By Harshvardhan, the Subject Matter Expert at Edumarz
Solution: After studying various forms of business organizations, it is evident that each form has certain advantages as well as disadvantages. It, therefore, becomes vital that certain basic considerations are kept in mind while choosing an appropriate form of organisation.
The important factors determining the choice of the organisation are listed and discussed as follows:
(i) Cost and ease in setting up the organisation: As far as initial business setting-up costs are concerned, the sole proprietorship is the most inexpensive way of starting a business. However, the legal requirements are minimum and the scale of operations is small. In the case of partnership also, the advantage of fewer legal formalities and lower cost is there because of the limited scale of operations. Cooperative societies and companies have to be compulsorily registered. The formation of a company involves a lengthy and expensive legal procedure. From the point of view of initial cost, therefore, the sole proprietorship is the preferred form as it involves the least expenditure. The company form of organisation, on the other hand, is more complex and involves greater costs.
(ii) Liability: In the case of sole proprietorship and partnership firms, the liability of the owners/partners is unlimited. This may call for paying the debt from the personal assets of the owners. In a joint Hindu family business, only the Karta has unlimited liability. In cooperative societies and companies, however, liability is limited and creditors can force payment of their claims only to the extent of the company’s assets. Hence, from the point of view of investors, the company form of organisation is more suitable as the risk involved is limited.
(iii) Continuity: The continuity of sole proprietorship and partnership firms is affected by such events as death, insolvency or insanity of the owners. However, such factors do not affect the continuity of business in the case of organisations like joint Hindu family businesses, cooperative societies and companies. In case the business needs a permanent structure, the company form is more suitable. For short term ventures, proprietorship or partnership may be preferred.
(iv) Management ability: A sole proprietor may find it difficult to have expertise in all functional areas of management. In other forms of organisations like partnerships and companies, there is no such problem. Division of work among the members in such organisations allows the managers to specialise in specific areas, leading to better decision making. But this may lead to situations of conflicts because of differences of opinion amongst people. Further, if the organisation’s operations are complex in nature and require professionalised management, the company form of organisation is a better alternative. Proprietorship or partnership may be suitable, where the simplicity of operations allow even people with limited skills to run the business. Thus, the nature of operations and the need for professionalised management affect the choice of the form of organisation.
(v) Capital considerations: Companies are in a better position to collect large amounts of capital by issuing shares to a large number of investors. Partnership firms also have the advantage of combined resources of all partners. But the resources of a sole proprietor are limited. Thus, if the scale of operations is large, company form may be suitable whereas for medium and small-sized businesses one can opt for partnership or sole proprietorship. Further, from the point of view of expansion, a company is more suitable because of its capability to raise more funds and invest in expansion plans. It is precisely for this purpose that in our opening case Neha’s father suggested she should consider switching over to the company form of organisation.
(vi) Degree of control: If direct control over operations and absolute decision-making power is required, proprietorship may be preferred. But if the owners do not mind sharing control and decision making, partnership or company form of organisation can be adopted. The added advantage in the case of a company form of organisation is that there is complete separation of ownership and management and it is professionals who are appointed to independently manage the affairs of a company.
(vii) Nature of business: If direct personal contact is needed with the customers such as in the case of a grocery store, proprietorship may be more suitable. For large manufacturing units, however, when direct personal contact with the customer is not required, the company form of organisation may be adopted. Similarly, in cases where services of a professional nature are required, a partnership form is much more suitable.
It would not be out of place to mention here that the factors stated above are interrelated. Factors like capital contribution and risk vary with the size and nature of business, and hence a form of business organisation that is suitable from the point of view of the risks for a given business when run on a small scale might not be appropriate when the same business is carried on a large scale. It is, therefore, suggested that all the relevant factors must be taken into consideration while making a decision with respect to the form of organisation that should be adopted.