Forms of Business Organization and Company Formation

Sole Proprietorship

• Meaning: The word "sole" implies only and "proprietor" implies owner. It refers to a form of business organization which is owned, managed, and controlled by an individual who is the recipient of all profits and bearer of all losses.     

• Definition by James Stephenson: "Sole proprietorship is the form of business which is owned, managed and controlled by an individual. It is the simplest form of business, established with limited resources, ability and capital of the individual of an individual known as sole trader or entrepreneur."

• Examples: Grocery stores, chemist shops, etc.

• Features:

  • Formation and Closure: It is easy to start as no special law governs it. Legal formalities are minimal except for licenses in specific cases. Closure is equally easy.

  • Liability: The owner has unlimited liability and is personally responsible for debts if business assets are insufficient.

    • Example: If the external liability of XYZ, a drycleaner, is $-Rs80,000-$ at dissolution but assets are only $-Rs60,000-$, the owner must pay the remaining $-Rs20,000-$ from personal property.

  • Sole Risk Bearer and Profit Recipient: The proprietor bears all risk of failure alone but enjoys all benefits and profits as a direct reward for risk-bearing.

  • Control: Decision-making power lies solely with the proprietor. They procure resources, employ workers, and direct all affairs.

  • No Separate Entity: In the eyes of the law, the proprietor and the business are one and the same; there is no legal distinction.

  • Lack of Business Continuity: Death, insanity, imprisonment, physical ailment, or bankruptcy of the trader can lead to the closure of the business.

• Merits:

  • Quick Decision Making: No consultation is required, allowing for prompt action and capitalization on market opportunities.

  • Confidentiality: Accounts do not need to be published, and secrets are not shared, providing competitive strength.

  • Direct Incentive: The owner keeps all profits, creating a direct link between effort and reward.

  • Sense of Accomplishment: Handling all dimensions single-handedly provides a high sense of personal confidence.

  • Ease of Formation and Closure: Minimum legal formalities allow for business initiation with small capital.

• Limitations:

  • Limited Resources: Funds are restricted to the owner's savings and borrowing capacity, hindering large-scale operations.

  • Limited Life: Business existence is tied to the owner; illness or death can bring it to a standstill.

  • Unlimited Liability: Creditors can recover dues from the owner’s personal assets.

  • Limited Managerial Ability: One person rarely possesses all necessary qualities like judgment and wisdom. Hasty decisions and lack of professional expert employees (due to cost) prevent specialization benefits.

• Suitability: Ideal for small-scale businesses with low investment, those requiring personal attention (tailoring, repair shops), and non-standardized products (embroidery, artistic items).

Hindu Undivided Family (HUF) Business

• Meaning: A form of business where the family possesses inherited property and the Karta manages affairs. It is governed by the Hindu Succession Act, 1956.

• Membership: Membership is by birth in the family and includes three successive generations.

• Key Roles:

  • Karta: The eldest member of the family who controls the business.

  • Coparceners: Other members of the business.

• Foundational Elements:

  • Coparcenary: Common ownership in ancestral property created by law, not contract.

  • Common Property: Includes ancestral property or property created with its help.

• Hindu Succession (Amendment) Act, 2005: Daughters of a coparcener become coparceners by birth with equal rights in property. During partition, property is divided equally regardless of gender. The eldest member (male or female) becomes the Karta.

• Features:

  • Formation: Requires at least $-2-$ members and ancestral property. No agreement is needed.

  • Liability: Karta has unlimited liability. All other members' liability is limited to their interest in the joint property.

  • Control: Karta has the sole legal right to enter contracts and manage business. Members cannot question Karta's decisions.

  • Continuity: Business continues after Karta’s death as the next eldest coparcener takes over. It is not affected by insolvency or death of members.

  • Minor Members: Minors are coparceners from the moment of birth.

Partnership

• Meaning: A voluntary association of two or more persons agreed to carry on business jointly and share profits/losses.

• Definition (Indian Partnership Act 1932): "Partnership is the relation between persons who have agreed to share the profits of the business carried on by all or any one of them acting for all."

• Features:

  • Formation: Governed by the Indian Partnership Act 1932. Requires a legal agreement (oral or written) for a lawful business aimed at profit.

  • Liability: Partners are jointly and individually liable for debts. Personal assets can be used to repay business debts.

  • Risk Bearing: All partners share risks and rewards in an agreed ratio.

  • Decision Making: All partners can participate in management. Crucial policy decisions require the consent of all partners.

  • Continuity: Death, retirement, or insolvency of a partner ends the partnership, though remaining partners can continue by settling claims and forming a new agreement.

  • Membership: Minimum $-2-$ members. Maximum is $-100-$ per Companies Act 2013 (Section 464), but the Government currently prescribes a maximum of $-50-$ partners per Rule 10 of Companies (Miscellaneous) Rules 2014.

  • Mutual Agency: Every partner is both a principal and an agent. They bind others by their acts and are bound by the acts of others.

• Merits:

  • Ease of Formation: No complex legal formalities; registration is optional but advisable.

  • Balanced Decisions: Pooling of skills and specialized talents reduces errors.

  • More Funds: Multiple partners contribute more capital and increase creditworthiness.

  • Sharing of Risks: Reduces individual anxiety and stress.

  • Secrecy: No requirement to publish annual accounts or file reports with the government.

• Limitations:

  • Unlimited Liability: Partners with higher personal wealth may have to repay the entire firm debt if others cannot.

  • Limited Resources: Membership caps restrict the ability to raise massive capital or hire top-tier technical skills.

  • Conflict: Human nature and differences in opinion can lead to ruins. Transfer of ownership is restricted.

  • Lack of Public Confidence: Lack of government regulation and published reports makes financial transparency difficult for the public.

• Types of Partnerships:

  • On the Basis of Duration:

    1. Partnership at Will: No specified time limit; dissolved by any partner giving notice.

    2. Particular Partnership: Constituted for a specific period or project; ends when the period expires.

  • On the Basis of Liability:

    1. General Partnership: All partners have unlimited liability; acts are mutually binding; registration is optional.

    2. Limited Partnership: At least one partner has unlimited liability; others have limited liability.

• Types of Partners:

  1. Active Partner: Contributes funds, manages the firm, shares profits/losses, and has unlimited liability.

  2. Sleeping/Dormant Partner: Contributes capital and shares profits/losses but does not participate in management. Liability is unlimited.

  3. Secret Partner: Association with the firm is unknown to the public; participates in management and has unlimited liability.

  4. Nominal Partner: Allows the use of their name; no capital contribution or management role; liable to third parties for debts.

  5. Partner by Estoppel: Through conduct, gives the impression of being a partner. Held liable for debts extended based on this impression (e.g., Mohan telling Sohan he is a partner in Shipra Enterprise for a $-Rs20,000-$ credit).

  6. Partner by Holding Out: Not a partner but knowingly allows representation as one. Must issue a denial to avoid liability for debts extended based on that representation.

• Partnership Deed: A written agreement specifying terms like firm name, nature/location of business, duration, investment, profit distribution, interest on capital/drawings, and dispute resolution methods.

• Registration: Optional. Non-registration results in:

  • Partners cannot sue the firm or other partners.

  • The firm cannot sue third parties.

  • The firm cannot sue partners.

Cooperative Society

• Meaning: Voluntary association of persons for member welfare. Defined by the Indian Cooperative Societies Act 1912 as promoting economic interests in accordance with cooperative principles.

• Features:

  • Voluntary Membership: Open to all regardless of religion or caste. Members can leave after giving notice but cannot transfer shares.

  • Legal Status: Registration is compulsory under the Indian Cooperative Act, 1912. It is a separate legal entity that can hold property and enter contracts.

  • Limited Liability: Limited to the extent of capital contributed.

  • Control: Managing Committee (elected by members) takes decisions. "One man one vote" principle applies.

  • Service Motive: Primary purpose is help, not profit. Surplus is distributed as dividends per bye-laws.

• Merits: Equality in voting, limited liability, stable existence (not affected by death/insanity), economy in operations (honorary services, no advertising), government support (low taxes/subsidies), and ease of formation (requires $-10-$ adults).

• Limitations: Limited resources (due to low investment incentives), inefficiency in management (unskilled elected members), strict government control (regular audits/reports), lack of secrecy, and internal disputes/differences in opinion.

Joint Stock Company

• Meaning: An association of persons for business with an independent legal status. Classified under Section 2(20) of the Companies Act 2013.

• Definition (Prof. Haney): "A company can be described as an artificial person having a separate legal entity, perpetual succession and a common seal."

• Features:

  • Artificial Person: Created by law; has no physical body but can own property and enter contracts.

  • Separate Legal Entity: Existence is independent of members.

  • Formation: Minimum $-2-$ (Private) or $-7-$ (Public) members. Must register with the Registrar of Companies under Companies Act 2013.

  • Perpetual Succession: Only law can end its existence; deaths or insolvency of members do not affect its life.

  • Control: Shareholders elect a Board of Directors to manage the business.

  • Liability: Limited to the nominal value of shares or guarantee amount.

  • Risk Bearing: Losses are spread across a large number of shareholders.

• Types of Companies:

  • One Person Company (OPC): Only $-1-$ member. Must be a natural Indian citizen and resident. Paid-up capital cannot exceed $-Rs50-$ lakh; average annual turnover cannot exceed $-Rs2-$ crore. Cannot perform Non-Banking Financial Investment activities.

  • Private Company: Restricts share transfer. Min $-2-$ and max $-200-$ members. Prohibits public invitation to subscribe. Min paid-up capital of $-Rs1-$ Lakh. Must use "Private Limited."

  • Public Company: Not a private company. Min $-7-$ members; no maximum limit. No restriction on share transfer. Min paid-up capital of $-Rs5-$ lakh. Can invite public subscription.

Comparison of Business Organizations

• Formation:

  • Sole Proprietorship: Minimum legal formalities.

  • Partnership: Registration optional.

  • HUF: Less legal formalities.

  • Cooperative Society: Registration compulsory.

  • Joint Stock Company: Very lengthy and complex registration.

• Members:

  • Sole Proprietorship: $-1-$

  • Partnership: Min $-2-$, Max $-50-$

  • HUF: Min $-2-$, Max No limit.

  • Cooperative Society: Min $-10-$, Max No limit.

  • Joint Stock Company (Private): Min $-2-$, Max $-200-$

  • Joint Stock Company (Public): Min $-7-$, Max No limit.

• Liability:

  • Sole Proprietorship: Unlimited.

  • Partnership: Unlimited/Joint.

  • HUF: Karta (Unlimited), Coparceners (Limited).

  • Cooperative/Company: Limited.

Formation of a Company

Stage 1: Promotion

• Promoter (Section 69): Someone named in the prospectus, identifying as having control over affairs, or whose advice the Board of Directors follows (excluding professionals).

• Functions:

  1. Identifying Business Opportunity: Analyzing profitability and risk.

  2. Feasibility Studies: Includes technical (resource availability), financial (capital sourcing), and economic (profitability) feasibility.

  3. Name Approval: Submit three names to the Registrar. Must not be identical to existing firms, misleading, or use prohibited words like "cooperative."

  4. Preparation of Documents: MOA, AOA, Prospectus, Consent of Directors.

  5. Fixing Signatories to MOA: Usually the first directors.

• Legal Status: Promoters are neither agents nor trustees but stand in a fiduciary relationship with the company. They cannot make secret profits and are personally liable for pre-incorporation contracts unless ratified.

Essential Documents

• Memorandum of Association (MOA): The "Charter" defining objectives and powers. Clauses include: Name, Object, Liability, Capital (Registered/Authorised), Registered Office, and Association.

• Articles of Association (AOA): Bye-laws for internal management (Doctrine of Indoor Management). Specifies forms in Table F, G, H, I, and J.

Stage 2: Incorporation

• Submit MOA (signed by $-7-$ for public, $-2-$ for private), AOA, list of directors, written consents, and statutory declaration.

• Certificate of Incorporation: Conclusive evidence of legal existence. A private company can start business immediately upon receipt.

Stage 3: Capital Subscription (Public Company Only)

1. SEBI Approval: Must follow Disclosure and Investor Protection Act 2000 guidelines.

2. Filing of Prospectus: Or a "Statement in Lieu of Prospectus" if not inviting public funds.

3. Appointment of Professionals: Bankers, Brokers, and Underwriters.

4. Minimum Subscription: Per SEBI, must be $-90 \%-$ of the issue size. Must be collected within $-30-$ days. If not met, money must be returned within $-15-$ days.

5. Stock Exchange Application: Permission to deal in shares.

6. Allotment of Shares: Filing "Return of Allotment" with the Registrar within $-30-$ days.