On e of the first decisions a person setting up in must make is which type of business organization is most appropriate. Choosing the right type of organization involves considering several factors about the business and the person setting it up. Later, as the business develops and grows, its needs, and the needs of its owners, are different, so that a different type of ownership may be more suitable.
Factor influencing the choice of type of business organization
Ownership
Ownership is perhaps the most obvious factor affecting the type of organization appropriate for business. In some cases this will be the factor that dictates the type of organization chosen.
For example, a small trader who intends to work on his or her own in a business, such as that of a dressmaker or plumber, will almost inevitably set up as a sole trader. A sole trader may, however, decide to take on a partner, perhaps to help them in an area of business where they do not feel they have sufficient skills, such as in finance and administration. Setting up a partnership rather than a sole trader business allows for a division of labour, with each partner specializing in one area of the business. Many professional firms are set up in this way.
Where more owners are involved, or where continuity of the business is needed, perhaps in a family business, it may be more appropriate to set up a private limited company. The owners will have a share in the business, which can be increased or transferred if necessary. The death or retirement of one of the shareholders will not affect the existence of the business, and shares can be passed from generation to generation.
Control
The type of organization appropriate for a business very much depends on the amount of control over the running of the business the owners want to keep for themselves. A sole trader has complete control over all decisions regarding the running of the business. Partners share control as set in the partnership agreement.
Control of a limited company is shared by the shareholders in proportion to the number of shares they own. In the case of a private limited company, the shareholders are normally closely involved with the day-to-day running of the company, and control is therefore largely kept within the company. Control of public limited company, on the other hand, passes to the shareholders, who are mainly outside the company itself. It is even possible for a public limited company to be taken over by another company. In this case control would pass to an entirely different company.
Source of finance
We have seen in previous units that more sources of finance are available to incorporated companies than to unincorporated businesses. This is important if a business needs access to large amounts of finance. While a sole trader may able to finance the purchase of small premises and limited equipment from his or her own resources, a manufacturing business needing a factory and expensive machinery may need the additional sources of finance available to a limited company, including bank and venture capitalists (see unit 10). Businesses requiring really large amounts of capital may need to consider becoming public limited companies by offering shares to the general public, although this is not suitable for start-up businesses.
Use of profits
The owners of unincorporated businesses such as sole traders and partnerships have complete control over the use of any profits of the business. Such profits can be re-invested in the business, perhaps to buy new equipment or fund expansion, or kept by owners. The owners of unincorporated businesses pay normal income tax on the profits of the business as if those profits were their private income.
The profits of limited company, however, must be used, firstly to pay business tax to the government (see unit 12), and secondly to pay a dividend to shareholders as their reward for investing in the company. Only after these items have been paid can a decision be taken on how to use any remaining profits: to re-invest in the company, or perhaps distribute part to employees as a bonus in recognition of their efforts.
Size
The size of a business can be measured in several ways: by sales turnover; by number of employees; by number of outlets. One person can run a small business more easily than a large business, since there is less involved. Larger businesses have to employ specialists in various aspects of running the business, such financial management, administration, personnel and so on.
Generally speaking, therefore, sole traders tend to be the smallest type of businesses, followed by partnerships. Limited companies tend to be larger, with public limited companies the largest of all.
There are some notable exceptions to this, however. JCB is privately owned, although it rivals all but the largest of public limited companies. Similarly, some large firms of accountants, such as Ernst and Young and KPMG, are partnerships although they are as large as many private and public limited companies and operate.
Growth
As a business grows it may have different needs and these will determine which is the most suitable type of organization. A sole trader may need to take on a partner in order to cope with the additional work. If additional finance is required, perhaps to purchase a larger factory or office, or buy more machinery, the business may consider becoming a private or even a public limited company in order to gain access to more sources of finance.
Summary
· Several factors affect the choice of type of organization for a business.
· These include: type of ownership; the degree of control the owner requires; the amount of finance needed, how profits are to be used; the size of the business.
· As the business develops, a different type of organization may be more suitable.
Glossary
Venture capitalist: people or groups willing to provide capital for a business, usually in return for a share in the business and any future profits the business makes.
Resource: Chris J. Nuttall, IGCSE Business Studies, Cambridge University 2002
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