The Nature and Forms of

Business Organizations
Business ethics
Have you ever thought who brings the required capital, takes the
responsibility of arranging other resources, puts them into
action, and coordinates and controls the activities to earn the
desired profits?
If you look around, you will find that a small grocery shop is
owned and run by a single individual who performs all these
activities. But, in big businesses, it may not be possible for a
single person to perform all these activities. So in such cases
two or more persons join hands to finance and manage the
business properly and share its profit as per their agreement.
Business organization is the single-most important choice you’ll
make regarding your company. What form your business adopts
will affect a multitude of factors, many of which will decide your
company’s future. Aligning your goals to your business
organization type is an important step, so understanding the
pros and cons of each type is crucial.
 MAJOR BUSINESS ORGANIZATION
FORMS
 Sole Proprietorship
 Partnership
 Corporation
 Limited Liability Company, or LLC
 SOLE PROPRIETORSHIP

A Sole Proprietorship is a business owned and operated by one

individual. Sole Proprietorships own all the assets of the
business and the profits generated by it. They also assume
complete responsibility for any of its liabilities or debts. In the
eyes of the law and the public, you are one in the same with the
business.
 SOLE PROPRIETORSHIP

J.L. Hanson: “A type of business unit where one person is solely

responsible for providing the capital and bearing the risk of the
enterprise, and for the management of the business.”
 CHARACTERISTICS OF SOLE PROPRIETORSHIP
FORM OF BUSINESS ORGANIZATION

Single Ownership

The sole proprietorship form of business organisation has a

single owner who himself/herself starts the business by bringing
together all the resources.
 No Separation of Ownership and Management

The owner himself/herself manages the business as per his/her

own skill and intelligence. There is no separation of ownership
and management as is the case with company form of business
organisation.
 Less Legal Formalities

The formation and operation of a sole proprietorship form of

business organisation does not involve any legal formalities.
Thus, its formation is quite easy and simple.
 No Separate Entity

The business unit does not have an entity separate from the
owner. The businessman and the business enterprise are one
and the same, and the businessman is responsible for
everything that happens in his business unit.
 No Sharing of Profit and Loss

The sole proprietor enjoys the profits alone. At the same time,
the entire loss is also borne by him. No other person is there to
share the profits and losses of the business. He alone bears the
risks and reaps the profits.
 Unlimited Liability

The liability of the sole proprietor is unlimited. In case of loss, if

his business assets are not enough to pay the business
liabilities, his personal property can also be utilised to pay off the
liabilities of the business.
 One-man Control

The controlling power of the sole proprietorship business always

remains with the owner. He/she runs the business as per his/her
own will.
 MERITS OF SOLE PROPRIETORSHIP
FORM OF BUSINESS ORGANIZATION
Easy to Form and Wind Up

It is very easy and simple to form a sole proprietorship form of

business organisation. No legal formalities are required to be
observed. Similarly, the business can be wind up any time if the
proprietor so decides.
 Quick Decision and Prompt Action

As stated earlier, nobody interferes in the affairs of the sole

proprietary organization. So he/she can take quick decisions on
the various issues relating to business and accordingly prompt
action can be taken.
 Direct Motivation

In sole proprietorship form of business organizations. the entire

profit of the business goes to the owner. This motivates the
proprietor to work hard and run the business efficiently.
 Flexibility in Operation

It is very easy to effect changes as per the requirements of the

business. The expansion or curtailment of business activities
does not require many formalities as in the case of other forms
of business organization.
 Maintenance of Business Secrets

The business secrets are known only to the proprietor. He is not

required to disclose any information to others unless and until he
himself so decides. He is also not bound to publish his business
accounts.
 Personal Touch

Since the proprietor himself handles everything relating to

business, it is easy to maintain a good personal contact with the
customers and employees. By knowing the likes, dislikes and
tastes of the customers, the proprietor can adjust his operations
accordingly. Similarly, as the employees are few and work
directly under the proprietor, it helps in maintaining a
harmonious relationship with them, and run the business
smoothly.
 LIMITATIONS OF SOLE PROPRIETORSHIP
FORM OF BUSINESS ORGANIZATION
Limited Resources

The resources of a sole proprietor are always limited. Being the

single owner it is not always possible to arrange sufficient funds
from his own sources. Again borrowing funds from friends and
relatives or from banks has its own implications. So, the
proprietor has a limited capacity to raise funds for his business.
 Lack of Continuity

The continuity of the business is linked with the life of the

proprietor. Illness, death or insolvency of the proprietor can lead
to closure of the business. Thus, the continuity of business is
uncertain.
 Unlimited Liability

You have already learnt that there is no separate entity of the

business from its owner. In the eyes of law the proprietor and the
business are one and the same. So personal properties of the
owner can also be used to meet the business obligations and
debts.
 Not Suitable for Large Scale Operations

Since the resources and the managerial ability is limited, sole

proprietorship form of business organization is not suitable for
large-scale business.
 Limited Managerial Expertise

A sole proprietorship from of business organisation always

suffers from lack of managerial expertise. A single person may
not be an expert in all fields like, purchasing, selling, financing
etc. Again, because of limited financial resources, and the size
of the business it is also not possible to engage the professional
managers in sole proprietorship form of business organisations.
 ADVANTAGE OF SOLE PROPRIETORSHIP

 All profits are subject to the owner.

 There is very little regulation for proprietorships.
 Owners have total flexibility when running the business.
 Very few requirements for starting—often only a business
license
 DISADVANTAGE OF SOLE
PROPRIETORSHIP
 Owner is 100% liable for business debts.
 Equity is limited to the owner’s personal resources.
 Ownership of proprietorship is difficult to transfer.
 No distinction between personal and business income
EXAMPLES OF A SOLE PROPRIETORSHIP
BUSINESS
 PARTNERSHIP

A legal form of business operation between two or more

individuals who share management and profits. The federal
government recognizes several types of partnerships. The two
most common are general and limited partnerships.
‘Partnership’ is an association of two or more persons who pool
their financial and managerial resources and agree to carry on a
business, and share its profit. The persons who form partnership
are individually known as partners and collectively a firm or
partnership firm.
 CHARACTERISTICS OF PARTNERSHIP
FORM OF BUSINESS ORGANIZATION
Two or More Persons

To form a partnership firm at least two persons are required. The

maximum limit on the number of persons is ten for banking
business and 20 for other businesses. If the number exceeds the
above limit, the partnership becomes illegal and the relationship
among them cannot be called partnership.
 Contractual Relationship

Partnership is created by an agreement among the persons who

have agreed to join hands. Such persons must be competent to
contract. Thus, minors, lunatics and insolvent persons are not
eligible to become the partners. However, a minor can be
admitted to the benefits of partnership firm i.e., he can have
share in the profits without any obligation for losses.
 Sharing Profits and Business

There must be an agreement among the partners to share the

profits and losses of the business of the partnership firm.
 Existence of Lawful Business

The business of which the persons have agreed to share the

profit must be lawful. Any agreement to indulge in smuggling,
black marketing etc. cannot be called partnership business in
the eyes of law.
 Principal Agent Relationship

There must be an agency relationship between the partners.

Every partner is the principal as well as the agent of the firm.
When a partner deals with other parties he/she acts as an agent
of other partners, and at the same time the other partners
become the principal.
 Unlimited Liability

The partners of the firm have unlimited liability. They are jointly
as well as individually liable for the debts and obligations of the
firms. If the assets of the firm are insufficient to meet the firm’s
liabilities, the personal properties of the partners can also be
utilised for this purpose. However, the liability of a minor partner
is limited to the extent of his share in the profits.
 MERITS OF PARTNERSHIP FORM OF
BUSINESS ORGANIZATION
Easy to Form

A partnership can be formed easily without many legal

formalities. Since it is not compulsory to get the firm registered,
a simple agreement, either in oral, writing or implied is sufficient
to create a partnership firm.
 Availability of Larger Resources

Since two or more partners join hands to start partnership firm it

may be possible to pool more resources as compared to sole
proprietorship form of business organization.
 Better Decisions

In partnership firm each partner has a right to take part in the

management of the business. All major decisions are taken in
consultation with and with the consent of all partners. Thus,
collective wisdom prevails and there is less scope for reckless
and hasty decisions.
 Flexibility

The partnership firm is a flexible organization. At any time the

partners can decide to change the size or nature of business or
area of its operation after taking the necessary consent of all the
partners.
 Sharing of Risks

The losses of the firm are shared by all the partners equally or
as per the agreed ratio.
 Keen Interest

Since partners share the profit and bear the losses, they take
keen interest in the affairs of the business
 Benefits of Specialization

All partners actively participate in the business as per their

specialization and knowledge. In a partnership firm providing
legal consultancy to people, one partner may deal with civil
cases, one in criminal cases, another in labor cases and so on
as per their area of specialization. Similarly two or more doctors
of different specialization may start a clinic in partnership.
 Protection of Interest

In partnership form of business organization, the rights of each

partner and his/her interests are fully protected. If a partner is
dissatisfied with any decision, he can ask for dissolution of the
firm or can withdraw from the partnership
 Secrecy

Business secrets of the firm are only known to the partners. It is

not required to disclose any information to the outsiders. It is
also not mandatory to publish the annual accounts of the firm.
 LIMITATIONS OF PARTNERSHIP FORM
OF BUSINESS ORGANIZATION
Unlimited Liability

The most important drawback of partnership firm is that the

liability of the partners is unlimited i.e., the partners are
personally liable for the debt and obligations of the firm. In other
words, their personal property can also be utiliZed for payment
of firm’s liabilities.
 Instability

Every partnership firm has uncertain life. The death, insolvency,

incapacity or the retirement of any partner brings the firm to an
end. Not only that any dissenting partner can give notice at any
time for dissolution of partnership.
 Limited Capital

Since the total number of partners cannot exceed 20, the

capacity to raise funds remains limited as compared to a joint
stock company where there is no limit on the number of share
holders
 Non-transferability of share

The share of interest of any partner cannot be transferred to

other partners or to the outsiders. So it creates inconvenience
for the partner who wants to transfer his share to others fully and
partly. The only alternative is dissolution of the firm.
 Possibility of Conflicts

You know that in partnership firm every partner has an equal

right to participate in the management. Also every partner can
place his or her opinion or viewpoint before the management
regarding any matter at any time. Because of this, sometimes
there is friction and quarrel among the partners. Difference of
opinion may give rise to quarrels and lead to dissolution of the
firm.
 ADVANTAGE OF PARTNERSHIP

 Shared resources provides more capital for the business.

 Each partner shares the total profits of the company.
 Similar flexibility and simple design of a proprietorship.
 Inexpensive to establish a business partnership, formal or
informal
 DISADVANTAGE OF PARTNERSHIP

 Each partner is 100% responsible for debts and losses.

 Selling the business is difficult—requires finding new partner.
 Partnership ends when any partner decides to end it
EXAMPLES OF PARTNERSHIP BUSINESS
 CORPORATION

Corporations are, for tax purposes, separate entities and are

considered a legal person. This means, among other things, that
the profits generated by a corporation are taxed as the “personal
income” of the company. Then, any income distributed to the
shareholders as dividends or profits are taxed again as the
personal income of the owners.
A corporate structure is perhaps the most advantageous way to
start a business because the corporation exists as a separate
entity. In general, a corporation has all the legal rights of an
individual, except for the right to vote and certain other
limitations. Corporations are given the right to exist by the state
that issues their charter.
 ADVANTAGE OF CORPORATION

 Limits liability of the owner to debts or losses.

 Profits and losses belong to the corporation.
 Can be transferred to new owners fairly easily.
 Personal assets cannot be seized to pay for business debts
 DISADVANTAGE OF CORPORATION

 Corporate operations are costly.

 Establishing a corporation is costly.
 Start a corporate business requires complex paperwork.
 With some exceptions, corporate income is taxed twice
EXAMPLES OF CORPORATION BUSINESS
 LIMITED LIABILITY CORPORATION

This business structure protects the owner's personal assets

from financial liability and provides some protection against
personal liability. It is designed to provide limited liability features
of a corporation and the tax efficiencies and operational flexibility
of a partnership. Formation is more complex and formal than
that of a general partnership.
LLC’s must not have more than two of the four characteristics
that define corporations: Limited liability to the extent of assets;
continuity of life; centralization of management; and free
transferability of ownership interests.
 ADVANTAGE OF LIMITED LIABILITY
COMPANY
 Limits liability to the company owners for debts or losses.
 The profits of the LLC are shared by the owners without
double-taxation
 DISADVANTAGE OF LIMITED LIABILITY
COMPANY
 Ownership is limited by certain state laws.
 Agreements must be comprehensive and complex.
 Beginning an LLC has high costs due to legal and filing fees