IB BUSINESS MANAGEMENT HL | UNIT 1: INTRODUCTION TO BUSINESS MANAGEMENT
1.2 Types of Business Entities
Comprehensive IB Business Management HL study notes covering all types of business entities: sole traders, partnerships, private and public limited companies, cooperatives, social enterprises, public-private partnerships, and non-governmental organisations. Includes legal structures, liability distinctions, incorporation process, financial formulas, and HL extension content on franchising, joint ventures, and strategic alliances.
Key Definition
A business entity is the legal structure under which a business operates. The choice of entity determines ownership, control, liability, taxation, sources of finance, and how profits are distributed. In IB Business Management, understanding the advantages, disadvantages, and suitability of each entity type is essential for exam success.
Limited vs Unlimited Liability
The concept of liability is the single most important distinction between business entities. It determines the personal financial risk that owners face if the business fails or incurs debts.
Unlimited Liability
There is no legal separation between the owner and the business. If the business cannot pay its debts, the owner's personal assets (house, car, savings) can be seized to cover the shortfall.
Applies to: sole traders, general partnerships
Limited Liability
The business has a separate legal identity from its owners. Owners (shareholders) can only lose the amount they have invested in the business. Personal assets are protected.
Applies to: private limited companies, public limited companies, LLPs
Owner's Maximum Loss
\[ \text{Unlimited:} \quad \text{Maximum Loss} = \text{Business Debts} + \text{Personal Assets} \]
\[ \text{Limited:} \quad \text{Maximum Loss} = \text{Amount Invested (Share Capital)} \]
Sole Traders (Sole Proprietorships)
A sole trader is a business owned and run by one person. There is no legal distinction between the owner and the business. It is the simplest and most common form of business ownership globally.
Advantages
- Easy and inexpensive to set up (minimal legal formalities)
- Owner keeps all profits after tax
- Complete control over decision-making
- Privacy: financial information is not publicly disclosed
- Flexibility to adapt quickly to market changes
Disadvantages
- Unlimited liability: personal assets at risk
- Limited sources of finance (personal savings, bank loans)
- Heavy workload: owner handles all management functions
- Lack of continuity: business may end if owner retires, becomes ill, or dies
- Difficult to achieve economies of scale
Sole Trader Profit Formula
\[ \text{Net Profit} = \text{Total Revenue} - \text{Total Costs} \]
\[ \text{Total Revenue} = \text{Price per Unit} \times \text{Quantity Sold} \]
Partnerships
A partnership is a business owned by two or more individuals (typically 2-20) who share responsibility, investment, decision-making, and profits. A Deed of Partnership (partnership agreement) outlines the terms: profit-sharing ratio, roles, capital contributions, and procedures for admitting or removing partners.
Advantages
- More capital can be raised than a sole trader
- Shared workload, skills, and expertise (specialisation)
- Shared risk between partners
- Relatively easy to set up
- Privacy of financial information
Disadvantages
- Unlimited liability for general partners
- Profits must be shared
- Disagreements between partners can disrupt operations
- Slower decision-making (need to consult partners)
- Lack of continuity if a partner leaves or dies
Partnership Profit Distribution
\[ \text{Partner's Share} = \text{Total Profit} \times \frac{\text{Partner's Ratio}}{\text{Sum of All Ratios}} \]
Example: If three partners share profits in the ratio 3:2:1 and total profit is $120,000, the first partner receives \( 120{,}000 \times \frac{3}{6} = \$60{,}000 \).
Limited Liability Partnerships (LLPs)
An LLP combines the flexibility of a partnership with limited liability for all partners. Each partner's liability is limited to their investment in the firm. LLPs are common among professional services firms (accounting, law, consulting). Unlike general partnerships, an LLP has a separate legal identity.
Companies (Corporations)
A company (corporation) is a business with a separate legal identity from its owners. This process of becoming a separate legal entity is called incorporation. The owners are shareholders who have limited liability.
The Incorporation Process
Memorandum of Association
Company name,
registered address,
objectives
Articles of Association
Internal rules:
voting, meetings,
share transfers
Certificate of Incorporation
Legal birth
of the company
Separate Legal Entity
Can sue, be sued,
own property,
enter contracts
Private Limited Companies (Ltd / LLC)
Shares are sold privately to selected individuals (family, friends, investors). Shares cannot be traded on a public stock exchange. The number of shareholders is restricted.
- Ownership: Private shareholders (often family, founders, angel investors)
- Liability: Limited to the value of shares held
- Share transfer: Restricted; requires approval of existing shareholders
- Privacy: Less disclosure required than public companies
- Examples: IKEA, Deloitte, Mars Inc., Bosch
Public Limited Companies (PLC / Inc)
Shares are sold to the general public through a stock exchange via an Initial Public Offering (IPO). Anyone can buy and sell shares freely.
- Ownership: Public shareholders (individuals, pension funds, institutional investors)
- Liability: Limited to the value of shares held
- Share transfer: Free; traded on stock exchanges
- Disclosure: Must publish annual reports, audited accounts
- Risk: Vulnerable to hostile takeovers
- Examples: Apple, Unilever, Toyota, Tata, Shell
Shareholder Value Formulas
\[ \text{Dividend per Share} = \frac{\text{Total Dividends Paid}}{\text{Number of Shares}} \]
\[ \text{Dividend Yield} = \frac{\text{Dividend per Share}}{\text{Market Price per Share}} \times 100\% \]
\[ \text{Earnings per Share (EPS)} = \frac{\text{Net Profit after Tax}}{\text{Number of Shares}} \]
Private vs Public Companies: Comparison
| Feature | Private Limited (Ltd) | Public Limited (PLC) |
|---|---|---|
| Share trading | Privately only; restricted | Publicly on stock exchange |
| Minimum capital | No minimum (varies by country) | Often requires minimum (e.g. 50,000 in UK) |
| Disclosure | Limited public disclosure | Full annual reports, audited accounts |
| Control | Founders often retain control | Dispersed; risk of hostile takeover |
| Finance | Private investors, retained profit | Huge capital through public share issues |
| Pressure | Long-term strategic focus | Short-term shareholder pressure |
Cooperatives
A cooperative is a business owned and democratically controlled by its members, who share the benefits. The principle is "one member, one vote" regardless of capital contributed. Cooperatives exist in many forms: worker cooperatives, consumer cooperatives, producer cooperatives, and credit unions.
Worker Cooperative
Owned and managed by employees. Profits are shared among workers based on contribution. Example: Mondragon Corporation (Spain).
Consumer Cooperative
Owned by customers who buy goods or services. Members receive dividends based on purchases. Example: The Co-operative Group (UK).
Producer Cooperative
Owned by producers (often farmers) who pool resources for processing, marketing, and distribution. Example: Fonterra (New Zealand dairy).
Credit Union
A financial cooperative owned by its members (depositors), offering savings and loans at favourable rates. Example: Navy Federal Credit Union (US).
Cooperative Profit Allocation
\[ \text{Member's Dividend} = \frac{\text{Member's Purchases (or Labour)}}{\text{Total Cooperative Activity}} \times \text{Surplus} \]
Advantages
- Democratic control (one member, one vote)
- Profits shared fairly among members
- Members are motivated (they are also owners)
- Often focused on ethical and sustainable practices
Disadvantages
- Slow decision-making (democratic process)
- Limited access to external capital
- Members may lack business expertise
- Potential for free-riding (members contributing unequally)
Social Enterprises
A social enterprise is a business that trades to tackle social, environmental, or community problems. It generates revenue through commercial activities but reinvests the majority of profits back into its social mission rather than distributing them to shareholders.
Triple Bottom Line
Social enterprises measure success using the Triple Bottom Line (TBL):
\[ \text{TBL} = \text{People} + \text{Planet} + \text{Profit} \]
TOMS Shoes
For every product purchased, TOMS helps a person in need (one-for-one model). Combines commercial sales with social impact.
Grameen Bank
Provides microloans to the poorest communities without requiring collateral. Founded by Nobel laureate Muhammad Yunus.
The Big Issue
A magazine sold by homeless people who keep a portion of the cover price. Provides income and a route out of poverty.
For-Profit vs Non-Profit Organisations
| Feature | For-Profit | Non-Profit (NGO/Charity) | Social Enterprise |
|---|---|---|---|
| Primary aim | Maximise profit for owners/shareholders | Social, environmental, or humanitarian mission | Social mission funded by trading |
| Profit distribution | Dividends to shareholders | All surplus reinvested in mission | Majority reinvested; limited distribution |
| Funding | Share capital, retained profit, loans | Donations, grants, government funding | Revenue from sales + grants |
| Ownership | Shareholders/partners/sole trader | No owners; governed by board of trustees | Varies (CIC, cooperative, etc.) |
| Examples | Apple, Unilever, local restaurants | Oxfam, Red Cross, Doctors Without Borders | TOMS, Grameen Bank, The Big Issue |
Private Sector vs Public Sector
All business entities operate within either the private sector (owned by individuals or companies) or the public sector (owned and operated by the government). Some operate as public-private partnerships (PPPs).
Private Sector
- Owned by individuals, families, or corporate shareholders
- Aim: profit maximisation, growth, market share
- Funded by private investment, retained profits, bank loans
- Examples: Samsung, Nestlé, local start-ups
Public Sector
- Owned and controlled by the government
- Aim: provide essential services, not profit
- Funded by taxation and government budgets
- Examples: NHS (UK), national railways, state schools, police
Public-Private Partnerships (PPPs)
A PPP is a collaboration between a government body and a private sector company to finance, build, or manage public infrastructure or services. The government provides regulatory oversight and the private sector brings efficiency, capital, and expertise. Examples include hospital construction projects, highway toll roads, and airport operations. PPPs can reduce the burden on public finances but may raise concerns about accountability and profit motives in public services.
HL Extension: Other Business Structures
Franchising
A franchise is a legal agreement where a franchisor grants a franchisee the right to use its brand name, products, and business model in exchange for fees and royalties.
Franchise Fee Structure
\[ \text{Franchisee Pays} = \text{Initial Fee} + (\text{Royalty Rate} \times \text{Revenue}) \]
Franchisor Benefits
- Rapid expansion with low capital risk
- Revenue from fees and royalties
- Motivated franchisees (they invest their own money)
Franchisee Benefits
- Proven business model reduces risk
- Brand recognition from day one
- Training and ongoing support
Examples: McDonald's, Subway, 7-Eleven, Hilton Hotels
Joint Ventures
A joint venture (JV) is a temporary strategic alliance where two or more businesses create a new, separate entity to undertake a specific project or enter a new market. Each partner contributes resources, shares risks, and shares profits.
JV Profit Distribution
\[ \text{Partner A Profit} = \text{JV Net Profit} \times \frac{\text{A's Capital Contribution}}{\text{Total Capital}} \]
Example: Sony Ericsson (Sony + Ericsson to produce mobile phones); Hulu (Disney + NBCUniversal + Fox)
Strategic Alliances
A strategic alliance is an agreement between two or more businesses to cooperate on a specific objective while remaining independent entities. Unlike a joint venture, no new separate entity is created.
- Share resources, technology, or distribution channels
- Reduce costs through shared R&D or marketing
- Access new markets or customer segments
- Examples: Star Alliance (airlines), Starbucks + Barnes & Noble
Master Comparison: All Business Entities
| Entity | Ownership | Liability | Profit | Purpose | Examples |
|---|---|---|---|---|---|
| Sole Trader | Individual | Unlimited | Owner keeps all | Profit, autonomy | Corner shop, freelancer |
| Partnership | 2-20 partners | Unlimited (general) | Shared by ratio | Pool skills/capital | Law firm, accounting firm |
| Private Ltd (Ltd) | Private shareholders | Limited | Dividends by shareholding | Growth with control | IKEA, Mars, Bosch |
| Public Ltd (PLC) | Public shareholders | Limited | Dividends; share price | Large-scale expansion | Apple, Toyota, Shell |
| Cooperative | Members | Limited (usually) | Shared by usage | Member benefit | Mondragon, Co-op UK |
| Social Enterprise | Varies (CIC, co-op) | Limited (usually) | Reinvested in mission | Social/environmental | TOMS, Grameen Bank |
| NGO / Charity | Board/trustees | Limited | Reinvested fully | Humanitarian/social | Oxfam, Red Cross, MSF |
| Public Sector | Government | Usually limited | No distribution | Public service | NHS, state schools |
| Franchise | Franchisee (licence) | Varies | Franchisee keeps (minus fees) | Brand expansion | McDonald's, Subway |
Factors Affecting the Choice of Business Entity
Entrepreneurs must consider multiple factors when selecting the most appropriate legal structure. The IB frequently asks students to evaluate or recommend a suitable entity based on given circumstances.
Liability Risk
How much personal financial risk is the owner willing to accept? Unlimited liability risks personal assets; limited liability protects them.
Capital Requirements
How much start-up capital is needed? Sole traders have limited access; PLCs can raise millions through public share issues.
Control and Decision-Making
Does the owner want full control? Sole traders have complete autonomy; PLC directors answer to shareholders.
Profit Distribution
Should profits go to owners, members, or be reinvested? This determines whether a for-profit, cooperative, or social enterprise is appropriate.
Legal and Administrative Costs
Incorporation involves legal costs and disclosure requirements. Sole traders and partnerships have minimal paperwork.
Business Objectives
Is the primary aim profit, social impact, or public service? The entity must align with the organisation's mission and values.
Common IB Exam Mistakes
- Confusing limited liability with limited company: Limited liability is a concept (owners' risk is capped). A limited company is a type of entity that provides limited liability. Not all limited liability entities are companies (e.g. LLPs).
- Saying sole traders have "no liability": Sole traders have unlimited liability, meaning they are personally responsible for all debts. This is one of their biggest disadvantages.
- Forgetting the HL distinction between franchises and chains: A franchise is independently owned (by the franchisee) and pays fees to use the brand. A chain is fully owned by the parent company.
- Confusing private company with private sector: A private limited company (Ltd) is a legal structure. The private sector is any business not owned by the government. Both PLCs and Ltd companies are in the private sector.
- Stating cooperatives cannot make profit: Cooperatives can and do generate surplus (profit). The difference is that surplus is distributed among members based on their participation, not among external shareholders.
- Not linking entity choice to context: In evaluation questions, always explain why a particular entity is suitable for the specific business described, considering size, objectives, risk tolerance, and industry.
Official and Recommended Resources
The following are verified official and authoritative resources for IB Business Management 1.2.
International Baccalaureate Organisation
Official IB Business Management course page with the guide, assessment criteria, and specimen papers.
ibo.org - Business ManagementIB Programme Resource Centre
Past papers, markschemes, examiner reports, and teacher support materials for registered IB schools.
resources.ibo.orgInvestopedia - Business Structures
Comprehensive articles on sole proprietorships, partnerships, LLCs, corporations, and cooperatives with financial formulas and comparisons.
investopedia.com - Business StructureKhan Academy - Forms of Business
Free video lessons covering types of business organisations, liability concepts, and corporate structure.
khanacademy.org - Core FinanceWorld Bank - SME Finance
Data and resources on small and medium enterprise development, financing structures, and business formation worldwide.
worldbank.org - SME FinanceOECD - Corporate Governance
Research on corporate governance principles, shareholder rights, and public-private partnerships across OECD countries.
oecd.org - CorporateTest Your Knowledge: 1.2 Types of Business Entities Quiz
Check your understanding of the key concepts. Select the best answer for each question.
Key Takeaways for the IB Exam
- Unlimited liability means personal assets are at risk (sole traders, general partnerships). Limited liability protects personal assets (Ltd, PLC, LLP).
- Incorporation creates a separate legal entity requiring a Memorandum and Articles of Association. This grants limited liability but requires disclosure.
- Private Ltd companies sell shares privately (restricted transfer); PLCs sell shares publicly on stock exchanges (free transfer, risk of takeover).
- Cooperatives operate democratically (one member, one vote). Social enterprises use the Triple Bottom Line (People, Planet, Profit).
- HL: Franchises, joint ventures, and strategic alliances are alternative structures for growth and market entry. Know the fee structures and risk-sharing models.
- Always link entity choice to context in exam answers: consider size, objectives, risk appetite, capital needs, and desired level of control.
Frequently Asked Questions About IB BM 1.2
What is the difference between limited and unlimited liability?
With unlimited liability, the owner is personally responsible for all business debts. If the business cannot pay, personal assets (house, car, savings) can be seized. With limited liability, the business is a separate legal entity and the owner can only lose the amount they invested. This is the fundamental distinction that separates unincorporated businesses (sole traders, general partnerships) from incorporated ones (Ltd, PLC).
What are the main differences between a private limited company and a public limited company?
A private limited company (Ltd) sells shares privately to selected investors and restricts share transfers. A public limited company (PLC) sells shares on a stock exchange to the general public. PLCs can raise more capital but face greater disclosure requirements, shareholder pressure for short-term profits, and the risk of hostile takeovers. Ltd companies retain more owner control and privacy.
What is a social enterprise and how does it differ from a charity?
A social enterprise generates most of its revenue through commercial activities (selling goods or services) but reinvests the majority of profits into its social or environmental mission. A charity relies primarily on donations, grants, and fundraising. Social enterprises are self-sustaining through trade, while charities depend on external funding. Both aim for social impact, but their revenue models differ significantly.
What is a franchise and what are the key IB exam points?
A franchise is an agreement where a franchisor allows a franchisee to operate using its brand, business model, and support systems in exchange for an initial fee and ongoing royalties. For the IB exam, know the advantages for both parties (franchisor gets expansion with low risk; franchisee gets a proven model) and disadvantages (franchisee lacks creative freedom; franchisor risks brand damage from poor franchisees). This is HL-only content.
How should I approach "evaluate the suitability" questions about business entities?
Structure your answer using the CUSP framework: Control (who decides?), Unlimited vs limited liability (risk tolerance?), Sources of finance (how much capital is needed?), and Purpose (profit, social, or service?). Always refer back to the specific business described in the question. Provide advantages and disadvantages of the recommended entity and explain why it suits the given context better than alternatives.
What is the difference between a joint venture and a strategic alliance?
A joint venture creates a new, separate entity jointly owned by the partner companies (e.g. Sony Ericsson). A strategic alliance is a cooperative agreement between independent companies that remain separate (e.g. Star Alliance). Joint ventures involve shared ownership and governance of a new entity; strategic alliances involve collaboration without creating a new legal entity. Both are HL concepts.
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Start here (prerequisites)
Practice and application
- 1.2 Types of Business Entities (SL)
- 1.3 Business Objectives (SL)
- 1.4 Stakeholders (SL)
- 3.2 Sources of Finance (SL)