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ABSTRACT

This write-up aims to explore the different forms of business ownership prevalent in today’s
business environment. The next important decision a would-be business owner will have to make
after conceiving a business idea is which structure will best suite his idea. This decision will
have long-term implications on the size of the business, the level of control the owners will have
on it, the legal implication of decisions, and sources of financing for the business.

This assignment, therefore, seeks to firstly explore the nature of these forms of business and the
different features that made each of them unique. Drawing from the views of different writers
and business practitioners, this paper also seeks to bring out the merits and the demerits that will
make a would-be entrepreneur to either adopt a particular business structure or reject it.

The final part of this write up shows the implications of the choice of any of the forms on the
financial decisions of the owners. These financial decisions relate to the firm’s investment,
financing, as well as, dividend decisions.

FORMS OF BUSINESS ORGANISATION

Once an entrepreneur makes a decision to float a business, one of the first issues to be resolved is
what form of ownership the entity will have. Understanding the features and characteristics of
each form of business ownership is key to choosing the right one. Zimmerer and Scarborough
(2008) listed some key issues that an entrepreneur should consider in the evaluation process of
choosing a form of business ownership as comprising: cost of formation, managerial ability,
start-up and future capital requirements, liability exposure, tax consideration, and business goals.

Like many other writers, The Nevada Small Business Development Center (2010) listed three
major forms of business ownership to include: sole proprietorship, partnership, and company or
corporation. The following sections will individually discuss each of these forms bringing out
their features, merits, and demerits.

SOLE PROPRIETORSHIP
Sole proprietorship is a form of business that is owned, controlled, and managed by an individual
who formulates the business idea and arranges for capital to start up the business. He or she runs
the business alone and is entitled to the profit, but also bears the loss of the business alone.

J.L Hanson (1997) defines sole proprietorship as “A type of business unit where one person is
solely responsible for providing the capital and bearing the risks of the enterprise, and for the
management of the business.” It is the oldest, simplest, and the most easily formed business
because there are no much legal requirements involved in the formation. It is also known by
other names such as one-man business and sole trader, if the entrepreneur is solely engaged in
merchandizing.

FEATURES OF SOLE PROPRIETORSHIP

The sole proprietorship form of business by its nature has the following features:

 Single ownership: by its name, the term ‘sole’ means single while ‘proprietorship’
means ‘ownership’. Thus, only one person is the owner who starts the business by
bringing together all the resources required-both human and material.
 Non separation of ownership from management: the owner also manages the business.
Though he or she may sometimes employ the services of other for the purpose of
management but they exercise direct supervision.
 None sharing of profit and loss: the sole proprietor bears the entire risk of the business.
He/she enjoys the profit alone; and at the same time, the entire loss is borne by him.
 Secrecy: the sole proprietor takes all the important decisions alone and keeps all the
business secrets to themselves. There is no legal obligation on him/her to publish books
of account.
 Unlimited liability: the liability of the sole proprietor, in case of loss, is not limited to his
business as his personal assets can be employed to pay off his liability when necessary.
 No separate legal entities: the proprietor and his business are one and same by law. He
bears the legal burden of whatever decision that is made in the name of his business.

MERITS OF SOLE PROPRIETORSHIP


 Easy formation and wind up: a sole proprietorship business is easy to form as there are
no legal formalities involved in setting up the business except that the business is lawful.
Also, the owner can close shop without any form of consultations.
 Quick decision making and better control: decisions are quicker as there are no
hierarchies of authority to be consulted. The owner takes the decisions alone and can
quickly meet up with business exigencies.
 Direct motivation: the sole proprietor takes all the business profits and this is a direct
motivation to put in extra effort and take more calculated risks.
 Direct relationship with customers and employees: the sole proprietor being in charge
of running the business can maintain close contact with his/her customers and employees.
This helps him/her understand the customers’ likes and dislikes and to make appropriate
adjustments where necessary. Also, the small number of employees helps build
harmonious relationship with the owner and ensure cordial industrial relation.

DEMERITS OF SOLE PROPRIETORSHIP

 Limited resources for expansion: being the sole owner of the business, the sole
proprietor has a limited source of financing his business as his personal finance may not
be enough to expand the business and borrowing form banks may not be easy,
 Limited managerial expertise: a sole proprietor may not have expertise in all aspects of
his business and, because of his limited resources, may not be able to engage the required
professionals to handle them. This can hinder the growth and expansion of the business.
 Lack of continuity: most times, the death of the sole proprietor always means the death
of the business as the entire business is built around him/her.
 Unlimited liability of the owner: the proprietor’s personal property may be used to
settle his/her business liabilities where the assets of the business are not enough.

PARTNERSHIP
Partnership is an association of persons who have decided to combine their financial and
managerial abilities to run a business and share the profit in agreed ratio. Section 1 of the UK
partnership act 1890 defines partnership as “the relation which subsists between persons carrying
on a business in common with a view of profit.” Similarly, Indian partnership act defines it as
relation between persons who have agreed to share the profits of a business carried on by all
(The Indian Partnership Act 1932). It is a business “ in which two or more individuals pool
capital, skills, and other resources together to start a business and share profit and loss in
accordance with the terms of the partnership agreement. In absence of such agreement, a
partnership is assumed to exist where the participants in an enterprise agree to share the
associated risks and rewards proportionally”. (Businessdictionary.com).

There exist several types of partnership. The two most common are general and limited
partnership.

 General partnership: this is the standard form of partnership where all the partners are
equally responsible for the business debts and liabilities. In addition, all partners are
allowed to be involved in the management of the company. In fact, in the absence of a
statement to the contrary in the partnership agreement, each partner has equal rights to
control and manage the business. Therefore, unanimous consent of the partners is
required for all major undertaken. Any obligation made by one partner is legally binding
on all the partners, whether or not they have been informed.
 Limited partnership: in this type of partnership, one or more partners are general
partners, and one or more are limited partners. General partners are personally liable for
the business debts and judgments against the business; they can also be directly involved
in the management. Limited partners are essentially investors (silent partners who do not
participate in the general management of the business.

ADVANTAGES OF PARTNERSHIP

 Collaboration: as compared to a sole proprietorship, which is essentially the same form


of business but only one owner, a partnership offers the advantage of allowing the owners
to draw on the resources and expertise of the co-partners. In a partnership business,
responsibilities are shared and workloads are made lighter. Members often find that they
have more time for other activities in their lives.
 Tax advantage: the profits of a partnership are taxed through its owners who report their
share on their individual tax returns. Therefore, the profits are only taxed once (at the
personal income tax level of its owners) rather than twice as is the case with corporations
which are taxed at the corporate level and then at personal level.
 Simple operating structure: a partnership is fairly simple to establish and run. No forms
need to be filled or formal agreement drafted (although it advisable to write a partnership
agreement in the event of future disagreements). The most that is ever required is perhaps
filing a partnership certificate with a state office in order to register the business name
and securing a business license.
 Flexibility: because the owners are usually the managers, the company is fairly easy to
manage and decisions can be made quickly with much bureaucracy.
 Acquisition of capital: partnerships have an advantage of pooling resources together

DEMERITS OF PARTNERSHIP

 Conflict: while collaborating with partners can be a great advantage to a small business
owner, having to actually run a business from day to day with one or more partners can
be a nightmare. Firstly, each partner has to give up absolute control of the business and
learn to compromise. And when big decisions have to be made, such as whether and how
to expand the business, partners often disagree on the best course and are often left with a
potentially explosive situation.
 Authority of partners: when one partner signs a contact, the other partners are legally
bound to fulfill it.
 Death or departure, or incapacitation of partner will dissolve a general partnership.
 Limitations on the transfer of ownership: the existence of a partnership depends on
the owners; therefore, the uniform partnership act stipulates that ownership may not be
transferred.
 Unlimited liability: The liabilities of the ordinary partners are unlimited and can extend
to their personal properties in the event of business failure.
COMPANY

Company as the third form of business ownership originally came into existence as a result of the
inadequacies in the sole proprietorship and partnership forms of business. Lack of limited
liability, restriction in the number of owners, limited sources of raising capital, as well as the
growth in the size of businesses and the need to have more people investing in businesses
necessitated the search for a new form of business ownership. Company, as a form of business
ownership, has bridged these gaps.

Company is defined as a voluntary association of persons, incorporated by law; having separate


legal existence, perpetual succession, and a common seal. It is considered to be the most suitable
form for organizing business activities on a large scale as it does not suffer the limitations of
capital and management like the other two forms discussed earlier. Due to the limited liability of
its members, it has the advantage of attracting huge capital form people and is capable of
employing trained and experienced managers.

As partnership is governed by Partnership Act, company is governed by company law. In


Nigeria, formation and incorporation of a company is governed by The Company and Allied
Matters Act (CAMA). According CAMA (1990) Part II Section 21, there are three types of
companies:

 Companies limited by share: these are companies in which the liabilities of their
members are limited to the unpaid portion of their shares.
 Companies limited by guarantee: these are companies in which the liabilities of their
members are limited to the amount each has agreed to contribute to the asset of the
company in the event of liquidation.
 Unlimited companies: these companies are rare to find and the liabilities of their
members have no limit.

Any of these types of company can either be private or public company. A private company is
formed by individuals from two to fifty, prohibits the sale of its shares to the public, and restricts
the right to transfer its shares. A public company, on the other hand, is formed by minimum of
seven individuals with no upper limit. It can by law issue its shares to the public for subscription,
and its shares can be transferred easily through the stock exchange.

FEATURES OF A COMPANY

 Incorporation: a company comes into existence only through incorporation by


complying with all the legal formalities of the company act.
 Separate legal entity: a company has a separate existence from its owners or members.
In law, it can sue and be sued, and it can enter into contracts and carry on businesses in
its own name. It is an artificial person recognized by law, but whose powers are
exercised on its behalf by the directors.
 Perpetual succession: a company has continuous existence separate from its owners.
The life of company can only come to an end through the legal process of liquidation.
Death, insolvency, and change of members have no effect on the life of a company.
 Limited liability: the liability of the owners of a company is limited to extent of their
shareholding or the amount agreed to be contributed.
 Transferability of its shares: for public company, its membership can be transferred to
anyone who buys its shares. There are no legal restrictions on the transfer of its shares.

MERITS OF COMPANY

 Large source of capital: a company can raise new capital by issuing its shares to the
public. It can also raise funds easily from lending institutions as it can easily provide
collaterals to guarantee the loans.
 Limited liability: the limited liability of its members to their shareholdings only attracts
large pool of investors.
 Growth and expansion: a company can easily finance growth and expansion strategy
through various sources of capital available of funding available to it. Expansion creates
economy of scale which results in higher profit.
 Durability and stability: because of its perpetual succession and continuous existence, a
company can undertake projects of long duration.
 High public confidence: because they are legally obligated to disclose their financial
activities and position, companies, especially public ones, enjoy high public trust and
confidence.
 Bigger employment opportunities are provided by their large scale operations.
 Efficient management: with the large resources available at their disposal, companies
can afford the services of qualified and competent managers.

DEMERITS OF COMPANY

 Difficulty in formation: the arduous and tedious legal procedures that precede
incorporation are both expensive and tasking.
 Slow decision making and action: because of their size and management hierarchy,
companies are slow in making decisions and reacting to exigencies.
 Excessive government regulation: companies are always subjected to various legal
obligations and government regulations. Filing of returns and reports take considerable
time and money, and there are fines for non-compliance.
 Conflict of interest: because owners are separate from the managers, conflict of interest
often ensues as the directors oftentimes take decisions that benefit them at the expense of
the owners
 Growth of monopoly: companies, because of their size and their ability to raise more
funds easily can always easily eliminate competition to control the market and charge
exorbitant prices

IMPLICATIONS OF EACH FORM OF BUSINESS OWNERSHIP ON FINANCIAL


DECISIONS

Financial decisions that business organizations make are of three types: investment decisions,
financing decisions, and dividend decisions. The structure that business owners choose, have
direct or indirect implications on these decisions.

Investment decisions:
These are decisions made by firms on what assets to invest their capital on to get the highest
return. In other words, it is about how business organizations channel their limited resources to
get the best value.

In sole proprietorship business, this decision is the sole responsibility of the sole proprietor who
determines what type of business to undertake and how to combine resources to achieve success.
He alone decides the extent of risk to take and how to employ his capital to implement his
business ideas.

In partnership, however, investment decisions are a bit difficult as all the partners have equal
stake in decision making. Choosing what to spend their capital on or how to set up and expand
their business is normally done through consensus and agreement. With lack of limited liability
as in sole proprietorship, any wrong investment decision can lead to loss of partners’ personal
property.

Investment decision in an incorporated company is complex but is geared towards profit


maximization as in other forms of business. In companies and corporations, these decisions must
ensure enhancement of shareholders value through either share appreciation or more dividend
payout.

Financing decision:

This decision deals with how firms raise capitals or funds to undertake planned investments; it
deals with the different options or sources of funds that are available to firms to finance their
operations, and how to get the right mix of financing to achieve profitability.

The sole proprietor has a limited option when making financing decision as his sources of capital
are limited and not as diverse as that of a company. The proprietor finances his business through
personal savings or borrowing from friends and relatives. Borrowing from lending institutions
may be difficult because of the collateral requirements; and unlike company, it cannot sale its
shares to raise more capital. Self-financing is the primary source of capital for a sole
proprietorship business and hence, it may not be able to undertake gigantic investments that
require huge capital outlay.
Partnership business, however, can pool funds and resources together to finance bigger
investments. But like the sole proprietorship, it cannot sale shares to the public in the form of
equity to raise more capital. Financing decisions of a partnership business will revolve around
partners pooling their funds together, and borrowing from lending institutions at a cost.

Corporations have wide sources of financing and hence can finance large investments. In
additions to internal sources of finance like retained profit, public company can sale shares to the
public to raise new equity capital. It can also float bonds to raise long-term finance, in addition to
borrowing from lending institutions. Whereas borrowing comes with interest, selling equity
means giving right of ownership to the equity holder.

Dividend decision

Dividend decisions deals with how profits are distributed among the owners or those who
supplied capital to the firm. It is concerned with the quantum of profits to be distributed among
shareholders. The profit of a firm is distributed among various parties such as creditors,
employees, debenture holders, shareholders, etc.

In sole proprietorship, the sole owner takes all the profits of the business and can choose to either
re-invest part of the profit or withdraw all.

Dividend decision in partnership is done according to the partnership agreement; and where none
exists, profits are shared equally according the partnership act.

In a company, this decision is made by the managers who decide which part of the profit should
be retained and how much to be distributed to the shareholders. If more investment opportunities
are available, more profit is kept aside as retained earnings and less is given as dividend; but if
company wants to satisfy its shareholders, then more is given as dividend distribution.
References

Thomas, W. Zimmerer & Norman, M. Scarborough (2008). Essentials of entrepreneurship and


small business. New Jersey: Prentice Hall Inc.

Nevada Small Business Development Center. (2010). Forms of business ownership. Retrieved
from http://www.nsbdc.com

Hanson, J.L. (1997). A text book of economics. London: MacDonalds and Evans Publishers.

Partnership. (nd). Retrieved from http://www.businessdictionary.com/definition/partnership.html