Choice of a Suitable Form of Business Organization
Choice of a Suitable Form of Business Organization
Nature of Business Activity
In small trading businesses, professions, and rendering of personal services, a sole proprietorship is predominant. E.g. small retail shops, medicine stores, etc.
The partnership is suitable in all those cases where sole proprietorship is suitable, provided the business is to be carried on a slightly bigger scale with help of one or more partners (owner). E.g. trading, consulting agencies, hotels, small manufacturing, etc.
Scale of Operations
If the scale of operations of business activities is small, a sole proprietorship or a Person Company (OPC) is suitable.
If the scale of operations is modest — neither too small nor too large — a partnership or limited liability partnership (LLP) is preferable.
Capital requirement
Enterprises requiring heavy investment (like iron and steel plants, large-scale infrastructure projects, etc.) should be organized as companies. Depending on the capital required, they can be set up as public companies and in some cases, maybe in the form of listed companies by raising money from the public and being listed on the stock exchanges.
In a sole proprietorship, the owner may raise additional capital by borrowing, purchasing on credit, and investing additional amounts himself. Banks and suppliers, however, will look closely at the proprietor’s individual financial resources before sanctioning any loans or advances.
Partnerships can often raise funds with greater ease since the resources and credit of all partners are combined in a single enterprise.
Companies are usually best able to attract capital because investors are assured that their liability will be limited, their operations are in the public domain in a transparent manner, easily accessible and the ownership can be transferred to other investors.
Managerial ability
The sole proprietor didn’t have expertise in all functional areas of the business and the size of the business may not permit the engagement of professional management.
In other forms of organizations like partnerships and companies, there is a division of work among the partners which allows the partners to specialize in specific areas, leading to better outputs and decision-making. However, this may sometimes lead to conflicts due to differences of opinion.
A company form of organization is a better alternative if the operations are large, complex in nature, and require professional management at various levels.
Degree of Control and Management
In Sole proprietor and OPC, the control is completely centralized with the owner/sole member.
In Partnership/LLP, the management and control are distributed among the members vide Partnership/LLP Agreement
In a Company, the management and control lie with the Directors, who are appointed by the shareholders (owners) of the Company.
Degree of risk and liability
In Sole proprietorship, the sole proprietor is solely liable for all acts and liabilities of the business.
In a partnership, partners are individually and jointly liable for all their acts and liabilities
In the case of OPC/LLP/Company, the liability of owners is limited
Stability of Business
Companies and LLPs have the most stability due to their feature of perpetual succession and separate legal entities. Members may come and go but the business continues.
The sole proprietorship is the least stable form as it depends upon an individual.
Flexibility of Administration
This means the ease with which an internal organization can be formed or changed.
Sole Proprietor and Partnership firms have the advantage of carrying out the business most administratively.
Companies have a rigid structure and thus are less flexible.
Division of Profit
One of the most important factors considered while setting up a business.
If this is the criteria for forming an organization, then the most preferred way is setting up Sole Proprietorship.
In a Partnership, the profits are divisible among the partners in the ratio as agreed between them in the Partnership deed and thus is the preferred way of an organization where the owners want to distribute the profit.
Costs, Procedure, and Government regulations
Sole Proprietorship is the easiest and cheapest way of starting a business. There is no government regulation and the owner needs to acquire the basic approvals like GST, license, etc. for setting up the business.
Partnerships are also simple as it requires an agreement (though even written agreements are not compulsory). Dissolution of partnership is also simple.
Independence
The company is subject to strict government regulations. So, if the entrepreneur wants to have freedom in business with little governmental interference, he has to go for either sole proprietorship or partnership.
Choice of a Suitable Form of Business Organization, Division of Profit, Flexibility of Administration, Nature of Business Activity
