The 3 Forms of business organizations

There are three major forms of business organizations. Sole traders, partnerships and companies.

Sole trader

Nature:

Sole Trader is the amoeba of the business organization world. This is a one-person operation with no legal filing requirements in order to start off a business. Capital used for this business organization is provided through personal savings or a personal bank loan and here is no legal distinction between the sole trader’s personal and business assets. The sole trader has contract in their own name. There are various advantages and disadvantages associated with this.

Advantages:

  • Little risk of disagreement
  • No need for a formal organizational structure

Disadvantages:

  • Personal liability for all the debts of the business

Partnership

Second form of business organization is partnerships. There are two major types of partnerships. Regular partnership, according to the partnership Act 1932 and Limited liability partnership, according to the limited Liability Partnership Act 2017.

Regular partnership

  • Section 4 of the Partnership Act 1932:

                “…the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. Persons who have entered       into partnership with one another called individually “partners” and collectively “a      firm” and the name under which their business is carried on is called the “firm                 name.”

  • Section 5 of the Partnership Act 1932:

                “The relation of partnership arises from contract and not from status…”;

  • Section 6 of the Partnership Act 1932:

                “In determining whether a group of persons is or is not a firm or whether a person is or is not a partner in a firm regard shall be had to the real relation between the parties as shown by all relevant facts taken together.”

Nature:

Partnership Act 1932 applies to all partnerships and can be modified by contract, i.e. partnership deed. This deedcontains mutual rights and obligations of the partners and conditions relating to partnership and the regulations governing its internal management. There is also a deed of dissolution that provides for the valuation of assets and distribution amongst the partners.

By default, partners are entitled, amongst other things, to:

  • Participate in management;
    • An equal share of the profit;
    • Indemnity in respect of liabilities assumed in the course of the partnership business by other partners

Partner acts as agent of the firm and there is no limited liability, which means partners are jointly and severally liable for the debts of the partnership. Registration of partnership is not compulsory by law but it is preferred. In effect of non-registration, partner cannot sue the firm and firm cannot sue third parties. Partnerships ends on death of partner meaning there is no perpetual succession.

Advantages:

  • Facilitates investment because it allows partners to pool funds
  • Flexible organizational structure through partnership deed

Disadvantages:

  • No limited liability – partners jointly and severally liable for the debts of the firm

Limited liability partnership

LLP is formed under Limited liability partnership agreement and incorporated by the SECP. The activities are overseen by the SECP. This corporate body is separate from its partners and has the advantage of perpetual succession. Limited liability of the partners to the extent of their contribution as per the LLP agreement

Advantages:

  • Facilitates investment because it allows partners to pool funds
  • Flexible organizational structure through LLP agreement
  • Limited liability to the extent of the contribution of each partner

Disadvantages:

  • Minimum two members required
  • Cannot raise money through equity financing
  • The income of a partner is personal income and liable to income tax

Companies

Third form of business organization is companies.

Section 14 of the Companies Act 2017:

“(1) Any-

  • three or more persons associated for any lawful purpose may, by subscribing their names to a memorandum of association and complying with the requirements of this Act in respect of registration, form a public company; or
  • two or more persons so associated may in the like manner form a private company; or
  • one person may form a single member company by complying with the requirements in respect of registration of a private company and such other requirement as may be specified…

(2) A company formed under this section may be a company with or without limited liability, that is to say-

(a) a company limited by shares; or

(b) a company limited by guarantee; or

(c) an unlimited company.”

Company limited by shares

Section 2(20) of the Companies Act 2017:

                “company limited by shares means a company; having the liability of its members limited by the memorandum to the extent of amount, if any, remaining unpaid on the shares respectively held by them;”

  • Most common form
  • Capital raised through issuance of shares

Company limited by guarantee

Section 2(19) of the Companies Act 2017

                “company limited by guarantee means a company having the liability       of its members limited by the memorandum to such amount as the      members may respectively thereby undertake to contribute to the                 assets of the company in the event of its being wound up;”

  • Capital not raised through shares but donations, subscriptions, etc.
  • Hence mostly used for NGOs, charities, associations, etc.

Unlimited company

Section 2(71) of the Companies Act 2017

                “unlimited company means a company not having any limit on the            liability of its members;”

  • Form rarely used
  • Sole traders who wish to have an incorporated company for a sense of prestige and legitimacy but do not require limited liability

Public sector company

Section 2(54) of the Companies Act 2017:

                “…a company, whether public or private, which is directly or      indirectly controlled, beneficially owned or not less than fifty-one    percent of the voting securities or voting power of which are held by         the Government or any agency of the Government or a statutory      body, or in respect of which the Government or any agency of the                 Government or a statutory body, has otherwise power to elect,    nominate or appoint majority of its directors and includes a public       sector association not for profit, licensed under section 42…”

  • E.g. Pakistan State Oil

Public & Private companies

Forms of business organization

Also read: Introduction to Corporate Law