Types of Business Entities

I. Sole Proprietorship

The sole trader is the simplest, oldest and natural form of business organization. It is also called sole proprietorship. ‘Sole’ means one. ‘Sole trader’ implies that there is only one trader who is the owner of the business.

Features

• It is easy to start a business under this form and also easy to close.

• He introduces his own capital. Sometimes, he may borrow, if necessary.

• He enjoys all the profits and in case of loss, he alone suffers.

• He has unlimited liability which implies that his liability extends to his personal properties in case of loss.

• He has a high degree of flexibility to shift from one business to the other.

• Business secrets can be guarded well.

• There is no continuity. The business comes to a close with the death, illness or insanity of the sole trader. Unless, the legal heirs show interest to continue the business, the business cannot be restored.

• He has total operational freedom. He is the owner, manager and controller.

• He can be directly in touch with the customers.

• He can take decisions very fast and implement them promptly.

• Rates of tax, for example, income tax and so on are comparatively very low.

Advantages

1. Easy to start and easy to close: Formation of a sole trader form of organization is relatively easy even closing the business is easy.

2. Personal contact with customers directly: Based on the tastes and preferences of the customers the stocks can be maintained.

3. Prompt decision-making: To improve the quality of services to the customers, he can take any decision and implement the same promptly. He is the boss and he is responsible for his business Decisions relating to growth or expansion can be made promptly.

4. High degree of flexibility: Based on the profitability, the trader can decide to continue or change the business, if need be.

5. Secrecy: Business secrets can well be maintained because there is only one trader.

6. Low rate of taxation: The rate of income tax for sole traders is relatively very low.

7. Direct motivation: If there are profits, all the profits belong to the trader himself. In other words. If he works more hard, he will get more profits. This is the direct motivating factor. At the same time, if he does not take active interest, he may stand to lose badly also.

8. Total Control: The ownership, management and control are in the hands of the sole trader and hence it is easy to maintain the hold on business.

9. Minimum interference from government: Except in matters relating to public interest, government does not interfere in the business matters of the sole trader. The sole trader is free to fix price for his products/services if he enjoys monopoly market.

10. Transferability: The legal heirs of the sole trader may take the possession of the business.

Disadvantages

1. Unlimited liability: The liability of the sole trader is unlimited. It means that the sole trader has to bring his personal property to clear off the loans of his business. From the legal point of view, he is not different from his business.

2. Limited amounts of capital: The resources a sole trader can mobilize cannot be very large and hence this naturally sets a limit for the scale of operations.

3. No division of labour: All the work related to different functions such as marketing, production, finance, labour and so on has to be taken care of by the sole trader himself. There is nobody else to take his burden. Family members and relatives cannot show as much interest as the trader takes.

4. Uncertainty: There is no continuity in the duration of the business. On the death, insanity of insolvency the business may be come to an end.

5. Inadequate for growth and expansion: This form is suitable for only small size, one-man-show type of organizations. This may not really work out for growing and expanding organizations.

6. Lack of specialization: The services of specialists such as accountants, market researchers, consultants and so on, are not within the reach of most of the sole traders.

7. More competition: Because it is easy to set up a small business, there is a high degree of competition among the small businessmen and a few who are good in taking care of customer requirements along can service.

8. Low bargaining power: The sole trader is in the receiving end in terms of loans or supply of raw materials. He may have to compromise many times regarding the terms and conditions of purchase of materials or borrowing loans from the finance houses or banks.

II. Partnership

Partnership is an improved from of sole trader in certain respects. Where there are like-minded persons with resources, they can come together to do the business and share the profits/losses of the business in an agreed ratio. Persons who have entered into such an agreement are individually called ‗partners‘ and collectively called ‗firm‘. The relationship among partners is called a partnership.

Indian Partnership Act, 1932 defines partnership as the relationship between two or more persons who agree to share the profits of the business carried on by all or any one of them acting for all.

Features

Relationship: Partnership is a relationship among persons. It is relationship resulting out of an agreement.

Two or more persons: There should be two or more number of persons.

There should be a business: Business should be conducted.

Agreement: Persons should agree to share the profits/losses of the business

Carried on by all or any one of them acting for all: The business can be carried on by all or any one of the persons acting for all. This means that the business can be carried on by one person who is the agent for all other persons. Every partner is both an agent and a principal.

Unlimited liability: The liability of the partners is unlimited. The partnership and partners, in the eye of law, and not different but one and the same. Hence, the partners have to bring their personal assets to clear the losses of the firm, if any.

Number of partners: According to the Indian Partnership Act, the minimum number of partners should be two and the maximum number if restricted, as given below:

10 partners is case of banking business
20 in case of non-banking business

Division of labour: Because there are more than two persons, the work can be divided among the partners based on their aptitude.

Personal contact with customers: The partners can continuously be in touch with the customers to monitor their requirements.

Flexibility: All the partners are likeminded persons and hence they can take any decision relating to business.

Partnership Deed

The written agreement among the partners is called ‘the partnership deed’. It contains the terms and conditions governing the working of partnership. The following are contents of the partnership deed:

1. Names and addresses of the firm and partners

2. Nature of the business proposed

3. Duration

4. Amount of capital of the partnership and the ratio for contribution by each of the partners

5. Their profit sharing ration (this is used for sharing losses also)

6. Rate of interest charged on capital contributed, loans taken from the partnership and the amounts drawn, if any, by the partners from their respective capital balances

7. The amount of salary or commission payable to any partner

8. Procedure to value good will of the firm at the time of admission of a new partner, retirement of death of a partner

9. Allocation of responsibilities of the partners in the firm

10. Procedure for dissolution of the firm

11. Name of the arbitrator to whom the disputes, if any, can be referred to for settlement

12. Special rights, obligations and liabilities of partners(s), if any

Kind Of Partners:

1. Active Partner: Active partner takes active part in the affairs of the partnership. He is also called a working partner.

2. Sleeping Partner: Sleeping partner contributes to capital but does not take part in the affairs of the partnership.

3. Nominal Partner: Nominal partner is a partner just for namesake. He neither contributes to capital nor takes part in the affairs of business. Normally, the nominal partners are those who have good business connections and are well placed in society.

4. Partner by Estoppels: Estoppels means behavior or conduct. Partner by estoppels gives an impression to outsiders that he is the partner in the firm. In fact, he neither contributes to capital nor takes any role in the affairs of the partnership.

5. Partner by holding out: If partners declare a particular person (having social status) as a partner and this person does not contradict even after he comes to know such declaration, he is called a partner by holding out and he is liable for the claims of third parties. However, the third parties should prove they entered into a contract with the firm in the belief that he is the partner of the firm. Such a person is called a partner by holding out.

6. Minor Partner: A minor has a special status in the partnership. A minor can be admitted for the benefits of the firm. A minor is entitled to his share of profits of the firm. The liability of a minor partner is limited to the extent of his contribution of the capital of the firm.

Advantages

1. Easy to form: Once there is a group of like-minded persons and good business proposal, it is easy to start and register a partnership.

2. Availability of larger amount of capital: More amount of capital can be raised from more number of partners.

3. Division of labour: The different partners come with varied backgrounds and skills. This facilitates division of labour.

4. Flexibility: The partners are free to change their decisions, add or drop a particular product or start a new business or close the present one and so on.

5. Personal contact with customers: There is scope to keep close monitoring with customers requirements by keeping one of the partners in charge of sales and marketing. Necessary changes can be initiated based on the merits of the proposals from the customers.

6. Quick decisions and prompt action: If there is consensus among partners, it is enough to implement any decision and initiate prompt action. Sometimes, it may more time for the partners on strategic issues to reach consensus.

7. The positive impact of unlimited liability: Every partner is always alert about his impending danger of unlimited liability. Hence he tries to do his best to bring profits for the partnership firm by making good use of all his contacts.

Disadvantages:

1. Formation of partnership is difficult: Only like-minded persons can start a partnership. It is sarcastically said, ‘it is easy to find a life partner, but not a business partner‘.

2. Liability: The partners have joint and several liabilities beside unlimited liability. Joint and several liability puts additional burden on the partners, which means that even the personal properties of the partner or partners can be attached. Even when all but one partner become insolvent, the solvent partner has to bear the entire burden of business loss.

3. Lack of harmony or cohesiveness: It is likely that partners may not, most often work as a group with cohesiveness. This result in mutual conflicts. Lack of harmony results in delay in decisions and paralyses the entire operations.

4. Limited growth: The resources when compared to sole trader, a partnership may raise little more. But when compare to the other forms such as a company, resources raised in this form of organization are limited. Added to this, there is a restriction on the maximum number of partners.

5. Instability: The partnership form is known for its instability. The firm may be dissolved on death, insolvency or insanity of any of the partners.

6. Lack of Public confidence: Public and even the financial institutions look at the unregistered firm with a suspicious eye. Though registration of the firm under the Indian Partnership Act is a solution of such problem, this cannot revive public confidence into this form of organization overnight. The partnership can create confidence in other only with their performance.

III. Joint Stock Company

Company Defined

Lord justice Lindley explained the concept of the joint stock company from of organization as „an association of many persons who contribute money or money‟s worth to a common stock and employ it for a common purpose‟.

Features

1. Artificial person: The Company has no form or shape. It is an artificial person created by law. It is intangible, invisible and existing only, in the eyes of law.

2. Separate legal existence: it has an independence existence, it separate from its members. It can acquire the assets. It can borrow for the company. It can sue other if they are in default in payment of dues, breach of contract with it, if any. Similarly, outsiders for any claim can sue it.

3. Voluntary association of persons: The Company is an association of voluntary association of persons who want to carry on business for profit. To carry on business, they need capital. So they invest in the share capital of the company.

4. Limited Liability: The shareholders have limited liability i.e., liability limited to the face value of the shares held by him.

5. Capital is divided into shares: The total capital is divided into a certain number of units. Each unit is called a share.

6. Transferability of shares: In the company form of organization, the shares can be transferred from one person to the other. A shareholder of a public company can sell his holding of shares at his will. However, the shares of a private company cannot be transferred.

7. Common Seal: As the company is an artificial person created by law has no physical form, it cannot sign its name on a paper; so, it has a common seal on which its name is engraved. The common seal should affix every document or contract.

8. Perpetual succession: ‛Members may comes and members may go, but the company continues for ever.

9. Ownership and Management separated: The shareholders are spread over the length and breadth of the country, and sometimes, they are from different parts of the world. To facilitate administration, the shareholders elect some among themselves directors to a Board, which looks after the management of the business. The Board recruits the managers and employees at different levels in the management. Thus the management is separated from the owners.

10. Winding up: Winding up refers to the putting an end to the company. Because law creates it, only law can put an end to it. The company is not affected by the death or insolvency of any of its members.

11. The name of the company ends with „limited‟: it is necessary that the name of the company ends with limited (Ltd.) to give an indication to the outsiders that they are dealing with the company with limited liability and they should be careful about the liability aspect of their transactions with the company.

Advantages

1. Mobilization of larger resources: A joint stock company provides opportunity for the investors to invest, even small sums, in the capital of large companies. The facilities rising of larger resources.

2. Separate legal entity: The Company has separate legal entity. It is registered under Indian Companies Act, 1956.

3. Limited liability: The shareholder has limited liability in respect of the shares held by him. In no case, does his liability exceed more than the face value of the shares allotted to him.

4. Transferability of shares: The shares can be transferred to others. However, the private company shares cannot be transferred.

5. Liquidity of investments: By providing the transferability of shares, shares can be converted into cash.

6. Inculcates the habit of savings and investments: Because the share face value is very low, this promotes the habit of saving among the common man and mobilizes the same towards investments in the company.

7. Democracy in management: the shareholders elect the directors in a democratic way in the general body meetings.

8. Continued existence: The Company has perpetual succession. It has no natural end. It continues forever and ever unless law put an end to it.

9. Growth and Expansion: With large resources and professional management, the company can earn good returns on its operations, build good amount of reserves and further consider the proposals for growth and expansion.

Disadvantages

1. Formation of company is a long drawn procedure: Promoting a joint stock company involves a long drawn procedure. It is expensive and involves large number of legal formalities.

2. High degree of government interference: The government brings out a number of rules and regulations governing the internal conduct of the operations of a company such as meetings, voting, audit and so on, and any violation of these rules results into statutory lapses, punishable under the companies act.

3. Inordinate delays in decision-making: As the size of the organization grows, the number of levels in organization also increases in the name of specialization. The more the number of levels, the more is the delay in decision-making.

4. Lack or initiative: In most of the cases, the employees of the company at different levels show slack in their personal initiative with the result, the opportunities once missed do not recur and the company loses the revenue.

5. Lack of responsibility and commitment: In some cases, the managers at different levels are afraid to take risk and more worried about their jobs rather than the huge funds invested in the capital of the company lose the revenue.

IV. Limited Liability Company (LLC)

Limited Liability Company is another category of company registered under the Indian New Companies Act, 2013. There are number of companies available in India including private limited and public limited ones but Limited Liability Company is a brand new one in the line. It’s often called as a Limited Liability Corporation and its nature of business is quite similar with partnership firm and sole trade business. Company is an association of persons or an artificial person formed under the Indian Companies act in order to carry out a certain business. Under the Limited Liability Company Act, liability is limited among members or partners.

New Companies Act, 2013 has defined all rules and regulations regarding incorporating and registering all limited liability companies. One should apply to the Registrar of Companies (ROC) by giving all the details regarding company including name of the company, name and address of board of directors, location of the company as per the company registration services.

A private company whose owners are legally responsible for its debts only to the extent of the amount of capital they invested. A Limited Liability Company, also known as an LLC, is a type of business structure that combines traits of both a sole-proprietorship and a company. An LLC is eligible for the pass-through taxation feature of a partnership or sole proprietorship, while at the same time limiting the liability of the owners, similar to a company. As the LLC is not considered a separate entity, the company does not pay taxes or take on losses. Instead, this is done by the owners as they have to report the business profits, or losses, on their personal income tax returns. However, just like company, members of an LLC are protected from personal liabilities, thus the name Limited Liability.

A limited liability company is an U.S. form of privately owned company that combines the limited liability of a company with the simplified taxation of a sole proprietorship or partnership. Owners of a limited liability company, referred to as an ―LLC,‖ report the company‘s profits and losses on their personal income tax returns, rather than preparing separate corporate tax returns. This is known as ―pass-through taxation.‖ LLC owners are referred to as ―members,‖ and the company may be owned by a single individual, two or more individuals, or by a company or another LLC.

Features

1. Limited liability: As the name implies, members‘ liabilities for the debts and obligations of the LLC are limited to their own investment.

2. Pass-through taxation: For taxation purposes, income from your business can be treated as your own personal income, and is therefore not subject to certain corporate taxes for which companies are liable.

3. Separate Legal Entity: A LLP is a legal entity and a juristic person established under the Act. Therefore, a LLP has wide legal capacity and can own property and also incur debts. However, the Partners of a LLP have no liability to the creditors of a LLP for the debts of the LLP.

4. Uninterrupted Existence: A LLP has ‘perpetual succession’, that is continued or uninterrupted existence until it is legally dissolved. A LLP being a separate legal person, is unaffected by the death or other departure of any Partner. Hence, a LLP continues to be in existence irrespective of the changes in ownership.

5. Audit not Required: A LLP does not require audit if it has less than Rs. 40 lakhs of turnover and less than Rs.25 lakhs of capital contribution. Therefore, LLPs are ideal for startups and small businesses that are just starting their operations and want to have minimal regulatory compliance related formalities.

6. Easy Transferability: The ownership of a LLP can be easily transferred to another person by inducting them as a Partner of the LLP. LLP is a separate legal entity separate from its Partners, so by changing the Partners, the ownership of the LLP can be changed.

7. Owning Property: A LLP being an artificial judicial person, can acquire, own, enjoy and sell, property in its name. No Partner can make any claim upon the property of the LLP – so long as the LLP is a going concern.

Advantages

1. Limited liability: As the name implies, members‘ liabilities for the debts and obligations of the LLC are limited to their own investment.

3. Limitless ownership: Some legal structures limit the number of people allowed to file as owners. With an LLC, there is no limit to the number of owners. An LLC can have one member or hundreds of members.

4. Allocation flexibility: In an LLC, the amount of money that owners invest into the business doesn‘t need to equal their percentage of ownership. When an LLC is formed, members create an operating agreement, in which different percentages of company profits and losses can be assigned to owners regardless of the amounts of their initial investments.

5. Freedom in management: Unlike standard companies, LLCs are not required to have a board of directors, annual meetings, or strict book requirements. This can free up a lot of time and stress to let you run your business on your own terms. As you can imagine, this can be an important advantage of a limited liability company as well.

Disadvantages

1. Building capital: Unlike companies, which can issue stock in order to increase funds for their companies, LLCs have to work a little harder to find investors and sources of capital due to the greater legal obligations to add a new member to an LLC. If you have a fast growth internet company that needs venture capital to scale, this limitation is one of the major disadvantages of a limited liability company.

2. Higher fees: LLCs must typically pay more fees to file as LLCs compared to some other business entities or sole proprietorships.

3. Government regulation: Because of the protections afforded to LLCs, some types of businesses are ineligible to file as LLCs. Banks, insurance companies, and medical service companies are examples of businesses that may be barred from filing.

4. Lack of case law: The LLC business form is a relatively new concept. As a result, not a lot of cases have been decided surrounding LLCs. Case law is important because of predictability. If you know a court has ruled a certain way, you can act accordingly to protect yourself.

5. Confusion About Roles: Whereas corporations have specific roles (like directors, managers, and employees), LLCs generally do not. This can make it difficult for the company and especially investors to know who‘s in charge, who can sign certain contracts, etc. Some of this confusion can be avoided by creating an LLC Operating Agreement.

6. Limited Life: In many jurisdictions, if a member departs the LLC, the LLC ceases to exist. This is unlike a corporation whose identity is unaffected by the comings and goings of shareholders. Members of LLCs can combat this weakness in the Operating Agreement.