UNIT I - BM Notes- Part II

Forms of Business Organizations - Sole Proprietorship, Partnership Firm, Joint Hindu

Family Business, Joint Stock Company and Co- Operatives

Sole proprietorship
Sole proprietorship is a popular form of business organisation and is the most
suitable form for small businesses, especially in their initial years of
operation. Sole proprietorship refers to a form of business organization that is
owned, managed and controlled by an individual who is the recipientof all
profits and bearer of all risks. This is evident from the term itself. The
word “sole” implies “only”, and “proprietor” refers to “owner”. Hence, a sole
proprietor is the one who is the only owner of a business. This form of
business is particularly common in areas of personalised services such as
beauty parlours, hair saloons and small-scale activities like running a retail
shop in a locality.
Sole trader is a type of business unit where a person is solely responsible for
providing the capital, for bearing the risk of the enterprise and for the
management of business. J.L. Hansen
The individual proprietorship is the form of business organisation at the head
of which stands an individual as one who is responsible, who directs its
operations and who alone runs the risk of failure. L.H. Haney
Salient characteristics:
(i) Formation and closure: There is no separate law that governs sole
proprietorship. Hardly any legal formalities are required to start a
sole proprietary business, though in some cases one may require a
license. Closure of the business can also be done easily. Thus, there
is ease in formation as well as closure of business.
(ii) Liability: Sole proprietors have unlimited liability. This implies the
owner is personally responsible for payment of debts in case the
assets of
the business are not sufficient to meet all the
debts.
(iii) Sole risk bearer and profit recipient: The risk of failure of business is
borne all alone by the sole proprietor. However, if the business is
successful, the proprietor enjoys all the benefits. He receives all the
business profits which become a direct reward for his risk bearing.
(iv) Control: The right to run the business and make all decisions lies
absolutely with the sole proprietor. He can carry out his plans
without any interference from others.
 (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. The owner is, therefore, held
responsible for all the activities of the business.
(vi) Lack of business continuity: The sale proprietorship business is
owned and controlled by one person, therefore death, insanity,
imprisonment, physical ailment or bankruptcy of the sole proprietor
will have a direct and detrimental effect on the business and may
even cause closure of the business.
Merits of Sole Proprietorship:
(i) Quick decision-making: A sole proprietor enjoys a considerable
degree of freedom in making business decisions. Further, the
decision making is prompt because there is no need to consult
others. This may lead to timely capitalisation of market
opportunities as and when they arise.
(ii) Confidentiality of information: Sole decision-making authority
enables the proprietor to keep all the information related to business
operations confidential and maintain secrecy. A sole
trader is also not bound by law to publish firm’s
accounts.
(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. The
need to share profits does not ariseas he/she is the single owner.
This provides maximum incentive to the sole trader to work hard.
(iv) Sense of accomplishment: There is a personal satisfaction involved
in working for oneself. The knowledge that one is responsible for
the success of the business not only contributes to self-satisfaction
but also instils in the individual a sense of accomplishment and
confidence in one’s abilities.
(v) Ease of formation and closure: An important merit of sole
proprietorship is the possibility of entering into business with
minimal legal formalities. There is no separate law that governs
sole proprietorship. As sole proprietorship is the least regulated
form of business, it is easy to start and close the business as per the
wish of the owner.
Limitations:
(i) Limited resources: Resources of a sole proprietor are limited to his/ her
personal savings and borrowings from others. Banks and other lending institutions
may hesitate to extend a long-term loan to a sole proprietor. Lack of resources is one
of the major reasons why the size of the business rarely grows much and generally
remains small.
(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 a sole proprietorship is that the
owner has unlimited liability. If the business fails, the creditors can recover their dues
not merely from the business assets, but also from the personal assets of the
proprietor. A poor decision or an unfavourable circumstance can create a serious
financial burden on the owner. That is why a sole proprietor is less inclined to
take risks in the form of innovation or expansion.
(iv) Limited managerial ability: The owner has to assume the responsibility of varied
managerial tasks such as purchasing, selling, financing, etc. It is rare to find an
individual who excels in all these areas. Thus decision-making may not be
balanced in all the cases. Also, due to limited resources, sole proprietors may not be
able to employ and retain talented and ambitious employees. Though sole
proprietorship suffers from various shortcomings, many entrepreneurs opt for this
form of organisation because of its inherent advantages. It requires less amount of
capital. It is best suited for businesses which are carried out on a small scale and
where customers demand personalised services.
Partnership:
A partnership is a formal arrangement by two or more parties to manage and operate a
business and share its profits.
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.”
Salient Characteristics
● Agreement- Partners, who decide to start this business, have to make a formal
mutual contract between them. This agreement is usually written following the
norms of government act.

● Number of Partners- According to section 11 the Indian Partnership Act,

1932, the maximum number would be 10 for a banking partnership business.
Furthermore, this number rises to 20 for other Partnership businesses.

● Share of Profit- One of the primary features of a Partnership is to make and

share the profit among the partners as per agreed ratios. However, the income
will be distributed equally if there’s no clause mentioned in the agreement
about the same.
 ● Liabilities- In general partnerships, all the partners are subjected to liabilities.
It means all of them are collectively responsible for recovering all debts of the
firm, even if they have to liquidate their personal assets.

● Non-Transferability of Interest- By any means, a partner cannot shift his/her

interest from existing firm to others. There is a strict restriction upon inclusion
and retirement of the partners. Even a minor change in the ownership of a
business has to make with the consent of the other members involved in
Partnership.

Types of Partners

Not all partners of a firm have the same responsibilities and functions. There can be
various types of partners in a partnership. Let us study the types of partners and their
rights and duties.

● Active Partner: As the name suggests he takes active participation in the

business of the firm. He contributes to the capital, has a share in the profit
and also participates in the daily activities of the firm. His liability in the
firm will be unlimited. And he often will act as an agent for the other
partners.

● Dormant Partner: Also known as a sleeping partner, he will not

participate in the daily functioning of the business. But he will still have to
make his share of contribution to the capital. In return, he will have a share
in the profits. His liability will also be unlimited.

● Secret Partner: Here the partner’s association with the firm is not public
knowledge. He will not represent the firm to outside agents or parties.
Other than this his participation with respect to capital, profits,
management and liability will be the same as all the other partners.

● Nominal Partner: This partner is only a partner in name. He allows the

firm to use the name of his firm, and the attached goodwill. But he in no
way contributes to the capital and hence has no share in the profits. He
does not involve himself in the firm’s business. But his liability too will be
unlimited.

● Partner by Estoppel: If a person makes it out to be, through their conduct

or behaviour, that they are partners in a firm and he does not correct them,
then he becomes a partner by estoppel. However, this partner too will have
unlimited liability.

Types of Partnerships
A partnership is divided into different types depending on the state and where the
business operates. Here are some general aspects of the three most common types of
partnerships.

● General Partnership
A general partnership comprises two or more owners to run a business. In this
partnership, each partner represents the firm with equal right. All partners can
participate in management activities, decision-making, and have the right to control
the business. Similarly, profits, debts, and liabilities are equally shared and divided
equally.

In other words, the general partnership definition can be stated as those partnerships
where rights and responsibilities are shared equally in terms of management and
decision making. Each partner should take full responsibility for the debts and
liability incurred by the other partner. If one partner is sued, all the other partners are
considered accountable. The creditor or court will hold the partner’s personal assets.
Therefore, most of the partners do not opt for this partnership.

● Limited Partnership
In this partnership, includes both the general and limited partners. The general partner
has unlimited liability, manages the business and the other limited partners. Limited
partners have limited control over the business (limited to their investment). They are
not associated with the everyday operations of the firm.

In most of the cases, the limited partners only invest and take a profit share. They do
not have any interest in participating in management or decision-making. This non-
involvement means they do not have the right to compensate the partnership losses
from their income tax return.

● Limited Liability Partnership

In Limited Liability Partnership (LLP), all the partners have limited liability. Each
partner is guarded against other partners' legal and financial mistakes. A limited
liability partnership is almost similar to a Limited Liability Company (LLC) but
different from a limited partnership or a general partnership.

● Partnership at Will
Partnership at Will can be defined as when there is no clause mentioned about the
expiration of a partnership firm. Under section 7 of the Indian Partnership Act 1932,
the two conditions that have to be fulfilled by a firm to become a Partnership at Will
are:

● The partnership agreement should have not any fixed expiration date.
 ● No particular determination of the partnership should be mentioned.
Therefore, if the duration and determination are mentioned in the agreement, then it is
not a partnership at will. Also, initially, if the firm had a fixed expiration date, but the
operation of the firm continues beyond the mentioned date that it will be considered as
a partnership at will.

Advantages of Partnership Firm

1. Simple formation: In the event of a partnership firm, registration is not

required. It can be founded without the need for any legal formalities or
expenditures. As a result, they are easy and cost-effective to construct and run.
2. More resources: When compared to a sole proprietorship, a partnership firm
has more resources for business operations because of the greater number of
members.
3. Operational flexibility: Because of the restricted number of partners, there is
greater flexibility in the operations of the firm, as the partners can alter any
aims or change any operations at any moment with the approval of the other
partners.
4. Improved Management: The business of a partnership firm is extremely well
managed by all of the partners, who are actively involved in the day-to-day
operations of the company as a result of their ownership, profit, and control.
5. Risk-sharing: In a partnership, each member is responsible for his or her own
risks because it is less complicated than operating as a sole proprietorship.
6. In a partnership, the interests of each partner are safeguarded against any fraud
that may occur.
Disadvantages of Partnership Firm
1. A partnership firm does not exist for an endless period of time due to the fact
that it is inherently unstable. The death, insolvency, or insanity of one of the
partners may result in the dissolution of the partnership.
2. Every partner in a partnership firm is subject to unlimited liability, as any of
the partners may be required to pay all of the debts incurred by the partnership
firm, including those incurred through the use of personal property. A single
poor judgement made by one partner might result in significant losses and
obligations for the other partners.
3. A lack of harmony: According to the partnership agreement, each partner has
the same rights as the other. When one or both partners do not agree on
something, it is possible that mistrust and disharmony will develop between
them.
4. Limited Capital: In addition, because of the restriction on the maximum
number of members, a restricted amount of capital can be raised.
5. Limited Liability: In contrast to a Joint Stock Company, a partnership firm
does not have a legal status of its own.
6. Transferring ownership in a partnership firm is a complicated process.
Transferring ownership of a business requires the consent of all of the partners.