CHAPTER - 2
FORMS OF BUSINESS ORGANISATION
LEARNING OBJECTIVES
Identify different forms of business organization
Meaning, features, merits and limitations of different forms of business organization i.e.
Sole Proprietorship, Partnership, Co-operative Organisation & Joint Stock Company
Meaning & features of Hindu Undivided Family Business
Types of partners & partnership
Types of co-operative organisation
Concept of partnership deed & registration of partnership
Types & formation of company
Distinguish between various forms of organization
Discuss the factors determining choice of an appropriate form of business organisation
MEANING OF SOLE PROPRIETORSHIP
Sole proprietorship refers to a form of business organisation which is owned, managed and
controlled by an individual who is the recipient of all profits and bearer of all risks.
FEATURES:
(i) Formation and closure: There is no separate law that governs sole proprietorship
(ii) Liability: Sole proprietors have unlimited liability.
(iii) Sole risk bearer and profit recipient: The risk of failure of business is borne all alone by
the sole proprietor.
(iv) Control: The right to run the business and make all decisions lies absolutely with the sole
proprietor.
(v) No separate entity: In the eyes of the law, no distinction is made between the sole trader and
his business, as business does not have an identity separate from the owner.
MERITS:
(i) Quick decision making: A sole proprietor enjoys considerable degree of freedom in making
business decisions.
(ii) Confidentiality of information: Sole decision making authority enables the proprietor to
keep all the information related to business operations confidential and maintain secrecy.
(iii) Direct incentive: A sole proprietor directly reaps the benefits of his/her efforts as he/she is
the sole recipient of all the profit.
(iv) Sense of accomplishment: There is a personal satisfaction involved in working for oneself.
(v) Ease of formation and closure: An important merit of sole proprietorship I the possibility of
entering into business with minimal legal formalities.
LIMITATIONS:
(i) Limited resources: Resources of a sole proprietor are limited to his/her personal savings and
borrowings from others.
(ii) Limited life of a business concern: The sole proprietorship business is owned and
controlled by one person, so death, insanity, imprisonment, physical ailment or bankruptcy of a
proprietor affects the business and can lead to its closure.
(iii) Unlimited liability: A major disadvantage of sole proprietorship is that the owner has
unlimited liability
(iv) Limited managerial ability: The owner has to assume the responsibility of varied
managerial tasks such as purchasing, selling, financing, etc.
MEANING OF JOINT HINDU FAMILY BUSINESS
Joint Hindu family business is a specific form of business organisation found only in India. It is
one of the oldest forms of business organisation in the country.
FEATURES:
(i) Formation: For a joint Hindu family business, there should be at least two members in the
family and ancestral property to be inherited by them.
(ii) Liability: The liability of all members except the karta is limited to their share of co-
parcenery property of the business.
(iii) Control: The control of the family business lies with the karta.
(iv) Continuity: The business continues even after the death of the karta as the next eldest
member takes up the position of karta, leaving the business stable.
(v) Minor Members: The inclusion of an individual into the business occurs due to birth in a
Hindu Undivided Family.
MEANING OF PARTNERSHIP
The Indian Partnership Act, 1932 defines partnership as “the relation between persons who have
agreed to share the profit of the business carried on by all or any one of them acting for all.”
FEATURES:
(i) Formation: The partnership form of business organisation is governed by the Indian
Partnership Act, 1932.
(ii) Liability: The partners of a firm have unlimited liability.
(iii) Risk bearing: The partners bear the risks involved in running a business as a team
(iv) Decision making and control: The partners share amongst themselves the responsibility of
decision making and control of day to day activities.
(v) Continuity: Partnership is characterised by lack of continuity of business since the death,
retirement insolvency or insanity of any partner can bring an end to the business.
(vi) Number of Partners: The minimum number of partners needed to start a partnership firm is
two. According to section 464 of the Companies Act 2013.
(vii) Mutual agency: The definition of partnership highlights the fact that it is a business carried
on by all or any one of the partners acting for all.
MERITS:
(i) Ease of formation and closure: A partnership firm can be formed easily by putting an
agreement between the prospective partners into place whereby they agree to carryout the
business of the firm and share risks
(ii) Balanced decision making: The partners can oversee different functions according to their
areas of expertise.
(iii) More funds: In a partnership, the capital is contributed by a number of partners.
(iv) Sharing of risks: The risks involved in running a partnership firm are shared by all the
partners.
(v) Secrecy: A partnership firm is not legally required to publish its accounts and submit its
reports.
LIMITATIONS:
(i) Unlimited liability: Partners are liable to repay debts even from their personal resources in
case the business assets are not sufficient to meet its debts.
(ii) Limited resources: There is a restriction on the number of partners, and hence contribution
in terms of capital investment is usually not sufficient to support large scale business operations.
(iii) Possibility of conflicts: Partnership is run by a group of persons wherein decision making
authority is shared.
(iv) Lack of continuity: Partnership comes to an end with the death, retirement, insolvency or
lunacy of any partner.
(v) Lack of public confidence: A partnership firm is not legally required to publish its financial
reports or make other related information public.
TYPES OF PARTNERS:
(i) Active partner: An active partner is one who contributes capital, participates in the
management of the firm, shares its profits and losses, and is liable to an unlimited extent to the
creditors of the firm.
(ii) Sleeping or dormant partner: Partners who do not take part in the day to day activities of
the business are called sleeping partners.
(iii) Secret partner: A secret partner is one whose association with the firm is unknown to the
general public.
(iv) Nominal partner: A nominal partner is one who allows the use of his/her name by a firm,
but does not contribute to its capital.
(v) Partner by estoppel: A person is considered a partner by estoppel if, through his/her own
initiative, conduct or behaviour, he/she gives an impression to others that he/she is a partner of
the firm.
(vi) Partner by holding out: A partner by ‘holding out’ is a person who though is not a partner
in a firm but knowingly allows himself/herself to be represented as a partner in a firm.
TYPES OF PARTNERSHIP:
(A) CLASSIFICATION ON THE BASIS OF DURATION
(i) Partnership at will: This type of partnership exists at the will of the partners.
(ii) Particular partnership: Partnership formed for the accomplishment of a particular project
say construction of a building or an activity to be carried on for a specified time period is called
particular partnership
(B) CLASSIFICATION ON THE BASIS OF LIABILITY
(i) General Partnership: In general partnership, the liability of partners is unlimited and joint.
The partners enjoy the right to participate in the management of the firm and their acts are
binding on each other as well as on the firm.
(ii) Limited Partnership: In limited partnership, the liability of at least one partner is unlimited
whereas the rest may have limited liability.
MEANING OF PARTNERSHIP DEED
The written agreement which specifies the terms and conditions that govern the partnership is
called the partnership deed.
The partnership deed generally includes the following aspects:
• Name of firm
• Nature of business and location of business
• Duration of business
• Investment made by each partner
• Distribution of profits and losses
• Duties and obligations of the partners
• Salaries and withdrawals of the partners
• Terms governing admission, retirement and expulsion of a partner
• Interest on capital and interest on drawings
• Procedure for dissolution of the firm
•Preparation of accounts and their auditing
• Method of solving disputes
REGISTRATION OF A PARTNERSHIP FIRM:
Registration of a partnership firm means the entering of the firm’s name, along with the relevant
prescribed particulars, in the Register of firms kept with the Registrar of Firms. If the firm does
not get registered, following are the consequences:
1. Partner of an unregistered firm cannot file a suit against the firm or other partners.
2. The firm cannot file a suit against third parties.
3. The firm cannot file a case against the partners.
MEANING OF CO-OPERATIVE ORGANISATION
The cooperative society is a voluntary association of persons, who join together with the motive
of welfare of the members.
FEATURES:
(i) Voluntary membership: The membership of a cooperative society is voluntary.
(ii) Legal status: Registration of a cooperative society is compulsory. This accords a separate
identity to the society which is distinct from its members
(iii) Limited liability: The liability of the members of a cooperative society is limited to the
extent of the amount contributed by them as capital.
(iv) Control: In a cooperative society, the power to take decisions lies in the hands of an elected
managing committee
(v) Service motive: The cooperative society through its purpose lays emphasis on the values of
mutual help and welfare.
MERITS:
(i) Equality in voting status: The principle of ‘one man one vote’ governs the cooperative
society.
(ii) Limited liability: The liability of members of a cooperative society is limited to the extent of
their capital contribution.
(iii) Stable existence: Death, bankruptcy or insanity of the members do not affect continuity of a
cooperative society.
(iv) Economy in operations: The members generally offer honorary services to the society
(v) Support from government: The cooperative society exemplifies the idea of democracy and
hence finds support from the Government in the form of low taxes, subsidies, and low interest
rates on loans.
(vi) Ease of formation: The cooperative society can be started with a minimum of ten members.
LIMITATIONS:
(i) Limited resources: Resources of a cooperative society consists of capital contributions of the
members with limited means.
(ii) Inefficiency in management: Cooperative societies are unable to attract and employ expert
managers because of their inability to pay them high salaries
(iii) Lack of secrecy: As a result of open discussions in the meetings of members as well as
disclosure obligations as per the Societies Act (7).
(iv) Government control: In return of the privileges offered by the government, cooperative
societies have to comply with several rules and regulations related to auditing of accounts,
submission of accounts, etc.
(v) Differences of opinion: Internal quarrels arising as a result of contrary viewpoints may lead
to difficulties in decision making.
TYPES OF COOPERATIVE ORGANISATION:
(i) Consumer’s cooperative societies: The consumer cooperative societies are formed to protect
the interests of consumers
(ii) Producer’s cooperative societies: These societies are set up to protect the interest of small
producers. The members comprise of producers desirous of procuring inputs for production of
goods to meet the demands of consumers.
(iii) Marketing cooperative societies: Such societies are established to help small producers in
selling their products.
(iv) Farmer’s cooperative societies: These societies are established to protect the interests of
farmers by providing better inputs at a reasonable cost. The members comprise farmers who
wish to jointly take up farming activities.
(v) Credit cooperative societies: Credit cooperative societies are established for providing easy
credit on reasonable terms to the members. The members comprise of persons who seek financial
help in the form of loans.
(vi) Cooperative housing societies: Cooperative housing societies are established to help people
with limited income to construct houses at reasonable costs.
MEANING OF JOINT STOCK COMPANY
A company can be described as an artificial person having a separate legal entity, perpetual
succession and a common seal.
FEATURES:
(i) Artificial person: A company is a creation of law and exists independent of its members.
(ii) Separate legal entity: From the day of its incorporation, a company acquires an identity,
distinct from its members. Its assets and liabilities are separate from those of its owners.
(iii) Formation: The formation of a company is a time consuming, expensive and complicated
process.
(iv) Perpetual succession: A company being a creation of the law, can be brought to an end only
by law. It will only cease to exist when a specific procedure for its closure, called winding up, is
completed.
(v) Control: The management and control of the affairs of the company is undertaken by the
Board of Directors, which appoints the top management officials for running the business.
(vi) Liability: The liability of the members is limited to the extent of the capital contributed by
them in a company.
(vii) Common seal: The company being an articial person cannot sign its name by itself.
(viii) Risk bearing: The risk of losses in a company is borne by all the share holders. This is
unlike the case of sole proprietorship or partnership firm where one or few persons respectively
bear the losses.
MERITS:
(i) Limited liability: The shareholders are liable to the extent of the amount unpaid on the shares
held by them.
(ii) Transfer of interest: The ease of transfer of ownership adds to the advantage of investing in
a company as the share of a public limited company can be sold in the market and as such can be
easily converted into cash in case the need arises.
(iii) Perpetual existence: Existence of a company is not affected by the death, retirement,
resignation, insolvency or insanity of its members as it has a separate entity from its members.
(iv) Scope for expansion: As compared to the sole proprietorship and partnership forms of
organisation, a company has large financial resources.
(v) Professional management: A company can afford to pay higher salaries to specialists and
professionals.
LIMITATIONS:
(i) Complexity in formation: The formation of a company requires greater time, effort and
extensive knowledge of legal requirements and the procedures involved.
(ii) Lack of secrecy: The Companies Act requires each public company to provide from time-to-
time a lot of information to the office of the registrar of companies.
(iii) Impersonal work environment: Separation of ownership and management leads to
situations in which there is lack of effort as well as personal involvement on the part of the
officers of a company.
(iv) Numerous regulations: The functioning of a company is subject to many legal provisions
and compulsions.
(v) Delay in decision making: Companies are democratically managed through the Board of
Directors which is followed by the top management, middle management and lower level
management.
(vi) Oligarchic management: In theory, a company is a democratic institution wherein the
Board of Directors are representatives of the shareholders who are the owners. In practice.
(vii) Conflict in interests: There may be conflict of interest amongst various stakeholders of a
company.
TYPES OF COMPANIES:
1. Private Company:
(a) restricts the right of members to transfer its shares.
(b) has a minimum of 2 and a maximum of 200 members, excluding the present and past
employees.
(c) does not invite public to subscribe to its securities
2. Public Company:
/(a) has a minimum of 7 members and no limit on maximum members;
(b) has no restriction on transfer securities.
(c) is not prohibited from inviting the public to subscribe to its securities.
3. One Person Company:
According to Sec.2 (62) of the Companies Act, 2013, ‘company which has only 1 person as a
shareholder’. Rule number 3 of the Companies (Incorporation) Rules, 2014 says that:
Only a natural person who is an Indian citizen and an Indian resident can form 1 person
company.
It cannot execute non-banking financial investment pursuits.
It is paid-up share capital which is not more than ₹ 50 Lakhs.
Its aggregate annual turnover of 3 years does not cross ₹ 2 Crores.
STAGES IN THE FORMATION OF A COMPANY
1. Promotion of company: It entails conceptualizing a business idea and taking the initiative to
start a company so that the available business opportunity can be put into practice.
Promoter: The term Promoter is defined in Section 2 (69) of the Companies Act 2013 as
(i) who has been named as such in a prospectus or is identified by the company in the annual
return referred to in section 92; or
(ii) who has control over the affairs of the company, directly or indirectly whether as a
shareholder, director or otherwise; or
(ii) in accordance with whose advice, directions or instructions the Board of Directors of the
company is accustomed to act:
Functions of Promoter:
1. Identification of business opportunity
2. Feasibility studies:
Technical feasibility
Financial feasibility
Economic feasibility
3. Name approval
4. Fixing up Signatories to the Memorandum of Association
5. Appointment of professionals
6. Preparation of necessary documents
2. Incorporation
The application must be filed with the Registrar of Companies in the state where the company's
registered office will be located. A registration application must be accompanied by specified
papers.
Effect of the Certificate of Incorporation:
The date inscribed on the Certificate of Incorporation marks the beginning of a company's legal
existence. On that date, it becomes a legal entity with eternal succession.
3. Capital Subscription:
Unlike a public limited company, a private corporation is not required to produce a prospectus or
complete the formalities of a minimum subscription. SEBI clearance is required to raise funds
from the public.
Process of Capital Subscription:
1. SEBI Approval
2. Filing of Prospectus
3. Appointment of Bankers, Brokers, Underwriters
4. Minimum Subscription
5. Application to Stock Exchange
6. Allotment of Shares
4. Commencement: Company applies to the registrar to issue “Certificate of Commencement of
Business”. Along with application, some documents are also submitted. The registrar will verify
all the documents submitted by the company. If he is satisfied, he will issue a Certificate for
Commencement of Business. The company can start its activities from the date of issue of this
certificate. All the dealings after issue of this certificate are binding on the company.
IMPORTANT DOCUMENTS USED IN FORMATION OF A COMPANY
The Memorandum of Association, Articles of Association, and Consent of Directors are the
documents required. Documents required to be submitted given as below
1. Memorandum of Association: It identifies the company's goals. The following
clauses are included in the MoA:
1. Name Clause
2. Registered office clause
3. Object’s clause
4. Liability clause
5. Capital clause
6. Subscription Clause
2. Articles of Association: They are the rules that govern a company's internal
management. These regulations are an addendum to the Memorandum of Association;
they should not conflict with or supersede anything in the Memorandum of Association.
3. Consent of Proposed Directors: In addition to the Memorandum and Articles of
Association, everyone nominated as a director must sign a written permission stating that
they accept to function in such capacity and agree to purchase and pay for qualification
shares.
4. Agreement: Another document that must be presented to the Registrar for the
company to be registered under the Act is the agreement that the firm forms with an
individual as a Director or a full-time Director or Manager.
5. Statutory Declaration: A declaration confirming that all legal conditions for
registration have been met must be presented to the Registrar along with the above-
mentioned documents for the company to be legally registered.
6. Receipt of Payment of Fee: The necessary payments for the company's registration
must be paid. The amount of such fees will be determined by the company's authorized
share capital.
Basis of Memorandum of Association Article of Association (AoA)
Difference (MOA)
Objectives The purposes of company is AoA described the rules of internal
defined in the Memorandum of management.
Association.
Position This is the company's primary This is a supporting document that
document, and it is governed by exists along side the Memorandum of
the Companies Act. Association and the Companies Act.
Relationship The company's interaction with Articles clarify the members' and
outsiders is defined by the company'sconnection.
Memorandum of Association.
Validity Acts that go beyond the MoA Members can ratify acts that go
are void and cannot be ratified beyond the Articles as long as they
by the members even if they don't contradict the Memorandum.
vote unanimously
Necessity A Memorandum of Association It is not required to be filed by a
is required for every business. public limited business. Table F of
the Companies Act of 2013 may be
adopted.
FACTORS AFFECTING CHOICE OF FORM OF BUSINESS ORGANISATION
(i) Cost and ease in setting up the organisation: As far as initial business setting-up costs are
concerned, sole proprietorship is the most inexpensive way of starting a business
(ii) Liability: In case of sole proprietorship and partnership firms, the liability of the
owners/partners is unlimited.
(iii) Continuity: The continuity of sole proprietorship and partnership firms is affected by such
events as death, insolvency or insanity of the owners.
(iv) Management ability: A sole proprietor may find it difficult to have expertise in all
functional areas of management.
(v) Capital considerations: Companies are in a better position to collect large amounts of
capital by issuing shares to a large number of investors.
(vi) Degree of control: If direct control over operations and absolute decision making power is
required, proprietorship may be preferred.
(vii) Nature of business: If direct personal contact is needed with the customers such as in the
case of a grocery store, proprietorship may be more suitable.
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SELF-ASSESSMENT
1. State the important privileges available to a private company.
2. How does a cooperative society exemplify democracy and secularism?
3. Why is it important to choose an appropriate form of organisation? Discuss the factors
that determine the choice of form of organisation.
4. Discuss the characteristics, merits and limitation of cooperative form of organisation.
Also describe briefly different types of cooperative societies.
5. Distinguish between a Joint Hindu family business and partnership.
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