We are going to start this week’s question and answer session on the various kinds of business set-ups with some rather basic questions. Read on to know the answers.
A friend wants to start a business, and is quite clear about the nature of business, the revenue projections, and so on. But she is not sure about the business structure to opt for. What are the choices here?
Essentially, there are three forms of business structure (or, in more formal terminology: business organisation).
These are: proprietorship, partnership and company
And what is the actual difference between these three?
A proprietorship is the simplest form of business organisation. Here, one person starts the business, brings in the necessary capital and manages the business. He may employ other people to assist him, but he retains the ultimate authority over the business. This one person is the sole owner / proprietor of the business.
A partnership has more than one person involved and they are together co-owners of the business.
A company also has many people who invest in the business. Typically, companies are businesses that operate on a larger scale or require more investment. But this is not a hard and fast rule, only a broad indication.
Why would a person start a proprietorship or a partnership? I mean, what makes some people do this and some others choose that?
Proprietorships tend to be businesses where the owner wishes to retain complete control, and does not feel the need to involve other people to any extent, other than as employees.
Partnerships tend to be those businesses where the owner(s) thinks that other people need to be closely involved since their expertise / investment capacity is required for the business
Which of these is easier to form?
It is easy to form a proprietorship business. The originator of the idea chooses a name for his business, brings in the capital, completes the necessary formalities, and is ready to operate.
Forming a partnership is also relatively easy. In this case, some formalities have to be gone through with each partner bringing in the necessary capital. A partnership deed — that is, an agreement among partners, needs to be executed. The deed spells out the rights and duties of the partners. There are two basic types of partnership and the partners need to decide on the type of partnership. A few formalities relating to registration of partnership also need to be carried out.
Forming a company is much more complex and time-consuming. There are various formalities to be followed. The services of an expert are required here.
What are the pros and cons of these three forms of business?
Well, one way to look at it is in terms of how much capital is required.
The other way is in terms of the formalities involved. Proprietorships are the easiest to start, as well as the easiest to wind up.
A third angle is in terms of the ease of raising further capital after starting the business, to scale it up. It is better to form the business as a company from this point of view.
There is one more consideration — that of limited and unlimited liability.
Can you explain that?
The general principle is that a business is a different entity from the owner(s).
A business may buy assets, rent property, employ people, buy and sell stuff, and so on.
And if something goes wrong — say, there is a loss or a loan cannot be repaid — then it is the business which is responsible / liable, and not necessarily the owners.
But this concept is not applicable to proprietorships. In the case of proprietorships, there is no difference between the business and the proprietor. The proprietor is personally liable for the losses or loans, if any, of the business.
This concept is known as ‘unlimited liability’ of the owner. In the case of companies, the liability of owners is limited.
How about partnerships?
Partnerships can be formed in two ways — either as limited liability or as unlimited liability.
So what do you finally recommend to my friend? What kind of business structure should she opt for?
That is not something which can be treated as one simple rule, so no advice as of now. It is a decision to be taken on a case-to-case basis, keeping the business plans, long-term vision and the other considerations in mind.
With inputs from Mr R Ravi Sankar, CEO of CDMS (www.mgrlskills.org)
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