Sole Proprietorship, Partnership and Hindu Undivided Family Business

Sole proprietorship

A sole proprietorship is a business owned, managed and controlled by one person, who gets all the profit and bears all the risk.

Features

• Easy to form and close: few legal formalities.
• Unlimited liability: the owner's personal property can be used to pay business debts.
• Sole risk bearer and sole profit taker.
• Full control and quick decisions.
• No separate legal entity: the business and the owner are the same in law.
• Lack of business continuity: death, illness or insanity of the owner can end it.
• One-man control.

Merits

• Quick decision making.
• Secrecy of business matters.
• Direct incentive: all profit goes to the owner.
• Sense of accomplishment and self-respect.
• Ease of formation and closure.

Limitations

• Limited money: only owner's savings and small loans.
• Limited life of the business.
• Unlimited liability makes the owner afraid to take big risks.
• Limited managerial ability: one person cannot be expert in everything.

Partnership: concept, features, merits and limits

The Indian Partnership Act, 1932 describes partnership as a relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all.

Features

• Formed by an agreement, oral or written.
• At least 2 partners; the present legal limit is 50 partners.
• Profit and loss are shared in an agreed ratio.
• Unlimited liability: partners are liable jointly and individually.
• Mutual agency: each partner is both an owner and an agent of the firm.
• Lack of continuity: death, retirement or insolvency of a partner can end the firm.

Merits

• Easy formation and closure.
• Balanced decisions: partners bring different skills.
• More funds than a sole trader.
• Risk is shared.
• Secrecy: accounts need not be published.

Limitations

• Unlimited liability.
• Funds are still limited compared to a company.
• Possibility of conflicts among partners.
• Lack of continuity.
• Lack of public confidence, since accounts are not published.

Types of partnership

On the basis of duration

• Partnership at will: no fixed period; lasts as long as partners wish and ends when any partner gives notice.
• Particular partnership: formed for one job or a fixed time, like building a mall; ends when the job is done.

On the basis of liability

• General partnership: all partners have unlimited liability and can take part in management; registration is optional.
• Limited partnership: at least one partner has unlimited liability, others have limited liability and cannot manage; registration is compulsory. In India the idea is used through the Limited Liability Partnership (LLP) under the LLP Act, 2008.

Partnership deed

A partnership deed is the written agreement among partners. It avoids fights later. It usually states:

• name of the firm, nature and place of business,
• duration of the partnership,
• capital given by each partner,
• profit-sharing ratio,
• interest on capital and on drawings, salaries to partners,
• duties and rights of partners,
• rules for admission, retirement and expulsion of a partner,
• how accounts are kept and how disputes are settled,
• how the firm will be closed.

Registration of a partnership firm

In India, registration of a partnership is optional, but an unregistered firm faces problems:

• a partner cannot sue the firm or other partners,
• the firm cannot sue outsiders (third parties),
• the firm cannot claim a set-off in a case against it.

Steps: fill the application form with firm name, place, names and addresses of partners, date of joining and duration; submit it with the fee to the Registrar of Firms of the state; after checking, the Registrar enters the firm in the Register of Firms and issues a certificate of registration.

Kinds of partners

A minor (below 18) can be admitted only to the benefits of partnership with the consent of all partners. On becoming adult he has six months to decide whether to stay as a full partner.

Hindu Undivided Family business

A Joint Hindu Family (HUF) business is owned and run by members of an undivided Hindu family. It is governed by Hindu law. Under the Mitakshara school (most of India), three generations share the property; under Dayabhaga (West Bengal and Assam), membership is by succession.

Features

• Formation needs at least two members and ancestral property; no agreement needed.
• Membership by birth.
• Management by the karta, the eldest member.
• Liability: karta unlimited; coparceners limited to their share.
• Continuity: the death of the karta does not end it; the next eldest takes over. It ends only if all members agree to divide it.
• Minors can be members from birth.

Merits

• Effective control and quick decisions by the karta.
• Continued business existence.
• Limited liability of members.
• Increased loyalty and cooperation, since the business belongs to the family.

Limitations

• Limited funds (ancestral property only).
• Unlimited liability of the karta.
• Dominance of the karta; others may feel left out.
• Limited managerial skill of one person.

Try it

Ask an elder at home: which shops in your area are run by one owner, by partners, or by a family? For one partnership, guess which kind each partner is.

Key formulas and definitions

• Unlimited liability: personal property can pay business debts
• Partnership: 2 to 50 partners, agreement, profit sharing, mutual agency
• HUF: karta = unlimited liability; coparceners = limited to share

Worked examples

Common mistakes

• Saying partnership registration is compulsory in India. It is optional, but non-registration has serious effects.
• Thinking a sleeping partner has limited liability. His liability is unlimited like other partners.
• Writing that HUF membership comes from an agreement. It comes by birth.
• Mixing up nominal and secret partners: nominal lends only his name (known, no capital); secret gives capital and manages but is hidden.