Business organizations in the private sector differ from one another in terms of ownership structure and control, the purpose of existence, how they raise finance, how they are managed and who manages them, their size and how the profits are distributed or losses covered.
Businesses in the private sector are divided into three main types depending on profit orientation:
1. For-profit commercial organizations
a. Unincorporated businesses: Sole trader, Partnership
b. Incorporated businesses: Private limited company, Public limited company, Holding company
2. For-profit social organizations
a. Cooperative
b. Microfinance provider
3. Non-profit social organizations
a. Non-governmental organization (NGO)
b. Charity
1. For-profit commercial organizations:
For profit commercial organizations are businesses that operate in the private sector aiming to make and maximize profit. Business organizations can only survive in the long-term, if they are profitable.
The main types of profit-based commercial organizations are sole traders, partnerships, limited liability companies (private limited company and public limited company), and holding companies.
For profit commercial organizations are divided into unincorporated businesses and incorporated businesses. Unincorporated businesses include sole traders and partnerships, while incorporated businesses include private limited companies, public limited companies and holding companies.
a. Unincorporated businesses
An unincorporated business is a business organization that does not have legal identity separated from its owners. This means that the owner is the same legal entity as the business itself, the owner is the business himself or herself. The owners of unincorporated businesses (sole traders and partners) have unlimited liability for business debts. They are responsible for all debts of the business and risk losing all their personal wealth to pay for these business debts.
Sole trader
It is the most common type of business ownership around the world. Although sole traders are great in number, they account for only a small proportion of total business turnover.
Characteristics of sole traders
A sole trader is a business owned and managed by one person, an individual who runs a personal business. The sole trader provides the permanent finance (capital) for the business and, in return, has full control of the business, and keeps all of the profits. The owner is totally held responsible for its success or failure.
Start-up capital is usually obtained from personal savings of the sole trader and borrowing small amounts of money from family members or friends.
Sole proprietorships are often small family-run businesses and can be set up with relatively little capital. Sole traders may work alone or they might employ other people to help them run the business. Although there is a single owner, it is common for sole traders to employ others, but the firm is likely to remain very small nonetheless.
Since there is no legal difference between the business and the owner, the sole trader bears full responsibility for all losses (liabilities). The owner’s personal possessions and property can be taken to pay off the debts of the business. This can be discouraging for some potential entrepreneurs from starting a small business.
Reasons for becoming a sole trader
People often choose to become sole traders for their own personal reasons. They want to have a business that uses their skills and interests, and where they can be their own boss to make all of the decisions by themselves, for example, when and how many hours to work, or what products to sell.
Examples of sole traders
Sole traders are self-employed and most commonly established in the local house construction (plumbers, carpenters, electricians) and renovations (interior decorators, architects), retailing fruits & vegetables and other conveniences, florists, freelance photographers and photo editors, hairdressing, nail and SPA salons, car-servicing garages (mechanics) and catering (small restaurants or wedding houses).
Many well-known companies started as sole traders, but then as the business kept growing, they changed into another form of a business organization such as a partnership or a private limited company
What happens when the sole trader business grows?
Many sole traders choose to remain small because the owner wishes to remain in total control of their own business, or due to the limitations in raising additional capital. For injections of capital, sole traders are dependent on their own savings, profits retained in the business and small bank loans.
However, as soon as the sole trader decides to grow the business, other partners (for a partnership) or shareholders (for a private limited company) are sought in order to raise additional finance and/or skills and expertise.
To sum up, there are no documents needed to start this business organization, but permits or licenses may be needed. It is easy to terminate – just pay debts and quit. The life span is usually as long as the sole trader lives and the business is terminated on death, sale or retirement. The ownership can be transferred when the sole trader sells sole proprietorship. Financial resources are very limited to owner’s capital and loans. There is high personal risk of losses as every sole trader has unlimited liability. Income TAXes are paid as personal income. The owner manages all areas of the business, hence faces high management responsibilities.
Partnership
Partnerships are often formed to overcome some of the disadvantages of sole traders such as difficulties in raising substantial amount of finance, no clients or lack of experience.
Characteristics of partnerships
A partnership is a profit-seeking business owned and managed by two or more people For ordinary partnerships, the maximum number of owners is 20 (although this can vary from one country to another). So, the number of partners in the partnership is usually between 2 and 20 people.
The partnership agreement does not create a separate legal unit (a partnership is just a group of individuals), therefore partnerships are unincorporated business organizations. It means that owners have unlimited liability and they must share the liability; the same applies to sole traders.
Like sole traders, partnerships are financed mainly from the personal funds of each partner as all of the owners pool their funds together to raise more finance than an individual sole trader is able to.
They can also raise money from ‘silent partners’ who are also owners, but who do not actively participate in the running of the partnership on daily basis, but have a financial stake in it, therefore are eligible for a portion of the profits.
Examples of partnerships
Partnerships are the most common form of business organization in some professions such as lawyers, dentists, doctors, solicitors and accountants. Small building firms often operate as partnerships, too.
Drafting the deed of partnership
Although it is not a legal requirement, most partnerships create a legal agreement between each of the partners to formulate their legal privileges and responsibilities. When an official contract is drawn up, it is known as a deed of partnership. It is a legally binding document that lays out the terms of the partnership and which can be referred to when conflict arises.
A partnership deed will include the following sections:
1. The roles, obligations and responsibilities of each partner.
2. The amount of finance contributed by each partner.
3. The portion of profit each partner is entitled to, or how losses will be shared between the partners.
4. Requirements for introducing new partners into the existing partnership.
5. Conditions for the withdrawal of a partner, either voluntarily or enforced by law.
6. Procedures for ending the partnership and closing the business organization.
With the deed of partnership, it is clear how profits or losses are shared amongst the partners, and it is confirmed that all partners have the same rights in the running of the partnership.
To sum up, documents needed to start this business organization include the partnership agreement (either oral or written). It may be difficult to terminate depending on agreements of the partners. Though, it will be terminated on death or withdrawal of partners unless the agreement specifies otherwise. Any transfer of ownership requires agreement of partners as written in the partnership agreement. Financial resources are limited to partners’ capital and loans. Partners face personal risk of losses as they have unlimited liability. Income TAXes are paid as personal income. Partners manage all areas of the business sharing management responsibilities.
