4.1 – Types of Business Organizations
Sole Trader/Sole Proprietorship
A business organization ​owned and controlled by one person​. Sole traders
can employ other workers, but only he/she invests and owns the business.
Advantages:
1. Easy to set up​: there are very few legal formalities involved in
starting and running a sole proprietorship. A less amount of capital is
enough by sole traders to start the business. There is no need to
publish annual financial accounts.
2. Full control​: the sole trader has full control over the business.
Decision-making is quick and easy, since there are no other owners
to discuss matters with. This will also eliminate possibilities of
conflicts among owners.
3. Sole trader receives all profit​: Since there is only one owner,
he/she will receive all of the profits the company generates.
4. Personal:​ since it is a small form of business, the owner can easily
create and maintain contact with customers, which will increase
customer loyalty to the business and also let the owner know about
consumer wants and preferences.
Disadvantages:
1. Unlimited liability​: if the business has bills/debts left unpaid, legal
actions will be taken against the investors, where their even personal
property can be seized, if their investments don’t meet the unpaid
amount. This is because the business and the investors are the
legally not separate (​unincorporated​).
2. Full responsibility​: Since there is only one owner, the sole owner
has to undertake all running activities. He/she doesn’t have anyone to
share his responsibilities with. This workload and risks are fully
concentrated on him/her.
3. Lack of capital:​ This is a major disadvantage to sole proprietorship.
As only one owner/investor is there, the amount of capital invested in
the business will be very low. This can restrict growth and expansion
of the business. Their only sources of finance will be personal savings
or borrowing or bank loans (though banks will be reluctant to lend to
sole traders since it is risky).
4. Lack of continuity:​ If the owner dies or retires, the business dies
with him/her.
Partnerships
A partnership is a legal ​agreement between two or more​ (usually, up to
twenty) ​people to own, finance and run a business jointly​ and to share all
profits.
Advantages:
1. Easy to set up​: Similar to sole traders, very few legal formalities are
required to start a partnership business. A partnership agreement/
partnership deed is a legal document that all partners have to sign,
which forms the partnership. There is no need to publish annual
financial accounts.
2. Partners can provide new skills and ideas:​ The partners may have
some skills and ideas that can be used by the business to improve
business profits.
3. More capital investments​: Partners can invest more capital than
what a sole trade only by himself could.
Disadvantages:
1. Conflicts:​ arguments may occur between partners while making
decisions. This will delay decision-making.
2. Unlimited liability:​ similar to sole traders, partners to have unlimited
liability- their personal items are at risk if business goes bankrupt
3. Lack of capital​: smaller capital investments as compared to large
companies.
4. No continuity:​ if an owner retires or dies, the business also dies with
them.
Joint-stock companies
These companies ​can sell shares​, unlike partnerships and sole traders, to
raise capital. Other people can buy these shares (stocks) and become a
shareholder (owner) of the company. Therefore they are jointly owned by the
people who have bought it’s stocks. These shareholders then receive
dividends (part of the profit; return on investment), according to the amount of
capital they invest.
The shareholders in companies have ​limited liabilities​. That is, only their
individual investments are at risk if the business fails or leaves debts. If the
company owes money, it can be sued and taken to court, but it’s shareholders
cannot.
The companies have ​a separate legal identity​ from their owners, which is
why the owners have a limited liability. These companies are ​incorporated​.
Companies also enjoys ​continuity​, unlike partnerships and sole traders. That
is, the business will continue even if one of it’s owners retire or die.
Shareholders will elect a​ board of directors​ to manage and run the company
in it’s day-to-day activities. In small companies, the shareholders with the
highest percentage of shares invested are directors, but directors don’t have
to be shareholders.
Shareholders with more than 50% value of the shares will have the upper
hand in all decision-making and control. The more shares a shareholder has,
the more their voting power.
These are two types of companies:
Private Limited Companies​: One or more owners who can sell its’ shares to
only the people known by the existing shareholders (family and friends).
Example: Reliance Industries Limited.
Public Limited Companies​: Two or more owners who can sell its’ shares to
any individual/organization in the general public through stock exchanges (see
topic ​3.1 – Money and Finance​). Example: Verizon Communications
Advantages:
1. Limited Liability:​ this is because, the company and the shareholders
have separate legal identities.
2. Raise huge amounts of capital:​ selling shares to other people
(especially in Public Ltd. Co.s), raises a huge amount of capital,
which is why companies are large.
3. Public Ltd. Companies can advertise their shares, in the form of a
prospectus, ​which tells interested individuals about the business, it’s
activities, profits, board of directors, shares on sale, share prices etc.
This will attract investors.
Disadvantages:
1. Required to disclose financial information:​ Sometimes, private
limited companies are required by law to publish their financial
statements annually, while for public limited companies, it is legally
compulsory to publish all accounts and reports. All the writing, printing
and publishing of such details can prove to be very expensive, and
other competing companies could use it to learn the company
secrets.
2. Private Limited Companies cannot sell shares to the public​. Their
shares can only be sold to people they know with the agreement of
other shareholders. Transfer of shares is restricted here. This will
raise lesser capital than Public Ltd. Companies.
3. Public Ltd. Companies require ​a lot of legal documents​ and
investigations before it can be listed on the stock exchange.
4. Public Limited Companies must also hold an ​Annual General
Meeting (AGM)​, where all shareholders are informed about the
performance of the company and company decisions, vote on
strategic decisions and elect board of directors. This is very
expensive to set up, especially if there are thousands of
shareholders.
5. Public Ltd. Companies may have ​managerial problems​: since they
are very large, they become very difficult to manage. Communication
problems may occur which will slow down decision-making.
6. In Public Ltd. Companies, there may be​ a divorce of ownership
from control​: The shareholders can lose control of the company
when other large shareholders outvote them or when board of
directors control company decisions.
A summary of everything learned until now, in this section, in case you’re
getting confused:
Multinational Corporations
(MNCs)
A multinational is ​a firm that has business operations in more than one
country,​ but will usually have its headquarters based in it’s country of origin.
They are all usually joint-stock companies. Example: Wal-Mart Stores Inc.
Advantages:
1. Reach more consumers​ globally, increasing sales.
2. Avoid trade barriers and import tariffs​ by setting up operations in
countries that impose them. This will reduce costs.
3. Minimize transportation costs​ of exporting by locating operations in
the countries where products are sold.
4. Minimize wage costs​ by locating operation in countries with low
wage costs.
5. A large scale of production will ​lower it’s average costs​ (economies
of scale, explained later in the syllabus).
Advantages to host country of MNCs:
1. They ​increase investments​ in the country (​direct inward
investments​), which will contribute to the development and growth of
the economy.
2. They ​provide jobs and incomes​ for local workers.
3. They ​bring in new knowledge and skills​, which will be beneficial in
increasing productivity of domestic (local) firms.
4. They will have to ​pay taxes on their profits to the host country​,
help raising govt. revenue.
Disadvantages to host country of MNCs:
1. They ​may exploit workers​: In economies with a low wage,
multinationals may pay employees far less than what they do in other
countries. They may also provide poor health and safety measures in
less-developed economies.
2. Natural resources may be exploited​: As multinational use up more
resources for production, natural resources (land) such as water and
wood may get exhausted. They may even damage the environment.
3. Profits maybe switched to origin countries​, to avoid taxation. This
is called repatriation of profits, This will reduce any possibilities of the
govt. gaining more tax revenue from them.
4. They can use their power and reputation to obtain subsidies and tax
deductions form the govt.: Because they provide lots of jobs and
incomes, governments encourage multinationals to locate there. This
would be unfair to other local firms.
5. Local competition may be threatened​: Domestic firms will find it
hard to keep up with multinationals and they lose a lot of customers to
these MNCs, forcing them to close down.
Cooperatives:
Business organization ​owned and controlled by a group of people, to
undertake an economic activity, to their mutual benefit​. Anyone can
become a member and invest small amounts of capital. They have a strict
policy of one person one vote. Thus, the amount of investment doesn’t
determine voting powers, unlike companies.They have limited liability.
There are mainly two types of co-operatives:
Worker Cooperatives​: Owned by their workers, who are the members. For
example: farming co-operatives, where farmers pool in money to buy
equipments and equally share business profits.
Retail Cooperatives​: Retailing businesses run for the benefit of their
consumers. All profits made by the business goes to it’s consumers, who are
the members.
Public Sector Organizations (Public
Corporation)
All organizations ​owned and controlled by the government​ (all of the above
are owned by private individuals). They deliver essential services such as
healthcare, education, street-lights and roads.They are usually given at low
costs or sometimes freely and do not aim to make a profit. Instead they aim at
providing cost-effective services that are funded by tax revenue. Businesses
under the public sector are called ​public corporation.
Public corporations’ profits are either reinvested into the business for
improvement or used by the government to fund their activities. They also
have limited liability in the sense that when debts exist, the corporation can be
sued, but the government can’t, because they are a ​incorporated​ business
(has separate legal identity)
Public corporations are run by a board of directors, chosen by a govt. minister
to run and manage the corporation and they are accountable to the minister .
Nationalization and Privatization
Nationalization​ is the transfer of ownership of an entire industry from the
private sector to the public sector.
Why are private firms nationalized?
● To control large powerful firms, especially those providing essential
products, such as electricity and gas.
● To protect employment in large firms which may be on the verge of
closing down.
● To protect public services. Private firms may be charging too high a
price for essential services in order to maintain profits. Nationalized
firms can provide these even at a loss.
Privatization​ is the transfer of ownership of an entire industry from the public
sector to the private sector.
Why are public firms privatized?
● To increase efficiency of a particular industry, since the private sector
is profit-motive.
● To raise money for other government projects (by selling firms to
private individuals, the govt. gets money)