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Forms of Business Organisation

Introduction

When individuals decide to start a business, one of the fundamental decisions they must make is regarding the form of organisation the business will take. The choice of business structure significantly impacts various aspects of the business, including legal status, liability of owners, ease of formation, access to finance, continuity, and management.

The different forms of business organisation evolve based on factors like the number of owners, capital requirements, risk-bearing capacity, and the nature of business activities.

The common forms of business organisation in India are:

  1. Sole Proprietorship
  2. Joint Hindu Family Business
  3. Partnership
  4. Cooperative Society
  5. Joint Stock Company

Each form has its own distinct characteristics, advantages, and disadvantages, making it suitable for different types and scales of businesses.


Sole Proprietorship

A Sole Proprietorship is the simplest form of business organisation where the business is owned, managed, and controlled by a single individual who receives all the profits and bears all the risks.

This is the most common form of business in the unorganised sector in India, suitable for small-scale activities like local retail shops, handicraft units, individual service providers (like tailors, beauticians), etc.

Features

1. Single Ownership

The business is owned by one individual.

2. Formation and Closure

It is relatively easy to start and close a sole proprietorship. There are minimal legal formalities required, though specific licenses or registrations might be needed depending on the nature of the business (e.g., Shop and Establishment Act registration).

3. Unlimited Liability

The most significant feature is that the owner has unlimited liability. This means that if the business incurs losses and its assets are not sufficient to cover the debts, the personal assets of the proprietor can be used to repay the creditors.

4. One-man Control

The proprietor has complete control over the business and makes all the decisions. There is no need to consult anyone else.

5. No Separate Legal Entity

The business and the owner are considered one and the same in the eyes of the law. The business does not have an existence independent of the owner.

6. Lack of Business Continuity

The existence of the business is directly linked to the life of the proprietor. Death, insolvency, or illness of the owner can lead to the closure of the business.

Merits

1. Quick Decision Making

Since the proprietor is the sole decision-maker, decisions can be made quickly without delays caused by consultations.

2. Confidentiality of Information

All business decisions and information are kept confidential with the owner, as there is no obligation to share them with others.

3. Direct Incentive

All the profit earned by the business belongs solely to the proprietor. This acts as a strong motivation to work hard and efficiently.

4. Sense of Accomplishment

There is immense personal satisfaction and a sense of achievement in successfully running one's own business.

5. Ease of Formation and Closure

Starting and closing the business is relatively simple with minimal legal hassles.

Limitations

1. Unlimited Liability

The unlimited liability of the owner is a major drawback, as it puts personal assets at risk.

2. Limited Resources

The capital is limited to the personal savings and borrowing capacity of one individual, which may restrict the size and expansion of the business.

3. Limited Managerial Ability

A single individual may not possess all the necessary skills (marketing, finance, production, HR) to manage the business effectively. Hiring experts might be constrained by limited resources.

4. Limited Life of a Business Concern

The business is vulnerable to the owner's health, age, and life, impacting its continuity.

Despite limitations, its simplicity and ease of operation make it suitable for small-scale local businesses.


Joint Hindu Family Business

The Joint Hindu Family (JHF) Business is a unique form of business organisation found only in India. It is governed by the Hindu Succession Act, 1956. It is a business owned and carried on by the members of a Hindu undivided family.

It arises by operation of law, not by agreement.

Features

1. Formation

It is created by operation of Hindu law. There must be at least two male members in the family and some ancestral property inherited by them.

2. Membership

Membership is by birth in the Hindu undivided family. Persons who acquire membership by birth are called coparceners. (Under the Hindu Succession (Amendment) Act, 2005, daughters are also recognised as coparceners by birth in their own right in the same manner as sons).

3. Liability

The liability of all members, except the Karta, is limited to their share in the business (their share in the ancestral property). The Karta (the eldest male member, or now potentially the eldest coparcener, depending on interpretation and court rulings) has unlimited liability.

4. Control

The management and control of the business is vested in the hands of the Karta. He has the sole authority to manage business affairs and is not accountable to other coparceners.

5. Continuity

The business continues even after the death of the Karta, as the next eldest surviving coparcener becomes the new Karta. The business can only be dissolved if all coparceners agree or if a partition of the property takes place.

6. Minor Members

A person becomes a member by birth, so minors can also be members (coparceners) in a JHF business. Their liability is limited.

Merits

1. Effective Control

Control by the Karta ensures quick and decisive decision-making, avoiding conflicts among members.

2. Continuity of Business

The death or incapacity of the Karta does not affect the continuity of the business.

3. Limited Liability of Members (except Karta)

Coparceners' liability is limited, providing them some protection compared to the Karta or sole proprietors.

4. Increased Loyalty and Co-operation

Since the business is family-owned, there is a sense of loyalty and cooperation among members.

Limitations

1. Unlimited Liability of Karta

The Karta bears unlimited liability, putting his personal assets at risk.

2. Limited Financial Resources

The business relies on ancestral property and the capacity of the Karta to borrow, which may be limited, restricting growth and expansion.

3. Dominance of Karta

The Karta's absolute control and non-accountability can sometimes lead to conflicts among members or mismanagement if the Karta is not capable.

4. Limited Managerial Skills

The Karta may not possess expertise in all areas of management, and his unilateral decision-making might not always be optimal.

JHF businesses are declining in popularity due to factors like decreasing joint family systems and increasing preference for professional management structures like companies.


Partnership

A Partnership is defined by the Indian Partnership Act, 1932, as "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."

It is formed when two or more persons come together to carry on a business with the objective of sharing profits.

Features

1. Formation

A partnership is formed by an agreement between persons to carry on a business. The agreement can be oral or written, though a written agreement (Partnership Deed) is advisable. The business must be legal and carried on with the object of earning profit.

2. Number of Partners

There must be at least two partners. The maximum number of partners is 50 for any business firm (as per Companies Act, 2013 read with Companies (Miscellaneous) Rules, 2014). For specific professional partnerships, other limits might apply.

3. Unlimited Liability

Similar to sole proprietorship, partners generally have unlimited liability. Partners are jointly and severally liable for the debts of the firm. This means if the firm's assets are insufficient, the personal assets of any partner can be used to pay off the firm's debts. The liability is unlimited, joint, and several.

4. Mutual Agency

Each partner is both an agent and a principal. An act of one partner binds all other partners (mutual agency). A partner is an agent because he represents the other partners, and he is a principal because he is also bound by the act of other partners.

5. Decision Making and Control

Decisions are generally taken jointly by partners. Control is exercised by all partners. In practice, the partnership deed might delegate specific responsibilities, but all partners have the right to participate.

6. Lack of Continuity

The partnership firm can come to an end on the death, retirement, insolvency, or insanity of any partner, unless the partnership deed provides otherwise. Even if the remaining partners continue, it constitutes a new partnership.

7. Sharing of Profit and Loss

Partners share the profits or losses of the business in the agreed ratio. If there is no agreement, profits and losses are shared equally.

Merits

1. Ease of Formation

Formation of a partnership is relatively easy, based on an agreement, with fewer legal formalities compared to a company.

2. Balanced Decision Making

Decisions are usually the result of consultation among partners, leading to potentially more balanced and considered decisions.

3. More Financial Resources

Capital contributions from multiple partners provide access to larger financial resources compared to a sole proprietorship.

4. Sharing of Risks

The risk of the business is shared among all partners, reducing the burden on any single individual.

5. Confidentiality

There is no legal requirement to publish financial accounts, allowing for greater confidentiality compared to public companies.

Limitations

1. Unlimited Liability

The unlimited and joint liability of partners remains a significant disadvantage.

2. Limited Resources

While better than sole proprietorship, the financial resources are still limited compared to joint stock companies that can raise funds from the public.

3. Possibility of Conflicts

Differences of opinion among partners can lead to conflicts and disputes, potentially harming the business.

4. Lack of Continuity

The instability due to the departure or death of a partner can disrupt the business.

5. Lack of Public Confidence

Absence of regulation and mandatory public disclosure can sometimes lead to a lack of trust from the public.

Types Of Partners

Partners can be classified based on their role, liability, and participation in the business:

Types Of Partnerships

Partnerships can be classified based on the duration of the business or the extent of liability:

Based on Duration:

Based on Liability:

Note: The traditional Partnership Act, 1932, deals with General Partnerships. LLP is a separate legal structure.

Partnership Deed

A Partnership Deed is a written agreement among partners that specifies the terms and conditions governing the partnership. While not mandatory, it is highly recommended to avoid disputes later.

It typically includes:

Registration

Registration of a partnership firm is not mandatory as per the Indian Partnership Act, 1932. However, it is advisable to register the firm due to certain benefits:

Consequences of Non-registration:

However, non-registration does not affect the rights of third parties to sue the firm or its partners, nor does it affect the firm's right to sue a third party for matters outside the contract (e.g., a suit based on property ownership).

Registration involves submitting an application to the Registrar of Firms of the state in which the firm is located, along with the prescribed fee and a copy of the partnership deed.


Cooperative Society

A Cooperative Society is a voluntary association of persons, usually of limited means, who come together to protect their common economic interest. It is governed by the Cooperative Societies Act, 1912, or respective State Cooperative Societies Acts.

The main principle of a cooperative society is "each for all and all for each" or "self-help through mutual help". The primary motive is service to its members rather than profit earning.

Features

1. Voluntary Association

Membership is voluntary. Any person with a common interest can join or leave the society, subject to rules.

2. Legal Status

A cooperative society must be registered under the Cooperative Societies Act. Upon registration, it becomes a separate legal entity, distinct from its members. This gives it perpetual succession and the capacity to own property, enter contracts, and sue/be sued in its own name.

3. Limited Liability

The liability of members is limited to the extent of the capital contributed by them or the guarantee given by them.

4. Control

Control rests with a managing committee elected by the members on the basis of 'one member, one vote', irrespective of the number of shares held. This promotes democratic control.

5. Service Motive

The primary objective is to render service to its members and society, rather than maximising profits. Any surplus generated is distributed among members as dividends or used for their welfare.

6. Finance

Capital is contributed by members through the purchase of shares. It can also raise funds through loans from government, cooperative banks, and others.

Merits

1. Ease of Formation

Formation is relatively easy, requiring a minimum of 10 adult members and compliance with the Act.

2. Stability and Continuity

Being a separate legal entity, the death, insolvency, or incapacity of any member does not affect the society's existence.

3. Limited Liability

Members enjoy limited liability, protecting their personal assets.

4. Democratic Management

The 'one member, one vote' principle ensures equal participation in decision-making, preventing dominance by a few.

5. Reduced Risk of Exploitation

Middlemen are eliminated, allowing members to get better prices for their goods or services.

6. Government Support

Cooperative societies often receive support from the government in the form of loans, grants, and tax exemptions.

Limitations

1. Limited Resources

Capital contribution from members is usually limited due to their restricted means. Raising large amounts of capital can be challenging.

2. Inefficient Management

Management is often run by elected members who may lack managerial expertise. Voluntary management may also lack commitment.

3. Lack of Secrecy

Meetings are open, and decisions are discussed among members, making it difficult to maintain secrecy.

4. Government Control

While government support is beneficial, excessive government interference and control can sometimes hinder the independent functioning of the society.

5. Conflicts Among Members

Differences in opinions and personal rivalries among members can lead to conflicts and affect the society's working.

Types Of Cooperative Societies

Cooperative societies can be formed for various purposes:

Cooperative societies play a significant role in promoting economic and social welfare among members.


Joint Stock Company

A Joint Stock Company is an association of persons formed for carrying on business activities and having a separate legal existence, perpetual succession, and a common seal. It is registered under the Companies Act, 2013 (or previous Acts). The capital is divided into transferable units called shares.

This is the most complex but often the most suitable form for large-scale business operations.

Features

1. Separate Legal Entity

A company is a distinct legal entity separate from its owners (shareholders). It can own assets, incur debts, enter contracts, and sue/be sued in its own name.

2. Formation

Formation of a company involves complex legal procedures and formalities as per the Companies Act, 2013. It requires registration with the Registrar of Companies.

3. Perpetual Succession

The existence of a company is independent of its members. The death, insolvency, or exit of any or all members does not affect the company's existence. "Members may come, members may go, but the company goes on forever".

4. Limited Liability

The liability of shareholders is limited to the unpaid amount on the shares held by them or the amount guaranteed by them. Their personal assets are not at risk for the company's debts.

5. Control

Control and management are vested in the Board of Directors, who are elected by the shareholders. Management is separated from ownership.

6. Common Seal

As an artificial person, the company uses a common seal as its official signature for authenticating documents (though this is no longer mandatory if authorised by two directors or one director and CS).

7. Transferability of Shares

Shares of a public limited company are freely transferable. Shareholders can easily buy and sell shares on the stock market.

Merits

1. Limited Liability

This is a major advantage, attracting investors as their personal assets are protected.

2. Transfer of Interest

Easy transferability of shares provides liquidity to investors.

3. Perpetual Existence

The long and stable life of the company ensures continuity of operations.

4. Scope for Expansion

Companies can raise large amounts of capital by issuing shares and debentures to the public, facilitating large-scale operations and expansion.

5. Professional Management

The separation of ownership and management allows companies to hire professional managers and experts, leading to efficient functioning.

Limitations

1. Complexity in Formation

Forming a company involves lengthy, complex, and expensive legal procedures.

2. Lack of Secrecy

Companies are required to disclose significant information to regulatory authorities and the public through financial statements and annual reports, making it difficult to maintain secrecy.

3. Impersonal Work Environment

Due to large scale and separation of ownership and management, there might be a lack of personal contact and motivation among employees compared to smaller structures.

4. Numerous Regulations

Companies are subject to extensive legal regulations and government control.

5. Delays in Decision Making

Decision making can be slow due to the requirement of board meetings, shareholder approvals, and formal procedures.

6. Oligarchic Management

While control is theoretically democratic ('one share, one vote' for equity), in practice, control often rests in the hands of a few people (promoters or a group with majority shares) rather than all shareholders.

Types Of Companies

As discussed in a previous topic, companies can be classified based on various criteria under the Companies Act, 2013, including:

The most common distinction is between Private Limited Company and Public Limited Company, differing mainly in terms of minimum/maximum members, transferability of shares, and ability to invite the public to subscribe to shares.


Choice Of Form Of Business Organisation

The selection of an appropriate form of business organisation is a critical decision for any entrepreneur. The choice depends on a careful consideration of various factors:

1. Ease of Formation and Closure

If ease of starting and closing is a priority, Sole Proprietorship is the simplest. Partnership is also relatively easy. Company formation is complex and time-consuming.

2. Liability

If the owner wants to limit their personal liability, a Company (Private or Public) or an LLP (for partners other than designated partners) is preferable. Sole Proprietorship and General Partnership involve unlimited liability.

3. Continuity and Stability

If perpetual succession is important for long-term stability, a Company or LLP is suitable. Sole Proprietorship and General Partnership lack continuity.

4. Capital Requirements

For businesses requiring large amounts of capital, a Public Limited Company is the most suitable form as it can raise funds from the public. Partnership and Sole Proprietorship have limited access to large funds.

5. Managerial Ability

If the business requires diverse expertise and professional management, a Company or a large Partnership is better positioned to hire or have partners with different skills. Sole Proprietorship relies on one person's abilities.

6. Scale of Operations

For small-scale, local operations, Sole Proprietorship or a small Partnership might be sufficient. For medium to large-scale operations, Partnership, LLP, or Private Company might be considered. Large-scale, multi-location, or national/international operations typically require a Public Limited Company structure.

7. Degree of Control

If the owner wants complete control, Sole Proprietorship is ideal. Control is shared in Partnership and democratic/delegated in Company.

8. Nature of Business

Some businesses are naturally suited to certain forms (e.g., professional services might prefer Partnership/LLP, large manufacturing needs Company, local retail often Sole Proprietorship). Service motive is central to Cooperative Societies.

9. Regulation and Compliance

Companies are subject to extensive regulation and compliance requirements, which might be burdensome for small businesses. Sole Proprietorship and General Partnership have fewer regulatory requirements.

10. Sharing of Profit/Risk

Sole Proprietorship allows the owner to keep all profits but bear all risk. Partnership allows sharing of both. Company allows for widespread distribution of ownership and risk.

Entrepreneur must weigh these factors based on their specific business idea, resources, risk appetite, and long-term goals to choose the most appropriate form.