ENTREPRENEURIAL AWARENESS

The learner should be able to

1. Discuss legal aspects of a business

2. Identify and discuss various legal forms of business ownership

Legal aspects of business
An entrepreneur should be aware of certain legal requirements that will affect his business this
include an understanding of;
1. Business laws and regulations
2. Legal forms of business organizations
Business laws and regulations
These are government laws and regulations that an entrepreneur needs to comply with. They include;
1. Product safety laws
2. Building laws
3. Labour laws
4. Insurance
5. Taxation etc

Product Safety and Liability

It is very important for the entrepreneur to assess whether any product that is to be marketed in the
new venture is subject to any regulations under the consumer product.
In addition to setting standards for products the commission also has a great deal of responsibility
and power to identify what to consider being a substantial hazard and barring any products that may
be considered unsafe.
Any products introduced by entrepreneurs must obtain clearance from the Kenya bureau of standards
under the consumers protection Act.
Building laws-These are laws enacted to ensure safety and suitability of business premises.

Labour laws –these laws guide the relationship between employer (entrepreneur) and employee
e.g., employment Act, workers injury Act, labour relations Act, industrial attachment Act etc.

Insurance –certain types of insurance are required by the law and cannot be avoided e.g., third
party vehicle insurance
Taxation – its mandatory for business people to pay tax to Kenya revenue authority
FORMS OF BUSINESS ORGANISATIONS
Overview of forms of businesses
Business enterprises /organizations are of diversified nature from the point of view of ownership,
control and size. A business enterprise may be owned by one person or a group of persons or it
may be controlled by the owners themselves or by managers on behalf of the owners. The forms
of business organizations can be classified as under
1. Private sector- which comprises of businesses owned by private individuals either singly
or in groups. E.g. sole-proprietorships, partnerships and limited companies.
2. Public sector-which comprises of business organizations owned by the government. The
government owns them either wholly or through majority shareholding e.g. parastatals,
local authorities.
Private sector organizations can further be classified as incorporated and unincorporated
businesses.
a) Incorporated businesses- it is a business or a corporation with a separate entity from the
business owner and has natural rights e.g. public and private limited companies.
b) Unincorporated businesses- it is a business or a corporation where the owner and an
unincorporated business are the same, and the owner personally bears all risks and
liabilities of the business. Unincorporated businesses are usually sole proprietorships or
partnerships.

SOLE PROPRIETORSHIP / SOLE TRADER BUSINESS

This is a business owned and operated by one person. He is the owner and manager of the
business although he may get assistance from family members or a few attendants that he may
have employed.
Requirement for formation of Sole proprietorship
Basically the sole trader is required to look for a business premises from which to run the
business and obtain a trading/single permit license from the local authority.

Characteristics of Sole proprietorship

a) Capital is contributed by the owner who cannot appeal to the public at large to subscribe to the
capital.
b) The owner is the organizer and manager of the business assisted by members of his family. He
may also employ an outsider but all the risks fall upon the owner.
c) The owner takes all the profits and suffers all the losses and risks.
d) The liability of a sole trader is unlimited i.e. in the eyes of the law there is no distinction
between him and his business and in case of failure to pay debts the creditors of the business can
claim payment from his personal property.
e) It is the most common form of business ownership and is found in retail trade and persons
engaged in direct services such as lawyers, doctors, accountants etc.

Sources of Finances for sole proprietor

a) Personal savings
b) Sale of personal assets
c) Inheritance from parents
d) Borrowing from relatives/ friends
e) Loans from micro finance institution e.g. Faulu Kenya, Kenya women finance trust
f) Loans from SACCOS
g) Government grants in form of youth fund, women fund and Uwezo fund
h) Conversion of personal assets into business assets
i) Donations/ grants from NGO’s

Advantages and disadvantages of a sole proprietor

Advantages
i. Requires little capital to start as compared to other forms of business ownership such
as partnerships and companies.
ii. Enjoys profit alone/ his efforts thus determines profits
iii. Easy formation process- requires only a premises and trading license
iv. Enjoys business secrets
v. There is direct contact between the owner and the customer; this leads to customer
satisfaction.
vi. Control of the business is easy as the owner is the final decision maker; this often
leads to fast decision making
Disadvantages
i. Lack of sharing of responsibility thus the owner may be forced to overwork. This can
lead to fatigue and sometimes health problems.
ii. The life of the business is pegged on the life of the owner i.e. business
continuity/perpetual succession is not guaranteed after the death of the owner
iii. Incurs the losses and risks alone
iv. The sole proprietorship has unlimited liability- personal assets of the owner can be
sold to recover the liabilities of the business.
v. There are limited sources of capital due to high risk levels and lack of security for
debt finances
vi. Lack of second opinion in decision making; this may lead to bad decisions.

PARTNERSHIP
A partnership is an association between two or more persons carrying out a business in common
with a view of making profit; two or more people jointly run the partnership. The number of the
partners will depend on the type of the partnership e.g. trading business that do not require any
professionalism may have 2-20 partners while personal and Professional business partnership
that requires skills of operations such as medical and advocate practice may have 2-50 partners.
The partnership is managed by the partners. They share responsibilities and duties according to
their availability. However they can hire people to work for them.
Features of partnership
a) Just like sole proprietor partners have unlimited liabilities i.e. partners are held liable for
the debts of the business and they risk loosing their personal property to meet such debts.
b) The partners contribute the capital to start and run the business and no appeal is made to
the public to subscribe to the capital.
c) The partnership has a limited life i.e. it lacks continuity on death withdrawal, bankruptcy,
retirement of a partner.
d) Each partner act as an agent of the firm with authority to enter into contract on behalf of
the partnership.
e) Each partner is responsible for the debt and losses of the firm.
f) Responsibility, profit and losses are shared on an agreed basis
Requirement for formation of partnership
In Kenya, all partnerships are formed in accordance with the Partnership Act. The formation of
partnership may be simply by agreement between the partners. Partners can agree to use their
personal name to constitute the name of the firm or use a name quite distinct from their own. If
they use a name distinct from their own, the partnership’s name must be registered under the
registration of business names act. Partners should also agree on how the proposed business will
be run to avoid future misunderstanding. The partnership agreement can be oral or written. A
written legal agreement is referred to as a partnership deed.

Contents of the partnership deed

 Name, address, location and nature of the business.
 Names, addresses, occupations, duties and rights of the partners.
 Types of partners.
 Salaries to be paid to the active partner
 Amount of capital to be contributed by each partner.
 Duration of the partnership.
 The procedure for sharing profits and losses.
 Method of dealing with the death, retirement and insolvency of a partner.
 Methods of admitting a new partner.
 Methods of solving disputes.
 Agree on what should be done on the dissolution of partnership
 Interest to be charged on capital and drawings.
NB: Drawings is anything taken by the partners for their own personal use and not for business
purposes.
In the absence of a partnership deed the business should be governed by a Partnership Act as
provided by the laws of Kenya.
Contents of the Partnership Act
 All the partners must contribute equal capital.
 Every partner must take part in management of the partnership.
 No salary is payable to any partner.
  No interest will be allowed on capital or drawings
 Losses and profit will be shared equally
 Every partner has a right to inspect the books of accounts
 No partner should carry a competing business
 No admission of a new partner without the consent of all the partners
 Anyone partner who incurs loss on behalf of the partnership must be compensated.
Types of partnership
a. Ordinary/ general/unlimited partnership
This is a partnership in which all members have unlimited liability i.e. they are answerable for all
debts of the firm to the extent of selling their personal property.
b. Limited Partnership
This is a partnership in which the liability of the members is restricted to the amount of capital
they have put into the business. Limited partners do not participate in the management of the
firm. Therefore there must be at least one partner whose liability is unlimited.
c. Temporary Partnership
This is a partnership formed for an agreed period of time. Its ripe period is known when it is
being formed e.g. Two constructors may come into partnership to undertake a certain project and
after its completion, they dissolve the partnership.
d. Permanent Partnership
It’s meant to continue indefinitely and therefore its end is not known. e.g. the two constructors
mentioned above may continue taking one project after another indefinitely.
e. Trading partnership
This is a partnership whose major activity is production, purchasing and selling of goods.
f. Non –trading partnership
It is a partnership, whose major activity is to provide services to the public e.g. medical,
advocacy and accounting services.

Types of partners
i. Active partner
He is involved in daily management/operation of the partnership on behalf of the other partners.
He is normally paid a salary for assuming this role. However it should be noted that the other
partners are equally liable for the actions of the active partner.
ii. Sleeping / passive/ dormant/ silent partner
This partner is not involved in the day to day affairs of the business. He invests capital into the
business but his share of profits will generally be lower than that of the active partner.
iii. Real partner
He is real partner in the sense that he contributes capital, shares in losses and debts of the
business. He was also present when the partnership was coming to being.
iv. Quasi/ nominal partner
He is a half partner in the sense that he does not contribute capital or share in the losses and debts
of the firm but shares in the profits. He only allows the business to use his name as a partner. He
is normally a celebrity or a famous person who has been admitted into the partnership to
influence customers or for prestige.
v. Major partner
This is a partner who has attained the age of the majority (18years); this partner shares in the
losses and liabilities of the partnership
vi. Minor partner
This is a partner who has not attained the age of the majority and is admitted with the consent of
all existing partners. He does not share in the losses but shares profits. The liability of the minor
is limited only to the amount of capital contributed to the business since any liabilities arising
may not be part of his decision making. The minor partners can act on behalf the partnership and
such acts shall be binding on the other partners. When the minor partner attains the age of
majority he/she has up to six months to decide whether or not to continue with the partnership. If
he/she decides to stay, he has full responsibilities and rights of a major partner.

Dissolution of partnership
This is bringing a partnership to an end. A partnership may be dissolved in the following
circumstances:
a) Dissolution by the partners
i) When the fixed time if any are stated in the articles of the partnership expires.
ii) If the partnership was specifically entered into for a given venture, transactions or
undertakings the completion of which or achievement will automatically dissolve the
partnership.
iii) If the partnership is a partnership at will, it can be dissolved by any partner giving notice of
his intention to dissolve the partnership.
iv) By mutual consent of all partners
v) By bankruptcy or death of one the partners.

b) Dissolution by law
i) Withdrawal, bankruptcy or death of general partner.
ii) If any events occur which will make the partnership business illegal, the partnership will stand
dissolved irrespective of the content of the partnership deed.

c) Dissolution by the court order

A court may order a partnership to be dissolved if a partner applies for the court order. It may be
based on the following circumstances.
i) By one partner’s shares in the partnership being charged or attached by a court order
for private debts.
ii) If any one of the general partners becomes insane.
iii) If any of one partner becomes permanently incapacitated thus incapable of
performing his/her duties.
iv) Where a partner has acted in a manner which is pre-judicial to the carrying out firm’s
business and may bring the name of the business to its disable.
v) Where a partner was found guilty of breaching the partnership contract.
vi) Where the firm has been operating in losses.
vii) Internal disagreements
viii) In case of serious fraud

Advantages disadvantages of partnerships

Advantages
a) It is easy to form- there are few legal formalities required as compared to larger companies
b) There is freedom to undertake any business agreed upon
c) More capital can be raised from the members contribution making it easy to expand
d) There is specialization with each partner taking part in the areas they are best suited ie the
partnership enjoys a variety of skills and talents since people have different methods of
knowledge ideas and experience leading to efficiency.
e) There is even distribution of work which reduces the work load and fatigue for each partner
f) Losses and liabilities are shared among the partners
g) Better decision making as compared to sole proprietorship arising from consultation
h) Easy to dissolve without legal formalities

Disadvantages
a) Have unlimited liability except for limited partnership and limited partners ie the general
partners are liable for the debts of the firm and may loose their personal property to meet the
debts of the partnership
b) Partnership has a limited life- death, retirement, bankruptcy of a partner may suddenly cause
dissolving of the partnership.
c) Continued disagreement may lead to dissolution of the partnership
d) Has limited access to capital since partnership is not a separate entity like joint stock
companies obtaining loans from banks may be difficult.
e) Less freedom of action compared to sole traders as all the partners must agree before a
decision is made.
f) Agency problem i.e. any agreement entered by one partner on behalf of the other become
binding on all partners
g) A hardworking partners efforts are enjoyed by other partners
h) Slow decision making as all the partners must agree on issues.
i) Overreliance on one partner may affect the partnership adversely incase the partner retires,

dies or withdraws.
LIMITED COMPANIES (JOINT STOCK COMPANIES)
1.4.1 Overview of companies
A company is an association of persons who contribute capital by buying shares in order to carry
out business together with a view of making profit. A limited company is formed under the
companies Act and is a legal entity, separate and distinct from its members. A company is
formed to exist indefinitely until it is liquidated/ wound up or dissolved. It is an association
recognized by the law as having an existence that is separate and distinct from its owners. It has
the following rights and obligations as a natural person:
It can own and dispose property
It can enter into contract in its own name
It can hire and fire employees
It can sue and be sued
It can form agencies
It can disseminate information

1.4.2 Features of a limited company

1. It has a legal personality and has rights and obligation as a natural person – it is an artificial
person and has the right to own property, sue and be sued in a court of law, enter into contracts in
its own name etc.
2. It has a legal entity, separate and distinct from its owners/members
3. Its capital is divided into transferable shares
4. It has a perpetual succession- continues indefinitely until it is liquidated- the company is not
affected by the death, retirement, bankruptcy of a shareholder.
5. It is managed by a board of directors
6. Members cannot bind a company by their acts
7. It has limited liability

1.4.3 Management of limited companies

The management of a company is in the hands of the board of directors. The initial directors stay
in the office till the first meeting (AGM) is held at which new directors are elected. The size of
the board is usually determined by the size of the company. Board of directors is charged with
the responsibility of formulating and overseeing the implementation of company policies. The
board is normally supported by a team of professionals employed to be responsible for the day to
day management of various departments. For a public limited company, the directors are
required by law to present the company’s financial statement at the AGM meetings and file with
the registrar of companies.

1.4.4 Limited liability concept

This concept arises due to the fact that liability of members is restricted to the amounts of capital
contributed by members and members cannot be called upon to contribute any more money from
their personal resources to meet the company’s debts. A company can be limited by shares or
guarantee.
Companies limited by guarantee
These are companies in which each member guarantees to contribute a fixed sum of money
towards the liabilities of the company as long as he/she remains a member. In other words the
members’ liability is limited by the amount the members have agreed to contribute towards the
payment of debts. The members can only be called upon to pay for companies debts up to the
amount guaranteed by them.

Companies limited by shares

The liability of each shareholder is restricted to the value of the shares held by him/her i.e.
members can only be called upon to pay for company’s debts up to the capital they have
contributed.

1.4.5 Formation of limited company

In Kenya, limited companies are formed according to the company’s Act of 1962(chapter 486)
For a company to be formed there must be some founder member who come up with the idea of
forming the company. These founder members are referred to as promoters. Promoters oversee
the birth of a new company and they are in charge of all the requirements and operations until the
company is fully in operation. To form a private ltd company two promoters are required and a
public ltd company requires seven promoters.
The promoters are supposed to submit to the registrar of companies these documents:-
i) Memorandum of association
ii) Articles of association
iii) List of directors (names, addresses, occupations and statement of agreement to serve as
directors)
iv) Declaration that registration procedure has been duly complied with

Memorandum of Association
It is a document that gives information to the outside world about the company i.e. it governs the
relationship between the company and outsiders. It tells the outside world the objectives of the
company (what the company was formed to do) its powers, location, the capital it requires etc.

Contents of the Memorandum of Association

i) Name clause- this clause states the name of the company with the word limited as the last
word in the name. The word limited shows the public that the liability of members is limited by
shares or guarantee. A company can select any name as long as:
It is not prohibited by the law
Not similar to another
It has no immoral intention
It is not abusive especially to the government and presidency.

ii) Situation clause- it gives the location of the registered office of the company i.e.:
Where the company is situated i.e. city, street, building
Where the company’s letters can be delivered
Where the company can be summoned

iii) Objectives clause- it outlines the objectives of the company i.e. activities it is authorized to
engage in. A company can only carry out the objectives specified in the memorandum and
beyond such powers it is termed ultra-vires. The objective clause serves the following purpose:
Defines the limits of the company’s operations
Informs the shareholders the purpose their money is put to
Protects the subscriber from misuse of their money
Protects outsiders by informing them the limits of the company’s operations

iv) Liability clause-Shows the liability of the members indicating that they are limited. It is
meant to protect the outsiders who may enter into contracts with the company.

v) Capital clause-it shows the nominal authorized capital i.e. amount of capital which the
company is authorized to raise by sale of shares, the subdivision of this capital into units of
shares and the value of each share.

Articles of Association
Gives a guideline on how the internal affairs of the company should be run i.e. it outlines rules
and regulations that should guide the relationship between the company and its shareholders and
relationship between shareholders themselves.

Contents of Articles of Association

a) Types of shareholders e.g. ordinary or preference shares
b) Rights of shareholders e.g. voting rights
c) Procedure of Issuing and transferring of shares
d) Procedure of calling and conducting general meetings
e) Qualifications, duties, powers of directors
f) Provides guidelines on how officials should be elected eg chairpersons, directors and auditors
g) Guidelines on how books of accounts should be audited
h) Procedure of altering share capital

When the above required documents are presented to the registrar of companies and found
satisfactory a certificate of incorporation is issued. The certificate gives the company legal
existence and a separate legal entity. After acquiring a certificate of incorporation a private ltd
company can start doing business while a public ltd company must wait for a certificate of
trading before it is allowed to start business activities. The certificate of trading gives the
company power to commence its business activities. The company must also acquire a trading
license from the local authority in the area it is operating.

Differences between memorandum of association and articles of association

Memorandum of association Articles of association

It deals with relationship between company It deals with relationship between company
and outsiders and its members
 It must be prepared by all companies before it It is not mandatory before registration
is registered
It is a main document required for registration It is a subsidiary document

Can only be amended by law Can by be amended by special resolution by

the members
Contain specific number of clauses for Contains varied information depending on the
companies company

Types of limited companies

Companies can assume two forms:
1) Public limited companies
2) Private limited companies

1.4.6 Public limited company.

Public limited companies invite any member of the public to subscribe to their shares i.e. it
draws its members from the whole country. Its membership ranges from seven shareholders to
infinite.

1.4.6.1 Features of public limited companies

i) It has a minimum of 7 shareholders and no maximum limit
ii) The liability of the members is limited
iii) It is allowed to subscribe its shares to members of the public i.e. can sell shares through the
stock exchange market.
iv) It must have an authorized share capital authorized by the government
v) Shares are freely transferable from one shareholder to another
vi) It is managed by a board of directors- minimum of three directors
vii) It cannot start its business activities after receiving a certificate of incorporation but has to
wait for a certificate of trading.
viii) It is required by the law to publish its final books of accounts in the news paper

1.4.7 Private limited company

Private limited companies draw their members from a selected group of people e.g. family
members, group of friends, work colleagues etc. its membership ranges between 2-50
shareholders.

1.4.7.1 Features of private limited companies

i) It has a minimum of 2 members and a maximum of 50 members
ii) It is not allowed to call upon members of the public to subscribe to its shares i.e. it cannot sell
shares through the stock exchange market. This is because its shares are sold privately to a
selected group of people
iii) Members cannot transfer shares freely without the approval of the board of directors
iv) It can be managed by one or two directors however a big private ltd company requires a
board of directors
v) It can start business immediately after receiving a certificate of incorporation. It does not have
to wait for a certificate of trading.
vi) Its final accounts are confidential i.e. it is not required by law to publish its accounts
vii) It’s not necessarily required to prepare the memorandum of association.
viii) The liability of the members is limited

1.4.8 Advantages and disadvantages of Limited Companies

Advantages of limited companies
1. They have access to large amount of capital raised by sale of shares
2. Companies have perpetual succession- enjoy continuity of business i.e. not affected by death,
withdrawal or bankruptcy of a member.
3. Shareholders have limited liability
4. Practice specialization because companies have strong financial base to employ specialists
5. Risk of loss is spread to all the members
6. They enjoy economies of scale i.e. benefits of large scale operation e.g. discounts for
purchasing in large quantities
7. They enjoy service of experts in different fields
8. They enjoy separate legal entity from the members who own them

Additional advantages for public limited companies

1) They have a wider access of sources of capital than private limited companies

2) Their books of accounts must be published and this safeguards shareholders against fraud by
management.
3) Their shares are freely transferable

Additional advantages for private limited companies

1) They can be formed more easily than public limited companies
2) Unlike public limited companies they can start their business operations immediately after
receiving a certificate of incorporation.
3) They are not necessarily required to prepare the memorandum and articles of association.
4) Their final accounts are confidential i.e. they are not required by law to publish their accounts

Disadvantages of Limited Companies

1. They require large amount of capital to establish
2. They are required to comply with complicated legal procedures
3. Slow decision making because all decision require approval of Board of directors
4. Shareholders do not participate in management of their own business.
5. It is difficult for shareholders to control the company as management is left in the hands of the
board of directors
6. Companies are subjected to high taxes by the government
7. There are chances of mismanagement of shareholders property by directors
8. They must have their accounts audited before presentation to the shareholders
9. They must hold shareholders annual general meetings

Additional disadvantages for public limited companies

1. Their operations are limited by the objectives clause in the memorandum of association
2. They are more costly to form than private limited companies
3. They are exposed to excess government control
4. Minority shareholders are neglected as they have little say in the affairs of the company
5. The accounts of the public company must be published; so there can be little secrecy or
privacy about its affairs
6. Sometimes a public limited company grows so big that it becomes difficult to manage

Additional disadvantages for private limited companies

1. They have limited access to a wider range of capital as compared to public limited companies
because they can’t invite members of the public to subscribe to their shares
2. Share transfer is restricted to members only
3. They cannot achieve major benefits of economies of scale as much as public ltd companies

1.4.9 Sources of capital for limited companies

1. From the public, through the sale of shares
2. Borrowing from commercial banks and other financial institutions
3. Overdrafts from banks
4. Government institutions e.g. KIE (Kenya Industrial Estate), ICDC (Industrial and
Commercial Development Corporation IDB (Industrial Development Bank) etc.
5. Getting Supplies inform of trade credits.
6. The business itself inform of retained profits
7. Acquiring property on hire purchase
8. Acquiring property on lease and mortgage
9. Rent revenue i.e. earnings from any investments
10. Profits ploughed back into the company

1.4.10 Dissolution of a Joint Stock Company

When a company has started it’s expected to continue with its operations to the future since it is
a form of business with perpetual succession. Termination of the life of a company may be
through;
1. Failure to commence business within one year of its formation – upon this it may be wound up
by a court order on application.
2. The membership falling below the required minimum and this dissolution may be decided by a
court order.
3. Accomplishment of the purpose or expiry of the period of operation.
4. If it fails to comply with statutory requirements of registration e.g. failure to file annual
financial statements to the registrar of companies or engaging in illegal activities.
5. A resolution by members to voluntarily wind up the company which may arise through;
a. where the company does not have a future on that line of business
 b. The members wish to sell it as a going concern in order to share profits.
c. Where one company is acquired by another and the members wish to discontinue it so
as to terminate its existence as a separate legal entity.
d. Through a merger with a larger company
e. Insolvency – the company is not able to meet its obligations.

1.4.11 Differences between public and private limited companies

Public limited companies Private limited companies

Have a minimum of 7 shareholders and no Have a minimum of 2 shareholders and a

maximum maximum of 50 shareholders

Shares are freely transferable Shares cannot be transferred freely without

the
consent of other members

Invite members of the public to subscribe to Cannot invite members of the public to
shares- can sell through the stock exchange subscribe to shares

Required by the law to publish annual Not required by the law to publish annual
accounts accounts
Cannot start operations after receiving
Can start business operations immediately
certificate of incorporation but must wait for
after
certificate of trading receiving certificate of incorporation
Must have authorized share capital as It’s not a requirement to have authorized
authorized by the government share
capital
Must always have a board of Directors Can operate with even one director
(minimum of three)

Must prepare memorandum of association It is not mandatory

1.4.12 Types of shares

A public limited company should prepare a prospectus to invite the members of the public to
subscribe to its shares. A prospectus is a document that gives the necessary information about the
company e.g. the past history and all the information contained in the memorandum of
association.
There are two major types of shares that can be issued by Joint stock companies:
1. Ordinary shares
2. Preference shares
Ordinary shares
All companies issue ordinary shares which are sometimes referred to as the risk capital of the
business. This is because the owner of the share receives a dividend on them only if there are
sufficient profits. If profits are too low or no profits are made the ordinary shareholders do not
receive dividend. In exchange for the risk the ordinary shareholders have the control of the
company in that they have one vote for each share when it comes to electing board of directors
who are responsible for the general policy of the company

Characteristics of ordinary shares

a) It is permanent in nature and can only be refunded in the event of liquidation/dissolution of the
company.
b) It earns dividends as a return to the investments.
c) The investors carry voting rights and usually each share is equal to one vote.
d) The ordinary shares are quoted at the stock exchange where they are sold and bought.
e) It carries the highest risks in the company because it gets its return after other types of shares
have got theirs and also in the event of liquidation it is paid last.
f) The dividends are not a legal obligation on the part of the company to pay.
g) Where the profits are good ordinary shareholders get the highest return because their
dividends are varied.
h) This type of finance grows with time and this growth is equity which basically is facilitated by
retention of earnings.

Advantages of Ordinary Share to Shareholders

1. Ordinary shares have a right to vote and their votes influence the company’s activities.
2. Ordinary shareholders can use their shares to secure loan.
3. Ordinary shares are easily transferable.
4. The owners of the ordinary shares earn dividends in perpetuity.
5. The ordinary shareholders benefit from the residual claim in the event of liquidation ie they
are entitled to all the remaining profits and properties of the company after all other types of
shares and creditors have been paid

Disadvantages of Ordinary Shares

1. Receives no dividend during low or non-profit years.
2. In case of liquidation an ordinary shareholder may lose everything.
3. The sale of more ordinary shares dilutes ownership of the existing shareholders.
4. The dividends of an ordinary shareholder are double taxed.

Preference shares
While ordinary shares provide an attractive investment for those who do not mind the risk of
getting no reward in low income years others find that preference shares offer a safer investment
because they earn fixed dividend whether the company makes profits or not.

Preference shares falls into several groups

1. Basic preference shares
Holders of which receive a fixed dividend out of profits of the company
2. Accumulative preference shares
A dividend missed in one year is carried forward to the next year
3. Non accumulative preference shares- A dividend missed in one year is not carried forward
to the next year i.e. it is foregone completely
4. Participating accumulative preference shares
Not only carry a fixed rate of dividend but also entitle their holders to a further share of surplus
profits together with ordinary shares.
5. Redeemable preference shares-these are shares that are bought back by the company after a
stated period of time.
6. Irredeemable preference shares - these are shares that are never bought back by the
company after a stated period of time. They keep on earning dividend as long as the company is
in operation.

NB: Most preference shareholders have no say in the control of the company as majority do not
offer permanent capital and have privileged position with respect to dividends payment.

1.4.13 Debentures
If a company does not raise enough capital by selling shares it can also issue debentures. A
debenture is a certificate that gives evidence that a company has borrowed money from the
person named on its face and undertakes to pay a fixed rate of interest for it. Debentures are
simply loans to the company on which a fixed rate of interest are paid even when preference or
ordinary shareholders do not receive anything. Unlike shares debenture holders do not share in
the ownership of the company.

Types of debentures
a. Secured debentures- They are secured i.e. some property is pledged against them ie the
company must secure them with some properties. That is to say if the company fails to pay them,
the agreed property must be sold and proceeds used to repay the debentures holders
b. Naked/unsecured debentures- They have no security pledged against them.
c. Redeemable debentures- they are redeemed back by the company after a specified period
where holders surrender them back and they are paid principle amount plus interest accrued.
d. Irredeemable debentures- they are never bought back unless the company dissolves.

Advantages of debentures
a. The holders do not have management control of the company
b. They do not share residual profits or assets
c. They are cheaper than to float shares
d. They can also be issued by private ltd companies

Disadvantages of debentures
a. Interest payable is mandatory whether profits are made or not
b. Most of them require security in form of assets
c. Failure to pay interest can make creditors put the company into liquidation
d. The company has to put the money aside to redeem the debentures when due
e. Debenture just like any other Creditors usually give many restrictions
Differences between shares and debentures
Shares Debentures

Share is part of capital for the company A debenture is a loan to the company
A share create an owner of the company A debenture creates a creditor of the
company
A share receives dividend as a return A debenture receives interest as a return
Most Shares are paid dividend only Debenture holders are paid interest
when the company makes profit whether the company makes profit or not

Shareholders have voting rights Debenture holders do not have voting

rights