SESSION 11: FORMS OF BUSINESS ORGANIZATIONS

Expected learning outcomes

At the end of the session, learners should be able to:

1. Distinguish between a private limited company and a public limited company.

2. Explain the main benefits of running a business in for of partnership business
3. Discuss the benefits of running a sole proprietorship business.
4. Analyze the importance of choosing the appropriate form of ownership to an entrepreneur
starting a technology business.
5. Discuss the importance of building a strong ethical culture in a firm.
One of the important decisions that an entrepreneur needs to take before launching a Business
enterprise is that of selecting the form of Business organization for his/ her venture.
• Choosing a legal entity for the venture is not a onetime event. The form of organization
can be changed from time to time. As a business grows and matures, it becomes
necessary to periodically review whether the current form of business remains
appropriate.
• No single form of business organization works best in all situations and is appropriate.
The entrepreneur thus needs to select the best form that meets his needs and that of the
enterprise.
Choice of business organization can be based on the following;
• The type and size of Business
• The cost of starting and maintaining the form of ownership
• Form of Business liability applicable
• Desired level of autonomy by the entrepreneur
• Tax considerations
• If and the number and type of investors the founding members want to attract.
• The level of financing required
A business organization can be can be owned by one person or a group of persons and its
operations can be controlled by owners or by the managers on behalf of the owners. It can be
classified as micro, small, medium or large.

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The major forms of Private business organizations are;

1. Sole proprietorship
2. Partnership
3. Company
The form of ownership chosen depends on factors like owner’s capacity to take decisions, bear
the risk, economic soundness, educational attainment.

Sole proprietorship
Also called individual proprietorship and is the oldest, simplest and natural type of business
organization. This type of business enterprise is established, financed, owned, managed and
controlled by an individual entrepreneur.
The owner introduces his own capital, uses his skills and intelligence in the management,
assumes all risks and is solely responsible for its operations and is entitled to all profits.
It’s the most popular form in Kenya due to its distinct advantages. Most bakeries, hardware
stores, boutiques, barber shops, bookshops, grocery stores, beauty parlours are sole
proprietorship businesses. This is an appropriate form of ownership where direct and personal
service is a major characteristic of the business.

Characteristics of Sole Proprietorship

• Ownership: The business is owned by one person
• Management and Control: The owner is the active manager who controls the business,
however if the business is large he may delegate some responsibilities to some
employees.
• Finance; the sole owner provides the necessary finances needed to run the business. If
additional finances are required, capital may be increased through borrowing
• Size of business unit; usually small but not necessarily small especially in view of capital
invested and income generated.
• No separation between ownership and management- proprietor is also the manager
• Risk; The proprietor bears all the risk
• Personal Incentive; the proprietor takes personal interest for the success of the business
• Independence; the owner is independent and can take quick prompt decisions

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 • Legal status; the sole proprietor and his business are considered as one i.e. the assets and
liabilities of the business organizations are personal assets and liabilities of the proprietor
• Unlimited liability;- incase the enterprise incurs loses, the private property of the
proprietor can be utilized to meet the business obligations to outside parties. The sole
proprietor is personally liable for debts of the business.
• Enjoys all profits realized but bears all losses incurred as an individual.
Sole proprietorship is favorable in the following circumstances
• Where the market is local and scale of business operation is small with less capital
requirements
• When personal contact/ attention with customers is required- beauty parlor, tailoring
shops, cafeteria
• Where one prefers autonomy and being one’s own boss
• Where promptness is required in decision-making Where business is carried out on small
scale
• Where there is ease of organization

2. PARTNERSHIPS
• Is formed when a sole proprietor wants to expand business and brings partners on board
or Partners may just come together to form a Business partnership
• A partnership is a business owned by two or more people up to 20 who come together
with a common objective of operating a business to earn profits.
• A partnership consists of not more than 20 people except in certain cases e.g practicing
solicitor, professional accountants and members of the stock exchange where this may
be exceeded. In case of banking business, the number of partners is limited to 10.
• In Kenya, all partnerships are formed in accordance with the partnership Act.
• The name of the partnership must first be registered under the registration of Business
names Act
FEATURES OF A PARTNERSHIP
1. Association of at least 2 -20 persons
2. This is a contractual relation which is formed by an agreement among the partners

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3. Requires an Article of partnership prepared in writing to cover the rights of the partners,
duties, obligations and the arrangements which partners have mutually agreed on.
4. Partners contribute towards the finances of the firm as per the terms of agreement
5. All partners need to take part in the management of the business
6. Consent required in important business decision-making e.g the decision to transfer one’s
shares to another person
7. Liability of the individual partner is unlimited unless the partnership agreement provides for
limitations- hence if the business suffers losses the assets of the partnership are not sufficient
to meet its obligations, creditors can sue one or all of the partners one or all of the partners.
They are jointly and severally liable for any debt. This is a serious handicap to partners who
may possess more personal assets as one may be forced to cover the entire debt of the
partnership solely
8. Partnership is a temporal form of ownership operating at the pleasure of the partners and can
be dissolved by obtaining a decree from the court if a partner leaves or dies
9. Each partner acts as an agent of the firm or of the other partners with authority to enter into
contracts, trade for the partnership
10. Responsibilities, profits and risks are shared on the agreed basis by the partners- any act by a
member is considered the act of the firm or of all the partners
Partnership Agreement/ Deed
A partnership deed is an agreement entered into by partners in writing which contains all matters
determining and governing the mutual rights, duties, liabilities of partners in the conduct and
management of the affairs of the partnership. May be referred to as ‘articles of partnership’
Elements of A partnership deed

These are usually defined by the partnership but include;

1. Name of firm, names of partners
2. Nature of Business, Place of business
3. Mode & Amount of capital to be contributed by each member & the profit/loss sharing
ratio
4. Loans and advances from partners and the amount of interest
5. Drawings allowed to partners
6. Amount of salaries/ commissions payable to members

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 7. Duties, powers and obligations of partners
8. Maintenance of accounts and audit
9. Mode of valuation of goodwill in the event of admission, retirement or death
10. Method of revaluation of assets, liabilities on admission, retirement or death of a partner
11. Procedure to be followed in expulsion of a partner
12. Procedure for dissolution of the firm and settlement of accounts
13. Arbitration in case of disputes among partners
Importance of a Partnership Deed
1. It forms the basis of formation of the partnership
2. It defines the mutual rights, duties and liabilities of the partners
3. Helps in minimizing disputes among partners
4. It serves as guidepost for the conduct of firm’s business

3. Limited companies
Definition:
A company is a voluntary association of persons bound together for a particular objective,
usually to carry out a business with the view of making profits. A limited company is formed
under the Companies’ Act.

Features of A limited company

1. Is an artificial person created by law and has an entity separate from that of its members. As
a legal entity it can sue or be sued, or enter into contracts in its own name, it can own
properties, incur liabilities, enter into legal proceedings, it can join trade agreements with
other firms
However because it is artificial it can only carry out activities according to the aims and
objectives for which it was formed. It also doesn’t suffer personal liabilities of a natural
person e.g. imprisonment
2. Capital is divided into transferable shares – hence a shareholder can sell his interests in the
company to another party without seeking consent of the shareholders( However in case of a
private company there are various restrictions)
3. Common Seal – As an entity there is need to sign documents and such signature is embodied
in the common seal of the company

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4. Long Life – it enjoys continued existence, as its life is separate from the life of its members.
Despite the death of retirement of any member the business continues until it is wound up by
provisions of the Company Act.
5. Members cannot bind the company by their Act
Third parties are expected to know the powers granted to each shareholder and they have to
see that their acts are in strict accordance with the regulations of the company.
6. Centralized management – Company is managed by a board of directors who are elected by
members. Individual shareholders don’t take part in the daily management of the company
7. Limited liability – Each shareholder is liable only to the amount of capital contributed by him
and to the unpaid value of the shares he holds
8. Number of members – In public companies, min of 7 members and there is no maximum
While in a private company, the min number is 2 and the max 50 members
9. Transferability of shares - Shares of a public company are transferable and can easily be sold
or purchased in the stock market
10. Changing nature of business – nature of business is specified in the objectives of a company
hence changing is not easy and involves a legal process- need to amend and register the
changes
11. Winding up - Existence of a company can come to end through winding up through a legal
process. A liquidator is appointed for this purpose who does the dissolution through a legal
procedure
Types of Limited Companies
i. Private Limited Company
• min 2 members, max 50 members
• Is not allowed to get money from the public through the issue of shares
• Transfer of shares is restricted - must be approved by the board of directors
• Must use the word limited in its name
ii. Public Limited Company
• Membership - min 7 and no prescribed maximum
• Transfer of shares allowed
• Can expand through the sale of shares to the public
• Management through directors elected by members
Formation of a Limited Company

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 Steps involved
1. Search for the company name- founders come up with a name which is taken to for a search
at the registrar of companies to ensure no other company is registered with a similar name
2. Preparation of some legal documents which include;
i. The memorandum of association
ii. Articles of Association
iii. Registered office
iv. List of Directors
v. Form of Statutory declaration

Memorandum of Association
This consists of the formal application signed by all members to the registrar of companies
declaring the intention of formation a company
It defines the companies objectives, powers and serves as a guide to the outside public

Elements of a Memorandum of Association

i. Name of company including the word limited
ii. Country and town where the registered office is situated
iii. A statement that the liability of members is limited
iv. Objectives of the company – Outlines the aims and purpose for which the company is formed
v. A statement of the nominal authorized capital with which the company wants to be registered
Articles of Association
It serves as a guideline to the internal management of the company
It includes regulations governing the internal management and administration of the company.
This is very important especially for a private company
Contains;
i. Classes and rights of shareholders
ii. Issue and transfer of shares
iii. Methods of dealing with alterations in capital
iv. Procedures of general meetings and voting rights
v. Qualifications, duties and powers of directors
vi. Borrowing, dividend and reserve policies

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After presenting the required documents and paying registration fee to the registrar the
company is registered and issued with a certificate of incorporation.
The company will then require a trading license to carry out its business activities.

Ethical culture for a firm

The founders of an entrepreneurial venture have an obligation to establish a strong ethical culture
of their firms. Leading by example is the best approach that an entrepreneur or a team of
entrepreneurs can do to build a strong ethical culture in their organizations. This can be done by:

• Having leaders who intentionally make ethics a part of their daily conversations
• Having supervisors who emphasize integrity when working with their direct employees
• Peers who encourage each other to act ethically.
Developing s strong ethical culture may be reinforced by establishing a Code of conduct (code of
ethics); this is a formal statement of an organization’s values on certain ethical and social issues.
It provides guidance to managers and employees’ regarding what is expected of them in terms of
ethical behaviour. The managers and employees are required to adhere to the code of ethics. The
code of ethics may contain guidance on; integrity, safe work place, drugs and alcohol, freedom
of expression and privacy, avoiding conflict of interest, preserving confidentiality, protection of
firm assets, financial integrity and responsibility and obeying the law.

Firms may also use an Ethics training program to promote ethical behaviour. The training helps
to deal with ethical dilemmas and improve their overall ethical conduct. An ethical dilemma is a
situation that involves doing something that is beneficial to oneself or the organization, but may
be unethical. The training is helpful because employees confront ethical dilemmas at some point
during their careers.

Ethical cultures are built by establishing a strong ethical leadership and administrative tools that
reinforce and govern ethical behavior in organizations. Benefits of establishing a strong ethical
culture include:

• Potential avoidance of fines and penalties

• Decreased vulnerability
• Improved customer loyalty
• Improved employee commitment
• Improved brand loyalty
• Better access to capital
An entrepreneur should select a lawyer for the firm when developing a business venture. Most
entrepreneurs may see engaging a lawyer as an unnecessary expense, however there are ways in
which entrepreneurs can save on legal fees and increase the value of the relationship with their
legal practitioners. This may be done by grouping together legal matters and consult with the

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lawyer on several matters at one time. An entrepreneur can help the lawyer by writing the first
few drafts of the founders’ agreement or contract or help in gathering the documents needed to
deal with the legal issues. The entrepreneur may also ask the selected lawyer to join the firms’
advisory board, where in most cases advisory board members serve as volunteers to help young
firms get off to a good start. The lawyer becomes a coach and a confidant as well as a paid
service provider.

Importance of a founders’ agreement

A founders’ agreement also known as shareholders agreement, is a written document that deals
with issues such as the company equity, how individual founders will be compensated for the
cash, or “sweat equity” they put into the firm, and how long the founders will have to remain
with the firm for their shares to be fully invested.

Items included in a founder’s agreement are:

• Nature of the prospective business
• Identity and proposed titles of the founders
• Legal form of business ownership
• Apportionment of stocks or division of ownership
• Consideration paid for stock or ownership share
• Identification of any intellectual property signed over to the business by any of the
founders
• Description of any initial operating capital
• Buy back clause which explains how a founder’s share will be disposed of if he or she
dies, wants to sell, or is forced to sell by court order.
Ways of avoiding legal disputes
Entrepreneurs should avoid getting bogged down in legal disputes and therefore it is important
early in the life of a new business to establish practices and procedures to help avoid legal
disputes. There are several steps entrepreneurs can take to avoid legal disputes and
complications:

1. Have everything in writing, especially a nondisclosure agreement that binds an employee or

another party to not disclose a company’s trade secrets.

2. Meet all contractual obligations on time where possible, such as, paying vendors, contractors,
employees as agreed and delivering goods and services as promised. If an obligation cannot be
met on time the parties concerned should be communicated to early enough. Having an open
communication with the vendors if an obligation cannot be met and provide a realistic repayment
plan will help to maintain productive relationships between suppliers and vendors.

3. Set standards that govern employees’ behavior beyond what can be expressed through a code
of conduct.

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4. Obtain business licenses and permits required before the business is launched. In some places
an entrepreneur may find governments publish documents or maintain online resources that
provide guidance for doing business in their countries or cities.

Review questions:

1. Distinguish between a private limited company and a public limited

company.
2. Highlight the main benefits of running a business in for of partnership
business
3. Discuss the benefits of running a sole proprietorship business.
4. Analyze the importance of choosing the appropriate form of ownership
to an entrepreneur starting a technology business.
5. Discuss the importance of building a strong ethical culture in a firm.
6. Describe the steps taken by an entrepreneur in order to build a strong
ethical culture
7. Discuss the importance of having a founder’s agreement in place
before launching an entrepreneurial venture.

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