A business cannot run in isolation. It requires proper management and organisation of business activities in an appropriate form. For this, it is essential for an organisation to determine its form of business organisation defining the form of ownership of the business. Ownership here consists of sharing of profits, capital investment, and management of the business. The different forms of business organisation that a firm can choose are Sole Proprietorship, Partnership, Hindu Undivided Family Business, Joint Stock Company, and Cooperative Society.
The decision of choosing an appropriate form of business organisation falls on a firm either at the time of starting a business or expanding an existing business. To select the most appropriate form of the business organisation, one has to weigh the merits and demerits of each type of form of an organisation against their own requirements.
Choice of Form of Business Organisation
To identify the most appropriate form of a business organisation one has to weigh the merits and limitations of each type of organisation. Some of the considerations for which the merits and demerits are weighed are as follows:
1. Cost and Ease in Setting up the organisation
Starting up a new business or expanding an existing business needs some cost. The first and crucial consideration for the selection of the form of business organisation is the cost and ease of forming the organisation. It is easy to start a sole proprietorship business with minimum cost and fewer legal requirements. Forming a partnership firm also requires less cost and legal formalities as it has a limited scale of operation. However, for the formation of cooperative societies and a company it is compulsory to get registered. Opening up a company or expanding a business into a company is a complex process and requires expensive and lengthy legal requirements.
By taking cost and ease in setting up the organisation into consideration for selecting the form of organisation, it can be concluded that a Sole Proprietorship is an appropriate form as it involves less cost and legal requirements. However, the drawback of Sole Proprietorship is its limited scale of operations.
Liability is the obligation or something owed by an individual or a company to a third party. Every form of organisation creates some liability for the owner of the business. Therefore, it is also an important consideration in the selection of the form of business organisation. The owner/partners of Sole Proprietorship and a Partnership Firm has unlimited liability. It means that at the time of paying off the debts of the business, their personal property can also be used. In a Hindu Undivided Family Business, only the Karta has unlimited liability, the rest of the members of the family enjoys limited liability up to the extent of their share in the coparcenary property of the business. However, the members of a company and cooperative society enjoy limited liability.
By taking liability into consideration for selecting the form of business organisation, it can be concluded that Company is the most suitable form of organisation, as the members of a Company enjoy limited liability up to the extent of their share in the business.
An ideal form of business organisation should always ensure its continuity. In a Hindu Undivided Family Business, Company, and Cooperative Society, the members enjoy continuity or perpetual existence, as the death, insanity, or insolvency of the owner does not affect the business. However, the continuity of a Partnership Firm and Sole Proprietorship is affected by the death, insanity, or insolvency of a partner and owner, respectively.
By taking Continuity into consideration for selecting the form of business organisation, it can be concluded that Partnership or Sole Proprietorship is suitable for short-term ventures. However, if the members forming a business wants a permanent structure, the Company form of business organisation is suitable.
4. Management Ability
Another consideration for the selection of form of business organisation is the nature of operations and the requirement of professionalized management in the business. It is difficult to have expertise in all areas of management in the case of Sole Proprietorship. However, in the case of the Company, Cooperative Society, and Partnership, the work is divided amongst members of the business allowing them to work with their specialization in different areas, resulting in better performance and decision making. But, the members of these forms of business organisation might face conflicts due to differences of opinion.
Partnership or Sole Proprietorship is a suitable form of a business organisation if the operations of the business are simple and do not require many specializations. However, Company is a better form of business organisation if the operations of the business are complex and require professionalism for better performance.
5. Capital Considerations
Capital or finance is the basic requirement for starting or expanding any form of business organisation. Therefore, it is essential to determine in advance the total amount of finance required by an entrepreneur for opening up a business. If the owner of the business requires less capital and can manage the capital requirement from his/her own resources, then Sole Proprietorship is suitable. However, if the owner of the business requires large capital and cannot manage the capital requirement from his/her own resources, then the Company form of business organisation is suitable, as a company can easily gather a large amount of capital through the issue of shares. A company can even raise additional funds in the long run, which makes it suitable for the expansion of a business also.
If the scale of operations of a business is large, then the Company form of business organisation is appropriate. However, if the scale of operations is small or medium, Sole Proprietorship or Partnership is preferable.
6. Degree of Control
The level of degree of control desired by the owner of a business is also an important consideration for the selection of a form of business organisation. If the owner of the business wants to have direct control over the business activities and its operations, then Sole Proprietorship is suitable. However, if the owners of the firm don’t want direct control and agree to share the control over the business and the decision-making power, then the Company and Partnership form of business organisation is preferable. The Company form of business organisation also provides the owners with an additional advantage of complete separation of the management and ownership of the business. In this case, a company can appoint professionals who can independently manage company affairs.
7. Nature of Business
The last consideration for the selection of a form of business organisation is the nature of business. If the owners of the business want direct personal contact with the customers, then Sole Proprietorship is suitable. Partnership is preferable for professional services. However, for large manufacturing units, Company is the best form of organisation.
The above-mentioned points are just general guidelines for the selection of an ideal form of organisation. One should keep in mind that only one consideration cannot be a determining factor in selecting a form of business organisation. It is essential to consider every factor while making a decision.