(a) Explain five reasons why many small business turn into private limited liability companies. (b) What are the disadvantages of such a decision?

Answer Details

(a) Five reasons why many small businesses turn into private limited liability companies

1. Limited liability: Once incorporated, the members' liability is limited to the amount unpaid on their shares. Their personal property is protected if the business fails, unlike the unlimited liability of a sole trader or partnership.
2. Easier to raise more capital: A company can raise larger capital by admitting more shareholders (up to fifty) than a sole trader or partnership can, enabling the business to expand.
3. Separate legal entity: The company becomes a legal person distinct from its owners. It can own property, sue and be sued in its own name, which gives the business a firmer legal standing.
4. Continuity of existence (perpetual succession): The company does not come to an end because of the death, insanity or withdrawal of a member, so the business is more stable and lasting.
5. Greater credibility and access to credit: As a registered company keeping proper accounts, it enjoys more confidence from banks and suppliers and can obtain loans and trade credit more easily.

(b) Disadvantages of such a decision

• Formation is costly and involves legal formalities such as preparing the Memorandum and Articles of Association and registration.
• The company must comply with legal requirements such as auditing and filing of annual returns, which increase costs and paperwork.
• Business affairs must be disclosed in accounts and records, so there is loss of secrecy.
• Shares cannot be freely transferred or sold to the public, which limits the raising of capital compared with a public company.
• Decision making may be slower because of the involvement of more members and legal controls.