Limited Liability Companies (Business Organisations III): Economics Lesson Note

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Lesson Note

Subject: Economics
Topic: Business Organisations III – Limited Liability Companies
Lesson Objectives: At the end of the lesson, learners should be able to;
i. Define a company,
ii. List and explain the types of companies
iii. State the similarities and differences between the two types of companies,
iv. Explain the formation of a limited liability company
v. State the features of each type of company,
vi. List the advantages and disadvantages of each type of company,
vii. State the sources of finance for each type of company,
viii. Define a share,
ix. List and explain the different types of share,
x. Define a stock and a debenture,
xi. State the differences between shares and stock,
xii. State the differences between debenture and share.

Discussions

A company can be defined as a legal person or entity created by the association of a number of people in accordance with the law for the purpose of pooling their capital together in order to set up a business venture. Examples of limited liability companies include Dunlop Nigeria Plc, Guinness Nigeria Place, C.F.A.O Nigeria Plc, Julius Berger Nigeria Plc, Evan Medical Plc, etc. A company is an artificial person and is more than a mere association of individuals. It is a legal person with a personality of its own.

Types of Companies

(1) Unlimited liability companies: In an unlimited liability company, the liability of a member is limitless and he may be liable to the full amount of the company’s debts in the event of liquidation. The members will contribute more money, including their capital, to settle the debt of the company. Section 21(1) of the Company and Allied Matters Act defines it as one not having any limit on the liability of members.
(2) Limited liability companies: In the case of limited liability companies, the liability or burden of debt in the company is limited to the amount of share capital the shareholders had agreed to contribute individually in the event of liquidation. In this case, a shareholder cannot suffer the liability of the company up to his or her private property.

Types of Companies Under Limited Liability Companies

i. Companies limited by government: Companies limited by guarantee are not formed with the aim of engaging in trading activities or making profits. They are often formed by societies and other charitable contributions from members of the public to promote and develop certain interests or professions. The liability of its members is limited by the Memorandum of Association to such an amount as the members may have undertaken to contribute to the assets in the events of its being wound up. Guarantee companies are usually formed for the furtherance of art, science, education, religion, charity, etc.
ii. Companies limited by shares: Companies limited by shares are the companies in which the liability of the shareholders is limited to the fall value of the shares they have acquired. In case of liquidation, the shareholders will only be liable to the full extent of their shares contributed as capital. They normally engage in business activities to make profit. Section 21(1) of the Company and Allied Matters Act, 1990 defined a company limited by shares as: “A company having the liability of its members limited by memorandum to the amount, if any, unpaid on the shares held by them.”

Types of Limited Liability Companies

1. Private Limited Liability Company: Private limited liability company is defined as one which by its articles restricts the right to transfer its shares, limits the number of its shareholders from two to fifty, prohibits any invitation to the public to subscribe to its shares and the name of the private company must end with “Limited”, e.g Bluebird Nigeria Limited.
2. Public Limited Liability Company: Public liability company is defined as one which by its articles allows the public to subscribe to its shares, must have a minimum of seven persons but no maximum number is prescribed. It allows the shares to be transferred and the name of the public company must end with “plc”. Dunlop Nigeria Plc, Guinness Nigeria Plc, First Bank Plc, etc. This is the type that is popularly referred to as Joint Stock Company.

Similarities and Differences Between Private and Public Limited Liability Companies

Similarities:

i. Legal entity or status: Both companies are legal entities, which means that they can sue and be sued in their own names due to the fact that both are registered companies. The business name is different from the owner’s names.
ii. Limited Liability: Both companies have limited liability, meaning that in the event of liquidation, the shareholders can only lose the value attached to the shares they contributed.
iii. Continuity of existence: The chances of continuity or existence of both companies are high as the death or withdrawal of a shareholder cannot affect the existence of the company.
iv. Ploughing back of profits: Part of the profit can be ploughed back into the business for both companies while the remaining can be shared to the shareholders, according to the amount of shares contributed.
v. Large capital outlay: Both companies are capable of pooling large capital together to set up a business.
vi. Management: Both companies appoint directors for the proper and efficient management of the business.

Differences:

i. In private limited company, shares are not easily transferable except with the consent of their members while in public limited company, shares are easily transferable.
ii. In the private limited company, shares are not quoted me in the stock exchange while in the public limited company, shares are quoted in the stock exchange.
iii. The minimum number of shareholders in private limited company is two while the public limited company has a minimum of seven people as shareholders.
iv. Private limited company has a maximum number of 50 owners while public limited company has no maximum number of people as owners.
v. Private limited company does not issue debentures while public limited company issues debentures.
vi. Private limited company makes use of “limited” at the end of their name while public limited company use “plc ” at the end of their names.
vii. Private limited company does not need certificate of Trading to commerce business while public limited company do need certificate of trading before they can communicate business.
viii. Private limited company does not allow public to subscribe for its shares while public limited company allows the public to subscribe for its shares.

Formation of a Limited Liability Company

The steps involved in the formation of a limited liability company (be it private or public limited company) are as follows;
Step 1: The promoter(s) devise a scheme of capitalisation, bearing in mind the cost of formation, assets to be bought and working capital.
Step 2: The promoter(s) are required to secure the services of a solicitor to prepare certain documents to be filled with the registrar of companies. The documents are:
(a) Memorandum of Association
(b) Article of Association
(c) Statement of Nominal Capital
Step 3: The documents are stamped and lodged with the registrar of companies.

Memorandum of Association

Memorandum of Association is a document forming the constitution of a company and defining its objectives and powers with regards to its dealing with the outside world. It is the document containing the rules and regulations which govern the external relationship of a company with outsiders. Once registered, the memorandum becomes a public document.
A Memorandum of Association contains the following information;
i. The name of the company, which must end with the word “Limited” or “Plc”.
ii. The registered office of the company
iii. The objectives of the company
iv. The amount of authorised capital and the various shares into which it is divided.
v. A declaration that the liability of the members are limited.
vi. The names of founders of the company.
vii. Status of the company, that is, private or public.
viii. The restriction, if any, on the power of the company.

Articles of Association

Articles of Association is a document in which the regulations which govern the internal management of the company’s affairs, the duties, rights and powers of the shareholders are stated. It complements the memorandum of association. However, where there is conflict between the two documents, the memorandum prevails.
The contents of an Article of Association includes;
i. The method of issuing capital
ii. The method of holding meetings
iii. Definition of powers and duties of directors
iv. The right of shareholders
v. How directors are to be elected
vi. How auditors are to be Renu
vii. Method of sharing dividend
viii. Transfer and forfeiture
ix. Method of auditing the account of the business.

Prospectus

A prospectus is a document issued by the public limited companies only inviting the public to subscribe for shares of the company. A copy of such a prospectus, signed by the directors or proposed directors in writing, must be filed with the registrar of companies. The Company Act defines it as: “Any notice, circular, advertisement which invites the public for subscription or purchase of shares of a company”.

Content of a prospectus include;
i. Particulars of the company’s past history.
ii. Information about the present position and future prospects of the company.
iii. The amount of capital offered for subscription
iv. Particulars of directors and other officials.
v. Promoter’s renumeration
vi. The date of opening the lists
vii. The nature of capital offered for subscription
viii. Amount payable on application and allotment on each share
ix. The number of founders’ shares
Step 4: After going through the documents, the registrar of companies then issues a certificate of incorporation to the company. This gives the company the powers to commence business.
Step 5: A private limited company can commence business after receiving the certificate of incorporation, but a public liability company cannot commence until it receives the certificate of trading.

Certificate of Incorporation

Certificate of incorporation, which confers legal status on the company to come business, is issued by the registrar of companies, i.e the company has put on a veil of incorporation. The certificate is given out as an evidence that all the requirements of the Act in respect of registration have been complied with by the company and is therefore duly registered under the Act. It contains the name of the company, registration number and signature of the registrar.

The Company Act contains the effects of incorporation as:

i. Right of the company to own properties which are separated from shareholders
ii. Right to perpetual existence
iii. Right to sue and be sued
iv. Right to transfer shares
v. Right to borrow.

Certificate Of Trading

Certificate of trading is the document which allows the public limited company to come business activities. It is issued to a public liability company to enable it commence operation after the company has been given the certificate of incorporation. If it is a private limited company, it is at liberty to commence business immediately without the certificate of trading.

Private Limited Liability Companies

A private limited liability company is defined as one which by its articles restricts the right to transfer its shares, limits the number of its shareholders from two to fifty, prohibits any invitation to the public to subscribe for its shares, and the name of the private liability company must end with the abbreviation of “Limited”, e.g Bluebird Nigeria Limited, Goodwill Nigeria Limited, etc.

Features or Characteristics of Private Limited Liability Companies

i. Ownership: The business is owned by shareholders who may be between two and fifty persons in number.
ii. Objective: The major aim of private limited company is to make profit.
iii. Source of capital: The capital required to set up and run the business is provided by the shareholders in form of shares. However, shares are not sold to the general public. They are sold privately.
iv. Liability: The shareholders have limited liability. In the event of liquidation, the amount a shareholder can lose is limited to the fully paid up value of his share or the capital he has invested in the business. His personal assets or properties are protected by the law.
v. Legal entity: The business is a separate legal entity and is different from the owners of the business. The business can sue or be sued in its own name, without involving the owners.
vi. Continuity: There is continuity of business operations as the withdrawal or death of a shareholder may not affect the existence of the company.
vii. Management: The private limited company is managed by a board of directors appointed by shareholders.

Sources Of Finance Or Capital Available To Private Limited Company

i. Loans and overdraft from banks: Loans and overdrafts can be obtained from commercial or development banks.
ii. Shares raised by shareholders: Shares are usually raised by shareholders (owners), which form the capital base of the company.
iii. Equipment leasing: Equipment can be leased out by companies for money.
iv. Retained (plough back) profits: The profits made by the company can be set aside or re-invested.
v. Trade credit: Raw materials can be purchased by the company on credit.
vi. Hire purchase: Facilities can be granted to the company to buy and pay by instalments.

Advantages of Private Limited Liability Company

i. Large capital: Private limited liability company can easily raise capital as a result of many shareholders that form the business.
ii. It has legal entity: Private limited liability company has legal existence, hence it can sue and be sued in its own name.
iii. Shareholders have limited liability: In the event of business failure, the shareholder only loses his shares which he has contributed and his personal properties or assets are protected.
iv. Continuity of existence: The chances of continuity of existence is high as the death or withdrawal of a shareholder cannot affect the existence of the company.
v. Efficient management: The business is efficiently managed by a board of directors appointed by the shareholders.
vi. Large profits: Private limited liability companies do enjoy large profits because of their large size.
vii. Possibility of expansion: The business can easily expand because of the large capital available to set up and run the company.

Disadvantages of Private Limited Liability Company

i. Limited capital: As a result of few number of shareholders coupled with the fact that shares cannot be sold to the public, the capital available for use is limited.
ii. Shares are not sold to public: The private limited company cannot sell its shares directly to the public. This acts as a limitation to the capital base and to expansion.
iii. Shares not easily transferable: A shareholder cannot sell his shares without the consent of other shareholders.
iv. Lack of privacy: There is lack of privacy as companies are required to publicise their accounts.
v. Payment of corporate tax: Private limited companies are usually required to pay corporate tax, unlike personal income tax paid by sole proprietorship and partnership.
vi. Lack of personal contact: There is less personal contact with both the employees and customers, unlike in the sole proprietorship and partnership.

Public Limited Liability Company Or Joint Stock Company

A public limited liability company is defined as one which by its articles allows the public to subscribe for its shares, must have a minimum of seven persons but no maximum number is prescribed, allows the shares to be transferred and the name of the public limited company must end with the abbreviation “plc”.
The word public is used to imply that any member of the public is free to purchase shares in the business when shares are advertised for sale. Public limited companies are actually owned by private individuals and organisations.
Public limited liability companies or joint stock companies are organisations which have separate legal entity. It is regarded in law as having an identity of its own. The shareholders are not personally responsible for anything that is done in the name of the organisation. The shareholders also enjoy limited liability, and above all, it enjoys the advantage of a large number of people who through the purchase of shares become owners of the company.
Examples of public limited liability companies are: Zenith bank Plc, Guinness Nigeria plc, Texaco Nigeria Plc.

Features Or Characteristics Of Public Limited Liability Company (Or Joint Stock Company)

i. Ownership: The number of shareholders range from seven to infinity, i.e owners must be at least seven but there is no maximum number.
ii. It is a legal entity: The joint stock company has a distinct personality from that of the owners. It can sue and be sued in its own name.
iii. Perpetual existence: The death or withdrawal of some shareholders will not affect the existence of the company. It enjoys continuous existence.
iv. Formation: A public limited liability company must follow some special formalities before registration. They secure incorporation by filing the article of association and memorandum of association with the registrar of companies.
v. Preparation of annual accounts: It is required by statute to keep certain prescribed book of account. The accounts must be audited and published annually.
vi. Specific line of business: A public limited liability company is authorised by law to carry on business specified in the object clause.

Advantages 0f Public Limited Liability Company (or Joint Stock Company)

i. Public limited liability companies have legal existence. They have a distinct personality from the owners, hence they can sue and be sued in their own name.
ii. Perpetual existence: There is continuity in a joint stock company. The death or withdrawal of a shareholder cannot put an end to the business.
iii. Limited Liability: Their liability is limited to the amount invested as capital in the business; private properties will not be affected.
iv. Large capital: They can raise enough capital by selling more shares or debentures to the public.
v. Transferability of shares: Shares of a public limited liability company can easily be transferred without having an effect on the business operation.
vi. Loan Facilities: Many banks prefer to grant loans to public limited companies than other forms of business units because there is no likelihood of default in payment.

Disadvantages of Public Limited Liability Company

i. Lack of privacy: Public limited liability companies lack privacy because they are mandated by law to publish their annual audited accounts to the public. This makes it impossible for them to maintain secrecy or privacy.
ii. Conflict of interest: There is the possibility of conflict of interest among the shareholders, directors and staff, which may affect the efficiency of operations of the business.
iii. Slow decision making: Decision making is slow because of wider consultations and discussions in the management hierarchy.
iv. Separation of owners from control: The owners of the business (shareholders) have little or no say in the affairs of the business, while the people at the helm of affairs who are not owners may not put in their best.
v. Lack of flexibility: The company can only carry on business provided for it in its object clause in the memorandum of association. It cannot venture into any other type of business.
vi. Large capital requirement: The capital required to set up and run a joint stock company is usually very large.

Sources of Finance or Capital Available to Public Limited Liability Company (or Joint Stock Company)

i. Loans and overdraft: Joint stock company can obtain loans and overdrafts from commercial or development banks.
ii. Sales of shares: A joint stock company can also raise capital by issuing shares for public subscription.
iii. Sales of debentures: These are long term loans obtained from the general public at a fixed interest.
iv. Bill of exchange: This is a document duly signed by the debtor’s bank to the creditor and the creditor cashes the money with some

vi. Trade credit: Raw materials can be purchased by the joint stock company on credit.
vii. Hire purchase: Facilities can be granted to the company to buy and pay by instalments.
Shares
A share can be defined as the individual portion of the company’s capital owned by shareholders. It is the interest which a shareholder has in a company. In other words, share is a unit of capital measured by a sum of money. The Company Act defines a share as: “The interest in a company’s share capital of a member who is entitled to share in the income of such company”.

Types of shares

There are two major types of shares. These are Preference shares and Ordinary shares.
1. Preference shares: A preference share is the type of share which has priority in terms of dividend payment and repayment of capital in the event of winding up. They have a fixed rate of dividends.

Features of preference shares

i. Preference shares have no voting rights
ii. They have finally rates of interest
iii. Holders receive dividends before others
iv. They are entitled to return of capital first at winding up.

Types of preference shares

a. Cumulative preference shares: Cumulative preference shares have priority in the share of dividends over others. Cumulative preference shares receive arrears of dividends not paid before other shares, i.e when no profit is declared, their dividends will be carried forward to the following year.

Features of cumulative preference shares

i. No voting right
ii. It has a fixed rate of dividend
iii. They receive arrears of dividend
b. Participating preference shares: Participating preference shares are shares which are entitled to further percentage of dividends after the ordinary shares have received a specified percentage of profits. Participating preference shares have the right to participate equally with the ordinary shareholders in surplus dividends apart from their fixed dividends.

Features of participating preference shares

i. They receive fixed rate of dividends like other preference shares
ii. They also participate in further documents after all others have been paid.
iii. They usually receive dividends before ordinary shares.
c. Redeemable preference shares: Redeemable preference shares are shares which have prior claims to dividends before all other preference shares. The owners of the business can buy back these shares after some time. The shares are issued to finance a particular project. The redemption of preference shares must not be regarded as amounting to reduction of capital.

Features of redeemable preference shares

i. They have prior claims before other preference shares
ii. They can be bought back
iii. They are issued out to finance a particular project.
d. Non-cumulative preference shares: In this type of share, the dividend dloellaccumulate from one year to another. Where a company fails to pay dividend in a particular year, it cannot be carried forward.
e. Non-participating preference shares: Non-participating preference shares are the opposite of participating preference shares. They are not entitled to further dividends after the ordinary shares have been paid.
2. Ordinary shares: Ordinary shares are also known as equities. The ordinary shareholders are the real owners of the business. The holders are the risk bearers and they receive their dividends after all other shares have been paid. They can vote and be voted for. They have no fixed rate of dividend.

Features of ordinary shares

i. There is no fixed rate of dividend
ii. They have voting rights
iii. The holders are the real owners of the business.
iv. They are the risk bearers
v. They receive dividends last, after others have been paid.

Types of ordinary shares

a. Deferred or founder’s shares: Deferred shares are shares which are entitled to the remainder of profit after all other shares (preference and ordinary) have been paid. They are usually issued to the founders or promoters of the business.

Features of deferred shares

i. They have more voting rights
ii. They are issued to the founders of the business
iii. The holders are entitled to the remainder of the dividends after all others have been paid.
b. Preferred ordinary shares: Preferred ordinary shares are shares which receive dividend after the preference shares have been paid. They have preference over other classes of ordinary shares.

Raising of Capital

The methods by which a company raises capital or issue its shares are:
i. By prospectus: A prospectus, giving particulars of the company and its business, is published with application form. Shares are allotted to those who apply.
ii. By offer for sale: The whole issue of shares is allotted to an issuing house (merchant bank, finance house) which offers them to the public by means of a document known as “offer for sale”.
iii. By placing: This is the method of issuing securities through an intermediary such as a form of stock brokers. The intermediary will endeavour to place the issue among its institutional investors.
iv. By a right issue: When a company is established, it may raise further capital by offering the shares concerned to existing members on favourable terms.
v. By introduction: The company concerned can apply to the stock exchange for sales of its shares. There will be an offer to the public of a new issue of shares through the stock exchange.

Types of capital

There are different types of capital available to a company. These include;
i. Issued capital: This represents the part of the authorised capital given out to members of the public for subscription. It is after the issued capital is fully subscribed that it can now be referred to as subscribed capital.
ii. Reserved capital: This represents the portion of the capital not called up, which the directors have assumed to be incapable of being called up anytime. The uncalled up capital is a liability to the company and is set aside for future expansion.
iii. Authorised capital: This is also called nominal or registered capital. This is the highest amount of capital stipulated in the memorandum of association considered as enough to set up and run a company.
iv. Called-up capital: This is the portion of the capital which the management considers good enough to be called up on the issued shares.

Stock

Stocks can be defined as the bundle of shares or mass of capital which can be transferred in fractional amounts. Stocks are always fully paid, e.g stocks can be quoted per #100 nominal value. It is a collection of shares into a bundle. Stocks are not issued but converted from shares issued.

Differences between shares and stock

i. In shares, the unit of capital is transferable only in their entirety while in stock, mass unit of capital, any of which is transferable.
ii. Shares are issued while stocks are converted from shares issued.
iii. Shares are numbered serially while stocks are not numbered serially.
iv. Shares may be partly paid while stocks are always fully paid.

Debentures

A debenture may be defined as a bond, acknowledging a loan, generally under the company’s seal and bearing a fixed rate of interest. It is usually giving security for the repayment of the loan and the payment of the interest. In other words, debenture is a document setting out the terms of a loan to a company, i.e a certificate of indebtedness. Holders of debentures cannot share from the profit of the company. The Company Act defines debenture as: “A written acknowledgement of indebtedness by the company, setting out the terms and conditions of the indebtedness, and includes debenture stock, bonds and any other securities of a company, whether constituting a charge on the assets of the company or not”.

Types of debentures

a. Mortage debentures: Mortgage debentures are issued on the security of the company’s assets. It gives a charge upon the whole or part of the company’s assets upon liquidation.
b. Simple or naked debentures: When there is no charge created on the company’s property or assets, the debentures is described as naked or simple. In this case, there is no security for the debenture.
c. Secured debenture: Secured debenture is the type whose repayment is guaranteed through a collateral security tendered by the borrower.
d. Redeemable debenture: Redeemable debenture is repayable at a date which has been fixed or determined. A company may issue debentures which are liable to be redeemed.
e. Irredeemable debenture: Irredeemable debenture is repayable only in the event of some specified contingency, such as winding up of the company. It cannot be cashed at any time and it is bought solely for interest payments.

Differences between debentures and shares

i. A debenture is a certificate of indebtedness while share is a unit of capital.
ii. Debenture is a loan while shares are not loans.
iii. Holder of debenture receives interest while holder of shares receive dividends.
iv. The holder of a debenture is a creditor while the holder of shares is the owner.
v. In debenture, the interest is credited to profit and loss account while in shares, dividend is credited to appropriation account.

Differences between Partnership and Public Limited Liability Company

i. Partnership has no separate legal entity while public limited liability company has separate and distinct legal entity.
ii. Partnership has unlimited liability while public limited liability company has limited liability.
iii. Partnership has a minimum of two and a maximum of twenty members while public limited liability company has a minimum of seven and no maximum limit on members.
iv. In partnership, the death or withdrawal of a partner can end the business while in public limited liability company enjoys perpetual existence.
v. In partnership, no audit of account while in public limited liablity company, the law prescribes an annual audit and publishing of accounts.

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Take a quick test for this lesson

i. Define a company
ii. State and explain the types of company
iii. Briefly explain the procedures involved in the formation of a limited liablity company
iv. State five features each of private and public limited liability company
v. State five sources of Capital each for private and public limited liablity company
vi. What is a share?
vii. List and explain the types of shares you know
viii. State five differences betwen shares and stock
ix. State five differences between Partnership and Public limited liablity company
x. What is debenture?
xi. List and explain types of debentures
xii. State five differences between debentures and shares.

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