Forms of Organizations

• Sole Proprietorship Firm* (OPC: One Person Co.)

• Partnership*
• Limited Liability Partnership (LLP)
• Private Limited Company
• Public Limited Company (Corporation)
o Closely Held Co.
o Widely Held Co.
• International Organization (Exports; Forex)
• MNC (Centralized Management System)
• TNC (Decentralized Management System)

1. The Sole Proprietorship

The sole proprietorship is the least complex form of business enterprise.
This form of business is owned by one individual who makes all the
business decisions receives the profits that the business earns and bears
the financial responsibility for losses.
From this description, the simplicity of individual proprietorship is apparent.
Barring legal restrictions any individual can simply decide to go into business
except in areas of enterprise where business licenses are required. Such
restrictions aside, the individual who has accumulated or borrowed sufficient
funds to set up a business can do so. No legal work is required to set up a sole
proprietorship, although the individual proprietor will often seek legal and
accounting advice.
The proprietor is responsible for all business decisions.
• The owner determines how many employees to hire when they should
be rewarded or penalized.
• What products to produce
• How to market
• The owner need not seek anyone’s permission to make such decisions.
• The basic limitation upon decision-making is that the owner must
observe the law and honor the contracts.
• Owner is free to make wise or unwise decisions.
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Advantages:
• Decision-making authority is clear-cut; it resides with the owner
who need not consult anyone.
• Decision making is very fast.
• The profits of the business enterprise are taxed only once.
The individual proprietor will receive any profits that the
businessearns after meeting its expenses.
• The proprietor has to pay personal income taxes on these profits.
Disadvantages:
1. Unlimited Liability:
The first is that the owner must assume unlimited liability
(responsibility) for the debts of the company. The owner enjoys the
profit of the business if it is successful, but if the business suffers a
loss, the owner is personally liable. If the company borrows money,
purchases materials, and incurs other bills that it cannot cover out
of its revenues, the owner must personally cover the losses. The
owner stands to lose personal wealth accumulated over the years in
paying off the debts of the company.

2. Limited Capital:
The second disadvantage of the sole proprietorship is its limited
ability to raise financial capital. This limitation makes it difficult
for sole proprietorships are small businesses. Financial capital for
the expansion of the company can be raised in several ways in the
case of sole proprietorship. The owner can choose to flow profits
back into business.
The owner can use the personal wealth to invest in the company, or
the owner can borrow money from relatives, friends, and lending
institutions. The ability of the owner to borrow is determined by
the owner’s earning capacity (which will depend upon the success
of the business) and personal wealth.
Lending money to an individual proprietorship can be risky
because the success of the business depends very much on one
person, and if that person dies or becomes incapacitated, the
lender will have to stand in line with other creditors.

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 3. Non-permanence:

The third disadvantage is that the business will typically die

with the owner. Since the firm does not have a permanent
existence, it may be difficult to find reliable employees. In fact,
most employees prefer to work in firms that will exist for long and
thus offer employees bright carrier prospects.

2A. Partnership
A partnership is much like an individual proprietorship but with more
than one owner (2 to 20).

A partnership is a business enterprise that is owned by two or more

people (called partners) who make all the business decisions, who share
the profits of the business, and who bear the financial responsibility for
any losses.

Like the individual proprietorship, partnerships are easy to establish.

Most partnerships are based upon an agreement that spells out the
ownership of shares and duties of each partner. The partners may
contribute different amounts of financial capital to the organization;
there may be an agreement on the division of responsibility for running
the business.

One partner may make all the business decisions, while the other partner
(a “silent partner”) may simply provide financial capital. A partnership
can be a corner petrol pump owned by three friends or brothers or a
nationally known law firm or brokerage house.

Advantages:
1. Similar:
The advantages of partnerships are much like those of the sole
proprietorship. Partnerships are easy to set up. The profits of the
company accrue to the partners and are taxed only once as personal
income.

2. Specialization:
Unlike the sole proprietorship, however, there is a greater opportunity to
specialize and divide managerial responsibility because the partnership
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consists of two or more individuals. The partner who is the better
salesperson will be in charge of the sales department. The partner who is
a talented mechanical engineer will be in charge of production. “Two
heads are better than one”, when each has different talents that are
useful to the business enterprise.
3. Large Capital Base:
(Two persons’ capital)
Second a partnership can raise more financial capital than a sole
proprietorship because the wealth and borrowing ability of more than
one person can be mobilized. In fact, if a large number of wealthy
partners can be assembled, such partnership can indeed raise huge sums
of capital.

Disadvantages:
1. Limited Capital (of only the no. of partners):
The ability of the partnership to raise financial capital is limited by the
amount of money the partners can raise out of their personal wealth or
from borrowing.
2. Unlimited Liability:
The partners have unlimited liability for the debts of the partnership. A
business debt incurred by any of the partners is the responsibility of the
partnership. Each partner stands to lose personal wealth if the company
is a commercial failure. Clearly, a conflict in goals can arise because the
richer partner may be more risk-averse than the poorer partner.
3. Complicated Decision-making Process:
“Two heads are better than one” if the two heads agree. But, if partners
fail to agree, decision-making can become quite complicated. In a
partnership where all partners are responsible for management
decisions, there is no longer one single person who is in charge.
Partnerships can be immobilized when partners disagree on a
fundamental policy. Partnerships involve a more complicated decision--
making process that can become more complicated as the number of
partners grows.
4. Instability:
Partnerships can also be unstable. If disagreement over policy causes
one partner to withdraw from the partnership, the partnership must be
reorganized. When one partner dies, again the partnership agreement
must be renegotiated.
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5. Great risk:
Finally, partnerships can involve a considerable risk for the individual
partners. The sole proprietor does bear unlimited liability for the debts
of the company, but at least the owner is the one who makes the business
decision that may turn out to be bad. In case of partnership, each partner
is responsible for business debts incurred by another partner even if that
partner acted without the consent of the other partners.

For this reason, the partnerships are often made up of family

members, close relatives, and close personal friends, who
have come to trust one another over the years Partnership with
more partners would have a greater ability to raise capital. However,
because additional partners complicate decision-making and increase
the like-hood of an irresponsible act being committed by a partner, many
partnerships have a limited number of partners.

2B. Limited Liability Partnership (LLP) [2008]

3. Private Limited Company

Advantages:
(a) Liability limited to the assets of the company.

(b) Easy availability of large credit from financial institutions as well as

small credit from individuals (as fixed deposits)

(c) High scope of growth of the company

(d) Stable organization image among distribution channel partners

(e) Trusted and respected entity

(f) It is possible to attract and employ well-qualified and competent

personnel (managers, non-managerial staff, workers etc.)

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Disadvantages:
(a) Statutory requirement of audit of accounts
(b) Requirement of rules and procedures
(c) More govt. regulations
(d) Closing the company requires govt. approval

4. Corporation:
A. Closely Held Companies

B. Widely Held Companies

The corporation or the corporate form of business was set up to
overcome some of the disadvantages of the proprietorship and
partnership.

A corporation is a form of business enterprise that is owned by a large

number of shareholders. The corporation has the legal status of a
fictional individual and is authorised by law to act as a single person. The
shareholders elect a board of directors that appoints the management of
the corporation, usually headed by a president. Management is charged
with the actual operation of the corporation.

Unlike the sole proprietorship and partnerships that can be established

with minimal paperwork, a corporate charter is required to set up a
corporation. The laws of each state are different, but typically, for a fee,
corporations can be established (incorporated) and can become legal
“persons” subject to the laws of that state.

According to state and Central laws, the corporation has the legal status
of a fictional individual. Officers of the corporation can act in the name
of the corporation without being personally liable for its debts. If
corporate officers commit criminal acts, however, they can be
prosecuted.

The corporation is owned by individuals (shareholders) who have pur-

chased equity shares of stock in the corporation. A shareholder’s share of
ownership of the corporation will equal the number of shares owned by
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that individual divided by the total number of shares outstanding
(owned by shareholders).

If a person owns 1,00,000 shares of PAL stock and there are 630 million
PAL shares outstanding, then the person would own only 0.016 per cent
of PAL. Owners of shares of stock have the right to vote for the board of
directors and to vote on special referenda at the annual meeting of the
corporation.

The management of the corporation is required by law to issue periodic

reports to its shareholders describing the financial and business
activities of the corporation during the reporting period. The
shareholders may cast their votes in person at the annual meeting (the
greater is the number of shares owned, the greater is the weight of the
individual’s vote) or can vote by proxy (that is, turn over voting privileges
to the current management or to some other group).

The shareholder who owns 1 percent of the stock of PAL will receive 1 per
cent of the dividends; the PAL management choose to pay to its
shareholders out of profits. In the case of the sole proprietorship and
partnership, the owners decide what to do with the profits.

In the case of the corporate stockholder, the management determines

what to do with the profits of the corporation. The shareholder who does
not approve of the way these profits are handled can vote to change the
current board of directors or sell the stock and buy some other asset.
Ordinary shares preference shares and convertible bonds are three types
of corporate stock!
Ordinary shares confer voting privileges but no prior claim on dividends.
Common stock dividends are paid only if they are declared by the board
of directors in any given year.

Preference shares confer a prior claim on dividends but no voting

privileges. Dividends on preference shares must be paid before paying
dividends on ordinary shares but after meeting interest obligations.

Convertible stock is a hybrid between a stock and a bond. The owner of

convertible stock receives fixed interest payments but has the privilege of
converting the convertible stock into ordinary share at a fixed rate of
exchange.
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Corporations often have thousands or millions of shares are typically
owned by a large number of stockholders. In the case of closely held
corporations, the number of shareholders is limited, and each
shareholder owns a substantial share of the corporation’s stock.

Unlike the sole proprietor or the partner, shareholders do not participate

directly in the running of the corporation unless they happen to own a
substantial share of the outstanding stock. Moreover, even if an effort
was made to involve shareholders in corporate decision-making, there
would be too many of them they would be graphically dispersed, and
they would be too involved in their own business affairs.

For these reasons, there is usually a separation of ownership and

management in the modern corporation. The board of directors appoints
a professional management team that makes decisions for the
corporation. The professional management team serves as agents for the
corporation.

As long as the corporation is run successfully, the management team is

allowed to continue. If the corporation falls on hard times, then the
shareholders may vote out the current board of directors or the board of
directors itself may decide to bring in a new management team.

Statistical studies of modern corporations have demonstrated the

magnitude of the separation of ownership and management.
Shareholders, however, can exercise substantial indirect control over
management by simply selling their shares. The sale of shares by a
large number of unhappy stockholders will depress the price of each
share and invite possible takeovers by other corporate teams.
Advantages:
1. Limited liability:
The first advantage of the corporation is limited liability. The owners of
the corporation (the shareholders) are not personally liable for the debts
of the corporation. If a corporation incurs debts that it cannot meet, its
creditors will have claim to the assets of the corporation (its bank
accounts, equipment, supplies, buildings and real-estate holdings), but
they cannot file claims against the shareholders. The worst thing that can
happen to shareholders is that the value of their stock will decline (in

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extreme circumstances, it can become worthless).

2. Large capital base:

Limited liability contributes to a second advantage of the corporation.
Corporation can raise large sums of financial capital by selling corporate
bonds, by issuing stock, and by borrowing from public financial
institutions.

3. Separate legal status:

The third advantage of the corporation follows from its status as a legal
individual distinct from the officers of the corporation. A change in the
board of directors, the death or resignation of the current president, or a
transfer ownership could destroy a partnership or sole proprietorship,
but these events do not alter the legal status of the corporation.

The continuity of the corporation is a distinct advantage. Many major US

corporations are more than a century old. Few corporations have the
same owners and officers that they had when the corporations started
their operations.

New shareholders can also be brought into the operation because they
know that the existence of the corporation is not dependent upon the
individuals that currently run the corporation. Continuity also makes it
easier for the firm to hire a carrier-minded and talented labour force.

4. Separation of ownership from management:

The fourth advantage of the corporation follows from the separation of
ownership and management.

Because, the two functions are separated, professional managers who

specialize in running different parts of the corporation’s operations can
be hired. Experience shows that the owners of businesses (those
individuals with money to invest) do not always make the best managers.
In the modern corporation, talented officers can be brought into the
business who own little (or no) capital to invest.
Disadvantages:
1. Double taxation:
The major disadvantage of the corporation is the double taxation of
corporate income. The profits (earnings) of the corporation can either be
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distributed to shareholders as dividends or kept as retained earnings to
be reinvested (ploughed back) in the corporation. The profits of the
corporation are subject to a Central income tax.

If the corporation chooses to plough back all profits into the company,
corporate profits will be taxed only once, but if it distributes some of its
profits to shareholders in the form of dividends, shareholders must pay
personal income tax on these dividends. Corporate profits can, therefore,
be taxed twice, first by the corporate income tax and second by the
personal income tax on dividends.

The double taxation of corporate earnings is indeed a disadvantage, but

the prevalence of the corporate form of business enterprise suggests that
the advantages of corporations (more specifically limited liability) can
compensate for double taxation.

2. Complexity:
A second disadvantage of the corporation is its complexity. A modern
corporation can have thousands or even millions of different owners
(shareholders). Often ownership is so dispersed that it is difficult to get
the owners to agree (or even assemble), even when important issues are
at stake. Power struggles among shareholding groups can break out and
paralyze decision-making.

It is difficult to mobilize widely dispersed stockholders to get rid of

incompetent management. The costs of gathering information about the
complex dealings of the corporation are high to individual shareholders,
who are often poorly informed about the corporation.

3. Conflicting objectives:
A third disadvantage of the corporation is the possibility of
conflicting objectives between the principals (the
shareholders) and the agents (the corporation’s professional
management team). Shareholders are interested in maximizing the
long-run profits of the corporation (thereby getting the best return from
their shares of stock). The professional management team may be more
interested in preserving their jobs or in maximizing their personal
income or perquisites than in profit maximization.

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MNC & TNC

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