Business Entity and Financial Environment

Every business needs a legal form through which it is owned, managed, and held responsible for its dealings. This legal form is called a business entity. The three most common forms in Nepal are the sole proprietorship, the partnership, and the company. The choice of entity decides who owns the business, who bears the risk, how much capital can be raised, and how long the business can survive. Around these entities operates the financial environment, that is, the whole set of financial institutions, markets, instruments, and regulations through which money flows between those who have surplus funds and those who need them. This chapter studies both the business entities themselves and the financial environment in which they raise and use finance.

Key features of sole proprietorship, partnership, and company

Sole proprietorship

A sole proprietorship is a business owned, financed, and managed by a single person, called the sole proprietor or sole trader. It is the oldest and simplest form of business organization. The owner supplies the entire capital, takes all decisions, enjoys all profits, and bears all losses alone. Its key features are:

• Single ownership: The business is owned by only one person who contributes the whole capital from personal savings or borrowing.
• No separate legal existence: The owner and the business are treated as one and the same in the eyes of law. The business has no identity separate from the proprietor.
• Unlimited liability: The liability of the owner is unlimited. If the business assets are not enough to pay the debts, the personal property of the owner can be used to settle them.
• Sole management and control: The proprietor alone manages the business and takes all decisions, which allows quick decision making and flexibility.
• Minimum legal formalities: It is easy to start and easy to close, with few legal requirements and low registration cost.
• Secrecy: Since the owner runs the business alone, business secrets can be maintained fully.
• Limited life: The life of the business depends on the life of the owner. Death, insolvency, or insanity of the owner can bring the business to an end.

Partnership

A partnership is an association of two or more persons who agree to carry on a business together and to share its profits and losses in an agreed ratio. The persons are individually called partners and collectively called a firm. The relationship among partners is governed by an agreement known as the partnership deed. Its key features are:

• Two or more persons: At least two persons are required to form a partnership. The members join through a mutual agreement.
• Agreement: A partnership arises from an agreement, oral or written. The written agreement is the partnership deed, which states the capital, profit sharing ratio, duties, and rights of each partner.
• Sharing of profit and loss: Partners share the profits and losses of the firm in the ratio fixed by the agreement, or equally if no ratio is stated.
• Unlimited liability: The liability of the partners is unlimited and joint. Their personal property can be used to pay the firm's debts if the firm's assets fall short.
• Mutual agency: Every partner is both an agent and a principal of the firm. Each partner can bind the firm and the other partners by acts done in the ordinary course of business.
• No separate legal existence: Like a sole proprietorship, the firm has no legal identity separate from its partners.
• Restriction on transfer of share: A partner cannot transfer his or her share to an outsider without the consent of all the other partners.

Company

A company is a voluntary association of persons formed and registered under the Companies Act to carry on a business, having a separate legal existence, a common seal, and perpetual succession, with the capital divided into transferable shares. The owners are called shareholders and the business is managed by a board of directors elected by them. Its key features are:

• Separate legal existence: A company is an artificial person created by law. It is distinct from its shareholders and can own property, enter into contracts, sue, and be sued in its own name.
• Limited liability: The liability of the shareholders is limited to the face value of the shares they hold, or to the amount they have guaranteed. Their personal property is safe.
• Perpetual succession: The company has a continuous existence. The death, insolvency, or exit of any shareholder does not affect its life. It continues until it is legally wound up.
• Transferability of shares: The shares of a public company are freely transferable, which gives investors an easy exit and helps the company raise capital.
• Common seal: The company acts through its common seal, which serves as its official signature on documents.
• Separation of ownership and management: The shareholders own the company but do not run it directly. Management is carried out by the board of directors on their behalf.
• Large capital: By issuing shares and debentures to the public, a company can collect a large amount of capital from many investors.