Chapter 4: Forms of Business Organisation
Every business, before it begins trading, must settle one question: under which legal form will it be owned and run? A tailor working alone, a family firm run by two brothers, a dairy owned by the farmers who supply it, and a steel plant owned by the government are all businesses, yet each is organised on a different legal footing. That footing decides who supplies the capital, who takes the decisions, who carries the losses and to whom the enterprise must answer. This is why the form of organisation is treated as a legal matter and not merely a matter of convenience — outsiders such as banks, suppliers and customers deal with the enterprise on the strength of the form it has adopted. This chapter examines what a business undertaking is and the characteristics common to all undertakings; how enterprises are classified by ownership into private, public and joint sector; the forms available to private enterprise; and the public-private partnership model now used for large infrastructure projects.
Figure
Fig. 4.0-1 — Enterprises Of Different Ownership Forms Photograph showing a small owner-run shop and a large corporate office building side by side, illustrating different forms of business ownership.
4.1 Business Undertakings And Enterprises
Before a business begins its activity, someone must supply the capital, someone must take the decisions and someone must bear the loss if the venture fails. These three questions cannot be left to informal understanding, because outsiders — banks, suppliers, employees and customers — must know whom they are dealing with and whom they can hold answerable. The business is therefore organised as a distinct unit with an identity of its own, and that unit is called a business undertaking.
4.1.1 Meaning Of A Business Undertaking
A business undertaking, also called a business enterprise or a business firm, is an institutional arrangement set up to carry on business activity. It is a separate and distinct unit, known by its own name, holding its own assets and owing its own liabilities.
An undertaking may be owned and controlled by a single individual or by a number of individuals who have come together under a formal or an informal agreement. In either case the owners contribute the capital, direct the activity and accept the risks that the activity brings. Profit is the reward they receive for accepting those risks.
What distinguishes one undertaking from another is not the goods it deals in but the legal basis on which it is owned and run. That legal basis is the form of business organisation, and it determines the rights the owners enjoy and the liabilities they must carry. Two shops selling identical goods on the same street may therefore stand on very different legal footings.
4.1.2 Characteristics Of A Business Undertaking
Whatever form an enterprise adopts, four characteristics are common to every business undertaking. Each of them exists because the undertaking must be treated as a unit independent of the persons connected with it.
- Separate entity — every undertaking has an identity of its own and is generally known by a distinct name. Its assets, liabilities and accounts are kept separate from those of the persons who own it, so that the results of the business can be measured on their own.
- Independent unit of ownership — the undertaking is owned by those who have contributed its capital, and ownership follows capital contribution. Where private individuals supply the capital the undertaking belongs to the private sector; where the government supplies it, the undertaking belongs to the public sector.
- Independent unit of management — every undertaking has its own management, which decides the quantity and quality of goods to be produced, their pricing, packaging and marketing. The management of one undertaking cannot interfere in the working of another. The form this management takes depends on the nature, size and legal requirements of the particular undertaking.
- Independent unit of risk — every undertaking bears its own risks and its own profits and losses. Some risks, such as fire or theft, may be transferred to an insurer, but the residual risk of the business itself rests with the owners.
These four characteristics apply to a one-person shop and to a large corporation alike. What changes from one form of organisation to another is the extent of each — how far the separation of identity is legally recognised, how widely ownership is spread, and how far the owner’s personal assets are exposed to the risk of the business.
4.2 Types Of Business Enterprises On The Basis Of Ownership
Enterprises can be grouped in several ways — by size, by the industry they belong to, or by the number of persons they employ. For the purposes of business organisation, however, the useful basis is ownership, because ownership settles who supplies the capital, who controls the enterprise, whose objective it serves and to whom it is answerable. On this basis business enterprises fall into three broad categories, as set out in FC 4.1.
Flowchart
FC 4.1 — Classification Of Business Enterprises By Ownership Business Enterprises → Private Sector Enterprises, Public Sector Enterprises, Mixed or Joint Sector Enterprises
4.2.1 Private Sector Enterprises
A private sector enterprise is one that is established, owned, managed and controlled by private individuals, families or groups, without government ownership or direct participation. Its capital comes either from the owners themselves or from outside private investors, and its central objective is to earn profit by supplying goods and services for which there is market demand. Reliance Industries Ltd., Tata Motors Ltd. and Dabur India Ltd. are large enterprises of this kind.
Because private enterprises usually operate in competitive markets, they must innovate and adapt to changing consumer preferences in order to survive. Their principal characteristics follow from this position.
- Ownership and capital — the enterprise is owned by individuals or groups and the capital comes from the owners or private investors. Since no public funds are involved, the whole of the risk and the whole of the reward rest with the private owners.
- Management — the enterprise is managed either by the owners themselves or by professional managers appointed by them. Owners retain full control of day-to-day operations, though larger firms depend on professional expertise for efficiency.
- Profit motive — profit maximisation is the primary objective. Social welfare may also be pursued, but it remains secondary, because the enterprise must first satisfy those who have invested in it.
- Accountability to owners — the enterprise answers to its owners or shareholders for its performance, so its decisions are shaped by their expectations of profitability, growth and efficient use of resources.
- Limited financial resources — capital has to be raised from private sources alone, which limits the funds available and makes expansion into very large projects difficult.
- Independence of operation — private enterprises frame their own policies and are not bound by the government rules and bureaucratic procedures that govern public enterprises, which allows decisions to be taken quickly.
Scope Of Private Enterprise
The scope of a private enterprise is generally narrower than that of a public enterprise, and the reason is the one given above — restricted access to capital and resources places a ceiling on how far it can grow. This limitation, rather than any lack of willingness, is what keeps most private undertakings out of very large infrastructure and defence projects.
4.2.2 Public Sector Enterprises
A public sector enterprise is a business organisation owned, managed and controlled by the government at the central, state or local level. Such enterprises exist to serve the public interest rather than to maximise profit, and they are commonly found in transport, power, healthcare, defence production and other essential services where the object is to supply the service at an affordable rate. Indian Railways, ONGC and BHEL are enterprises of this kind.
Because these enterprises are financed out of public money, their characteristics differ at almost every point from those of private enterprise.
- Government ownership — ownership is wholly or predominantly with the government, and the capital required for establishment and operation is provided from public funds.
- Government control — management and control rest with the government, and operations are subject to government policies, regulations and guidelines. The profit motive is therefore secondary to public welfare.
- Public welfare objective — the primary aim is to make essential services such as electricity, water, transport and healthcare available to the public at affordable rates, which may require prices to be held below what a profit-seeking firm would charge.
- Public accountability — since public money is involved, these enterprises are answerable to Parliament or to the concerned State legislature and are subject to audit and review by government agencies.
- Wide scope — backed by public funds, they operate on a much larger scale than private firms and undertake activities of national importance such as railways, power generation and defence production.
- Bureaucratic management — decisions must follow laid-down government procedure, which protects public interest but slows down decision-making and can hold back innovation and efficiency.
4.2.3 Mixed Or Joint Sector Enterprises
A joint sector enterprise, also called a mixed sector enterprise, is one in which ownership, management and control are shared between the government on one side and private individuals or organisations on the other. The arrangement is used where a project needs heavy investment, technical expertise and coordination that neither sector can conveniently supply alone: the private partner brings capital and efficiency, while government participation keeps the undertaking aligned with public welfare.
The characteristics of a joint sector enterprise follow from this sharing of ownership.
- Joint ownership — the enterprise is owned jointly by the government and private individuals or organisations, and in many cases the general public also holds shares.
- Shared control — management and control are exercised jointly through representatives of both partners, so neither side can direct the enterprise alone.
- Dual objectives — the enterprise pursues profit and public welfare together, which is possible only because each partner presses for the objective it values.
- Shared risk and reward — financial risks and returns are divided between the two sectors, which makes large projects easier to attempt than they would be for either partner acting alone.
- Large-scale operations — pooled resources allow these enterprises to operate on a large scale.
- Dual accountability — the enterprise is answerable both to the government and to its private investors, so it must satisfy welfare expectations and financial expectations at the same time.
4.3 Distinction Between Private, Public And Joint Sector Enterprises
The three categories described in the previous section are not merely three groups of owners. Because ownership settles who supplies the capital and whose objective the enterprise serves, a change in ownership changes the purpose the enterprise pursues, the manner in which it is managed and the body to which it must answer. The differences between the three are set out in Table 4.1.
Read across any one row and the same logic appears. Where the capital is private, the enterprise answers to those who supplied it and profit becomes the governing objective; where the capital is public, the enterprise answers to the legislature and welfare becomes the governing objective. The joint sector sits between the two precisely because its capital comes from both sources.
This also explains why the scope of the three differs. A private enterprise can attempt only what its own funds permit. A public enterprise, drawing on public funds, can undertake railways or power generation. A joint sector enterprise, pooling both, can attempt projects that neither partner would readily finance alone — though it must also satisfy two sets of expectations at once, which can slow its decisions.
4.4 Forms Of Private Enterprises
Deciding that an enterprise will belong to the private sector settles only the question of who owns it. It does not settle the legal form the enterprise will take, and that form matters a great deal, because it decides how many owners the business may have, how its capital may be raised and whether the owners’ personal assets can be reached by those to whom the business owes money.
From the legal point of view, private enterprises are of two kinds — non-corporate and corporate. The distinction turns on whether the enterprise collects its capital in the form of shares and is registered under a law that gives it an existence of its own. The full classification is set out in FC 4.2.
Flowchart
FC 4.2 — Forms Of Private Enterprise Private Sector Enterprises → Non-Corporate, Corporate; Non-Corporate → Sole Trader, Joint Hindu Family Business, Partnership; Corporate → Cooperative Society, Joint Stock Company; Joint Stock Company → Private Company, Public Company
4.4.1 Non-Corporate Enterprises
Non-corporate enterprises are those in which private persons invest capital directly, without the business being incorporated as a body with a legal existence separate from theirs. Sole trading concerns, joint Hindu family businesses and partnership firms belong to this group. Their common feature is that ownership and the business remain closely tied together, which keeps formalities light but leaves the owners personally exposed.
Sole Trader
A sole trader is a person who carries on business exclusively by and for himself. He provides both the capital and the management, is entitled to the whole of the profit and bears the whole of the loss. In law no distinction is drawn between the sole trader and his business, which is why the form is the simplest to start and also the most exposed.
Partnership
A partnership is the relation between persons who have agreed to share the profits of a business carried on by all of them or by any of them acting for all. A firm comes into existence when two or more persons enter into such an agreement, and the maximum number of partners permitted is fixed by law. Because each partner may act on behalf of the others, the firm gains from pooled capital and pooled skill, but every partner is answerable for what the others do in the course of the business.
Joint Hindu Family Business
A joint Hindu family business is a business inherited by the heirs of a Hindu under Hindu law and carried on by the family as a unit. The head of the family, called the Karta, manages its affairs and takes the decisions, while the other members who acquire an interest in the family property by birth are called coparceners. The form requires no agreement and no registration, since membership arises from birth in the family rather than from contract.
4.4.2 Corporate Enterprises
Corporate enterprises are those undertakings which collect their capital in the form of shares and are registered under the law applicable to them. Registration gives the enterprise an existence of its own, and it is this that allows a corporate body to admit a far larger number of members than a non-corporate firm can manage. Cooperative societies and joint stock companies fall in this group.
Cooperative Societies
A cooperative society is formed when persons voluntarily come together for their common benefit and register themselves under the Co-operative Societies Act, 1912 or the corresponding State Act. Its aim is service to its members rather than profit maximisation, since the members are ordinarily both the owners and the users of what the society supplies. Registration brings with it a greater degree of government control than any other organisation in the private sector faces.
Joint Stock Companies
A joint stock company is the form adopted where a business requires large capital, which it raises by issuing shares to a body of members. Companies are of two kinds. A private company restricts the transfer of its shares and may be formed with a minimum of two members, the maximum being limited by law. A public company may offer its shares to the public, must have at least seven members, and has no maximum limit on the number of members it may admit.
4.5 Public-Private Partnership
4.5.1 Meaning And Need For Public-Private Partnership
Roads, bridges, ports and airports were for long built and run entirely by the government, because they serve the public and are too large for most private firms to finance. Two difficulties followed. The financial burden on the public exchequer grew heavier as the demand for infrastructure rose, and projects executed wholly through government departments were often slow and expensive. The public-private partnership developed as a way of meeting both difficulties at once.
A public-private partnership, commonly abbreviated to PPP, is a collaborative arrangement between the public and private sectors under which both contribute resources to deliver a public service or an infrastructure project. The private partner ordinarily supplies capital, technology, expertise and managerial efficiency; the government supplies regulatory support, policy backing and, in many cases, land, and ensures that the project continues to serve public welfare. The private sector takes on the responsibility of building and often of operating the facility, while the government protects the public interest through regulation and monitoring.
The model is used chiefly for projects that need heavy investment, advanced technology and efficient execution together. The Delhi-Mumbai Industrial Corridor, the Bangalore International Airport, the Mumbai Metro and the National Highways Development Project are examples of the arrangement in India.
4.5.2 Characteristics Of Public-Private Partnership
Each characteristic below follows from the basic bargain of the model — the private partner accepts commercial risk in return for a return on its investment, and the government accepts a regulatory role in return for infrastructure it does not have to finance in full.
- Joint investment — both parties contribute resources to the project. The private sector typically provides capital, technology and expertise, while the government supports the project through regulatory frameworks, policy guidance and assistance such as land or funding for the viability gap.
- Shared risk and reward — risks and returns are divided between the partners. The private sector generally carries the financial and operational risks, while the government carries the regulatory and policy-related risks. Sharing lightens the burden on any one party and makes large projects sustainable.
- Long-term collaboration — PPP agreements are long-term, often running for a few decades, because the private partner must recover a large investment out of the earnings of the facility over time.
- Focus on public welfare — the aim remains the provision of a public service such as transport, healthcare or education, so the private partner’s profit motive is balanced against the government’s welfare objective through the terms of the contract.
- Private sector expertise — the private partner brings specialised skills, advanced technology and cost efficiency, which improve the quality of the service and shorten the time taken to complete the project.
- Government oversight — although execution rests with the private partner, the government continues to oversee the project to ensure that it adheres to public policy, safety regulations and legal standards, and this oversight is what protects the public interest.
- Performance-based payments — in many PPP models the private partner is paid according to the performance of the project, such as the number of users served or the quality of service delivered, so that its earnings depend on the standard of service it maintains.
Taken together, these features explain why the model has spread. It allows the government to develop infrastructure without bearing the entire financial burden, and it brings private efficiency to bear on services that were formerly delivered by departments alone. Its weakness lies on the same side: the public interest in a PPP is protected only so far as the contract and the regulator can secure it, since the private partner has no independent obligation to pursue welfare.
4.6 Summary
- A business undertaking, also called a business enterprise or firm, is an institutional arrangement for carrying on business activity as a separate and distinct unit, owned by those who contribute its capital and bearing its own profits, losses and liabilities.
- Four characteristics are common to every business undertaking:
- Separate entity — it has its own name, assets, liabilities and accounts, kept apart from those of its owners.
- Independent unit of ownership — it belongs to those who have contributed its capital.
- Independent unit of management — it takes its own decisions on production, pricing and marketing, free of interference by other undertakings.
- Independent unit of risk — it bears its own risks, profits and losses, though some risks may be transferred to an insurer.
- The form of business organisation is the legal basis on which an enterprise is owned and run, and it determines the rights and liabilities of the owners.
- On the basis of ownership, business enterprises are classified as private sector, public sector, and mixed or joint sector enterprises.
- A private sector enterprise is owned, managed and controlled by private individuals or groups. Its capital comes from private sources, profit is its primary objective, it answers to its owners, it operates independently of government procedure, and its scope is limited by the capital privately available to it.
- A public sector enterprise is owned and controlled by the Central, State or local government and financed out of public funds. Public welfare is its primary objective, profit is secondary, it is accountable to the legislature and the public, its scope is wide, and its management tends to be bureaucratic.
- A mixed or joint sector enterprise is owned and managed jointly by the government and private parties. It pursues profit and public welfare together, shares risks and rewards between the two sectors, operates on a large scale and is accountable to both partners.
- Ownership determines purpose, control and accountability, which is why the three sectors differ on establishment, ownership, capital, management, purpose, accountability, social objective and scope.
- Private enterprises take two legal forms — non-corporate and corporate — the distinction being whether the enterprise collects its capital in the form of shares and is registered as a body with an existence of its own.
- Non-corporate enterprises are of three kinds:
- Sole trader — one person supplies the capital and the management, takes the whole profit and bears the whole loss, with no legal distinction between the owner and the business.
- Partnership — the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all.
- Joint Hindu family business — a business inherited under Hindu law, managed by the head of the family and owned by the coparceners.
- Corporate enterprises are of two kinds:
- Cooperative society — a voluntary association registered under the applicable co-operative law, formed for service to its members rather than profit maximisation, and subject to greater government control than any other private organisation.
- Joint stock company — an enterprise that raises large capital by issuing shares, formed either as a private company, which restricts the transfer of its shares, or as a public company, which may offer shares to the public and has no maximum limit on members.
- A public-private partnership is a long-term contractual arrangement in which the government and a private party jointly deliver a public service or infrastructure project, the private partner supplying capital, technology and efficiency and the government supplying policy support, regulation and monitoring.
- Public-private partnerships are marked by joint investment, shared risk and reward, long-term collaboration, a focus on public welfare, private sector expertise, government oversight and performance-based payments. They allow infrastructure to be created without the government bearing the whole financial burden, but the public interest in them is protected only through the contract and the regulator.
4.7 Key Terms
- Business undertaking An institutional arrangement for carrying on business activity as a separate and distinct unit, owned by those who contribute its capital and bearing its own profits, losses and liabilities.
- Cooperative society A voluntary association of persons registered under the applicable co-operative law, formed to promote the common economic interest of its members, in which service to members takes precedence over profit maximisation.
- Coparcener A member of a joint Hindu family who acquires an interest in the family property by birth.
- Form of business organisation The legal basis on which an enterprise is owned and run, which determines the rights and liabilities of its owners.
- Joint Hindu family business A business inherited under Hindu law and carried on by the family as a unit, managed by the head of the family and owned by the coparceners.
- Joint sector enterprise An enterprise in which ownership, management and control are shared between the government and private individuals or organisations, pursuing profit and public welfare together.
- Joint stock company A corporate enterprise that raises large capital by issuing shares to its members and is registered under the law applicable to it.
- Partnership The relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all.
- Private company A joint stock company that restricts the right to transfer its shares, cannot invite the public to subscribe to them, and may be formed with a minimum of two members.
- Private sector enterprise An enterprise established, owned, managed and controlled by private individuals or groups, without government ownership or direct participation, and run primarily to earn profit.
- Public company A joint stock company that may offer its shares to the public, must have at least seven members, and has no maximum limit on the number of members.
- Public sector enterprise A business undertaking wholly or predominantly owned and controlled by the Central, State or local government, financed out of public funds, and established primarily to serve public welfare rather than to maximise profit.
- Public-private partnership A long-term collaborative arrangement in which the government and a private party jointly contribute resources to deliver a public service or infrastructure project, sharing the risks and rewards, with the government retaining a regulatory and monitoring role.
- Sole trader A person who carries on business exclusively by and for himself, providing both the capital and the management, taking the whole of the profit and bearing the whole of the loss.
4.8 Points To Ponder
- A sole trader keeps every rupee of profit but also risks every rupee of personal savings. At what point in the growth of a business does that trade-off stop being worth accepting?
- Public sector enterprises are answerable to the legislature, which is meant to protect the public interest, yet the same requirement is what makes their decisions slow. Can accountability be preserved without the delay that accompanies it?
- If a public sector enterprise supplies an essential service below cost in order to keep it affordable, it will run at a loss. Should such a loss be judged a failure of the enterprise, or the price of its objective?
- In a joint sector enterprise the government presses for welfare and the private partner for profit. Is this tension a weakness of the form, or the very thing that keeps each objective in check?
- A public-private partnership hands the building and running of a public facility to a private firm for a fixed term. What would you look for in the contract to be satisfied that the public interest is genuinely protected?
- Corporate forms admit many owners and raise large capital, but they also carry heavier legal formalities and closer regulation. Why might a profitable family business still choose to remain non-corporate?
4.9 Objective Questions
- The primary basis on which business enterprises are classified into private, public and joint sector is: [1]
- the number of persons employed
- the ownership of the enterprise
- the nature of the goods produced
- the location of the enterprise
- Which of the following is not a characteristic of a business undertaking? [1]
- Separate entity
- Independent unit of management
- Independent unit of risk
- Freedom from all liabilities
- Assertion (A): The profit motive is secondary in a public sector enterprise. [1] Reason (R): A public sector enterprise is financed out of public funds and is established to provide essential services at affordable rates.
- Both (A) and (R) are true, and (R) is the correct explanation of (A).
- Both (A) and (R) are true, but (R) is not the correct explanation of (A).
- is true, but (R) is false.
- is false, but (R) is true.
- Match Column A with Column B and choose the correct option. [1] Column A
- Sole trader
- Joint Hindu family business
- Cooperative society
- Public company Column B
- Minimum of seven members and no maximum limit
- Managed by the head of the family
- Owner supplies both capital and management
- Service to members rather than profit maximisation
- (i)–(C), (ii)–(B), (iii)–(D), (iv)–(A)
- (i)–(B), (ii)–(C), (iii)–(A), (iv)–(D)
- (i)–(C), (ii)–(D), (iii)–(B), (iv)–(A)
- (i)–(A), (ii)–(B), (iii)–(D), (iv)–(C)
- State whether the following statement is true or false: In a public-private partnership, the government withdraws from the project once construction has been handed over to the private partner. [1]
4.10 Check Your Concepts
- Define a business undertaking and name any two of its general characteristics. [2]
- Explain, with an example, why the scope of a private sector enterprise is generally narrower than that of a public sector enterprise. [3]
- Distinguish between a private company and a public company on any three bases. [3]
- Why does a change in the ownership of an enterprise change the objective it pursues and the body to which it is accountable? Explain with reference to the private and public sectors. [4]
- ‘The public-private partnership model gives a country better infrastructure than either sector could deliver alone.’ Evaluate this claim, stating the advantages of the model and one limitation that must be guarded against. [6]
4.11 Case-Based Questions
- The State government of a coastal region wishes to build and operate a container terminal at one of its ports. The project needs heavy investment and specialised handling technology, neither of which the port department possesses. The government therefore signs an agreement with Harbourline Infra Ltd. under which the company will finance and build the terminal, operate it for a fixed term while collecting charges from users, and then hand it back to the government. The government retains the power to fix the maximum charges the company may collect and to inspect safety standards at the terminal.
- Identify the arrangement described above and state two characteristics of it that are visible in the situation. [2]
- Explain why the government has retained the power to fix maximum charges, and state one benefit it obtains by not building the terminal itself. [2]