Introduction to Business and Commercial Knowledge

Forms of Business Organizations

As an economic activity, the forms of business organization are based on a variety of criteria like the nature of the business, size of operations, etc. In this article, we will look at some important points about business ownership which will help us in understanding the various forms of a business organization.

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Important Aspects of Business Ownership

Business Ownership is a Bundle of Rights

Since the business owners invest money in it, they have multiple rights. The first right is that of exclusive ownership. For example, if you buy a book, then no one else can claim ownership to the copy you hold. You can derive benefit from it, lend it, sell it, or even donate it as per your will. Similarly, when a person invests capital, he gets the ownership of a business.

This means that the profits belong to the owners. On the other hand, the owners have to bear the losses too. Apart from the right of exclusive ownership, business owners also have a right to run and manage the business. However, it is important to note that in some forms of business organization, ownership and management are separate.

Another important right of business ownership is the right to dispose of and transfer the ownership of the business. Further, this includes the transfer of ownership by succession after the death of the owner. In such cases, the succession is smooth if the owner registers a will, dividing the ownership in the business among his successors.

Business may be Owned Singly or Jointly

The forms of business organizations can be based on ownership too. We can have a single owner of a business – sole-proprietorship concern or a partnership or even a cooperative. In the case of a single owner, if all profits belong to the owner, then so do the losses.

Shared ownership is particularly useful while undertaking large projects. This is because, in shared ownership, the owners pool the capital together. Another important reason for shared ownership is the sharing of risks.

The joint family business is a concept similar to Hindu Undivided Families in India. A joint family business is viewed as family property and the ownership lies with the family members. In such cases, the sharing of ownership is not to raise large sums of money or sharing risks. It is more about distributing ownership rights among family members.

Over the years, many business theorists have contemplated on the forms of business organization whereby the owners (single or joint) have minimal impact of the business adversities. One such idea is the concept of limited liability. Usually, in a business, there is no distinction between the business owner and the business itself since all the profits and losses accrue to the business owners.

However, if business liabilities are more than its assets, then the personal wealth of the business owners is used to meet the liabilities. In a limited liability, the liability of a business owner is capped to the extent of his investment in the business. Initially, this idea was implemented in the form of a company and eventually extended to partnerships as well (Limited Liability Partnership – LLP).

Business may be Organized as a Proprietary or a Corporate Concern

In a proprietary concern, business owners are not passive providers of the capital alone. They actively take part in the day-to-day operations of the firm. Therefore, the business becomes subservient to the self-interests of its owners. Needless to say, such a situation is more favourable when the number of owners is at least 4/5. Also, the nature and size of the business allow it to draw on the competencies of the owners.

Next, imagine a business with a large number of people, geographically dispersed, holding a share in its capital (thousands and more). In such businesses, it is impossible to separate ownership from management. The managers act as agents of the owners and also work in their interest. In the case of a corporate entity, the organization has many peculiar characteristics. One such characteristic is the limited liability of the shareowners.

In a proprietary business, the performance of the business relies heavily on the health and life of the owners. However, in the corporate form, the company exists as a separate entity, distinct from the owners. Hence, as a separate legal person, it has a life independent of its owners.

business organization

Forms of a Business Organization – A Quick View

  • Sole-Proprietorship
    • Sole provider of capital
    • The sole bearer of risks
    • Unlimited liability
  • Hindu Undivided Family (HUF) Business
    • Formed by birth in a Hindu family
    • The family pool of resources
    • Family members are automatic co-owners
    • Head of the family (Karta) is the decision maker
    • The Karta has unlimited liability
  • Partnership
    • Two or more persons can start a partnership firm (maximum 20)
    • Profit and risk sharing can be pre-determined
    • The firm works for common and mutual goals
    • Liability of all partners is joint and several
  • Limited Liability Partnership (LLP)
    • Limited liability of each partner
    • No personal liability of any partner (except in the case of fraud)
    • It is a legal entity and is separate from its partners
    • No maximum limit on the number of partners
  • Private Company
    • Minimum members = 2, maximum members = 200, and a minimum of two directors
    • Certain restrictions on the transfer of shares
    • Once incorporated, the company can start the business
  • Public Company
    • Minimum members = 7, maximum members = no limit, and a minimum of three directors
    • Shares are freely tradeable on the stock exchange through a listing
    • Also, post-incorporation, the company must obtain a Certificate of Commencement of Business to start the business

Solved Question on Forms of Business Organizations

Question: In the case of a limited liability business, the liability of the owners is:

  1. limited to the extent they want
  2. capped to the extent of their investment in the business
  3. limited only to 2 owners
  4. all of the above

Answer: In a regular business organization, if the liabilities are more than the assets, the personal wealth of the owners is used to meet the liabilities. However, in the case of limited liability, as the name suggests, there is a limit on the liability of each owner. The limits are drawn based on the amount invested in the business. Therefore, the correct answer is option b – capped to the extent of their investment in the business.

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