Chapter 2- Unit 1.

2 Types of Business Entities

Unit 1.2 Types of business entities

“Business shapes the world. It is capable of changing society in almost any way you can imagine.”
- Dame Anita Roddick (1942 - 2007), Founder of The Body Shop
Businesses exist to satisfy the needs and wants of their customers by selling goods and services,
usually in return for profit. This section of the syllabus considers the main functions of business
organizations (HRM, finance, marketing and operations management).
The learning outcomes (or assessment objectives) for this section of the IB Business Management
syllabus are:

 Distinction between the private and the public sectors (AO2)

 The main features of the following types of organizations (AO3):

• Sole traders
• Partnerships
• Privately held companies
• Publicly held companies

 The main features of the following types of for-profit social enterprises (AO3):
• Private sector companies
• Public sector companies
• Cooperatives

 The main features of the following type of non-profit social enterprise (AO3):
• Non-governmental organizations (NGOs).

Distinction between the private and the public sectors (AO2)

 The private sector of the economy consists of businesses owned and run by private individuals and
organizations that usually, but not always, aim to earn a profit. They operate independently of the
government, although need to operate within the rules and regulations in the country. Examples of
private sector businesses, which are covered in this section of the syllabus, include the following:

 Sole traders
 Partnerships
 Privately held companies

 Publicly held companies

 Social enterprises, including cooperatives and non-governmental organizations
 Multinational corporations (MNCs)
Business organizations that operate in the public sector consist of those controlled by a regional
and/or national government, with the main aim being to provide essential goods and services for the
general public. Such businesses can, but do not always, directly charge customers for such
services. In some cases, such as government housing or state-funded education, the service is
provided by and/or funded by the government.
Examples of such goods and services deemed to be of benefit to society, but would be
underprovided without the public sector, include:

 Infrastructure (such as communication networks, transportation networks, road and highway

networks, waste disposable systems, and flood control systems)
 Housing (public and social housing)
 Health care services
 Education
 National defence (national security)
 Renewable energy
 Refuse collection
 Museums
 Public parks
 Emergency services (ambulance, fire and police).

Key terms
 The private sector of the economy consists of businesses owned and run by private individuals
and organizations that usually aim to earn a profit for their owners.
 The public sector consists of those organizations controlled by a regional and/or national
government, with the main aim being to provide essential goods and services for the general public.

Types of for-profit organizations (AO3)

This section of the IB Business Management syllabus covers the following types of for-profit
(commercial) organizations:

 Sole traders
 Partnerships

 Privately held companies

 Publicly held companies

A sole trader (also known as a sole proprietor) is a commercial for-profit business owned by a
single person. Although this person can employ as many people as needed, the sole trader is the
only owner of the business.

Advantages of sole traders / sole proprietors

The advantages of setting up a business as a sole trader (or sole proprietor) as a type of for-profit
(commercial) organization include:

 It is the quickest and easiest type of business to set up. Sole traders can avoid complicated and
costly set-up procedures.

 The owner receives all of the profits if the business succeeds.

 Sole traders are likely to be highly motivated as the owners have a sense of achievement from
running their own business and can keep all of the profits made.

 The sole trader (owner) has complete control without having to consult with or be accountable to
others.

 Hence, decision-making is also swift as the owner does not have to consult anyone else and seek
their permission to execute a decision.

 The sole trader enjoys privacy as it only needs to publish its financial accounts to the tax authorities
(rather than to the general public like a publicly held company). For example, sole traders in Hong
Kong only need to submit paperwork for the Inland Revenue if their annual sales revenue exceed
HK$2m (around US$260,000). Similarly, sole proprietors in the UK are able to complete their own
business tax returns without the formal requirement of final accounts being externally audited.
 The owner can benefit from tax advantages. As a small business, many sole traders work from
home, so can claim tax concessions by using part of their home for business purposes.

Disadvantages of sole traders / sole proprietors

However, there are some potentially significant disadvantages of being a sole trader too. These
include:

 The finance to set up and run the business is generally provided by the owner (from personal
savings) as s/he cannot easily access external sources of finance.

 The sole trader accepts all the risks of owning and running their own business, including any losses
made or even the collapse of the organization.

 The workload for a sole trader can be extremely high. There is no one else to share ideas or to ask
questions, so all pressures, burdens and responsibilities fall on the owner. This means the sole
trader often has to work very long hours.

 Legally, a sole trader is treated as the same legal entity as the business, i.e. it is
an unincorporated business. This means the sole trader has unlimited liability so is responsible
for any debt owed to other individuals or organizations, even if this requires the owner to pay the
debts from their personal belongings and assets.

 There is a lack of continuity in the operations of the business if the owner is unwell, wishes to take a
holiday or wants to retire. The latter is a main reason why many sole trader businesses struggle to
continue.

 As sole proprietorships are usually small businesses (such as a small convenience store owner),
they are unlikely to be able to gain any economies of scale, perhaps because they cannot buy their
materials or stocks (inventory) in bulk. This means sole traders pay more for their goods, their prices
charged to customers also tend to be higher. By contrast, larger business (such as supermarket
chains) gain these cost-saving benefits, so are able to charge much lower prices due to their ability
to exploit economies of scale.

 Since access to external finance is difficult for most sold traders (because they represent a high
degree of risk), expansion of the business is difficult.

 Partnership (AO3)
 A partnership is a commercial business that strives to earn a profit for its owners. It is
owned by two or more people.
 For an ordinary partnership, the maximum number of partners is usually capped at twenty
owners, although this does vary from one country to another. Some organizations can have
more than 20 partners, such as law firms and health clinics. Highly specialised professional
service providers (such as doctors, solicitors, dentists and accountants) are usually set up as
 partnerships. Many family-run businesses are also established as partnerships. The owners
of a partnership are called partners.
 The vast majority of partnerships are unincorporated businesses, so at least one of the
owners must have unlimited liability. In practice, it is usual for all the partners to share
responsibility for any liabilities made by the partnership. In some countries, it is possible to
have a limited liability partnership (LLP). Setting up an LLP protects each individual partner
from being responsible or liable for another partner’s misconduct or shortcomings.
 Most partnerships sign a Deed of Partnership (or Partnership Agreement) as this helps to
resolve potential misunderstandings and disagreements. This formal contract between the
partners outlines each of their responsibilities, voting rights, and how profits are to be shared
between the owners.

Advantages of partnerships
The advantages of partnerships as a type of for-profit (commercial) business organization include:

 Partnerships can raise far more finance than sole traders, especially as there can be up to 20
partners (subject to the laws in different countries) in the business. Silent partners (also known
as sleeping partners) can provide additional capital without having any role in the actual running of
the business.
 Having partners enables the firm to benefit from having more ideas and different skills and
expertise.
 Unlike a sole trader, partners can share the burden of their workload and responsibilities.
 Hence, unlike a sole trader, partnerships benefit from continuity as the partnership can remain in
operation if a partner is unwell or wants to go on a family vacation.
 Partnerships can benefit from specialization and the division of labour. For example, a law firm
might have partners who specialize in different specialisms, such as criminal law, civil law, business
law and tax law.
 As with sole traders, business affairs of a partnership are kept confidential, so only the tax
authorities need to know about the financial position of the partnership.

Disadvantages of partnership
However, there are limitations to setting up a business as a partnership. These potential drawbacks
include:

 As the business has more than one owner, this can easily lead to disagreements and conflict
between the owners, which can seriously damage the running of the partnership.
 Decision making is slower than with sole traders because there are more owners involved. This can
also lead to disagreements and conflicts between the owners
 Unlike with a sole trade, the profits made by a partnership must be shared between all the owners.
 In general, partners have unlimited liability so are liable for any debts, fines, penalties or law suits
against the business, even if this these were caused by another partner in the firm. However,
sleeping partners are exempt from unlimited liability.
 Compared to limited liability companies, access to finance is restricted to the finances available from
the different partners in the firm. There is no maximum number of owners in limited liability
companies, so they can raise finance through their shareholders.
 There is no continuity if a partner decides to leave the firm or if one of the partners die. This is
because such cases would void the Deed of Partnership. There would be a time delay in setting up
a new partnership agreement

Privately held companies (AO3)

Companies (also known as corporation) are commercial for-profit businesses owned
by shareholders. Hence, the profits of a company belong to and are shared among the various
owners. As incorporated businesses, the owners have limited liability. Limited liability protects
shareholders who cannot lose more than the amount they invested in the business. This is because
shareholders are not personally liable for the debts of the company should it go into debt or
bankruptcy.
In legal terms, there is a divorce of ownership and control as the owners (shareholders) are treated
as separate legal entities from those who control and run the business (the board of directors and
CEO). It is the board of directors and the CEO (or managing director) who are responsible for the
strategic direction of the company.
There are two categories of companies: privately held companies and publicly held companies.

Features of privately held companies

 The shares of privately held companies cannot be advertised for sale nor sold via a stock exchange.
Shares are not available on an open stock exchange such as the New York Stock Exchange.

 Most privately held companies (sometimes referred to as private limited companies) are small
businesses, with shares typically owned by family, relatives, and friends.

 The company and its owners are separate legal entities, i.e., there is a legal divorce (separation) of
ownership and control, with the owners (shareholders) appointing a board of directors to run the
company on their behalf.

 Owners have limited liability, so if the business experiences a financial collapse, then the owners
will only be liable for the capital they invested in the company.

 The number of shareholders in a privately held company may be limited. In some countries, the
maximum number is 50 (Turkey) and in others it is 200 (India). In other countries, like the UK and
Switzerland, there is no maximum (source: DLA Piper).

 There is usually no legal requirement for the company to publish detailed financial accounts for the
general public (this is only needed for corporate tax purposes).
Examples of well-known privately held companies include:

 Dell

 Deloitte

 Dyson

 Ernst & Young

  IKEA

 Lego

 Mars

 Pricewaterhouse Coopers

Advantages of privately held companies

The advantages of establishing a business as a privately held companies as a type of for-profit
(commercial) organization include the following points:

 There is better control of a privately rather than publicly held company, as shares in a privately held
company cannot be bought or sold without the agreement of existing shareholders.

 Significantly more finance can be raised compared with a sole trader (one owner) or a partnership
(up to 20 owners).

 Privately held companies have greater privacy compared to publicly held companies; the latter must
make their final accounts available to the general public.

 Shareholders have limited liability, so cannot lose more than what they invest in the company.
Owners are protected against any misconduct or misjudgments of those who run the company.

 Unlike a sole trader or partnership, a privately held company can enjoy continuity in the event of the
death of a major shareholder.

Disadvantages of privately held companies

However, the potential limitations of being a privately held company include the following :

 Privately held companies can only sell their shares to family, friends, and employees, with the
approval of the majority of existing shareholders. This can make it difficult to buy and sell shares in
the company.

 They are more expensive to operate than a sole trader or partnership. For example, there are higher
legal fees and auditing fees (for checking and approving of the financial accounts).

 A privately held company can become a target for a takeover by a larger company which purchases
a majority stake, although other owners have to agree to the sale of the company.

Publicly held companies (or joint-stock companies) are limited liability companies owned by
shareholders with the shares in the business being traded (bought and/or sold) on a public stock
exchange (or stock market).
 Share prices of companies can go down as well as up

Features of publicly held companies

 Also known as a joint-stock company, a publicly held company is owned by shareholders. The
shares in such companies can be bought and sold by the general public, without prior approval of
existing owners.

 Shares in a publicly held company can be bought and sold via a stock exchange (or stock
market), such as the New York Stock Exchange (NYSE), London Stock Exchange, Hong Kong
Stock Exchange, Tokyo Stock Exchange, Shanghai Stock Exchange, and the National Association
of Securities Dealers Automated Quotations (NASDAQ).

The New York Stock Exchange (NYSE)

 When a company first sells its shares to become a publicly held company, it does so through
an initial public offering (IPO) via a stock exchange.

 In order to protect shareholders, publicly held companies are strictly regulated and are required to
publish their final accounts each year.

 As there is no legal limit placed on the maximum number of shareholders in a publicly held
company, the company can raise a significant amount of finance so long as it can attract investors.

Advantages of publicly held companies

The advantages of establish a business as a publicly held company as a type of for-profit
(commercial) organization include the following points:

 Additional finance can be raised through a share issue (the process of subsequently selling more
shares in a company). Hence, it is easier for publicly held companies to obtain finance from a stock
exchange to fund its growth and evolution by selling additional share capital. In 2010, Brazil’s state
oil company Petrobras raised $70 billion, in the world’s largest share issue.

 It is also easier for large publicly held companies to borrow money from bank loans and mortgages,
due to their lower level of risk for financial lenders.

 As with privately held companies, the shareholders of publicly held companies enjoy limited liability.

 Large publicly held companies get to enjoy the benefits of operating on a large scale, such as
opportunities to exploit economies of scale, market share, and market power.
 As with privately held companies, publicly held companies enjoy continuity even if a principal or
major shareholder leaves the organization or passes away.

Disadvantages of publicly held companies

The limitations or drawbacks of being a publicly held company include the following points:

 There is a lack of privacy because the general public have access to the financial accounts of
publicly held companies.

 Publicly held companies are the most administratively difficult and expensive form of commercial
for-profit business to set up and run. For example, there are high costs of complying with the rules
and regulations of the stock market.

 As the general public can buy and sell share freely, there is always a potential threat that a rival
company will make a takeover bid.

 Large companies can suffer from diseconomies of scale. Being too large can cause inefficiencies in
the company, and hence higher average costs of production.

Types of for-profit social enterprises (AO3)

Social enterprises are an example of social purpose organizations (SPOs). They aim to primarily provide
a solution to important social or environmental issues. They exist to to create a better world due to the
role they play to improve society overall. As they are not always revenue-generating, SPOs often need
financial funding and suitable human resources. Other SPOs include charities, cooperatives, and non-
governmental organizations (NGOs).Although there is no universally accepted definition of a social
enterprise (and the legal definition differs between countries), it is essentially an organization that
focuses on meeting social objectives (such as improving social and environmental well-being) and not
only commercial business objectives such as profit maximization or maximizing shareholder returns (see
Case Study 2 - M-Pesa below).

Traditional, for-profit organizations strive to maximise profits or financial gains for their owners
(shareholders). Jack Welch (former Chairman and CEO of GE - General Electric) said: "Even in these
uncertain times, every company should practise good corporate citizenship post op but they also need to
face the reality that's you first have to make money before you can give it away." In other words, whilst
traditional businesses might donate money to charitable causes or have ethical objectives, they
primarily aim to earn a profit.

Unlike traditional commercial for-profit businesses, social enterprises combine social and commercial
agendas in order to achieve their social and environmental agenda, i.e., they strive to gain a financial
surplus to facilitate social gain. Their activities, by definition, purposely create social benefits.

Some differences between social enterprise, traditional commercial (for-profit business entities), and
charitable organizations are outlined below.
 Charities Social enterprises Traditional businesses

Mission driven (charitable Vision driven (commercial

Purpose driven (social purpose)
mission) vision)

Funded by owners, investors,

Funded by internal and external
Funded by donations and
sources
internal and external sources

Profits distributed to owners

Surplus reinvested Profits reinvested
and/or redistributed

Corporate social
Purely charitable Focus on social benefits
responsibilities*

Focus on social impact and

Focus on societal gains Focus on financial returns
financial gains

* Whist traditional businesses may allocate some funds to corporate social responsibilities (CSR), it is not
their main or most important focus. Instead, the main drivers for such businesses is profit, growth,
and protecting shareholder value. A growing number of traditional businesses are reporting on the triple
bottom line to as part of their CSR and sustainability goals.

A for-profit social enterprise uses commercial business practices in order to achieve social goals,
such as improving the environment, building better communities and developing social wellbeing.
Such organizations do not focus on generating profits for their shareholders but strive to build and
improve communities.

There are three main types of for-profit social enterprises covered in the IB Business Management
syllabus:

 Private sector companies

 Public sector companies

 Cooperatives.
Note: The IB acknowledges that the legal definition of a social enterprise varies between countries.
Therefore, the IB recommends that teachers and students should research and arrive at an
appropriate set of definitions that differentiate between the different types of organizations in their
respective local or national context, especially with respect to the legal differences between social
enterprises and charities
 Private sector companies (AO3)
Private sector companies are for-profit business organizations that operate in the private sector.
They differ from those that operate in the public sector in terms of ownership, and control, the
purpose of their existence, how they raise finance, how they are managed, and how any profits
(financial surplus) are distributed or how losses dealt with.
For-profit social enterprises can operate in as private sector companies in the private sector of an
economy. Examples of for-profit social enterprises that operate as private sector companies include:
Examples of private sector for-profit social enterprises include:

 Change Please - The British coffee chain with outlets in London and Manchester donates all of its
profits to tackle the problems of homelessness (see Case Study 1 below).

 KASHF Foundation - This organization provides financial and social-support services to female
entrepreneurs to empower them to set up their own businesses in food production, cloth making,
and other industries in Pakistan.

 M-Pesa - A multinational mobile phone-based money transfer, financing, and microfinance service
provider that also provides mobile banking services (see Case Study 2 below).

 SECLO Foundation - Financial company that provides sustainable energy solutions, such as solar-
powered lightning, to low-income households and small businesses in India.

 Thaely - A vegan footwear brand that manufactures sports shoes (sneakers) from waste plastic
bags and bottles (each pair contains 15 plastic bags and plastic 22 bottles)

 TOMS Shoes, known for giving away one pair of shoes (to those in need) for every pair the private
sector social enterprise sells.
 A further example is microfinance providers. Microfinance providers are for-profit social
enterprises that operate as private sector companies. They offer a financial service to those
without a job or on very low incomes. These members of society would not ordinarily be able
to secure bank loans. The concept of microfinance was developed by Nobel Prize winner
Muhammad Yunus (www.muhammadyunus.org/) in 2006, in association with the Grameen
Bank.
 The aim of providing microfinance is to help entrepreneurs, especially women, struggling to
finance their business start-ups to gain access to loans of a small amount. Microfinance can
give these people the opportunity to become self-sufficient and empower them to run their
businesses. As with the majority of loans, interest is charged on the amount borrowed,
although these are typically lower than what commercial banks would charge.
 Public sector companies (AO3)

 Mass rail transit operators are often run as public sector companies
 The public sector is the part of the economy composed of government-owned and/or
government-controlled enterprises. It does not include any private sector enterprises (sole
traders, partners, limited liability companies, and private sector social enterprises).
 Public sector companies operate in a commercial-like way (selling goods and/or services
in order to generate a financial surplus) but are owned and/or controlled by government
authorities. They can be owned wholly or partially by the government. They are set up as
legal business entities to partake in the commercial business activities, enabling successful
public sector companies to earn a financial surplus for the government to be used for the
benefit of society as a whole.
  An example is Canada Line, which is a mass rapid transit operator in British Columbia,
Canada. It was opened in 2009 and is owned by TransLink, the statutory authority
responsible for the regional transportation network in British Columbia. As with all
transportation operators, Canada Line's main revenue stream is from commuters who use
their train services. It is also funded by the Canadian government, government agencies,
and private partners.

Advantages of public sector companies

The advantages of establishing public sector enterprises as a form of for-profit social enterprise
include:

 Providing a viable solution for the government to finance projects that it simply does not have
enough money for unless it is able to charge for the services provided.
 As the product is provided by the government, there are fewer risks involved.
 By being able to charge for their services, public sector companies help to reduce the debt burden
of the economy and taxpayers in particular.
 Public sector companies create secure employment opportunities and have a positive impact on
local communities and the country’s overall economic growth and development.

Limitations of public sector companies

However, there are potential drawbacks of establishing public sector enterprises. These limitations
include the following points:

 By funding a particular public sector enterprise, the government gives up the option of financing
other items of government expenditure, such as road maintenance, flood defence systems, and
developing communications networks.
 In addition, most public sector enterprises are expensive to operate (involving high set-up costs and
running costs). This means they can be high-risk businesses with unpredictable rates of return on
the investments. For example, Hong Kong Disneyland opened in 2005 but took seven years to
declare a profit (the annual profit in 2012 was only US$13.97 million).
 Hence, it can be difficult to persuade private sector partners or investors to help fund public sector
companies. Investors could be unsure and unwilling to form a PPP, for example, due to the
uncertainty of such businesses being able to generate any long-term profit.
 Public sector companies are often associated with bureaucratic policies and procedures, which can
cause inefficiencies and delays to decision making.
 Cooperatives (AO3)
 
 Cooperatives exist for their owner-members
 Cooperatives are for-profit social enterprises that are owned and managed by their
members. Examples are employee cooperatives, producer cooperatives, managerial
cooperatives and customer cooperatives. Cooperatives exist throughout the world, but are
predominant in the agricultural and retail sectors of the economy in many parts of Europe.
 According to the United States Federation of Worker Cooperatives (USFWC), there were
612 worker cooperative in the US in 2021, generating a gross revenue of $283 million.
Globally, there are around 3 million organizations set up as a cooperative and around 12% of
the world population are members of at least one of these cooperatives.
 This chart shows the largest cooperatives in the US. State Farm, with its headquarters in
Bloomington, Illinois, is America's largest cooperative in terms of sales turnover. The
insurance company operates as a member-owned cooperative and generated an income of
$42 billion in 2020. The business model used by State Farm means the cooperative pays its
policyholders either a dividend or reduces premiums.

Features of cooperatives
 As a category of for-profit social enterprises, cooperatives strive to provide a service for the
members, providing and creating value, instead of seeking to earn a desired level of profit margin
for their member-owners. However, any profits of the cooperative are shared with its members.
 Most cooperatives are registered as limited liability organizations. Like limited liability companies,
cooperatives have a separate legal entity from their shareholder owners. Hence, shareholders,
directors, managers, and employees are not held personally liable for any debts incurred by the
cooperative.
 All member shareholders are expected to help run the cooperative, although it is overseen by an
elected board of directors that makes long-term strategic decisions.
 All members of a cooperative have equal voting rights, irrespective of their role in the business or
their level of investment in the cooperative.
 Members of a cooperative have limited liability, restricted to the amount they invested in the
business.
 Cooperatives tend to have a democratic culture, with empowerment of its members to make
decisions. The organizational structure is rather flat as there is decentralised decision making (see
Unit 2.2).
 Advantages of cooperatives
The advantages of establishing cooperatives as a form of for-profit social enterprise include:

 Cooperatives are not difficult or expensive to set up.

 Cooperatives are tax exempt because the focus of the business is on serving the collective interests
of its member-owners and the community (such as home care associations for the elderly).
 As all member shareholders are expected to help run the cooperative, it is more likely to succeed.
 Similarly, as the owners have equal voting rights, the cooperative is more democratic so the
members feel equally important to the success of the business. This is likely to lead to a harmonious
working environment.
 There is an absence of pressure from external investors and shareholders, so the member-owners
of the cooperative can run the business that best suits their own interests.
 As cooperatives strive to benefit their members and society, they often qualify for government
financial support.
 Unlike partnerships or sole traders, there is continuity in a cooperative should a key owner leave the
organization, for whatever reason.

Disadvantages of cooperatives
However, there are potential drawbacks of establishing a business as a cooperative. These include
the following points:

 As cooperatives are not profit-driven, it can be difficult to attract investors, financiers and member-
shareholders.
 Similarly, employees and managers of cooperatives may lack the financial motivation to excel, due
to the absence of a profit motive.
 Most cooperatives have very limited sources of finance as their capital depends on the amount
contributed by their members.
 Most cooperatives are unable to hire a range of specialist managers to run the business, due to the
lack of financial rewards and sources of finance to remunerate their senior staff. This can limit the
success of the cooperative.
 A democratic culture is not always effective. Despite some members having more to contribute to
the organization and greater responsibilities, they only get one vote as do all other members. This
can be somewhat inefficient and perceived as unfair for some members.