Chapter 3: Forms of business organisation

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 lets take a look at them.

Private Sector

Sole Traders

Sole traders are the most common form of business in the world, and take up as much as 90% of all businesses in a country. The business is owned and run by one person only. Even though he can employ people, he is still the sole proprietor of the business. These businesses are so common since there are so little legal requirements to set up:

• The owner must register with and send annual accounts to the government Tax Office.
• They must register their business names with the Registrar of Business Names.
• They must obey all basic laws for trading and commerce.

There are advantages and disadvantages to everything, and here are ones for sold traders:

Pros:

• There are so few legal formalities are required to operate the business.
• The owner is his own boss, and has total control over the business.
• The owner gets 100% of profits.
• Motivation because he gets all the profits.
• The owner has freedom to change working hours or whom to employ, etc.
• He has personal contact with customers.
• He does not have to share information with anyone but the tax office, thus he enjoys complete secrecy.

Cons:

• Nobody to discuss problems with.
• Unlimited liability.
• Limited finance/capital, business will remain small.
• The owner normally spends long hours working.
• Some parts of the business can be inefficient because of lack of specialists.
• Does not benefit from economies of scale.
• No continuity, no legal identity.

Sole traders are recommended for people who:

• Are setting up a new business.
• Do not require a lot of capital for their business.
• Require direct contact for customer service.

Partnership

A partnership is a group consisting of 2 to 20 people who run and own a business together. They require a Deed of Partnership or Partnership Agreement, which is a document that states that all partners agree to work with each other, and issues such as who put the most capital into the business or who is entitled to the most profit. Other legal regulations are similar to that of a sole trader.

Pros:

• More capital than a sole trader.
• Responsibilities are split.
• Any losses are shared between partners.

Cons:

• Unlimited liability.
• No continuity, no legal identity.
• Partners can disagree on decisions, slowing down decision making.
• If one partner is inefficient or dishonest, everybody loses.
• Limited capital, there is a limit of 20 people for any partnership.

Recommended to people who:

• Want to make a bigger business but does not want legal complications.
• Professionals, such as doctors or lawyers, cannot form a company, and can only form a partnership.
• Family, when they want a simple means of getting everybody into a business (Warning: Nepotism is usually not recommended).

Note: In some countries including the UK there can be Limited Partnerships. This business has limited liability but shares cannot be bought or sold. It is abbreviated as LLP.

Private Limited Companies

Private Limited Companies have separate legal identities to their owners, and thus their owners have limited liability. The company has continuity, and can sell shares to friends or family, although with the consent of all shareholders. This business can now make legal contracts. Abbreviated as Ltd (UK), or Proprietary Limited, (Pty) Ltd.

Pros:

• The sale of shares make raising finance a lot easier.
• Shareholders have limited liability, therefore it is safer for people to invest but creditors must be cautious because if the business fails they will not get their money back.
• Original owners are still able to keep control of the business by restricting share distribution.

Cons:

• 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 b 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.

• Shares cannot be freely sold without the consent of all shareholders.
• The accounts of the company are less secret than that of sole traders and partnerships. Public information must be provided to the Registrar of Companies.
• Capital is still limited as the company cannot sell shares to the public.

Public Limited Companies

Public limited companies are similar to private limited companies, but they are able to sell shares to the public. A private limited company can be converted into a public limited company by:

1. A statement in the Memorandum of Association must be made so that it says this company is a public limited company.
2. All accounts must be made public.
3. The company has to apply for a listing in the Stock Exchange.

A prospectus must be issued to advertise to customers to buy shares, and it has to state how the capital raised from shares will be spent.

Pros:

• Limited liability.
• Continuity.
• Potential to raise limitless capital.
• No restrictions on transfer of shares.
• High status will attract investors and customers.

Cons:

• Many legal formalities required to form the business.
• Many rules and regulations to protect shareholders, including the publishing of annual accounts.
• Selling shares is expensive, because of the commission paid to banks to aid in selling shares and costs of printing the prospectus.
• Difficult to control since it is so large.
• Owners lose control, when the original owners hold less than 51% of shares.

Control and ownership in a 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 loose 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.

Co-operatives

Cooperatives are a group of people who agree to work together and pool their money together to buy "bulk". Their features are:

• All members have equal rights, no matter how much capital they invested.
• All workload and decision making is equally shared, a manager maybe appointed for bigger cooperatives
• Profits are shared equally.

The most common cooperatives are:

• producer co-operatives: just like any other business, but run by workers.
• retail co-operatives: provides members with high quality goods or services for a reasonable price.

Other notable business organizations:

Close Corporations:

This type of business is present in countries such as South Africa. It is like a private limited company but it is much quicker to set up:

• Maximum limit of 10 people.
• You only need a simple founding statement which is sent to the Registrar of Companies to start the business.
• All members are managers (no divorce of ownership and control).
• A separate legal unit, has both limited liability and continuity.

Cons:

• The size limit is not suitable for a large business.
• Members may disagree just like in a partnership.

Joint ventures

Two businesses agree to start a new project together, sharing capital, risks and profits.

Pros:

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

Cons:

• Profits have to be shared.
• Disagreements might occur.
• The two partners might run the joint venture differently.

Franchising

The franchisor is a business with a successful brand name that recruits franchisees (individual businesses) to sell for them. (e.g. McDonald, Burger King)

Pros for the franchisor:

• The franchisee has to pay to use the brand name.
• Expansion is much faster because the franchisor does not have to finance all new outlets.
• The franchisee manages outlets
• All products sold must be bought from the franchisor.

Cons for the franchisor:

• The failure of one franchise could lead to a bad reputation of the whole business.
• The franchisee keeps the profits.

Pros for the franchisee:

• The chance of failure is much reduced due to the well know brand image.
• The franchisor pays for advertising.
• All supplies can be obtained from the franchisor.
• Many business decisions will be made by the franchisor (prices, store layout, products).
• Training for staff and management is provide by the franchisor.
• Banks are more willing to lend to franchisees because of lower risks.

Cons for the franchisee:

• Less independence
• May be unable to make decisions that would suit the local area.
• Licence fee must be paid annually and a percentage of the turnover must be paid.

Public Sector

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.

Pros:

• 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)

Cons:

• 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.

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 privatised.

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