Well begun is half done,- Choose the right legal structure for your business

Well begun is half done,- Choose the right legal structure for your business

When you plan to start a new business, there are several questions that need to be answered. But the first question often tumbled upon by businessmen and entrepreneurs are, “How do I choose the type of business form that befits my business accurately?” The answer to this question tells you about the amount of paperwork to be done, taxes to be paid, the type of liability you will be entitled to, whether or not you can borrow funds and if you can, what form of borrowal is acceptable.

In the light of SME’s there are mainly 5 types of legal entities.

1. Sole Proprietorship

There is a single owner. Formation of business is as simple as opening a bank account with own PAN. The owner exercises complete control and risk bearing, with the benefit of no profit sharing. The owner is liable to pay all debts due to the firm if the business is unable to meet its liabilities. Business comes to a standstill once the owner is unable to continue business. It is suitable for business like local markets, artistic works, personal services, etc where there are no major operational risk or expansion plans.

2. Partnership

Partnership is a form of business where two or more persons come forth to start a new business, mitigating the limits put forth by sole proprietorship. Partners are to draft a Partnership Deed containing the profit-sharing ratio, capital contributions, bank account operations, rights and duties of partners including a scenario of retirement, admission or death of the partners. They enjoy optional registration with the Registrar of Firms. A minimum of 2 and maximum of 50 partners can be appointed and these general partners are liable to unlimited liability jointly and severally. This form is highly adopted for services like construction, legal and medical services.

3. Limited Liability Partnership (LLP)

An LLP has to be registered under Registrar of Companies. Partners are required to draft a LLP agreement and has to include a minimum of 2 partners. There has to be minimum 2 designated partners, who perform the same functions as of a director in any company. An LLP need not perform mandatory audit, provided turnover or partner’s contribution doesn’t exceed forty and twenty-five lakhs respectively. Partners are liable to pay off business debts only to the extent of their unpaid contributions. Unlike a private company, there are no restrictions in raising funds/loans from outside parties for business purposes. Also They are recommended only for profit running businesses.

4. One Person Company (OPC)

An OPC is a company with only one person as member, paid-up capital not exceeding fifty lakhs and a turnover of less than two crores. The company enjoys a separate legal status and so the owner enjoys limited liability, i.e., his personal assets are safe. The owner and has to be a resident of India and can appoint a nominee. OPC will be suitable for a business with very little expansion plans. If you are someone with several business plans, this may not be the one for you. A person can be owner to only one OPC at a time.

5. Private Limited Company

A Company is governed by Companies Act and is a separate legal entity. A company is required to file forms, prepare Memorandum of Association and Articles of Association prior to its formation. Its shareholders should be limited between two and two hundred shareholders having a minimum of two directors to take care of the working of the company. Liability is limited to the extent of unpaid share capital. Company form of legal structures are preferred by investors, banks, venture capital companies, etc for extending loans and investments. Although they suffer from high compliances, they do enjoy a set of government schemes and benefits from law. It would be suitable for businesses with huge opportunity and great plans of scale. Flipkart, BookMyShow, Ola are a few examples of Private Limited Companies

 

COMPARISON AMONG VARIOUS BUSINESS ENTITIES

SOLE PROPRIETORSHIP PARTNERSHIP LLP COMPANY

 

Liability Unlimited liability Unlimited liability Limited liability Limited liability
Tax rate Individual tax rates 30% 30% Starting at 15%
Foreign Direct Investment Not Permitted Not Permitted *Specific sectors *Some sectors
Transfer of shares Not Applicable With consent of all partners Ease of transfer
Investment in other businesses Not Permitted Not Permitted Permitted Permitted
Availability of information(Public) Not available Not available Available.

No confidentiality

Available.

No confidentiality

Formation Ease in formation Ease in formation Time consuming Time consuming
Compliances Less Less Moderate High
Scalability Low scalability Low scalability Moderate High
*100% automatic route – does not require any prior approval from RBI or Government. All kinds of FDI is prohibited in agriculture, plantation and real estate.

From the above table we can clearly see that no two forms are similar nor is any one form the best. Every entity has a different identity. You have to focus on what each form offers and match them with your own requirement. Choosing the right kind of business structure is the key to the smooth functioning of business. Aristotle had said the very famous proverb, “Well begun is half done”.

Click here to watch CA. Anand Kumar, partner at JAKS & Associates talk about different types of entity structures/legal forms available and how can we decide upon the right business structure

 

 

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