Forms of Business Organisations Class 11 Notes

Sole proprietorship is the simplest form, in which one person owns the business and takes all the decisions. It is the natural choice when a business is small, needs no capital beyond what the owner can raise personally, and has not yet outgrown the owner's own capacity to run it.

• Merits: the owner takes all the profit, decisions are quick because there is nobody to consult, the establishment cost is the lowest, and the proprietor can take quick personal decisions without any legal formality.
• Merits: the business can be started with little capital, and in case of need, the proprietor can borrow against the firm's assets or his own credit with the bank.
• Limitations: capital is limited to what the owner can provide, so the form is not suitable for a large-scale enterprise.
• Limitations: the proprietor bears unlimited liability, so the risk of the business falls entirely on him and his personal assets are at stake.
• Limitations: no separate legal personality, so the business cannot be carried on after the owner's death, and there is no continuity.
• Limitations: the burden of management rests on one person, and as the business grows it becomes increasingly difficult for one person to supervise every department.

The Indian Partnership Act, 1932 defines a partnership as the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. Two points in that definition are examinable: the agreement, and the sharing of profit.

• Agreement: partnership arises from a contract between the partners and not from status, so the relationship is created by consent and it can be ended by consent.
• Sharing of profit: profit must be shared according to an agreed ratio, which is what distinguishes a partner from a mere employee or a lender.
• Limited liability partnership: some partners may be limited partners whose liability is limited to the amount of capital they contribute, while the others remain general partners with unlimited liability.
• Advantages: more capital than a sole proprietorship, and more brains, because partners with different skills are brought together.
• Advantages: easy to form, it needs only a deed and registration, so it costs far less than a company.
• Advantages: better supervision, since the work is divided among partners by agreement, and the profits are shared, so the incentive to work is present.
• Limitations: liability of the partners is unlimited, and in the case of an ordinary partnership each partner can be made to pay the whole of the firm's debts out of his own assets.
• Limitations: limited liability is possible only for some partners, the firm is not recognised as a separate legal entity, and the partnership may be disturbed by the death, bankruptcy or retirement of one partner.
• Limitations: disagreement between partners is possible, and the profits of the firm must be shared even if one partner contributes very little to the business.
• The types of the partners: an active or the actual partner takes an active part in the conduct of the business, and his actions bind the firm, while a dormant or the sleeping partner has contributed the capital and shares the profit but takes no part in the working and is not known to the public, so he is a member of the firm for the liability but not for the conduct.
• A nominal partner is a partner in name only, who lends his name and his reputation to the firm and shares the profit, but he contributes no capital and takes no part in the working, and yet he is liable to the outsiders for the debts of the firm, because they relied on his name.
• A partner by estoppel or by holding out is a person who has held himself out to be a partner or who has allowed the firm to use his name, so he is estopped from denying the partnership to a person who has given the credit on the strength of the appearance, and the liability thus arises from the conduct and not from the agreement.
• A secret partner is one whose membership is not known to the general public, but he takes the full part in the working and bears the same unlimited liability as an active partner, and at the other end of the life of the firm, an incoming partner is not liable for the debts incurred before he joined, while an outgoing partner remains liable for the debts of the firm that were incurred before his retirement.

A company is an artificial person created by law, with a legal personality separate from its members, and that separation is the whole point of the form. A company can own property, sue and be sued, borrow and lend, in its own name and with its own liability, which is why it is the form used by every large enterprise.

• Private limited company: the number of members is limited by the articles, the shares cannot be offered to the public, and the name must carry the words Private Limited.
• Public limited company: shares may be offered to the public, the number of members is not so limited, and it is formed to raise capital from the public for a large enterprise.
• One person company: a company in which a single person may be a member, and which may be formed by converting an existing sole proprietorship or a partnership into a company.
• Merits: limited liability, so the liability of each shareholder is limited to the amount unpaid on the shares held, and the shareholders are ordinarily not liable for the debts beyond that.
• Merits: continuity, because the company is a separate legal person whose life is not affected by the death, retirement or bankruptcy of a shareholder.
• Merits: a large volume of capital can be raised from the public, and a large number of people may share the risk.
• Limitations: the formation of a company is difficult and costly, involving registration, a formal constitution, the issue of share certificates and compliance with the law.
• Limitations: the management lies with the directors and not with the shareholders, so a shareholder who wants control must buy a large holding, and the double taxation of the company tax plus the dividend tax is a further limitation for small businesses.

These two forms exist for social reasons rather than purely for capital reasons, and both are examined more briefly, but each has features the examiner expects.

• Hindu undivided family business: it is formed by a joint Hindu family, the capital is the joint family property, and the members who have received a portion of it are the coparceners.
• HUF merits: no legal formalities are required to start it, the family business is held together, and the system of coparcenary provides a recognised way of settling succession.
• HUF limitations: the coparcenary was restricted to the males under the old law, though the Hindu Succession Amendment Act of 2005 makes a daughter a coparcener by birth, the business is not a separate legal person, a coparcener who takes a share and enjoys the income loses coparcenary status, and the coparceners' interests may not match the interests of the firm.
• Cooperative society: it is an association of persons who have voluntarily joined to meet their common economic, social and business needs through a non-profit motive, and its profits are shared not in proportion to capital but in proportion to the transactions of the members.
• Cooperative merits: limited liability, the democratic one member one vote principle, ease of formation, and the removal of middlemen, so the producer receives a better price.
• Cooperative limitations: limited capital, limited area of operation, difficulty in attracting competent managers, and the tendency of members to expect too much from the society.
• The types of the cooperative societies: a consumer cooperative is formed by the consumers themselves and buys the goods in bulk at a cheaper rate to sell to its members, and a producer cooperative collects the output of the small producers and sells it so that the members get a better price than they would get alone.
• A marketing cooperative pools the products of its member farmers and handles the procurement, the grading, the storage and the sale of them, so that the middleman is removed, and a farmer or the agricultural cooperative supplies the credit, the raw material and the implements to its farmer members, while a credit cooperative extends the credit to its members at a concessional rate, and a housing cooperative arranges the land and the construction of the houses for its members, so the six types are the consumer, the producer, the marketing, the farmer, the credit and the housing.

The formation of a company follows a sequence of steps, and each step has a document. The sequence is examinable as a chain, because the questions usually ask which document comes at which stage.

• The promoters first satisfy themselves that there is a genuine need for a new company, and they apply to the Registrar of Companies for the availability of a name.
• A Memorandum of Association is drafted and signed, and it is the constitution of the company, so it contains the objects, the name, the registered office, the authorised capital, the rules of management and the subscription clause.
• The articles of association are drafted, and they deal with the internal management, the transfer of shares, the appointment of directors and the payment of dividends, and the memorandum can be described as the external and the articles as the internal constitution.
• A prospectus is issued to the public inviting applications for shares, the company receives the share applications and the allotment letters are issued, and the share certificates are made out.
• The first directors are appointed, and they take office, the file of the company is submitted to the Registrar with the particulars of the directors and the statutory declaration of compliance, and the certificate of incorporation is issued, which is the point at which the company comes into existence.

The last part of the chapter asks why a particular form is chosen in a particular situation, and the answer is never one factor. A form of organisation is chosen to suit the size of the enterprise, the amount of capital available, the degree of control the founder wishes to keep, the legal restrictions on the industry, and the tax position.

• Size and nature of the enterprise: a small enterprise needing little capital will choose sole proprietorship or a partnership, while a large one needing a large volume of capital will choose a company.
• Capital available: capital that is scarce and personal points to sole proprietorship, while capital raised from the public points to a company.
• Degree of control: a sole proprietor controls everything, and a company is needed where control can be shared with outside investors.
• Legal and statutory requirements: banks, insurance and certain other businesses are permitted by law to take only a particular form of organisation, so the choice is made for the founder in these cases.
• Risk: the larger the risk, the greater the need for limited liability, so a risky business tends towards a company.
• Profit motive and tax: a company is a useful form where the volume of profit justifies the double taxation, while a small firm avoids the company because the tax burden is not worth it.