The 30 Day MBA (34 page)

It was not until 1791 that the United States had its first bourse when the Philadelphia traders organized a stock exchange. The following year, 21 New York traders agreed to deal with each other under a buttonwood tree on Wall Street. By 1794 the market had moved indoors. India's premier stock exchange, Bombay Stock Exchange (BSE), can also trace its origin back as far as 125 years when it started as a voluntary non-profit-making association. In the 1870s, a securities system was introduced in Japan and public bond negotiation began. This resulted in the request for a public trading institution, and the ‘Stock Exchange Ordinance' was enacted in May 1878. Based on this ordinance, the ‘Tokyo Stock Exchange Co., Ltd' was established on 15 May 1878 and trading began on 1 June.

These early stock exchanges were gentlemen's clubs governed only by a few house rules. Trading rarely started before 10.30 and was over by 15.30. No records were filed, no rules governed the case of a trader who could not deliver what he had sold and nothing prevented prices being manipulated.

Limited liability companies

From the earliest trading times to the present day, the most popular legal structure under which to operate has been as a sole trader, which in effect means every man for himself. In the beginning, a merchant always risked his
own money, if he had any to invest: if he travelled, as most did, he risked his life on the journey. The caravan trade of Asia, Asia Minor, and North and Central Africa ploughed their way through the sands that separated distant cities and seaports. The largest caravans comprised thousands of camels and required careful administration. They also stimulated people to band together in partnerships, pooling protection costs and profits to spread the risks. The partnerships would usually last only for the particular journey. Later on, older merchants who had made money from earlier ventures could join such expeditions by putting up money, without the hardship of making the trip themselves. This could be seen as an early form of limited partnership.

As the ventures became more costly and of longer duration, partnership structures of fixed duration between one, three or five years became common, with an ever-increasing range of partners with differing shares in the venture. To add to the complications these partners could join and leave, perhaps for no more sinister reason than death, at different times.

The concept of limited liability, where the shareholders are not liable, in the last resort, for the debts of their business, changed the whole nature of business and risk taking. It opened the floodgate, encouraging a new generation of entrepreneurs to undertake much larger-scale ventures without taking on themselves all the consequences of failure. As the name suggests, in this form of business liability is limited to the amount you contribute by way of share capital and, in the event of failure, creditors' claims are restricted to the assets of the company. The shareholders of the business are not normally liable as individuals for the business debts beyond the paid-up value of their shares.

The concept itself can be traced back to the Roman Empire, where it was granted, albeit infrequently, as a special favour to friends for large undertakings by those in power. The idea was resurrected in 1811 when New York State brought in a general limited liability law for manufacturing companies. Most US states followed suit and eventually Britain caught up in 1854. Today, most countries have a legal structure incorporating the concept of limited liability.

The age of financial panics (1900–to date)

For most people the financial crisis that erupted in 2007/08 was the first full-blown global financial crisis that anyone alive had seen. The man at the helm of the most important financial market, Ben Bernanke, chairman of the Federal Reserve, the central bank of the United States, was as well placed as anyone to oversee the Federal Reserve's response.

Formerly a tenured professor at Princeton University, chairing the department of economics there, his reputation is in part founded on his interest in the economic and political causes of the Great Depression. He has published
numerous academic journal articles on the subject including the much quoted 1983 article in the
American Economic Review
: ‘Nonmonetary Effects of the Financial Crisis in the Propagation of the Great Depression.'

But even the 1929 depression and the ensuing banking failures that rocked the world, was not the first financial crisis to strike. Major banking panics hit the United States in 1857, 1873, 1884, 1890, 1893, 1896 and 1907. Argentina in 1890 and Australia in 1893 suffered banking system losses of roughly 10 per cent of GDP in the wake of real estate market collapses in those countries. When 22 two banks failed in Norway in 1900 the economy was dragged down 3 per cent and in 1893 Italy's financial crisis wiped 1 per cent of GDP.

The catalogue of disasters is long and spreads across almost every economy; the US Savings and Loan industry disaster of the 1980s, banking collapses in Japan and Scandinavia a decade later and similar banking failures occurring in 140 developing countries over these same decades wiped between 1 per cent of GDP and more than 10 per cent of GDP in 20 of those countries.

Contrast that with the global economy's contraction of just 2 per cent in 2009 and the present crisis doesn't seem that unusual. But in some economies the consequences of the latest financial crisis have been more severe. In the United States real GDP declined a total of 4.7 per cent between the fourth quarter of 2007 and the second quarter of 2009, before stabilizing. Estonia, Latvia and Lithuania saw real GDP fall by between 15 and 18 per cent in 2009 before corners were being turned. In the final half of 2012 the Greek economy was still in free fall with GDP dropping at an annualized rate of some 7 per cent.

These resources will help you get up to speed on financial crisis:

Bank Failures in Theory and History: The Great Depression and Other
‘Contagious' Events
, Charles W Calomiris, Working Paper 13597, National Bureau of Economic Research (
www.nber.org/papers/w13597
), November 2007.

Manias, Panics and Crashes: A History of Financial Crises
, Sixth Edition, by Charles P Kindleberger and Robert Z Aliber, Palgrave Macmillan, August 2011.

The Recent Financial Crisis and Its Predecessors; an elective at Copenhagen Business School
.

6

Business law

• Forms of business
  
• Employing staff
  
• Innovation issues
  
• Tax legalities
  
• Trading regulations
  
• Rules on mergers and acquisitions
  

S
ome business schools take law very seriously; for example, at Northwestern University's Kellogg School and George Washington University, MBA students can take a joint MBA and JD (juris doctor), the basic professional degree for lawyers. Babson in Wellesley, Massachusetts has law as one of its core subjects. Penn State, on the other hand, offers only an optional module in the second year on ‘Business Law for Innovation and Competition'.

Nevertheless, lawyers dominate big businesses in the United States and both Congress and the Senate. In the UK around 12 per cent of MPs are either barristers or solicitors, the largest professional grouping in the House of Commons. Other than very large businesses, it is not usual to have either a qualified lawyer or a legal department in businesses in the UK. Such services are usually bought in on either a contractual or ad hoc basis. Law is an imprecise field. As Henry L Mencken, the American journalist and critic, so succinctly expressed it: ‘a judge is a law student who marks his own examination papers'.

The complexity of commercial life means that, sooner or later, you will find yourself taking, or defending yourself against, legal action. It may be a contract dispute with a customer or supplier, or perhaps the lease on your premises turns out to give you far fewer rights than you hoped. A former employee might claim you fired them without reason. Or the Health and Safety Inspector will call and find some aspect of your machinery or working practices less than satisfactory.

Ignorance does not form the basis of a satisfactory defence, so every MBA needs to know enough law to know when they might need legal advice, however high their standard of ethics and social responsibility may be.

Corporate structures

As an MBA it's highly likely that you will be working for a conventional company, private or public (see
Chapter 2
for more on public companies). There are, however, a number of distinct forms that a business can take, the choice of which depends on a number of factors: commercial needs, financial risk and the need for outside capital.

In most parts of the world corporate structures are broadly similar despite a variety of exotic sounding names. Sole trader is personaline imone in Lithuania and empresário emnome individual in Portugal; Partnerships are Offene Gesellschaft – OG in Austria and verejná obchodná spoloènos in Slovakia; limited partnerships are Kommanditgesellschaft – KG in Austria and komanditná spoloènos in Slovakia and the limited company is Sabiedriba ar ierobežotu atbildibu in Latvia and Socitatea cu Raspundere Limitata in Romania.

Each of these forms is explained briefly below, together with the procedure to follow on setting them up. You can change your ownership status later as your circumstances change, so while this is an important decision it is not a final one.

Sole trader

Over 80 per cent of businesses start up as sole traders and indeed around 55 per cent of all businesses employing fewer than 50 people still use this legal structure. It has the merit of being relatively formality free and, unless you intend to register for VAT, there are few rules about the records you have to keep. There is no requirement for your accounts to be audited, or for financial information on your business to be filed at Companies House.

As a sole trader there is no legal distinction between you and your business – your business is one of your assets, just as your house or car is. It follows from this that if your business should fail, your creditors have a right not only to the assets of the business, but also to your personal assets, subject only to the provisions of the Bankruptcy Acts. The capital to get the business going must come from you – or from loans. There is no access to equity capital.

Partnerships

Partnerships are effectively collections of sole traders and, as such, share the legal problems attached to personal liability. There are very few restrictions
to setting up in business with another person (or persons) in partnership, and several definite advantages. By pooling resources you may have more capital; you will be bringing, hopefully, several sets of skills to the business; and if you are ill the business can still carry on.

There are two serious drawbacks that you should certainly consider. First, if your partner makes a business mistake, perhaps by signing a disastrous contract, without your knowledge or consent, every member of the partnership must shoulder the consequences. Under these circumstances your personal assets could be taken to pay the creditors even though the mistake was no fault of your own.

Second, if your partner goes bankrupt in his or her personal capacity, for whatever reason, his or her share of the partnership can be seized by creditors. As a private individual you are not liable for your partner's private debts, but having to buy him or her out of the partnership at short notice could put you and the business in financial jeopardy. Even death may not release you from partnership obligations and in some circumstances your estate can remain liable. Unless you take ‘public' leave of your partnership by notifying your business contacts and legally bringing your partnership to an end, you could remain liable.

The legal regulations governing this field are set out in the Partnership Act 1890, which in essence assumes that competent businesspeople should know what they are doing. The Act merely provides a framework of agreement that applies ‘in the absence of agreement to the contrary'. It follows from this that many partnerships are entered into without legal formalities – and sometimes without the parties themselves being aware that they have entered a partnership!

The main provisions of the Partnership Act state:

• All partners contribute capital equally.
  
• All partners share profits and losses equally.
  
• No partner shall have interest paid on his capital.
  
• No partner shall be paid a salary.
  
• All partners have an equal say in the management of the business.
  
• Unless you are a member of certain professions (eg law, accountancy, etc) you are restricted to a maximum of 20 partners in any partnership.
  

It is unlikely that all these provisions will suit you, so you would be well advised to get a ‘partnership agreement' drawn up in writing by a solicitor at the outset of your venture.

Limited partnerships

One possibility that can reduce the more painful consequences of entering a partnership is to form a limited partnership combining the best attributes of a partnership and a company.

A limited partnership works like this. There must be one or more general partners with the same basic rights and responsibilities (including unlimited liability) as in any general partnership, and one or more limited partners who are usually passive investors. The big difference between a general partner and a limited partner is that the limited partner isn't personally liable for debts of the partnership. The most a limited partner can lose is the amount that he or she: paid or agreed to pay into the partnership as a capital contribution; received from the partnership after it became insolvent.

To keep this limited liability, a limited partner may not participate in the management of the business, with very few exceptions. A limited partner who does get actively involved in the management of the business risks losing immunity from personal liability and having the same legal exposure as a general partner.

The advantage of a limited partnership as a business structure is that it provides a way for business owners to raise money (from the limited partners) without either having to take in new partners who will be active in the business or having to form a limited company. A general partnership that's been operating for years can also create a limited partnership to finance expansion.

Limited company

Of the 4.5 million businesses trading in the UK, over 1.4 million are limited companies. A similar proportional split applies to the 22 million businesses in the United States. As the name suggests, in this form of business your liability is limited to the amount you state that you will contribute by way of share capital, though you may not actually have to put that money in.

A limited company has a legal identity of its own, separate from the people who own or run it. This means that, in the event of failure, creditors' claims are restricted to the assets of the company. The shareholders of the business are not liable as individuals for the business debts beyond the paid-up value of their shares. This applies even if the shareholders are working directors, unless of course the company has been trading fraudulently. Other advantages include the freedom to raise capital by selling shares.

Disadvantages include the cost involved in setting up the company and the legal requirement in some cases for the company's accounts to be audited by a chartered or certified accountant. Usually it is only businesses with assets approaching £3m that have to be audited but if, for example, you have shareholders who own more than 10 per cent of your firm they can ask for the accounts to be audited. The behaviour of companies and their directors is governed by Companies Acts that have come into effect since 1844, the latest of which came into effect in November 2006.

Public limited company (PLC)

PLCs are companies that can sell shares to the public at large, either through a recognized stock market or by advertising in the press or through intermediaries. They need to fulfil some minimum, not too onerous conditions:

• It must state that it is a PLC in its articles of association.
  
• It must have an authorized share capital of at least £50,000.
  
• Before it can trade, £50,000 ($78,400/€56,200) of share capital must be taken up and a quarter of that must be actually paid up.
  
• Each allotted share must be paid up to at least a quarter of its nominal value.
  
• There must be at least two shareholders, two directors and a company secretary who meets certain standards in terms of qualifications or experience.
  

See also
Chapter 2
for more on public capital.

Company limited by guarantee

This type of incorporation is used for non-profit organizations that require corporate status as a means of protecting participants. There are no shareholders but its members give an undertaking to contribute a nominal amount towards the winding up of the company in the event of a shortfall when it closes down. It cannot distribute its profits to its members, and is therefore eligible to apply for charitable status if necessary. You may find this type of company being used by a business as a means of isolating part of its activities, such as clubs or sports associations that are not part of its profit-generating business.

Co-operative

A co-operative is an enterprise owned and controlled by the people working in it. Once in danger of becoming extinct, the workers' co-operative is enjoying something of a comeback. There are functioning co-operatives in some 90 countries employing over 800 million people worldwide. The International Co-operative Alliance (
www.ica.coop/ica
) represents agriculture, banking, fisheries, health, housing, industry, insurance, tourism and consumer cooperatives and is the largest non-governmental organization in the world.

Over 4,990 independent co-operatives exist in the United Kingdom, employing some 237,800 people and generating sales of £33.5 billion a year. Co-ops sell bicycles, furniture, camping equipment, appliances, carpeting, clothing, handicrafts and books. Co-operative wholesalers exist like those in the hardware, grocery, and natural foods businesses. Some co-operatives disseminate news, and others are for artists. Co-operative electric and
telephone utilities exist, as well as co-operatively managed banks, credit unions, and community development corporations.

Some co-ops provide healthcare, such as health maintenance organizations and community health clinics. Co-operative insurance companies have also been established, as well as co-operative food stores, food-buying clubs, and discount warehouses. You get the idea. Co-ops have been set up in virtually every area of business you can possibly imagine. You can find out everything you need to know about the size, structure and prospects of co-operatives in a free 36-page report that can be downloaded at:
www.uk.coop/resources/documents/uk-co-operative-economy-2010
.

Help and advice on business corporate structure

A Guidance Note entitled ‘Choose a legal structure for a new business' is available from GOV.UK (
www.gov.uk/business-legal-structures/overview
).

Cooperatives UK (
www.cooperatives-uk.coop
> Services > Co-operative Development) is the central membership organization for co-operative enterprises throughout the UK. This link is to the regional network.

Desktop Lawyer (
www.desktoplawyer.co.uk
> BUSINESS > BUSINESS START-UP > Choosing a business structure > The Partnership) has a summary of the pros and cons of partnerships as well as inexpensive partnership deeds.

Employment law

Trading regulations

Organizations are heavily regulated in almost every sphere of their trading operations. Some types of business require a permit before they can even start trading and all businesses have to comply with certain standards when it comes to advertising, holding information or offering credit. These are the regulations that govern the trading activities of most business ventures.

Getting a licence or permit

Some businesses, such as those working with food or alcohol, employment agencies, mini-cabs and hairdressers, need a licence or permit before they can set up in business at all. Even playing music in public, recorded or live, or putting a table and chairs on a pavement means getting permission from someone. Your local authority planning department can advise you on what rules will apply to your business. You can also use this website (
www.gov.uk/licence-finder
) from which you can use their interactive tool to find out which permits, licences and registrations will apply and where to get more information.