The four business organizations in the private sector are sole proprietorships, partnerships, private limited companies and public limited companies. They also have distinct advantages and disadvantages.
Businesses in the private sector operate in a variety of different industries. But, they share something in common, namely profit-oriented. They make money by producing goods and services to satisfy consumers.
The private sector contributes greatly to the economy. By providing goods and services, businesses create jobs for households. Thus, an increase in their output contributes to more jobs and income.
Then, businesses in the private sector also have a variety of operating scales. They range in size from small businesses targeting a local market and few employees to giant multinational corporations with millions of dollars in revenue and recruiting large numbers of employees.
The areas of operation in the private sector are also diverse. Some businesses operate in the primary sector and produce agricultural and mining commodities. Others operate in the secondary sector and process inputs from the primary sector into various products such as food, beverages, clothing and automotive. Then, there are also businesses in the tertiary and quaternary sectors, which provide services such as finance, information technology, trade, tourism, and hotels.
The private sector is profit-driven. Businesses produce goods and services for sale. They create value by processing inputs into higher value outputs. Then they sell it at a higher price to make a profit.
Different from the public sector, businesses in the private sector face competition. They try to outperform each other to satisfy consumers. It then forces them to be more efficient and productive in order to be competitive.
Business organizations in the private sector
There are various types of business ownership in the private sector. The four most common are:
- sole proprietorship
- Private limited company
- Public limited company
The business organizations in the private sector above differ in aspects such as the extent of the owner’s responsibilities to operations, financial and legal obligations. Each has advantages and disadvantages.
Alright, let’s discuss one by one. For the last two, I combined them in one subheading: limited companies.
This business organization is owned by one person. The owner is responsible for all operations and functional areas. The other four characteristics are:
- Owners and businesses are not considered legally separate entities.
- Owners have unlimited liability, which can lose personal assets to pay off business debts.
- Business liability also applies to business legal obligations.
- The scale of business operations is small, with few employees and usually, serves the local market.
The advantage of a sole proprietorship is flexibility. Owners can make all business decisions on their own and are free to run the business as they see fit. Therefore, they can stop business at any time and pursue business in other areas.
Then, the owner is also entitled to all the profits of the business, because in essence, the money of the business is the money of the owner.
Businesses are easy to set up and have fewer rules and regulations than other business organizations in the private sector.
However, sole proprietorships also have a major disadvantage, namely unlimited liability. The owner takes all the business risks, including failure to make a profit. Then, they are also responsible for business debts, which risk losing personal assets to pay off business debts.
The next disadvantage is limited resources. Businesses usually rely on money from owners. Creditors such as banks are also reluctant to lend money because businesses have a high risk profile. Businesses are also unable to access alternative sources of funding such as stocks and bonds.
Limited resources also make competitive capacity low. Sole proprietorships are vulnerable to competitive pressure from more established competitors. Owners also find it difficult to recruit experienced employees because they prefer to work in more established companies.
Stress and exhaustion is another disadvantage. Owners are in charge of the entire operation, requiring them to play different roles in functional areas and work long hours.
Partnerships are established by two or more owners. We call them partners. This business can be found in professional services such as lawyers and real estate agents.
Each partner shares responsibility for the operations, obligations and profits of the business. They work according to partnership arrangements and deeds.
In general, partners have unlimited liability – under a general partnership. However, in specific cases, partners may have limited liability. The variations can be Limited Partnership, Limited Liability Partnership (LLP), and Limited liability limited partnership (LLLP).
Unlike a sole proprietorship, a partnership has more resources. Each partner can contribute capital and bring different skills to the business. They work together to make the business a success. In contrast, under a sole proprietorship, the success of the business depends entirely on one person.
However, partnerships also contain drawbacks. Decision making becomes more difficult as partners have to come to a mutual understanding. It doesn’t always run successfully. For example, some partners arguing and disagreeing with other partners about the future direction of their business, could lead to conflict. In contrast, under a sole proprietorship, the owner is the sole decision maker.
Another drawback is about the profit sharing of the business. Partners must share the profits, making less money each one receives than when operating as a sole proprietorship.
Limited liability company
A limited liability company or limited liability company is more complex than the other two organizations. However, the organization is more structured because the functional areas are clearly divided.
Another characteristic is limited liability. The business is considered a separate entity from the owners. The company’s finances are separate from the personal finances of the owners (also called shareholders). Likewise, the legal and financial obligations of the company are not attached to the owner, but to the business. Thus, owners are not personally responsible for paying off business debts, not at risk of losing their personal assets.
Limited companies fall into two categories:
- Private limited company
- Public limited company
Both differ from the aspect of whether the company’s shares are publicly available or not. Public limited companies are publicly available and traded on a stock exchange whereas private limited companies are not (closely-held).
When it needs capital, a private limited company can list its shares on the stock exchange for the first time (called an initial public offering). Once active, the company turns into a public limited company.
Limited liability companies have several advantages, such as:
- Owners have limited liability and are not personally obligated to settle business debts or lawsuits against the company.
- The company has a higher competitive capacity because it has more resources than the other two business organizations in the private sector.
- Organizations are more structured where operations are clearly divided into functional areas.
- Companies have better access to capital such as by issuing shares or bonds, making it easier for future expansion.
However, limited companies also have disadvantages such as:
- Setting up a business is expensive, more complex and difficult because it has to comply with many rules and involves a lot of paperwork.
- Agency problems arise because owners typically delegate day-to-day operationsto management, who may not act in their best interest.
- Management may not distribute dividends for reasons such as to strengthen internal capital, which means no income for the owners.
- Owner’s wealth may fall due to negative speculative activity, which lowers the company’s stock price (applies specifically to public limited companies).