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Home1.2 - Types of organizations
1.2 - Types of organizations
The private and public sectors
Organizations in the private sector: Owned and controlled by private individuals and businesses, rather than the government
Main goal (for most): Make profit (the positive difference between a firm’s sales revenue (the money earned from selling its products)) and its costs (production expenditure such as wages and rent)
Organizations in the public sector: Under ownership and control of the government
Provide essential goods and services
Education, health care, etc
Reasons for public sector business activity
Ensures that everybody has access to basic services
To protect citizens and businesses through institutions, such as the police
To create employment opportunities
To stabilize the economy
Profit-based organizations
Profit-based organizations differ in terms of ownership and control, how they raise finance, and how the profits are distributed
Three main types of profit-based organizations:
Sole traders
Partnerships
Limited liability
Profits are made by subtracting total costs from total revenue
Sole traders:
Also known as a sole proprietor
Runs and owns a personal business
Held responsible for its success or failure
Are often small family-run businesses and can be set up with relatively little capital
Start-up capital: Usually obtained from personal savings and borrowing
The business is unincorporated
Unincorporated: The owner is the same legal entity as the business
Advantages | Disadvantages |
Privacy: Sole traders enjoy privacy as they do not have to make their financial records public | Limited economics of scale: Not able to exploit the benefits of large scale production, so their prices might be less competitive compared with those of larger rivals |
Profit taking: The sole trader is the only owner and receives all profits made by the business | Lack of continuity: Running a business can be jeopardised if the owner isn’t present |
Few legal formalities: Sole traders are quite easy to set up and start-up costs are lower compared to other types of business organizations | High risks: Statistically, sole proprietorships have the largest risk of failure |
Partnerships:
A profit-seeking business owned by 2+ people
Ordinary partnerships: The maximum number of owners is 20 (number can vary, depending on the country)
Partnerships are financed mainly from the personal funds of each owner
Can also raise money from owners who don’t actively take part in the running of the partnership
Called silent partners or sleeping partners; Eligible for a portion of the profits
Most partnerships formulate a legal agreement between the partners
Likely to include:
The amount of finance contributed by each partner
The roles, obligations, and responsibilities of each partner
How profits or losses will be shared among the partners
Conditions for introducing new partners
Clauses for the withdrawal of a partner
Procedures for ending the partnership
Advantages | Disadvantages |
Financial strength: More financial strength than sole proprietorships | Prolonged decision-making: Decision-making is likely to take longer as there are more owners involved. Disagreements and conflict might also occur. |
Specialisation and division of labour: Partners can benefit from shared expertise, shared workload and moral support. | Lack of harmony: Disagreements and conflicts are common, but there must be mutual trust. Each partner is legally and financially answerable to the others, so a mistake made by one person can reduce the profits for all other partners |
Cost-effective: Can be more cost-effective than sole traders as each partner specialises in certain aspects of their business, thus raising productivity | Unlimited liability: Partnerships are responsible for their debts ‘wholly and severally’ meaning the debts can be repaid by either one partner (wholly) or shared among the partners (severally). |
Companies (corporations)
Businesses owned by their shareholders
Shareholders: Individuals or other businesses that have invested money to provide capital for a company
Corporations are sometimes called joint-stock companies: The shares of the business are jointly held by numerous entities
Companies are incorporated businesses
A legal difference between the owners of the company (shareholders) and the business itself
Companies have limited liability - Shareholders don’t stand to lose personal belongings if the company goes into debts
The maximum they could lose is the value of their investment in the company
A board of directors (BOD): Elected by the shareholders to run the company on their behalf
Elected because of their skills and expertise and because shareholders don’t want to get involved in the daily running of the company
Each share held means one vote
Individual shareholders have very little say, as the larger institutional investors and directors hold most of the shares
Two types of limited liability companies:
Private limited companies
A company that can’t raise share capital from the general public
Shares are sold to private family members and friends
Can’t be traded without the prior agreement from the BOD
Many private limited companies are run as family businesses and will usually have the word “Limited” or the letters ‘Ltd.’ after its name
Public limited companies
Able to advertise and sell its shares to the general public via a stock exchange
Often carries the letters ‘PLC’ after its name, but varies between countries
2 documents must be produced and submitted before companies can begin trading:
Memorandum of Association: A relatively brief document outlining the fundamental details of the company
Name, main purpose, registered address and the amount of share capital invested
Articles of Association (or Articles of Incorporation): Stipulates the internal regulations and procedures of the company
The rights, roles and power of the BOD and shareholders
Administrative issues are covered
Once the documents have been approved and an application fee has been paid → a Certificate of Incorporation is issued
Recognizes the business as a separate legal entity from its owners and allows the business to start trading as a limited liability company
Floatation: When a business first seels all or part of its business to external investors (shareholders)
Known as initial public offering (IPO)
Makes the company list on a stock exchange
Helps to generate additional sources of finance
The largest shareholders of companies tend to be institutional and commercial investors
Companies have shares in other companies
Porsche is the majority shareholder of Volkswagen
Shareholders face potential risks, despite the limited liability
Unsuccessful companies can’t distribute any dividends
Shareholders place their trust in the management team to run the company on their behalf, although interests may conflict
All companies must hold an Annual General Meeting (AGM) → Allow the owners to have a say in the running of the business
There are 3 main processes at a typical AGM
Shareholders vote on (promises or declarations) and re-election (or sometimes election) of the board of directors
Shareholders ask questions of the chief executive officer, directors and chairperson about various aspects of the company
Shareholders approve the previous year’s financial accounts after the directors present the annual report containing information about the company’s performance
Advantages | Disadvantages |
Economies of scale: Due to their larger size, companies can benefit from economies of scale (lower unit costs of production as the firms enlarges) | Added complexities: Running a sole-proprietorship or partnership is cheaper and less bureaucratic than running a corporation |
Tax benefits: Sole traders and partnerships pay income tax on their profits, and companies pay corporate tax on their profits. The highest income tax rate tends to be greater than the rate for corporate tax. | Disclosure of information: Financial data must be provided to all shareholders. This can be a time consuming and expensive task as auditors have to be paid and annual reports have to be published and distributed. Privacy no longer exists. |
Continuity: The legal difference between the company and its owners means it can continue to operate as a separate entity, even with a change of owners | Loss of control: Public limited companies face the potential threat of a takeover by a rival company that purchases a majority stake in the business. |
For-profit social enterprises
Social enterprises: Revenue-generating businesses with social objectives at the core of their operations
Can be operated as a non-profit organization or as a for-profit organization
All social enterprises have 2 main goals:
To achieve social objectives
To earn revenue in excess of costs
There are 3 main types of for-profit social enterprises:
Cooperatives
For-profit social enterprises owned and run by their members, with the common goal of creating value for their members by operating in a socially responsible way
Share any profits earned between their members
3 main types of cooperatives, all democratically owned and controlled:
Consumer cooperatives: Owned by the customers who buy the goods and/or services for personal use
Credit unions (financial services)
Worker cooperatives: Set up, owned and organized by their employee members
Cooperatives involved in production and manufacturing
Producer cooperatives:
Cooperatives that join and support each other to process or market their products
Advantages | Disadvantages |
Incentives to work: Employees have a key stake in the cooperative so are more interested in how it performs | Limited sources of finance: Cooperatives might suffer from a lack of finance as most of them can’t raise funds through a stock exchange |
Social benefits: Cooperatives are run on socially responsible principles, leading to gain for other members of society rather than for the owners | Limited promotional opportunities: Cooperatives tend to have flatter organizational structures, so there are fewer opportunities for employees to progress in their professional careers. |
Microfinance providers
Type of financial service aimed at entrepreneurs of small businesses, especially females and those on low income
Enables the disadvantaged members of society to gain access to essential financial services
Advantages | Disadvantages |
Social wellbeing: Successful applicants who receive microfinance are less likely to take their children out of school. | Immortality: Critics claim that microfinance is an unethical operation of lenders as the providers are for-profit organizations, so profit from the poor and the unemployed. |
Job creation: The effective use of microfinance can help create new job opportunities, with beneficial effects on society as a whole | Limited eligibility: Not all poor individuals qualify for microfinance. As a for-profit organization, microfinance providers have to minimise their own risks by ensuring borrowers have the ability to repay their loans |
Public-private partnerships (PPP)
Occurs when the government works together with the private sector to jointly provide certain goods or services
It is argued that a public-private partnership can benefit from the dynamics, finance and efficiency of the private sector alongside the benefits of public sector funding and support
Profit is not the priority
Advantages | Disadvantages |
Because the private partner may provide project financing, PPPs can permit the completion of projects that the government might have been unable to finance on its own. | Setting up and monitoring a PPP can be expensive; PPPs may therefore not be suitable for smaller projects. |
Because the private partner shares in the risk and reward of the project, they are incentivised to innovate in order to save costs. | Because PPPs require that contracts be signed for a long duration, they may not be appropriate in certain sectors, such as IT, where conditions change rapidly. If the cost of IT services declines rapidly, for example, the public sector could end up overpaying for services if the PPP contract cannot be renegotiated. |
Governments may benefit from the expertise of private enterprise. |
Non-profit social enterprises
Businesses run in a commercial-like manner but without profit being the main goal
Use their surplus revenues to achieve their social goals rather than distributing the surplus as profits or dividends
The term “non-profit organization” doesn’t mean that the business isn’t allowed to make a profit or surplus but that this must be retained in the business for its self-preservation and growth
Non-governmental organizations (NGOs)
Non-governmental organization: Non-profit social enterprise that operates in the private sector (not owned or controlled by the government)
Also known as private voluntary organizations (PVOs)
Don’t aim primarily to make a profit
They’re set up and run for the benefit of others in society
The United Nations defines NGOs as “private organizations that pursue activities to relieve suffering, promote the interests of the poor, protect the environment, provide basic social services or undertake community development.”
2 types of NGOs:
Operational NGOs: Established from a given objective or purpose and tend to be involved in relief-based and community projects
Advocacy NGOs: Take a more aggressive approach to promote or defend a cause, striving to raise awareness through direction action
Charities
A non-profit social enterprise that provides voluntary support for good causes, such as the protection of children, animals, and the environment
Key function: Raising funds from individuals and organizations to support a cause that is beneficial to society
They must use refined marketing techniques to catch the attention of donors
Depending on the organization → Some managers and employees of charities will be paid for their services, whilst others operate on a voluntary basis
Advantages | Disadvantages |
Social benefits: Charities provide financial support for the welfare of society, whether domestic or international | Bureaucracy: Charities must be registered before they can operate. Governing bodies can also place restrictions on what charities can and can’t do |
Tax exemptions for NPOs: Charities are exempt from corporate tax | Charity fraud: Financial activities must be recorded and reported to a governing body. This is to protect the interest of donors and to prevent charity fraud. |
Limited liability: Charities can register to be limited companies to protect the interest of employees and managers who have limited liability | Inefficiencies: Although limited liability charities offer protection to the owners, it also means that those who run the charity are not personally held liable for any debts incurred. |