This section explores how ownership structure affects legal responsibility and financial arrangements in businesses, especially regarding liability, share capital, and dividends.
Limited vs Unlimited Liability
Definition and Importance
One of the most important legal distinctions in business ownership is between limited and unlimited liability. This determines the extent to which business owners are legally responsible for any debts or legal claims made against their business.
Understanding this difference is crucial when deciding how to structure a business, particularly in terms of personal risk and access to finance.
Limited Liability
In a limited liability business structure, the business is seen as a separate legal entity from its owners or shareholders. This means the company itself is legally responsible for its debts and obligations.
Key features:
Owners/shareholders are only liable for the money they have invested.
Their personal assets are protected if the business incurs losses or legal claims.
This applies to both private limited companies (Ltd) and public limited companies (Plc).
Legal implications for owners:
Shareholders cannot be asked to repay debts using personal funds beyond their shareholding.
Even if a company goes bankrupt owing large sums, individual investors lose only what they put in.
Example:
Sarah invests £10,000 in a private limited company. If the company is sued or collapses with debts of £250,000, Sarah loses only her £10,000 investment. Her house, car, or other personal belongings cannot be used to cover the company's debts.
Implications for creditors/investors:
Creditors may be more cautious and demand greater evidence of a company’s ability to repay loans, since they cannot pursue owners' personal assets.
Investors are often more willing to fund businesses with limited liability due to reduced personal financial risk.
Unlimited Liability
With unlimited liability, there is no legal separation between the business and its owner(s). This is common in sole traders and general partnerships.
Key features:
Owners are personally liable for all business debts and obligations.
If the business cannot pay its debts, creditors can seize the owner’s personal assets.
Legal implications for owners:
Full financial risk lies with the individual.
A poor business decision or market downturn could lead to personal bankruptcy.
Example:
Tom is a sole trader running a mobile repair service. The business owes £30,000, but only has £5,000 in business assets. Tom must pay the remaining £25,000 from his personal savings or assets, such as his car or home.
Implications for creditors/investors:
Creditors prefer this structure as they have greater security of repayment.
However, this form discourages external investors, as they would also take on unlimited risk.
Ordinary Share Capital
What Is Ordinary Share Capital?
Ordinary share capital is the money a company raises by issuing ordinary shares to investors. It is a permanent source of finance used by limited companies, and shareholders become part-owners of the business.
Key features:
Shares usually give voting rights at the Annual General Meeting (AGM).
Shareholders receive dividends if the business makes profits.
Shareholders share in the business’s success or failure.
Ordinary shares are risk-bearing capital. If the business performs poorly, shareholders may receive no dividends. However, if the business grows and profits increase, they may benefit from higher dividends and increased share value.
Role in Business Financing
Ordinary share capital is critical for a company’s ability to:
Launch new projects
Develop new products
Enter new markets
Fund mergers or acquisitions
Unlike loans, share capital does not need to be repaid, making it a long-term solution for business finance. However, it involves giving away part of the ownership and possibly control of the business.
Example:
A tech start-up issues 500,000 shares at £1 each. This gives the business £500,000 to invest in product development. Shareholders now own a part of the company and expect returns through dividends or increased share value.
Market Capitalisation
Definition
Market capitalisation is the total market value of a company's outstanding shares. It is used to assess a company’s size and value on the stock exchange.
How to Calculate
Market Capitalisation = Current Share Price × Number of Issued Shares
This figure changes continuously as share prices fluctuate in the stock market.
Role in Valuing Businesses
Market capitalisation is used to classify companies into categories:
Large-cap: Companies with a market cap over £10 billion
Mid-cap: Market cap between £2 billion and £10 billion
Small-cap: Market cap under £2 billion
These classifications help investors assess:
The size and stability of a company
The level of risk involved in investing
Growth potential
Example Calculation:
If a Plc has 1,000,000 shares trading at £7 per share:
Market Capitalisation = 1,000,000 × £7 = £7,000,000
If the share price rises to £8:
Market Capitalisation = 1,000,000 × £8 = £8,000,000
This £1 million increase indicates growing investor confidence or improved financial performance.
Significance of Market Capitalisation
Used to compare companies of different sizes.
Helps investors understand whether a company is undervalued or overvalued.
Influences how companies are listed on stock market indexes like the FTSE 100 or FTSE 250.
Investor Perspective:
A high market capitalisation often signals stability, while smaller companies may offer greater growth potential, but with more risk.
Dividends
What Are Dividends?
Dividends are payments made to shareholders from a company’s profits. They are typically paid:
Annually or biannually (called interim and final dividends)
In cash or as additional shares (scrip dividends)
Dividends are a reward to shareholders and an important part of investment returns.
Why Companies Pay Dividends
To reward shareholders and encourage long-term investment.
To show confidence in the business’s financial health.
To enhance the company’s reputation among investors.
To maintain share price stability by keeping investors satisfied.
When Companies Might Not Pay Dividends
If profits are too low.
If the company prefers to reinvest profits in growth.
If it’s a new business in its early expansion phase.
Dividend Example
A company earns a profit of £600,000. The directors decide to distribute 30% of this as dividends.
Dividend paid = 30% of £600,000 = £180,000
If there are 900,000 shares:
Dividend per share = £180,000 ÷ 900,000 = £0.20
An investor with 2,000 shares would receive:
2,000 × £0.20 = £400
This income supplements any increase in share price (capital gain) that the investor may receive.
How Dividends Influence Investor Behaviour
Investors often choose shares based on dividend potential. Some want reliable annual income, while others prefer capital growth.
High dividends:
Attract income-focused investors.
Signal business profitability.
May result in less reinvestment for business growth.
Low or no dividends:
May deter income investors.
Can appeal to growth investors if profits are being reinvested.
Dividend Yield
Dividend Yield = (Dividend per Share ÷ Share Price) × 100
This measures the return on investment from dividends relative to the share price.
Example:
Dividend per share = £0.50
Share price = £10
Dividend Yield = (0.50 ÷ 10) × 100 = 5%
This 5% yield means for every £100 invested, an investor earns £5 in dividends annually, assuming the dividend stays constant.
Investor Significance:
A higher yield suggests better returns but might also signal a falling share price (potential risk).
A lower yield with rising share prices may indicate confidence in future growth.
Recap of Key Calculations
Ordinary Share Capital
If a business issues:
100,000 shares at £2 each
Ordinary Share Capital = 100,000 × £2 = £200,000
This is long-term capital the business can use without the obligation to repay.
Market Capitalisation
If a Plc has:
500,000 shares
Current share price = £4.50
Market Capitalisation = 500,000 × £4.50 = £2,250,000
A change in share price affects this figure and reflects market sentiment and business performance.
Dividends
If profits = £1 million and the company pays out 25%:
Total dividend payout = £1,000,000 × 0.25 = £250,000
Number of shares = 1 million
Dividend per share = £250,000 ÷ 1,000,000 = £0.25
A shareholder with 3,000 shares receives:
3,000 × £0.25 = £750 in dividends
Final Notes on Student Application
Be confident in identifying which business forms offer limited vs unlimited liability.
Practise calculating ordinary share capital and market capitalisation using given values.
Understand how dividends reflect business strategy and affect investor decisions.
Always use real-life-style examples in exam answers to show applied knowledge.
FAQ
Yes, a company can issue ordinary shares without guaranteeing dividend payments. Unlike preference shares, ordinary shares do not entitle shareholders to fixed or mandatory dividends. Dividend distribution is at the discretion of the company’s board of directors and depends on profitability, cash flow, and strategic priorities. If profits are low or the company chooses to reinvest earnings into growth, dividends may be withheld entirely. While this may disappoint shareholders, especially income-seeking investors, it is a legally acceptable and common business practice.
If a company performs a share buyback, it reduces the number of shares in circulation, which can affect market capitalisation depending on share price movements. While the share price may increase due to the perception of strong financial health or higher earnings per share, the total number of shares decreases. Market capitalisation is calculated as share price multiplied by the number of issued shares, so if the share price rises proportionally, market capitalisation may remain stable or even increase slightly despite the reduced share count.
Only incorporated businesses—private limited companies (Ltd) and public limited companies (Plc)—can legally raise finance through issuing ordinary share capital. Sole traders and partnerships cannot issue shares as they are not separate legal entities. Private limited companies can issue shares to family, friends, or private investors but cannot sell them publicly. In contrast, Plcs can list shares on the stock exchange, allowing them to raise significant capital from a wide pool of investors. Therefore, incorporation is essential for accessing equity finance through share issuance.
Yes, dividends are typically paid equally per share to all ordinary shareholders. This means that each share carries the same dividend entitlement. For example, if the company declares a dividend of £0.30 per share, every ordinary share receives this amount, regardless of who owns it. However, shareholders with larger holdings will receive more total dividend income. Exceptions may occur with different share classes if the company has issued multiple types of ordinary shares with varied rights, but standard practice is equal distribution per share.
Generally, dividends cannot be paid if a company is making a loss, as they must be paid from distributable profits—usually accumulated retained earnings. UK company law restricts businesses from paying dividends out of capital or reserves not classified as distributable. Doing so can be unlawful and lead to legal consequences for directors. In rare cases, if a company has large retained profits from previous years, it may still pay dividends despite a current-year loss, but this must be done cautiously and within legal limits.
Practice Questions
Explain one reason why a public limited company might choose to pay dividends to shareholders, even if it has opportunities for reinvestment. (6 marks)
A public limited company might choose to pay dividends to maintain investor confidence and satisfy shareholder expectations. Shareholders, especially institutional investors, often rely on dividends as a return on investment. By paying dividends, the business signals financial strength and stability, which can support its share price. If the company fails to pay dividends despite profitability, it could damage its reputation, reduce demand for its shares, and make raising future capital more difficult. While reinvestment can drive growth, companies must balance this with keeping shareholders satisfied to maintain long-term access to external equity funding.
Analyse the impact of limited liability on a shareholder’s willingness to invest in a private limited company. (9 marks)
Limited liability reduces the personal financial risk for shareholders, as they are only liable for the amount they invest in shares. This encourages investment, particularly from individuals or institutions who may avoid high-risk ventures. Investors are more likely to provide capital, knowing their personal assets are protected, even if the business fails. It creates a safer investment environment, helping the business to attract funding. However, the lack of personal risk could result in reduced accountability. Overall, limited liability increases investor confidence, making it easier for private limited companies to raise capital for expansion or development.
