This article has been written by Pranav. Pranav is an advocate and deals in corporate advisory, commercial agreements, and civil and criminal litigation.
Before you start a business, it is important to understand how to structure your business. Structuring means choosing the right commercial framework for your business. According to the incorporation process, liability, capital, workforce, taxes, compliances, investment, control over business, credibility, regulations, licenses, ease of getting loans, and various other factors, different businesses have different requirements and different factors to grow their business.
We have four kinds of commercial business structures in our country, namely, proprietorship, partnership firm, LLP, and company. Everytime we choose to do a business, we have to select any one of the above stated structures. To choose any one structure, we should be aware of the basic differences among all of them.
In a proprietorship, the founder is the sole owner and he himself manages the business.
In a partnership firm, we have two or more partners who are the owners, who invest their money into the business and have certain rights and responsibilities as agreed by their agreement.
In an LLP, we have two or more partners as the owners of the business who have their limited liabilities. An LLP is a separate legal entity and its own owner. Here, the owners and the management may be the same or different.
A company is a legal entity separate from its owners. The company is itself the owner. The founders have ownership in the company equal to the number of shares they hold. However, it can be transferred anytime. The management of the company lies with the board of directors. Members may or may not be a part of the board.
In this article, we intend to discuss the most important factors which play a major role in choosing the best structure, according to the wants, requirements, vision and expected growth of the business.
Legal status : A proprietorship is no different from its owner. Personal assets of the proprietor can be annexed to fulfil the obligations of the business.
In a partnership firm also, the status of a partnership firm is not separate from its owners. The legal status of a partnership firm is the same as that of a proprietorship concern. Partners are personally liable for the obligations and the liabilities of the firm.
An LLP is a separate legal entity different from its partners. Partners are liable upto the extent of their contribution in the LLP. Change in partners would not affect the existence, liabilities, rights and obligations of the LLP.
The legal status of a company is the same as that of an LLP. Promoters are liable upto the extent of their shares in the company. Personal assets of the promoters do not get impacted by the liabilities of the company. A company is its own owner and its status and existence does not change with the change in members.
To simplify the complexity, let’s understand it through an example :
Suppose you took a loan of rupees 20 lac from a bank to start your business and unfortunately, your business failed disastrously….In this case, if you are a company or a limited liability partnership, you are not personally liable for the loss but the company or the limited liability partnership is, as the case may be. The bank may recover its money from the assets of your entity but not your personal assets.
In the reverse case, if you are a proprietorship or a partnership firm, the bank can recover its loan even from your personal assets such as your home, your movable property etc. other than from the assets of the firm.
Ownership and management : In case of a proprietorship and a partnership firm, the proprietor or the partners, as the case may be, are also the managers of their business. The ownership and management lies in the same hands. Therefore, there is no difference between the proprietor or the partners, as the case may be, and the owner.
In case of an LLP or a company, the management of the business may not necessarily be with the founders. It depends completely on the agreement executed by the founders. Owners and management may be different. The ‘board’ generally controls the management and is responsible for decision making of the business.
Incorporation process : For a proprietorship, there is no requirement of incorporation, however, business licenses may be required subject to concerned laws. For example in case of a restaurant, registration and license is required as per the FSSAI Act, 2006.
In case of a partnership firm, a stamped partnership deed is required to be signed, submitted and registered with the registrar of partnerships.
In an LLP, a detailed incorporation document is required to be filed with the registrar of state along with a statement made either by an advocate, or a CA, or a CS, or a cost accountant that the requirements under the law have duly been complied with.
In a company, a detailed incorporation process along with memorandum and articles of association is required to be filed with the registrar. For an incorporation of a company, the process is more lengthy and expensive as compared to the others.
Taxes : If you’re a sole proprietorship, your tax slab will be according to your personal income. There are various tax slabs starting from zero to 30% being the highest.
If you’re a partnership firm or a limited liability partnership, you’re taxable at a flat rate of 30% of your income plus surcharge and cess.
If you’re a company, you’re taxable at 30% along with surcharge and cess plus the profits distributed to owners are also taxed at 20% separately.
Compliances : In a proprietorship, no compliances are required other than filing returns for tax. Same is the case for a partnership firm.
In case of an LLP, compliances are very less as compared to a company. An LLP is just required to file with the Registrar its annual account statements, annual return and solvency statements.
For a company, compliance requirements are a total headache. A company is required to file various documents with the RoC including its financial statements, directors reports, meetings, appointment of auditors, managing various registers, filing resolutions etc.
Credibility : The credibility of a company is the highest amongst all as all its records including financial statements, resolutions passed, management, control, track record is accessible to the public and may be checked anytime by paying as low as rupees 100 on the mca website. Reputation of the board of directors, who are the decision makers for the company play a crucial role in the credibility of the company.
For an LLP also, the account statements, annual returns and solvency documents are a matter of public record and can be easily accessed by any individual. Therefore, credibility of an LLP is more than that of a proprietorship and a partnership firm but less than that of a company.
In case of a proprietorship or a partnership firm, credibility is less as compared to company or LLP, as there are no public records available and no track record can be looked into. Generally, it is the goodwill which helps these entities grow their businesses.
Credibility plays a major role when you are looking to expand your business or looking for investments for your business.
Loans and investments : It is easier to get loans or investments for a company as compared to others. Venture capitalists, angel investors, HNIs always prefer to invest in companies as they rather prefer to become shareholders than partners in a business.
It is also easier for companies to get loans from banks as compared to other structures due to the public information of the company, track record, and capabilities of the board. However, LLPs, proprietorships or partnership firms can also avail loans but it is slightly difficult as compared to companies. There are always various factors involved in obtaining loans such as credibility, goodwill, track record. In some cases, a partnership firm may get a loan easier than a company.
Foreign loans can be obtained at a far lesser percentage than domestic loans. A company is entitled to obtain a foreign loan but a proprietorship,or a partnership firm, or an LLP is not entitled to obtain foreign loans. Therefore, for foreign loan purposes, a company can be the best structure.
Incentivisation of employees : It is always difficult to retain your over-performing and hard working employees as there are always getting better options to work with competing business entities with higher pay cheques and more powers, due to their high productivity. Therefore, incentivisation of employees at regular intervals is a must these days. But what if, you don’t have enough money and resources to pay and retain them.
In a proprietorship or partnership firm, employees are generally incentivised by increasing their salaries at regular intervals or even giving them bonus. But in situations, when the profits and revenues have been less than expected it becomes difficult to pay them. Same is the case for LLP also.
But companies always have better options to retain their employees even in cases where their revenues are less. They may do so by giving them some equity in the company or by creating a stock options plan for them by which they will have the right to purchase the shares of the company at a predetermined rate on a future date. This encourages them to work even harder, come up with new ideas for the growth of the company and put in more efforts. When the company will earn, they will be benefited too.
Conclusion : It depends completely on the approach to the business, the intended growth, the capital invested, the ownership and control a founder wishes to retain, the tax applicabilities, ease of raising loans and investments, and various other factors as to which would be the best structure for your business. Therefore, it is always recommended to choose wisely among all the structures noted above.
Regulating laws : A partnership is regulated by ‘The Partnership Act, 1932’. An LLP is regulated by ‘The Limited Liability Partnership Act, 2008’. A company is regulated by ‘The Companies Act, 2013’.
For feedbacks relating to this article, feel free to contact the author at Pranav J | LinkedIn or you may also whatsapp him at 9991189110.
