Forms of Business OrganisationClass 11 Business Studies Notes

Introduction

Starting or expanding a business involves a very important decision: choosing the right form of organisation. Think of it like choosing the right vehicle for a journey. A bicycle is great for a short trip around the neighborhood, but you'd want a car or a bus for a long-distance journey with lots of luggage. Similarly, the best business structure depends on your specific needs, goals, and resources.

We will explore the advantages and disadvantages of the main forms of business organisations you can choose from:

• Sole proprietorship
• Joint Hindu family business
• Partnership
• Cooperative societies
• Joint stock company

Sole Proprietorship

Have you ever bought a notebook or a pen from a small neighborhood stationery shop? If so, you've likely met a sole proprietor. This is the simplest and one of the most popular forms of business, especially for new and small-scale operations.

A sole proprietorship is a business that is owned, managed, and controlled by a single individual. This person, the sole proprietor, receives all the profits and is responsible for all the risks. The name says it all: "sole" means "only," and "proprietor" means "owner."

Features

• Formation and Closure: Starting and closing a sole proprietorship is very easy. There's no specific law governing it, and very few legal formalities are required, although some businesses might need a specific license to operate.
• Liability: This is a crucial feature. Sole proprietors have unlimited liability. This means the owner is personally responsible for all the business's debts. If the business assets aren't enough to pay off its liabilities, the owner's personal property (like their car or house) can be sold to cover the debt.
• Sole Risk Bearer and Profit Recipient: The owner alone bears all the risks of the business failing. However, if the business succeeds, they get to keep all the profits. This direct reward is a powerful motivator.
• Control: The sole proprietor has complete control over the business. They make all the decisions without needing to consult anyone else.
• No Separate Entity: In the eyes of the law, the business and the owner are one and the same. The business does not have a legal identity separate from its owner.
• Lack of Business Continuity: The business's existence is tied directly to the owner. The death, illness, or bankruptcy of the proprietor can directly impact the business and may even lead to its closure.

Merits

• Quick Decision Making: Since the owner doesn't need to consult anyone, they can make decisions quickly and take advantage of market opportunities as they arise.
• Confidentiality of Information: All business information is kept secret because the sole owner is in charge. They are not required by law to publish their financial accounts.
• Direct Incentive: The owner receives 100% of the profits. This provides a strong incentive to work hard and ensure the business is successful.
• Sense of Accomplishment: Running your own business and being responsible for its success brings a great deal of personal satisfaction and builds confidence.
• Ease of Formation and Closure: As mentioned, this is the least regulated form of business, making it simple to start and stop as the owner wishes.

Limitations

• Limited Resources: The funds for the business are limited to the owner's personal savings and any money they can borrow. Banks are often hesitant to give large, long-term loans to sole proprietorships. This is why these businesses often remain small.
• Limited Life of a Business Concern: The business may end if something happens to the owner. There is no guarantee of continuity.
• Unlimited Liability: This is a major drawback. A single bad decision can lead to serious financial trouble for the owner, putting their personal assets at risk. This often makes proprietors less willing to take big risks like expansion or innovation.
• Limited Managerial Ability: One person has to handle everything—purchasing, selling, financing, etc. It's very rare for one individual to be an expert in all these areas. Also, due to limited funds, they may not be able to hire talented employees.

Joint Hindu Family Business

This is a unique form of business organisation found only in India and is one of the oldest in the country. A Joint Hindu Family (JHF) business, or Hindu Undivided Family (HUF), is a business owned and carried on by the members of a Hindu Undivided Family.

It is governed by Hindu Law. Membership is not by agreement but by birth into the family. Up to three successive generations can be members. The business is controlled by the head of the family, who is the eldest member and is called the karta. All other members, known as co-parceners, have an equal ownership right over the ancestral property.

Features

• Formation: To start a JHF business, there must be at least two family members and ancestral property for them to inherit. No formal agreement is needed, as membership is automatic by birth.
• Liability: The liability of the karta is unlimited. However, the liability of all other members (co-parceners) is limited to their share of the family's property.
• Control: The karta has full control of the business. They make all decisions, and these decisions are binding on all other members.
• Continuity: The business continues even after the death of the karta. The next eldest member automatically takes over the position, making the business stable.
• Minor Members: Since membership is by birth, even minors can be members of the business.

Merits

• Effective Control: With the karta having all decision-making power, there are fewer conflicts among members. This leads to quick and flexible decisions.
• Continued Business Existence: The business is not threatened by the death of the karta, ensuring continuity.
• Limited Liability of Members: Except for the karta, the risk for all other members is limited and well-defined by their share in the property.
• Increased Loyalty and Cooperation: Since the business is a family affair, members often have a strong sense of loyalty and work together for the family's success.

Limitations

• Limited Resources: The business depends mainly on ancestral property, which limits the amount of capital available and restricts the scope for expansion.
• Unlimited Liability of Karta: The karta bears the full responsibility of management and also has unlimited liability, meaning their personal property is at risk.
• Dominance of Karta: The karta's complete control might not be acceptable to all members, which can lead to conflicts and even a breakdown of the family unit.
• Limited Managerial Skills: The karta may not be an expert in all areas of management. Poor decisions can lead to losses for the business.

Partnership

When a sole proprietorship needs more money, more skills, and someone to share the risks with, a partnership becomes a great option.

According to The Indian Partnership Act, 1932, a partnership is "the relation between persons who have agreed to share the profit of the business carried on by all or any one of them acting for all."

Features

• Formation: A partnership is formed through a legal agreement between the partners. This agreement outlines the terms, conditions, profit/loss sharing, and how the business will be run. The business must be lawful and have a profit motive.
• Liability: Partners have unlimited liability. Their personal assets can be used to repay business debts if the business assets are not sufficient. Partners are liable both jointly (as a group) and individually (each partner can be held responsible for the full debt).
• Risk Bearing: The partners share the risks of the business as a team. They also share the profits in an agreed-upon ratio. If there are losses, they are shared in the same ratio.
• Decision Making and Control: The partners share the responsibility of making decisions and managing the day-to-day activities, usually with mutual consent.
• Continuity: A partnership lacks continuity. The death, retirement, or bankruptcy of any partner can legally end the partnership. However, the remaining partners can form a new agreement and continue the business.
• Number of Partners: A minimum of two partners are required. The maximum number of partners is currently 50.
• Mutual Agency: This is a key feature. Every partner is both a principal and an agent. As an agent, a partner can bind the other partners through their actions. As a principal, they are bound by the actions of the other partners.

Merits

• Ease of Formation and Closure: A partnership can be formed easily with an agreement. Registration is not compulsory, and closing the firm is also a simple process.
• Balanced Decision Making: Partners can handle different functions based on their expertise. This reduces the workload on any one person and leads to more balanced and effective decisions.
• More Funds: With multiple partners contributing capital, a partnership can raise more funds than a sole proprietorship.
• Sharing of Risks: Risks are shared among all partners, which reduces the burden and stress on each individual.
• Secrecy: A partnership is not legally required to publish its financial accounts, so it can maintain confidentiality.

Limitations

• Unlimited Liability: This is a major disadvantage. Partners with more personal wealth are at greater risk, as they might have to cover the entire debt if other partners cannot pay their share.
• Limited Resources: Because there is a cap on the number of partners, the total capital that can be raised is still limited, which can hinder expansion beyond a certain point.
• Possibility of Conflicts: Disagreements between partners are common, as decision-making authority is shared. An unwise decision by one partner can cause financial ruin for all.
• Lack of Continuity: The firm can be dissolved if any partner dies, retires, or becomes insolvent.
• Lack of Public Confidence: Since the firm is not required to make its financial information public, it can be difficult for outsiders to assess its true financial status, leading to lower public confidence.

Types of Partners

Partners can have different roles and liabilities:

• Active Partner: Contributes capital, participates in management, shares profits/losses, and has unlimited liability.
• Sleeping or Dormant Partner: Contributes capital, shares profits/losses, and has unlimited liability, but does not participate in day-to-day management.
• Secret Partner: Their association with the firm is unknown to the public. Otherwise, they are just like an active partner (contributes capital, manages, shares profits/losses, has unlimited liability).
• Nominal Partner: Allows the firm to use their name but does not contribute capital, participate in management, or share profits/losses. However, they still have unlimited liability to third parties who give credit to the firm based on their reputation.
• Partner by Estoppel: A person who, through their own actions or behaviour, gives the impression that they are a partner. They are held liable for the firm's debts, even if they don't contribute capital or manage the business.
• Partner by Holding Out: A person who knows that a firm is representing them as a partner and does not issue a denial. They become liable to anyone who extends credit to the firm based on that representation.

Minor as a Partner

A minor cannot legally become a partner. However, with the consent of all other partners, a minor can be admitted to the benefits of a partnership.

• The minor's liability is limited to the capital they contributed.
• They cannot participate in management.
• They can only share profits, not losses.
• Within six months of turning 18, they must decide whether to become a full partner. If they don't give a public notice, they will automatically be treated as a full partner with unlimited liability.

Types of Partnerships

Partnerships can be classified based on duration and liability.

Based on Duration:

• Partnership at Will: Exists as long as the partners wish. It can be terminated anytime a partner gives notice of withdrawal.
• Particular Partnership: Formed for a specific project (like constructing a building) or for a specific period. It dissolves automatically once the project is complete or the time expires.

Based on Liability:

• General Partnership: The liability of all partners is unlimited and joint. All partners can participate in management. Registration is optional.
• Limited Partnership: At least one partner must have unlimited liability, while the others can have limited liability. Limited partners cannot participate in management, and the firm does not dissolve upon their death or insolvency. Registration for this type of partnership is compulsory.

Partnership Deed

A Partnership Deed is a written agreement that specifies the terms and conditions governing the partnership. While an oral agreement is valid, a written deed is highly advisable to avoid future misunderstandings.

It typically includes:

• Name and location of the firm
• Nature and duration of the business
• Capital contributed by each partner
• Profit and loss sharing ratio
• Duties and obligations of partners
• Salaries and withdrawals
• Terms for admission, retirement, or expulsion of a partner
• Procedures for dissolving the firm and settling disputes

Registration

Registration of a partnership firm means getting the firm's name and details entered in the official Register of Firms. While registration is optional under the Indian Partnership Act, 1932, it is highly recommended.

Consequences of Non-Registration:

• A partner cannot sue the firm or other partners.
• The firm cannot sue third parties (like customers who haven't paid).
• The firm cannot file a case against its own partners.

Due to these serious limitations, most firms choose to get registered.

Cooperative Society

The word cooperative means working together for a common purpose. A cooperative society is a voluntary association of people who join together to promote their economic interests and welfare. The main motive is service to its members, not profit.

These societies are formed to protect members from exploitation by middlemen who are focused on earning large profits. A cooperative society must be registered under the Cooperative Societies Act, 1912.

Features

• Voluntary Membership: Anyone can join or leave the society freely. Membership is open to all, regardless of religion, caste, or gender.
• Legal Status: Registration is compulsory, which gives the society a separate legal identity distinct from its members. It can own property, enter into contracts, and sue or be sued in its own name.
• Limited Liability: The liability of members is limited to the amount of capital they have contributed. Their personal assets are safe.
• Control: Power lies with an elected managing committee, chosen by the members. This follows the democratic principle of 'one man one vote,' regardless of how much capital a member has contributed.
• Service Motive: The primary goal is mutual help and welfare. Any surplus or profit generated is distributed among members as a dividend, according to the society's bye-laws.

Merits

• Equality in Voting Status: Every member gets one vote, ensuring a democratic setup.
• Limited Liability: Members' personal property is protected from business debts.
• Stable Existence: The society's continuity is not affected by the death, bankruptcy, or departure of its members.
• Economy in Operations: By eliminating middlemen, costs are reduced. Since members are often the customers or producers, the risk of bad debts is also lower.
• Support from Government: As they promote democracy, cooperative societies often receive government support in the form of lower taxes, subsidies, and loans at low interest rates.
• Ease of Formation: The registration process is simple, with fewer legal formalities compared to a company.

Limitations

• Limited Resources: Capital comes from members, who often have limited means. The low rate of dividend also makes it difficult to attract more capital.
• Inefficiency in Management: Societies often cannot afford to hire expert managers. Members who offer voluntary services may not have the professional skills to manage effectively.
• Lack of Secrecy: Operations are discussed openly in meetings, and disclosure is required by law, making it hard to maintain business secrecy.
• Government Control: In exchange for government support, societies must comply with many rules and regulations, which can interfere with their operational freedom.
• Differences of Opinion: Conflicts can arise among members, leading to difficulties in decision-making. Personal interests can sometimes overshadow the welfare motive.

Types of Cooperative Societies

• Consumer's Cooperative Societies: Formed to protect consumers. They buy goods in bulk directly from wholesalers and sell them to members at reasonable prices, eliminating middlemen.
• Producer's Cooperative Societies: Formed to protect small producers. They supply raw materials and equipment to members and may also sell their finished products, enhancing their bargaining power against large capitalists.
• Marketing Cooperative Societies: Help small producers sell their products. They pool the output of members and handle marketing functions like transportation and warehousing to get the best possible price.
• Farmer's Cooperative Societies: Provide better quality seeds, fertilizers, and machinery to farmers. This helps them benefit from large-scale farming and increase productivity.
• Credit Cooperative Societies: Provide easy credit and loans to members at reasonable interest rates, protecting them from exploitation by lenders who charge high rates.
• Cooperative Housing Societies: Help people with limited income construct houses at reasonable costs. They may build flats or provide plots to members, often with payment in installments.

Joint Stock Company

A company is an association of people formed to carry out business activities. It has a legal status that is independent of its members. It is governed by The Companies Act, 2013.

A company can be described as an artificial person with a separate legal entity, perpetual succession, and a common seal.

The owners of the company are the shareholders, but the business is managed by a Board of Directors elected by them. The company's capital is divided into small units called shares, which can be freely transferred (in a public company).

Features

• Artificial Person: A company is a creation of law. It can own property, borrow money, and enter into contracts just like a person, but it cannot breathe, eat, or talk.
• Separate Legal Entity: From the day it is incorporated, a company has its own identity, separate from its owners (shareholders). Its assets and liabilities are its own, not those of its members.
• Formation: Forming a company is a complex, time-consuming, and expensive process involving many legal requirements and documents.
• Perpetual Succession: A company's existence is not affected by the death, retirement, or insolvency of its members. It can only be brought to an end through a specific legal procedure called winding up. "Members may come and members may go, but the company continues to exist."
• Control: The Board of Directors manages and controls the company. Shareholders do not have the right to be involved in the day-to-day running of the business.
• Liability: The liability of shareholders is limited to the amount of capital they have contributed, specifically the unpaid amount on their shares. Their personal assets are safe.
• Risk Bearing: The risk of loss is spread across a large number of shareholders.

Merits

• Limited Liability: This is a major advantage, as it reduces the risk for investors and encourages them to invest.
• Transfer of Interest: Shares of a public company can be easily sold in the stock market, allowing investors to convert their investment into cash whenever they need.
• Perpetual Existence: The company has a stable and continuous life, unaffected by changes in its membership.
• Scope for Expansion: A company can raise large amounts of capital by issuing shares to the public and taking loans from banks, giving it huge scope for growth.
• Professional Management: A company can afford to hire specialists and experts to manage different departments, leading to greater efficiency and balanced decision-making.

Limitations

• Complexity in Formation: The formation process is complicated and expensive.
• Lack of Secrecy: Public companies must disclose a lot of information to the public and the Registrar of Companies, making it difficult to maintain secrecy.
• Impersonal Work Environment: The separation of ownership and management can lead to a lack of personal involvement from employees and managers. It's hard for top management to maintain personal contact with employees and customers.
• Numerous Regulations: Companies are subject to many legal rules and restrictions regarding audits, reporting, and voting, which reduces their operational freedom.
• Delay in Decision Making: Decisions must go through multiple levels of management (Board of Directors, top, middle, lower), which can cause significant delays.
• Oligarchic Management: In theory, a company is democratic. In practice, because shareholders are spread out and few attend meetings, the Board of Directors often has complete control, sometimes acting against shareholder interests. This becomes a "rule by a few."
• Conflict in Interests: Different stakeholders have conflicting goals. Employees want higher salaries, customers want lower prices, and shareholders want higher dividends. Balancing these interests can be very difficult.

Types of Companies

Private Company

A private company is one which:

• Restricts the right of members to transfer its shares.
• Has a minimum of 2 and a maximum of 200 members.
• Does not invite the public to subscribe to its securities (shares or debentures).

A private company must use the words "Private Limited" after its name.

Privileges of a Private Company:

• Can be formed with only two members (a public company needs seven).
• Does not need to issue a prospectus.
• Can start its business as soon as it receives the certificate of incorporation.
• Needs only two directors (a public company needs three).

Public Company

A public company is a company that is not a private company. It:

• Has a minimum of 7 members and no maximum limit.
• Has no restriction on the transfer of its securities.
• Can invite the public to subscribe to its securities.

Choice of Form of Business Organisation

Choosing the right form of organisation is a critical decision that depends on several factors. There is no single "best" form; the ideal choice depends on the specific needs of the business.

Here are the key factors to consider:

• Cost and Ease in Setting Up:

  • Most Advantageous: Sole proprietorship is the cheapest and easiest to start, with minimal legal formalities.
  • Least Advantageous: A company is the most complex and expensive to form due to its lengthy legal procedures.

• Liability:

  • Most Advantageous: A company and cooperative society offer limited liability, protecting the personal assets of the owners/members. This is a huge advantage for investors.
  • Least Advantageous: Sole proprietorship and partnership have unlimited liability, which puts the owners' personal wealth at risk.

• Continuity:

  • Most Advantageous: A company, cooperative society, and Joint Hindu Family business have stable, continuous existence that is not affected by the death or departure of members.
  • Least Advantageous: Sole proprietorship and partnership lack continuity and can be dissolved easily.

• Management Ability:

  • Most Advantageous: A company can afford to hire professional managers and experts for different functions, leading to better decision-making.
  • Least Advantageous: A sole proprietor must handle all management functions alone, often without expertise in every area.

• Capital Considerations:

  • Most Advantageous: A company is in the best position to raise large amounts of capital by issuing shares to the public.
  • Least Advantageous: A sole proprietorship has very limited financial resources.

• Degree of Control:

  • Most Advantageous: A sole proprietorship offers absolute control and direct decision-making power to the owner.
  • Least Advantageous: In a company, there is a separation of ownership and management. Owners (shareholders) have very little direct control.

• Nature of Business:

  • If direct, personal contact with customers is important (like a grocery store or salon), a sole proprietorship is often more suitable.
  • For large manufacturing units where personal contact isn't necessary, a company is a better choice.
  • For professional services (like law or accounting firms), a partnership is often preferred.