3-Organization

What it means to “become a legal entity”

An organization becomes a legal entity when the law treats it as a separate “person” that can own property, make contracts, sue and be sued. Why: being a legal entity separates the organization from the individuals who run it, so risk, ownership and legal responsibility can be organised and limited.

Types of organisations (and when each is appropriate)

There are three broad types of organisation: commercial (aim to make profit), public (run or funded by government to provide public services) and not-for-profit (charities or associations that reinvest surplus to pursue a social purpose). Why: the legal structure you choose should match the organisation’s goals — commercial for profit-making ventures (e.g., a software startup), public for services like a national health service, and not-for-profit for charities or professional associations.

Sole trader

A sole trader is one individual who owns and runs the business and no separate company is formed; the business and the individual are the same legal person. Why: it’s the simplest setup (fast, cheap), but the owner has unlimited liability, meaning personal assets (home, savings) can be used to pay business debts — so risk is high if the business fails. Example (IT): a freelance web developer who invoices clients personally is usually a sole trader.

Turnover & VAT: if the business turnover (total sales) passes a legal threshold, the owner must register for VAT (a tax collected on sales). Why: tax rules depend on scale of trading.

Partnership

A partnership is where two or more people run a business together without forming a limited company; the partnership is the trading form unless they choose a limited company. Why: partnerships are simple and common for small professional practices (law firms, design studios), but partners face joint and several liability (each partner may be fully responsible for the partnership’s debts). Legal reference: in many places, traditional partnerships are governed by acts such as the Partnership Act 1890. Why: the Act sets default rules about profit sharing, authority, and dissolution — useful when there’s no written agreement.

Changing ownership is difficult in a partnership because each partner’s rights are intertwined with the others. Why: selling your share often requires agreement from other partners or following a partnership agreement.

Limited Liability Partnership (LLP)

An LLP is a hybrid where the organisation is a legal entity separate from its members (like a company), but members have limited liability. Why: it gives professional groups (e.g., consultancies, law firms) the flexibility of partnership while protecting personal assets.

Limited company — the preferred commercial form

A limited company is a separate legal person (a “company” in law) and is the preferred form for commercial firms. Why: it gives limited liability to owners, making business risk manageable and attracting outside capital.

Three core principles of a limited company:

Separate legal personality: the company is distinct from its owners and employees. Why: it can enter contracts and own assets in its own name.
Ownership divided into shares: ownership is split in shares that can be bought and sold by shareholders. Why: shares make it easy to fund growth and transfer ownership.
Limited liability of shareholders: owners are only liable up to the money they invested in shares (they won’t usually lose personal assets if the company fails). Why: this encourages investment and allows businesses to take larger risks.

UK types: a public limited company (plc) may offer shares to the public (trade on stock markets); a private limited company (Ltd) cannot offer shares publicly. Why: plcs are used when large public fundraising is intended; Ltd is common for smaller or privately held businesses.

Legal obligations of limited companies

A limited company must register and provide information to an official registry (in the UK, Companies House), and must file annual accounts and reports. Why: public filing promotes transparency and protects creditors & investors.

Historically, companies could only be formed by a special Act of Parliament or Royal Charter, which was slow and expensive; modern law (e.g., Companies Act 2006 in the UK) made company formation simple and codified many rules. Why: simpler formation reduces barriers to entrepreneurship and standardises corporate governance.

Setting up a company: you can either buy an “off-the-shelf” company and adapt it, or register one yourself for a modest fee. Why: flexibility and low cost speed business creation in many countries (though procedures vary internationally).

Constitution of a limited company — two main documents

A company’s constitution is typically made of two documents:

Memorandum of Association — a short document giving the company’s official name, registered office address, stated objects (purpose), liability clause (limits of members’ liability), share capital details (number and value of shares), and a declaration by the founders agreeing to form the company. Why: it records the company’s formation and basic identity; historically it limited what the company could legally do.

Articles of Association — a detailed set of internal rules about how the company will be managed, the powers and duties of directors, shareholders’ rights, how meetings are run, dividend policy, and how the company can be wound up. Why: these govern day-to-day governance and relationships between shareholders and directors.

Shareholders’ agreement (separate, private document) often supplements the articles with specific commercial arrangements (e.g., pre-emption rights, drag-along/tag-along clauses). Why: it handles confidential commercial terms that founders don’t want publicly filed.

Public record: once registered, the memorandum and articles are placed on public record at Companies House so creditors and investors can inspect them. Why: public filing increases transparency and trust.

Key parts of the memorandum (explained)

Company name: the legal trading name. Why: identifies the legal person in contracts and proceedings.
Registered office address: the official legal address for notices. Why: ensures a place for legal documents to be served.
Objects clause: historically described permitted activities; in many modern companies this is unrestricted. Why: older laws constrained companies; now flexibility helps business adapt.
Liability clause: explains members’ liability (limited to unpaid amount on shares). Why: clarifies how much owners may be required to contribute.
Capital clause: shows share capital (number/value of shares). Why: indicates how ownership is structured and potential funding capacity.
Association clause: founders agree to form the company and take initial shares. Why: formalises the founders’ commitment.

Key parts of the articles (explained)

Internal rules & governance: how decisions are made, voting rules, meeting procedures. Why: prevents dispute and provides predictable decision-making.
Shareholder rights & powers: voting, transfer, issue of new shares. Why: protects owners’ economic and voting interests.
Appointment/removal of directors: process for directors’ terms, powers, duties. Why: ensures leadership can be changed and held accountable.
Dividend policy: how and when profits are distributed to shareholders. Why: clarifies reward to owners.
Winding up: steps to dissolve the company and distribute assets. Why: provides an ordered exit if the company fails or closes.

Directors — roles, duties and legal obligations

Directors may be owners (shareholder-directors) or employees hired to run the company; in large companies directors are often paid managers. Why: separation of ownership and management is common in growth businesses.

Directors must:

Have regard to the interests of owners and employees and act in good faith for the benefit of the company. Why: they must balance stakeholder interests and not pursue personal gain at the company’s expense.
Exercise skill and care expected of someone with their qualifications and experience (a duty of competence). Why: negligent decisions can harm the company and lead to personal liability.
Declare conflicts of interest (situations where directors’ personal interests may conflict with the company’s interests). Why: transparency prevents self-dealing and preserves trust.
Be aware of the company’s financial position and not allow it to trade while insolvent (incur debts it cannot realistically repay). Why: directors can be personally liable for wrongful trading if they continue to incur debts when insolvency is inevitable.
Prepare and file annual reports and accounts and comply with applicable law and regulatory requirements. Why: legal compliance protects shareholders, employees, and creditors.

Companies typically have executive directors (employees running operations) and non-executive directors (independent advisors who provide oversight). Public companies must usually have a company secretary responsible for legal compliance and official communications. Why: governance structures combine operational leadership with oversight and legal administration.

Examples of director duties in practice

If a director signs a contract for computers that are unsuitable for the company’s needs (and loses money), a court may later order the director to personally compensate the company if the action shows lack of skill/care. Why: accountability deters reckless decisions.

If a director has a personal interest in a contract (for example, awarding a cleaning contract to a company they own), they must inform the board and should not vote on the decision. Model articles typically prohibit the interested director from voting. Why: prevents conflicts of interest and self-dealing.

Takeovers — what they are and why they happen

A takeover happens when one company (B) acquires the shares and control of another company (A), typically by buying the shareholders’ shares for cash, or by offering B’s own shares, or a mixture of both. After a takeover, original owners may continue as directors under the new ownership. Why: takeovers are a common way to reallocate resources, acquire capabilities, or expand market reach.

Reasons owners sell: they may want to convert their share value into cash, need additional capital, or the buyer may have complementary technology, customers, or skills (e.g., A has niche IP; B has distribution). Why: strategic fit or financial needs drive consolidation.

Example: SD-Scicon (a British software house) was taken over by EDS, later EDS was acquired by HP. Sometimes takeover leads to disappearance of the acquired brand if the buyer does not continue that market. Why: corporate strategy, market focus, or redundancy can lead acquirers to fold or retain the target’s identity.

Regulation: strict takeover rules exist to prevent exploitative behaviour and protect minority shareholders; large mergers can raise competition concerns and be examined under monopoly/antitrust laws. Why: regulators protect public interest and healthy competition.

Common takeover motives (quick list + why)

Expand customer base — reach new markets or geographies.
Expand product range — add complementary products or services.
Acquire new staff/skills — bring in talent or specialist teams.
Economies of scale — reduce per-unit costs through larger operations.
Vertical integration — control more steps in the supply chain (e.g., Netflix producing content, not only licensing).
Eliminate a competitor — reduce competition and increase market power. Why: each motive aims to strengthen revenue, reduce costs, or increase market control.

Mergers

A merger is when two companies combine to form a new company that acquires the shares of both (e.g., Bell Atlantic + GTE → Verizon). Large mergers may be reviewed under competition (antitrust) laws and can take years to approve. Why: mergers reshape markets; regulators assess effects on competition and public interest.

Management buyouts (MBOs)

A management buyout occurs when a company’s existing managers purchase the company from its owners. These usually require large capital and can present conflicts of interest (managers may have privileged information). Why: MBOs let insiders gain control but create ethical and valuation issues.

Outsourcing — definition, reasons and risks

Outsourcing is when an organisation hires an external company to provide services (e.g., IT support) that were previously done in-house. Governments sometimes outsource to reduce civil service size or when public bodies struggle to recruit/retain specialist staff. Arguments for outsourcing: it frees management to focus on core activities, makes IT costs visible and controllable, gives access to specialist firms with more experience, can justify hiring highly qualified staff, and may save money overall. Why: outsourcing leverages vendor expertise and can be cost-efficient.

Risks: excessive outsourcing can reduce the organisation’s control/understanding of core operations and create dependency on suppliers; when things go wrong, political blame often shifts between officials and contractors. Why: losing in-house capability can weaken strategic oversight and increase vulnerability.

Non-commercial bodies — statutory bodies and other not-for-profit entities

Statutory bodies are public organisations created by law to provide public services (e.g., local government, National Health Service, police, education, armed forces). In the UK, about 20% of jobs are public sector. These organisations handle large datasets (e.g., the Department for Work and Pensions holds records for millions). Why: public bodies need significant IT systems and must run them with accountability and legal compliance.

Objectives differ: private sector aims to make profit and is controlled by shareholders; public sector aims to provide public services (roads, education). Why: different purposes imply different performance measures and accountabilities.

Management accountability in public bodies is exercised through democratic mechanisms: elected representatives (Members of Parliament, councillors) set policy, then civil servants and professionals implement it. This creates tension between politicians’ policy goals and professionals’ technical advice. Why: political decisions can be ambitious or short-term; professionals bear the operational consequences.

Other non-profit bodies — professional bodies and charities

Professional bodies (e.g., BCS) and charities (e.g., Oxfam) are often set up as companies limited by guarantee rather than by shares. In such organisations, members do not subscribe shares but guarantee to pay a small nominal amount if the organisation is wound up, and profits cannot be distributed to members. Why: this structure protects members, reinforces non-profit status, and allows civic/charitable objectives.

A large professional body such as the BCS may be incorporated by Royal Charter (a formal grant by the Crown) and be a registered charity. The Royal Charter may vest control of the organisation in a Trustee Board. BCS is run by members and volunteers, reflecting its public and professional service role. Why: chartered status enhances prestige, public trust, and a governance framework consistent with public interest duties.

Tough exam-style questions (answer these to test deep understanding)

You are advising two IT founders: one wants the safety of limited liability, the other wants simple setup and low cost. Explain clearly the legal and practical trade-offs between forming a sole trader, a partnership, an LLP, and a private limited company (Ltd). Include examples of liability, tax and investor perceptions.
A small cybersecurity consultancy currently trading as a partnership wants to win large government contracts with high liability exposure. What legal form would you recommend and why? Explain the steps and documents needed to convert their organisation to that form.
Describe the memories and articles of association: what each contains, why they are filed publicly, and how they affect the rights of a minority shareholder who wants to block issuance of new shares.
A director signs a technology contract that risks the company’s solvency if it goes wrong. Under what legal principles could creditors or courts hold the director personally liable? Explain the tests or standards used to judge whether the director acted with required skill and care.
Design (in plain language) three clauses a shareholders’ agreement should include to protect a minority shareholder in case of a hostile takeover — explain why each clause matters.
A takeover results in the acquiring company closing the acquired company’s product line and laying off staff, destroying the acquired brand. Which legal or regulatory mechanisms exist to protect employees, minority shareholders, or public interest? Analyse pros and cons of those mechanisms.
For a public body outsourcing its IT system that handles personal data, list the legal and governance steps that must be satisfied before outsourcing (e.g., procurement rules, data protection, service levels), and explain why each step is important.
Compare and contrast management buyout (MBO) and external acquisition from the perspectives of valuation, conflict of interest, funding sources, and effects on company culture.
Explain why a company limited by guarantee is the preferred form for a professional association like BCS, and why it cannot distribute profits to members. Would it be suitable for a software startup? Why or why not?
Draft a short memo explaining to a city council why it should avoid outsourcing strategic IT functions without retaining in-house capability. Include three concrete risks and three mitigation measures.
A multinational IT firm wants to expand into a jurisdiction where registration and disclosure costs are high and setting up a local legal entity is slow. Discuss practical structures (local subsidiary, branch, joint venture, distributor) and the legal/corporate/compliance tradeoffs of each.
Discuss how corporate law (companies acts) and competition/antitrust law interact when two large tech firms propose a merger. What authorities and tests will be involved, and how could the merger be modified or blocked?