Choose the best Business Set Up

Business / Jul 06, 2020

India today is working on various aspects diligently to emerge as a global superpower. The country is thriving to be self-sufficient as well as a worldwide provider. All this is evident from the recent government policies like MAKE IN INDIA, Startup benefits, MSMEs support et cetera. No doubt, government is laying all these policies to encourage people to come forward with their business ideas and execute them more efficiently without worrying much about the risk and technicalities. As a result, we have seen an increase in incorporation of new business entities.

However, while initiating a business, the first question which comes to mind is ‘How to choose the Form of Business Organization?’

The answer to this question depends on various factors and ultimately determines the power, risk, control and responsibility of the entrepreneur. This also determines the system in which profit and losses will be divided in the business setup. Therefore, choosing which structure will suit you best requires a critical analysis of the pros and cons of each type of business structure and it is suggested to consult experts for guidance while making the choice.

We will here discuss the various forms of business structures and the advantages and disadvantages associated with them. This will help you in simplifying your concern of choosing the right form of business setup. The choice of business structure depends on various interlinked and inseparable factors. These are:

The operations of these factors significantly vary in different business organizations. For instance, ‘Degree of Control’ by owner is limited in a Private Company and maximum exercised in a Sole Proprietorship.

The following are the different profit making forms of business organizations existing under the Indian legal framework:

Private Limited Company
Sole Proprietorship
One Person Company
Public Limited Company
Partnership Firm
Limited Liability Partnership

Let us look at these one by one comprehensively to ease the choice making.

PRIVATE LIMITED COMPANY

A Private Company as defined in Companies Act, 2013 is a voluntary association by private persons for small scale businesses. It can be formed with minimum 2 members; however, the maximum strength cannot exceed 200. Limited liability is assigned to its members in accordance with the number of shares they hold. Such a company prohibits any invitation to the public to subscribe for any of its securities.

Advantages of Private Limited Company:

Separate Legal Entity – A Private Limited Company is a separate legal entity distinct from its members. Therefore, it is capable of holding property and enters into contracts in its own name. It can be a debtor or a creditor independently. Such an entity can sue and be sued like a natural person.
Limited Liability – The members of the company do not own its assets nor are they personally liable for the debts incurred by the company. Therefore, the debts are paid by the assets held in the name of the company hence; the liability of its members is limited.
Perpetual Succession – The death of the members do not affect the company as an entity and it continues to operate unless dissolved as per law.
Legal Benefits – The legal liabilities related to company can be carried in its own name. The company independently can sue and be sued through its members and also bear the consequences of an adverse order by paying from its assets.

Disadvantages of a Private Limited Company:

Restriction on Shares Transfer – A Private Limited Company, by its Articles, restricts the transferability of its shares to the public in general.
Limit on Number of Members – The maximum strength of a Private Limited Company cannot exceed 200 as mentioned in section 2(68) of the Companies Act, 2013.
Registration Process – The registration process is a bit time consuming and involves a sound cost.
Accountability – Annual reports and formation documents are required to be filed with the authorities making the company accountable. Also, annual tax return is mandatory for a company and it is also required to appoint a Chartered Accountant within 30 days of its incorporation.

SOLE PROPRIETORSHIP

Under Sole Proprietorship, a single individual owns the organization and manages its affairs. No outside control is present in such setups. Therefore, the owner bears the loss as well as enjoys the profits single handedly. Unlike as company, it has no independent identity and registration is also not essential. All in all, it is simpler to initiate but burdensome to continue. Let us look at the advantages and disadvantages of having a sole proprietorship in detail.

Advantages of Sole Proprietorship:

Ease of Formation – The most attractive feature of this type of business is the ease of initiating it without much formalities and technicalities. It can exist without registration but a local license is generally required.
Profit Enjoyment – The owner enjoys the profits and benefits related to his business without any obligation to share as he is the sole administrator.
Complete Control – The decision-making power is completely in the hands of the owner which leads to quick and efficient decisions motivated by the factor of maximum personal benefit.
Privacy – No compliance is required in relation to filing of annual reports and formation documents with the authorities, therefore, the business is not subject to public disclosure.

Disadvantages of Sole Proprietorship:

Unlimited Liability – Sole Proprietorship is not a separate legal entity and therefore, there is no separation between the assets of the entity and assets of the owner. Under this, if the proprietorship is liable to pay certain debt then it is liability of the owner which goes up to his personal assets and is not limited to the extent of capital invested in the business.
Restricted Capital – There are no partners or investors in this form of business who can invest money from their end. This type of business is under the control of the sole owner who mostly depends on his personal savings or business loans. Time to time additional investments to strengthen the business are not common due to lack of financial resources.
Taxes – The tax liability of the business is discharged personally by the owner who pays on behalf of the business as a self-employed person.
Limited Management – Being the sole decision making authority, the owner sometimes has to make serious decision on complex issues single-handedly.

ONE PERSON COMPANY (OPC)

The concept of OPC is recently introduced by the Companies Act of 2013. Section 2(62) of the Act defines OPC as a company which has only one person as a member. Only a natural person who resided in India in the preceding calendar year is eligible to form an OPC. This form of setup offers flexibility similar to that of a company and also protects owner from incurring unlimited liability which is faced in case of sole proprietorship and partnership. Under the Act, an OPC is treated as a Private Company.

Advantages of One Person Company:

Limited Liability – Unlike a Sole Proprietorship, the liability of shareholder is limited to the subscription of shares. Therefore, his personal assets are not subject to discharge the liability incurred by an OPC.
Stated Nominee – The name of the nominee is required to be stated at the time of formation of an OPC. Hence, at the time of death of the holder, there is no complex procedure to decide the succession and it easily devolves upon the nominee.
Private Company Status – As an OPC enjoys the status of a private company, it enjoys the benefits associated with a private limited company and also exemptions as to easier compliance unlike a company.
Minimum Setup – Only one director and shareholder required to form the Company (both can be same natural person). Also, only one nominee required to be named at the time of incorporation.

Disadvantages of One Person Company:

Ownership Restrictions – Only a natural person who is an Indian citizen residing in India is permitted to form an OPC.
Operations Restriction – Non-Banking financial Investment activities are not allowed to be carried out by an OPC; also it cannot convert to a Section 8 Company under the Companies Act, 2013.
Small Scale – This structure is suitable for small businesses only, if it exceeds the prescribed annual turnover limit then it is required to be converted to a Private Limited Company.

PUBLIC LIMITED COMPANY

A Public Company as defined in Companies Act, 2013 is a voluntary association that has a separate legal entity where the liability of its members is limited to the amount of shares they hold in the company. It can be formed with a minimum of 7 members and there is no limit as regards to the maximum number.

Advantages of Public Limited Company:

Continuity – This type of company is an independent legal person and therefore, it does not get affected by the death, insolvency or retirement of any of its shareholders and continues in its own name.
Limited Liability – The liability of its members is limited as the assets of the company are liable for its obligations and the personal assets of members are not at risk.
Larger Capital – Shares of a Public Company are freely transferable and the consent of other shareholders is also not necessary. Anyone who is willing to purchase can obtain share in a public company.
Strong Management – With a strong board of directors who make decisions according to the majority rule, the company is under a great chance of flourishing.

Disadvantages of Public Limited Company:

Complex Setup Process – Setting up a Public Company is comparatively difficult and technical. The incorporation process requires guidance and involves cost as well as formalities.
Public Accountability – This form of business lacks secrecy as the annual accounts are published and the records are open to public for inspection.
Governmental Control – Governmental control over Public Companies is excessive and thereby the company is required to observe several legal formalities.
Slow Decision Making – The decision making is comparatively slow in comparison to OPC and Sole Proprietorship. Decisions are taken by the Board of Directors generally after consulting the concerned officials.

PARTNERSHIP FIRM

Partnership Act defines Partnership as the relation between persons who have agreed to share the profits of a business carried on by all or any of them acting for all. Persons who have entered into partnership with one another are called individually “partners” and collectively a “firm”, and the name under which their business is carried on is called the “firm name”. The Act makes registration of firm optional but specifies certain benefits which cannot be enjoyed if the firm is unregistered.

Advantages of Partnership Firm:

Easy Setup – The Partnership Firm can be formed easily without much legal formalities and compliance as its Registration is not mandatory.
More Capital – The capital investment in a partnership firm comes from different partners which results in collection of more funds unlike Sole Proprietorship.
Division of Burden – Any liability is divided between the partners according to the Partnership Agreement and reduces burden on single person.
Effective Management – The partners share the profit, loss, ownership and control of the business and effectively participate in decision making for maximum profit.

Disadvantages of Partnership Firm:

Unlimited Liability – The liability of the firm extends to the liability of the partners and each partner is personally liable to make good the debt incurred by the firm and the personal assets of partners are not separately protected.
Principle of Agency – Each partner is bound by the act of all other partners undertaken in the name of the firm. This leads to situations where because of fault or fraud of one partner all other partners bear the risk.
No Separate Existence – A partnership firm is not a separate legal entity and has no existence independent of its partners in the eyes of law.
Unstable – It can be dissolved by Death, Lunacy or Insolvency of a partner.

LIMITED LIABILITY PARTNERSHIP (LLP)

LLP is a corporate business vehicle that enables professional expertise and entrepreneurial initiative to combine and operate in flexible, innovative and efficient manner. The members enjoy limited liability and the configuration allows the internal structure to operate as a partnership. Unlike partnership, it is a legal entity separate from its partners and a minimum of two partners are required to initiate its business. The Limited Liability of the partners depends upon the capital proportion invested by them in its formation.

Advantages of Limited Liability Partnership:

Independent Legal Entity – LLP holds assets independently and is a separate identity in eyes of law which can sue and be sued in its own name.
Limited Liability – The partners enjoy Limited Liability, it makes this form of partnership popular because partners are responsible to the extent of their contribution in LLP.
Perpetual Succession – LLP enjoys perpetual succession and the LLP Act clearly mentions that any change in the partners of a Limited Liability Partnership shall not affect the existence, rights or liabilities of the Limited Liability Partnership.
Agreement Setup – Subject to the provisions of LLP Act, 2008, the mutual rights and duties between the partners inter se and between the firm and partners shall be governed by the agreement agreed upon by all.

Disadvantages of Limited Liability Partnership:

Penalties for Non-Compliance – There are more compliances to be made as compared to a Partnership and in case of failure to meet the compliance requirement, higher penalties are imposed.
Restriction on NRI/Foreign Nationals – There is a requirement to be fulfilled which states that if an NRI or Foreign National wants to incorporate an LLP in India then at least one partner who is an Indian Citizen is required.
Ownership Transfer – Consent of all the partners has to be obtained in case a partner wants to transfer his/her ownership rights.
Absence of Equity Investment – There is no concept of shareholding in an LLP like a company; hence investment cannot be made as shareholders. This restricts the funding and ultimately LLPs depend on funds raised by partners and promoters and on debt funding.

India with a majority segment of people between the age group of 18-35, has a great opportunity to produce the best entrepreneurs across the globe. But, an entrepreneur doesn’t just become one with a business idea, one has to also look into the legal aspect of the business he is conducting. So, before initiating business of any form, it is necessary to do a due diligence in choosing a business form which will be the best fit for him. For matters of critical analysis and expert guidance, you can always reach out us as we structure business in a way for it to grow and be sustainable in the long run. Reach out to us for all matters of business consultation.

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Choose the best Business Set Up