Unit 4: Types of business organization

Almost every country consists of two business sectors, the private sector and the public
sector. Private sector businesses are operated and run by individuals, while public sector
businesses are operated by the government. The types of businesses present in a sector can
vary, so let’s take a look at them.

1. 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:

 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.
 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.
 Sole trader receives all profit: Since there is only one owner, he/she will receive all
of the profits the company generates.
 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:

 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).
 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.
 Lack of capital: 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).
 Lack of continuity: If the owner dies or retires, the business dies with him/her.

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 2. 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.

In partnership, it is required to draw up a formal deed of partnership or agreement between

partners. A deed of partnership can be defined as a written and legal agreement between
partners. It is not essential for partners to have such an agreement but it is always
recommended.
This deed will provide agreement on issues such as:

 How to distribute the profit

 How much capital each partner has invested in the business
 The management role of each partner
 Who has authority to sign contracts?
Advantages:

 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.
 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.
 More capital investments: Partners can invest more capital than what a sole trade only
by himself could.
Disadvantages:

 Conflicts: arguments may occur between partners while making decisions. This will
delay decision-making.
 Unlimited liability: similar to sole traders, partners too have unlimited liability- their
personal items are at risk if business goes bankrupt
 Lack of capital: smaller capital investments as compared to large companies.
 The business did not have a separate legal identity. If an owner retires or dies, the
business also end with them.
o (both sole trader and partnership are said to be unincorporated business)

An unincorporated business is
one that does not have a
separate legal identity.

3. Private limited company

A private limited company is a small to medium-sized business that is owned by shareholders
who are often members of the same family; this company cannot sell shares to the general
public.

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Advantages:

 shareholders have limited liability

 separate legal personality
 continuity in the event of the death of a shareholder
 original owner is still oft en able to retain control
 able to raise capital from sale of shares to family, friends and employees
 greater status than an unincorporated business
Disadvantages:

 legal formalities involved in establishing the business

o Owners need to deal with many legal formalities before forming a private
limited company:
o The Articles of Association: This contains the rules on how the company
will be managed. It states the rights and duties of directors, the rules on the
election of directors and holding an official meeting, as well as the issuing of
shares.
o The Memorandum of Association: This contains very important
information about the company and directors. The official name and
addresses of the registered offices of the company must be stated. The
objectives of the company must be given and also the amount of share capital
the owners intend to raise. The number of shares to be bought each of the
directors must also be made clear.
o Certificate of Incorporation: the document issued by the Registrar of
Companies that will allow the Company to start trading.
 capital cannot be raised by sale of shares to the general public
 quite difficult for shareholders to sell shares
 end-of-year accounts must be sent to Companies House – available for public
inspection there (less secrecy over financial affairs than sole trader or partnership)

4. Public limited company

Public limited company is a large business, with the legal right to sell shares to the general
public – share prices are quoted on the national stock exchange.
Advantages:

 limited liability
 separate legal identity
 continuity
 ease of buying and selling of shares for shareholders
 access to substantial capital sources due to the ability to issue a prospectus to the
public and to offer shares for sale

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Disadvantages:

 legal formalities in formation

 cost of business consultants and financial advisers when creating such a company
 share prices subject to fluctuation – sometimes for reasons beyond business control,
for example state of the economy
 legal requirements concerning disclosure of information to shareholders and the
public, for example annual publication of detailed report and accounts
 risk of takeover due to the availability of the shares on the stock exchange
 directors influenced by short-term objectives of major investors

Note: Private and public limited company have a separate legal identity from their owners,
which is why the owners have a limited liability. These companies are incorporated.

 Control and ownership in public limited company

The Annual General Meeting (AGM) is held every year and all shareholders are invited to
attend so that they can elect their Board of Directors. Normally, Director are majority
shareholders who has the power to do whatever they want. However, this is not the case for
public limited companies since there can be millions of shareholders. Anyway, when
directors are elected, they have to power to make important decisions. However, they must
hire managers to attend to day to day decisions. Therefore:

 Shareholders own the company

 Directors and managers control the company

This is called the divorce between ownership and control. Because shareholders invested in
the company, they expect dividends. The directors could do things other than give
shareholders dividends, such as trying to expand the company. However, they might lose
their status in the next AGM if shareholders are not happy with what they are doing. All in
all, both directors and shareholders have their own objectives.

Other private sector business organization

5. Joint ventures
Two businesses agree to start a new project together, sharing capital, risks and profits.
Advantages:

 Shared costs are good for tackling expensive projects. (e.g aircraft)
 Pooled knowledge. (e.g foreign and local business)
 Risks are shared.

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Disadvantages:

 Profits have to be shared.

 Disagreements might occur.
 The two partners might run the joint venture differently.

6. Franchise business
It is a business that uses the name, logo and trading systems of an existing successful
business.

The business may use the name of a well-reputed organization for profit maximization.
Therefore, franchising is the use of a well-known brand by one business for profit-making
but on payment of a license fee or royalties.

In fact the franchisor (owner of the brand name) rents the brand name to the franchisee (the
user of the brand name) against payments.
Advantages to franchisor

 Obtains royalties
 Spreading of brand name and reputation nationally and globally
 Controls its products
 He does not need to invest massively as compared to multinational
Disadvantages to franchisor

 No complete control on franchisee

 One franchisee may destroy or affect or spoil the brand name
Advantages to franchisee

 He is enjoying ready- made reputation without struggle

 He does not need to invest in research and development but may have to adopt the
product according to local needs.
 Low or no costs of training and advertisement
 Take most of the day to day decision

Disadvantages to franchisee

 Increase in royalties may affect the franchisee

 Being owner, he is limited in decision making power
 Local promotion may have to be pay by the franchisee.

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Business organization in the public sector
7. Public corporations:
A business owned by the government and run by Directors appointed by the government.
These businesses usually include the water supply, electricity supply, etc. The government
give the directors a set of objectives that they will have to follow:

 to keep prices low so everybody can afford the service.

 to keep people employed.
 to offer a service to the public everywhere.

These objectives are expensive to follow, and are paid for by government subsidies.
However, at one point the government would realise they cannot keep doing this, so they will
set different objectives:

 to reduce costs, even if it means making a few people redundant.

 to increase efficiency like a private company.
 to close loss-making services, even if this mean some consumers are no longer
provided with the service.
Advantages:
 Some businesses are considered too important to be owned by an individual.
(electricity, water, airline)
 Other businesses, considered natural monopolies, are controlled by the government.
(electricity, water)
 Reduces waste in an industry. (e.g. two railway lines in one city)
 Rescue important businesses when they are failing.
 Provide essential services to the people (e.g. the BBC)
Disadvantages:

 Motivation might not be as high because profit is not an objective.

 Subsidies lead to inefficiency. It is also considered unfair for private businesses.
 There is normally no competition to public corporations, so there is no incentive to
improve.
 Businesses could be run for government popularity.

8. Municipal enterprises
These businesses are run by local government authorities which might be free to the user and
financed by local taxes. (e.g, street lighting, schools, local library, rubbish collection). If
these businesses make a loss, usually a government subsidy is provided. However, to reduce
the burden on taxpayers, many municipal enterprises are being privatized.