Notes - Forms of Business Organisations
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When someone plans to start or to expand a business, an important decision is to be taken regarding choice of the form of business organisation. By weighing merits and limitations of each type of organisation, one can determine most appropriate form for his business.
Various forms of business organisations are mentioned below
2.1 Sole Proprietorship
A business which is owned, managed and controlled by a single individual who is recipient of all profits and bearer of all risks is known as sole proprietorship. The term sole proprietorship defines itself evidently as sole means only and proprietor refers to owner. Thus, a sole proprietor is one and only owner of this type of business organisation. Sole proprietorship is a popular form of business organisation and the most suitable form for small businesses, especially in their initial years of experience.
2.1.1 Features of Sole Proprietorship
The main features of sole proprietorship are:
(i) Individual Ownership: There is single person ownership in sole proprietorship.
(ii) One man Control: The proprietor alone takes all the decisions.
(iii) No Separate Legal Entity: The law makes no distinction between the proprietor and his business.
(iv) Unlimited Liability: The proprietor is personally liable for all the debts of the business. In case, the assets are insufficient to meet its debts, the personal property of the proprietor can be attached.
(v) No Profit Sharing: The sole proprietor alone is entitled to all the profits and losses of business.
(vi) Small Scale: A sole proprietor can arrange limited funds and managerial ability. Therefore, the scale of business is small.
(vii) No Legal Formalities: No legal formalities are required to start, manage and dissolve sole proprietorship. Only a license may be required in some kinds of businesses.
2.1.2 Merits of Sole Proprietorship
A sole proprietorship firm enjoys the following benefits:
(i) Easy to start and dissolve
(ii) Maximum incentive to work, as there is no sharing of profits
(iii) Independent control
(iv) Quick decision-making
(v) Secrecy of affairs is maintained
(vi) Freedom from government control
(vii) Personal attention to customers
(viii) Self-employment
(ix) Self-confidence and sense of accomplishment
2.1.3 Demerits of Sole Proprietorship
A sole proprietorship firm suffers from the following drawbacks:
(a) Limited finance
(b) Limited scope of expansion
(c) Unlimited liability
(d) Uncertain life of business
(d) Lack of specialisation
(e) Conservative approach
2.2 Partnership
A partnership is an agreement in which two or more parties agree to cooperate to advance their mutual interests. It involves greater capital investment/varied skills and sharing of risks.
According to The Indian Partnership Act, 1932 (Sec. 4), “Partnership is the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all.”
Partnership Deed
It is a document in writing, containing different term and condition of partnership, as agreed to, by the partners in regard to operators of business and its affairs.
2.2.1 Features of Partnership
The salient features of partnership are as follows:
(i) Number of Members: Minimum two or more persons can form a partnership. Maximum number of members is 10 in banking business and 20 in other types of business.
(ii) Agreement: There must be an oral or written agreement. The written document containing the agreement is called ‘partnership deed’.
(iii) Lawful Business: A partnership can only be formed for a business, which is legal.
(iv) Sharing of Profits: The agreement of partnership must provide for sharing of profits of a business, in an agreed ratio. There is no partnership without the intention of mutual gain. In absence of an agreed ratio, profits are to be shared equally. Sharing of profits implies sharing of losses too.
(v) Mutual Agency: Partnership business can be carried on by all the partners or by any of them acting on behalf of others. Each partner is liable for acts performed by other partners on behalf of the firm.
(vi) Non-transferability of Share: No partner can transfer his share in partnership without the consent of all other partners.
(vii) Unlimited Liability: Each partner is liable to an unlimited extent for the firm’s obligations towards outsiders. This means that if firm’s assets are inadequate to meet its debts in full, even the personal property can be attached to satisfy the claims.
(viii) No Separate Legal Entity: A firm has no separate legal existence independent of the partners. Therefore, insanity, insolvency, retirement or death of a partner can bring an end to the business.
(ix) Registration: Registration of firm is optional.
2.2.2 Merits of Partnership
Main merits of partnership are:
(i) Formation is easy
(ii) Larger financial resources
(iii) Sharing of risks
(iv) Secrecy is maintained
(v) Flexibility in operations
(vi) Balanced decision-making
(vii) Pooling of skills
(viii) Scope for expansion
2.2.3 Demerits of Partnership
The following are the demerits of partnership:
(i) Limited resources
(ii) Unlimited liability
(iii) Risk of implied agency
(iv) Delay in decision-making
(v) Conflicts between partners
(vi) Lack of public confidence
(vii) Uncertainty of existence
(viii) Non-transferability of interests
2.2.4 Types of Partnership
Partnership firms can be classified on two basis:
(i) On the Basis of Duration
(a) Partnership at Will: It is a partnership formed for an indefinite period. The time period or the purpose of the firm is not mentioned at the time of its formation.
(b) Particular Partnership: It is a partnership formed for a specific time period or to achieve a specified objective. It is automatically dissolved on the expiry of specified time or completion of purpose.
(c) Joint Venture: It is organised for completing a specific project during a certain period. All members of joint venture are personally liable for its debts and obligations.
It is not affected by the death of a member and no member can withdraw his membership from the joint venture before the completion of the specific project.
(ii) On the Basis of Liability
(a) General Partnership: Under this form of partnership, the liability of partners is unlimited and joint registration of firm is optional. Existence is affected by death, lunacy, insolvency or retirement of a partner.
(b) Limited Partnership (LP): In this form, liability of atleast one partner is unlimited, whereas, the rest may have limited liability.
The position of a limited partner is similar to that of a shareholder of a joint stock company, with respect to his liabilities.
2.2.5 Types of Partners
Partners may be classified as:
(i) Active Partners: These partners contribute capital, take part in management, have unlimited liability and share profits and losses of the firm.
(ii) Sleeping or Dormant Partners: A sleeping partner is an inactive partner, who does not participate in management. Except this feature, he contributes capital and also shares the profits and losses of the business.
(iii) Nominal Partners: A nominal partner is one who allows the use of his name by a firm. He does not contribute capital, does not participate in management and also does not share profits or losses.
(iv) Secret Partners: A secret partner is one whose association is not known to the general public. Other than this distinct feature, he is like rest of the partners in all respects,
(v) Partner by Estoppel: In case, a person represents himself/herself by words or actions or has allowed himself to be represented as a partner of the firm, even though he is not a partner, he is called partner by estoppel.
Such a partner cannot deny his liability, if outside party lends money to the firm supposing him to be a partner and the firm is not in a position to repay debt.
(vi) Partner by Holding: Out When a person is declared as a partner and he does not deny this even after becoming aware of it, he becomes liable to the third party, who lends money or credit to the firm on the basis of such a declaration.
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Minor as a Partner
Partnership is based on legal contract between two persons who agree to share the profits or losses of a business carried on by them. As such a minor is incompetent to enter into a valid contract with others, he cannot become a partner in any firm. However, a minor can be admitted to the benefits of a partnership firm with the mutual consent of all other partners. In such cases, his liability will be limited to the extent of the capital contributed by him and in the firm. A minor can share only the profits and can not be asked to bear the losses. |
2.3 Hindu Undivided Family Business/Joint Hindu Family
Hindu Undivided Family Business or Joint Hindu Family Business is that form of business organisation which is owned and carried on by the member of Hindu Undivided Family (HUF). It is the oldest form of business organisation and can be found only in India.
This type of business is governed by the Hindu Law. According to the Hindu law, “Hindu Undivided Family is a family which consists of all persons lineally descended from a common ancestor and include their wives and unmarried daughters.”
2.3.1 Features of HUF
The salient features of HUF are:
(i) Membership by Birth: A person automatically becomes the member of HUF business, by taking birth in that family.
(ii) Minor Members: Minor can become full fledged member of the HUF.
(iii) Only Males as Members: There is a restriction of membership of females.
(iv) No Limit on Number of Members: HUF can have any number of coparceners.
(v) Management by Karta: The management is done by the senior most member of the family, who is known as the ‘karta’ and other members are called ‘coparceners’.
(vi) Liability: Liability of karta is unlimited, whereas, liability of other members is limited to the amount of their share in the property.
(vii) Right to Accounts: All members can inspect the accounts of the business.
(viii) Governed by Hindu Law: The rights, duties and liabilities of the members are governed by Hindu Succession Act, 1956.
(ix) Perpetuality: Its continuity is not affected by the death of family members. After the first generation, next generation controls the business and thus, business goes forever.
2.3.2 Merits of HUF
The main merits of HUF are as follows:
(i) Ease of formation
(ii) Unrestrained membership
(iii) Quick decision-making and effective control
(iv) Secrecy is maintained
(v) Limited liability of coparceners
(vi) Continuity of business
(vii) Freedom of business
(viii) Close relations with employees and customers
(ix) Enjoys ancestral goodwill
(x) Minors too have equal shares in business
2.3.3 Demerits of HUF
HUF has certain disadvantages. Some of them are:
(i) Limited capital
(ii) Unlimited liability of the karta
(iii) Hasty decisions
(iv) Limited managerial skills
(v) Only karta has power
2.4 Cooperative Societies
The term cooperative means working together with a common purpose. A cooperative society is a voluntary association of persons, who have joined together for the economic interests of its members. It is necessary for such societies to be compulsorily registered under Cooperative Societies Act, 1912. To form a cooperative society, consent of ten adult persons is required. The capital of a society is raised from its members through issue of shares. A distinct legal identity is achieved by society by its registration.
According to The Indian Cooperative Societies Act, 1912, “Cooperative organisation is a society which has its objectives for the promotion of economic interests of its members in accordance with cooperative principles.”
2.4.1 Features of Cooperative Societies/Organisations
The salient features of cooperative societies are:
(i) Registration: A cooperative society must be registered under Cooperative Societies Act, 1912. On registration, it becomes a body corporate, having a separate legal entity, with perpetual succession and limited liability of members.
(ii) Voluntary Association: Membership is open to all, irrespective of their religion, caste and gender. Any person having a common interest may join and leave by giving a prior notice.
(iii) Minimum Persons: A minimum of 10 adult persons are needed to form a cooperative organisation.
(iv) Limited Liability: The liability of members is limited to the amount contributed by them as capital.
(v) Service Motive: The primary aim of cooperative society is to provide some service or benefit to its members,
(vi) Democratic: Management Business of a cooperative society is managed by a managing committee, which is elected by the members.
(vii) One Man One Vote: Every member of the society has one vote irrespective of the number of shares held by him.
(viii) Finance: The capital of cooperative society is raised from its members through issue of shares. It can also raise loans from banks.
(ix) State Control: Government exercises control over cooperatives to protect the interests of members of cooperatives.
2.4.2 Merits of Cooperative Societies
Following are the merits of cooperative societies:
(i) It is easy to form as only 10 persons desiring to form cooperative society can form it.
(ii) Principles of universal brotherhood is followed.
(iii) Democratic management managed by elected representatives.
(iv) Have government support through loans at lower rate of interest, relief in taxes, etc.
(v) Stable existence due to corporate form of business.
(vi) Limited liability only to the amount of capital contribution.
2.4.3 Demerits of Cooperative Societies
Cooperative societies have certain limitations. Some of them are:
(i) Limited resources/shortage of funds
(ii) Inefficiency of management
(iii) Lack of motivation due to limited liability
(iv) Government’s control
(v) Conflicts among members
2.4.4 Types of Cooperative Societies
Cooperative societies can be classified as:
(i) Consumers Cooperative Societies: These are formed by consumers who are desirous of obtaining good quality products at reasonable prices. Eliminates middlemen, by purchasing in bulk from wholesalers and selling to members.
(ii) Producers Cooperative Societies: These are formed by producers desirous of procuring inputs for production of goods. Such societies provide inputs to the members and also buy their output for sale.
(iii) Marketing Cooperative Societies: These are formed by producers, who wish to obtain reasonable prices for their output. Such societies pool the output of individual members and perform marketing functions to sell the output at the best possible price.
(iv) Farmers Cooperative Societies: Farmers, who wish to jointly take up farming activities and gain the benefits of large scale farming, form these societies.
(v) Credit Cooperative Societies: These are formed to provide easy credit on reasonable terms to the members.
(vi) Cooperative Housing Societies: These are formed to help people with limited income to construct houses at reasonable costs.
2.5 Joint Stock Company
According to Lord Justice Lindley, “An association of persons who contribute money or money’s worth to a common stock and employ it for some common purpose.”
2.5.1 Features of Joint Stock Company
The salient features of Joint Stock Company are:
(i) Artificial Person: A company is a creation of law. Hence, it is an artificial legal person, who has no body or soul. However, for its own business purposes, it can hold property in its own name, can enter into contracts and can sue and be sued by others.
(ii) Distinct Legal Entity: The company has an entity or a personality, which is absolutely independent and separate from the entity of its members. Thus, it can hold property in its own name, it can file a suit and be sued. It can continue to exist, even if all members die.
(ii) Number of Members: There should be minimum 2 and maximum 50 members in private company and minimum 7 members with no limit for maximum members in a public company.
(iv) Perpetual Succession: Members may come and go but the company remains active. Even, if all the members die, company continues to exist. Life of the company comes to end, only through a prescribed legal procedure of winding up.
(v) Limited Liability: The maximum liability of a member is limited to the unpaid value of shares.
(vi) Transferability of Shares: The shares of a company are transferable, except in case of private company.
(vii) Common Seal: As an artificial person, a company cannot act and sign itself. It acts through human beings known as directors. All the acts of the company done through the directors, are authenticated by a common seal of a company. It is like an official signature of the company.
(viii) Management by Board of Directors: Directors are elected representatives of the members of the company. Hence, through the Board of Directors, a company is managed in a democratic manner.
2.5.2 Merits of a Joint Stock Company
Following are the merits of a joint stock company:
(i) Huge financial resources
(ii) Limited liability
(iii) Transferability of shares
(iv) Efficient management
(v) Economies of large scale of business
(vi) Democratic set-up
(vii) Permanent life
(viii) Public confidence
(ix) Risk sharing
(x) Assumption of social responsibility
2.5.3 Demerits of a Joint Stock Company
A joint stock company suffers from the following drawbacks:
(i) Complex procedure of formation
(ii) Delay in decision-making
(iii) Lack of incentive
(iv) Lack of secrecy
(v) Excessive government control
(vi) Oligarchic management
(vii) Conflicts among various groups
2.5.4 Types of Companies
2.6 Public Company and Private Company
Public Company
It is one which:
(a) Is not a private company.
(b) has a minimum paid-up capital of ` 5 lakh.
(c) Is a private company, being a subsidiary of public company.
(d) Has minimum 7 members and no limitation for maximum members.
(e) Has minimum 3 directors.
Private Company
It is one which:
(a) Prohibits any invitation to public to subscribe to its shares/debentures.
(b) Has minimum 2 members and maximum 50 members.
(c) Has a restriction on transfer of shares.
(d) has a minimum paid-up value of ` 1 lakh.
(e) Has minimum 2 directors.
Formation of a Company
It is a complex process involving several legal formalities and procedural decisions.
The formation of a company involves following stages:
Stage 1 Promotion
It refers to the sum total of activities by which a business enterprise is bought into existence. It involves the discovery of business idea, investigation and assembling necessary resources to set-up a profitable concern.
The person or a group of persons who performs the work of promotion and forms a company is known as promoter.
Functions of Promoter
Main functions of promoter are as follows:
(i) Identification of business opportunity
(ii) Feasibility viz economic, technical and financial
(iii) Name approval
(iv) Fixing of signatories to the Memorandum of Association (MoA)
(v) Appointment of professionals
(vi) Preparation of necessary documents required for the formation of a company, viz:
(a) Memorandum of Association (MoA)
(b) Articles of Association (AoA)
(c) Consent of proposed directors
(d) Agreement
(e) Statutory declaration
Stage 2 Incorporation
It implies the registration of a company as a body corporate under the Companies Act, 1956.
It consists of following steps:
(i) Approval of name
(ii) Filing of necessary documents
(iii) Payments of fee
(iv) Registration
(v) Certificate of incorporation
Stage 3 Capital Subscription
A private company can commence business immediately after incorporation. But a public company must raise necessary capital to obtain commencement of business certificate.
Capital subscription follows following steps:
(i) SEBI approval
(ii) Filing of prospectus
(iii) Appointment of brokers
(iv) Underwriting
(v) Issue of prospectus
(vi) Listing
(vii) Subscription
(viii) Allotment
(ix) Refund
(x) Share certificates
Stage 4 Commencement of Business
To commence business, a public company has to obtain a certificate of commencement of business.
For this, the following documents have to be filed with the registrar of companies:
(i) A declaration that 90% of the issued amount of capital has been subscribed.
(ii) A declaration that all directors have paid in cash, in respect of allotment of shares made to them.
(iii) A statutory declaration that the above requirements have been completed and must be signed by the director or secretary of company.
2.7 Choice of form of Business
Many factors affect the choice of a suitable form of organisation. Some main factors are
2.7.1 Forms of Business Organisation
The important factors determining the choice of organisation are listed below
Setting up costs are low and the legal requirements are minimal in sole proprietorship and partnership from of business. Since, cooperative societies and companies have to be compulsorily registered and the formation is quite lengthy and expensive.
In case of sole proprietorship and partnership firms, the liability of the owners/partners is unlimited but in the case of cooperative societies and companies, the liability of the member is limited.
Hence, from the point of view of liability, the company form of organisation is more suitable.
The continuity of sole proprietorship and partnership firms is affected by such events as death, insolvency or insanity of the owners. However, such factors do not affect the continuity of business in the case of organisations like Joint
Hindu Family business, cooperative societies and companies. In case, the business needs a permanent structure, company form is more suitable. For short, term ventures, proprietorship or partnership may be preferred.
A sole proprietor may find it difficult to have expertise in all functional areas of management but in other forms of organisations like partnership and company, no such problem is exist.
Companies are in a better position to collect large amounts of capital by issuing shares to a large number of investors. Partnership firms also have the advantage of combined resources of all partners.
But the resources of a sole proprietor are limited. Thus, if the scale of operations is large, company form may be suitable whereas for medium and small sized business one can opt for partnership or sole proprietorship.
If direct control over operations and absolute decision-making power is required, proprietorship may be preferred.
But if the owners do not mind sharing control and decision-making, partnership or company form of organisation can be adopted.
If direct personal contact is needed with the customers such as in the case of a grocery store, proprietorship may be more suitable. For large manufacturing units, however, when direct personal contact with the customer is not required, the company form of organisation may be adopted.
Similarly, in cases where services of a professional nature are required, partnership form is much more suitable.
An entrepreneur must memorise the following chart before making a choice for the form of business organisation.
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