Topic 2: Forms of Business

Organization

Forms of Business Organization

A business can be organized in one of several ways, and the form its owners choose will affect the company's and owners' legal liability and income tax treatment

Business Organizations: The Private Sector

Sole traders Partnerships Private limited companies Public limited companies Co-operatives Close corporations Joint ventures Franchises

Business Organizations: The Public Sector

Public corporations

Municipal enterprises

Private sector organizations

Afa runs a grocery shop in the local market. She buys

goods from the wholesale market and sells it to the customers as per

their requirement. By doing so she earns some profit. She had started

her business two years ago by investing MVR. 50,000 which she had

borrowed from her friend Ahsan. Today, she is running her business

successfully, earning a good profit, and has been able to pay back

the borrowed money. She has also employed two persons to help her

in the shop. Afa says, she is the owner of a sole proprietor concern.

Sole Proprietorship Definition

J.L. Hanson: ‚A type of business unit where one person is solely responsible

for providing the capital and bearing the risk of the enterprise, and for the

management of the business.

‛Thus, ‘Sole Proprietorship’ from of business organization refers to

a business enterprise exclusively owned, managed and controlled

by a single person with all authority, responsibility and risk.

Sole Proprietorship

The term ‘sole’ means single and ‘proprietorship’ means ‘ownership’. So, only one person is the owner of the business organization.

The most common form of business organization.

Owned and operated by one person

Very few legal requirements for setting it up.

Afa is happy in running her business in sole proprietorship form because she enjoys many benefits in doing this business. At the same time, she also comes across many difficulties. Would you like to know the merits and limitations of this form of business organisation? Let us discuss.

Sole Proprietorship: Advantages

Ease of Startup

Few legal requirements in setting up the business.

No co-owners to consult

Least expensive to start

Pride of Ownership

Flexibility

Owner has complete control over the business.

Close contact with customers.

Incentive to work hard ” do not have to share profits.

Secrecy of business matters.

Sole Proprietorship: Disadvantages

Limited Management Expertise - No shared ideas / decision making

Unlimited liability ” business not a separate legal entity, therefore owner is fully responsible for the debts of the business.

Limited access to capital ” hard to grow

Limited skills

Hard to take leave Limited Life ” Business ends when owner leaves the business Limited Access to Credit Difficulty in Hiring Employees

A textile factory is going to be started in the nearby area where Afa is carrying on her business. As a businessman, she is now in a jubilant mood. She is thinking that once the textile factory is set up, she will get more customers; the sales will increase and she will earn more profit. But, for all these, she will have to expand her business, and for this she needs more money.

The major problem is how to arrange the additional funds. She has the option of getting loans from the banks. But the fear of loss comes to her mind again and again. She does not want to take that risk. Another option is that she may join hands with some other person. By doing so, more resources can be raised, work can be shared, and business can be run in a better way. The risk of loss will also be shared. But this involves a new form of business organization known as Partnership. Afa has to gain clarity on the exact nature of this form of business organization, its pros and cons before she goes in for it.

Partnerships ‘Partnership’ is an association of two or more persons

who pool their financial and managerial resources and agree to carry on a business, and share its profit. The persons who form a partnership are individually known as partners and collectively a firm or partnership firm.

Partnerships

Group of 2 ” 20 people.

Each partner contributes capital.

Each partner takes part in the running of the business.

Each partner gets a share of the profits.

A Deed of Partnership / Partnership Agreement sets out the rights and responsibilities of the partners.

Types of Partnership

In a general partnership, all partners are personally liable for business debts,

any partner can be held totally responsible for the business and any partner can

make decisions that affect the whole business.

In a limited partnership, one partner is responsible for decision-making and

can be held personally liable for business debts. The other partner merely

invests in the business. Although the general structure of limited partnerships

can vary, each individual is liable only to the extent of their invested capital.

Types of Partnership.

Limited Liability Partnership are most commonly used by

professionals such as doctors and lawyers. The LLP structure protects

each partner's personal assets and each partner from debts or liability

incurred by the other partners. Different states have varying

regulations regarding these establishments of which business owners

must take note.

Partnership Agreements

Partnership agreements usually include:

The amount of capital invested by partners;

The tasks to be undertaken by each partner;

How profits are to be shared;

The lifespan of the partnership;

Arrangements for absences;

Arrangements for retirement and new partners being admitted.

Partnership: Advantages

More capital (than sole trader).

Responsibilities can be shared.

Losses are shared.

Easier to take leave.

Increased skills.

Greater Access to Capital

More Management Expertise

Partnership: Disadvantages

Unlimited liability

limited life ” if one partner dies, the partnership ends.

Decision-making can be difficult when there are disagreements.

One incompetent / dishonest partner could cause other partners to suffer.

Limited to capital of 20 people.

Private Limited Company (Ltd)

Separate legal entity from owners.

Shareholders are the owners ” they buy shares in the company.

Shares sold to a small group of people ” not through the stock exchange.

The shareholders appoint the board of directors to run the company.

Private Limited Company: Advantages

Shares can be sold to a large number of people.

Limited liability ” shareholders are not personally responsible for the debts of the business.

The main shareholders can keep relative control of the company.

Private Limited Company: Disadvantages

Significant legal requirements when setting up. Shares cannot be sold / transferred without the

agreement of other shareholders. Accounts are much less private than sole trader /

partnership. Cannot sell shares on stock exchange ” limits

expansion.

Public Limited Company (PLC)

Suitable for very large businesses.

Owned by private individuals ” don’t mistakenly think it is government owned.

Shares sold on the stock exchange.

Public Limited Company: Advantages

Limited liability to shareholders.

Continuity should a shareholder die.

Opportunity to raise very large sums of capital.

No restrictions on the buying, selling and transfer of shares.

Usually has a high status

Public Limited Company: Disadvantages

Complicated and time consuming legal formalities in setting up.

More regulations and controls.

Is costly to sell shares to the public.

Shareholders have little control over the running of the company.

Co-operatives Groups of people who agree to work

together and pool their resources.

All members have one vote.

All members help in running the business

Profits are shared equally among members.

Types: producer co-ops, retail co-ops, worker co-ops.

Close Corporations

Similar to Private limited company but quicker to set up.

Fewer rules and regulations.

Limited to maximum of 10 people.

Members are also managers

Separate legal entities ” limited liability and continuity.

Joint Ventures

Two or more businesses agree to start a new project together.

Common in the research and development of new products.

Spread costs and reduce risks.

Can lead to disagreements and disputes over policy and management of the venture.

Franchising The franchisor licenses the rights to its name, operating procedure, designs, and business expertise to another business called the franchisee. A franchise agreement can provide the franchisee with

“ a ready made, fully operational business “ brand recognition that is appealing to consumers

Examples: The Body Shop, McDonalds.

Franchising

Requirements before a franchise is awarded may include

“ paying the franchise fee “ agreeing to pay a monthly percentage fee as

well as any national or local advertising costs “ purchasing all supplies centrally from the

franchiser “ participating in franchiser standards training

Franchising: Advantages to Franchisor

Expansion is paid for by franchisee.

Expansion is fast and effective.

Franchisor can make large profits via franchisees.

Franchisor does not have management problems of the individual retail stores.

Franchising: Advantages to Franchisee

Franchisees buy a business with a good reputation All supplies come from a single source ” the franchisor. Many decisions have already been made for them. Banks more willing to loan money to franchises. Franchisors supply training and financial knowledge Franchisors usually provide packaging, advertising, and

equipment to the franchisee Reduced chance of failure.

Franchises can be expensive to buy: The requirement to pay the franchise fees and royalty to the franchisor

Franchisees may have to follow a lot of rules laid down by the franchisors

If a franchisor’s business fails, so will the franchisee’s business

The transfer of all goodwill built in the local market to the franchisor upon expiration or termination of the franchise contract.

Reduced corporate profit margin due to payment of royalties and levies

Franchising: Disadvantages to Franchisee

Franchising : Disadvantages to Franchisor

Considerable capital allocation is required to build the franchise infrastructure and pilot operation.

At the beginning of the franchise program there is a broader risk that the trade name can be spoiled by misfits until such time the franchisor is capable of selecting the right candidate for the business.

There is a risk that franchisees exercise undue pressure over the franchisor in order to implement new policies and procedures.

The franchisor has to disclose confidential information to franchisees and this may constitute a risk to the business.

Public sector organizations

Public Corporations

Wholly owned by the state or central government.

Usually businesses that have been nationalized (sold by private individuals to the government).

The government appoints a Board of Directors to run the organization.

The Board of Directors runs the organization according to the objectives set by the government.

Public Corporations: Objectives Traditionally, objectives of public corporations included: To keep prices low so that everyone can afford the

service. To keep people in jobs. To offer a service to all areas of the country. This often led to public corporations making huge losses, which had to be subsidized out of taxes.

Public Corporations: Objectives

Today, the objectives have become:

To reduce costs (this may include reducing the number of workers).

To increase efficiency

To close loss-making services (even if this means some consumers are not provided the service).

This way of running public sector organizations is called corporatization.

Public Corporations: Advantages

Some industries are so important they need to be government owned e.g. electricity supply.

Ensures consumers are not taken advantage of by privately owned monopolists.

Government can nationalize important businesses that are failing to get them on their feet again.

Non-profit but important services can still be offered to consumers.

Public Corporations: Disadvantages

Lack of profit motive may cause inefficiency. Subsidies can further reduce efficiency. Usually no close competition ” lack of

motive to increase consumer choice and efficiency. Public corporations could be used for

political reasons e.g. creating jobs to win votes before elections.

Municipal Enterprises

Services offered by local government authorities. Some services are free to the user

and paid for out of taxes e.g. street lighting. Some services are charged for to

cover costs e.g. public swimming pools. These local services are increasingly

being privatized.

Key Terms

Sole trader

Unlimited liability

Partnership

Separate legal entity

Partnership Agreement

Private limited company (Ltd)

Public limited company (PLC)

Cooperative

Franchise

Public Corporation

Corporatisation

Nationalisation

Municipal enterprises