As a young entrepreneur you are brimming with innovative ideas- you know your product, its technical aspects and your target audience. All you need to decide upon is how to set up, i.e. what sort of legal structure should you adopt for your business?
The following analysis of different forms of business aims to serve as a guide to enable you to decide which form of business best suits your goals and requirements.
1. Sole Proprietorship: This business model is nothing but the entrepreneur himself. Launching your business as a sole proprietor requires nothing but opening a current bank account to begin with and subsequently you can comply with the tax registration requirements such as VAT registration or service tax registration depending on the nature of your business.
The pros and cons: While the advantage of a sole proprietorship is that the process of starting it is easy and less cumbersome, the disadvantage is that it does not constitute a separate legal entity. Consequently the liability of the business becomes the liability of the entrepreneur, exposing the entrepreneur’s personal assets to risk. In addition this model is not suitable for businesses where there are two or more founders.
2.Partnership: The formation of a partnership firm is governed by the provisions of the Indian Partnership Act 1932. The partners mutually decide their rights and obligations and set them forth in a Partnership Deed which then governs the relationship between the partners. The Partnership Deed is required to be registered with the Registrar of Firms.
The pros and cons: While the formation of a partnership is simple and does not require extensivedue diligence. The disadvantages of a partnership include:(a) Uncertainty of continuity because if a partner wishes to retire or leave the firm, the partnership dissolves and a new partnership has to be created;(b) Unlimited liability of partners which exposes them to the risk of their personal assets getting attached; (c) The principal-agent relationship between all the partners wherein any act done by one partner will bind all of them. This model of business is not recommended for entrepreneurs seeking investment in their business as no investor would want to bear the risk associated with being a partner.
3.Private Limited Company: A private limited company is a separate legal entity distinct from the shareholders and key managers, which means that the liability of the Company is not the same as that of the shareholders of the Company. The formation of a private limited company is governed by The Companies Act, 2013 and requires entrepreneurs/shareholders to contribute a minimum of Rupees One Lakh (Rs.1,00,000/-) for the purposes of share subscription.
The Pros: (a) Being a distinct legal entity its liability is also distinct from that of its shareholders. The liability of a shareholder is limited to the value of shares held by him/her- Therefore personal assets are not at stake;(b) It is easier to attract investors as their liability is limited. In addition given the fact that a company is subject to a number of regulatory compliance, investors feel confident about the functioning of a company and are thus more willing to invest in such a structure.
The Cons: (a) The cost of incorporating a company is relatively higher when compare to other forms of businesses. These costs are in addition to the initial contribution of Rupees One Lakh (Rs. 1,00,000/-) as mandated by statute;
(b) A company is subjected to substantial compliance and due diligence requirements as stipulated in the Companies Act, 2013. For instance, it is mandatory for a company to hold an Annual General Meeting every calendar year, to hold four Board Meetings, to conduct a statutory audit, to file their financial statements and annual returns with the Registrar of Companies, etc.
(c) The winding up of a company is a time consuming, court-driven process. Therefore if, as an entrepreneur you feel that your start-up is not performing as well as you had expected it to and that it would be best to shut shop, winding up a company would not be the easiest;
(d) The number of members in a private limited company cannot exceed 200. Although running a company is a relatively expensive and complex process it is recommended for entrepreneurs seeking Foreign Direct Investment or equity funding or venture capital funding.
Please note that single entrepreneurs now have the option of incorporating a One Person Company (OPC), which is a corporate form of proprietorship. The main advantages of an OPC are that the liability of the entrepreneur is limited to the unpaid subscription money as opposed to the risk of unlimited liability in a sole proprietorship. In addition the entrepreneur is required to designate a nominee who will succeed him in case of death. Therefore through an OPC an individual entrepreneur can secure greater trust and prove more attractive to lenders rather than a sole proprietorship.
4. Limited Liability Partnership (LLP): The LLP model of business was introduced under the Limited Liability Partnership Act, 2008 and is a hybrid between a general partnership and a private limited company.
(a) There is no minimum capital requirement for setting up an LLP as opposed to incorporating a company;
(b) There are fewer legal compliance requirements involved- for instance LLPs are not required to hold statutory meetings, board meetings or get their accounts audited annually unless they have a turnover of more than Rupees forty lakh.
(c) LLPs could prove to be more tax efficient as they are not required to pay Dividend Distribution Tax which companies are required to pay.
(d) In addition in the case of an LLP, management rights rest with designated partners and founders can exercise direct control over the business.
The disadvantages of setting up an LLP are that:
(a) Ownership rights are not easily transferable as the LLP is governed by the LLP agreement;
(b) This business model does not command the same credibility as a company does. Therefore entrepreneurs seeking funding may find investors more comfortable investing in a Company.
Conclusion: As an entrepreneur you should bear in mind that while selecting the correct form of business is an important business decision there is no fixed formula for doing so. A number of factors such as liability implications, requirement of raising funds, size of the organization, compliance requirements, tax implications etc. have to be considered before zeroing in on a suitable business form. Another important factor that should motivate your choice of business is whether you want to avail of the benefits of the Start-Up India Plan- a Government initiative to encourage start-ups, as only start-ups set up as private limited companies, LLPs or partnerships qualify under the Plan.
This article is aimed at giving a brief overview of the different legal forms of a business. For specific advice related to the same it is recommended that a Chartered Accountant or Corporate Lawyer be consulted.
By Geeta Daswani Geeta.firstname.lastname@example.org
SpiderG is platform for startups and SMEs to automate their bookkeeping, employee management, Collaboration Management and increase productivity.