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BUSINESS STRUCTURE ANALYSIS FOR A DRUG REGULATORY AFFAIRS CONSULTANCY COMPANY

SOLE TRADER VS PRIVATE LIMITED COMPANY

There are various model structures that may be considered when setting up a new business. The four main vehicles for small start-up companies include: sole trader, partnership, limited liability company and limited liability partnership. It is important to choose the right legal structure to suit one’s company so as to ensure the successful growth of the business. Restructuring of a business is possible and in certain cases necessary due to growth. Nevertheless, it would be best to take all options into careful consideration at an early stage so as to avoid unnecessary upheaval and costs in the future. This assignment shall seek to compare and critically analyze the various business and managerial aspects of a sole trader and a private limited liability company.

It is essential that a director of any small business understands the economic factors that are responsible for increasing aggregate demand so that he/she may plan for growth and future opportunities. There are a number of direct and indirect factors which may affect this demand including wealth, inflation, expectations, interest, taxes and government expenditures.

There has been a dramatic change in inflation during the past few years, starting from the global financial crisis in 2008. The change in inflation for the UK is graphically represented in Figure 1. The global recession led to a decrease in inflation in 2009. Following this drastic drop, a gradual increase in inflation was observed peaking in 2011 at 5.2% (CPI) and decreasing once again in 2012 and 2013 due to weak demand.

Figure 1: Inflation 2000-2013. Percentage change over 12 months (ONS 2013a, quoted in BBC 2013)

According to the Office for National Statistics (ONS 2013b, 1) the inflation rate, measured by the consumer prices index (CPI), is currently at 2.1% - the closest it has been to the Bank of England’s (BoE) target of 2% in months. The pressure for policymakers to raise interest rates has therefore been reduced. During the last meeting held in September, the Monetary Policy Committee (MPC) of the BoE kept the interest rate at 0.5% (BBC 2013a). This rate has not changed since March 2009. Furthermore, Mark Carney, governor of BoE, stated that the bank will consider maintaining the rate as such until unemployment has fallen below 7% (BBC 2013a). The interest rates are therefore not expected to vary for the next few years. However, a recent study carried out by Markit has shown that activity in the service industries has risen at a fast rate this past year both in the UK and globally (BBC 2013a, Markit 2013, 1). As depicted in Figure 2, activity in companies providing business support services such as consultancy has risen significantly.

Figure 2: Global Industrials PMI: Detailed Sectors (Markit 2013, 1)

As a result, James Knightley from ING suggested that the interest rates in the UK may subsequently increase sooner than planned (BBC 2013a). Moreover, wage growth is still lagging behind the rate of inflation during the past four years (ONS 2012, 11). Consequently, consumers cannot afford to buy as much with the current income, leading to a further reduction in purchasing power.

The change in inflation and interests rates will have an effect on both the consumer as well as the start-up business regardless of the business structure. At entry, the two business vehicles will be affected in a similar manner as both structures will be dependent on some form of borrowing or asset-based lending. With high inflation and interest rates, consumers will have less money at hand to purchase medicines. This will also negatively affect the percentage investment that is put into research and development of new drugs thus resulting in a lower demand for Regulatory Affairs Consultancy. The increase in cost of borrowing and the need to reduce price levels to maintain a competitive streak will result in lower confidence levels for start-up and growth of small businesses such as the company being discussed.

A business director must therefore keep a close eye on such trends to ensure the company makes the right strategy shift. In a rising-rate environment, the company will have to cut costs and forecast the robustness of the firm. The directors should strive to keep borrowings and cash on the balance sheet to a minimum so that in high-rate environments, the company will be able to outflank rivals. Conversely, if the rate of inflation and interest is to remain low as originally forecasted, then the firm must ensure that it has the right capacity and work force to deal with the demand and to provide an efficient service.

In May 2012, the European Commission concluded that the UK was “experiencing macroeconomic imbalances” (European Union 2013, 15) particularly in regards to external competitiveness. A closer look at the pharmaceutical industry shows that this market is expected to grow in the coming years (IMARC Group 2013). However the developed markets, namely the US, UK and EU are now facing increased levels of competition as new pharmaceutical economies such as India, Brazil and China emerge (ABPI 2013; EFPIA 2013, 4; IMARC Group 2013). There has been a gradual shift of research-based activity from the EU to these markets. This may negatively impact the Regulatory Affairs Consultancy firm, both as a sole trader and as a limited company, since the business will initially be targeting UK research and development companies seeking to launch their products nationally.

Apart from the economic factors, a potential business owner must consider the merits of the different business vehicles before registration of the company. As the business vehicle title suggests, all official documentation of a sole trader shall contain the name of the ‘trader’ or business owner. This implies that the assets/liabilities etc of the trader and the business are indistinguishable. Such a business structure would involve fewer legal responsibilities and tax payments. Any profits obtained are taxed by the HM Revenue and Customs as income. The business owner would effectively be self-employed and the business finances are treated as such. This vehicle may seem ideal during start-up of a business since certain costs such as business travel and some premises costs may be tax-deductible (Startups 2013). Having said that, once the business starts to grow, tax rates for a sole trader will increase considerably from 20% (basic rate) to 40% and 45% tax rate is applied once profits top £32,011 and £150,000 respectively in 2013-2014 (Crown 2013a). Moreover, should the business fail, any debts are paid off using the owner’s personal assets. Fortunately, since setting up of a Regulatory Affairs Consultancy would not incur extensive start-up costs, the risk of financial liability is quite low and may therefore be outweighed.

Although staff may be employed in a sole trader business, in most cases, especially in the service sectors, the business is operated by a one man/woman band. This business vehicle is ideal for Regulatory Affairs Consultancy as the company may start off at anytime without having to search for potential partners and deal with additional bureaucratic procedures. Furthermore, any decisions taken are instant as no consultation with other board members is required.

Alternatively, owners of a potentially fast-growing business may decide to start-up as a limited company. The main reasons for this would be to take advantage of the limited liability status as well as the trust and credibility which is implicated by the word ‘Limited’ in the company name as this creates the impression of a larger and sound organisation. A limited company may start operating once it has been registered with Company House. Such a business vehicle will have both directors as well as shareholders. In the case of a private limited company, these shareholders can be partners in the business and cannot be offered to the general public at large. The appointment of a company secretary is not a legal requirement; however a number of companies still opt to do so as the secretary may take up some of the administrative responsibilities such as preparing and submitting the business accounts to Companies House. As opposed to a sole trader, the company is considered as a separate entity to the business owners. Therefore the business directors are somewhat protected from financial risk as they are not personally liable for the company’s debts on insolvency unless a personal guarantee has been made on a bank loan or the ‘trading’ continues after dissolution of the company. Table 1 provides a comparison of the varying responsibilities involved in the two business organisations.

Table 1: Comparison of the responsibilities involved between a Sole Trader and a Limited Liability Company (Bytestart Limited 2013; Crown n.d.a; Crown 2013a-c; Startups 2013)

The Consultancy firm will start off as a very flat structure for both a sole trader and a limited company since the workforce will be highly restricted and the number of divisions required would be minimal. This will later gradually transition to a more traditional hierarchical structure to accommodate expansion. Both a sole trader and a limited company will require a more structured management organisation once the company is established; however this will be particularly important for a limited company. Once the business branches out to other markets, the number of projects taken on by the firm will increase, resulting in the need to strengthen workforce as well as expertise to adequately meet client requests. Consequently, a business director may consider alternative management structures.

The best structure for this small but fast-growing firm would be the matrix model, depicted in Figure 3, which combines the advantages of functional and project structures resulting in a flexible system that uses small, self-managed teams. These teams will resolve work-related issues with the departmental manager and report other administrative matters to the corporate manager ensuring tight control of the business whilst retaining the flexibility and fluidity to adapt to market changes. Information sharing is horizontal within the team, across task boundaries. Employees will be encouraged to collaborate, share ideas and expertise as well as to empower themselves. Dividing the employees into teams to work on particular projects will allow for specialisation and strengthen in-depth knowledge. Due to the increase in workforce other departments, namely human resources, finance, marketing, legal and IT will also be introduced to ensure smooth running of the business.

Figure 3: Matrix Model for the Regulatory Affairs Consultancy Firm

One of the main concerns during start-up and growth of a business is finance. The Regulatory Affairs company will need office equipment and upon growth, a building to operate – hence the need for investment capital. It will also require adequate working capital to ensure smooth running of the company with sufficient funds to cover short-term and future expenses. Attracting capital is not easy especially at start-up for both a sole trader and limited company during the current economic climate. However, there are a number of sources of funding and financing options that may be considered. The legal structure adopted by the business will largely determine the financial options available. Although costs at start-up will be more or less comparable, a limited liability company will have higher running costs due to certain legal requirements such as audits. This vehicle however has a greater borrowing potential and may have more funding options. Financing options for a sole trader especially of a knowledge-based business may, at a pre-revenue stage, find it easier to access equity finance rather than debt finance. Eventually, a company generating turnover and making a profit will use a mix of financing sources (ICAEW 2012, 5).

Loans – Loans are credits that are borrowed and later repaid together with interest after a set period of time. These are usually provided by banks or other financial institutions. More often than not, banks require personal guarantees from the directors as well as security over the company’s assets (Companyregistry.eu 2013). A limited company will have a greater chance of being granted a loan due to the increased security this vehicle provides. A sole trader with exactly the same assets as a limited company will not be able to create a floating charge and therefore will not have this form of security for a bank loan. Moreover, as depicted in Figure 4, the post-crisis financial constraints have led to a decrease in access to bank loans as these institutions have become more cautious with regards to lending money to high-risk businesses.

Figure 4: Index of SME access to bank loans (European Commission 2013, 37)

A number of governmental finance policies have now been established with the aim to enhance credit to firms. In fact, in July 2012, the government together with the BoE introduced the Funding for Lending Scheme (FLS) which allows banks to borrow money at a lower cost thus increasing corporate lending (European Commission 2013, 42). This scheme has been extended to January 2015 (Bank of England n.d.). A limited company may also consider turning to the bond market to raise capital.

Some governmental schemes such as the Enterprise Finance Guarantee (EFG) offer loans to those businesses that were not granted a commercial loan. The British Business Bank is a governmental programme that supports the UK’s economic growth by creating new lending and investment schemes for small businesses wishing to expand or to unlock finance for start-up companies (British Business Bank 2013).

Loans may also be provided by friends and family. This in fact is usually the first financing option to be considered during the early stages of start-up for either business vehicle. Such an option provides flexibility in terms of repayment and low (if any) interest rates depending on the agreement made between both parties. A formal contract should be drawn up so as to reduce the risk of damaging personal relationships.

Overdraft – A second financing option that may be used to cover short-term working capital costs is an overdraft. This may be a cheaper option than a loan however it must be repaid, together with interest, on demand. Although it is relatively accessible to both business vehicles, it is easier to obtain when trading performance is positive.

Grants – There are a range of grants under the Government Solutions for Business Scheme. These grants need not be repaid and will not have a negative effect on cashflow. However the requirements for eligibility may be quite strict. Businesses looking to expand a few years down the line may also consider applying for grants such as the Growing Places Fund and the Regional Growth Fund.

Selling of shares – The selling of shares may be a financing option on expansion of the company. This will only be an option for the limited company. However a sole trader may choose to change the business structure to a limited company once the business has been established. Shares of a private limited company may not be sold to the public at large; however friends and family may have the opportunity to invest in the firm.

Asset Based Lending – Both business vehicles may benefit from leasing and asset financing. This form of funding has become quite popular amongst small businesses over the past few years (Financial Times 2013). This type of funding will save the company from having to fork out the full initial costs outright and involves a lower risk than a loan.

Sales factoring/Invoice financing – This financing option may be considered once the firm has starting ‘trading’. Third parties may agree to ‘buy’ the clients’ unpaid invoices (usually around 85%) via factoring or invoice financing. The latter will require a good credit control system so as to ensure all debts are repaid. Therefore such an option may be more suitable upon growth of the firm as this may involve extra costs in terms of time and human resources.

Equity Funding – Another option for a business is to seek out private investors interested in funding the business. Private investors, also known as business angels offer seed capital or venture capital. In certain cases investors may also provide networking opportunities, experience and guidance. Although private investors tend to take more risks on new start-up companies than banks, a limited company is more likely to receive funding from such investors. There are also a number of companies, known as venture capitalists or private equity companies that invest large sums of money in small businesses that they believe will grow quickly. It is important to note however that any outside investors will have a joint ownership together with the business directors. Consequently, they will have a say in the business decisions and are entitled to dividends. Venture capitalist/private equity funding is better-suited for a fast-growing limited company as it appears to contain lower risks and is therefore more likely to secure investors. In fact, according to the European Commission (2013, 43) such lending remains largely restricted to bigger companies and will therefore better suited to the Regulatory Affairs Consultancy upon growth of the firm.

A governmental scheme known as the Seed Enterprise Investment (SEIS) is ideal to attract investors to invest in early-stage companies as it offers a range of tax-reliefs for individual investors (Crown 2013e). There are two other similar schemes, namely the Venture Capital Trust (VCT) and the Enterprise Investment Scheme that are also designed to help small companies raise finance by offering tax relief to those who invest in the new shares of the small high-risk enterprises (Mullen 2012, 11).

Crowdfunding and Peer-to-peer funding – These are two innovative options as a result of digital revolution, whereby the public or potential lenders pool in their resources to invest in a business idea. This usually takes place via the internet.

As previously discussed, details of share ownerships and financial records of a limited liability company must be submitted to Companies House and are placed in the public file. This may be viewed as an inconvenience to some businesses however such information may make it easier for a company to get credit once it is established (Companyregistry.eu 2013). Furthermore, although a sole trader need not publicly report the business financial records, such information should still be recorded for internal reference. Additionally, both business structure owners should regularly review and update management accounting records such as performance, costing and pricing, budgeting and forecasting so as to make informed decisions for the company, devise organisation strategy, business plans and performance management systems.

Any business must have the following two main elements for success: direction and focus i.e. short- and long-term goals and a plan to achieve them. This requires careful planning, strategising and management of resources to reach client and stakeholder expectations. The business planning process for both business structures is dynamic and should involve all employees to achieve a feeling of “our plan” as opposed to “the plan imposed on us”. This is possible since at start-up both companies will have a very small workforce. Table 2 describes the steps involved in strategic business planning using Ackoff’s Corporate Planning model.

Table 2: Ackoff’s Corporate Planning

There are a number of strategic factors that must be taken into consideration by any business owner when preparing a business plan. Figure 5 describes the strategic vision and objectives of the Regulatory Affairs Consultancy firm.

Figure 5: Strategic Vision and Objectives to be considered in the Regulatory Affairs Consultancy Firm

Whilst preparing the business plan, it is essential that the financial impact of the strategy being proposed is taken into account such as the cost of training, salaries etc. Apart from the external funding described above, financial requirements may be satisfied using the return on investment. Careful consideration of fixed and variable costs is important when pricing. Although both business structures may cater for growth, a limited company has a greater chance of expanding in the market as it will have a greater access to various financial options. Growth for a sole trader may be restricted and it may be advisable to consider transitioning to an incorporation should the director wish to take the business to another level.

Marketing is imperative for any business vehicle, particularly at start-up but also once the company is well-established so as to retain clients and keep them informed about new services being offered. The firm must have clear marketing objectives and a route to achieve the marketing goals. “Marketing can thus be seen as the process of developing and implementing a strategy to plan and coordinate ways of identifying, anticipating and satisfying consumer demands, in such a way as to make profits” (Business Case Studies LLP 2014). Apart from making a profit, a business should aim to establish its market share by anticipating trends and monitoring rival companies.

Marketing for a Regulatory Affairs Consultancy firm is based on B2B i.e. business to business. The firm will therefore have few clients; however the buyer-seller relationship will be close and after-sales is extremely important. The volume of sales will also be low albeit the unit price for each service high. A consultancy company need not invest much in media advertising unless it is in trade journals and directories; however these tend to be very expensive (Simply Business n.d., 24). Most of the promotion takes place via networking and personal selling (interactive marketing) to key companies. This will incur costs as marketing and sales personnel will be required to visit pharmaceutical companies, attend seminars, meetings and events to promote the business. Travelling costs, company car and fuel must also be included in the profit and loss accounts. Due to the greater financial options available, a limited company will have a larger marketing budget. It will also have a larger marketing power due to the increased credibility that comes with an incorporation.

The client is valuable to the business as it is through the client that profit may be maximized. Therefore for a service industry that is intangible, variable, perishable and inseparable, the marketing strategy should begin with the Customer Perspective (4C) depicted in Figure 6. The customer perspective is essential to ensure loyalty, retention, acquisition and profitability. Communication is key and buyer-seller relationships are imperative. In fact, a lot of importance is now given to Customer Relationship Management (Figure 6). Directors of a limited company must ensure a good CRM system is set up more so than for a sole trader as a limited company will most likely have a larger client database and possibly a larger workforce. Establishing a good feedback system is essential but will also target costs. Marketing analysis may then focus on the enterprise perspective i.e. 7Ps of the marketing mix i.e. product, price, place, promotion, people, process and physical evidence.

The process of developing a marketing strategy is similar to the business planning process and must also take into account the micro- and macro-economic environment. This may be done by analyzing the opportunities and threats of the firm such as the threat of new entrants and substitutes. The bargaining power of buyers is also important as is largely affected by inflation and the economy as discussed above.

When formulating a market strategy, it is imperative that a business owner considers the cost-effective and competitive advantages offered by IT. Due to the digital revolution, a lot of marketing is carried out online. The Regulatory Affairs Consultancy will make use of the internet and other computer networking systems to provide a major part of its service on the World Wide Web. E-commerce may help to improve and speed up the transaction process resulting in increased customer satisfaction. It also reduces management expenditure and provides a strategy for market differentiation. The website must have good visibility and must be designed around customer journeys so as to increase rankings for search engine optimisation. Although a number of Regulatory Agencies already provide their services online, one may consider taking it a further step to set up a time-saver App for providing regulatory advice – thus introducing new opportunities for the company. However, a secure system will be required due to the sensitive nature of the data being shared. Setting up of such a system will most certainly incur costs but may be considered for future plans of firm, particularly for a limited company.

Cloud computing can enable businesses to run software online without actually having to install or own the software. Business owners and employees may therefore work from home and may access data outside the office. This is ideal for business meetings and presentations and provides quick access of client information. The cloud service also offers security as it reduces the risk of data loss and improves speed of disaster recovery.

One of the 7Ps of the Marketing mix model is ‘People’ i.e. the employees. Due to the inseparable nature of the service employees may have a profound positive or negative effect on customer satisfaction. Since this service-based firm largely depends on retaining high-value customers, it is essential that all employees are trained, empowered and incentivised. Using a number of motivation theories such as Hertzberg’s Two-factor Theory of Hygiene and Motivator Factors and Maslow’s Hierarchy of Needs and personal experience, one may draw up a diagram such as that in Figure 7 which lists a number of motivational factors that will help retain and incentivise employees.

Figure 7: Possible Motivators for the Regulatory Affairs Consultancy firm

Many of the perks mentioned in Figure 7 incur costs and will not be feasible for a start-up company or a sole trader; albeit there are a number of tax-free benefits such as pension and child-care that may be included as part of a Salary Sacrifice Scheme. Other motivational factors such as good communication i.e. having an effective horizontal alignment and an open-door policy are feasible, if not more effective in small firms. Due to the nature of the work, employees may also work part-time, flexible hours and use VPN or Cloud to work from home – this is a major perk for potential female employees. Employment of female employees may also trigger tax-incentives.

When considering human resources, one must not forget the value of diversity. Apart from being illegal, discrimination is unprofessional. Managing diversity may gain a competitive advantage as insignificant measures such as sex, ethnic origin, religion and sexual orientation are put aside and focus is given to the quality of work.

Communication within a firm’s workforce is often enhanced using knowledge and information management systems. The latter helps to store and retrieve data such as client details efficiently. This system therefore supports operation management, information-sharing and continuous improvement (in the case of IPO systems) of the business. Knowledge management is different from information management in that it is not about storing data but rather enhancing skills and expertise. It ensures that knowledge-based assets such as those saved on electronic repositories (ex: manuals, SOPs) and those held by the employees (ex: problem-solving experiences) are used efficiently to improve the company’s behaviours, decision-making, services and consequently, performance (King n.d., 4-5). Such systems may include “points to remember” or “lessons learned” repositories and directories.

The systems described above, although efficient, involve extra costs for labour, system set-up, maintenance, audits and system updates. These systems are therefore more commonly used in a limited company. Although these are costly to set up and maintain, they are essential for a limited company to ensure organisational efficiency. Moreover such systems promote a proactive business attitude in the eyes of clients and shareholders alike.

Credit or record management systems are often used by companies to keep track of debts owed to the business. This is essential to the company as such debts may have a negative impact on cash flow and as a result will affect profits (Simply Business n.d.). Accounting and CRM software systems are also more likely to be of use to a limited company where finance issues are more complex and the client-base is potentially larger than those of a sole trader, in which case manual input of data into an excel database may suffice.

As previously discussed, the business director of a limited liability company has more responsibilities set by the law as opposed to a sole trader. The process by which one may set up a limited company is regulated by the Companies Act 2006 (including 2013 amendments to Part 25 of the Act). The legal responsibilities of a director of a limited company include, but are not limited to two core principles (Crown 2011, 4-5; Crown 2013d):

· To act in the interest of the business and its members.

· To provide accountability and transparency of the company’s financial records (annual accounts and return) and updates thereof to both the shareholders as well as the public.

According to Companies Act (2006, 179), all accounting records must be kept for at least 3 years in a private limited company. These records must sufficiently describe the financial transactions and position of the company at any given time. Such documentation would include the balance sheet, profit and loss account, director’s and auditor’s report (Companies Act of 2006, 183). A ‘small’ company with a turnover of not more than £5.6 million and a balance sheet of not more than £2.8 million, may simply file a modified balance sheet and need not sign up for an audit.

However, there are certain legal regulations such as employment, tax, health and safety laws that may be applicable to both business vehicles once the company invests in a larger workforce. Some of the relevant Acts include the Health and Safety at Work Act 1974 , Management of Health and Safety at Work Regulations 1999, Trade Descriptions Act 1972, Supply of Goods and Services Act 1982 and the Data Protection Act 1998. For both business structures, it is essential that the company has adequate insurance cover for professional risks. Although this may be seen as an extra burden in terms of cost, this is essential especially during the early stages of start-up when business owners have a lot to lose. The Professional Indemnity Insurance (although not a legal requirement for a sole trader) is a commercial and personal safety investment. Two other forms of insurance that may be applicable to the firm are the Third Party Liability and the Employer’s Liability Insurance. A Limited Company is legally-bound to provide Employer’s Liability Insurance for any employee, including those that work on a part-time or temporary basis.

The decision as to which vehicle best suits the company would depend on the foreseen capabilities of the director and the level of confidence in the business’ potential success. Setting-up of a Regulatory Affairs Consultancy company has a relatively low capital involved as it needs little or no assistance and can be run from home without expensive capital equipment. However, growth of the business will most definitely incur more costs due to the need of increased human resources, skills and expertise, office space and equipment and more efficient operation, knowledge and information management systems. Consequently, one may consider starting off as a sole trader and eventually updating registration to a limited company once the firm is well established. In this way the company will have more financing options available and may expand services to other markets.

REFERENCES

ABPI. 2013. “Global Pharmaceutical Industry and Market”. ABPI Bringing Medicine to Life. Accessed