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.
b. Incorporated businesses
Another form of a business organization is a limited company – private limited company and public limited company. There are lots of examples of limited companies in the world ranging from family businesses with a few owners to large airlines with thousands of owners.
Limited companies are businesses owned by their shareholders who are investors. Investors invest money in the company to provide necessary capital for running and growing a company in exchange for owning a part of the business – shares.
A share is a certificate confirming part ownership of a company and entitling the shareholder (owner) to dividends and certain shareholder rights (e.g. voting to choose directors).
Those shareholders who have more shares will have more control and can take more profits. A shareholder is a person or another institution owning shares in a limited company. Legal companies can also be shareholders.
Limited companies are incorporated business organizations. An incorporated business is a business organization that has legal identity separated from its owners – there is a legal difference between the owners of the company (the shareholders) and the business itself. This means that the owners are not the same legal entity as the business. Because the company is being treated as a separate entity, it is the company that has its own legal rights and duties. The business can form contracts, employ people, sue and be sued in its own right, etc.
The owners of incorporated businesses have limited liability for business debts. They are not responsible for any debts of the business, therefore are not at risk of losing all their personal wealth or belongings to pay for these business debts, if the company owes money. The debts of the business as well as all assets belong only to the business. For example, the company, rather than the owners, would take those who infringe trademarks, patents or copyright to court.
The maximum what shareholders can lose is the value of their investment in the company. This is to safeguard investors. An ordinary individual, as a shareholder, having to share the debts of a large multinational company would be unimaginable.
Conclusively, people who own the limited business (shareholders) and people who run the business (directors and managers) are not responsible for the business’s debts.
Directors are appointed by shareholders and should run the company as the shareholders wish. Directors form the Board of Directors (BoD) which is headed by a chairperson (a chairman or chairwoman). Because directors are accountable to shareholders, if the company’s performance does not live up to shareholder’s expectation, the directors can be ‘voted out’ and removed from managing the company any longer.
This is called ‘divorce between ownership and control’ and can lead to conflicts because the objectives set by directors and managers to be taken by the business (e.g. long-term growth) may differ from what the shareholders might prefer (e.g. receive short- term profits in the form of a dividend).
Private Limited Company (Ltd.)
Private limited companies are one type of limited company.
Owners of a small business can gain protection of their personal wealth when they establish a private limited company. And that protection that comes from forming a company is great and worth the hassle. However, to do so, certain legal formalities must be followed in setting up such a business which makes running limited company more complicated than operating as a sole trader or partnership.
A private limited company usually has the word ‘Limited’ or a shortcut ‘Ltd.’ after its name which tells us that the business has legal form. Private limited companies vary in size from a small business through medium-sized business to even a large multinational corporation (IKEA is a good example).
Private limited companies are owned by its shareholders who are often members of the same family or close friends. Therefore, many private limited companies are run as family businesses. A private limited company cannot raise share capital from the general public (new issues of shares cannot be sold on the open market or even advertised for general sale). Therefore, investors in a private limited company are restricted to family members, friends, relatives and employees.
The original owner (often the former sole trader) usually has a controlling interest. Because the shares cannot be traded without the prior agreement from the Board of Directors (BoD), existing shareholders may sell their shares only with the agreement of the other shareholders. The directors of these firms tend to be main shareholders and are involved in the running of the business.
To sum up, documents needed to start a private limited company include article of incorporation and bylaws. It is not difficult to terminate – need to pay off all debts, sell off all assets, withdraw cash from the bank account and pay TAXes to the government. A private limited company has perpetual life. It is easy to transfer ownership – just sell shares to some other family members or friends (unless bylaws specify otherwise). Financial resources come from only owner’s capital and bank loans as no public stock issue is allowed. There is no personal risk of losses as owners (shareholders) have limited liability. The company pays corporate income TAX plus lower personal income TAX on dividends. Owners usually manage all areas of the business when a private limited company is small, or hire professional managers when a private limited company is large.
Public Limited Company (plc)
Public limited companies are another type of limited company. This company name usually ends in ‘plc’. PLCs are in the private sector, despite their name. They are ‘public’ only because any private individual (a member of the public) can buy shares in them.
Not many but only around 1% of all companies in any country are public limited companies. However, they contribute far more to national output, have higher brand recognition and hire more employees than private limited companies. Many private limited companies convert to plc status.
A public limited company has the advantages of the status of a private limited company such as limited liability, plus the right to advertise and sell shares to the general public on the stock exchange.
A public limited company is then a limited company with large scale of operations, usually a multinational business or a medium-size company that is planning to become a multi-national company as this kind of business organization has access to very substantial funds for expansion. Google, Apple, Amazon and Facebook are examples of public limited companies which are also the largest companies in the world.
A public limited company can advertise and sell its shares to the general public via a stock exchange, basically to anyone, anytime and anywhere in the world. The process of issuing shares (‘going public’) is called floatation or Initial Public Offering (IPO). Flotation happens when a business first sells shares to external investors. Share prices are quoted in real time and change every minute. One of the world’s biggest IPOs include those of Agricultural Bank of China (ABC) or Alibaba.
Public limited companies can raise very large sums from public issues of shares, and existing shareholders may also quickly sell their shares later, if they wish to do so. This flexibility of share buying and selling encourages the public to purchase the shares in the first instance and thus invest in the business. The shares are later sold for capital gain.
Due to the sheer volume of shares issued and number of people and institutions being investors, the original owners cannot continue to exercise management control any longer. The shareholders who own the company will appoint, at the annual general meeting, a Board of Directors (BoD) who control the management and decision-making of the business. The bBoard of Directors’ main responsibility is to maximize the performance of the business and provide dividends for shareholders.
It is still possible for the directors or the original owners to convert it back from a public limited company to a private limited company status, but it is difficult and time consuming.
To sum up, documents needed to start a public limited company include article of incorporation and bylaws. It is very difficult and expensive to terminate. A public limited company has perpetual life. It is very easy to transfer ownership – just sell shares to someone else on the stock market. Financial resources come from issuing shares and bonds as the company may issue as many shares and bonds as market will absorb. There is no personal risk of losses as owners (shareholders) have limited liability. The company pays corporate income TAX plus lower personal income TAX on dividends. Owners usually do not manage all areas of the business by themselves but professional directors and managers manage the business. Management is separated from ownership.
Holding Company
Holding companies are not a different legal form of business organization. Some public limited companies operate as a holding company, for example, Warren Buffet’s Berkshire Hathaway.
It is an increasingly common way for businesses to be owned when this type of company wants to have a diverse range of business activities under one roof.
A holding company is a legal business organization that owns and controls a number of separate businesses (often in completely different markets), but does not unite them into one unified company.
On one hand, a holding company wants to have diversified interests to spread the risk when one market fails, take advantages of market opportunities in different industries or keep separate businesses independent of each other for major decisions or policy changes.
On another hand, a holding company wants to provide centralized control from the directors of the holding company over really crucial issues in those separate businesses, such as a major new investment.
