2.11 – Forms of Business Organizations

This chapter discusses different kind of private sector business organizations.

Sole Proprietorship

It refers to a form of business organization which is owned, managed and controlled by a single individual who is the recipient of all profits and bearer of all risks.

Features

  1. Individual ownership
  2. Easy formation and easy closing
    • No legal formalities to open a sole proprietorship business.
    • No legal formalities to shut down the business.
  3. Unlimited liabilities
    • This implies that the owner is personally responsible for payment of debts in case the assets of the business are not sufficient to meet all the debts.
    • As such the owner’s personal possessions such as his/her personal car and other assets could be sold for repaying the debt.
  4. Sole risk bearer and profit recipient
    • The risk of failure of business is borne all alone by the sole proprietor. However, if the business is successful, the proprietor enjoys all the benefits. He receives all the business profits which become a direct reward for his risk bearing.
  5. Control
    • The right to run the business and make all decisions lies absolutely with the sole proprietor.
    • He can carry out his plans without any interference from others.
  6. No separate entity
    • In the eyes of the law, no distinction is made between the sole trader and his business, as business does not have an identity separate from the owner.
    • The owner is, therefore, held responsible for all the activities of the business.
  7. Lack of business continuity
    • Since the owner and business are one and the same entity, death, insanity, imprisonment, physical ailment or bankruptcy of the sole proprietor will have a direct and detrimental effect on the business and may even cause closure of the business.

Examples of Sole Proprietorship

  • Grocery store, stationery store, medical store, bakery, small factories, tailor units, dry cleaning, internet cafés, salons, craft centers, embroidery works, etc.

Merits

  1. Quick decision making – Peter has all freedom to make decisions
  2. Confidentiality of information – Peter keeps all his business secrets
  3. Ease of opening and closure – No big legal formalities
  4. Direct incentives – Peter gets all profits
  5. Sense of accomplishment – When his ice-creams become more popular, Peter feels a great pride and satisfaction
  6. Flexibility of operation – Peter can do anything as he wishes

Limitations

  1. Limited resources – Peter doesn’t have a lot of money to invest so his business will have to remain small. Even banks do not give him long term loans of big amount.
  2. Unlimited liability – Peter will have to suffer any kind losses
  3. Limited life of business concern – Eat India Company can get closed in case of Peter’s:
    1. Death
    2. Illness
    3. Imprisonment
    4. Insolvency – Unable to pay bank loans
    5. Insanity – Becoming mentally ill
  4. Limited managerial ability – Peter may be good as an entrepreneur but he is not a good manager

Joint Hindu Family Business

Features

  1. Membership by birth – Siddharth, by being born to a Hindu family that has a business, becomes a member of the business
  2. No maximum limit –
  3. Formation – There should be at least two members and ancestral property
  4. Control – Karta is the controller of this kind of business
  5. Liability – Karta has the highest liability while the members have limited liability as per their shares
  6. Continuity – Business is not affected by the Karta’s death. The eldest of the members will become the next karta
  7. Minor Members – Since membership is taken by birth, minors can also become members of the business

Questions & Answers

  1. What is joint Hindu family business? What are its features?
    Hints
    – Define – Karta – Co-parceners – Dayabhaga (WB) – Mitakashara (Except WB) – FeaturesLiability limited to the share of co-parcenery property – Control is in the karta’s hands – Continuity of the business is never at risk until the parceners agree to terminate the business – Minor members of the families can join the business.
  2. What are the advantages of Joint Hindu Family Business?
    Hints – Effective control – long-term business existence – limited liability of members – high loyalty and cooperation
  3. What are the limitations of HJFB – Joint Hindu Family Business?
    Hints – Limited resources

Partnership

After running Eat India Company for 5 years, Peter suffered certain losses. He then decided to convert his company into a partnership firm with Sidharth Gupta. Let’s see how Eat India Company as a partnership firm works:

What are the features of partnership?

  1. Formation
    1. Under the Indian Partnership Act, 1932
    2. Partnership Deed (Agreement)
  2. Membership
    1. Minimum of 2 partners
    2. Maximum 50 members
  3. Unlimited Liability – All partners have unlimited liability
  4. Risk Bearing – Both Peter and Sidharth have to bear all the losses involved in the running of the business.
  5. Decision Making and Control – Both Peter and Sidharth have equal decision making power. Mutual consent.
  6. Continuity – If Peter or Sidharth died, became insolvent, retired, became mentally ill, the partnership comes to a break. Eat India Company can continue being a partnership by issuing a new partnership deed by adding other partners.
  7. Mutual Agency – Partnership can be carried on by all partners or any one of them acting for all.

What are the merits/advantages of partnership?

  1. Ease of formation and Closure
  2. Balanced Decision making
  3. More funds
  4. Sharing of risks –
  5. Secrecy

What are the limitations of partnership business?

  1. Unlimited liability
  2. Limited resources
  3. Possibility of conflicts
  4. Lack of continuity
  5. Lack of public trust/confidence

What are the types of partners?

  1. Active partner
  2. Sleeping or Dormant partner
  3. Secret Partner
  4. Nominal Partner
  5. Partner by Estoppel – His/her behavior makes people take a non-partner for a partner
  6. Partner by holding out – One who intentionally gives the impression that he/she is a partner

What are the types of partnership?

Based on Duration

  1. Partnership at Will
    1. Exists at the will/wish of the partners.
    2. Lasts as long as the partners will/wish
    3. Terminate by giving a withdrawal notice.
  2. Particular partnership
    1. Formed for a particular project/purpose
    2. Terminates when the project is completed.

Based on Liability

  1. General Partnership
    1. Unlimited and joint liability for all partners – All partners have to suffer any loss to the firm.
    2. All partners have the right to participate in the management of the firm.
    3. Registration of the firm is optional.
    4. The firm expires with the death/lunacy/insolvency/retirement of the partners.
  2. Limited Partnership
    1. At least one partner has unlimited liability.
    2. This partnership does not terminate with the death/lunacy/insolvency/retirement of the limited partners.
    3. Limited partners do not enjoy the right of management.
    4. Registration is compulsory.

Cooperative Societies

Definition

It is a form of organization wherein people voluntarily associate together on the basis of equality for the promotion of economic interest for themselves.

Case

Mr. Ragav and Mr. Peter are members of a Co-operative society formed in their residential colony. The name of the Co-operative is Whie & Light Milk Society for helping over 300 families that depend on their milk produces.

  • Members – 300+
  • Core activity – Creamery. Production of milk and milk products
  • Institutions – White & Light cattle farm; creamery; cheese unit; curd unit; milk unit; Pasteurization unit, etc
  • Monthly income – 1 million rupees

Features

  • Voluntary membership/association
  • Equal voting rights – All the members of White & Light have equal voting rights.
  • Service motive – The only motive of White & Light is and should be service. No business here, please!
  • Separate legal status/entity
  • Distribution of surplus – Members get profits based on their work and contribution; not based on their investment.

Questions

  1. Mr. Ragav and Mr. Peter are members of a Co-operative society formed in their residential colony. The name of the Co-operative is Whie & Light Milk Society for helping over 300 families that depend on their milk produces. What are the benefits both Ragav and Peter expected to get from the Society?

Merits

Ease of formation

  • 10 adults can form a cooperative society.
  • Registration process is very simple involving a few legal formalities.

Democratic Management.

  • Equality in voting status.
  • The principle of ‘one man – one vote’ governs the cooperative society.
  • Irrespective of the amount of capital contribution by a member, each member is entitled to equal voting rights.

Limited liability

  • The liability of members of a cooperative society is limited to the extent of their capital contribution. The personal assets of the members are, therefore, safe from being used to repay business debts.
  • Like, members will not suffer from liability. Even if the business failed or stopped, the members can go to fishing with their old boat!

Stable existence

  • Death, bankruptcy or insanity of the members do not affect continuity of a cooperative society. A society, therefore, operates unaffected by any change in the membership.
  • Like, the cooperative will not stop functioning because of the death of a member.

Economy in operation

  • As the focus is on elimination of middlemen, this helps in reducing costs.
  • The customers or producers themselves are members of the society, and hence the risk of bad debts is lower.
  • Like, the fishing business will go on uninterrupted.

Support from government

  • The cooperative society exemplifies the idea of democracy and hence finds support from the Government in the form of low taxes, subsidies, and low interest rates on loans.
  • Like, the cooperative of the fishermen will be eligible for lower taxes, subsidies and low interest rates on loans.

Limitations

Limited resources

  • Resources of a cooperative society consists of capital contributions of the members with limited means.
  • The low rate of dividend offered on investment also acts as a deterrent in attracting membership or more capital from the members.
  • Like, “because the fishermen are economically backward, they cannot raise a big capital/money so the boat they can buy will not be sufficient.

Lack of Secrecy

  • As a result of open discussions in the meetings of members as well as disclosure obligations as per the Societies Act (7), it is difficult to maintain secrecy about the operations of a cooperative society

Inefficiency in management

  • Cooperative societies are unable to attract and employ expert managers because of their inability to pay them high salaries.
  • The members who offer honorary services on a voluntary basis are generally not professionally equipped to handle the management functions effectively.
  • Like, “As the members of the society are mostly uneducated and not well qualified to run a business, the management will make wrong decisions.

Government control

  • In return of the privileges offered by the government, cooperative societies have to comply with several rules and regulations related to auditing of accounts, submission of accounts, etc.
  • Interference in the functioning of the cooperative organisation through the control exercised by the state cooperative departments also negatively affects its freedom of operation.
  • Like, “Due to the government control, the cooperative society of the fishermen will have to abide by so many rules and regulations of the government thus losing their freedom to exercise.

Questions

  1. Government involvement in a cooperative society does good and bad at the same time. Elaborate. (4 marks)
  2. Recently Prime Minister Narendra Modi, in a meeting with the Kerala CM suggested forming a cooperative society for fishermen on the coast of Kerala to effectively deal with fish-scarcity and tackling the high expenditure of fishing/trolling equipment such as big boats/ships. How will the formation of a cooperative society help the fishermen? What hurdles will they have to jump? (4 marks)

Types of Cooperative Societies

Consumer Cooperative Societies

  1. It is formed to protect the interest of the consumers.
  2. It eliminates middlemen and makes sure quality goods reach the consumer at reasonable prices.
  3. Profits are distributed among the members of the cooperative on the basis of either their capital contribution to the society or purchases made by of members.

Producer Cooperative Societies

  1. It is formed to protect the interest/concern of small producers and help them in procuring/getting inputs for production of goods.
  2. It supplies raw-materials and equipment to the members.
  3. Eliminates middlemen of small producers.

Marketing Cooperative Societies

  1. It is established to help small producers in selling their products at the best possible prices.
  2. Eliminates middlemen of marketing.

Farmer’s Cooperative Societies

  1. It is established to protect the interest/concerns of farmers by providing better inputs at reasonable costs.
  2. It provides better quality seeds, fertilizers, machinery and other techniques for the cultivation of crops.

Credit Cooperative Societies

  1. Credit Cooperative Societies provide easy credit and loans to members at reasonable terms.
  2. They protect the members from money lenders who charge high rate of interest.

Cooperative Housing Societies

  1. Cooperative housing societies help members with limited/low income to construct or buy houses at reasonable cost.
  2. The money can be paid in easy installments.

Questions

  1. How do consumers’ cooperative societies help the consumers? (2 marks) Hints – No exploitation from the middlemen – protect the interest of the consumers – reasonable prices – buys directly from wholesalers – sells among members of the society – profits distributed equally
  2. How do producer’s cooperatives societies function? (2 marks) Hints – Protect the interests of small-scale producers – fight against big capitalists – enhance the bargaining power of the small producers – help the producers buy raw-materials at a cheaper price and buy their produce at a reasonable price and sell.
  3. You are a farmer in the village of Champa, Madhya Pradesh. Unfortunately, the lack of capital/money always prevents you to farm in a large scale. Recently you heard about farmer’s cooperative societies that aim at enabling small-scale farmers to work jointly. How will you form your own farmers’ cooperative society in Champa?
  4. Imagine that you are going to buy a house in a decent and safe colony but the property dealers in the area have a number of houses in their hold but they cost more than 90 lakhs. How can a cooperative housing society help you buy your dream home at half the price? (2 marks) Hints – CHSs aim at helping low income people own decent homes at reasonable prices – installment payments – no exploitation of the agents.

Joint Stock Company

  • A company is an association of persons formed for carrying out business activities and has a legal status independent of its members.
  • The company form of organisation is governed by The Companies Act, 1956.
  • A company can be described as an artificial person having a separate legal entity, perpetual succession and a common seal.
  • The shareholders are the owners of the company while the Board of Directors is the chief managing body elected by the shareholders.
  • Usually, the owners exercise an indirect control over the business.
  • The capital of the company is divided into smaller parts called ‘shares’ which can be transferred freely from one shareholder to another person (except in a private company).

Features

Artificial person

  • A company is a creation of law and exists independent of its members.
  • Like natural persons, a company can own property, incur debts, borrow money, enter into contracts, sue and be sued but unlike them it cannot breathe, eat, run, talk and so on.
  • It is, therefore, called an artificial person.

Separate legal entity

  • From the day of its incorporation, a company acquires an identity, distinct from its members.
  • Its assets and liabilities are separate from those of its owners.
  • The law does not recognise the business and owners to be one and the same.

Formation

  • The formation of a company is a time consuming, expensive and complicated process.
  • involves the preparation of several documents and compliance with several legal requirements before it can start functioning.
  • Registration of a company is compulsory as provided under the Indian Companies Act, 1956.

Perpetual succession

  • A company being a creation of the law, can be brought to an end only by law.
  • It will only cease to exist when a specific procedure for its closure, called winding up, is completed.
  • Members may come and members may go, but the company continues to exist.

Control

  • The management and control of the affairs of the company is undertaken by the Board of Directors, which appoints the top management officials for running the business.
  • The directors hold a position of immense significance as they are directly accountable to the shareholders for the working of the company.
  • The shareholders, however, do not have the right to be involved in the day-to-day running of the business.

Liability

  • The liability of the members is limited to the extent of the capital contributed by them in a company.
  • The creditors can use only the assets of the company to settle their claims since it is the company and not the members that owes the debt.
  • The members can be asked to contribute to the loss only to the extent of the unpaid amount of share held by them.
  • Suppose Akshay is a shareholder in a company holding 2,000 shares of Rs.10 each on which he has already paid Rs. 7 per share.
  • His liability in the event of losses or company’s failure to pay debts can be only up to Rs. 6,000 — the unpaid amount of his share capital (Rs. 3 per share on 2,000 shares held in the company).
  • Beyond this, he is not liable to pay anything towards the debts or losses of the company.

Common seal

  • The company being an artificial person acts through its Board of Directors.
  • The Board of Directors enters into an agreement with others by indicating the company’s approval through a common seal. The common seal is the engraved equivalent of an official signature.
  • Any agreement which does not have the company seal put on it is not legally binding on the company.

Risk bearing

  • The risk of losses in a company is borne by all the share holders.
  • This is unlike the case of sole proprietorship or partnership firm where one or few persons respectively bear the losses.
  • In the face of financial difficulties, all shareholders in a company have to contribute to the debts to the extent of their shares in the company’s capital.
  • The risk of loss thus gets spread over a large number of shareholders.

Merits

Limited liability

  • The shareholders are liable to the extent of the amount unpaid on the shares held by them.
  • Also, only the assets of the company can be used to settle the debts, leaving the owner’s personal property free from any charge.
  • This reduces the degree of risk borne by an investor.

Transfer of interest

  • The ease of transfer of ownership adds to the advantage of investing in a company as the share of a public limited company can be sold in the market and as such can be easily converted into cash in case the need arises.
  • This avoids blockage of investment and presents the company as a favourable avenue for investment purposes.

Perpetual existence

  • Existence of a company is not affected by the death, retirement, resignation, insolvency or insanity of its members as it has a separate entity from its members.
  • A company will continue to exist even if all the members die.
  • It can be liquidated only as per the provisions of the Companies Act.

Scope for expansion

  • As compared to the sole proprietorship and partnership forms of organisation, a company has large financial resources.
  • Further, capital can be attracted from the public as well as through loans from banks and financial institutions. Thus there is greater scope for expansion.
  • The investors are inclined to invest in shares because of the limited liability, transferable ownership and possibility of high returns in a company.

Professional management

  • A company can afford to pay higher salaries to specialists and professionals.
  • It can, therefore, employ people who are experts in their area of specialisations.
  • The scale of operations in a company leads to division of work.
  • Each department deals with a particular activity and is headed by an expert. This leads to balanced decision making as well as greater efficiency in the company’s operations.

Limitations

Complexity in formation

  • The formation of a company requires greater time, effort and extensive knowledge of legal requirements and the procedures involved.
  • As compared to sole proprietorship and partnership form of organisations, formation of a company is more complex.

Lack of secrecy

  • The Companies Act requires each public company to provide from time-to-time a lot of information to the office of the registrar of companies.
  • Such information is available to the general public also. It is, therefore, difficult to maintain complete secrecy about the operations of company.

Impersonal work environment

  • Separation of ownership and management leads to situations in which there is lack of effort as well as personal involvement on the part of the officers of a company.
  • The large size of a company further makes it difficult for the owners and top management to maintain personal contact with the employees, customers and creditors.

Numerous regulations

  • The functioning of a company is subject to many legal provisions and compulsions.
  • A company is burdened with numerous restrictions in respect of aspects including audit, voting, filing of reports and preparation of documents, and is required to obtain various certificates from different agencies, viz., registrar, SEBI, etc.
  • This reduces the freedom of operations of a company and takes away a lot of time, effort and money.

Delay in decision making

  • Companies are democratically managed through the Board of Directors which is followed by the top management, middle management and lower level management.
  • Communication as well as approval of various proposals may cause delays not only in taking decisions but also in acting upon them.

Oligarchic management

  • In theory, a company is a democratic institution wherein the Board of Directors are representatives of the shareholders who are the owners.
  • In practice, however, in most large sized organisations having a multitude of shareholders; the owners have minimal influence in terms of controlling or running the business.
  • It is so because the shareholders are spread all over the country and a very small percentage attend the general meetings.
  • The Board of Directors as such enjoy considerable freedom in exercising their power which they sometimes use even contrary to the interests of the shareholders.
  • Dissatisfied shareholders in such a situation have no option but to sell their shares and exit the company.
  • As the directors virtually enjoy the rights to take all major decisions, it leads to rule by a few.

Conflict in interests

  • There may be conflict of interest amongst various stakeholders of a company.
  • The employees, for example, may be interested in higher salaries, consumers desire higher quality products at lower prices, and the shareholders want higher returns in the form of dividends and increase in the intrinsic value of their shares.
  • These demands pose problems in managing the company as it often becomes difficult to satisfy such diverse interests.

Types of Companies

Private Company

  • A private company restricts the right of members to transfer its shares.
  • A private company has a minimum of 2 and a maximum of 50 members, excluding the present and past employees.
  • A private company does not invite public to subscribe to its share capital.
  • A private company must have a minimum paid up capital of Rs.1 lakh or such higher amount which may be prescribed from time-to-time.
  • It is necessary for a private company to use the word private limited after its name. If a private company contravenes any of the aforesaid provisions, it ceases to be a private company and loses all the exemptions and privileges to which it is entitled.

Privileges

  • A private company can be formed by only two members whereas seven people are needed to form a public company.
  • There is no need to issue a prospectus as public is not invited to subscribe to the shares of a private company.
  • Allotment of shares can be done without receiving the minimum subscription.
  • A private company can start business as soon as it receives the certificate of incorporation.
  • The public company, on the other hand, has to wait for the receipt of certificate of commencement before it can start a business.
  • A private company needs to have only two directors as against the minimum of three directors in the case of a public company.
  • A private company is not required to keep an index of members while the same is necessary in the case of a public company.
  • There is no restriction on the amount of loans to directors in a private company. Therefore, there is no need to take permission from the government for granting the same, as is required in the case of a public company.

Public Company

  • A public company means a company which is not a private company.
  • A public company has a minimum paid-up capital of Rs. 5 lakhs or a higher amount which may be prescribed from time-to-time.
  • A public company has a minimum of 7 members and no limit on maximum members.
  • A public company has no restriction on transfer of shares.
  • A public company is not prohibited from inviting the public to subscribe to its share capital or public deposits.
  • A private company which is a subsidiary of a public company is also treated as a public company.

Stages in the formation of a Company

1. Promotion (For Private and Public)

  1. Identification of business idea or opportunities – It is very important to identify the purpose of business – the goods it is going to produce or the services it will render, etc.
  2. Feasibility studies – The promoters undertake detailed feasibility studies to investigate all aspects of business with the help of specialized experts.
  3. Name Approval – Having decided to launch a company, the promoters have to select a name for it and submit an application to the registrar of the companies. The proposed name must not be identical to another existing name of a company.
  4. Fixing up signatory/association – Promoters have to decide about the members who will sign the memorandum.
  5. Preparation of necessary legal documents – Documents are to be submitted to the registrar of companies for the registration of the companies. These documents include documents of assertion, article of association and prospectus.

2. Incorporation (For Private and Public)

Incorporation means registration of the company according to the Indian Company’s Act.

  1. The promoters have to make an application along with the memorandum and article of association, copy of registrar’s letter aproving the company’s name, address of the registered office and necessary registration fees.
  2. If the registrar is satisfied about the formalities, will issue a certificate of incorporation. A private company can start its affairs immediately after that but the public company has to undergo two more stages.

Questions

  1. What are the documents to be submitted to the registrar? The following are the necessary documents to be submitted to the registrar of companies. Memorandum of Association, Articles of Association, Consent of proposed directors, Agreement, if any, with proposed managing or whole time director, Statutory declaration, Payment of Fees, Registration and the Certificate of Incorporation.

Now, the private company registration is complete. It can go one with its activities. Let’s now move to the two stages that a public (government) has to undergo:

3. Capital Subscription Stage (For Public)

After incorporation (registration), the company has to raise necessary funds from the general public.

  1. Prior approval from SEBI (Securities Exchange Board of India). It is for protecting the interests of the investors.
  2. Filing of prospectus. The company has to make a prospectus or statement in lieu of (in agreement with) the prospectus and file it with the registrar.
  3. The directors have to appoint the company’s banks, brokers and underwriters.
  4. Every public company must raise minimum subscription amount, which is 90% of the total shares offered in order to avoid shortage of funds.
  5. Before starting to sell the shares, the company has to get itself listed in the stock exchange. After that, shares are allocated.

4. Commencement of Business (For Public)

After receiving a minimum subscription amount, the company must make an application to the registrar for the issue of the certificate of the commencement (starting) of the business.

  • A declaration is to be made that a minimum subscription amount has been made.
  • A declaration that the directors have paid for the qualification of shares.
  • A declaration that is required relating to the commencement of business have been duly made.

Biju John is an educational writer, educator and the author of OM - The Otherwise Men. He gives live classes on Skype and Facebook. You can attend his 3 Day Classes (English & Business Studies) in Delhi, Bangalore, Qatar and Dubai. His Contact number is 91 9810740061.

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