Business Studies Chapter 2 Notes NCERT Class 11th – Forms of Business Organisation

2.1 Introduction

The choice of business organization form is a crucial decision for starting or expanding a business. The most suitable form is determined by weighing the advantages and disadvantages of each type against specific requirements.

Various forms of business organizations include:

Sole Proprietorship
Joint Hindu Family Business
Partnership
Cooperative Societies
Joint Stock Company

2.2 Sole Proprietorship

A popular and suitable form for small businesses, especially in their initial years.

Definition: Sole proprietorship refers to a business organization owned, managed, and controlled by an individual who receives all profits and bears all risks. The term “sole” means “only,” and “proprietor” refers to “owner.”

Common in personalized services like beauty parlours, hair saloons, and small-scale retail shops.

Definitions by Experts:

J.L. Hansen: A business unit where a person is solely responsible for providing capital, bearing risk, and managing the business.
L.H. Haney: The form of business organization headed by an individual responsible for operations and bearing the risk of failure alone.

Features:

Formation and Closure: No separate law governs sole proprietorship. Minimal legal formalities are required to start, and closure is also easy, though a license may be needed in some cases.
Liability: Sole proprietors have unlimited liability, meaning personal assets can be used to repay business debts if business assets are insufficient.
Sole Risk Bearer and Profit Recipient: The proprietor bears all risks of business failure but enjoys all profits if successful, which is a direct reward for risk-bearing.
Control: The sole proprietor has absolute right to run the business and make all decisions without interference.
No Separate Entity: Legally, there is no distinction between the sole trader and their business; the business does not have an identity separate from the owner.
Lack of Business Continuity: The business’s existence is directly affected by the sole proprietor’s death, insanity, imprisonment, physical ailment, or bankruptcy, potentially leading to closure.

Merits:

Quick Decision Making: Freedom in decision-making and prompt action due to no need for consultation, allowing timely capitalization of market opportunities.
Confidentiality of Information: The sole proprietor can keep all business information confidential as they are the sole decision-making authority and are not legally bound to publish accounts.
Direct Incentive: The proprietor directly reaps all profits, providing maximum incentive to work hard.
Sense of Accomplishment: Personal satisfaction from working for oneself and responsibility for success contributes to self-satisfaction, accomplishment, and confidence.
Ease of Formation and Closure: Minimal legal formalities and least regulation make it easy to start and close the business.

Limitations:

Limited Resources: Resources are limited to personal savings and borrowings; banks may hesitate to offer long-term loans, limiting business growth.
Limited Life of a Business Concern: The business can cease due to the proprietor’s death, insanity, imprisonment, physical ailment, or bankruptcy.
Unlimited Liability: Creditors can recover dues from personal assets if business assets are insufficient, creating a significant financial burden and reducing inclination to take risks.
Limited Managerial Ability: The owner handles all managerial tasks, and it’s rare to excel in all areas, leading to potentially unbalanced decisions. Limited resources also hinder hiring talented employees.

2.3 Joint Hindu Family Business

A unique and one of the oldest forms of business organization found only in India.

Definition: Owned and carried on by members of a Hindu Undivided Family (HUF), governed by Hindu Law. Membership is by birth in a particular family, with up to three successive generations being members.

Karta: The business is controlled by the head of the family, the eldest member, known as the Karta.
Co-parceners: All members have equal ownership rights over ancestral property and are known as co-parceners.
Governed by the Hindu Succession Act, 1956.

Features:

Formation: Requires at least two family members and ancestral property. No agreement is needed as membership is by birth.
Liability: The Karta has unlimited liability, while all other members (co-parceners) have liability limited to their share of the co-parcenery property.
Control: The Karta holds absolute control, making all decisions binding on other members.
Continuity: The business continues even after the Karta’s death, as the next eldest member takes over. Termination requires mutual consent of members.
Minor Members: Minors can be members due to birth in the HUF.

Gender Equality (Hindu Succession (Amendment) Act, 2005):

Daughters become co-parceners by birth.
Co-parcenary property is equally divided among all co-parceners, regardless of gender, at partition.
The eldest member (male or female) can become Karta.
Married daughters have equal rights in the property.

Merits:

Effective Control: Karta’s absolute decision-making power avoids conflicts and leads to prompt and flexible decisions.
Continued Business Existence: Business continuity is ensured as the next eldest member assumes the Karta’s position upon their death.
Limited Liability of Members: Co-parceners (except Karta) have limited liability, clearly defining their risk.
Increased Loyalty and Cooperation: Family-run nature fosters loyalty and cooperation among members, linking business growth to family achievements.

Limitations:

Limited Resources: Capital mainly depends on ancestral property, limiting expansion.
Unlimited Liability of Karta: The Karta bears unlimited liability, and personal property can be used for business debts.
Dominance of Karta: Karta’s individual management may not be acceptable to all members, potentially causing conflicts.
Limited Managerial Skills: The Karta may not be an expert in all management areas, leading to unwise decisions and potential losses.
Decline: The diminishing number of joint Hindu families in India contributes to its decline.

2.4 Partnership

A viable option for expanding businesses requiring greater capital, varied skills, and risk sharing, addressing limitations of sole proprietorship.

Definition (Indian Partnership Act, 1932): “The relation between persons who have agreed to share the profit of the business carried on by all or any one of them acting for all.”

Definitions by Experts:

L.H. Haney: The relation between competent persons who agree to carry on a lawful business for private gain.
Indian Contract Act 1872: The relation subsisting between persons who combine property, labour, or skill in business to share profits.

Features:

Formation: Governed by the Indian Partnership Act, 1932. Formed through a legal agreement specifying terms, conditions, profit/loss sharing, and business conduct. The business must be lawful and profit-motivated.
Liability: Partners have unlimited liability, individually and jointly, for firm debts, meaning personal assets can be used.
Risk Bearing: Risks are borne as a team, with profits and losses shared in an agreed ratio.
Decision Making and Control: Partners share decision-making and control of daily activities, generally through mutual consent.
Continuity: Lack of continuity as death, retirement, insolvency, or insanity of any partner can end the business, though remaining partners can continue with a new agreement.
Number of Partners: Minimum two partners. Maximum 50, as per Rule 10 of The Companies (Miscellaneous) Rules 2014, subject to Section 464 of the Companies Act 2013 (which allows up to 100).
Mutual Agency: Every partner is both an agent (represents others, binds them by acts) and a principal (can be bound by acts of others).

Merits:

Ease of Formation and Closure: Formed easily by agreement with no compulsion for registration. Closure is also simple.
Balanced Decision Making: Partners oversee functions based on expertise, reducing workload burden and errors, leading to more balanced decisions.
More Funds: Capital contributed by multiple partners allows for larger funds compared to sole proprietorship, facilitating additional operations.
Sharing of Risks: Risks are shared by all partners, reducing individual anxiety, burden, and stress.
Secrecy: Not legally required to publish accounts or reports, allowing maintenance of confidentiality.

Limitations:

Unlimited Liability: Partners are liable for debts even from personal resources, with joint and several liability which can be a drawback for wealthier partners.
Limited Resources: Restriction on partner numbers limits capital investment, hindering large-scale operations and expansion beyond a certain size.
Possibility of Conflicts: Shared decision-making can lead to disputes due to differing opinions. Unwise decisions by one partner can financially ruin others.
Lack of Continuity: Partnership ends with death, retirement, insolvency, or lunacy of any partner, though remaining partners can form a new agreement.
Lack of Public Confidence: No legal requirement to publish financial reports, making it difficult for the public to ascertain financial status, leading to lower confidence.

2.4.1 Types of Partners

Partnerships can have different types of partners with varying roles and liabilities.

Type of Partner	Capital Contribution	Management	Share in Profits/Losses	Liability
Active Partner	Contributes capital	Participates in management	Shares profits/losses	Unlimited liability
Sleeping or Dormant Partner	Contributes capital	Does not participate in management	Shares profits/losses	Unlimited liability
Secret Partner	Contributes capital	Participates in management (secretly)	Shares profits/losses	Unlimited liability
Nominal Partner	Does not contribute	Does not participate in management	Generally does not share	Unlimited liability
Partner by Estoppel	Does not contribute	Does not participate in management	Does not share	Unlimited liability
Partner by Holding Out	Does not contribute	Does not participate in management	Does not share	Unlimited liability

Partner by Estoppel: A person who, through their conduct, gives an impression of being a partner, and is held liable for firm debts extended on that basis.

Partner by Holding Out: A person who, though not a partner, knowingly allows themselves to be represented as one and becomes liable to outside creditors for debts extended based on this representation.

Minor as a Partner:

A minor cannot enter into a valid contract and thus cannot become a full partner.
Can be admitted to the benefits of a partnership with mutual consent of all other partners.
Liability is limited to their capital contribution.
Cannot take active part in management and only shares profits, not losses.
Can inspect firm accounts.
Upon attaining majority, the minor must decide within six months whether to become a full partner by giving public notice. Failure to do so makes them a full-fledged partner with unlimited liability.

2.4.2 Types of Partnerships

Partnerships are classified based on duration and liability.

Classification on the basis of Duration:

Partnership at will: Exists at the will of partners and can be terminated by any partner giving a notice of withdrawal.
Particular partnership: Formed for a specific project or time period and dissolves automatically upon fulfillment of purpose or expiry of time.

Classification on the basis of Liability:

General Partnership: Partners have unlimited and joint liability. They participate in management, and their acts bind the firm. Registration is optional. Firm’s existence is affected by death, lunacy, insolvency, or retirement of partners.
Limited Partnership: At least one partner has unlimited liability, while others have limited liability. It does not terminate with death, lunacy, or insolvency of limited partners. Limited partners do not have management rights or bind the firm. Registration is compulsory.

2.4.3 Partnership Deed

A partnership is a voluntary association aiming for common objectives. A clear agreement is essential to avoid misunderstandings.

Can be oral or written, but a written agreement is advisable as evidence.
Partnership Deed: The written agreement specifying the terms and conditions governing the partnership.

Contents of a Partnership Deed:

Name of firm
Nature and location of business
Duration of business
Investment by each partner
Distribution of profits and losses
Duties and obligations of partners
Salaries and withdrawals of partners
Terms governing admission, retirement, and expulsion of a partner
Interest on capital and interest on drawings
Procedure for dissolution of the firm
Preparation of accounts and their auditing
Method of solving disputes

2.4.4 Registration

Registration means entering the firm’s name and particulars in the Register of Firms. It provides conclusive proof of the firm’s existence.

Optional: Registration is optional for a partnership firm.
Consequences of Non-Registration:
- A partner cannot file a suit against the firm or other partners.
- The firm cannot file a suit against third parties.
- The firm cannot file a case against its own partners.
Recommendation: It is advisable to register due to these consequences.
Procedure:
1. Submit an application in the prescribed form to the Registrar of Firms, including: name and location of the firm, other business places, date each partner joined, names and addresses of partners, and duration of partnership. The application must be signed by all partners.
2. Deposit required fees.
3. The Registrar, after approval, will make an entry and issue a certificate of registration.

2.5 Cooperative Society

Definition: A voluntary association of persons working together for a common purpose, driven by the motive of members’ welfare and protection of economic interests from exploitation by middlemen.

Registration: Compulsory under the Cooperative Societies Act 1912.

Features:

Voluntary Membership: Free to join and leave, without compulsion. Open to all irrespective of religion, caste, and gender.
Legal Status: Registration grants a separate legal identity distinct from members. The society can enter contracts, hold property, sue, and be sued. Its existence is unaffected by members’ entry or exit.
Limited Liability: Members’ liability is limited to their capital contribution.
Control: Decisions are made by an elected managing committee. Each member has equal voting rights (“one man one vote”), giving it a democratic character.
Service Motive: Emphasis on mutual help and welfare. Surplus generated is distributed as dividends according to bye-laws.

Merits:

Equality in Voting Status: “One man one vote” principle ensures equal voting rights regardless of capital contribution.
Limited Liability: Members’ personal assets are protected as liability is limited to capital contribution.
Stable Existence: Continuity is unaffected by members’ death, bankruptcy, or insanity.
Economy in Operations: Members often offer honorary services, eliminating middlemen and reducing costs. Low risk of bad debts.
Support from Government: Receives government support in the form of low taxes, subsidies, and low interest rates on loans due to its democratic nature.
Ease of Formation: Simple registration procedure with few legal formalities under the Cooperative Societies Act 1912.

Limitations:

Limited Resources: Capital contributions from members with limited means and low dividend rates on investment hinder attracting more capital or members.
Inefficiency in Management: Inability to pay high salaries makes it difficult to attract expert managers. Voluntary members may lack professional management skills.
Lack of Secrecy: Open discussions in meetings and disclosure obligations make maintaining secrecy difficult.
Government Control: Subject to rules and regulations (auditing, reporting) and interference from state cooperative departments, affecting operational freedom.
Differences of Opinion: Internal quarrels due to conflicting viewpoints can delay decision-making, and personal interests may override the welfare motive.

2.5.1 Types of Cooperative Societies

Consumer’s Cooperative Societies: Protect consumer interests by providing good quality products at reasonable prices, eliminating middlemen. Profits distributed based on capital or purchases.
Producer’s Cooperative Societies: Protect small producers’ interests by procuring inputs and buying output for sale, enhancing bargaining power against big capitalists. Profits distributed based on contribution to goods produced/sold.
Marketing Cooperative Societies: Help small producers sell products at reasonable prices, eliminating middlemen, and improving competitive position through marketing functions like transportation, warehousing, and packaging. Profits distributed according to output contribution.
Farmer’s Cooperative Societies: Protect farmers’ interests by providing better inputs at reasonable costs, aiming for large-scale farming benefits and increased productivity. Helps with fragmented land holdings.
Credit Cooperative Societies: Provide easy credit on reasonable terms to members, protecting them from exploitative lenders. Loans are given from collected capital and deposits at low interest rates.
Cooperative Housing Societies: Help limited-income individuals construct houses at reasonable costs, solving housing problems by constructing flats or providing plots with installment options.

2.6 Joint Stock Company

An association of persons formed for business activities with a legal status independent of its members.

Definition: An artificial person with a separate legal entity, perpetual succession, and a common seal, governed by The Companies Act, 2013.

Owners: Shareholders are the owners, exercising indirect control.
Management: Board of Directors, elected by shareholders, is the chief managing body.
Capital: Divided into ‘shares’ that can be freely transferred (except in private companies).

Features:

Artificial Person: Created by law, exists independently of members, can own property, incur debts, borrow, contract, sue, and be sued.
Separate Legal Entity: Distinct identity from its members since incorporation. Assets and liabilities are separate from owners.
Formation: Time-consuming, expensive, and complicated, involving extensive legal formalities and documentation. Incorporation is compulsory under the Companies Act.
Perpetual Succession: Existence is not affected by members’ death, retirement, etc. It can only be terminated by law through a specific winding-up procedure.
Control: Management and control are by the Board of Directors, who appoint top management. Shareholders do not directly manage daily operations.
Liability: Members’ liability is limited to the unpaid amount on shares held. Creditors can only use company assets, protecting personal property.
Risk Bearing: Risk of losses is borne by all shareholders, spreading the burden across a large number of individuals.

Merits:

Limited Liability: Shareholders’ risk is limited to their investment in shares, protecting personal assets.
Transfer of Interest: Ease of transferring shares (especially in public companies) allows for liquidity, making it a favorable investment.
Perpetual Existence: Unaffected by changes in membership, ensuring stability and continuity.
Scope for Expansion: Large financial resources can be raised from the public, banks, and financial institutions, facilitating greater expansion.
Professional Management: Can afford to hire specialists and professionals, leading to balanced decision-making and greater efficiency due to division of work.

Limitations:

Complexity in Formation: Requires significant time, effort, and legal knowledge, making it more complex than other forms.
Lack of Secrecy: Public companies must disclose much information to the Registrar of Companies, which is publicly accessible, making complete secrecy difficult.
Impersonal Work Environment: Separation of ownership and management can lead to a lack of personal involvement and difficulty in maintaining personal contact with employees, customers, and creditors.
Numerous Regulations: Subject to many legal provisions and restrictions (audits, voting, reports), which consume time, effort, and money, reducing operational freedom.
Delay in Decision Making: Democratic management through multiple levels (Board of Directors, top, middle, lower management) can lead to delays in decisions and implementation.
Oligarchic Management: In practice, despite being democratic in theory, the dispersed nature of shareholders often leads to minimal owner influence, with the Board of Directors exercising considerable power.