18 Jun 2015 17:11 IST

How to decide on a legal structure for your business

If you’re looking for funding you have no option but to start a private limited company

Young entrepreneurs should educate themselves on all five business structures. The best options could enable efficiencies in several areas, particularly tax and compliance.

In the early stages of business, it can feel like a waste focussing on legal and compliance. But since it has to be done, many entrepreneurs simply go ahead with what they think is right. Consequently, small businesses end up with more compliance than necessary, having registered a private limited company, while businesses that can scale, having registered a limited liability partnership (LLP), are forced to convert to a private limited company in order to raise funding.

But it doesn't have to be this way. Picking the right option between a private limited company, LLP, one-person company (OPC), partnership, and a sole proprietorship, in fact, takes no more than five minutes, so long as you are aware of what it is that your business wants to do. By the time you get to the end of this post, therefore, you'll have the information you need to take a call on the right legal structure for your business. Here it is:

Funding

The question most relevant to start-ups today: Are you going to raise funding? If you are, you've got no option but to start a private limited company. It is the only legal structure that will easily accommodate an additional shareholder. This is because OPCs and sole proprietorships do not allow more than one shareholder, hence they cannot accommodate an investor. LLPs and partnerships, on the other hand, can only accommodate investors as partners, not shareholders. Moreover, partnerships have unlimited liability, which no investor would accept. Those not accepting funding could exclude the private limited company in favour of a structure with less compliance.

Compliance

While private limited companies enable you to add shareholders, they have the maximum compliance requirements. Such businesses must maintain books of accounts, comply with statutory audit requirements and submit IT returns, and annual filings. Therefore, only businesses that are looking for funding should ideally register themselves as private limited companies. For smaller businesses, the LLP is ideal, as it has just three annual compliances and no requirement for statutory audit while the business has revenues of less than Rs 40 lakh. For even smaller businesses, let's say a home bakery run by siblings, a partnership would be just fine. Partnerships and sole proprietorships have minimal compliance requirements, but unlimited liability (which means that your creditors could take the personal possessions of the partner/proprietor in case the business can't pay up.) This simply isn’t a good option for any serious business.

Tax Advantages

While many assume that private limited companies enjoy enormous tax advantages, they really don't. There are some industry-specific advantages, but overall, tax is to be paid at a flat rate of 30 per cent on profits, and wealth tax and Divident Distribution Tax (DDT) also apply. LLPs also pay tax at the same rate, but wealth tax and MAT are not applicable. From purely a tax perspective, it is surely the better option. Smaller businesses (let's say traders or merchants) may even consider a sole proprietorship as you pay tax at the individual tax slab rate. Moreover, if profits are under Rs 1 crore, you can simply pay tax at 8 per cent.

Business Continuity

Of your five available options, private limited companies, OPCs and LLPs have a completely separate existence from the founders or shareholders. Therefore, their existence is not at all dependent on any particular individual. Even if the founder quits the company, the business can go on, so long as it complies with MCA regulations. Sole Proprietorships and Partnerships, on the other hand, come to an end the moment the person managing dies or ceases participation.

Armed with this information, you should easily be able to take a decision on the business structure to choose. Some founders do take into account start-up costs, but now that the MCA has removed the need for paid-up capital, there's no need to do so. Starting up, whether you're doing so as an LLP, private limited company or OPC, shouldn't matter to a business.

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