limited
company are limited to potentially lose only the amount they have paid for the shares they own.
The maximum number of shareholders or members in a Public Limited Company is unlimited. It
can have as many shareholders as its share capital can accommodate.

Advantages of Public Company:

1. A large amount of capital can be raised more easily

2. Capital can be subscribed by the sale of different kinds of shares, eg. Ordinary and
Preference shares
3. Liabilities of the shareholders are limited to the amount of capital which they have
contributed
4. Better management can be obtained as it is carried on by the directors who have the
necessary ability and experience
5. Output can be increased
6. More job facilities can be created
7. The experience of a company is unaffected by the deaths of any of its members
8. Cost of production can be decreased by mass production

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Disadvantages of Public Company:

1. Most of the shareholders are out of touch with the affairs of the company
2. The salaried managers who may not have much interest in or sympathy with the junior
staff do the work. This often leads to strikes
3. It takes a long time and involves difficult formalities to set up a business. It takes a long
time to make decisions
4. It is difficult for a company to keep personal touch with customers and employees
5. Sometimes, more time and money is spent on documentation to control minor things.

COMPANY FORMATIOIN:

Types of companies

Chartered Companies: These are companies formed through a charter. They enjoy certain rights
and privileges and are bound by certain obligations under a special charter granted to it by the
sovereign authority of the state. Such a charter defines and limits rights, privileges, obligations
and the localities in which they were to be exercised. The charter usually conferred a trading
monopoly upon the company in a specific geographic area or for a specific type of trade item.

Statutory companies: These are formed through an enactment of parliament. A company

formed by government to provide a public service. Their precise nature may vary by jurisdiction
- they might be ordinary companies/corporations owned by a government with or without other
shareholders, or they might be a body without shareholders, which is controlled by central
government or local government.

Registered companies: These are formed through a Companies Act (Cap 42.01). A company that
is officially registered with the Registrar of Companies. (CIPA) Companies and Intellectual
Property Authority (CIPA)

Liability Issue: Companies may be classified on the basis of their liability, that is unlimited liability
or limited liability. A liability may be limited by shares or by guarantee.

Liability limited by shares: In this case the liability will be limited to the amount subscribed to
the share capital of the company by the shareholder. For example if John has agreed to subscribe
P1 000 and he pays only P600, under such situations he has to provide the remaining P400
towards the liability if it were to arise.

Liability limited by guarantee: This is liability limited to the guaranteed amount. This is applicable
to companies that do not have share capital. Such amount will be specified in the company
constitution.

Private Limited Company: In a private company, the number of members is limited excluding
the employees. In the case of private companies, the shares are not freely transferrable. They
can only be transferred subject to the consent of others. There is a prohibition of public invitation,
that is, the private companies cannot issue a prospectus in respect of raising share capital.

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Public Limited Companies: There are some key characteristics relating to Public companies:
There is no limitation as to the number of members; there is no restriction on the number of
shares; there is prohibition to the invitation of public to subscribe for shares

Formation of company: When a company is formed there are three key documents that emerge
as per companies Act

Memorandum of Association: This is basically the constitution of the company. It specifies the
following key aspects:

Name and address of the company; Objectives of the company; Share capital of the company.
The memorandum of association decides the relationship between the company and the
outsiders.

Articles of Association: The articles of association determine or guide the internal management
of the company. This is in respect of issues such as meetings, general procedures, staffing and
many others.

Certificate of Registration: Once the company has satisfied the requirements of the Companies
Act for registration, a certificate of incorporation is issued. The Registrar of companies signs this
certificate. With this certificate, the company would have come into being and can start raising
capital. Many companies start as private companies and later on convert and lit on the stock
exchange as public companies. A company can commence business only after the receipt of
minimum subscription.

Listing in the stock Exchange: Before listing in the stock exchange, a company is expected to
fulfill some requirement often referred to as Listings requirements. These requirements would
be outlined by the concerned stock exchange such as the BSE. Once the company has satisfied
the listings requirements, it can start issuing shares to the public to raise capital. The company
would have to extend an invitation to the public and this is done through a document called
Prospectus. The prospectus outlines the nature of the company, the prospects of the company
as well as the number shares on offer.

Types of Shares

A company can issue various types of shares. A company as per the Companies Act can issue any
type of shares to raise capital as long as they are legal. There are two commonly known types of
shares viz-ordinary shares and preference shares:

Ordinary Shares: Share capital is the most significant source of capital and this is mostly Ordinary
share capital. The ordinary shareholders are considered as the real owners of the business who
take the risk. There is no specification as to the rate of dividend payable on these shares. These
shareholders will be paid dividend subject to availability dividends after preference shareholders
have been paid.

Preference shares: Preference shares carry less risk and as a result should expect less reward.
Preference shares have a fixed rate of dividend and this is decided in advance e.g. 7.5%
Preference shares, 8% Preference shares, 10% Preference shares etc. This means that, say for 8%
Preference shares, for every P1.00 preference share, investors receive 8 thebe as dividend each
year. Where a company decides not to pay preference dividends due to low profits, no ordinary

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dividends can be paid either. This means that preference shareholders have preference (priority)
over ordinary shareholders with respect to payments of dividend.

Cumulative preference shares: There are various types of preference shares. They can be
cumulative. Cumulative preference share means that if a preference dividend is not paid, the
resulting arrears must be carried forward to the following years.

Non-cumulative preference shares: In this case where profits are not sufficient to pay, say 10 %
dividends and only 5% is paid; the other 5% is written off and forgotten

Redeemable Preference shares: The basic rule is that share capital will not be paid unless and
until the company is liquidated. Under the redeemable preference shares, the company can buy
back its shares subject to satisfaction of statutory requirements. Other shares can be redeemed
only at the time of liquidation.

Participating Preference shares & Convertible Preference Shares: Participating preference

shares have the right to participate in higher levels of dividend when the company earns higher
profits and the dividends rise above some predetermined level. Convertible preference shares
are deemed more attractive because they can be converted to ordinary shares.

Preference shares vs Liabilities: Preference shares are often viewed as liabilities because they
are seen as redeemable at some future date. IAS 32 for example requires that preference shares
be classified as liabilities and the preference share dividend be treated like interest payments.
This largely due to the obligation to pay the dividends when at year-end. Further, upon
liquidation and after paying creditors, the preference creditors are paid before the ordinary
shareholders are paid.

IAS 32 Financial Instruments: Provides presentation outlines, the accounting requirements for
the presentation of financial instruments, particularly as to the classification of such instruments
into financial assets, financial liabilities and equity instruments. The standard also provides
guidance on the classification of related interest, dividends and gains/losses, and when financial
assets and financial liabilities can be offset.

Share Capital Issues: A company may specify its maximum share capital in the memorandum of
association. Such specified share capital is referred to as: Registered share capital/ Nominal share
capital/Authorized share capital

The company will however choose to issue a fraction of this share capital and that is referred to
as Issued share capital. For example if the authorized share capital. is P100 000 and the issued
share capital may be P50 000. The public may however subscribe to half of the issued shares; this
is referred to as Subscribed share capital.

Members of the public will apply for these shares, and once the application has been received
the company directors will start allotting shares to eligible investors. Once allotment has been
made, the company may demand the capital in full or in installments. The amount demanded by
the company is known as Called up share capital. This demand by the company does not mean
every applicant will pay. In this respect, the actual amount collected in cash is known as paid up
share capital. This is the key amount that actually appears on the Statement of Financial Position.

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Issue of Shares: The amount that is remitted along with application for shares is referred to as
application money. The company has a number of alternatives in dealing with received
applications viz. Full acceptance, Partial Acceptance, Total Rejection.

Pro rata Oversubscription: This is a situation where people have applied for more shares than
are available for allotment. So, shares will be allotted on a proportionate basis. The proportionate
basis of allotment of shares is known as pro rata allotment. Thus the excess application money
received at application time will then be used to pay allotment money.

Face value of Shares: Shares being issued will have an initial value known as nominal value, par
value or face value. This initial value may be P0.50, P1.00 or P10.00 etc. When a company is
successful, the market value of shares will increase. New shares can however be issued at price
above the nominal value and if that is the case, shares are said to have been issued at a premium.

Forfeiture of Shares: Some applicants may fail to pay the requisite amounts on shares called. The
company may give them a timeline upon which they should have settled their arrears. If the
applicants completely fail to meet the deadlines set, the company has the option to forfeit the
shares. When shares are forfeited the applicant will lose the money paid to date on shares. Such
forfeited shares can be allotted to a different investor in future.