FORMS OF BUSINESS OWNERSHIP

One of the important decisions that an entrepreneur needs to take before launching a Business
enterprise is that of selecting the form of Business organization for his/ her venture.
- Choosing a legal entity for the venture is not a onetime event. The form of organization can be
changed from time to time. As a business grows and matures, it becomes necessary to
periodically review whether the current form of business remains appropriate.
- No single form of business organization works best in all situations and is appropriate. The
entrepreneur thus needs to select the best form that meets his needs and that of the enterprise.

Choice of business organization can be based on the following;

 The type and size of Business
 The cost of starting and maintaining the form
 Form of Business liability applicable
 Desired level of autonomy by the entrepreneur
 Tax considerations
 If and the no. and type of investors one wishes to attract
 The level of financing required

A business organization can be can be owned by one person or a group of persons and its
operations can be controlled by owners or by the managers on behalf of the owners. It can be
classified as small, medium or large.

The major forms of Private business organizations are;

1. Sole proprietorship
2. Partnership
3. Company
The form of ownership chosen depends on factors like One’s personal capacity to take decisions,
bear the risk, economic soundness, educational attainment.

Sole proprietorship
Also called individual proprietorship and is the oldest, simplest and natural type of business
organization. This type of business enterprise is established, financed, owned, managed and
controlled by an individual entrepreneur.
The owner introduces his own capital, uses his skills and intelligence in the management, assumes
all risks and is solely responsible for its operations and is entitled to all profits.
It’s the most popular form in Kenya due to its distinct advantages. Most bakeries, hardware stores,
boutiques, barber shops, bookshops, grocery stores, beauty parlours are sole proprietorship

Characteristics of Sole Proprietorship

 Ownership: The business is owned by one person
 Management and Control: The owner is the active manager who controls the business,
however if the business is large he may delegate some responsibilities to some employees.
 Finance; the sole owner provides the necessary finances needed to run the business. If
additional finances are required, capital may be increased through borrowing
 Size of business unit; usually small but not necessarily so
 No separation between ownership and management- proprietor is also the manager
 Risk; The proprietor bears all the risk
 Personal Incentive; the proprietor takes personal interest for the success of the business
 Independence; the owner is independent and can take quick prompt decisions
 Legal status; the sole proprietor and his business are considered as one i.e. the assets and
liabilities of the business organizations are personal assets and liabilities of the proprietor
 Unlimited liability;- incase the enterprise incurs loses, the private property of the proprietor
can be utilized to meet the business obligations to outside parties. The sole proprietor is
personally liable for debts of the business
 Enjoys all profits realized but bears all losses incurred

Advantages of Sole Proprietorship

 Ease or simplicity of formation
 Sole Authority;- The proprietor being the sole authority, takes decisions of planning,
organizing, staffing, coordinating, controlling and directing the business unit
 Sole beneficiary of profits
 Flexible management- he can make prompt decisions and take quick action without
consultations
 Minimum legal restrictions- easy to form, simple to run. Minimum legal requirements in
formation and operation
 Secrecy- affords the sole proprietor high secrecy-profits, business methods, special production
technique
 Reduced concentration of wealth in a few hands giving wider distribution of business
ownership in the country
 Ease and low cost of organization- legal fees, consultations
 Tax advantage- as compares to other forms of ownership, the profits are taxed as personal
income of the owner and taxed only once while corporate income can attract double taxation
 Self-employment; Provides business careers to a large number of persons with small means
 Development of personal qualities of the sole proprietor-initiative, self-reliance

Disadvantages
 Unlimited liability- businesses involve risks and losses are inevitable. The proprietor in case
of loss faces the risk of unlimited liability. Considered the greatest disadvantage and often
discourages the sole proprietor from getting a loan to boost the business to avoid the risk of
losing personal property if business goes down
 Difficulties in expansion- The sole proprietor has limited resources, and limitation in raising
funds make it to undertake business development and expansion
 Lack of continuity –Continuity is difficult to maintain in the event of the demise,
incapacitation etc of the sole proprietor
 Limited managerial ability- depends on individual skills and jugdement. Most proprietors
don’t posses all the management skills required for financing, marketing, production,
supervision etc-limits the enterprise to his capacity
 Operational disadvantages- due to limited resources-capital , human resources, machinery,
raw material, poor location, substandard machinery etc
 Overworked owner
 Loss in absence- business can come to standstill due to absence as a result of long illness etc
 Weak bargaining position – The sole trader both as buyer as seller has weak bargaining
position compared to the other types
 Limiting for developing business – this form of organization is limited in meeting the needs of
an expanding business.

Sole proprietorship is favourable in the following circumstances

 Where the market is local and scale of business operation is small with less capital requirements
 When personal contact/ attention with customers is required- beauty parlour, tailoring shops,
cafeteria
 Where one prefers autonomy and being one’s own boss
 Where promptness is required in decision-making Where business is carried out on small scale
 Where there is ease of organization
 2. PARTNERSHIPS
 Is formed when a sole proprietor wants to expand business and brings partners on board or
Partners may just come together to form a Business partnership
 A partnership is a business owned by two or more people up to 20 who come together with a
common objective of operating a business to earn profits.
- A partnership consists of not more than 20 people except in certain cases e.g practising
solicitor, professional accountants and members of the stock exchange where this may be
exceeded. In case of banking business, the number of partners is limited to 10.
- In Kenya, all partnerships are formed in accordance with the partnership Act 1934 (chap.29)
- The name of the partnership must first be registered under the registration of Business names
Act

FEATURES OF A PARTNERSHIP
1. Association of at least 2 -20 persons
2. This is a contractual relation which is formed by an agreement among the partners
3. Requires an Article of partnership prepared in writing to cover the rights of the partners,
duties, obligations and the arrangements which partners have mutually agreed on.
4. Partners contribute towards the finances of the firm as per the terms of agreement
5. All partners need to take part in the management of the business
6. Consent required in important business decision-making e.g the decision to transfer one’s
shares to another person
7. Liability of the individual partner is unlimited unless the partnership agreement provides for
limitations- hence if the business suffers losses the assets of the partnership are not sufficient
to meet its obligations, creditors can sue one or all of the partners one or all of the partners.
They are jointly and severally liable for any debt. This is a serious handicap to partners who
may possess more personal assets as one may be forced to cover the entire debt of the
partnership solely
8. Partnership is a temporal form of ownership operating at the pleasure of the partners and can
be dissolved by obtaining a decree from the court if a partner leaves or dies
9. Each partner acts as an agent of the firm or of the other partners with authority to enter into
contracts, trade for the partnership
10. Responsibilities, profits and risks are shared on the agreed basis by the partners- any act by a
member is considered the act of the firm or of all the partners
Advantages of A partnership
1. Simplicity of formation- partners enter into an agreement, get the firm registered and start
business
2. Partnership avails more capital for the business as each member contributes finances through
joint efforts. It is also easier to obtain external financing as the partnership is viewed as being
less risky than the sole proprietorship
3. Combined talent and skills for managing the firm- each partner brings some talents and skill-
giving the firm an advantage of collective expertise for making better decisions
4. Advantage of division of labor and specialization which promote efficiency as duties and
responsibilities are distributed to each partner based on their specialty and ability.
5. Diffusion of risk- risk shared as per their agreement
6. Combined judgment- leading to better decisions acts as a brake to hasty decisions
7. Skilled employees can be retained and become partners in the partnership
8. Relatively more flexible – having new members or exiting members with consultation
9. Increase in the spirit of cooperation
10. Ease of dissolution

Disadvantages
 Unlimited liability
 Limited life of the firm which can be occasioned by dissolution due to death or withdrawal of a
member, disagreement
 Frozen investment- It is hard for a member to withdraw one’s funds from the partnership even
when one withdraws
 Divided authority – Partners can pursue their interest of have differing opinions leading to
disagreements
 Decisions are made are binding to all members even when one has a different opinion. A
decision made by a partner for the firm is equally binding and all partners bear the risk of
wrong decisions
 Disputes and disagreements if not handled well can jeopardize the operations of the firm
 Possibility of misuse of funds or firms resources which are jointly owned
 Loss of business opportunities can occur due delay in decision-making especially when there is
no consensus
 Lack of Public confidence- may not enjoy public confidence due to lack of publicity and
absence of regulations
 Implied authority- Acts of a partner are binding to other partners hence partners may suffer or
pay for the follies and dishonesty of one partners actions

Partnership Agreement/ Deed

A partnership deed is an agreement entered into by partners in writing which contains all matters
determining and governing the mutual rights, duties, liabilities of partners in the conduct and
management of the affairs of the partnership. May be referred to as ‘articles of partnership’
Elements of A partnership deed

These are usually defined by the partnership but include;

1. Name of firm, names of partners
2. Nature of Business, Place of business
3. Mode & Amount of capital to be contributed by each member & the profit/loss sharing ratio
4. Loans and advances from partners and the amount of interest
5. Drawings allowed to partners
6. Amount of salaries/ commissions payable to members
7. Duties, powers and obligations of partners
8. Maintainance of accounts and audit
9. Mode of valuation of goodwill in the event of admission, retirement or death
10. Method of revaluation of of assets, liabilities on admission, retirement or death of a partner
11. Procedure to be followed in expulsion of a partner
12. Procedure for dissolution of the firm and settlement of accounts
13. Arbitration in case of disputes among partners

Importance of a Partnership Deed

1. It forms the basis of formation of the partnership
2. It defines the mutual rights, duties and liabilities of the partners
3. Helps in minimizing disputes among partners
4. It serves as guidepost for the conduct of firm’s business

Different types of partners

i. General partners – Those whose liability is unlimited in the firm
a. Active – A partner who takes part in the day to day running of the firm
b. Sleeping partner - one who contributes capital, shares profits or losses but is not involved in
the running of the firm
ii. Special partners – Liability is limited to the extent of the assets in the firm. Not actively
involved in the management of the firm
iii. Secret partner – Takes an active part in the affairs of the firm but is not known to the public
iv. Nominal partner – One who lends his name for the goodwill and credit worthiness of the firm
neither contributes capital nor participates in the management of the firm. He is not liable for
the debts of the firm but shares in the profits

3. LIMITED COMPANIES
Definition:
A company is a voluntary association of persons bind together for a particular objective, usually to
carry out a business with the view of making profits.
A limited company is formed under the companies’ Act CAP 486. Very popular in the field of
large scale production

Features of A limited company

1. Is an artificial person created by law and has an entity separate from that of its members. As a
legal entity it can sue or be sued, or enter into contracts in its own name, it can own properties,
incur liabilities, enter into legal proceedings, it can join trade agreements with other firms
However because it is artificial it can only carry out activities according to the aims and
objectives for which it was formed. It also doesn’t suffer personal liabilities of a natural person
e.g. imprisonment
2. Capital is divided into transferable shares – hence a shareholder can sell his interests in the
company to another party without seeking consent of the shareholders( However in case of a
private company there are various restrictions)
3. Common Seal – As an entity there is need to sign documents and such signature is embodied
in the common seal of the company
4. Long Life – it enjoys continued existence, as its life is separate from the life of its members.
Despite the death of retirement of any member the business continues until it is wound up by
provisions of the Company Act.
5. Members cannot bind the company by their Act
Third parties are expected to know the powers granted to each shareholder and they have to see
that their acts are in strict accordance with the regulations of the company.
6. Centralized management – Company is managed by a board of directors who are elected by
members. Individual shareholders don’t take part in the daily management of the company
7. Limited liability – Each shareholder is liable only to the amount of capital contributed by him
and to the unpaid value of the shares he holds
8. Number of members – In public companies, min of 7 members and there is no maximum
While in a private company, the min number is 2 and the max 50 members
9. Transferability of shares - Shares of a public company are transferable and can easily be sold
or purchased in the stock market
10. Changing nature of business – nature of business is specified in the objectives of a company
hence changing is not easy and involves a legal process- need to amend and register the
changes
11. Winding up - Existence of a company can come to end through winding up through a legal
process. A liquidator is appointed for this purpose who does the dissolution through a legal
procedure

Advantages of Limited Companies

 Limited liability- Liability of each shareholder is limited to shares in the company
 Larger capital base- due to a large number of members who raise capital through shares and
can mobilise more funds for expansion through sale of shares, debentures
 Assured continuity of business
 Expert management – The directors can be experts in different fields bringing in a wealth of
knowledge and can afford to hire specialists in different areas due to sound financial status
 Afford large scale production, trading etc due to large capital base
 Spread risk - Large membership that shares any loss incurred from the membership
 Shareholders are safeguarded- Publicity of company accounts safeguards shareholders from
fraud
 Enjoys Public confidence – due to the fact that a company is created by law and supervised by
legal authority. This is an advantage as it attracts investors in the company
 Transferability of shares- a member is able to easily withdraw their capital from the company
 Higher profits – Due to economies of scale in large production, employment of efficient
technology and machinery because the company can afford owing to its huge capital base
 Opportunity for investment - provides an opportunity for investment even to the small scale
investor promoting the culture saving and investment

Disadvantages of a limited company

 Formation of a company is complicated involving a lengthy legal process with financial
implications
 Observation of laws and regulation hence interference - subject to several regulation by
different bodies KRA, City council, Ministry of health e.g. one is not allowed to undertake any
business outside its registered objects,
 Delay in decision-making due to delegated powers of managing the company to the board who
must sit to deliberate on any issue and seek the mandate of members in serious issues
 Shareholders’ non participation in management – Directors may take due advantage of
members who are not involved in the daily running of the company, lack of personal interest
by members
 Difficult to control due to the large number of members, big size, and complex structure
 Weak relationship between the employers/owners and the workers
 Operating a company is costly due to its organization structure, government regulations
 Double taxation – Shareholders pay their personal taxes, profits and dividends are also taxed
 No secrecy- public companies have to publicly publish their accounts, several employees who
may leak the companies secrets
 Lack of flexibility
 Conflict of interest from different groups e.g. management, employees. Management may seek
to be popular to ensure they are re-elected into management which can affect members
 Stock exchange Speculation – speculation in shares is harmful to the interest of shareholders
and for sound investment

Types of Limited Companies

i. Private Limited Company
 min 2 members, max 50 members
 Is not allowed to get money from the public through the issue of shares
 Transfer of shares is restricted - must be approved by the board of directors
 Must use the word limited in its name
ii. Public Limited Company
 Membership - min 7 and no prescribed max
 Transfer of shares allowed
 Can expand through the sale of shares to the public
 Management through directors elected by members

Formation of a Limited Company

Steps involved
1. Search for the company name- founders come up with a name which is taken to for a search at
the registrar of companies to ensure no other company is registered with a similar name
 2. Preparation of some legal documents which include;
i. The memorandum of association
ii. Articles of Association
iii. Registered office
iv. List of Directors
v. Form of Statutory declaration

Memorandum of Association
This consists of the formal application signed by all members to the registrar of companies
declaring the intention of formation a company
It defines the companies objectives, powers and serves as a guide to the outside public

Elements of a Memorandum of Association

i. Name of company including the word limited
ii. Country and town where the registered office is situated
iii. A statement that the liability of members is limited
iv. Objectives of the company – Outlines the aims and purpose for which the company is formed
v. A statement of the nominal authorized capital with which the company wants to be registered

Articles of Association
It serves as a guideline to the internal management of the company
It includes regulations governing the internal management and administration of the company.
This is very important especially for a private company
Contains;
i. Classes and rights of shareholders
ii. Issue and transfer of shares
iii. Methods of dealing with alterations in capital
iv. Procedures of general meetings and voting rights
v. Qualifications, duties and powers of directors
vi. Borrowing, dividend and reserve policies

After presenting the required documents and paying registration fee ( ) to the registrar the
company is registered and issued with a certificate of incorporation
The company will then require a trading licence to carry out its business.