Lesson Two:Forms of Business Organizations and Business Organization

Structures.

What is a sole proprietorship?

A sole proprietorship is the simplest form of business. There is a single owner of an
unincorporated business who takes on all the responsibilities, including profits and
debts, of that company. This is the primary difference from corporations.
Characteristics of Sole Proprietorship Business-
1.Ownership of Business-
There is an individual who manages and controls his business. That sole trader has
both the authority and responsibility (i.e.ownership) of his business so that he
manages the assets and liabilities of his business and as well as increases the growth
of business also.

Because of the ownership, if he gets a profit from the business then the whole profits
are received by the sole proprietor. Similarly, if there is a loss in business, then that
loss has to bear it. The examples of sole proprietorship are- Medical stores, Grocery
stores, Telecom shops, Vegetable stores, Food corners, Chemist shops, Stationery
stores, and so on.

2. Management-
This means an owner of the sole trader business is also known as manager and
controller of his business. Through proper management, he manages all things,
resources (human and material resources), business activities and he also takes better
decisions for managing the challenges and opportunities for the purpose of creating
the better environment.

In simple words, management is such a process that we can assemble, manage,

control all the business and other related things.

3. Source of Capital Funds-

This indicates the way of acquisition of funds i.e., Where will the capital come from?
The answer is, sole proprietor capital is come from his personal savings, from friends
and families, and from financial institutions.

The capital volume is very limited in the sole proprietorship business because it’s
business size is very small and there is no factor of continuity also.

4. Stability-
This means the stability and continuity of the firm is totally depend upon efficiency,
capacity, and life cycle of a sole proprietor. The growth and success of the sole
proprietorship business also depend upon the stability because it develops the
improvement capacity of any business and also protects from the unnecessary
materials.
In the sole proprietorship business, stability is also the main feature or characteristic
of sole proprietor because it helps to define the majority, strength, fastness, and
continuity of the business enterprise.

5. Single Man Control-

This means an individual owner of a sole business controls all things individually. He
controls all efforts and resources related to the business solely. In this sole business,
an individual takes itself from all the decisions and implement it by enhancing his
business.

6. Liability-
This implies the liability of a sole trader is always unlimited. It means that, at the time
of loss, if an individual fails to pay his debts, then his personal property sold to pay
the liabilities of his creditors.

If we consider, it is also said that unlimited liability is also a huge disadvantage for
any sole proprietor.

7. No sharing of Profit & Loss-

Implies that whatever profits earned from the individual trader business, its totally
belongs to the sole owner of the business. Similarly, if there is a loss in a sole
proprietorship business, then he too will have to face it.

In this case, the sole proprietor follows the procedure of no profit or no loss. However,
in the partnership business, profit sharing function is a must.

8. Provide Employment Opportunities-

This means that sole proprietorship role is to provide the facility of employment
opportunities to our community and society. Through employment facilities, the sole
proprietor helps to fulfill the unemployment criteria and also increases the
engagement of the business (like enhancing the growth, productivity, labor facility,
sales, community and so on).

This feature point is very helpful to make solo business efficient and effective.

9. Minimum Legal Aspects or Formalities-

Legal formality papers
This means that in the sole proprietorship business, the legal document is necessary
for the business but in a minimum way. The sole trader business is the easiest
business structure because there is a very low capital invested in it and has minimum
formalities also. So, that’s the reason, the legal formalities is also an
important characteristic of sole proprietorship.

Advantages of a sole proprietorship

1. Affordable and simple

The advantages of a sole proprietorship are simplicity and affordability, particularly

when registering with Ownr. But, there are a few things you need to decide before
you register as a sole proprietor.

2. You have freedom and flexibility

Freedom and flexibility of running your business as a sole proprietorship are included
in this business structure. The process of registering as a corporation is longer and
costlier, and business operations as an incorporated business are also more
complicated.As a sole proprietor, you aren’t restricted to complicated and strict
regulations. This is particularly attractive to small proprietors who don’t have the
labour to continually ensure these strict guidelines are adhered to and carry them out.
Sole proprietors also have all the decision-making freedom.

3. Less paperwork

No business owner wants extra paperwork, so some people prefer to register as a sole
proprietorship rather than incorporate their business. With incorporation, it’s
mandatory to file yearly documentation. With less paperwork also comes less
overhead costs of a bookkeeper who is familiar with the legalities of incorporation
and securities laws. Simply put, less paperwork means you can spend more time
developing your unique business strategy to help prevent any hiccups down the road.

4. Simpler income tax

Taxes as a sole proprietorship (also considered self-employment taxes) are a lot

simpler. As a sole proprietor, there are certain tax advantages that come with small
business deductions. For a small business that uses their own home as a business base,
part of housing costs, including utilities, internet, and such, can be written off. This
helps reduce personal taxes and possibly even result in a tax refund when you file
your personal tax return. You don’t get this advantage with corporations.

5. Say hello to lower business fees

Fees for registering as a sole proprietorship business structure are decidedly lower
when compared to an incorporated business, which is among the most attractive
advantages.As a sole proprietor, you and your business are not separate legal
identities and in some cases, registering your sole proprietorship business is not
necessary. However, if you use a different name than your personal legal name for
your proprietorship business, registration is necessary. Many sole proprietors choose
to register their business name regardless of their regional requirements to put the
most professional foot forward possible.

6. Straightforward banking
Just like taxes, dealing with complicated banking is a hassle. The beautiful thing
about this form of business is banking simplicity. You can choose to keep your
personal chequeing account as your business account, but you may kick yourself at
tax time when you have to separate expenses. In this case, it’s advisable to open a
separate business bank account. This can be done quite easily, inexpensively, and
even online!
How’s that for straightforward?

7. Simplified ownership

A sole proprietorship is as simple as it gets in terms of business structure. It’s a single

owner making the decisions, taking responsibility, and controlling all aspects of the
business. For many small business owners, this is ideal as there isn’t the risk of
discord between owners of corporations or partnerships. Simply put, a sole proprietor
isn’t at risk of losing control.

Disadvantages of a sole proprietorship

1. No liability protection

Among the drawbacks of this type of business entity is personal liability. You are
solely responsible for all the financial aspects of your business. This means all debts
and any litigation fall on your shoulders. This puts your own money at risk as your
personal assets are exposed. In this case, having separate business insurance is a good
idea.This is among the primary differences between sole proprietorship and
incorporation that can be concerning. With incorporation, there is a limited liability
that rests solely on the business as a legal entity.

2. Financing and business credit is harder to procure

As a business entity, you may have a harder time securing financing and business
credit than a corporation. An incorporated business is eligible for government funding
and can raise funds fairly easily. A sole proprietorship generally can’t. Part of the
reason for this is that an incorporated business has a legal distinction that a sole
proprietor doesn’t.

3. Unlimited liability

Among one of the biggest disadvantages of a sole proprietorship is unlimited liability.

This liability not only spans the business but the business owner’s personal assets.
Debt collectors can access your savings, property, cars, and more to see a debt repaid.
When you register your business, it’s important to look into insurance as a precaution.

4. Raising capital can be challenging

 While sole proprietorship startup costs are low, difficulty raising capital can limit
growth and possibly even run you in the red for a little while. Because you’re
personally liable for business debts, it’s also your responsibility to foot the bill for
suppliers, overhead and labour costs, and so on. This is one of the significant
disadvantages of sole proprietorships as business owners’ personal assets are limited
or tied up in the business.

5. Lack of financial control and difficulty tracking expenses

Because financial reports aren’t usually required as a regular part of doing business
and one person plays the role of accountant, manager, marketer, and strategist all in
one, sole proprietors sometimes find themselves letting financial business transactions
slide.This can cause a significant lack of financial control and risk blending these
transactions with personal income, making keeping track of expenses a challenge. In
these cases, profits and losses can go unaccounted for, and tax time will be even more
difficult.

What is a Partnership?

An unincorporated business that two or more parties form and own together

A partnership is a kind of business where a formal agreement between two or more

people is made who agree to be the co-owners, distribute responsibilities for running
an organization and share the income or losses that the business generates.
In India, all the aspects and functions of the partnership are administered under ‘The
Indian Partnership Act 1932’. This specific law explains that partnership is an
association between two or more individuals or parties who have accepted to share the
profits generated from the business under the supervision of all the members or behalf
of other members.
Features of Partnership:
Following are the few features of a partnership:

1. 1.Agreement between Partners: It is an association of two or more individuals, and

a partnership arises from an agreement or a contract. The agreement (accord) becomes
the basis of the association between the partners. Such an agreement is in the written
form. An oral agreement is evenhandedly legitimate. In order to avoid controversies,
it is always good, if the partners have a copy of the written agreement.
2. Two or More Persons: In order to manifest a partnership, there should be at least
two (2) persons possessing a common goal. To put it in other words, the minimal
number of partners in an enterprise can be two (2). However, there is a constraint on
their maximum number of people.
3. Sharing of Profit: Another significant component of the partnership is, the accord
between partners has to share gains and losses of a trading concern. However, the
definition held in the Partnership Act elucidates – partnership as an association
between people who have consented to share the gains of a business, the sharing of
loss is implicit. Hence, sharing of gains and losses is vital.
4.Business Motive: It is important for a firm to carry some kind of business and
should have a profit gaining motive.
 5. Mutual Business: The partners are the owners as well as the agent of their
firm. Any act performed by one partner can affect other partners and the firm. It can
be concluded that this point acts as a test of partnership for all the partners.

6. Unlimited Liability: Every partner in a partnership has unlimited liability.

An unincorporated business structure that two or more parties form and own together is
called a partnership. These parties, called partners, may be individuals, corporations,
other partnerships, or other legal entities.

Partners may contribute capital, labor, skills, and experience to the business. They may
have unlimited legal liability for the actions of the partnership and its partners.

The most common type of partner is a general partner, who

actively manages and exercises control over the business operations.

Limited partners have limited legal liability. This type of partner cannot
manage or exercise control over the business.

Among the most common types of partnerships are general partnerships (GP), limited
partnerships (LP), and limited liability partnerships (LLP).

A partnership can even start without an oral or written contract. Where there is a written
contract between the partners, it is called a partnership agreement. The partners agree on
the purpose of the partnership and their rights and responsibilities.

A partnership splits its profit or loss among its partners. They are responsible
for filing and paying taxes for their portion of the partnership profit.

This form of business is similar to a joint venture. A joint venture is where two parties
(typically corporations) carry on a business together, though not necessarily for profit.

Types of Partners

General Partner:

 May contribute capital and expertise to the partnership.

 Actively manage and exercise control over the business operations.
 Have unlimited legal liability for the acts and obligations of the partnership.
Their assets are subject to any legal claims made against the partnership.
 Can be a party to any legal claims made by the partnership or any claims made
against the partnership and its partners.

Limited Partner:

 May only contribute capital (assets, cash, etc.) to the partnership.

 Do not manage and cannot exercise control over the business operations.
 Have limited legal liability for the acts and obligations of the
partnership. Only their contributions to the partnership, not their assets, are
subject to any legal claims against the partnership.
 Cannot be a party to any legal claims made by the partnership or any claims
made against the partnership and its general partner(s).

Types of Partnerships

General Partnership

General partnerships (GP) are the easiest and cheapest type of partnership to form. Two
or more general partners own it, with joint and several legal liabilities for all debts and
obligations. They jointly manage and control the business.

A general partnership can immediately start when partners decide to conduct business
together, even without an oral or written contract. This ease contrasts with potentially
costly disputes that may arise between partners if they cannot resolve them amicably.

This type of partnership is simple to dissolve. For example, the partnership dissolves if
any partners leave, go into bankruptcy, or pass away. Partnership rules differ worldwide.
Some jurisdictions may offer alternatives for the remaining partners who wish to
continue with the business[1] .

Except for registering a business name, there are few government requirements specific
to this type of partnership

Ongoing government requirements are also limited. For example, holding an annual
general meeting like a corporation or other kinds of business structures is unnecessary.

The partnership and its partners must regularly report and pay taxes on the partnership
income. Taxes are paid by the partners rather than by the partnership[3] .

A partnership agreement is valuable for many general partnerships. For example, it can
describe a process to value and compensate a departed partner for their business interest.
The transfer of interest may be more attractive to the remaining partners instead of
dissolving the business altogether.

Limited Partnership

A limited partnership (LP) is a type of partnership that limits the legal liability of some
partners for debts and obligations. At least one limited partner is a passive contributor of
cash and assets.

An LP gives contributors a way to invest without incurring legal liability. In some

jurisdictions, this business structure is considered a separate legal entity that can enter
into contracts and take on obligations.

There is at least one general partner with unlimited legal liability. The general
partner manages and controls the business.

When starting or dissolving this partnership, the LP must register and report to the local
authorities. It is more expensive and complex than forming a general partnership.
To start, an LP must register the limited partnership’s name and the general partners’
details with the local authorities. To dissolve, an LP typically files a document,
sometimes called a “Statement of Dissolution” or “Statement of Cancellation.”

A written contract is an essential component when forming this type of partnership[4] .

A partnership agreement between partners covers their rights and responsibilities while
protecting the limited partner’s contributions.

There may be ongoing government requirements. For example, some jurisdictions need
LPs to regularly file information reports to local authorities responsible for businesses in
the area. However, holding an annual general meeting is not mandatory unless stated in
the partnership agreement, unlike a corporation or some other kind of business structure.

The partnership and its partners must regularly report and pay taxes on the partnership
income. The partners’ portion is outlined in the partnership agreement. Taxes are paid
by the partners rather than by the partnership.

Limited Liability Partnership

A limited liability partnership (LLP) is an extension of a

general partnership that limits the legal liability of all partners. General partners in this
type of partnership have protection from the wrongful acts of the other partners, such as
negligence, misbehavior, and other unprofessional conduct.

In jurisdictions where this business structure is available, it is considered a separate

legal entity that can enter into contracts and take on obligations.

Local authorities may restrict the structure to eligible businesses in knowledge-based

industries, for example, legal and accounting professionals. Authorities may require
proof of permission from the professional governing body before partners may form an
LLP.

The partners manage and control the business.

When starting or dissolving this partnership, an LLP must register and report to the
local authorities. It is more expensive and complex than forming a general partnership.

To start, an LLP must register the limited liability partnership’s name and the number of
partners with the local authorities. To dissolve, an LLP typically files a document,
sometimes called a “Statement of Dissolution” or “Statement of Cancellation.”

A written contract is an essential component when forming this type of partnership.

A partnership agreement between partners covers their rights and responsibilities while
protecting the partner’s contributions.

There are ongoing government requirements. For example, an LLP must regularly file
information reports to local authorities responsible for businesses in the area. However,
holding an annual general meeting is not mandatory unless stated in the partnership
agreement, unlike a corporation or other kinds of business structure.
The partnership and its partners must regularly report and pay taxes on the partnership
income. The partners’ portion is outlined in the partnership agreement. Taxes are paid
by the partners rather than by the partnership.

Partnership Agreement

In business, a partnership agreement is a contract stating the terms of a partnership –

what it does, how it works, and how the partners can work together.
The rights and responsibilities of the partners are a vital component.

An agreement can provide a way to handle capital interests if a partner departs. A

sudden need to reorganize capital investment disrupts the business if a contract is not in
place.

At the minimum, the departing partner (or their estate) expects to recover their
contributions, assuming the partnership has been profitable. It may not be feasible if
neither the partnership nor the remaining partners have enough liquid assets to return
the contributions.

An agreement can describe other options, such as the process of valuing and transferring
the departing partner’s interest to the remaining partners, rather than dissolving the
business entirely.

Attracting new partners can also be challenging if the partnership needs to expand
beyond the partners’ existing capacity. An agreement can set the rules for adding
partners. The structure can attract prospective partners who do not have prior experience
working together.

As partners jointly make decisions, disputes can occur. Any decision and dispute
resolution process built into the agreement can provide a path forward. This process can
save time, money, and effort.

A partnership agreement can reduce uncertainty when the partners need to finalize any
decisions or resolve a dispute.

Advantages of a business partnership

The business partnership offers a lot of advantages to those who choose to use it.
1Less formal with fewer legal obligations
One of the main advantages of a partnership business is the lack of formality compared
with managing a limited company.
The accounting process is generally simpler for partnerships than for limited companies.
The partnership business does not need to complete a Corporation Tax Return, but you’ll
still need to keep records of income and expenses. A partnership tax return must be
submitted to HMRC and each partner will need to file their own self assessment tax
return including details of their profits from the partnership (as well as any other income).
Unlike a limited company, you don’t need to complete a confirmation statement and the
plethora of other possible Companies House forms that a limited company may need to
submit will never be required for the partnership. There are also fewer records to
maintain: in particular, a business partnership does not need to maintain a set of statutory
books like a limited company has to.
Unless a formal partnership agreement has been drawn up, a partnership business can
easily be dissolved at any time: this gives each partner the freedom to choose to leave if
they wish to.
2Easy to get started
The partners can agree to create the partnership verbally or in writing. There’s no need to
register with Companies House and registering the business partnership for taxation with
HMRC is quite simple. The partners will also individually need to register for self
assessment, which they can do online.
Although it will take longer and incur additional cost, it’s usually sensible to put in place
a partnership agreement. This documents how the partnership will work, the rights and
responsibilities of partners and what would happen in various possible situations,
including if the partners fundamentally disagree or someone wants to leave.
3Sharing the burden
Compared to operating on your own as a sole trader, by working in a business
partnership you can benefit from companionship and mutual support. Starting and
managing a business alone can feel stressful and daunting, particularly if you’ve not done
it before. In a partnership, you’re in it together.
4Access to knowledge, skills, experience and contacts
Each partner will bring their own knowledge, skills, experience and contacts to the
business, potentially giving it a better chance of success than any of the partners trading
individually.
Partners can share out tasks, with each specialising in areas they’re best at and enjoy
most. So if one partner has a financial background, they could focus on maintaining the
company books, while another may have previously worked extensively in sales and
therefore take ownership of that side of the business. As a sole trader, by contrast, you’d
have to do all of this yourself (or manage someone you employ to do some of it).
5Better decision-making
Compared with operating on your own, in a partnership the business benefits from the
unique perspective brought by each partner. In business, very often two heads really are
better than one, with the combined conclusion of debating a situation far better than what
each partner could have achieved individually.
6Privacy
Compared to a limited company, the affairs of a partnership business can be kept
confidential by the partners. By contrast, in a limited company certain documents are
available for public inspection at Companies House and a company’s shareholders can
choose to inspect various registers and other documents the company is required to keep.
7Ownership and control are combined
In a limited company, ownership and day to day management of the business is split
between shareholders and directors (although they’re often the same people). That can
mean that directors are constrained by shareholder preferences in pursuing what they see
as the best interests of the business.
By contrast, in a business partnership, the partners both own and control the business. As
long as the partners can agree how to operate and drive forward the partnership, they’re
free to pursue that without interference from any shareholders. This can make a
partnership business potentially more flexible than a limited company, with the ability to
adapt more quickly to changing circumstances.
8More partners, more capital
The more partners there are, the more money there may be available from their combined
resources to invest into the business, which can help to fuel growth. Together, their
borrowing capacity is also likely to be greater.
9Prospective partners
As a sole trader, while you can employ staff, it’s not really possible to bring someone on
board to manage the business alongside you. Employees will always believe you’ll be the
one running the business and good people may be demotivated if they feel, as far as their
own career is concerned, there’s “nowhere to go”.
By contrast, it’s usually possible to admit a new partner into a general partnership. Good
staff may be attracted to the business with the incentive that they could become a partner,
either when they join or at some point in the future.
10Easy access to profits
In a business partnership, the profits of the business are shared between the partners.
They flow directly through to the partners’ personal tax returns rather than initially being
retained within the partnership. In a limited company, by contrast, profits are retained by
the company until paid out, whether as salaries under PAYE or, with the approval of
shareholders, as dividends.
Disadvantages of a business partnership
While there are lots of benefits of a partnership business, this model also carries a
number of important disadvantages.
1The business has no independent legal status
A business partnership has no independent legal existence distinct from the partners. By
default, unless a partnership agreement with alternative provisions is put in place, it will
be dissolved upon the resignation or death of one of the partners. This possibility can
cause insecurity and instability, divert attention from developing the business and will
often not be the preferred outcome of the remaining partners.
Even if a partnership agreement is in place, the remaining partners may not be in a
position to purchase the outgoing partner’s share of the business. In that case, the
business will likely still need to be dissolved.
2Unlimited liability
Again because the business does not have a separate legal personality, the partners are
personally liable for debts and losses incurred. So if the business runs into trouble your
personal assets may be at risk of being seized by creditors, which would generally not be
the case if the business was a limited company.
The partners are jointly and severally liable. As one partner can bind the partnership, you
can effectively find yourself paying for the actions of the other partners. If your partners
are unable to settle debts, you’ll be responsible for doing so. In an extreme example
 where you only own 10% of the partnership, if your partners have no assets you might
end up having to settle 100% of the debts of the partnership and need to sell your
possessions in order to do so.
3Perceived lack of prestige
Like a sole trader, the partnership business model often appears to lack the sense of
prestige more associated with a limited company. Especially given their lack of
independent existence aside from the partners themselves, partnerships can appear to be
temporary enterprises, although many partnerships are in fact very long-lasting.
This appearance of impermanence, and the fact that the partnership’s financials cannot be
independently checked at Companies House, can appear to present more risk. Because of
this, some clients (more so in certain industries) will prefer to deal with a limited
company and even refuse to transact with a partnership business.
4Limited access to capital
While a combination of partners is likely to be able to contribute more capital than a sole
trader, a partnership will often still find it more difficult to raise money than a limited
company.
Banks may prefer the greater accounting transparency, separate legal personality and
sense of permanence that a limited company provides. To the extent that a partnership
business is seen as higher risk, a bank will either be unwilling to lend or will only do so
on less generous terms.
Several other forms of long-term finance are not available to partnerships. Most
importantly, they cannot issue shares or other securities in exchange for investment in the
way a limited company can.
5Potential for differences and conflict
By going into business as a general partnership rather than a sole trader, you lose your
autonomy. You probably won’t always get your own way, and each partner will need to
demonstrate flexibility and the ability to compromise.
There will be the potential for differences, large or small, with other partners. These
might relate to:
 The strategic direction in which the business should go (or how to get there)
 How to handle any number of discrete business issues that may arise
 Different views on how partners should be rewarded when they put different
amounts of time, skills and level of investment into the business
 Ambition. Some may want to dedicate every waking moment to growing and
developing the business, while others may want a quieter life
Differences might not be evident immediately. Over time, partners’ preferences, personal
situations and expectations may change so the fact they are aligned at the start is far from
a guarantee that cracks won’t appear later.
Disagreements and disputes can not only harm the business but also damage the
relationship between the individuals involved. Conflict can be a major distraction,
absorbing the partners’ time, energy and money.
That’s why is generally advisable to draft a partnership agreement (sometimes called a
deed of partnership) when forming the business partnership. This document ensures the
partners’ respective rights and responsibilities are enshrined, and that there is a common
understanding of the procedures to be followed in the case of disputes. If the partnership
needs to be dissolved, the partnership agreement will also detail what then happens.
6Slower, more difficult decision making
Compared to running a business as a sole trader, decision-making can be slower as you’ll
need to consult and discuss matters with your partners. Where you disagree, time will be
spent negotiating to build agreement or consensus. Sometimes this might mean
opportunities are missed. More often, it will frustrate a partner who has been used to
making all the decisions for their business.
7Profits must be shared
At a basic level, while a sole trader retains all the profits of their business, those of a
partnership are shared amongst the partners. By default, under the Partnerships Act 1890,
profits are shared equally, although that position can be amended by a partnership
agreement.
Sharing profits equitably can raise difficult questions. How do you value different
partners’ respective skills? What happens when one partner is seen to be putting in less
time and effort into the partnership, but still taking their share of the profits? It’s easy for
resentment to occur if there doesn’t appear to be a fair balance between effort and reward.
8Personally demanding
Although there’s at least one other person to share the worry and workload with, in a
partnership business the partners still essentially are the business. It can absorb a lot of
time and energy and disrupt your work/life balance, particularly where you end up
covering for other partners who don’t have such a strong work ethic. By contrast, in a
limited company it’s easier for the owners of the business – its shareholders – to appoint
directors to manage the business, at least on a day to day basis.
9Taxation
Historically, if the business made more than a certain level of profit, individuals could
incur less tax by withdrawing a combination of salary and dividends under a limited
company than they could via partnership drawings. But since changes to the taxation of
dividends, this difference is far less marked.
However, a limited company still often presents more tax planning opportunities than a
business partnership. With the profits earned by the partnership translated to income on
the individual partners, they’re subject to income tax in the financial year in which they
are made. Profits can’t be retained in the partnership to be drawn as income in a later
year, when a partner’s income (and potentially their marginal tax rate) may be lower.
The tax-efficiency of different business structures depends on your personal
circumstances. You should always consult a tax professional, who can offer advice based
on your personal circumstances.
10Limits on business development
Several of the other disadvantages we’ve looked at combine to restrain the growth of
most partnerships. That won’t worry a lot of businesses with modest expansion
expectations. But for any business looking to achieve massive growth, a combination of
unlimited liability, lack of funding opportunities and a lack of commercial status in the
eyes of the world is hardly the perfect recipe for success.
The lack of legal personality becomes important here too. Without it, the business cannot
own property, enter into contracts or borrow in its own right, difficulties which will
become harder to work around as the business grows.
Options for the partners eventually to exit the business and profit from it can be
complicated, particularly if it’s possible for the departure of one partner at an earlier date
to destroy the business. While it’s possible for one or more partners to sell their share of
the partnership business, exit strategies can be easier to manage within a limited
company structure.

Cooperative Form of Business

In this article we will discuss about the cooperative form of business.

Definition of Cooperative Form of Business:

Single ownership firms, partnership firms and the joint stock companies are described
as capitalistic form of business organisation. All these forms of business organisation
are operated with a view to making profits. The society, as a whole, loses in many
ways because of the profit motive.

Large sums are spent for advertisement, propaganda, etc., the workers are exploited,
the consumers are forced to pay high prices, the production of luxuries is encouraged
and that of necessaries neglected. In the opinion of many writers, production may be
carried on without these evils through a form of business organisations which is called
cooperation. A business organisation modelled on the principle of cooperation is
called a cooperative society.

A cooperative society has been defined in various ways. One such definition is as
follows- When some people voluntarily combine together for achieving an economic
objective on the basis of equality, they form a cooperative society. Another definition
states that through a cooperative society weak and unorganized poor people can enjoy
some of the economic advantages of rich people. As a result of this, poor people can
develop their faculties properly.

Features of a Cooperative Society

Feature # 1. Voluntarily Organisation:

Co-operative Organisation is a voluntarily association of individuals seeking to

improve their economic conditions through joint efforts. There is no legal binding or
coercion from any corner for a person to become a member. A member is also free to
quit the organisation at any time.

Feature # 2. Common Interest:

Unlike a Joint Hindu Family where membership is by – birth or by marriage into the
family, a common interest brings members of a cooperative society together. The
prime objective of the cooperative would be to this common interest.

Feature # 3. Open Membership:

Membership of the organisation is open to everybody. There is no restriction or time
limit for enrolling as a member. Members can join anytime by paying a small
membership fee or by subscribing to share capital of the co-operative. However, a
minimum of 10 members are required to start a cooperative.

Feature # 4. Democracy:

The Co-operative Organisation is run on democratic lines. Members elect a board of

Directors, who manage the affairs of the society on behalf of the members and are
answerable to the members of the society. Thus, cooperative societies are truly
democratic organisations.

Feature # 5. Equality of Vote:

In all matters requiring an opinion of members, a vote is taken. Each member,

irrespective of his position in the society or the number of shares held by him, is
entitled to only one vote. There is no provision for voting by proxy. This ensures that
the opinions all members of the society are given equal weightage.

Feature # 6. Limited Return on Capital:

The unique feature of a cooperative society is that its objective is to ensure the
wellbeing of its members, and not profit. Thus, capital contribution does not enjoy the
same importance as in case of other forms of business. However, capital rewarded
with a small rate of interest. Profit distribution is not based on capital contribution.

Feature #7. Distributive Justice:

Profits earned by the society are distributed amongst its members according to the
extent of business transacted by the member with the society. A specified portion of
profits is transferred to Statutory Reserve Fund and then a fair rate of interest is paid
on capital subscribed by the members. Remaining Profits are distributed based on
dealings of members with the society.

Feature # 8. Limited Capital:

Co-operative Societies are largely formed by people with limited economic means.
Moreover, there is no incentive to contribute more capital as it earns limited returns
and is not considered for distribution of profits. Thus, the amount of capital with the
society is very small. Bulk of the funds is raised in the form of loans and grants.

Feature # 9. Cash Transactions:

A distinctive feature of cooperative societies is that almost all transactions are in cash.
There is no trading in credit, as liquidity and -safety of funds is very crucial. The risk
of bad debts is eliminated to protect the small capital base.

Feature # 10. Legal Status:

A cooperative society must be registered under the Cooperative Societies Act, 1912,
or respective state cooperative laws. On registration, it becomes and independent
entity of its own, distain it from its members. It can enter into contracts on its own. It
can also sue other people and organisation in a court of law.

Feature # 11. Privileges:

A registered cooperative society enjoys certain privileges and exemptions granted by

the Central and State Governments. It is exempt from payment of Income Tax, Stamp
Duty, Registration Fees etc. A cooperative society has prior claim over the property of
its debtors compared to other creditors.

Feature # 12. State Control:

Cooperative societies are governed by provisions of relevant laws and are subject to
state supervision and control. One of the reasons is the amount of grants received by
the societies from the government.

Feature # 13. Morality and Ethics:

The objective of cooperative society is not profit, but mutual gain, based on mutual
trust. The society mainly deals with its members. The transactions of the society are
above board; “the moral element in its aims is as important as the material.”

Feature # 14. Transfer of Shares:

There is no provision for sale or transfer of shares held by a member of the society in
the capital of the society. However, there is a possibility of withdrawal of capital. The
member can quit the society and take back his capital contribution after giving due
notice.

Types of Cooperative Societies

i. Consumer’s Cooperative Societies:

1. Established – To protect the interests of consumers.

2. Members – Consumers desirous of obtaining good quality products at reasonable

prices.

3. Functions/Activities – It purchases goods in bulk directly from the wholesalers and

sells goods to the members.

4. Aim and distribution of profits – Eliminating middlemen to achieve economy in

operations. Profits are distributed on the basis of capital contributions of members or
purchases made by them.

ii. Producer’s Cooperative Societies:

1. Established – To protect the interest of small producers.

2. Members – Producers desirous of procuring inputs for production of goods.

3. Functions/Activities – It supplies raw materials, equipment and other inputs to the
members and also buys their output for sale.

4. Aim and distribution of profits – Fighting against the big capitalists and enhancing
the bargaining capacity of the small producers. Profits are distributed on the basis of
contribution of members to the total pool of goods produced or sold.

iii. Marketing Cooperative Societies:

1. Established – To help small producers in selling their products.

2. Members – Producers who wish to obtain reasonable prices for their output.

3. Functions/Activities – It pools the output of individual members and performs

marketing functions like transportation, warehousing, packaging etc., to sell the
output at best possible price.

4. Aim and distribution of profits – Eliminating middlemen and improving

competitive positions of its members by securing a favorable market for the products.
Profits are distributed according to each member’s contribution to the pool of output.

iv. Farmers Cooperative Societies:

1. Established – To protect the interest of farmers by providing better inputs at

reasonable costs.

2. Members – Farmers who wish to jointly take up farming activities.

3. Functions/Activities – It provides better quality seeds, fertilizers, machinery and

other modern techniques for use in the cultivation of crops.

4. Aim and distribution of profits – To gain the benefits of large-scale farming and
increase the productivity.

iv. Credit Cooperative Societies:

1. Established – To provide easy credit on reasonable terms to the members.

2. Members – Persons who seek financial help in the form of loans.

3. Functions/Activities – It provides loans to low interest rates out of the amount

collected as capital and deposits from the members.

4. Aim and distribution of profits – Protecting members from exploitation of lenders

who charge high rates of interests on loans.

v. Cooperative Housing Societies:

1. Established – To help people with limited income to construct houses at reasonable

costs.
2. Members – People who are desirous of procuring residential accommodation at
lower costs.

3. Functions/Activities – It constructs flats or provides plots to members for

construction.

4. Aim and distribution of profits – Solving the housing problems of the members by
constructing houses and giving the option of paying in installments.

Types of Cooperative Societies – On the Basis of the Nature of Services Offered

There are different types of cooperative societies which are classified on the basis of
the nature of services offered by them.

The various types of cooperative societies are as follows:

Type # 1. Consumers’ Cooperative Societies:

Consumers’ cooperative societies are set up to ensure a steady supply of essential
consumer products of standard quality at fair prices. Such societies aim at eliminating
the middlemen by linking themselves directly with the producers or their agents.

This practice leads to procurement of products at lower costs. The profit earned by a
consumers’ cooperative society is utilized by the society according to its bye-laws,
including the payment of dividend and issuing bonus shares to its members.

Type # 2. Producers’ Cooperative Societies:

These societies are formed by small producers of a particular location to fight against
the competitiveness of large producers by helping their members who need capital,
equipment, materials, etc., to use their skills in producing goods. These societies also
undertake marketing activities to market the products produced by their members.

Type # 3. Marketing Cooperative Societies:

These societies are formed by small producers for undertaking marketing of their
products. These societies pool the products of members who are small producers and
market the products on large-scale basis thereby relieving the members from selling
their products on fragmented basis. The profits earned by the societies are distributed
among their members according to the contributions made by these members.

Type # 4. Farmers’ Cooperative Societies:

These societies are formed by small farmers to pool their resources together for
cultivating their lands collectively. They aim at organizing agriculture on large-scale
basis so as to increase agricultural productivity and improve the economic condition
of the farmers. Cooperative farming makes possible mechanization of farming,
providing improved seeds and other agricultural inputs, irrigation facilities, etc., to
improve agricultural productivity.

Type # 5. Credit Cooperative Societies:

These societies are formed to provide financial assistance to their members in the
form of direct loans. Funds are pooled together by contribution of members and loans
are provided to needy members at easy terms. These societies may also take loans
from financial institutions to increase their lending position if needed. Such societies
aim at protecting their members from the onslaught of moneylenders in the
unorganized sector who charge very high interest.

Type # 6. Housing Cooperative Societies:

These societies are formed by those who strive to own a flat or a plot for constructing
their own house. These societies are mostly located in urban areas where housing
problems are acute. These societies purchase land from appropriate owners, including
Urban Development Authority. Afterwards, either flats/houses are constructed by the
societies to be allotted to the members or plots of appropriate sizes are given to them.

Advantages and Disadvantages of Cooperative Society

Merits:
1. Ease of Formation – Any ten persons can come together and form a cooperative
society. The legal procedures for registration are very simple. There is no complexity
as in case of Joint Stock Company.

2. Economical – Registration of cooperative society is exempt from registration fees.

Stamp duty also need not be paid. Hence, even people with very limited means can
also start a cooperative society.

3. Democratic Management – The affairs of the cooperative society are managed by a

Board of Directors duly elected by the members. The elected members can also be
removed from office. Thus, there is no single person having complete control of the
management.

4. Equality – All the members are equal to each other. Each member has only one
vote irrespective of his shareholding. Thus, all opinions are given due weightage and
a segment is not allowed to dominate.

5. Limited Liability – The liability of member is restricted to the total contribution

made by him towards the capital of the cooperative society. The private property of
members is not affected.

6. Elimination of Middleman – A cooperative society takes up activities that bring the

members in direct contact with customers. Middlemen are eliminated but producers
and consumers gain from the more.

7. Perpetual Existence – A cooperative society is an independent legal entity. It has

perpetual existence and is unaffected by death, insolvency etc. that may have led to
closure of business.

8. State Assistance – Cooperative societies are encouraged by Governments on

account of the various objectives attained by them. Grants from state are one of the
major sources of finance for the cooperative societies. This ensures better financial
health of the cooperative and greater chances of growth.

9. Privileges – Cooperative societies are granted exemption from payment of Income

Tax, Stamp Duty, Registration charges etc. Finance is made available at concessional
rates of interest.
10. Internal Finance – Cooperative societies act limits the amount of divided that can
be declared by the society to 6.25% of capital. ‘The Undistributed Profits’ or ‘retained
earnings’ are reinvested for further growth of the society.

11. Service Motive – Cooperative societies are guided by service motive rather than
profit motive. They are not competitive in nature and do not attempt to maximize
profits at the expense of others. The aim of the society is mutual benefit.

12. Economy in Operation – Cooperative societies spend little on expenses such as

establishment charges, advertisements etc. Management and Employees also offer
their services at a nominal charge. Thus, a cooperative is able to offer its products at a
lower price on account of lower price on account of lower expenses of operation.

13. Personal Liberty and Social Justice – Cooperative society is a voluntary

organisation that can flourish under capitalist as well as communist economic systems.
It not only ensures that the members of the society are able to earn more, but society
is also benefited. It ensures both personal liberty and social justice.

14. Presents Contribution of Wealth – The profits of a cooperative society are

distributed on the basis of individual transactions of members with the society. This
recognizes the value of economic justice and presents concentration of wealth in a
few hands.

15. Presents Speculation – The membership of the society is always open. Any person
can become a member or quit being a member at any time. The shares belonging to
the members are not tradable on the market, it is thus free from the evils of
speculation.

16. Scope for Self-Government – Cooperatives provide scope for self-government

workers, consumers, farmers etc. receive training in these societies in different fields
of business.

17. Social Virtues – Cooperative society encourages in its members, the virtues of
self-reliance, mutual help, honesty and discipline amongst its members.

18. Social Benefits – Cooperative societies inculcate a feeling of brotherhood amongst

the members. There is better understanding of viewpoints of others, resulting in
reduction of social friction.

Disadvantages of Cooperative Societies

1. Limitation of Capital- Cooperative societies are mainly started by people with

limited means. Moreover, capital earns only a small rate of return. Hence, there is no
incentive to contribute capital. Thus, the total capital of the society is likely to be
much less, inspite of having a large number of members.

2. Management Commitment- Members elect their representatives to manage the

affairs of the society. Normally, lot of members will be given a chance to participate
in management. The people elected also may not be keen to continue for a long period,
as remuneration is only honorary. Thus, the management might be weak, unstable and
lacking in commitment.
3. Lack of Expertise- On account of limited resources and small scale of operations,
cooperatives cannot afford to avail of the services of experts. The staff is largely
inefficient and unaware of basic principles of cooperative societies.

4. State Control- The operations of cooperatives are largely being controlled by the
state, on account of the amount of funds provided by the Government to the society.
There is very little that the members can actually do on their own without consulting
the Government. This destroys flexibility, hampers the growth of the business.

5. Lack of Loyalty- The bulk of transactions of a cooperative is with its members. The
success of the cooperative depends on the loyalty of the members to the cooperative.
For example, farmers in Gujarat are fiercely loyal to their cooperative, resulting in the
success of “Amul’. However, in Andhra Pradesh, the ‘Vijaya’ brand of milk and milk
products is not so successful, as many farmers shifted their loyalties to private
companies.

6. No Secrecy- The membership of a cooperative is always in a state of new members

keep joining, while old members might withdraw. Since the affairs of the society need
to be made known to all the members, there is no secrecy of business matters. This
results in surrender of competitive advantage.

7. Difference of Opinion- The cooperatives give equal weightage to the opinion of all
its members. In case of serious difference of opinion between any two groups, it
becomes difficult to resolve the issue. The resultant friction may spillover to other
issues also.

8. Cash Trading- Cooperative societies transact with members, who are mostly people
with limited means. They need credit facilities. By insisting only on cash transactions,
cooperatives are losing a sizeable portion of the market.

9. Lack of Understanding of Principle of Cooperative Societies- Many members of a

society join the society on peer pressure or on advice of local leaders, without fully
understanding the principles on which the society has been founded. Since their
members have an equal voice on any issue, they are likely to create confusion and
problems for other members.

10. Lack of Public Confidence- The performance of Cooperative societies in many

parts of the world does not inspire confidence. The initial optimism of collective
effort for mutual gain is being questioned. A greater proportion of members of such
societies is opting out of such arrangements.

11. Lack of Universal Applicability- A cooperative society form of business cannot be

applicable in all circumstances. They are particularly unsuitable for large-scale
industries.

12. Other Problems- Inefficiency, ignorance of principles of cooperation,

misappropriation of funds, pursuing sectional goods and political propaganda have
resulted in recurring losses and also relative inefficiencies in the cooperative study.
What is a corporation?

A corporation is a business recognized by the state as a legal entity separate from its
owners (also known as shareholders). A corporation can be owned by individuals
and/or other entities, and ownership is easily transferable via the buying and selling of
stock. Since a corporation is its own legal entity, it can enter litigation on its own,
protecting its owners from personal liability in the event of legal action.

“This entity type is often chosen by entrepreneurs who wish to have a more formal
business structure than that of an entity such as a limited liability company (LLC) and
may eventually consider taking the business global or establishing an IPO [initial
public offering],” Deborah Sweeney, CEO of MyCorporation, told Business News
Daily.

You must follow your state’s legal requirements to become a corporation. For many
businesses, these requirements include creating corporate bylaws and filing articles of
incorporation with the secretary of state. Preparing all the information to file your
articles of incorporation can take weeks or even months, but as soon as you’ve
successfully filed them with your secretary of state, your business is officially
recognized as a corporation.

It’s wise to seek guidance from an attorney and a tax advisor before you decide to
become a corporation. These experts can help you determine if it is the best legal
structure for you – and help you file if it is.

How do corporations work?

A corporation is a separate legal entity from its owners, offering liability protection
for each owner’s personal assets. According to Shannon Almes, attorney at Feldman
& Feldman, corporations can generally conduct any lawful business as well as the
actions necessary to conduct the business, like entering into contracts, owning assets,
borrowing money, hiring employees, suing and being sued. Corporations are
generally governed by a board of directors elected by the shareholders.

“Each shareholder typically gets one vote per share in electing the directors,” said
Almes. “The board of directors oversees the management of the daily operations of
the corporation, and often do so by hiring a management team.”

Each owner of the corporation generally owns a percentage of the company based on
the number of shares they hold. Since corporation shares are easy to buy or sell,
ownership of a corporation is easily transferable. This is especially helpful for
business continuity and longevity.

What types of corporations are there?

There are several types of corporations, including C corporations, S corporations, B

corporations, closed corporations and nonprofit corporations. Each has it benefits and
disadvantages. Some alternatives to corporations are sole proprietorships, partnerships,
LLCs and cooperatives.
C corporation

As one of the most common types of corporations, a C corporation (C-corp) can have
an unlimited number of shareholders and is taxed on its income as a separate entity.
C-corp shareholders are also taxed on the dividends they receive from the company,
and they receive personal liability protection from business debts and litigation.
Ownership for this type of corporation is divided based on stocks, which can be easily
bought or sold. A C-corp can raise capital by selling shares of stock, making this a
common business entity type for large companies.

S corporation

S corporations (S-corps) are similar to C-corps in that the owners have limited
personal liability; however, they avoid the issue of double taxation. An S-corp is
considered a pass-through entity, meaning its income, losses, credits, and deductions
can be passed on to the shareholders to be reported and taxed on their individual tax
returns instead of the company being taxed as a separate entity. All S-corp
shareholders must be U.S. citizens.

“In order to qualify as an S corporation, the corporation must meet several

requirements, including not having partnerships, nonresident aliens, or other
corporations as shareholders; having no more than 100 shareholders; and only having
one class of stock,” said Almes.

B corporation

A certified benefit corporation, also known as a B corporation or B-corp, is a for-

profit business structured to benefit society. This relatively new type of corporation is
essentially a seal of approval for S corporations and C corporations, certifying that
they are dedicated (and legally committed) to improving the environment and society.
To become a B corporation, you need to meet rigorous criteria, like scoring an 80 or
above on the B Impact Assessment, publicly reporting your scores
on BCorporation.net, and making a legal commitment to consider your organization’s
stakeholders. As a B-corp, you will still maintain your C-corp or S-corp tax status.

Closed corporation

A closed corporation – also known as a private company, family corporation or

incorporated partnership – is a privately held company owned by a few shareholders.
Shares for these corporations are not publicly traded, which can make it difficult to
raise capital for them; however, the owners still have the benefit of limited personal
liability.

Nonprofit corporation

Business owners can form a nonprofit corporation for religious, charitable, political,
educational, literary, scientific, social or benevolent purposes. Certain states may have
stricter requirements for nonprofit corporations. Almes said the main characteristic of
a nonprofit corporation is that it is prohibited from distributing profits to members,
directors or officers; however, this does not preclude nonprofit corporations from
paying wages or reasonable compensation for services rendered.

Nonprofits have specific tax advantages, including the ability to file for nonprofit tax-
exempt status with the state and federal governments.

“Typically, most nonprofit corporations choose 501(c)(3) tax-exempt status, which

exempts qualifying nonprofit corporations from having to pay federal and state taxes
because the nonprofit corporation is pursuing a nonprofit mission,” said Sweeney.

What are the advantages of forming a corporation?

There are several advantages to becoming a corporation, including the limited

personal liability, easy transfer of ownership, business continuity, better access to
capital and (depending on the corporation structure) occasional tax benefits. The legal
structure of your corporation and the benefits you receive from it will depend on the
specific setup of your business.

Personal liability protection

A corporation provides more personal asset liability protection to its owners than any
other entity type. For example, if a corporation is sued, the shareholders are not
personally responsible for corporate debts or legal obligations – even if the
corporation doesn’t have enough money in assets for repayment. Personal liability
protection is one of the main reasons businesses choose to incorporate.

Business security and perpetuity

Corporation ownership is based on percentage of stock ownership, which offers much

more flexibility than other entity types in terms of transferring ownership and
perpetuating the business for the long term.

Although specific details regarding transfer of ownership depend on the governing

agreement in the bylaws and articles of incorporation, ownership of this entity type is
often easy to buy and sell. For example, if an owner wants to leave a company, they
can simply sell off their stocks. Similarly, if an owner dies, their ownership stocks can
easily transfer to someone else.

Access to capital

Since most corporations sell ownership through publicly traded stock, they can easily
raise funds by selling stock. This access to funding is a luxury that other entity types
don’t have. It is great not only for growing a business, but also for saving a
corporation from going bankrupt in times of need.

Tax benefits

Although some corporations (C corporations) are subject to double taxation, other

corporation structures (S corporations) have tax benefits, depending on how their
income is distributed. For example, S corporations have the luxury of splitting their
income between the business and shareholders, allowing it to be taxed at different
rates. Any income designated as owner salary will be subject to self-employment tax,
whereas the remainder of the business dividends will be taxed at its own level (no
self-employment tax).

What are the disadvantages of forming a corporation?

A corporation is not for everyone, and it could end up costing you more time and
money than it’s worth. Before becoming a corporation, you should be aware of these
potential disadvantages: There is a lengthy application process, you must follow rigid
formalities and protocols, it can be expensive, and you may be double taxed
(depending on your corporation structure).

Lengthy application process

Filing your articles of incorporation with your secretary of state can be quick, but the
overall process of incorporating is often a long one. You will likely have to go
through extensive paperwork to properly determine and document the details of the
organization and its ownership. For example, Sweeney said you need to draft and
maintain corporate bylaws, appoint a board of directors, create a shareholders
ownership change agreement, issue stock certificates, and take minutes during
meetings.

Rigid formalities, protocols and structure

Alongside the lengthy application process is the amount of time and energy necessary
to properly maintain a corporation and adhere to legal requirements. You have to
follow many formalities and heavy regulations to maintain your corporation status.
For example, you need to follow your bylaws, maintain a board of directors, hold
annual meetings, keep board minutes and create annual reports. There are also
restrictions on certain corporation types (for example, S-corps can only have up to
100 shareholders, who must all be U.S. citizens).

Double taxation

Most corporations (like C-corps) face double taxation, which means that the business
income is taxed at the entity level as well as the shareholder level (based on their
percentage of profits earned). The only way around this is to operate as an S
corporation. S-corps eliminate this problem by only taxing each shareholder on their
individual income, not at the entity level. However, the IRS has been known to pay
closer attention to S-corps and even tax them as C-corps if their records fail to meet
the legal requirements.

Expensive

Corporations are expensive to form and operate. It might be easy for established
corporations to raise capital by selling shares, but forming and maintaining a
corporation can be costly. You will likely need a lot of startup capital to get a
corporation running, in addition to paying the filing charges, ongoing fees and larger
taxes. When weighing the pros and cons to determine whether a corporation is the
right legal structure for your business, consult an attorney and an accountant who are
well versed in the implications of creating a corporation.

What Is Organizational Structure?

An organizational structure is a visual diagram of a company that describes what

employees do, whom they report to, and how decisions are made across the business.
Organizational structures can use functions, markets, products, geographies, or
processes as their guide, and cater to businesses of specific sizes and industries.

Organic structures (also known as "flat" structures) are known for their wide spans of
control, decentralization, low specialization, and loose departmentalization. What's
that all mean? This model might have multiple teams answering to one person and
taking on projects based on their importance and what the team is capable of — rather
than what the team is designed to do.

As you can probably tell, this organizational structure is much less formal than
mechanistic, and takes a bit of an ad-hoc approach to business needs. This can
sometimes make the chain of command, whether long or short, difficult to decipher.
And as a result, leaders might give certain projects the green light more quickly but
cause confusion in a project's division of labor.

Nonetheless, the flexibility that an organic structure allows for can be extremely
helpful to a business that's navigating a fast-moving industry, or simply trying to
stabilize itself after a rough quarter. It also empowers employees to try new things and
develop as professionals, making the organization's workforce more powerful in the
long run. Bottom line? Startups are often perfect for organic structure, since they're
simply trying to gain brand recognition and get their wheels off the ground.

What's the point of an organizational structure? As a business leader, do you even

need one? As I said, org structures help you define at least three key elements of how
your business is going to run.

As your company gets bigger, an organizational structure can also be helpful for new
employees as they learn who manages what processes at your company.

Then, if you need to pivot or shift your leadership, you can visualize how the work
flows would work by adjusting your organizational structure diagrams.

To put it simply, this chart is like a map that simply explains how your company
works and how its roles are organized.

Organizational structure is the backbone of all the operating procedures and

workflows at any company. It determines the place and the role of each employee in
the business, and is key to organizational development.
A clear structure allows every team member to be involved. When employees know
what they’re responsible for and who they report to – which isn’t the case in many
fast-growing companies – they’re more likely to take ownership of their work.
To build an org structure, you need to consider your business size, life cycle, goals,
and positioning. Apart from considering the current environment your company
operates in, you should also think of where you want to see the organization in five
years – as its a pillar of organizational health.

Is It Possible to Change an Organization’s Structure?

Of course, organizational design can be reconstructed if needed. The business
landscape is constantly evolving, and keeping to a structure that has worked for years
might simply become inefficient. To adapt to market changes, you might need to
resort to organizational transformation which affects not only your strategy but also
the structure. Whether you want to build an organizational structure from scratch or
want to revisit the existing one, you’ll need to get down to the basics.

Basic Elements of Organizational Structure Design

An organizational structure is based on a range of elements, including:

Work specialization
Work specializations define how responsibilities are split between employees based
on the job description. It’s used to split projects into smaller work activities and
assign digestible tasks to individual employees. The most common results of improper
specialization are low efficiency and burnout.

Documentation
Documentation is an act of grouping specialists on the basis of the job description,
skills, location, or other factors that connect them. The biggest challenge is choosing
the criteria for departmentation. In many cases, it’s no more enough to apply
functional departmentation – where employees are grouped based on the tasks they
perform. Startups often go for matrix departmentation that involves combining two
types of departmentation and takes the best out of both worlds. For instance,
functional departmentation can be joined by geographical departmentation to better
serve clients in different locations.

Chain of command
Chain of command represents a system for passing instructions and reporting within
an organization. Ideally, it distributes the power, supports knowledge sharing, and
encourages employee accountability.The traditional chain of command makes
decision-making more complex and does not allow for much flexibility. On the
contrary, modern approaches strive to enhance employee autonomy and avoid
micromanagement.

Span of control
Span of control regulates the number of direct reporters managed by a single
supervisor. It heavily depends on the three aforementioned elements of organizational
structure. Furthermore, to identify the right span of control, you need to evaluate your
leaders’ capacity, workplace size, and experience level of employees.

Centralization and decentralization

Centralization and decentralization are the concepts defining how managers, as well
as employees, give input on company goals and strategy. While centralization gives
leaders the ultimate control over decision-making processes, decentralization allows
employees to impact business decisions. We’ll dive into centralized and decentralized
organizational structures in the further section.

Formalization
Formalization determines to which extent business processes, policies, and job
descriptions are standardized. It may regulate communication between employees and
managers, workplace culture, operational procedures, etc.

Centralized vs. Decentralized Organizational Structures

Back to centralization and decentralization. When designing an organizational
structure, you’ll need to choose a side. Do you want to implement top-down or
bottom-up management?

Centralized organizational structure

As has been said, in a centralized organizational structure, decisions are made by top
managers and are distributed down the chain of command.

For sure, the structure has a range of advantages. It ensures greater control over
business processes. But most importantly, it only includes highly experienced
professionals that are able to foresee the effect of decisions made in the long run.

The biggest drawback of a centralized organizational structure is the amount of time

the decision-making process takes in large companies. Imagine a customer support
manager being asked to implement an exclusive package for a high-ticket customer.
To get permission, they’d need to run the request up the chain of command and wait
for it to be processed by top management. When the request is approved, a high-ticket
customer might no longer be there.

Decentralized organizational structure

To avoid this issue, large organizations turn to decentralization. In a decentralized
structure, lower-level employees pinpoint issues and make decisions before
communicating it to upper management. Greater autonomy not only empowers
employees but also eliminates process delays, which are common for centralized
systems.
However, decentralization also brings coordination challenges and higher expenses.

Often, it’s recommended that early-stage startups and small businesses go after a
centralized organizational structure. Fast-growing companies and enterprises usually
choose a decentralization framework.

Types of Organizational Structures

The key purpose of any organizational structure is to make the processes more
straightforward. However, there are many ways to achieve that.

1. Functional structure

A functional structure groups employees into different departments by work

specialization. Each department has a designated leader highly experienced in the job
functions of each employee supervised by them.

Most often, it implements a top-down (centralized) decision-making process where

department managers report to upper management. Ideally, leaders of different teams
communicate regularly and coordinate their strategies while lower-level employees
have little idea of the processes taking place outside their department.

The main challenge companies with a functional structure face is the lack of
coordination between departments. Employees may lose the larger company context
when focusing on very specific tasks and failing to interact with members of other
departments.

To create a functional organizational structure that works, you’ll need to train leaders
to foster collaboration across departments

2. Divisional structure
A divisional structure organizes employees around a common product or geographical
location. Divisional organizations have teams focused on a specific market or product
line.

Examples of companies applying a divisional structure are McDonald’s Corporation

and Disney. These brands can’t help but split the entire organization by location to be
able to adjust their strategies for audiences representing different markets.

These smaller groups are relatively independent and mainly follow a decentralized
framework. Still, the leaders of each department are likely to operate under
centralized corporate management. It means that company culture is dictated by top
management, but operational decisions can be made by each division independently.

Giants such as McDonald’s and Disney also add functional units to their structure for
better control.

3. Matrix structure
Within a matrix organizational structure, team members report to several managers at
once. Wait, what’s the point?

Having multiple supervisors allows for company-wide interaction and faster project
delivery. For instance, when answering to functional managers and project managers,
employees have a chance to collect experience outside their team. While functional
managers can help to solve job-specific issues, project managers can bring in
knowledge or talents from other departments.

If you go after a matrix organizational structure, you’ll need to find a way to avoid
authority confusion and prevent conflicts between managers.

4. Team structure
A team-based organizational structure creates small teams that focus on delivering
one product or service. These teams are capable of solving problems and making
decisions without bringing in third parties.

Team members are responsible for managing their workload and have full control
over the project. Team-based organizations are distinguished by little formalization
and high flexibility. This structure works well for global organizations and
manufacturers.

5. Network structure
A network structure goes far beyond your internal company structure. It’s an act of
joining the efforts of two or more organizations with the goal of delivering one
product or service. Typically, a network organization outsources independent
contractors or vendors to complete the work.

In a network organization, teams are built from full-time employees as well as

freelance specialists – this way, in-house workers can spend most of their time
focusing on the work they specialize in. Such an approach allows companies to adapt
to market changes and obtain the missing skills fast.

Working with individuals that aren’t integrated into your company culture results in
lower formalization and higher agility.

6. Hierarchical structure
You must already have an idea of what a hierarchical structure is. It’s the most
common organizational structure type that follows a direct chain of command.
A chain of command, in this case, goes from senior management to general
employees through a range of executives on the departmental and team level. The
highest-level executive has the highest power over the decision-making process.
On one hand, this structure enables organizations to streamline business processes,
develop clear career paths, and reduce conflicts. A company hierarchy leaves no place
for challenging managers’ authority, which can be good in some cases.

On the other hand, a hierarchical structure slows down decision-making and may hurt
employee morale.

7. Flat organization structure

In a flat organizational structure, there are few middle managers between employees
and top managers. The structure requires less supervision, increases employee
involvement, and boosts trust in the workplace.

Due to its simple nature, a flat organization structure, also called a “flatarchy”, is
typically used by small businesses and startups.

How to Design Your Organization’s Structure

Whatever structure you choose, you’ll need to make an effort to implement it. Here
are eight simple steps towards designing an organizational structure from scratch.

1. Create a charter
First of all, you need to prepare documentation.

You need a project charter outlining the purpose of building a clear structure, key
stakeholders, and their responsibilities. This is your rough plan for implementing an
organizational structure that should give you a direction for your next steps.

When creating a charter, you’ll be able to answer the following questions:

 Why do we need to design (or re-design) an organizational structure?

 When do we start?
  Who are the key stakeholders in this project?

 What should we do first?

 Where is the company headed? Will our organizational structure be relevant in

a year?

2. Build your strategy

To build a structure from scratch, you’ll need to start by outlining a long-term strategy
and mapping out goals. Your future vision of your company determines which type of
organizational structure will work best for you.

3. Assess your internal processes & systems

If your business has already been operating for quite some time, take a look at your
current strategy and try to highlight the areas of improvement. Do you need to revisit
your core ideology and company culture? You can only answer this question by
talking to your employees and managers.

When you know where you stand and have a clear vision of what you want to achieve,
creating an organizational direction shouldn’t be a problem.

4. Design your structure

A clear understanding of your company’s strategy lets you filter out irrelevant
organizational structure types and pick the one that fits with your core values, mission,
and goals.

Choose one of the seven organizational structures and use it as a template for
designing a custom organizational chart. This chart is also known
as an organogram – it’s a diagram used to visualize the relationships between
individuals, teams, and departments within an organization

5. Create a transition plan

Next, it’s time to design an optimal workflow for implementing or switching to a new
structure.

Talk to the stakeholders and decide on the deadlines for establishing a brand new
organizational structure. Prepare a list of recommendations for top managers and team
leaders that will help to communicate the change to the rest of the organization.
6. Implement your new structure
From there, leaders should create an implementation plan that includes training their
teams to adopt new roles and skills, as well as how to follow a new decision-making
and reporting framework. Week by week, employees will become accustomed to their
new organizational structure and adapt to the change.

7. Monitor the impact

The transition process might take months, and it’s very likely that the performance of
individual employees or even entire teams will go down at some point. However, you
can assess the impact of a new structure in action only after the transition is complete.

With a new organizational structure in place, run the performance review and talk to
executives. It’s important that you monitor the contribution of each individual
department – chances are the changes don’t work equally well for everyone at the
company.

8. Gather feedback & improve

Again, once you implement an organizational structure, it’s never too late to make
adjustments. Alongside performance checks, survey your employees to learn how
they feel about a new structure. It can be that their input will help you fine-tune the
organizational design without extra cost and effort.

Why is having an organizational structure important?

Imagine a business that has no organizational structure. Instantly, questions arise

about the systems and processes. Who makes the decisions? How are employees held
accountable? What are the company’s goals? These questions are practically
impossible to answer without a functional organizational structure.

Organizational structure is necessary for running a successful business because it

improves workflow and efficiency, promotes communication, identifies company
needs, and aligns employees with company goals. It directly affects how a business
operates daily. When a company establishes a structure that works, the combined
efforts of its employees, in conjunction with its systems and processes, allow the
company to make better decisions for its future.

Navigating Organizational Structures

Organizational structures are central to a successful team. Employees can move

comfortably, confidently, and efficiently when given a clear definition of their role
within an organization.

Structure types will vary from business to business, so it’s important to remember that
these structures are not one size fits all. Every type may not suit your organization,
but chances are, one of them will. Use this post to determine which organizational
structure works for you, and then it’s time for the real work to begin.