There are different types of formats in which a business entity is owned and organized. Thus, each of these forms of business organization has its own advantages and disadvantages. The choice of a particular form of organization depends upon how the merits and demerits of various business entity types are balanced out.
Thus, it is extremely important for an entrepreneur to choose the right form of business organization. This is because the form of organization thus selected determines the control, power, risk and responsibility of an entrepreneur.
Further, it also determines how the profits and losses in such an organization are distributed. Thus, the choice of business organization must be made after extreme thought and discussion. This is because an entrepreneur commits to his organization for a long period of time .
Further, the choice of a particular form of organization influences the success and growth of business. Moreover, it is quite challenging to alter a particular type of business organization once the same is chosen. This is due to the fact that such a process involves complex procedures and issues that take a lot of time, effort and resources.
I. Sole Proprietorship
The term Sole Proprietor comprises of the words Sole meaning ‘single’ and proprietor meaning ‘owner. Thus, a sole proprietorship is a form of business structure that is owned, managed and controlled by a single individual. Such an individual receives all the profits and bears all the risks and losses attached to the business.
Further, he has all the authority to take all the decisions with regards to the business. Thus, a sole trader or proprietor is the person who is responsible for providing the capital, bearing the risk and management of business.
Such form business entity deals with small scale business activities like bakers, accounting firms, beauty salons, consulting agencies etc.
Characteristics of Sole Proprietorship
1. Easy Formation and Closure
Under Sole Proprietorship registration, as such there is no separate procedure for the registration of business. A person intending to start a sole proprietorship simply needs to register in his business name under any one of the government enactments.
Such a registration would depend on the nature of business the sole proprietor wishes to undertake. Similarly, the closure of sole proprietorship business takes place if the business owner decides to close the business himself or dies.
2. Unlimited Liability
The liability of a sole proprietor is unlimited. This means that the owner is personally responsible for the payment of debts in case the assets of the business are not sufficient to meet such debts. Furthermore, personal properties of the owner shall be used to pay off the outstanding debts.
3. Single Ownership
A single individual owns a sole proprietorship form of business. This means such an individual owns all the properties and assets of the business. As a result, he is the sole bearer of all the risk of the business.
4. No Sharing of Profits or Losses
The entire profit generated by a sole proprietor business belongs to the sole proprietor himself. Similarly, if such a business suffers any loss, it is also to be borne by the sole proprietor alone.
5. One Man’s Capital
The sole proprietor is the one who brings all the capital required to run such form of business. There are various sources of funding through which a sole proprietor can bring money on board. These include his personal resources or borrowings from family and friends, banks and other financial institutions.
6. Single Person’s Control
The right to run the business and make all the decisions resides with the sole proprietor alone. He can consult other people to make certain important decisions. However, he’s free to carry out his plans without any interference.
7. Less Legal Formalities
There are almost no legal formalities to form or operate a sole proprietorship type of business.No separate registration is needed for such a business entity. However, a sole proprietor may obtain a license under any of the government enactments as per the nature of his business. Also, a sole proprietorship entity needs to have seal in the name of its business.
Partnership is a form of business entity where two or more persons come together to provide the requisite resources and share the profits in an agreed ratio. Indian Partnership Act, 1932 defines “Partnership” as
“the relation between the persons who have agreed to share the profits of the business carried on by all or any of them acting for all.”
Thus, persons who agree to form a partnership form of business entity are individually called as partners. Further, the persons forming a partnership are collectively known as ”firm”.
According to the Companies Act, 2013, the minimum number of persons required to form a partnership form of business is 2. Whereas the maximum number of members in case of partnership firm should not exceed 100.
This is unlike the Companies Act 1956, which prescribes the maximum limit of members as 10 in case of partnerships and 20 for banking and other businesses.
Characteristics of Partnership Firm
1. Formed on the Basis of an Agreement
Partnership firm comes into existence based on an agreement between two or more partners agreeing to undertake the business. The terms and conditions that govern such a partnership are outlined in a document known as the Partnership Deed.
2. Existence of a Business Activity
The Partnership form of business activity can be formed only on the basis of the existence of a business activity. The business can be anything and include any trade, industry or profession.
3. Sharing of profit and Loss Between The Partners
Partners are entitled to share the profits as well as bear the losses if any in the course of business.
4. Existence of an Agency Relation
The partnership business can be undertaken by all the partners or any one partner acting on behalf of others. This means each partner is a principal in himself who can act in his own right. Further, he can also act on behalf of other partners by acting as their agent.
5. Unlimited Liability of the Partners
Each Partner is personally liable for all losses arising in the course of business. That is to say, their personal assets can be used to pay off the outstanding debts of the partnership firm.
6. Combined Management
Each partner is entitled to participate in the day to day operations of the business. However, it is not mandatory for each partner to participate in day-to-day operations of the business. But, partners running the business need to take consent of other partners for making the requisite decisions.
7. Limitation on the Transferability of Share
A partner cannot transfer his share to any other person. He may however do so on the consent of other partners.
8. No Compulsory Registration
It is not mandatory to register partnership form of entity. However, the partners can choose to register the firm with the Registrar of Firms.
9. Duration of the Partnership Firm
The partnership Firm may continue as long as the partners wish to do so. However, as per law, the partnership can come to an end if any of the partners dies, retires or becomes insolvent.
But, the remaining partners can continue doing business under the same name after sorting out the due share of the outgoing partner.
According to the Companies Act, 2013 there are three types of companies that can be registered under the act:
- Private Companies
- Public Companies
- One Person Company
However, on the basis of liability, there can be three types of companies:
- Unlimited Liability Companies
- Companies Limited by Guarantee
- And Companies Limited by Shares
A company’s liability limited by shares is the one in which the liability of the members of the company is restricted to the amount of shares held by them. Whereas, a company limited by guarantee is the one in which the liability of the members is limited to a predetermined amount. Such a predetermined amount is the one which the members of the company agree to contribute. This amount is contributed in case the company gets dissolved with outstanding liabilities.
Characteristics of a Pvt Ltd Company
1. Number of Members
In order to start a Pvt Ltd Company, a minimum number of two members are required. However, such a company can have a maximum of 200 members as per the Companies Act 2013.
2. Limited Liability
Each of the members’ or shareholders’ liability is limited in such type of business organization. This means that the shareholders are not liable to sell their personal assets in case a company faces losses. Thus, the personal, individual assets of the shareholders are not at risk.
3. Perpetual Succession
The life of the company keeps on existing for an infinite period. In case of death, insolvency or bankruptcy of the business, the company continues to exist. This gives way to the perpetual succession of the company.
4. Separate Legal Entity
A company has an identity distinct from its members. Thus, the assets and liabilities of the company are separate from that of its owners.
5. Risk Bearing
In a company form of organization, the risk of losses is borne by all the shareholders. This is unlike the case of sole proprietorship and partnership where one or few persons bear the losses respectively.
Thus, if a company incurs losses, all the shareholders contribute to such a loss to the extent of their share in the company’s capital. So, the risk of loss thus gets divided over a large number of shareholders.
IV. Limited Liability Partnership
As per the Limited Liability Partnership Act, 2008, an LLP is a body corporate formed and incorporated under this Act and is a legal entity separate from its members.
In other words, it provides the benefits of the Limited Liability and at the same time gives its members to organize the internal structure as Partnership. In order to better understand the meaning and benefits associated with an LLP, let’s have a look at its characteristics.
Characteristics of an LLP
1. Separate Legal Entity
LLP is a body corporate having legal entity separate from its members.
2. Perpetual Succession
The life of an LLP is unaffected by the death, retirement or insolvency of any of its partners. In other words, LLP would be dissolved only as per the provisions of the LLP Act.
3. Governed By LLP Act, 2008
LLP in India is governed by LLP Act, 2008. Thus, the provisions of the Partnership Act, 1932 would not apply to it.
4. Using LLP in the Name
Every LLP is required to use the words “Limited Liability Partnership” or “LLP” towards the end of its name.
5. Formation of LLP Agreement
An LLP is an outcome of an agreement between its partners. Such an agreement outlines the mutual rights and duties of the partners subject to the provisions of the LLP Act, 2008.
6. Limited Liability of the Partners
Since an LLP is a separate legal entity, the liability of the partners is limited only to the extent of the amount of capital contributed by them. That is, the personal assets of each of the partners would not be liable to pay off any of the outstanding debtors.
7. Minimum Two Designated Partners Required
There must be at least 2 designated partners in order to form LLP. Further, one out of the two designated partners must be a resident of India.
8. Maintaining Annual Accounts
An LLP is required to maintain annual accounts in order to show its true state of affairs. It is required to prepare the statement of accounts and solvency each year and file the same with the Registrar.
9. Dissolution of an LLP
Like a company form of business structure, an LLP can be dissolved voluntarily or via the tribunal established under the Companies Act, 2013.
Here is an infographic that explains Types of Business Structures in detail.