Choosing the right business structure for your startup
Business structure refers to the legal structure of an organisation that is recognised in a given jurisdiction. Choosing an appropriate business structure is a critical step for any Startup as it determines the activities that the organisation can do or cannot do for example the Indian laws grants one person company (OPC) a corporate identity while allowing only one member at all times which helps in creating separate legal identity but restrict the additional funding options.
In India, we primarily have 3 (three) types of Business structures namely Sole proprietorship, Partnership firms, and Company (private or public). However, with the increasing number of Start-ups in India and the Government’s focus on improving the ease of doing business in India, two new hybrid forms have emerged in the past few years.
Partnership firm + company = Limited liability Partnership (LLP); and
Sole proprietorship + Private Company = One Person Company.
Sole Proprietorship as the name suggests is a one-man business organisation. The owner and the business are one and the same. It is the most common and simplest form of business in India as it does not require registration under any specific law. Amongst the many advantages, Sole proprietorship offers tax and compliances advantages given the owner is taxed only once and that too at the rate applicable to an individual and not under the corporate tax slab. While the foremost disadvantages in the case of a sole proprietorship are unlimited liability which can cause the owner to risk all his personal assets to meet the business liability and difficulty in raising funds.
The Partnership Firm means when two or more people come together to work and earn profits. It is governed by the Partnership Act, 1932. However, registration of the Partnership firm is not mandatory under the law. The Partnership firm can be registered as well as unregistered. Needless to say, non-registration of a Partnership Firm has many adverse consequences like the Partnership firm cannot enforce its rights under the Act nor against any third party. Additionally, it is important that the Partnership Deed is well-drafted to capture all present and future events like the procedure of admission or withdrawal of a Partner, role, responsibility and assessment criteria for each Partner, criteria for appointment of a nominee.
One Person Company
This form of business has recently come into existence in India. It is a hybrid of Sole proprietorship and Private Limited Company. For a detailed understanding, refer to this details article here.
All Companies in India (whether private or public) are incorporated under the Companies Act, 2013 or under the previous company Act. One of the most crucial characteristics of this business form is a separate legal identity which means it is separate from its shareholders, members, and directors. This results in many operating advantages for the promoters like perpetual succession, limited liability, power to enter into contracts in its own name, and also own property in its own name. While few major disadvantages of a Company include annual audit and regular compliance requirements, complicated winding-up procedure, higher tax rate.
Limited Liability Partnership (LLP)
The concept of LLP was introduced by way of the Limited Liability Partnership Act, 2008 to provide the corporate benefit of limited liability of the Partners while offering flexibility to the Partners/ members to manage operations of the business by entering into the mutually consented agreement. It is important to highlight that while most characteristics of LLP are similar to a Private Limited company, most small to mid-size business owners prefer LLP because of lesser compliance like requirement of the annual audit of books of account arises only if the contribution in the LLL exceeds INR 25 Lakh or the turnover exceeds INR 40 Lakh.
It is quite noticeable that the Start up’s do not register from the very beginning or even if they do it is not a well-thought decision which eventually leads to waste of large money in redoing the compliances or paying up the penalties for failure. business owners should first consider their needs and goals and understand the features of each business structure before making a choice on the type of legal structure. Hence, it is advisable that the entrepreneurs obtain sound legal, and tax advice prior to formalising a business structure.