In order to make informed investment decisions or to start a new business, it is helpful for both investors and entrepreneurs to understand the various types of business organizations and their respective advantages and disadvantages. Every business, regardless of size, belongs to a different type of business organization, which can differ based on factors such as ownership structure, function, liability, and rights of the owners.
In this article, we discuss the common forms of business organization in India, exploring their pros and cons.
Forms of Business Organisation in India
In India, an entrepreneur can form various types of business firms. These are:
- Sole Proprietorship Business
- The Partnership Business
- Private Limited Company
- Public Limited Company
- Limited Liability Partnership (LLP)
- One Person Company (OPC)
- Section 8 Company (Non Profit Organisation)
- Co-operative firms
- Joint Hindu family Business.
Let us talk about each one of them in short.
Sole Proprietorship Business
A Sole proprietorship business is the simplest form of business organisation to start and run. Most of your neighbourhood shops, family stores, and corner stores are the sole proprietorship businesses.
A single individual owns a sole proprietorship business, and the owner makes all decisions regarding his business. So the owner reaps all the profits made by his business. He also bears all the liabilities.
The major benefit of this form of business organisation is that they are easiest to run. As all the decisions taken by a single individual so there is no conflict of different opinions. Also, these businesses are the easiest to dissolve.
But a major disadvantage of a sole proprietorship business is that they expose the owner to unlimited liability. If liabilities exceed the business capital because of any big lawsuit, debt or any other reason, the authorities can recover it from the owner’s personal assets.
Also, this form of the business organisation finds it most difficult to raise extra capital when they need it.
A partnership business is another type of proprietorship where there could be two or more owners instead of one.
Partnership businesses have some advantages over a sole proprietorship. As in a partnership business, the risk will pass over several partners. Also, they have access to more talent and capital than a sole proprietorship business.
But there are also some drawbacks of a partnership business. As there could be multiple opinions on a business decision that can interfere in day-to-day business. Also, in a partnership, one partner can be left responsible for the action of other partners.
While partnership businesses have a better risk and liability diversion than a sole proprietorship, but they do not protect owners against unlimited liability. To overcome this limitation and to get access to more capital, entrepreneurs take the incorporation route, which provides the perk of limited liability and potential to attract more funds.
Private Limited Companies
To tackle the risk of unlimited liability and to reap tax benefits, owners list their businesses as a corporation. A corporation can be a private limited company or a public company.
A private limited company use suffix ‘private limited’ in its name.
As the name suggests, private limited companies are of limited liability, meaning they do not expose owners’ assets in their business. In case of any big lawsuit or recurring debt, the maximum amount that can be recovered is equal to the total assets of the company. Owners’ personal assets can not be involved in the recovery process.
These companies function as an individual entity. They have their legal rights, they can sue and can be sued by the law.
The founders and private investors own the shares of a private company. Common investors can not buy shares of the private limited companies as their shares do not trade on stock exchanges.
Because private companies do not sell their shares to the public, they do not require legally to disclose their earnings and financial reports.
Private limited companies enjoy the benefits of limited liability and tax deductions, but they can not easily raise funds as compared to a public company. If private companies need capital, they can get it from private investors or borrow it from banks. But they can not issue bonds to borrow money from the public.
Being a private company does not mean its size would be small. Even some huge corporations are private firms.
A major advantage of these companies over a public company is that they do not have to comply with strict rules of regulators. They do not require publishing their quarter results or annual reports.
Private limited companies also do not require disclosing the outcome of their Annual General Meeting (AGM). But they have to maintain the board of directors and their board should have a minimum of 2 board members.
The major disadvantage of a private company is that they can not raise capital as easily as a public company.
Public Limited Company
When a company makes its shares available to the public through an IPO, it becomes a public company. Public limited companies use the suffix ‘Public Limited’ or ‘Limited’ (Ltd.) in their names. The biggest companies around the world belong to this form of business organisation.
Public companies raise money from the public by issuing shares as an IPO and list their shares on the stock exchange. Common investors can buy and sell these shares on the exchange.
Investors who invest their money in these companies get part ownership of these companies.
Public companies can issue bonus shares to raise extra capital. They can also borrow money from the public by issuing bonds that private companies can not do.
Public companies deal with the public, so they have to follow the strict regulatory norms set by the market regulators. They must publish their quarterly results and annual reports in public and disclose them to stock exchanges. The purpose of these regulations and reporting requirements is to protect investors against any potential fraud.
Because their financial reports are accessible to everyone, financial analysts and common investors can analyze these companies. Investors keep a close eye on the business activities of executives and board members of the public companies because their business decisions can make a direct impact on investors’ investments.
Public companies must have at least 5 members on their board of directors. Also, the outcome of their Annual General Meeting (AGM) must be made public.
Investors can transfer shares of public companies from one person to another with no restriction. The price of shares of a public company is decided by supply and demand of shares on the stock exchange.
The major advantage of a public company is that they have easy access to funds and they can borrow cheap loans as compared to a private company.
The disadvantage of a public company is that it has to follow the strict regulatory norms set by the regulators. Also, investors have rights to replace the top company officials from their positions.
LLP (Limited Liability Partnership)
Limited Liability Partnership or LLP is the type of business organisation in India introduced by the Limited Liability Partnership Act 2008. The LLP differs from the traditional partnership business by having the limited liability of partners in their business. Therefore, the action of one partner will not affect the personal assets of other partners.
However, in LLP, there is a concept of unlimited liability of a ‘negligent’ partner. The negligent partner will still bear unlimited liability. All other partners’ liabilities are limited to the extent of their invested capital.
The major advantage of a Limited Liability Partnership is that partners will not be held responsible for the action of another partner.
The disadvantage of an LLP is that the action of one partner will still cost other partners to their invested business capital.
OPC (One Person Company)
One Person Company or OPC is a form of business organisation introduced in India in the Companies Act, 2013. OPC works as a private company, but as the name suggest it can be registered by a single individual. It only requires one board member and one director instead of two board members in a private limited company.
The primary advantage of a One Person Company is that it can be registered by a single person and provide the benefits of limited liability to the business owner.
The major disadvantage of the OPC is that they can not raise capital as easily as a public company and can not get cheaper loans.
Section 8 Company
A Section 8 Company is a Non-profit organisation (NPO) registered with charitable objectives. A Section 8 Company is the limited liability organisation but they can not use suffix ‘limited’ or ‘Pvt Ltd.’ in their names.
These companies promote charitable activities, arts, sports, research, health-promoting activities, religion, environment protection, etc. They use their received donations and profits (if any) to fulfill their objectives. These organisations can not distribute their profits to their board members, they are only allowed to use it for social welfare activities.
Section 8 Company gets several tax benefits from the government.
A co-operative society is a voluntary association of members working for the common goal of increasing the profits of the society. The co-operative society works for the benefits of its members. These organisations are registered under the Cooperative Societies Act, 1912.
A co-operative firm is of limited liability. Their liability is limited to the extent of the contributed capital of society members.
The members of a co-operative society are free to enter and exit in society anytime of their will. There is no effect of entry or exit of a member on the structure of a co-operative society.
Joint Hindu Family Business
Joint Hindu family is an organisation which is governed by Hindu Law instead of the Companies Act.
Only members of the family can become the owner of the business.
The head of the joint family manages and controls the business who is called Karta. Karta can take advice and opinions of other members of the family, but only he can make a final decision regarding business.
The liability of Karta is unlimited in his business, but the liability of all other members is limited to the extent of their business assets.
Advantage of Joint Hindu Family Business: It is easy to form, operate, and dissolve.
Disadvantages: It can not attract funds from outsiders of the family, the liability of the main owner will be unlimited.