UNIT II

FORMS OF BUSINESS ORGANISATION

2.1:  Forms of Business Organization

Business organizations are broadly classified under three categories. They are-

1. Private sector enterprises
2. Public sector enterprises
3. Joint sector enterprises

Private sector enterprises are again sub-divided into the following-

1. Sole Proprietorship business.
2. Partnership business.
3. Hindu Undivided Family business.
4. Co-operative Societies.
5. Joint Stock Company.

Public sector enterprises have the following sub-categories-

1. Departmental Organizations.
2. Public Corporations.
3. Government Companies.

Key Takeaways

1. Business organizations are broadly classified under three categories- Private Sector, Public Sector and Joint Sector.

2.2:  Sole-proprietorship business

A business that is owned, controlled and managed by a single individual is a sole- proprietorship business. It is the simplest and most common form of business ownership. The business’ existence is entirely dependent on the owner’s decisions, so when the owner dies, so does the business. Examples are: hair salons, retail shops etc.

The features of sole- proprietorship business are-

1. A sole trade business is owned, managed and controlled by one person only.
2. The formation and closure of this form of business is very easy as it involves no legal formality.
3. All profits belong to a single owner only and he alone bears the risk of business.
4. All business decisions are taken by the owner alone.
5. The liability of the sole trader is unlimited. This means that when assets of the business are not sufficient to meet liabilities of the business, he is personally responsible to pay for his debts.

Merits

Merits/advantages of sole-proprietorship business are as follows:

1. A sole-proprietor is free to take decisions of his business alone. This helps in taking decisions without delay.
2. It is easy in formation and closure.
3. Being the only owner, he can maintain important business secrets.
4. A sole proprietor can keep the whole profit with himself.
5. The owner can have direct contact with customers and employees.

Demerits

The sole- proprietorship business also suffers from a number of demerits/ disadvantages, such as the following-

1. A sole-proprietor has limited resources. Due to this, the size of such business is small.
2. A sole-proprietor has unlimited liability. If the business assets are not sufficient for payment of debts of the business, his personal assets can be used for making payments.
3. Death, illness or insolvency of the proprietor affects the working of the business.
4. One person may not be an expert in every function of the business and he may not be able to supervise effectively. Such limited managerial capacity will hinder the growth of business.

Key Takeaways

1. A business that is owned, controlled and managed by a single individual is a sole- proprietorship business.

2.3  Partnership business

Partnership is the relation between two or more persons who have agreed to share profits of a business carried on by all or any of them acting for all.

Features/characteristics of partnership business are-

1. Partnership business comes into existence through an agreement among the partners which may be oral or in writing.
2. At least two persons are required to start a partnership business and maximum number of members is 50, as per the Indian Partnership Act, 1932.
3. Partners agree to share profits in the ratio mentioned in the agreement.
4. Decisions of the business are taken with the consent of all the partners.
5. Business comes to an end on the death, retirement or insolvency of any of the partners.
6. There is mutual agency among the partners, i.e. as an agent, a partner can represent other partners and all partners are liable to acts of one another.

Merits

The merits/advantages of partnership business are:

1. Partnership firm is easy to form and close. It comes into existence through an agreement. Registration is not compulsory.
2. Business decisions are jointly taken by all the partners. No partner is over-burdened.
3. Funds are more as compared to sole proprietorship because capital is contributed by all partners.
4. Business risk is jointly shared by all the partners.
5. A partnership concern is not expected to publish its Profit and Loss Account and Balance Sheet as is necessary for a joint stock company. Thus, partners can keep business secrets to themselves.

Demerits

Partnership is not free from demerits/disadvantages as well. Some are listed below-

1. Funds are limited as maximum number of members is restricted.
2. Partnership comes to an end on the death, retirement or insolvency of any partners.
3. Lack of confidence in each other can be a cause for quarrels and may also lead to dissolution of partnership.
4. Partnership firms are not required to publish their financial reports. Therefore, the confidence of public in these firms is very low.

Types of Partnership

Partnership can be divided into certain categories:

a)     Particular Partnership: when the partnership is started for a particular work then it is called particular partnership. When the work is completed, the partnership automatically comes to an end.

b)    Fixed-period Partnership: This type of partnership is started for a specific period of time and comes to an end when that period is over.

c)     Partnership-at-will: In this type of partnership, the business of the firm continues as long as the partners desire and is terminated when any partner gives a notice of dissolution.

d)    Limited Partnership: It is the partnership in which the liability of at least one member is limited to the extent of his capital in the business and the liability of other partners is unlimited.

e)     General Partnership: This type of partnership is formed not for a particular task and the liability of members is unlimited.

Types of partners

There are different kinds of partners namely,

1)     Active Partner: A partner who contributes capital and actively participates in the management and day-to-day working of the business, is known as active partner. He may also be called a working partner.

2)     Sleeping Partner: A partner who contributes capital, shares profit and losses but does not participate in the management and day-to-day working of the business is known as sleeping partner.

3)     Secret Partner: A partner whose membership in the firm is not known to outsiders is known as secret partner. He also contributes capital, shares profits and losses, takes part in the workings of the business and has unlimited liability.

4)     Nominal Partner: A partner who allows the partnership firm to use his/her name but does not contribute capital or take part in the working of the business is known as nominal partner. He does not share profits and losses of the firm but he is liable to the creditor for repayment of the firm’s debts.

5)     Partner by Estoppels or by Holding-out: When a person is not a partner, but poses himself as a partner either by words or in writing or by his acts, he is called partner by estoppels or by holding-out. Such a partner shall be liable to outsiders who deal with the firm on the presumption of that person being a partner. He also does not contribute anything to the business.

6)     Minor as a partner: A minor is a person below 18 years of age. According to Indian Contract Act, a minor cannot enter into a contract. Thus, a minor cannot enter into a contract of partnership. However, a minor may be admitted to the benefits of an existing partnership with the consent of all partners. The minor is not personally liable for liabilities of the firm, but his share in the partnership, property and profits of the firm will be liable for debts of the firm.

Partnership Deed

The document containing the partnership agreement among partners is called Partnership Deed. It contains the terms and conditions of the partnership firm.

The Partnership Act, 1932 does not make it compulsory to have a written agreement. However, to avoid all kinds of misunderstanding and disputes among the partners, it is always good to have a written agreement known as Partnership Deed.

The contents of Partnership Deed are-

1. Name of the firm.
2. Nature and location of business.
3. Duration of partnership.
4. Methods for preparing accounts and their auditing.
5. Rules regarding banking transactions.
6. Profits sharing ratio.
7. Capital invested by each partner.
8. Duties and responsibilities of the partners.
9. Salaries and drawings of the partners.
10. Rules applicable for accounting treatment on admission, retirement or death of the partner.
11. Procedure for dissolving the firm.

Key Takeaways

1. Partnership is the relation between two or more persons who have agreed to share profits of a business carried on by all or any of them acting for all.
2. The document containing the partnership agreement among partners is called Partnership Deed. It contains the terms and conditions of the partnership firm.
3. Partners may be active partner, sleeping partner, nominal partner, partner by estoppels or secret partner.
4. A minor may also be a partner.
5. Partnerships may be general, particular, fixed period, limited liability partnership or partnership-at-will.

2.4:  Joint Stock Company

“A joint stock company is a voluntary association of individuals for profit, having a capital divided into transferable shares, the ownership of which is the condition of membership.” –L. H. Haney.

A company is “an association of many persons who contribute money or money’s worth to a common stock and employ it in some trade or business, and who share the profit and loss (as the case may be) arising there from.”

The Companies Act, 2013 defines a company under Section 2(20) as any association of persons registered under the present or the previous Companies Act.

The features of a joint stock company are:

i. An artificial person created by law: Like a person a company can own property and bank account, borrow money, sue and be sued in its own name, but cannot run or breathe like us. Thus, it is called an artificial person.

ii. Formation: A company is formed under the Companies Act.

iii. Separate Legal Entity: A company’s assets and liabilities are separate from that of its members.

iv. Limited Liability: Liability of members is limited to the unpaid value of shares held by them, or by the amount guaranteed by them.

v. Common Seal: A company signs through a common seal, since it is an artificial person.

vi. Perpetual Succession: A company is not affected by the death, insolvency, lunacy or retirement of its members. It has continuous existence.

vii. Transferability of Shares: Shareholders of a public company can easily transfer shares to others.

viii. Separate ownership and management: A company is owned by its shareholders while managed by the Board of Directors.

Merits

The merits/advantages of a joint stock company are:

i. Members have limited liability.

ii. Shareholders of a public company can easily transfer shares to others.

iii. A company is not affected by the death, insolvency, lunacy or retirement of its members. It has continuous existence.

iv. A company is managed by the Board of Directors with specialized knowledge and skill in this regard.

v. A company can arrange for large financial resources, thus can easily go for expansion and diversification.

Demerits

i. The formation of a company is time consuming, expensive and complex process involving many formalities.

ii. Everything about a company is discussed in the meeting of Board of Directors. Trade secrets cannot be maintained.

iii. The company has to follow various rules and regulations for their working. Such formalities involve a lot of time, money and effort and also reduce the freedom of operation of a company.

iv. A company is managed by three tiers of management, viz. Top-level management, Middle-level management and Lower-level management. Therefore, there is delay in taking decisions.

Key Takeaways

1. A joint stock company is a voluntary association of individuals for profit, having a capital divided into transferable shares, the ownership of which is the condition of membership.

2.5:  Types of Companies

The classification of a company depends on many things such as, formation, incorporation, control, ownership, the number of members, liability, declaration by the leader of the country (King, Queen, President), Special Act or bill passed by the Parliament, the purpose of the company, location of the company, investment type of the company etc.

Let us take a look at the different types of companies and try to understand each of them.

A. Types of Companies Based on the Number of Members

i. Public Limited Company

ii. Private Limited Company

iii. One Person Company

B. Types of Companies Based on the Liability of the Members

i. Companies Limited by Shares

ii. Companies Limited by Guarantee

ii. Unlimited Company

C. Types of Companies Based on the Mode of Incorporation

i. Chartered or Royal Chartered Companies

ii. Statutory Company

iii. Registered or Incorporated Companies

iv. Unregistered Company

D. Other Types

i. Foreign Company

ii. Government Company

iii. Holding Company and Subsidiary Company

iv. Listed Company

v. Unlisted Company

vi. Dormant Company

vii. Banking Company

viii. Nidhi Company

Let’s try to understand each of them:

A. Types of Companies Based on the Number of Members

Based on the number of members/shareholders, the types of company are:

i. Public Limited Company

Public limited companies are listed on the stock exchange where its share/stocks are traded publicly. It must have a minimum of 7 members and can have an unlimited number of members. It operates as a legal entity separate from its owners and its stocks are traded publicly. Publishing complete and true financial position of the company is required by law so that investors can determine the true worth of its stock (shares). It has limited liability, which is by shareholders share.

ii. Private Limited Company

A private limited company has legal entity separate from its owners, does not require publishing the company’s financial positions, must have a minimum of 2 members and a maximum number of 200 members. It faces fewer regulations and government oversight than a public limited company. Companies can go from private to public, by selling shares to the public, often as a way to raise a large amount of money. In reverse, public companies can be taken private if, for example, a majority owner wants to consolidate control.

iii. One Person Company

This type of company has only one member and is treated as a private company for all legal purposes.

B. Types of Companies Based on the Liability of the Members

Based on the liability, the types of companies are:

i. Companies Limited by Shares

A company limited by shares is a registered company having the liability of its members limited by its memorandum of association to the amount, unpaid (if any) on the shares  held by them. A shareholder cannot be called upon to pay more than the amount remaining unpaid on his shares.

ii. Companies Limited by Guarantee

A company limited by guarantee is one having the liability of its members limited by the memorandum to such amount as the members may undertake to contribute to the assets of the company in the event of its being wound up.

iii. Unlimited Company

An unlimited company is where the liability of the members or shareholders is not limited. The legal liability of the members or shareholders is not limited, that is, its members or shareholders have a joint, several and non-limited obligations to meet any insufficiency in the assets of the company to enable settlement of any outstanding financial liability in the event of the company’s formal liquidation.

C. Types of Companies Based on the Mode of Incorporation

Based on the mode of incorporation the companies are:

i. Chartered or Royal Chartered Companies

Companies that are incorporated by the royal charter are called Charterd Companies. Such companies do not exist now. For example, East India Company in 1600.

ii. Statutory Company

These are the companies created by special Acts of Parliament or State Legislature. These companies are generally established to run institutions or industries of social or national importance. Examples are, Life Insurance Corporation of India, State Bank of India etc.

iii. Registered or Incorporated Companies

Companies that are registered under the Companies Act, 2013 or under any previous company law are Registered or Incorporated Companies.

iv. Unregistered Company

In simple terms, an unregistered company is a business that is not registered under the Companies Act of the country. Therefore it is not covered by the law.

D. Other Types

There are many other types of company which may fall into the previous types, but they have some distinct characteristics that make them different.

i. Foreign Company

A foreign company is a company which is incorporated in a foreign country outside India and wants to or has established business in the country.

ii. Government Company

A Government company is one in which not less than fifty-one percent (51%) of the paid-up share capital is held by the Central Government, or by any State Government or Governments or partly by the Central Government and partly by one or more State Governments.

A subsidiary of a Government company is also treated as a Government company.

iii. Holding and Subsidiary Company

Where a company has control over another company, it is known as the Holding Company and the company over which control is exercised is called the Subsidiary Company. A Company is deemed to be under the control of another if;

• the other controls the composition of its Board of Directors; or
• the other company holds more than half, in nominal value, of its equity share capital
• it is a subsidiary of a third company which itself is a subsidiary of the controlling company.

iv. Listed Company

A company, whose shares are listed on any stock exchange(s) for public trading, is called the listed company or quoted company.

v. Unlisted Company

The company, whose share is not listed on any stock exchange(s) for public trading, is called the listed company or quoted company.

vi. Dormant Company

A dormant company has been registered under the Companies Act but do not have any kind of business activity or receiving any form of income.

vii. Banking Company

A banking company in India is one which transacts the business of banking which means, the accepting, for the purpose of lending or investment, of deposits of money from the public, repayable on demand or otherwise and withdrawal by cheque, draft, order or otherwise.

viii. Nidhi Company

A Nidhi company’s whole business is borrowing and lending money between its members; these are known as Permanent Fund, Benefit Funds, Mutual Benefit Funds, and Mutual Benefit Company. It only allows individual members. A firm or group or company cannot become a member of a Nidhi company. These are non-banking finance organization in India, recognized under section 406 of the Indian Companies Act, 2013.

Key Takeaways

1. The classification of a company depends on many things such as, formation, incorporation, control, ownership, the number of members, liability, declaration by the leader of the country (King, Queen, President), Special Act or bill passed by the Parliament, the purpose of the company, location of the company, investment type of the company etc.

2.6:  Private versus Public Company

The points of difference between private company and public company are listed below:

Key Takeaways

1. There are a number of differences between a private company and a public company.
2. A private company is started with at least seven members and the maximum is 200, while a public company is started with two members and there is no maximum limit.
3. A private company is not required to issue a prospectus or statement to invite public to subscribe to its shares. A public company must issue prospectus or statement to invite public to subscribe to its shares.

References:

1. Dam, B.B., Choudhury, R.N., Nag, R & Dam, L.B. Company Law, Gayatri Publications, Guwahati, Assam (2020).
2. Tulsian, P.C. Business Organization and Management, Pearson Education, India (2002). Pp. 671.
3. Wason, V. Textbook of Business Studies, S.Chand, New Delhi (2010)