Types of business organisation
Contents: 8 sections
Limited liability, and why it decides most of this topic
Almost every advantage and disadvantage here traces back to one idea, so learn it first.
Limited liability means the owners of a company can lose only the money they put into it. If the company runs up debts it cannot pay, the owners' home, savings and car cannot be taken to settle them.
This works because a company has a separate legal identity from the people who own it. It signs its own contracts, owns its own assets, owes its own debts and can be sued in its own name.
Sole traders and partners have no such protection, because in law the owner and the business are one and the same. If the business owes $80,000 and cannot pay, the owner personally owes $80,000, and a court can take personal property to cover it. That single difference is why a growing sole trader eventually converts to a company.
Separate legal identity also gives a company continuity: it carries on if an owner dies or sells their shares, where a sole trader's business normally ends with the owner.
The 0264 specimen Paper 2 asks for two advantages and two disadvantages of being a private limited company, for 8 marks. Its mark scheme credits limited liability, separate legal identity, continuity and raising capital by selling shares on one side, and on the other shares sellable only to family and friends, the legal formalities of setting up, published financial statements, and shares being hard to transfer. Those eight are worth knowing by name.
The four main types
| Type | Who owns it | Liability | Key features |
|---|---|---|---|
| Sole trader | One person | Unlimited | Simplest to set up, owner keeps all profit and decides everything |
| Partnership | Usually 2 to 20 partners | Unlimited | Run under a partnership agreement setting out profit shares and responsibilities |
| Private limited company | Shareholders, shares sold privately to family and invited investors | Limited | Separate legal identity, must register, accounts published |
| Public limited company | Shareholders, shares sold to the public on a stock exchange | Limited | Can raise very large sums, ownership separated from control |
Sole trader
| Advantages | Disadvantages |
|---|---|
| Quick and cheap to set up, with few formalities | Unlimited liability, so personal assets are at risk |
| The owner keeps all the profit | Hard to raise finance: lenders see one person and few assets |
| Complete control, so decisions are fast | Long hours, with nobody to share the workload |
| Financial affairs stay private | No continuity: the business ends if the owner retires or dies |
| Close personal contact with customers | Limited skills: one person handles every function |
Partnership
| Advantages | Disadvantages |
|---|---|
| More capital than one person can raise alone | Unlimited liability, including for debts the other partners create |
| Skills and workload are shared, so partners can specialise | Profits are shared |
| Losses are shared, so a bad year hurts each partner less | Disagreements slow decisions, and every partner must be consulted |
| Still simple to set up compared with a company | May have to be dissolved if a partner leaves or dies |
The partnership agreement is where the evaluation marks are. Without one, disputes over profit shares, decisions and a departing partner have nothing to settle them. When a stem shows two friends starting a business on a handshake, that is what the question is fishing for.
Private limited company
| Advantages | Disadvantages |
|---|---|
| Limited liability protects shareholders' personal assets | Shares sell only to family, friends and invited investors, capping the sum raised |
| Separate legal identity | Legal formalities and costs in setting the company up |
| Continuity: the business survives a change of owner | Financial statements must be published, so competitors can read them |
| Capital raised from investors the owners choose | Shares are hard to transfer, since existing shareholders must agree |
| The original owners keep control | More regulation and paperwork than a sole trader faces |
Public limited company
| Advantages | Disadvantages |
|---|---|
| Very large sums raised by selling shares to the public | Expensive and complicated to convert and to run |
| Limited liability and separate legal identity | Anyone can buy shares, so the original owners can lose control |
| Easier to borrow: banks see a large, visible business | Risk of takeover by a rival buying enough shares |
| Shares are easily traded, so investors will buy them | Detailed accounts must be published |
| Economies of scale from the size the finance allows | Shareholders may push for short-term profit over long-term plans |
The last row is the real difference between the two kinds of company. In a public limited company ownership is separated from control: shareholders own it, directors run it, and the two do not always want the same thing.
Franchises
A franchise is an arrangement where one business, the franchisor, lets another, the franchisee, trade under its name and sell its products for a fee and a share of the revenue.
| Franchisor | Franchisee | |
|---|---|---|
| Advantages | Expands fast without funding each outlet; the franchisee pays the set-up costs; fees and a revenue share come in; local owners are motivated because it is their money | Sells a brand customers already trust; gets training, equipment and marketing support; the product is proven, so failure is less likely than starting alone |
| Disadvantages | A bad franchisee damages the whole brand; less control over daily standards; profit from each outlet is shared | Pays an initial fee and ongoing royalties; little freedom over products, prices or shop layout; must buy supplies from the franchisor; another franchisee can damage the brand |
Joint ventures
A joint venture is two or more businesses agreeing to work together on one project, sharing the costs, risks and profits, while each stays a separate business.
| Advantages | Disadvantages |
|---|---|
| Costs and risks are shared, so a project too big for one business is possible | Profits must be shared |
| Each side brings what the other lacks, such as local knowledge or technology | Disagreements over how to run the project can stall it |
| Local knowledge makes entering another country far less risky | Management styles and working cultures may clash |
| Combined resources win contracts neither could win alone | If one partner's reputation is damaged, the other suffers |
A joint venture is not a merger. The businesses stay separate and only the project is shared, which is why it suits a business testing a foreign market before committing to it.
Social enterprises
A social enterprise trades in order to achieve a social or environmental purpose, and reinvests most of its profit into that purpose rather than paying it to owners.
It is still a business. It sells products, covers its costs, and fails if it does not. What differs is the objective, and it pursues three at once:
- Social, such as employing people who struggle to find work.
- Environmental, such as recycling waste that would otherwise go to landfill.
- Financial, because it needs a surplus to survive and to fund the other two.
Those three pull against each other, and that tension is where the analysis marks are. Paying above-market wages serves the social aim and weakens the financial one, and an enterprise that runs out of cash helps nobody, so a recommendation ignoring the money is not justified.
The advantages are real: customers and employees are drawn by the purpose, and grants may be available that an ordinary business cannot get. The difficulty is raising finance, because investors looking for a return find the profit going elsewhere.
Choosing and justifying a type
0264 asks you to recommend and justify a suitable type of business organisation for a given situation, and that is not answered by listing advantages. Four things in the stem decide it.
- How much finance is needed. A project needing $2m cannot run on one person's savings.
- How much risk is involved. A high risk of debt makes limited liability the deciding factor.
- How much control the owner wants. An owner who insists on deciding everything will not enjoy shareholders.
- How quickly it must be set up. Someone starting next month cannot wait for company formalities.
Then say why the rejected options were rejected. In a Paper 2 part (b), discussing the alternatives and explaining why they were turned down is what separates the top band from the middle one. Recommending a private limited company because it has limited liability is a knowledge point. Recommending it because the owner is borrowing $150,000 for machinery and would otherwise risk the family home, while a public limited company would cost more to form than the project is worth, is a justification.
Common mistakes
- Saying a public limited company is owned by the government. Both kinds of company are private sector.
- Saying limited liability means the business cannot lose much. It limits what the owners personally lose, not the company's losses.
- Saying a sole trader works alone. A sole trader has one owner and may employ many people.
- Forgetting that partners are liable for debts run up by the other partners.
- Saying a private limited company can sell shares on the stock exchange. It cannot; that is what makes it private.
- Treating a joint venture as a merger. The businesses remain separate.
- Giving franchise advantages without saying whose. Franchisor and franchisee want different things.
- Saying a social enterprise does not aim to make money. It needs a surplus; the difference is where the surplus goes.
- Recommending a type of organisation without using the stem or saying why the alternatives were rejected.
What the syllabus asks for on this topicSyllabus points
Syllabus points
- Describe sole traders, partnerships, private limited companies and public limited companies.
- Explain the advantages and disadvantages of different types of business organisation.
- Recommend and justify a suitable type of business organisation in a given situation.
- Describe franchises, joint ventures and social enterprises.
- Explain the advantages and disadvantages of franchises for the franchisor and the franchisee.
- Explain the advantages and disadvantages of joint ventures.
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