If you are someone who is planning to launch a business, there are several integral decisions to be made even before you make the first sale. Some of these decisions may later determine the performance of the business- therefore it is important to make the right choices that are best suited for your endeavour.
One of the key considerations that should be a priority is in what form your business is structured at the time of incorporation. Each form is well-suited for particular businesses to fulfil short-term as well as long-term goals. Under Indian laws, the Companies Act, 2013 provides 6 different ways in which you can choose to incorporate your venture. These include:
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Private Limited Company- A private limited company is a privately held business entity held by private stakeholders. The liability arrangement, in this case, is that of a limited partnership, wherein the liability of a shareholder extends only up to the number of shares held by them.
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Partnerships- A partnership firm is very popular in India and is one of the oldest forms of business structure. A partnership means an agreement between two or more persons who pool their capital and resources to contribute to the business and agree to share the business profits.
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Limited Liability Partnership- An LLP is a corporate business form that provides the benefits of a partnership firm and a company. It is a hybrid between a company and a partnership firm as it incorporates properties of both structures.
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One Person Company- One person company (OPC) means a company formed with only one (single) person as a member, unlike the traditional manner of having at least two members. This is one of the new concepts introduced by the Companies Act of 2013.
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Sole Proprietorship- A sole proprietorship or sole trader is an unincorporated business with a single owner who pays personal income tax on business profits. This type of business has minimum compliance requirements.
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Section 8 Company- Section 8 company is a company that is licensed under Section 8 of the Companies Act, 2013. It is a non-profit organization (NPO) that is formed with the objective to promote commerce, arts, science, sports, education, research, etc.
In this article, 3 of the most preferred structures i.e. Sole Proprietorship, Limited Liability Partnership, and a Private Limited Company are discussed at length. Read on!
SOLE PROPRIETORSHIP
A sole proprietorship is a type of business structure that is entirely owned and run by one individual and there is no real distinction between the owner and the business. In other words, every asset of the business is owned by the proprietor, and all the debts and liabilities of the business are that of the proprietors.
Following are the documents required to register a sole proprietorship business:
The Aadhaar Card has now been made mandatory for applying for any registration in India.
PAN Card is an essential document as, without it, one is unable to file Income Tax returns.
For tax-related purposes, any business needs to have a valid bank account.
In the case of rented premises, the rent agreement and NOC from the landlord may have to be submitted. On the other hand, if the office address is owned by the proprietor, the electricity bill or any utility bill will suffice as proof.
For a sole proprietorship firm, the following may also be required:
Under recently enacted legal provisions, one may get their business registered as a Small and Medium Enterprise (SME) under the MSME Act. Although this is not compulsory, MSMEs receive several benefits from the government aimed at the growth of commerce, from time to time.
- Shop And Establishment License
In many local jurisdictions, this license is mandatory for those businesses which operate a shop or commercial establishment.
A GST Registration has to be applied for when the estimated annual turnover of your business is more than 40 lakhs. This is also required for online businesses and businesses dealing with commodities that come within the purview of GST.
In the following sections, the advantages and disadvantages of running a sole proprietorship entity have been enumerated:
Advantages Of Sole Proprietorship
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A sole proprietorship form of business is very easy to start as well as wind up. There are no legal formalities involved in this form except for those businesses which require a license to operate from the local authorities or the government health department. Similarly, sole proprietorship entities are also convenient to wind up at any time because the formalities involved are little to none.
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Starting a business on the lines of a sole proprietorship is great for motivation as the profits earned belong to the proprietor alone and there is no one to share the reward with.
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The sole proprietorship model is always associated with better control as the proprietor retains full control over every aspect of the business. He is the planner as well as the organiser, coordinating how the business functions on a day-to-day basis. Moreover, he is the sole decision-maker of the business which leads to prompt and decisive decisions for the business that may facilitate faster progress.
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A sole proprietary business is significantly more flexible than most other forms of business, especially those that require formal incorporation. The sole proprietor is free to change the nature and scope of business as per his discretion and the requirement of the time.
Disadvantages Of Sole Proprietorship
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Perhaps the biggest disadvantage of the sole proprietorship model is that the owner is personally liable for the losses and debts of the businesses. This means that the owner’s personal properties may have to be sold to meet the business obligations. There is no corporate veil of any kind involved.
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The question of capital is often problematic in a sole proprietorship business as it becomes difficult for a single individual alone to invest the huge amount required to launch a business and sustain it for the initial months. Even if the owner ends up borrowing some funds, it may still fall short of what is required.
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In case the business does well, expansion becomes an issue in a sole proprietorship model as there is a limit beyond which operation cannot be continued. Furthermore, it is not always possible for a single person to supervise and manage the affairs of the business.
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Among other reasons, the lack of continuity is also another issue that sole proprietorship businesses face. Since there is no distinction between owner and business, the illness, death, or insolvency of the owner also translates to the termination of the business. In other words, the sole proprietorship model makes the future of the business uncertain.
LIMITED LIABILITY PARTNERSHIP (LLP)
In the Indian framework, the concept of LLP was created in 2008 as a corporate business form that offers the perks of limited liability of a company while retaining the flexibility of a partnership firm, hence the name.
The following documents are usually required for the registration of a Limited Liability Partnership (LLP) firm in India:
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PAN Card of the Partners
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Address Proof of the Partners
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Utility Bill of the proposed Registered Office of the LLP
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No-Objection Certificate from the Landlord
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Recent Passport Size Photographs Of The Partners
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Passport (in case of Foreign Nationals/ NRIs)
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Rental Agreement Copy between the LLP and the Landlord
Advantages Of LLP
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Unlike a sole proprietorship, an LLP offers the advantage of a separate legal entity that protects the partners from the losses and liabilities of the business. All contractual relations with stakeholders are conducted in the name of the LLP which also gives them a sense of security in the business as opposed to a sole proprietorship.
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As compared to forming a private company, the cost of registration of an LLP as well as the expenses for its compliances and upkeep is much less. An LLP is only under the obligation of filing an Annual Return and a Statement of Accounts and Solvency each year.
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A major advantage of a Limited Liability Partnership is that there is no requirement for any minimum capital contribution for the business to be launched- any amount of capital that is invested by the partners will suffice for this form of business.
Disadvantages Of LLP
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Compared to a private limited company, the compliance applicable for an LLP is less. However, if these are completed on time, the LLP will be penalised substantively. For example, even if the LLP does not have any activity in the year, it is required to file returns with the Ministry Of Corporate Affairs otherwise it may be fined heavily for the omission.
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As is the structure of an LLP, there should be a minimum of two partners involved at all times. The law dictates that if this number is below two for six months, the LLP shall stand dissolved with immediate effect. An LLP is also liable for dissolution if it is not able to pay the outstanding debts.
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It is difficult for LLPs to raise money like a company as angel investors or venture capitalists are not allowed to invest in LLPs as shareholders. In other words, LLPs do not have the concept of equity or shareholders. This means that one of the few ways for an LLP to raise funds is through debt.
PRIVATE LIMITED COMPANY
A private limited company as laid down in the Companies Act, 2013 is a company that is usually opted for by small and medium-sized businesses. Following are the features of a Private Limited Company:
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Number of Members: To start a Private Limited Company, there should be a minimum number of 2 members and a maximum number of 200 members.
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Nature of Liability: The liability of each member or shareholder is limited. It means that if a company faces a loss under any circumstances, then its shareholders are liable to sell their assets for payment. The personal, individual assets of the shareholders are not at risk.
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Number of Directors– When it comes to directors a private company needs to have only two directors. With the existence of 2 directors, a private company can come into operation.
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Paid-up Capital– It must have a minimum paid-up capital of Rs 1 lakh or a higher amount which may be prescribed from time to time.
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Prospectus– A prospectus is a detailed statement of the company affairs that is issued by a company to its public. However, in the case of a private limited company, there is no such need to issue a prospectus because the public is not invited to subscribe to the shares of the company.
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Minimum subscription– It is the amount received by the company which is 90% of the shares issued within a certain period. If the company is not able to receive 90% of the amount then it cannot commence further business. In the case of a private limited company, shares can be allotted to the public without receiving the minimum subscription.
Advantages Of A Private Limited Company
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There is no minimum capital required. Private limited companies can be established with any amount of capital, regardless of the nature of the business. This is a substantial advantage for someone who cannot invest a large sum of money in setting up a business.
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100% Foreign Direct Investment (FDI) is allowed in a Private Limited Company which means any foreign entity or foreign person can directly invest in such an entity.
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If the company undergoes financial distress because of whatsoever reason, the personal assets of members will not be used to pay the debts of the Company as the liability of the person is limited.
Disadvantages Of A Private Limited Company
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A major disadvantage is that a Private Limited Company restricts the transferability of shares by its articles. The members of a private limited company are not able to transfer the shares according to the Company Act.
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In addition to this, the number of shareholders in a Private Limited Company is capped at 200 and cannot exceed this number. This means there are issues in scaling the business once it starts doing well as the influx of capital becomes restricted.
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Another drawback is a Private Limited Company cannot issue a prospectus to the public and its shares cannot be quoted on the stock exchange.
With the number of diverse options available under the Indian framework, it is important to weigh all the important parameters and take a call on which factors are most significant for your business needs and long-term goals. Paying less (or more) taxes, flexibility regarding everyday operations and allocation of profits and losses, limited liability, and even the dissolution process are all important issues, and one or the other may or may not be enough of a reason to choose a particular form. Not every entity form is right for every business, so you choose to reach out to a legal professional in these matters to better understand all the implications of your choice.
