If you are looking to start a new business, making your way through the legalities is the going to be the least interesting part. Though, you’ll do well to acknowledge that they actually form an essential part of initial business planning that converts your idea into a reality.
For instance, legal business structure is an enabler without which business operations or growth could get into a deep freeze. Let’s say, you are setting up as an online retailer. Nearly all marketplaces will ask for your business registration before discussing anything else. Similarly, most investors, credit suppliers, and channel partners would want to see your company’s existence in government records. Not to mention, it is a prima facie indicator of the seriousness and trustworthiness of an enterprise.
The choice largely boils down to compliance burden, tax implication, and ease of operation. Following are the possible ways to get going in India:
* Only the key distinguishing features are included here
1 One Person Company
2 Limited Liability Partnership
Once you know the characteristic differences among proprietorship, OPC, partnership, LLP and private company, you get some pointers on the choice of legal form. That said, each individual case requires a tailored approach based upon its own unique set of circumstances. An experienced consultant will make you see all practical and legal fine prints before integrating them to your business mission.
Proprietorship is the simplest and cheapest way to get up and running. If you have no idea about what it means to actually run a business and are bootstrapped, this is where you should start. A proprietor and the business are treated as the same entity under all statutes. That means you will enjoy all the benefits and tax exemptions of an individual. Only proprietorships and partnerships (not LLP) can avail presumptive tax scheme under sections 44AD/ADA. Books of accounts for both these types of entities are to be maintained under section 44AA, which also includes conditional relaxation. But, you cannot seek any type of equity funding – domestic or foreign. Even banks are more cautious in lending to proprietorship concerns – not that there is any rule against it. This is where OPC (One Person Company) comes in. It was introduced by Companies Act, 2013 as amended by Companies Act Amendment Bill, 2015. OPC offers private company like benefits without the same level of compliance burden and costs. If you want to retain the management/decision making for your venture, while appearing more organized, opt for OPC. Also, if after the initial testing phase, you have developed a trust in your idea but are still looking for a co-promoter, register as a one-person company. Banks are more generous with OPC, but equity funding will still be inaccessible.
Why OPC and not partnership? That’s because partnership is not a separate legal entity and entails unlimited liability individually and severally for each partner. You will benefit more from a hybrid construct that incorporates the positives of partnership (tax benefits, lesser regulation, and no minimum capital requirement) and a private company (limited liability). This format is known as LLP, introduced by Limited Liability Partnership Act, 2008. There is no ceiling on the number of partners unlike private limited company, where the number of directors is limited to 200. Loan finance is not a problem for an LLP. Funds can also be raised in the form of capital contribution by existing or new partners. An LLP can raise even foreign funds subject to some restrictions and prior government approval. For a brief period, the balance seemed to be tilting in favor of LLP until the 2015 amendment of Companies Act, which leveled the field by extending “no minimum capital” norms to both OPC and private companies.
However, if you have plans to scale your business into a large enterprise you will need to migrate to a private limited company structure. For starters, private equity investors prefer ventures organized as companies because only a private company can issue shares - a much more flexible and professional mode of investment. Moreover, the exit options under any other legal format either do not exist or are very cumbersome. For instance, an IPO is possible only in case of a private limited (conversion to public company). At the same time you cannot convert a LLP directly into a private company unless the transaction is designed as a business sale. Foreign investment norms too are easier for private companies than LLP. Also, angels, venture funds, and private equity firms have a huge focus on the quality of management team and only a company can effectively separate management function and ownership. In this case, you can hire an experienced and capable team that is not tied into conflicting ownership concerns. Not only for the investors, this also bodes well for overall organizational success.