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FMG First Year

Faculty of
Studies & Commerce University of Jaffna

Types Of Business Organization
Sole Proprietorship
i) Introduction
ii) Characteristics

v) Introduction
vii) Advantages
viii) Disadvantages
Company/ Corporate
x) Characteristics
xii) Disadvantages
What Is Agency Problem?
How It Is Arise In Corporation?
How It Is Manage a Corporation?

Sole Proprietorship
A sole proprietorship is a simple type of business structure that is owned and operated by the same
Sole proprietorships allow persons to report business income and expenses on their individual tax

Characteristic of a Sole Proprietorship

(1) Ownership
The business is owned by a single individual.
(2) Management and control
Being small in size, it is managed by the owner himself. However, he may have some paid
workers to assist him. In any Case, the ultimate control rests in his hands.
(3) Finance
The necessary capital to run the business is provided by the sole owner. However, he may
borrow from other sources such as friends or bank as need arises.
(4) Risk
The proprietor himself bears all the risks. No body else has any stake in the business.

(5) Unlimited liability

The sole trader is personally liable for debts of the business. The creditor can lay claim not only
on his business assets but also his persona! Property such as car, houses, furniture etc to recover
the loan.
(6) Legal status
In law, the sole trader and his business are considered as one, In other words, all the assets and
liabilities of the business are the personal assets and liabilities of the proprietor. We can say that
the owner and the business exist together. In other words, the two are considered as one in the
eyes of Paw.
(7) Relationship with customers
The sole trader tries to keep good relationship with his customers. The customers are generally
personally known to the proprietor and their orders are higher valued.
(8) No legal formalities
The sole trader can set up or close the lawful business as and when he likes the operation of his
business is not governed by any special act or ordinance.
(9) Ease of dissolution
The sole trading business is as easy to end or dissolve as is its formation. The decision of the
proprietor alone ends the business

Advantages of a Sole Proprietorship

Ease of formation: Starting a sole proprietorship is much less complicated than starting a formal
corporation, and also much cheaper. Some states allow sole proprietorships to be formed without the
double taxation standards applicable to most corporations. The proprietorship can be named after the
owner, or a fictitious name can be used to enhance the business marketing

Tax benefits: The owner of a sole proprietorship is not required to file a separate business tax report.
Instead, they will list business information and figures within their individual tax return. This can save
additional costs on accounting and tax filing. The business will be taxed at the rates applied to personal
income, not corporate tax rates.

Employment: Sole proprietorships can hire employees. This can lead to many of the benefits
associated with JOB creation, such as tax breaks. Also, spouses of the business owner can be employed
without having to be formally declared as an employee. Married couples can also start a sole
proprietorship, though liability can only assumed by one individual.

Decision making: Control over all business decisions remains in the hands of the owner. The owner
can also fully transfer the sole proprietorship at any time as they deem necessary.

Disadvantages of Sole Proprietorships

Liability: The business owner will be held directly responsible for any losses, debts, or violations
coming from the business.

Taxes: While there are many tax benefits to sole proprietorships, a main drawback is that the owner
must pay self-employment taxes. Also, some tax benefits may not be deductible, such as health
insurance premiums for employees

Lack of continuity: The business does not continue if the owner becomes deceased or
incapacitated, since they are treated as one and the same. Upon the owners death, the business is
liquidated and becomes part of the owners personal estate, to be distributed to beneficiaries

Difficulty in raising capital: Since the initial funds are usually provided by the owner, it can be
difficult to generate capital. Sole proprietorships do not issue stocks or other moneygeneratinginvestments like corporations do.

A partnership is an agreement between two or more people to finance and operate a business .
Partnerships, unlike sole proprietorships, are entities legally separate from the partners themselves. In a
general partnership, however, profits and losses flow through to the partners tax returns .

Characteristic of Partnership
Limited life
The life of a partnership may be established as a certain number of years by the agreement. If no such agreement is made, the
death, inability to carry out specific responsibilities, bankruptcy, or the desire of a partner to withdraw automatically terminates
the partnership.

Mutual agency
In a partnership, the partners are agents for the partnership. As such, one partner may legally bind the partnership to a
contract or agreement that appears to be in line with the partnership's operations.

Unlimited liability
Partners may be called on to use their personal assets to satisfy partnership debts when the partnership cannot
meet its obligations. If one partner does not have sufficient assets to meet his/her share of the partnership's debt,
the other partners can be held individually liable by the creditor requiring payment.

Ease of formation
Other than registration of the business, a partnership has few requirements to be formed.

Transfer of ownership
Although it is relatively easy to dissolve a partnership, the transfer of ownership, whether to a new or existing
partner, requires approval of the remaining partners

Number of partners
The informality of decision making in a partnership tends to work well with a small number of partners. Having a large number of
partners, particularly if all are involved in operating the business, can make decisions much more difficult.
Relative Lack of regulation
Most governmental regulations and reporting requirements are written for corporations. Although the number of sole proprietors
and partnerships exceeds the number of corporations, the level of sales and profits generated by corporations are much greater

Management structure and operations

In most partnerships, the partners are involved in operating the business. Their regular involvement makes critical
decisions easier as formal meetings are not required to get approval before action can be taken.



Partnerships are relatively easy to establish.

With more than one owner, the ability to raise funds may be increased, both because two or more
partners may be able to contribute more funds and because their borrowing capacity may be greater
Prospective employees may be attracted to the business if given the incentive to become a partner.
A partnership may benefit from the combination of complementary skills of two or more people. There is
a wider pool of knowledge, skills and contacts.
Partnerships can be cost-effective as each partner specializes in certain aspects of their business.

Partnerships provide moral support and will allow for more creative brainstorming.

Partnership Disadvantages
Business partners are jointly and individually liable for the actions of the other partners.
Profits must be shared with others. You have to decide on how you value each others time and skills
Since decisions are shared, disagreements can occur. A partnership is for the long term, and expectations
and situations can change, which can lead to dramatic and traumatic split ups.
The partnership may have a limited life; it may end upon the withdrawal or death of a partner
A partnership usually has limitations that keep it from becoming a large business.
You have to consult your partner and negotiate more as you cannot make decisions by yourself. You
therefore need to be more flexible

A major disadvantage of a partnership is unlimited liability. General partners are liable without limit for
all debts contracted and errors made by the partnership.

A legal entity that is separate and distinct from its owners. Corporations enjoy most of the rights and
responsibilities that an individual possesses; that is, a corporation has the right to enter into contracts,
loan and borrow MONEY , sue and be sued, hire employees, own assets and pay taxes.

Characteristics of a company
Separate legal existence:
A company has a distinct legal entity independent of its members. It can own property, make contracts
and file suits in its own name. Shareholders are not the joint owners of the company's property.
Perpetual succession:
Perpetual succession means continued existence. A company is a creation of the law and only the law
can bring an end to its existence. Its life does not depend on the life of its members .
Limited liability:

As a company has a separate legal entity, its members cannot be held liable for the debts of the company.
The liability of every member is limited to the nominal value of the shares bought by him or to the
amount of guarantee given by him.
Transferability of shares:
The capital of a company is divided into parts. Each part is called a share. These shares are generally
Separation of ownership and control:
Members have no right to participate directly in the day-to-day management of a company. They elect
their representatives, called directors, who manage the company's affairs on behalf of the members.
Voluntary association:
A joint stock company is a voluntary association of certain persons formed to carry out a particular
purpose in common. Members of a company can join it and leave it at their own free will.
Corporate finance:
The share capital of a company is generally divided into a large number of shares of small value. These
shares are purchased by a large number of people from different walks of life.
Artificial legal person:
A company is an artificial person created by law. It exists only in contemplation of law. It is competent to
enter into contracts and to own property in its own name.
Statutory regulation and control:
Government exercises control through company law over the management of joint stock companies. A
company is required to comply with several legal formalities and to file several documents with the
Registrar of Companies.

Advantages of a Corporation
Generally, a corporation's shareholders are not liable for any debts incurred or judgments handed down
against the corporation. Shareholders only risk their equity in the corporation.
Corporations may be able raise additional funds by selling shares in the corporation.
Corporations may deduct the cost of benefits it provides to employees and officers.
Some corporations may be able to elect treatment as an S corporation, which exempts them from federal
income tax other than tax on certain capital gains and passive income.

Disadvantages of Corporation
Forming a corporation requires more time and MONEY than forming other business structures.

Governmental agencies monitor corporations, which may result in added paperwork.

Corporate profits may be subject to higher overall taxes since the government taxes profits at the
corporate level and again at the individual level, if such profits are distributed to the shareholders.
Furthermore, a corporation may not deduce from its business income any dividends it pays to its

What is

A conflict of interest inherent in any relationship where one party is expected to act in another's best
interests. The problem is that the agent who is supposed to make the decisions that would best serve the
principal is naturally motivated by self-interest, and the agent's own best interests may differ from the
principal's best interests. The agency problem is also known as the "principalagent problem."


a. owners manage their company on their own behalf
b. there is no separation of ownership and control in a company
c. managers act in their own interest, rather than in the interest of shareholders
d. shareholders act in their own interest, rather than in the interest of the board.

The agency problem is also known as the "principle agent" problem. The idea is that the principle
(owner) wants to maximize her/his own wealth. Meanwhile, the manager wants to maximize his own
wealth, which may involve hiring his alcoholic brother in law, and using his sister in law's boyfriend's
company as a supplier, from which he gets a spiff for every load that he buys. So the manager is
maximizing his self-interest, but the owner is getting sub-standard returns on her/his capital.


The agency problem arises due to the
separation of ownership and control of
business firms. In theory the shareholders,
being the owners of the firm, control its
activities. In practice, however, due to a
diffuse and fragmented set of shareholders, the
latter appoints b o a r d o f d i r e c t o r s
to direct the affairs of the
c o m p a n y. T h e b o a r d w o u l d
s i m i l a r l y delegate the duty of
day to day running of the
organization to managers. In
terms of this arrangement
therefore, managers are the agents
of the board whereas board members
are a l s o a g e n t s o f t h e s h a r e h o l d e r s .
As the discussion that follows will
s h o w, a n a g e n c y problem exists when

shareholders, directors and managers have

conflicting ideas on how the company should be
The Agency Problem arises when a
conflict of interest arises between a principal and
his agent. The press often represents itself as an
'agent' of the larger society, a seeker after the
truth on behalf of the public. It is perfectly
legitimate to ask whether a conflict of
interest can arise between the media and the
public. A moment's reflection is enough to
establish it is not always the case that the
press -- whether a newspaper or an individual
blogger -- has interests which completely
coincide with the general public because any
media entity is a proper subset of the public:
being a part it cannot be the whole.


To mitigate the agency problem, effective monitoring has to done and appropriate incentives have to be
offered. Monitoring may be done by bonding managers, by auditing financial statements, by limiting
managerial discretion in certain areas, by reviewing the actions and performance of managers
periodically, and on.
Incentives may be offered in the form of cash bonuses and perquisites that are linked to certain
performance targets, stock options that grant managers the right to purchase equity shares at a certain
price there by giving them a stake in ownership, performance shares given when certain goals are
achieved, and so on.