CHAPTER TWO - FORMS AND STRUCTURES OF BUSINESS ORGANISATION

CHAPTER TWO
FORMS AND STRUCTURES OF BUSINESS ORGANISATION
2.0 Learning Objectives……………………………………………………………….
2.1 Forms of Business Organisations………………………………………………….
2.1.1 Sole-Proprietorship……………………………………………………………….
2.1.1.1 Advantages and Disadvantages…………………………………………………
2.1.2 Partnership…………………………………………………………………………
2.1.2.1 Contents of Partnership Agreements……………………………………………
2.1.2.2 The Main Advantages of Partnership Over Sole-Proprietorship………………
2.1.3 Limited Liability Company………………………………………………………
2.1.3.1 Formation Procedure……………………………………………………………….
2.1.3.2 Statutory Books…………………………………………………………………….
2.1.3.3 Issued Share Capital………………………………………………………………...
2.1.3.4 Reserves and Provisions……………………………………………………………
1.3.5 Advantages and Disadvantages…………………………………………………….
2.1.4 Public Enterprise……………………………………………………………………
2.2 Summary and Conclusion…………………………………………………………..



CHAPTER TWO

FORMS AND STRUCTURES OF BUSINESS ORGANISATIONS

2.0  Learning Objectives
After studying this Chapter, readers should be able to understand the forms and structures of business organizations, their characteristics, advantages and disadvantages.

2.1 In an economy, in which free-enterprise is allowed and encouraged by the government, business organizations take different forms in this situation, we discuss four different forms of business organizations: sole-proprietorship, partnership, Limited Liability Company and public enterprise.

            2.1.1  Sole-proprietorship
It is a business owned by an individual.  He bears the responsibility for running the business and he alone takes the profits or loss. The sole-proprietorship is not regulated by special rules of law.

2.1.1.1 Advantages and disadvantages

Advantages

(a) The individual provides the capital and employs a handful of people, if and when necessary.
(b) He takes decisions quickly without consulting anybody.
(c) He is highly committed because the profit is entirely his own in case of   success and he depends on the business for his livelihood.
(d) There is privacy
(e) It is not regulated by special rules of law.

Disadvantages

(a) The finance available for expansion is limited to that which the sole trader can raise.
(b) The owner has unlimited liability because all his assets might be seized if the business goes bankrupt.
(c) It lacks continuity because the death of the owner automatically leads to the collapse of the business.

Sole-proprietorship is common in retailing, farming, personal services such as hairdressing, fashion designing etc.

 
2.1.2 Partnership

Partnership Formation
Partnership is the relationship which exists between two or more persons, commonly referred to as partners, carrying on a business in common with a view to making profit.  The business may also result in a loss although the purpose is that of profit.  Coming together is voluntary and exit of a partner may also be voluntary.

The Partnership Act 1890 and the Limited Partnership Act 1907 contain the provisions which govern the relationship between persons carrying on a business with the intention of making profit.

The maximum number of partners in a firm is twenty. There is no maximum limit for professional firms such as accountants and solicitors who have received the approval of the law for this purpose.  A firm with more than twenty members would normally be incorporated as a Limited Liability Company.

Most partnerships are formed under a formal agreement.  In the absence of an agreement, the Partnership Act 1890 provides among other things, that:
(a)  All profits and losses are to be shared equally between the partners   (b)  No interest is allowed on capital and current account.
(c) No remuneration will be paid to a partner.
(d) Any advance or loan made by a partner in excess of his agreed share of capital will attract interest at 5% per annum.
An agreement is most important, if it is intended that partners should be rewarded according to their differing contributions made to the firm in form of capital, expertise, experience or effort.  Resulting from this, an agreement would necessarily contain provisions regarding the following, to ensure as far as possible, that there is an equitable distribution of profits or losses.

(a) The amount of capital to be provided and maintained by each partner.
(b) The rate of interest (if any) to be paid on capital.
(c) The extent to which drawings are allowed and the rate of interest (if any) to be charged on drawings.
(d) The remuneration (if any) to be paid to partners for their services.
(e) The interest to be paid on any advance or loan made to the firm by a partner over and above his agreed capital.
(f) The proportions in which profits and losses are to be shared after taking account of any adjustments as a result of the above.

Decisions regarding the distribution of profits can be quite interesting in practice due to the search for an equitable relationship among partners.  If all partners provide equally in all respects, an equal distribution of profits might adequately represent each interest.  But differing amounts of capital, all other contributions to the firm being equal, would usually be compensated for by allowing interest on capital at an agreed rate.  In this way; each partner would be given a return on his capital before distribution of the remaining profit. Differences in partners‟ contributions in the form of expertise, experience or effort could be taken into account by salaries and/or differential distribution of profits.

The problems inherent in determining a just and equitable distribution of profits are not usually a concern of examination students.  A question will normally indicate:
(a) Whether salaries are to be paid.
(b) Whether interest is to be allowed on capital
(c) Whether interest is to be charged on Drawings, and
(d) How the remaining profit should be distributed.

Students‟ problems are usually technical, arithmetical and presentational.

A partnership will often maintain a fixed amount of capital.  Under these circumstances, it is preferable that only an agreed capital ratio should be credited to a separate capital account for each partner.  All other transactions involving partners such as share of profits, interest, salary, drawings, should be dealt with in their current accounts rather than through the capital accounts. It is simple in this way to keep a constant check on the current accounts; provided a partner’s Current Account is not overdrawn, the agreed capital at least must remain with the firm.  Of course, profits (or losses) are accruing over the whole of the year, and not just when the final accounts are prepared.  It follows therefore that an overdrawn current account is not necessarily an indication that a partner is not maintaining his agreed capital.  It is up to the partners to agree on the extent to which drawings are allowed and whether the drawings may exceed the current account balance at the beginning of the year.


  Partnership Agreements
  Since the essence of partnership is mutual agreement, it is desirable for the partners to come to some understanding before entering into partnership as to the conditions upon which the business is to be carried on and their respective rights and powers.

 The Partnership Act 1890 provides certain rules to be observed in the absence of any agreement.  The circumstances must determine whether these rules are applicable in the particular case and since many matters should be decided which are not included in these rules, it is desirable that a formal agreement be entered into with a view to preventing disputes in the future.  The advantages of written agreements need no emphasis and it is preferable that it should be under seal, since the character of a deed precludes contradiction by any party of the terms which have been agreed.

 Even though a formal agreement is made, this does not preclude subsequent variation where changing circumstances demand it; such variation can always be effected with the consent of all the partners, which may be evidenced by an amended agreement.

2.1.2.1 Contents of Partnership Agreements
 
The provisions affecting partnership accounts are as follow:
(a) Capital Contribution
The agreement states whether each partner should contribute a fixed or a flexible amount.
   
(b) Division of Profits and Losses
The basis as to how profits and losses shall be shared among the partners.

(c) Fixed or Flexible Capital
Whether the Capital Accounts are to be Fixed Account, or if drawings and profits are to be adjusted in the current accounts, or in the capital accounts.
 
(d) Interest on Capital and/or Drawings
Whether interest on any of the two or both, is to be allowed or charged before arriving at the profits divisible in the agreed proportions, and if so, at what rate.
(e) Current Accounts
Whether current accounts (if any) are to bear interest, and if so, at what rate.

(f) Partners‟ Drawings
Whether partners‟ drawings are to be limited in amount in order to prevent a negative balance against the capital account, and/or whether interests are to be charged on drawings and at what rate.
   
(g) Partners‟ Remuneration
Whether partners are to be allowed remuneration for their services before arriving at divisible profits, and if so, the amount of the remuneration.
 
(h) Accounting Records
Proper accounts shall be prepared at least once a year and that these shall be audited by a professional accountant and signed by all the partners.

(i) Signed Accounts
The accounts, when prepared and duly signed, shall be binding on the partners, but shall be capable of being reopened within a specified period on an error being discovered.

(j) Valuation of Goodwill
The method by which the value of Goodwill shall be determined in the event of admission, retirement or death of any of the partners.

(k) Compensation to the Estate of Deceased Partner
The method of determining the amount due to the estate of a deceased partner and the manner in which the liability to his payment within a specified period, by instalments of certain proportions and the rate of interest to be allowed on outstanding balances.
   
(l) Insurance Premiums
In the event of any partnership insurance policies, the method of treating the premiums thereon and the division of the policy must be stated.
 
       2.1.2.2  The main advantages of partnership over sole-proprietorship are:

(a) More finance is available
(b) Higher performance may be achieved since two heads are better than one.
(c) Decision-making is also swift since partners are friends and they are not many.

The disadvantages are:
(a) The major disadvantage is that the liability of members of the partnership is unlimited.

(b) The amount of capital the partners can raise is still too small to enable them carry out large investments.

(c) The death and bankruptcy of a partner may lead to the dissolution of the firm.

(d) Disagreement may occur between the partners.  They may find out that they are not compatible which may lead to the dissolution of the partnership.

2.1.3  Limited Liability Company

  Nature, Formation and Statutory Books Of Limited Liability Companies

 A limited liability company is a form of business organization that has a personality distinct from those of its owners.  The attraction of this form of business enterprise is its access to capital larger than what its promoters can provide.  Because of its distinct legal personality, it can sue and be sued in its name and enter into contracts for which it is solely liable.

 The following are different types of companies:
(a) Private Limited Liability Company;
(b) Public Limited Liability Company;
(c) Company Limited by Guarantee and
(d) Unlimited Liability Company.

Companies derive their existence under the provisions of the Companies and Allied Matters Act, Cap. C 20 LFN 2004.  The rules and procedures guiding the incorporation or formation of limited liability or unlimited liability companies are contained in Sections 18 – 49 of the Companies and Allied Matters Act, Cap. C 20 LFN 2004.

      2.1.3.1  Formation Procedure

(a) The name proposed by the promoter of the Company has to be searched for and approved by the Corporate Affairs Commission, which must be utilized within 60 days, otherwise the name has to be revalidated.
(b) A limited liability company, private or public, may be brought into existence when the documents enumerated below and appropriate fees are paid to the Registrar, Corporate Affairs Commission:

(i) A Memorandum of Association signed by at least two subscribers, dated and witnessed by Chartered Accountant, Chartered Secretary and a Lawyer facilitating the registration of the Company. Each subscriber must agree to subscribe for at least one share.

(ii) A minimum of 25% of the authorized share capital must be taken up at incorporation.

(iii) Articles of Association will be similarly signed, dated and witnessed by the Professionals involved in the registration of the Company as mentioned above.

(iv) A statement of nominal capital (unless the company is to have no share capital) must be stated.  Stamp duty varying with the amount of authorized share capital is payable. Rate is at present N3 for every N200 worth of shares.

(v) There is no upper limit to the amount of the authorized share capital, although the minimum is currently N10,000 for a private company while that of a public limited liability company is N500,000 (except in cases of special companies such as, banks and insurance companies).

(vi) A statutory declaration by a solicitor engaged in the formation of the company or by one of the persons named as a director or secretary that the requirements of the Companies and Allied Matters Act 2004 in respect of registration have been complied with.

(vii) A statement (in the prescribed form) of the particulars of the first directors and secretary and the first address of the company’s registered office. The persons named as directors and secretary must sign the form to record their consent to act in the relevant capacity and when the company is incorporated; these persons are automatically appointed.

(c) When the Registrar General, Corporate Affairs Commission is satisfied that all the documents are in order and that the objects specified in the memorandum are lawful he issues a certificate of incorporation.
(d) The purpose of the memorandum and articles of association is to define the constitution of the company.  The memorandum sets out basic elements of the constitution while the articles are mainly internal rules, but of interest to outsiders since they define the powers of the directors to enter into contracts on behalf of the company.  The memorandum prevails if there is any inconsistency between it and the articles.

(e) A private company may do business and exercise its borrowing powers from the date of its incorporation but a public company (incorporated as such) may not do business or borrow until it has obtained a trading certificate (not a statutory expression) from the Registrar General.

(f) The memorandum of every company limited by shares must include:
(i) The company’s name, which if the company is “limited” by shares or by guarantee, should end with the word limited.  A limited company may in some circumstances omit the word “limited” from its name.  An unlimited company does not end its name with the word “Limited”.
(ii) The country (not the address) in which the company’s registered office is to be situated.  This determines the nationality and the place of domicile of the company which cannot be changed.

(iii) The objects of the company contained in an “objects clause” which, because of the developments of company law over time, specifying both alternative business activities and express powers to engage in every kind of business which the company might wish to undertake.
The objects stated in the opening paragraphs are treated as „main objects‟ while the others are ancillary to them, unless the contrary is stated.
(iv) The liability of members: If the company is one limited by guarantee, this is followed by a second clause which states the maximum amount that each member undertakes to contribute in a winding-up to enable the company pay its debts.  The authorized share capital (of a company limited by shares) must disclose the amount of the share capital with which the company proposes to be registered and specify shares of stated value into which that amount is divided.  For example, the share capital of the company is  N100,000 divided into 200,000 shares of 50k each‟.  The amount of the authorized share capital may be increased (or reduced) in the manner provided by the articles, usually by passing an ordinary resolution.  The authorized share capital is the maximum amount in shares which the company may issue.

(g) The articles of association deal mainly with the internal conduct of the company’s affairs, e.g. the issue and transfer of its shares, alterations of its capital structure, conduct of general meetings, members voting rights, powers of directors and board meetings, dividends, accounts and notices.

(h) The articles of association usually delegate the power to allot and issue shares to the directors as one of their management functions. The formal procedure is that the subscriber applies for shares (often in response to an invitation by the company) and the directors accept his offer by deciding at a board meeting to allot shares to him. His name is entered in the register of members, a share certificate is issued and within one month of allotment; a return is submitted to the Registrar General.

2.1.3.2   Statutory Books
(a) Once the company has been formed and it commences trading it has a statutory obligation to prepare financial statements showing a true and fair view of the company’s operations and statement of affairs and keep accounting records sufficient to show and explain the company’s transactions.
(b) Redeemable Preference Shares
Under section 122 and 158 of the Companies and Allied Matters Act Cap C20 LFN 2004, a company so authorized by its articles may issue redeemable preference shares, provided that:
(i) There are in issue other shares which are not redeemable.
(ii) The redeemable shares may not be redeemed unless they are fully paid.
(iii) The terms of redemption provide for the company to make payment at the time shares are redeemed.  The redemption may be effected on such terms and in such manner as may be provided by the articles as long as the provisions of the Act are complied with.
(iv) Redemption is made out of the:
- Distributable profits of the company
- Proceeds of a fresh issue of shares made for the purposes of the redemption.
(v) Any premium payable on redemption is payable out of the company’s distributable profits, except: the premium payable on the redemption of redeemable preference shares which were issued before the appointed day may be paid out of the share premium account or partly out of the distributable profits (section 158(4) of the Companies and Allied Matters Act, Cap. C20, LFN 2004).
(vi) Where the redemption is made out of the proceeds of a fresh issue of shares made for the purpose of the redemption and the shares to be redeemed were originally issued at a premium, any premium payable on their redemption shall be paid out of the share premium account up to an amount equal to the lower of:
 The aggregate of the premium received by the company on the issue of the shares redeemed, or

 The current amount of the company’s share premium account (including any sum transferred to that account in respect of premium on the new shares).

Where specific provision is made in the articles, preference shares may be participating preference shares.  This type of shares entitles the holders to share in any remaining profits after the preference shares and ordinary shares have received specified dividends.

(c) Ordinary shares
The ordinary share capital of a company is often termed the „equity capital.‟ Ordinary shares may be divided into preferred and deferred ordinary shares, in which case the balance of the profit is shared between the two types of ordinary shares in some prescribed proportions.

  2.1.3.3 Issued Share capital

A company does not necessarily issue all its authorized share capital immediately, or indeed ever.  The amount of capital that it does issue, whether for cash or otherwise, is known as its Issued Share capital.

Both the authorized share capital and the issued share capital must be shown in a company’s statement of financial position.
   
  2.1.3.4 Reserves and Provisions

Reserves are grouped under a separate heading in the statement of financial position with „opening reserves‟ shown first and ending with the balance carried forward on the income statement, i.e. retained profit.

It is important that reserves are distinguished from provisions.  The expressions „Reserves‟ and „Provisions‟ are defined in the Companies and Allied Matters Act, Cap. C20 LFN 2004, as follows:

(a) „Provision‟ means any amount written off or retained by way of providing for depreciation, renewals or diminution in value of assets or retained by way of providing for any known liability of which the amount cannot be determined with substantial accuracy.

(b) „Reserves‟ include any amount written off or retained by way of providing for depreciation, renewals or diminution in the value of assets or retained by way of providing for any known liability, or any sum set aside for the purpose of its being used to prevent undue fluctuations in charges for taxation.

(c) Any excess of the amount retained by way of providing for any known liability which in the opinion of the directors is reasonably necessary for the purpose, shall be treated as a reserve and not as a provision.

It should be noted, particularly, that the expression „provision‟ should be used only to indicate known depreciation, renewals or diminution in the value of assets and known liabilities, the amount of which, however, cannot be estimated with substantial accuracy.  It follows that the provisions will generally be deducted from the assets to which they relate.

  2.1.3.5 Advantages and disadvantages of Limited Liability Company
   
Advantages
(a) The liability of the shareholders is limited to the amount they have subscribed to the firm’s capital if the company goes bankrupt.

(b) It can raise substantial amount of capital from the numerous shareholders or from financial institutions.

(c) The chance of survival is high because the company is controlled and managed by highly skilled professional management team appointed by the Board of Directors who are elected by and answerable to the shareholders.

(d) The limited company is a separate legal entity distinct from its members.  It can sue and be sued in its name.

(e) Unless it is wound up, a limited company has perpetual succession so that it is not affected by the death, bankruptcy, mental disorder or retirement of its members.

(f) Floating charges can be created by a limited company.

(g) Shares in a public company can be transferred without the consent of other members.    

  Disadvantages
(a)  Formation of Limited Liability Company requires costly legal expenses
(b)  Decision making may be delayed due to bureaucratic bottlenecks.
(c) The members of the company have no power to manage its affairs.
(d) Much legal and publicity formalities are observed e.g. filing of annual returns, annual general meeting etc.
 
2.1.4 Public Enterprises

The public corporation is an enterprise owned by and controlled by the government.  The government provided the capital for the company.  The Commissioner (Minister) acting on behalf of the State or Federal government appoints the members of the Board of Directors who in turn formulate policies within the enabling Act establishing the Corporation and the framework.  Examples of public corporation are Ghana Airways, the Nigerian Railway Corporation, the Nigerian Ports Authority and the Nigerian National Petroleum Corporation.

Advantages
(a) Some activities such as the generation of electricity, provision of port facilities and rail transport services involve huge financial considerations which the private entrepreneurs cannot provide.  These facilities must be provided to quicken the pace of economic development and industrial growth.

(b) It enables some natural resources, especially minerals to be efficiently exploited and effectively managed.

(c) Some essential goods or services if left in the hands of private business may not be sufficiently provided or may be provided at exorbitant prices.  Thus, the common people will not be able to afford them as a result of which their conditions of living will worsen.

(d) The public company can borrow money externally by issuing bonds or debentures.  This is not possible for the private company.

The major disadvantage of public enterprises is that members of the Board of Directors are political appointees to control and manage the corporation.  At times, they  may not possess the relevant skills to manage such organization efficiently.  Some members of staff are appointed on political grounds and quota basis, resulting in low quality of labour.

The performance of public enterprise is poor when compared with the private sector.  Most of the public enterprises are being run at a loss as the motive for establishing them is not for profit. They receive subventions from the government.

2.2  Summary and Conclusions

Chapter 2 dealt with the forms and structures of business organizations covering their characteristics, advantages and disadvantages.

At the end of the chapter, students would have sufficiently familiarized themselves with;  -  advantages and disadvantages of Sole Trader.
- Procedure for the formation and drafting of Partnership Deed.
- Procedure for the formation of limited liability company, the required statutory books and sources of capital
- Advantages and disadvantages of Public Enterprises.