Cinnamon Roll Bakery: Partnership or Private Company?
Tharindu, Ishara and Nadeesha have operated 'Cinnamon Roll Bakery' for four years as an unregistered partnership, sharing profit equally. Monthly profit averages LKR 150,000 on sales of LKR 1,800,000, and they sell from one rented outlet. To rent a second outlet and buy a deck oven they need LKR 6,000,000 over three years. Their bank has offered a term loan, but only if the borrower is a body corporate able to provide audited financial statements and a registered name; otherwise the three must each sign personal guarantees and the loan limit is halved. Tharindu wants to stay as they are, arguing that registration means fees, annual returns and public disclosure. Ishara has read about a large food-safety compensation claim against a bakery in another district and wants limited liability. Nadeesha has LKR 1,500,000 of her own to put in, but wants a share certificate as written evidence of what she owns. The three also disagree about whether a fourth investor should be admitted later.
1. Compare the existing partnership with a private limited company on liability, ability to raise capital, continuity and compliance, and recommend a form with reasons.
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Liability. In an unregistered partnership the partners are personally liable for business debts without limit. On a LKR 6,000,000 loan, each partner's home and savings stand behind the whole debt, and a food-safety claim could fall on them personally. A private limited company is a separate legal person; shareholders lose only the unpaid amount on their shares.
Capital. A partnership is limited to the partners' own money and borrowing backed by personal guarantees. A company can issue shares, so Nadeesha's LKR 1,500,000 can be brought in as share capital with a certificate as evidence, and further shares can be issued to a fourth investor without redrafting a partnership deed.
Continuity. A partnership dissolves on the death or withdrawal of a partner; a company continues to exist regardless of changes in membership - valuable for a bank lending over three years.
Compliance. A company must register with the Registrar of Companies, file annual returns, keep statutory records and have accounts audited; the partnership need not. This is a real cost, but it is also exactly what the bank demands.
Recommendation: incorporate as a private limited company. The bank's condition, the need for limited liability given food-safety risk, and Nadeesha's wish for evidence of ownership all point the same way. The extra compliance is a price worth paying for access to the full loan and protection of personal assets.
2. Explain one disadvantage of your recommended form to each of the three partners, and suggest one safeguard for each.
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Tharindu (fears cost and disclosure). A company must file accounts and returns and pay registration and audit costs, and its accounts can be inspected. The bakery's profit figures become visible to competitors and to staff. Safeguard: keep the company small - a private company can keep its financial statements restricted to members and the Registrar - and budget the compliance cost as a fixed line in the cash forecast before deciding, so it is not a surprise.
Ishara (wants limited liability but may be asked to guarantee). Limited liability is easily undone if the bank requires directors' personal guarantees on the loan, and a director can also be personally liable for trading while insolvent or for breaches of food-safety law. Safeguard: negotiate the loan on the company's assets and stock rather than guarantees, and take out product liability insurance.
Nadeesha (bringing LKR 1,500,000). Her 25% (if shares are split 25:37.5:37.5 or equal thirds) may give her a certificate but no real control; the other two can outvote her, and her money can be locked in because shares in a private company are hard to sell. Safeguard: a shareholders' agreement setting out reserved matters, a fair valuation method for any buy-out and a dividend policy, plus equal voting shares if equal influence is intended.