1.

2 Types of business entities

Distinction between the
private and the public
sectors(AO2):

• The private sector of the economy consists of

businesses owned and run by private
individuals and organizations that usually, but
not always, aim to earn a profit. They operate
independently of the government, although
need to operate within the rules and
regulations in the country.
Examples of private sector businesses, which
are covered in this section of the syllabus,
include the following:

• Sole traders
• Partnerships
• Privately held companies
• Publicly held companies
• Social enterprises, including cooperatives and
non-governmental organizations
• Multinational corporations (MNCs)
 The table below outlines the main features of firms in
public and private sectors of the economy, and how they
differ.

Feature Private sector Public sector

Owned and operated by private individuals or Owned and operated by government bodies and
Ownership and control
businesses state-owned firms
Driven by the goal of making profits for private owners Driven by the goal of providing services to the general
Motive (motivation)
and shareholders public

Includes sole proprietorships, partnerships, limited Includes government departments (such as the tax
Types of organizations
liability companies, and social enterprises authorities), public enterprises, and regulatory bodies

Operates based on market forces of demand (such as Operates based on government decisions, policies,
Operating mechanism
consumer choice) and supply (such as competition) and regulations

Employment and economic Significant employer contributing to the economic Significant employer providing stable employment
contribution growth and development of the country as a whole and essential public services
Types of Sole traders Partnerships
business
organization
in the private
sector:[AO3] Privately
held
Publicly held
companies
companies
1. Sole trader:

• A sole trader (also known as a sole proprietor) is a commercial for-profit

business owned by a single person. Although this person can employ as
many people as needed, the sole trader is the only owner of the business.
Advantages of sole traders:
• It is the quickest and easiest type of business to set up. Sole traders can avoid complicated and costly set -up
procedures.
• The owner receives all of the profits if the business succeeds.
• Sole traders are likely to be highly motivated as the owners have a sense of achievement from running their own
business and can keep all of the profits made.
• The sole trader (owner) has complete control without having to consult with or be accountable to others.
• Hence, decision-making is also swift as the owner does not have to consult anyone else and seek their permission
to execute a decision.
• The sole trader enjoys privacy as it only needs to publish its financial accounts to the tax authorities (rather than
to the general public like a publicly held company). For example, sole traders in Hong Kong only need to submit
paperwork for the Inland Revenue if their annual sales revenue exceed HK$2m (around US$260,000). Similarly,
sole proprietors in the UK are able to complete their own business tax returns without the formal requirement of
final accounts being externally audited.
• The owner can benefit from tax advantages. As a small business, many sole traders work from home, so can claim
tax concessions by using part of their home for business purposes.
Disadvantages of sole traders:
• The finance to set up and run the business is generally provided by the owner (from personal savings) as s/he cannot easily access external sources of
finance.
• The sole trader accepts all the risks of owning and running their own business, including any losses made or even the collapse of the organization.
• The workload for a sole trader can be extremely high. There is no one else to share ideas or to ask questions, so all pressures, burdens and responsibilities fall
on the owner. This means the sole trader often has to work very long hours.
• Legally, a sole trader is treated as the same legal entity as the business, i.e. it is an unincorporated business. This means the sole trader has unlimited
liability so is responsible for any debt owed to other individuals or organizations, even if this requires the owner to pay the debts f rom their personal
belongings and assets.
• There is a lack of continuity in the operations of the business if the owner is unwell, wishes to take a holiday or wants to retire. The latter is a main reason
why many sole trader businesses struggle to continue.
• As sole proprietorships are usually small businesses (such as a small convenience store owner), they are unlikely to be able to gain any economies of scale,
perhaps because they cannot buy their materials or stocks (inventory) in bulk. This means sole traders pay more for their goods, their prices charged to
customers also tend to be higher. By contrast, larger business (such as supermarket chains)gain these cost-saving benefits, so are able to charge much lower
prices due to their ability to exploit economies of scale.
• Since access to external finance is difficult for most sold traders (because they represent a high degree of risk), expansionof the business is difficult.
 2. Partnerships

For an ordinary partnership, the maximum

number of partners is usually capped at twenty
owners, although this does vary from one country
to another. Some organizations can have more
A partnership is a commercial business that than 20 partners, such as law firms and health
strives to earn a profit for its owners. It is owned by clinics. Highly specialised professional service
two or more people. providers (such as doctors, solicitors, dentists
and accountants) are usually set up as
partnerships. Many family-run businesses are
also established as partnerships. The owners of a
partnership are called partners.
 Advantages
of
partnerships:
Disadvantages of partnerships:
As the business has more than one owner, this can easily lead to disagreements and
conflict between the owners, which can seriously damage the running of the partnership.

Decision making is slower than with sole traders because there are more owners
involved. This can also lead to disagreements and conflicts between the owners

Unlike with a sole trade, the profits made by a partnership must be shared between all
the owners.

In general, partners have unlimited liability so are liable for any debts, fines, penalties or
law suits against the business, even if this these were caused by another partner in the
firm. However, sleeping partners are exempt from unlimited liability.

Compared to limited liability companies, access to finance is restricted to the finances

available from the different partners in the firm. There is no maximum number of owners
in limited liability companies, so they can raise finance through their shareholders.

There is no continuity if a partner decides to leave the firm or if one of the partners die.
This is because such cases would void the Deed of Partnership. There would be a time
delay in setting up a new partnership agreement.
Companies (also known as corporation) are commercial for-
profit businesses owned by shareholders. Hence, the profits of a
company belong to and are shared among the various owners. As
incorporated businesses, the owners have limited
liability. Limited liability protects shareholders who cannot lose
more than the amount they invested in the business. This is
because shareholders are not personally liable for the debts of
the company should it go into debt or bankruptcy.

In legal terms, there is a divorce of ownership and control as the

owners (shareholders) are treated as separate legal entities from
those who control and run the business (the board of directors
and CEO). It is the board of directors and the CEO (or managing
director) who are responsible for the strategic direction of the
company.

There are two categories of companies: privately held

companies and publicly held companies.
Features of privately held
companies:
• The shares of privately held companies cannot be advertised for sale nor sold via
a stock exchange. Shares are not available on an open stock exchange such as
the New York Stock Exchange.
• Most privately held companies (often referred to as private limited
companies) are small businesses, with shares typically owned by family,
relatives, and friends.
• The company and its owners are separate legal entities, i.e., there is a legal
divorce (separation) of ownership and control, with the owners (shareholders)
appointing a board of directors to run the company on their behalf.
• Owners have limited liability, so if the business experiences a financial collapse,
then the owners will only be liable for the capital they invested in the company.
• The number of shareholders in a privately held company may be limited. In some
countries, the maximum number is 50 (Turkey) and in others it is 200 (India). In
other countries, like the UK and Switzerland, there is no maximum (source: DLA
Piper).
 Advantages of privately held
companies:

The advantages of establishing a business as a privately held

companies as a type of for-profit (commercial) organization
include the following points:

There is better control of a privately rather than publicly held

company, as shares in a privately held company cannot be
bought or sold without the agreement of existing shareholders.

Significantly more finance can be raised compared with a sole

trader (one owner) or a partnership (up to 20 owners).

Privately held companies have greater privacy compared to

publicly held companies; the latter must make their final
accounts available to the general public.
Disadvantages of privately owned
companies:
Privately held companies can only sell their shares to family,
friends, and employees, with the approval of the majority of
existing shareholders. This can make it difficult to buy and
sell shares in the company.

They are more expensive to operate than a sole trader or

partnership. For example, there are higher legal fees and
auditing fees (for checking and approving of the financial
accounts).

A privately held company can become a target for a

takeover by a larger company which purchases a majority
stake, although other owners have to agree to the sale of
the company.
 Case Study 2 - Sibling rivalry: Puma
vs Adidas

• Going into business with your own family has both its positive and negative points. Did you know that the founders
of Puma and Adidas were siblings?

• These are two of the world's best known sports shoe companies. However, less known is the fact that both companies
came about from a huge conflict between two German brothers. Adolf (Adi) Dassler (1900 - 1978) first produced
sports shoes in his mother's kitchen in 1918, after having returned from World War I. He was supported in starting his
own business by his father, who worked in a shoe factory. In 1924, his brother Rudolf (Bobby) Dassler (1898 - 1974)
joined the business, which Adi had registered as "Gebrüder Dassler Schuhfabrik" (meaning Dassler Brothers Shoe
Factory).

• Their business boomed after Dassler shoes were worn by gold-medal-winning Olympians in the 1930s. However, as
sales in their business continued to grow, so did the tension and conflict between the two brothers. World War II
proved the breaking point in their relationship. By the end of the war, the Dassler brothers had split the company but
continued in their own battle in the world of corporate business, with Adi Dassler setting up Adidas (by combining his
first and last names) and Rudolf establishing Puma. (Rudolf had initially used "Ruda" before changing the name to
"Puma").

• It is documented that the Dassler brothers never spoke to each other again, as they concentrated on building their
business empires, with their factories on opposite banks of their home town's river in Herzogenaurach.

• In September 2009, over three decades after the brothers had passed away, the two companies put aside their
historical and commercial feud in order face off in a friendly football match. Puma and Adidas continue to thrive as
competitors in the sports shoes and sports apparel arena.
 Publicly held companies:

• Publicly held companies (or joint-stock companies)

are limited liability companies owned by
shareholders with the shares in the business being
traded (bought and/or sold) on a public stock
exchange (or stock market).
Features of publicly held companies
• Also known as a joint-stock company or public limited company, a publicly
held company is owned by shareholders with the shares being bought and
sold by the general public, without the need for the prior approval of
existing owners.
• Shares in a publicly held company can be bought and sold via a stock
exchange (or stock market), such as the New York Stock Exchange (NYSE),
London Stock Exchange, Hong Kong Stock Exchange, Tokyo Stock Exchange,
Shanghai Stock Exchange, and the National Association of Securities Dealers
Automated Quotations (NASDAQ).
• When a company first sells its shares to become a publicly held company, it
does so through an initial public offering (IPO) via a stock exchange.
• In order to protect shareholders, publicly held companies are strictly
regulated and are required to publish their final accounts each year.
• As there is no legal limit placed on the maximum number of shareholders in
a publicly held company, the company can raise a significant amount of
finance so long as it can attract investors.
Advantages of publicly held companies

• Additional finance can be raised through a share issue (the process of

subsequently selling more shares in a company). Hence, it is easier
for publicly held companies to obtain finance from a stock exchange to
fund its growth and evolution by selling additional share capital. In 2010,
Brazil’s state oil company Petrobras raised $70 billion, in the world’s largest
share issue.
• It is also easier for large publicly held companies to borrow money from
bank loans and mortgages, due to their lower level of risk for financial
lenders.
• As with privately held companies, the shareholders of publicly held
companies enjoy limited liability.
• Large publicly held companies get to enjoy the benefits of operating on a
large scale, such as opportunities to exploit economies of scale, market
share, and market power.
• As with privately held companies, publicly held companies enjoy continuity
even if a principal or major shareholder leaves the organization or passes
away.
 • There is a lack of privacy because the general public have
access to the financial accounts of publicly held
companies.
• Publicly held companies are the most administratively
difficult and expensive form of commercial for-profit
business to set up and run. For example, there are high
Limitations of costs of complying with the rules and regulations of the
stock market.
PLC’s • As the general public can buy and sell share freely, there is
always a potential threat that a rival company will make a
takeover bid.
• Large companies can suffer from diseconomies of scale.
Being too large can cause inefficiencies in the company,
and hence higher average costs of production.
 • Limited liability companies must produce an Annual
Report and Final Accounts, which includes details such as
the reporting of profits (or losses) in the Profit & loss
account, as well as the assets of the business and where
cash has been spent during the last twelve months in the

Note: Balance sheet. These final accounts are scrutinised by an

external auditor (usually chartered accountants) before the
information is distributed to shareholders. As a legal
requirement, this can be quite an expensive and time-
consuming task, especially for larger multinational
companies.
Recap video on corporations:

• https://youtu.be/XC_PIy6iL08