Question 1. “ Company form of organization emerged essential because of the limitations of the sole Proprietorship and partnership forms of organizations ”. Discuss.
Solution: Sole proprietorships and partnerships have the disadvantages of limited resources, unlimited liability, limited managerial skills, etc. The life and stability of these organisations also depend on the life and stability of the proprietors/partners. Hence, they are not considered suitable for large scale business, For large scale business, you require large investment and specialised. Thus, Company form of organization emerged essential because of the limitations of the sole Proprietorship and partnership forms of organizations. These merits of company are discussed as follows:
- Limited capital: The capital and other resources of an individual are always limited. The sole trader has to mainly rely on his own money and earnings, or he can borrow, if necessary, from relatives and friends. Thus, the proprietor has a limited capacity to raise funds. This makes it difficult to plan any large scale expansion. On the other hand, the capital raising capacity of the partnership firms is limited as compared to a joint stock company. Since company form of organisations are allowed to have a large number of shareholders, it is possible to raise capital in large amounts. Whenever new capital is required, it can issue shares and debentures. For this reason, only the company form of organisation is best suited.
- Unlimited liability: The proprietor has an unlimited liability. In case of a loss, even his personal property and belongings can be utilised for clearing business obligations. Therefore, he cannot take much risk and is discouraged from expansion of his business. Same is the most important drawback of a partnership firm is that the liability of the partners is unlimited. While in case of company, the liability of shareholders, unless and otherwise stated, is limited to the face value of the shares held by them or guarantee given by them. Their private property is not attachable to recover the dues of the company. Thus, this form of organisation is a great attraction to persons who are not willing to take risk as is inherent in sole proprietorship and partnership.
- No public confidence: Since the accounts are not published and publicised, the partnership firm may not be able to command confidence of the public. While, Companies are subject to Government controls and regulations. Their accounts are audited by a chartered accountant and are to be published. This creates confidence in the public about the functioning of the company.
- Non-transferability of interest: In partnership, no partner can transfer his interest in a firm without the consent of other partners. However, the shares of the public limited company can be sold at any time in the stock exchange. Shareholders can sell their shares whenever they want. There is no need to take the consent of other shareholders. Thus, shareholders can convert their shares into cash at any time without much difficulty.
- Uncertainty: The continuity and stability of the Sole proprietorship business depends solely on one person. When the man dies, there is a likelihood of closure of the business. On the other hand, the sudden death, lunacy or insolvency of a partner leads to the dissolution of partnership. This breeds uncertainty in the continuity of a partnership firm. However, this could be partly avoided if such matters are specified in the partnership agreement. While, Perpetual Succession provides stability to Company form of organisation. A joint stock company has a continuous existence. Its life is not affected by the death, lunacy, insolvency or retirement of its shareholders or directors. Members may come and go, but the company continues its operations until it is legally dissolved. Thus, a company has perpetual succession irrespective of its membership.
- Limited managerial capability: In the modern business, knowledge and skills in various fields like production, finance, marketing, etc., are required. It is not possible for a single individual to possess expertise in all these areas. So, his decisions may not be balanced. On the other hand, know that the management of a company is in the hands of the directors who are elected by shareholders. Normally, experienced persons are elected as directors. You also know that day-to-day activities are managed by salaried managers. These managers are the experts in their respective fields. As companies have large scale operations and profits, attracting good professional managers is easy by paying attractive salaries. Thus, company form of organisation gets the services of professionals on the Board of Directors and in various management positions.
- Risk of implied authority: Since each partner acts as an agent of the firm, acts of one partner would bind the firm and all the remaining partners. A dishonest or incompetent partner may lend the firm into difficulties and the other partners may have to pay for it. In case sole proprietorship all risk has to be borne by sole proprietor only. However, as the membership is very large, the business risk is divided among the several members of the company. This is an advantage for small investors.
- Limited number of owners: Since the resources of the sole trader are limited, it is suitable only for small business and not for large scale operations. On the other hand, In case of Partnership firm there is a limit of maximum partners (20 in non-banking firms and 10 in banking firms). However As there is no limit to the maximum number of shareholders in a public limited company, expansion of business is easy by issuing new shares and debentures. Companies normally keep part of their profits as reserve and use them for expansion.
- Less scope for economies of scale: Sole trader usually operates on small scale only. So, he cannot enjoy the benefits of large scale production or buying or selling. This may raise the cost of business operations. While companies operate on a large scale, they can take advantage of large scale buying, selling, production, etc. As a result of these economies of large scale operations, companies can provide goods to consumers at a cheaper price.
- No check and control: As the sole trader is the monarch of the business, no outsider can question him on his acts and deals. There are no checks and controls on the sole trader. While a company is governed by the Companies Act and it has to follow various provisions of the Act. It has to submit a number of returns to the Government. Accounts of a company must be audited by a Chartered Accountant. Thus, the company form of organisation has to comply with numerous and varied statutory requirements.
- No separate legal entity: The sole proprietorship business does not have an entity separate from the owner. The proprietor and the business enterprise are one and the same. While a company has a distinct entity separate from its members. A shareholder of a company can enter into contract with the company and can sue the company and be sued by it. We know that in the case of partnership, every partner is an agent of the firm and also that of the other partners. But the shareholder is not the agent of the company or its shareholders. He cannot bind them with his acts.