formation of different forms of business organization

8/3/2019 Formation of Different Forms of Business Organization

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SOLE PROPRIERTORSHIP

'Sole' means single and 'proprietorship' means ownership. It means only one

person or an individual becomes the owner of the business. Thus, the business

organization in which a single person owns, manages and controls all the

activities of the business is known as sole proprietorship form of business

organization.

The individual who owns and runs the sole proprietorship business is

called a sole proprietor or sole trader.

A sole proprietor pools and organizes the resources in a systematic way

and controls the activities with the sole objective of earning profit.

This form of business is the oldest and most common form of business

organization.

Characteristics of Sole Proprietorship

Sole proprietorship form of business organizations have the following

characteristics.

Single Ownership


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No sharing of Profit and Loss

One-mans Capital

One-man Control

Unlimited Liability

Less legal formalities

Single Ownership

A single individual always owns sole proprietorship form of business

organization. That individual owns all assets and properties of the

business. Consequently, he alone bears all the risk of the business. Thus,

the business of the sole proprietor comes to an end at the will of the owner

or upon his death.

No sharing of Profit and Loss

The entire profit arising out of sole proprietorship business goes to the

sole proprietor. If there is any loss it is also to be borne by the sole

proprietor alone. Nobody else shares the profit and loss of the business

with the sole proprietor.

One mans Capital


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The capital required by a sole proprietorship form of business organization

is totally arranged by the sole proprietor. He provides it either from his

personal resources or by borrowing from friends, relatives, banks or other

financial institutions.

One-man Control

The controlling power in a sole proprietorship business always remains

with the owner. The owner or proprietor alone takes all the decisions to

run the business. Of course, he is free to consult any body as per his

liking.

Unlimited Liability

The liability of the sole proprietor is unlimited. This implies that, in case of

loss the business assets along with the personal properties of the

proprietor shall be used to pay the business liabilities.

Less Legal Formalities

The formation and operation of a sole proprietorship form of business

organization requires almost no legal formalities. It also does not require

to be registered. However, for the purpose of the business and depending

on the nature of the business, the sole proprietorship has to have a seal.


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He may be required to obtain a license from the local administration or

from the health department of the government, whenever necessary.

Advantages of Sole Proprietorship

The sole proprietorship form of business is the most simple and common in our

country. It has the following advantages:

Easy to Form and Wind up: A sole proprietorship form of business is very

easy to form. With a very small amount of capital you can start the

business. There is no need to comply with any legal formalities except for

those businesses which required license from local authorities or health

department of government. Just like formation it is also very easy to wind

up the business. It is your sole discretion to form or wind up the business

at any time.

Direct Motivation: The profits earned belong to the sole proprietor alone

and he bears the risk of losses as well. Thus, there is a direct link between

effort and reward. If he works hard, then there is a possibility of getting

more profit and of course, he will be the sole beneficiary of this profit.

Nobody will share this reward with him. This provides strong motivation for

the sole proprietor to work hard.


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Quick Decision and Prompt Action: In a sole proprietorship business the

sole proprietor alone is responsible for all decisions. Of course, he can

consult others. But he is free to take any decision on his own. Since no

one else is involved in decision making it becomes quick and prompt

action can be taken on the basis of this decision.

Better Control: In sole proprietorship business the proprietor has full

control over each and every activity of the business. He is the planner as

well as the organiser, who co-ordinates every activity in an efficient

manner. Since the proprietor has all authority with him, it is possible to

exercise better control over business.

Maintenance of Business Secrets: Business secrecy is an important factor

for every business. It refers to keeping the future plans, technical

competencies, business strategies, etc,. secret from outsiders or

competitors. In the case of sole proprietorship business, the proprietor is

in a very good position to keep his plans to himself since management

and control are in his hands. There is no need to disclose any information

to others.

Close Personal Relation: The sole proprietor is always in a position to

maintain good personal contact with the customers and employees. Direct

contact enables the sole proprietor to know the individual likes, dislikes


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and tastes of the customers. Also, it helps in maintaining close and

friendly relations with the employees and thus, business runs smoothly.

Flexibility in Operation: The sole proprietor is free to change the nature

and scope of business operations as and when required as per his

decision. A sole proprietor can expand or curtail his business according to

the requirement. Suppose, as the owner of a bookshop, you have been

selling books for school students. If you want to expand your business you

can decide to sell stationery items like pen, pencil, register, etc. If you are

running an STD booth, you can expand your business by installing a fax

machine in your booth.

Encourages Self-employment: Sole proprietorship form of business

organisation leads to creation of employment opportunities for people. Not

only is the owner self-employed, sometimes he also creates job

opportunities for others. You must have observed in different shops that

there are a number of employees assisting the owner in selling goods to

the customers. Thus, it helps in reducing poverty and unemployment in

the country.

Limited Capital: In sole proprietorship business, it is the owner who

arranges the required capital of the business. It is often difficult for a single

individual to raise a huge amount of capital. The owners own funds as


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well as borrowed funds sometimes become insufficient to meet the

requirement of the business for its growth and expansion.

Unlimited Liability: In case the sole proprietor fails to pay the business

obligations and debts arising out of business activities, his personal

properties may have to be used to meet those liabilities. This restricts the

sole proprietor from taking risks and he thinks cautiously while deciding to

start or expand the business activities.

Lack of Continuity: The existence of sole proprietorship business is linked

to the life of the proprietor. Illness, death or insolvency of the owner brings

an end to the business. The continuity of business operation is therefore

uncertain.

Limited Size: In sole proprietorship form of business organization there is

a limit beyond which it becomes difficult to expand its activities. It is not

always possible for a single person to supervise and manage the affairs of

the business if it grows beyond a certain limit.

Lack of Managerial Expertise: A sole proprietor may not be an expert in

every aspect of management. He/she may be an expert in administration,

planning, etc., but may be poor in marketing. Again, because of limited


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financial resources it is also not possible to employ a professional

manager. Thus, the business lacks benefits of professional management.

Suitability of Sole Proprietorship

Sole proprietorship form of business organisation is suitable:

Where the market for the product is small and local. For example, selling

grocery items, books, stationery, vegetables, etc.

Where customers are given personal attention, according to their personal

tastes and preferences. For example, making special type of furniture,

designing garments, etc.

Where customers are given personal attention, according to their personal

tastes and preferences. For example, making special type of furniture,

designing garments, etc.

Where the nature of business is simple. For example, grocery, garments

business, telephone booth, etc.

Where capital requirement is small and risk involvement is not heavy. For

example, vegetables and fruits business, tea stall, etc.

Where manual skill is required. For example, making jeweler, haircutting

or tailoring, cycle or motorcycle repair shop, etc.


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Formation of Sole Proprietorships

Sole proprietorships are formed simply by beginning business. Unlike

many other business organizations, no formal documents must be filed

with the secretary of state to create a sole proprietorship.

Registration of Assumed Business Name

If a sole proprietorship intends to operate under a name other than the

owners name, the owner must register the assumed business name or

trade name with the secretary of state to (1) reserve use of the name

and (2) prevent other businesses from operating with deceptively similar

names.

Licensing

The secretary of state and the counties in which a business is operating

may require a business license. The purpose of such licensing is to

regulate businesses, maintain business standards, protect existing

business interests, and protect the public (e.g., by requiring background

checks on companies that intend to work in residential environments).

Management


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Personal assets of proprietor shall not be liable for debts created by this

contract, or a breach thereof.

Note: Obviously, this doesnt work in the event of a tort (e.g., accident).

Bonding and Insurance

Sole proprietors can limit the personal liability through bonding and liability

insurance. While both are forms of insurance, their purpose is different.

Bonding ensures that a contract will be performed; liability insurance

protects against damage, theft, torts, and so on.

bonding: ensures performance of contract

liability insurance: protects against losses and damage (property

damage, theft)

Disadvantages

Bonding may not be available to high-risk or new businesses.

Additionally, it is very costly for many businesses (e.g., businesses that

deal with small children) and therefore may be cost prohibitive.

Taxation Considerations


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Sole proprietorship business profits = personal income of the sole

proprietor

Taxing the business profits as personal income allows business owners to

offset business income with other losses.

Termination

Upon Death

A sole proprietorship automatically terminates on the death of the sole

proprietor because a sole proprietorship is merely an extension of the

individual.

Upon Sale

Valuation of a business is based on the tangible assets (tables, chairs,

etc.) as well as the general reputation of a business (the goodwill).

Valuation:business assets + goodwill(reputation)

Sale Price:look to other business sales orbusiness income for specified

time


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A contract of partnership which may be oral or written, expresses or

implied, subject to the rules contained in Articles 1771 to 1773 of the New

Civil Code.

Two or more persons who have the legal capacity to enter into the

contract of partnership.

Valuable contribution to a common fund which may consist of money,

property or industry.

An intention to divide the profits between or among the partners.

Lawful purpose (s).

Characteristics of a Partnership

There are five basic characteristics of a partnership. These are:

Mutual agency

Voluntary association

Based on contract

Limited life

Unlimited liability


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Mutual Agency

Every partner is an agent of the partnership for the purpose of its

business. The act of every partner for apparently carrying on in the usual

way the business of the partnership of which he is a member binds the

partnership. This means that the act of each partner, provided that it is

within the scope of the business of the partnership, binds the partnership

or make the partnership liable to third parties.

Voluntary Association

A partnership is a voluntary association in as much as no person can be

forced against his will to become a partner to a partnership. This is

because a partner is responsible for the business acts of his partners

when the acts are within the scope of the business of the partnership; and,

also, because a general partner in unlimitedly liable for the partnership

debts. Consequently, it is only fair that a person be permitted to select the

people he wishes to join with in a partnership.

Based on contract

A partnership excludes from its concept all other associations which do

not have their origin in the contract. To form a partnership, all that is

required is that two or more competent people agree to become partners.


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Their agreement, be it oral or in writing, becomes a contract that binds all

the partners. If in writing, the contract is generally referred to as the

Articles of Co-Partnership.

Limited Life

In as much as the partnership is a relationship that originates from a

contract between or among individuals, any change in the relationship

terminates the contract and dissolves the partnership. The partnership is

dissolved by the death or withdrawal of a partner, the insolvency of a

partner, the termination of a project or purpose for which the partnership

has been formed, or the termination of the period specified in the contract

or agreement of partnership.

This does not, however, mean that the business will cease its operation. It

may or it may not. If the remaining partners decide to continue the

business, they may do so by forming a new partnership agreement. They

may even invite new partners into the business. If, on the other hand, the

remaining partners to liquidate the business, then the business ceases

operation.

Unlimited Liability


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A partnership is said to have unlimited liability in as much as the liability of

a partner extends beyond his interest in the partnership. Our law states

that all partners, including industrial ones, shall be liable pro rata with all

their property and after all the partnership assets have been exhausted. In

other words, creditors can run after the personal assets of the partners

(except limited partners), after all the partnership assets have been

exhausted, for the settlement of their claims on the partnership.

Classification of Partnerships

Partnerships may generally be classified on the basis of:

Scope of business operations

General Partnership

Special Partnership

Liability of members

General partnership

Limited partnership

Object of the partnership

Universal partnership


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Particular partnership

General Partnership (as to scope)

Is organized to engaged in a general line of business ( trading or

manufacturing) or for the exercise of a certain profession (service) during

the period of its existence. A general partnership engaged in trading or

manufacturing is referred to as a trading partnership while a general

partnership engaged in service activities is referred to as a nontrading

partnership.

Special Partnership

Is organized for a specific task or project, the completion of which shall

automatically dissolve the partnership and terminate its existence.

General Partnership (as to liability)

Is one in which all the members are general partners, i.e., all of the

partners are personally liable for partnership debts. The creditors of the

partnership can run after the personal assets of all the partners they being

general partners, after all of the partnership assets have been exhausted.

Limited Partnership


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Is one in which there is at least one (but not all) limited partner. In a limited

partnership, not all of the partners can be limited partners. There should

be at least one general partner to assume unlimited liability.

Universal Partnership

May refer to all the present property or to all of the profits. In a universal

partnership of all present property, the partners contribute all their property

to a common fund with the intention of dividing the property and all the

profits they may acquire therewith among themselves.

A universal partnership of profits comprises all that the partners may

acquire by their industry or work during the existence of the partnership.

In other words, in the universal partnership of all property, the property

becomes the common property of all the partners because ownership of

the said property passes to the partnership while the property in a

universal partnership of profits which each of the partners may possess at

the time of the formation of the partnership shall continue to pertain

exclusively to each, the usufruct or only the use of which shall pass on to

the partnership.

Particular Partnership


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Has for its object determinate things, their use or fruits, or a specific

undertaking, or the exercise of a profession or vocation.

Classification of Partners

Partners may be classified under several bases:

As to liability

General partner

Limited partner

As to contribution

Capitalist partner

Industrial partner

As to management of the firm

Managing partner

Ostensible partner

Nominal partner

Secret partner


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Silent partner

Dormant partner

General Partner

Is one who assumes unlimited liability, i.e., he is liable for partnership

debts up to the extent of his personal assets.

Limited Partner

Is one who is liable for partnership debts only up to the extent of his

interest in the partnership.

Capitalist Partner

Is one who contributes money or property.

Industrial Partner

Is one who contributes only his industry or personal service.

Managing Partner

Is one who manages the affairs of the business of the partnership. He may

be appointed as such either in the Articles of Co-Partnership or after the

Constitution of the partnership.


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Ostensible Partner

Is one who takes active part in the partnership and known to the public as

a partner in the business, whether or not he has an actual interest in the

firm. If he is not actually a partner, he is subject to liability by the doctrine

of estoppel.

Nominal Partner

Is one who is not really a partner having no financial interest in the

partnership, but is represented as being in fact a partner and, therefore,

liable as a partner. He is a partner in name only by permitting the use of

his name either for accommodation or for consideration.

Secret Partner

Is one who has financial interest in the firm and takes active part in the

business but is not known or held out to outside parties as a partner.

Silent Partner

Is one who has financial interest in the firm but does not take active part in

the business although he may be known to be a partner by outside

parties. He need not be a secret partner.

Dormant Partner


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Is one who has financial interest in the firm but who does not take active

part in the management and is not known or held out as a partner.

Corporation

Is an artificial body organized in accordance with the provision of aw in

which ownership is divided into shares of stocks.

The Corporation Code of the Philippines defines a corporation as an

artificial being created by operation of law, having the right of succession

and the powers, attributes and properties expressly authorized by law or

incident to its existence. Five or more persons are required to organize a

corporation. The owners of a corporation are called shareholders or

stockholders.

Characteristics of a Corporation

Separate legal existence

Transferable unit of ownership

Limited liability of stockholders

Continuity of existence

Centralized management by the Board of Directors


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Classification of Corporations

As to purpose. The Corporation Code of the Philippines implies two types

of corporations according to purpose. These are:

Public corporation. These are corporations formed or organized for the

government of a portion of the state, i.e., for political or public purpose

connected with the administration of government. They are also called

municipal corporations or local governments. Examples are barrios, cities,

municipalities, and provinces.

Private Corporations. These are corporations formed other than for the

government of a portion of a state. They are formed for some private

purpose, benefit, or end. Other classifications under this heading are:

Quasi-public corporations

Government-owned or controlled corporations

As to how membership is represented. The Corporation Code of the

Philippines, Section 3, classifies corporations under this basis as:

Stock corporations

Non-stock corporations


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As to the state of incorporation.

Domestic corporations

Foreign corporations

As to admission of stockholders.

Open corporations

Closed corporations

Parties to a Corporation

Corporators are those who compose the corporation whether

stockholders (for a stock corporation) or members (for a non stock

corporation). Hence, corporators include incorporators, stockholders, or

members.

Incorporators are those corporators mentioned in the articles of

incorporation as originally forming and composing the corporation and

who executed and signed the articles of incorporation as such. There

should be at least five but not more than fifteen incorporators.


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Stockholders/Shareholders are owners of shares of stock in a stock

corporation. Stockholders may be natural or artificial persons (other

corporations) but only natural persons can be incorporators.

Members are corporators of a non-stock corporation who do not own

capital stock.

Promoters are persons who undertake to form and organize a

corporation by bringing together the incorporators or the persons

interested in the enterprise. They procure subscriptions or capital for the

corporation and set in motion the machinery which leads to the

incorporation of the corporation itself.

Board of Directors We have already learned that the management of a

corporation is vested in the board of directors who are elected by the stock

holders or members among themselves. The Board of Directors shall not

be less than five or more than eleven.

The right to vote in stockholders meetings

The right to share in the profits

The right to share in the distribution of assets upon liquidation of the

corporation


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The right to purchase enough shares in case of new issues so as to be

able to maintain his proportionate interest in the corporation. This is called

stockholders preemptive right.

Organization of a Corporation

Promotion

Incorporation

Formal organization and commencement of business operations

Promotion

Refers to bringing together of the incorporators and person interested in

forming a corporation and procuring subscriptions or capital for the

corporation.

Incorporation

Registration of business name

Drafting and execution of the Articles of Incorporation by the incorporators.

Treasurers affidavit execution.

Filling of the Articles of Incorporation with the Securities and Exchange

Commission together with the treasurers affidavit.


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Issuance by SEC of the Certificate of Incorporation

Formal Organization

Adoption of By-Laws

Election of Board of Directors

Election of Officers

Commencement of business operations

The Articles of Incorporation

The Articles of Incorporation must substantially contain the following matters as

required by section 14 of the Corporation Code:

Name of the corporation;

Specific purpose or purposes for which the corporation is formed;

Location or principal place of business;

Term for which the corporation is to exist, not exceeding fifty years;

Names, nationalities, and residences of the incorporators;


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Names, nationalities, and residences of the persons who shall act as

directors or trustees until the first regular directors or trustees are duly

elected and qualified.

In case of stock corporations, the amount of its authorized capital stock,

the number of shares into which it is divided, and the par value of each

share (in case of par value shares).

In case of stock corporations, the names, nationalities, and residences of

the original subscribers and the amount subscribed and paid by each on

his subscription.

In case of non-stock corporations, the amount of its capital, the names,

nationalities, and residences of the contributors and the amount

contributed by each.

Such other matters as are not inconsistent with law and which the

incoporators may deem necessary and convenient.

formation of different forms of business organization

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