Any economic activity organized and directed towards producing goods and services with the intention of profit making is commonly referred to as a business. This thesis therefore seeks to examine the different forms of businesses formed with the intention of producing good and services profit making a profit purposes.
The thesis shall look into the composition of the different business units by examining their formation management; sources of capital, liability of the owners and the advantages and disadvantages that arise from there composition. But before looking into the above composition we shall begin by defining the key terms.
- Definition of Key terms
- Business unit; this is a distinctive form of organization formed by one or more persons with a view of providing goods and services. It is some times referred to as a firm or an enterprise depending on the scale of operation (Campbell 1990)
- Capital; these are the resources required to start a business
- Liability; this refers to the extent to which the owner(s) of a business can be called upon to meet the debts of the business.
- CLASSIFICATION OF BUSINESS UNITS
Businesses are varied in terms of legal structure, formation and ownership with each form having distinctive features. Business units can be classified as either private or public units. In some instances we have business units that are owned jointly by the government and the public while in some the government is in full possession of the entire business.
On the basis of legal structure, business units may be classified as being either incorporated or unincorporated. (McCahery; 2004). Unincorporated businesses are those that do not have separate legal existence/entity from their owners. Therefore the owners and organizations are inseparable in both their rights and obligations while incorporated business units are legally distinct from their owners thus their rights and obligations are separable (Lucas; 1994)
2.1 Sole Proprietorship
A sole proprietorship business is one that is formed and managed by one person. The formation of this type of business undergoes two procedures: the registration of the business name with the registrar and the acquisition of a license from the government. The purpose of the above condition being the protection of the business name from misuse and the latter securing protection of the public through streamlining what should be provided by the particular business. (Salaman; 2000)
With regard to the management, decision making of a sole proprietorship emanates from the proprietor him/herself. On the other hand the running of the business is undertaken by either employees or family members (McCahenry; 2004). The source of capital mainly emanates from the proprietors own contributions or savings and/or may at times be raised through donations by family friends, relatives or financial institutions.
The liability of a sole proprietor is normally unlimited. Its implications being that proprietors liability is not restricted to only capital contributions but extend to the proprietors personal property (McCahery 2004)
Form the foregoing examinations certain characteristics of the sole proprietorship business reveal its advantages of which include; its formation is cheap and therefore easy to start as it required only licensing and registration; management is also very simple since decision making is done by the proprietor alone. The business is also likely to be flexible since direct contact with the consumers is practiced thus adapting to their tastes and preferences. The sole proprietorship business is however not without fault.
As examined earlier the sole proprietor has unlimited liabilities as such any losses that arises are borne by the proprietor even if it means interference with his personal property. In addition to this it is observed also that the proprietor may employ family members and this would constitute of limited skills for proper administration of the business. Lastly where the proprietor dies the business may terminate then, as they would be no partners to assist in the management.
A partnership is a joint business of two or more persons carrying out an activity for a common purpose and benefit. Normally a partnership consists of a minimum of two persons and maximum of twenty people. Where such partnership offers professional services; it may extend to fifty people. (Partnership Act, 88.320)
The formation of partnerships does not require elaborate procedures. The formation is through written agreement, which stipulates the particulars of the parties, the terms and conditions of engagement and is executed upon signing of the parties. This is followed by the registration of the business name.
The management of a partnership is stipulated in the Partnership Act. Every partner has the right to take part in the management of the business, therefore, the Act prescribes for the sharing of duties and responsibility with regard to skill, knowledge and experience (NRS; 88.315),though they may decide to have other people to work for them upon their agreement. It is imperative to note that each partner is an agent of the partnership and any legal dealings entered into by either partner if not done within the confines of the business is not binding to other partners without their consent. (Salaman; 2000)
Partners are expected to contribute the capital of the business as specified in the partnership deed. Their contribution forms the main source of capital and other sources may be from loans of financial institutions; hire-purchase firms and government institutions (NRS; 88-330)
2.2.1Classification of partners
Partners are classified in reference to their activities and liability. With regard to activity partners may be either trading partners whose activity involves manufacturing or purchase and sale of goods and/or non-trading partners whose purpose is mainly to offer services (NRS 88:315)
In reference to liability, partners can either be general partners or limited partners. With regard to general partnership the partner’s liability to the company is unlimited. Unlike the limits of liability to capital where the partner’s assets are unable to meet the debts of the business, general partners are expected to contribute capital over and above the amount invested in the business in order to pay off such debts.
On the other hand in limited partnership the liability of partners is limited to the amount of capital they contribute to the business. Thus where the partnership property is insufficient to meet the company’s debt, the limited partner can only lose what he has invested in the business.( Rowley; 1916)
In instances where a partnership constitutes of both general and limited partners adherence to the statutory provision is of essence so as to protect the interests of the general partners. Thus the Partnership Act establishes certain restrictions of which stipulates that; a limited partner is not allowed to take part in the management of partnerships and has no power to bind the firm in any transaction. (NRS; 88.330). This is because decisions made by such a partner may result in debts to be handled by general partners.
A limited partner is however empowered to inspect the books of the firms account. The death, withdrawal or bankruptcy of such a partner may not cause dissolution of the partnership (Lucas; 1993). Such partnership can only be dissolved by the general partner’s decisions. Limited partners are not also entitled to decision making when differences arise. Any difference on matters pertaining to the partnership can only be decided by majority of general partners (Rowley; 1916). Similarly with the consent of the general partners a limited partner may assign his shares in the partnership to another person (Rowley; 1916)
Classification of partnership is also on grounds of the partner’s relationship with the business entity. This is in relation to the role played by each partner. With regard to activities, partners can either be active or dormant partners implying that dormant partners do not take active participation in the day-to-day management of the business. As regards capital contribution partners can either be real or nominal/quasi partners. With the former being a partner who contributes to the capital of the business and the latter not taking part in the contribution of any capital.
The advantages that amount from the partnership business are that; better decision-making is experienced as consultation from other partners is upheld. The contribution of capital is much faster and easy as it emanates from all the parties forming the business. Sharing of the business role and responsibility is also effected as well as sharing of losses incurred by the business.
The disadvantages that related to this business unit is however that though decision making may be better it is slow and time consuming especially where the partners are not in agreement. Though sharing of losses is experienced, this is also in relation to the sharing of profits. Vulnerability to disputes is also high in this business unit based on the leverage of partners and other factors. Finally the difference in leverage mostly occasioned by the level of capital contribution tends to make certain partners to place reliance on others.
A company is a business incorporated under the requirements of the companies act. Incorporation creates an organization that is separate and distinct from individuals who constitute of it. It is thus a legal entity that has the status of an artificial; enter into contracts; hire and fire employees sue and be sued et cetera (Companies Act; Section 2)
There are two types of companies; public limited companies and private limited companies.
Public limited companies constitute of a minimum of seven members with an infinite maximum number of members. It invites members of the public to subscribe to its shares and such shares are easily transferable to other members. On the other hand, private limited companies have a minimum of two persons and a maximum of fifty people. Such companies unlike the public companies do not invite the public to subscribe to their shares and as such their shares are not easily transferable to other people or shareholders.
Before examining the formation of limited companies it is imperative for us to understand what we mean by the term limited liability.
2.3.1 The concept of limited liability
The liability of company members is restricted to certain amounts of investments in the company plus any other amounts that they may undertake to contribute towards the payment of the company’s debt (Soderquit; 1999).
The word “limited” indicates that the liability of members is restricted to these stated amounts, therefore members cannot be made to contribute more than what is promulgated. Companies can be limited by shares or by guarantee. The former connoting liability limited to the value of shares held by an individual while the latter inferring liability limited to the amount that a member has undertaken to contribute to the business towards payment of debts. (Soderquist; 1999)
2.3.2 Formation of Companies
A company is formed upon the registration of such company with the registrar of companies pursuant to provisions of the Companies Act. For registration to be effected the memorandum and articles of association should be filed with the registrar with annexure of lists of persons to be directors, statement of share capital and declaration of compliance with the companies. (Companies Act; Sec.3)
The memorandum of association which defines the relationship between the company and outsiders encapsulates; the name clause constituting of description of companies name/logo, the objective clause which outlines the objectives and/or purpose of the company, situational clause describing its place of location; and liability subscription and association clause.
The article of association on the other hand contains the rules and regulations that govern the conduct of shareholders and their relation to the company and amongst each other. (Companies Act Section4)
With regard to management a company is managed by a board of directors who are elected or appointed from the shareholders. These directors stay in office until the first AGM when their terms may be renewed or appointment of new directors may take place (Sec.24). The size of the board is highly determined by the size of the company. A small private company may be managed by one director while a public company must have a minimum of three directors. Boards of directors are responsible for formulating policies and overseeing their implementation.
In examining the sources of capital, companies whether public or private raise their capital through sale of shares; through loans from financial institutions and/or government institutions through supplies in the form of retained profits among other forms of financial assistance.
The advantages that relate to this form of companies are that the liability of the members is limited thus personal property of shareholders cannot be interfered with. It also depicts a perpetual life of continuity since a change of membership or management does not affect it. The ability to hire professional services either from the outsiders or from within the members is also easy. Due to the number of members that constitute it is easy to raise capital for its status.
Though capital formation, which is the foundational basis of any company is easy such companies face difficulty in their formation since the legal process is long and taxing. Secondly the companies are also restricted to operate the activities stipulated in the memorandum of association. Decision-making is also slow since proposals have to be approved by the shareholders. The shareholders also face double taxation since the income of the company is also taxed.
The foregoing paper has examined the various different forms of businesses organizations in existence of which are the sole proprietorship, partnership and limited liability companies. In so doing it has examined the formation of these business units and has established that the sole proprietorship and partnership units require few legal formalities which entail registration and acquisition of licenses while the companies require an elongated legal process due to the elaborate documents involved in its formation.
With regard to management it has been examined that while the sole proprietorship is managed by one person that of the partnership and company require a minimum of two persons thus decision making is also elaborate. It has been established also that while this process is advantageous as better decisions are formulated, it is however time consuming as the process is also involves consultations.
The thesis has also examined the sources of capital of the various institutions and established a similarity that the key capital formation is from the entrepreneur’s own contribution seconded by outside financial assistance either from family members or financial institutions. It has however been established that the partnership and limited liability companies are most likely to raise a higher amount of capital and easily as compared to the sole proprietorship.
The liability of the entrepreneurs in the various forms of organizations has also been examined in which it is depicted that while a sole proprietor’s liabilities are unlimited the liability of partners within the partnership and companies is determined by the contracts the parties have established thus their liability can either be limited or unlimited.
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Soderquist Patrick, Corporate Law and Practice,(1999) Practicing Law institute
McCahery Anderson.(et al) The Governance of Close Corporations and partnerships: US and European perspectives;(2000) Oxford University press.
Uniform Limited Partnership Act (Chap 88)