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Cambridge IGCSE0450

Types of business organisation

Business Studies 0450 Chapter Notes

What this chapter covers

Types of business organisation - The main features of different forms of business organisation
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In this chapter

  1. 1Sole traders
  2. 2Partnerships
  3. 3Private limited companies
  4. 4Public limited companies
  5. 5Risk, ownership and limited liability
  6. 6Franchises and joint ventures
  7. 7The public sector
  8. 8Recommending a suitable form

1. Sole traders

A sole trader is one person who owns the business and has complete control of it. The owner makes all the decisions and keeps all the profit. It is easy to set up, with few legal requirements.

The owner has unlimited liability, so personal assets are at risk if the business cannot pay its debts. The business is unincorporated, with no separate legal identity. Access to finance is limited, which could limit expansion.

A sole trader can still employ workers. Do not write that the owner must do all the work. A question about sole traders in general is generic, so it has no marks for application.

Examiner insight

“Although candidates were able to identify points such as ‘being their own boss’ or ‘unlimited liability’ very few were able to explain how these represented an advantage or disadvantage to a sole trader.” “Some suggested there would be a ‘lack of ideas’ or ‘having to do all the work’ which ignored the fact that a sole trader can still employ people.”

Worked example 16 marks

Peter wants to start up a small business as a photographer who takes photographs at weddings. Peter will operate his business as a sole trader.

Do you think the advantages of being a sole trader are greater than the disadvantages? Justify your answer.

  1. 1

    Knowledge: the owner keeps all the profit. [1]

  2. 2

    Analysis: so the owner has an incentive to work harder. [1]

  3. 3

    Knowledge: a sole trader has less access to finance. [1]

  4. 4

    Analysis: this could limit expansion. [1]

  5. 5

    Evaluation: decision. The disadvantages are greater, because a business that misses the opportunity to expand could have less potential sales and revenue. [1]

  6. 6

    Evaluation: justification. If costs remain the same, there could be less potential profit. [1]

2. Partnerships

A partnership is a business owned by two or more people. Like a sole trader, it is an unincorporated business. Write that the partners own it. ‘Run’ or ‘manage’ loses the mark.

Partners share the work and the risk. They bring more capital, more ideas and additional skills.

The partners have unlimited liability. They can disagree, and that can slow decisions.

Examiner insight

“Although candidates were able to identify points such as ‘shared risk or workload’ and ‘unlimited liability’ most found it difficult to develop their points to show how these represented an advantage or disadvantage to a partnership.” “Weaker candidates could identify appropriate advantages and disadvantages, but these were often just listed points such as ‘a partnership can lead to disagreements and it has unlimited liability’.”

Worked example 14 marks

Kiran and Dev run Spice Lane Catering as a partnership. They cook food for weddings. Each partner invested textdollar10 000 to buy ovens and a delivery van.

Outline one advantage and one disadvantage to Spice Lane Catering of being a partnership.

  1. 1

    Knowledge: advantage. More capital can be raised. [1]

  2. 2

    Application: Kiran and Dev put in textdollar20 000 between them for the ovens and the van. [1]

  3. 3

    Knowledge: disadvantage. The partners have unlimited liability. [1]

  4. 4

    Application: if Spice Lane Catering cannot pay its food suppliers, Kiran's and Dev's personal possessions could be sold. [1]

3. Private limited companies

A private limited company is a business owned by shareholders, but its shares cannot be sold to the public or on the stock exchange. They can only be sold to friends and family, or people the owners know.

Its shareholders have limited liability. There are legal formalities to set it up, and shareholders expect dividends, so the profit is shared.

A private limited company is unlikely to be taken over without the consent of its shareholders. To define the term, write about the shareholders and who can buy the shares. Limited liability is a feature, not the definition.

Examiner insight

“Candidates tended to describe features such as limited liability rather than define the term.” “Some responses confused private limited company with private sector businesses.”

Worked example 12 marks

Define ‘private limited company’.

  1. 1

    Businesses owned by shareholders. [1]

  2. 2

    Their shares cannot be sold to the public / on the stock exchange. They can only be sold to friends and family / people they know. [1]

4. Public limited companies

A public limited company is owned by shareholders, and it can sell shares to the public on the stock exchange. It is in the private sector. The government does not own it.

Selling shares lets it raise large amounts of finance, and banks are more willing to lend to it. It can then grow and expand.

There are costs. It must publish its accounts, so competitors know how well it has performed. There are more legal formalities, which take time. There is a risk of takeover, so the original owners may lose control.

Examiner insight

“An incorrect answer given by many candidates was that the business would benefit from limited liability. Such answers failed to recognise that the business was currently a private limited company and therefore already had this benefit.” “Many candidates made vague statements about ‘access to capital’ and ‘control’.”

Worked example 16 marks

APL is a public limited company. It manufactures mobile phones. APL has 20 000 employees working in its 5 factories in country X.

Do you think the advantages of being a public limited company are always greater than the disadvantages? Justify your answer.

  1. 1

    Knowledge: a public limited company can raise large amounts of finance. [1]

  2. 2

    Analysis: so it can continue to grow. [1]

  3. 3

    Knowledge: there are legal formalities to complete. [1]

  4. 4

    Analysis: these can take time away from other activities. [1]

  5. 5

    Evaluation: decision. The advantages are greater, because without sufficient funds the business may have to delay any expansion plans, risking its ability to be competitive. [1]

  6. 6

    Evaluation: justification. Staying competitive is likely to be worth the time taken to complete the legal formalities. [1]

5. Risk, ownership and limited liability

The owners of an unincorporated business, such as a sole trader or a partnership, risk their personal possessions: they have unlimited liability for its debts.

In a limited company, the owners are shareholders with limited liability. They risk the capital they invested, but not their personal possessions.

A limited company is also a separate legal entity, which is a different idea from limited liability. Ownership differs too: only a limited company can sell shares to raise capital.

Examiner insight

“Many recognised limited liability as a feature of a limited company but then needed to outline how this was different to an unincorporated business.” “Some candidates needed to understand the difference between limited and unlimited liability.”

Worked example 14 marks

Tomas is a sole trader. His shop, Greenfield Bikes, fails owing suppliers textdollar40 000.

Outline how his liability would differ as a shareholder who had invested textdollar15 000.

  1. 1

    Knowledge: a sole trader has unlimited liability. [1]

  2. 2

    Application: Tomas's possessions could be sold to pay the textdollar40 000 owed to suppliers. [1]

  3. 3

    Knowledge: a shareholder is only liable up to the amount invested. [1]

  4. 4

    Application: as a shareholder in the bicycle shop, Tomas would lose at most his textdollar15 000. [1]

6. Franchises and joint ventures

A franchise gives the franchisee the right to use the brand name of an existing business, the franchisor, in return for payment. The franchisee does not buy the brand, only the right to use it.

The franchisee has a lower risk of failure, advertising by the franchisor, and training and advice. It has less control, pays a licence fee, and shares its profits with the franchisor. The franchisor expands faster, but a franchisee's actions can damage its reputation.

In a joint venture, two or more businesses work together. They share the costs and the risk, their ideas and the partner's knowledge of the local market. They share the profits too, and disagreements can arise.

Examiner insight

“A common error was to assume the franchisee bought the brand rather than the right to use it.” “It was clear that many candidates were unfamiliar with the concept of joint ventures or confused the term with franchising or mergers.”

Worked example 16 marks

Crunch Chicken is a small chain with 4 restaurants. It plans to sell franchises to open restaurants in other towns.

Explain two benefits to Crunch Chicken, the franchisor, of selling franchises.

  1. 1

    Knowledge: selling franchises allows quicker expansion. [1]

  2. 2

    Application: the franchisee makes the bulk of the investment in each new restaurant, so Crunch Chicken does not pay for the premises. [1]

  3. 3

    Analysis: so Crunch Chicken can open in several towns faster than its own funds allow. [1]

  4. 4

    Knowledge: the franchisee pays fees to the franchisor. [1]

  5. 5

    Application: every new Crunch Chicken restaurant pays a fee for the right to use the name. [1]

  6. 6

    Analysis: so Crunch Chicken gains a share of the profit without running the restaurant. [1]

7. The public sector

The public sector is made up of businesses and organisations owned by the government. A public corporation is one of them: a business that the government owns. Writing only that it is ‘in the public sector’ does not define it.

A public limited company is different. It is in the private sector and is owned by shareholders, not by the government.

Say that the government owns the business, not simply that it runs it. A public corporation is not the government itself, so do not give it government objectives such as job creation.

Examiner insight

“A common mistake was to confuse the term with a public limited company, which is an organisation in the private sector.” “Some responses needed more precision by referring to the government owning the business rather than simply running it.”

Worked example 14 marks

Northvale Water supplies water to a city and is a public corporation. Sellmore plc makes televisions and is a public limited company.

Outline one difference in ownership between Northvale Water and Sellmore plc.

  1. 1

    Knowledge: a public corporation is owned by the government. [1]

  2. 2

    Application: the government, not shareholders, owns the business that supplies the city's water. [1]

  3. 3

    Knowledge: a public limited company is in the private sector and is owned by shareholders. [1]

  4. 4

    Application: members of the public can buy shares in the television maker on the stock exchange. [1]

8. Recommending a suitable form

To recommend a form of business organisation, use the details in the question: how much capital the business needs, how much risk the owners will accept, and how much control they want to keep.

Compare only the forms that are suitable for that business. Explain the consequence of each advantage and disadvantage. Then justify the choice and say why the alternative was rejected.

Do not list an advantage of one form and then give its mirror as a disadvantage of the other. A mirror point is credited once.

Examiner insight

“Some candidates ignored the word ‘suitable’ in the question and focused on examples such as public limited companies, franchises or joint ventures.” “Another common mistake was to list an advantage of a sole trader e.g., keep all the profits and then give the mirror of this point for private limited companies e.g., had to share the profit, again this limited the marks that could be awarded.”

Worked example 112 marks

Sana runs Shine Salon as a sole trader. A second salon costs textdollar50 000. She has textdollar30 000. A bank refused her a loan. She fears for her house and wants to keep control.

Consider remaining a sole trader and becoming a private limited company. Recommend which Sana should choose. Justify your answer.

  1. 1

    Knowledge: a sole trader has limited access to finance and unlimited liability. [1]

  2. 2

    Application: Sana has textdollar30 000 and no loan, so she is textdollar20 000 short of the textdollar50 000. [1]

  3. 3

    Analysis: the second salon cannot open, so Shine Salon misses the chance to expand. [2]

  4. 4

    Knowledge: a private limited company can sell shares to friends and family. [1]

  5. 5

    Application: people Sana knows could buy textdollar20 000 of shares, leaving her with 60%. [1]

  6. 6

    Analysis: the salon opens. With limited liability Sana risks only her investment, not her house. With most of the shares she still controls decisions. [2]

  7. 7

    Evaluation: decision. Become a private limited company. Only this pays for the salon, and it removes the risk to her house while she keeps 60% of the shares. [2]

  8. 8

    Evaluation: rejecting the alternative. A sole trader keeps all the profit, but from one salon only. Sharing the profit of two salons as dividends is a smaller cost than not expanding. [2]

Recap

  • Sole trader: one owner with complete control, keeps all the profit, unlimited liability.
  • Partnership: owned by two or more people, unincorporated, more capital and ideas, unlimited liability.
  • Private limited company: owned by shareholders, shares sold only to friends and family.
  • Public limited company: sells shares to the public on the stock exchange. It is in the private sector.
  • Unincorporated owners have unlimited liability. Shareholders risk only what they invested.
  • A franchisee buys the right to use a brand name. A joint venture is businesses working together.
  • Public sector: owned by the government. A public corporation is a business the government owns.
  • To recommend: use the facts, develop each point, justify one form, and say why you rejected the other.

End-of-chapter exercise

Test yourself on the whole chapter. Work through these before moving on.

  1. Kofi and Esi are partners in Lakeside Café. Define ‘partnership’.2 marks
  2. Ali repairs bicycles in his own shop as a sole trader. Identify two features of a sole trader.2 marks
  3. City Water supplies water to a town. It is a business in the public sector. Define ‘public sector’.2 marks
  4. Rosa and Lee each invested textdollar5 000 in Harbour Tiles Ltd, a private limited company that fits bathroom tiles. The business closes owing its suppliers textdollar50 000. Outline how Rosa's liability differs from the liability she would have had as a partner in a partnership.4 marks
  5. Mina buys a franchise of Brew Bros, a chain of 200 coffee shops. She will open in a town where nobody knows her. Brew Bros sets the menu and the prices. Outline one advantage and one disadvantage to Mina of buying the franchise.4 marks
  6. Zest Juice sells fruit juice in its home country. It forms a joint venture with Mango Sun, a business in country X, to sell juice there. Outline one benefit and one drawback to Zest Juice of the joint venture.4 marks
  7. Kay and Jo run Moonlight Candles as a partnership. They need new equipment to make more candles. They are thinking of becoming a private limited company. Outline one difference between a partnership and a private limited company that matters to Moonlight Candles.4 marks
  8. Hasan owns Hasan's Hardware as a sole trader. He sells tools and paint from one shop and employs two assistants. He wants to buy more stock but has used all his savings. Explain two disadvantages to Hasan of being a sole trader.6 marks
  9. Pixel Ltd is a private limited company that designs phone cases. A family of four owns all 100 000 of its shares. Pixel Ltd needs textdollar3 000 000 to build a factory. It plans to become a public limited company and sell 150 000 new shares to the public at textdollar20 each. Do you think the advantages to Pixel Ltd of becoming a public limited company are greater than the disadvantages? Justify your answer.6 marks
  10. Omar runs Bright Bakes as a sole trader in one town and has 3 employees. He wants to open two more bakeries costing textdollar120 000. He has textdollar60 000 of savings, and a bank will lend textdollar20 000. His friend Nadia, a baker, offers to invest textdollar40 000, either as a partner or as a shareholder. Omar fears losing his house if the expansion fails. He also wants to keep control of decisions. Consider forming a partnership with Nadia and becoming a private limited company. Recommend which Omar should choose. Justify your answer.12 marks

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