How to decide the legal structure for your business?
When you settle on the choice to go into a business, there are a few steps to take initially all the while. This involves making a Business Plan, sorting out how you will get finance for your business, and choosing a business name. To get into the arena, another of the underlying strides of beginning a business is determining the right legal structure of your business.
Thinking why is important choosing a legal structure? The answer is, it will decide the tax and legal consequences for your business and affects the operations of your business and it can’t be decided based on assumptions. You need to scrutinize the crucial factors like understanding the nature of your business, credibility ,local, state, and central level laws and taxations. Also, the financial needs and ownership of liabilities are two prime factors that need to be evaluated carefully while determining which legal structure fits best as per your business needs and line of work.
So, if you are uncertain about your legal structure, let us attempt to answer your questions and give you much-needed information right here. To assist in you decision making we, at Financetree, have specific information in helping you to conquer these hindrances and to guarantee a smooth and fruitful journey for you.
Distinguish Between Types of Legal Structures
Legal structure, also known as business structure or business forms can be decided on the grounds of your own liabilities as an entrepreneur and tax obligations
There are a few kinds of legal structures, the most widely known sole proprietorship, partnerships, Company (Public or Pvt.), and Limited Liability Partnership (LLP).Each structure has its own advantages and disadvantages. Let’s understand each legal structure separately.
Sole Proprietorship is one of the most popular and basic business structures that allow an individual to start a business in shorter time frame with small capital and least regulations. Businesses under this form may differ in size from a roadside cart to a huge one. The proprietor is totally accountable for the business and every connected decision. It is like a one man show where proprietor is completely accountable for the business, obligation risk and every connected decision.
This business form is ideal for those who want to have sole ownership of the business and to start with limited funds and resources. Also it has least legal compliance and operational prerequisites.
In this business structure two or more partners manage and operate the business and share its profit under a formal arrangement or partnership. The agreement between the partners known as Partnership Deed need to be in place for clear understanding of the roles of each partner. It outlines the terms and conditions of operating, managing and sharing income and losses among partners occur by the business.
Partners can be individuals, trust or corporation who distribute the responsibilities as co-owners and share the profits or losses they generate from the business. In India, the partnership firms are administered under ‘The Indian Partnership Act 1932’. Under this act the partnership firm is explained as a formal agreement between two or more individuals and partners who have accepted to share the profits generated from the business under the supervision of all the members or behalf of other members.
Partnership is the simplest legal structure in which two or more people can owe a business together. It’s a good choice for Startups with multiple owners or group of professionals where they can share profits, obligations, risks and liabilities. Starting with a partnership business is easy and flexible. With the partnership, business can be started with more capital and resources as well as combining more skills, experiences and knowledge.
This business structure is more expensive and complex in nature. A company can be opened in the form of a private limited or public limited company depending upon how many members are there. Today there are some other forms available like one person company etc. Public Limited Company is an organization restricted by shares in which there is no limitation on the number of investors, public deposits, and transfer of the shares. The risk of every investor is restricted to the degree of the unpaid measure of the assumed worth of the offers and the premium subsequently, in regard to the offers held by him. However, the Director/Manager of such an organization are fully accountable for running the affairs of the business.
In a Pvt company, the Shareholders’ entitlement to transfer shares is limited. Also, the quantity of investors is restricted to fifty, and solicitation to the public to buy into any shares or debentures is not allowed. Private limited company are ideal for set ups which are closing held within a group of persons or family.
Starting with a company structure is complex and involved various regulations and taxation.
Limited Liability Partnership (LLP)
LLP is the hybrid format presenting the benefits of partnership and Pvt ltd Company. In this business structure, some of the partners have limited liabilities. In an LLP, one partner isn’t liable or accountable for other partners’ misconduct. You can say it is more regulated than the general partnership structure offering businesses to operate in a more flexible and innovative manner.
LLP is a good option for those who don’t want to suffer on the behalf of their partners losses and want have limited and predefined liability unlike general partnership where liability is unlimited on the partners.
Difference between Different Legal Structures
Determining a business structure is complicated and technical; but it can have extensive ramifications for your business. However, there’s no one size fit for all. The objectives of the business are essential in deciding the entity that includes components like nature and targets of the business, level of control wanted by the proprietor, total capital and funding required, tax implications, etc.
The factors to consider when settling on a legal structure for your business include:
- Liability- Liability in Sole Proprietorships and in partnership is unlimited whereas in other structures it is limited.
- Taxation- Sole proprietorship and partnership are not taxed as a different legal entity while in the case of LLP and company they are treated as different legal entity and therefore they file their returns separately from owners or members
- Ownership & Control – Proprietor has the complete ownership in sole proprietorship and in partnership is divided among partners. In company director has the control over operation activities of the business and the affairs of the company is governed by the board of directors
- Credibility- In term of credibility LLP and company are most credible business structure while in Sole proprietorship and partnership is dependent on the owner or partners’ credibility.
Table below provides a detailed comparison between each business entity set
|Sole Proprietorship||Partnership firm||LLP||Company|
|Statute||Not regulated under one law or regulation||Governed and regulated under The Indian Partnership Act, 1932||Governed and regulated under Limited liability Partnership Act,2008||Governed and regulated under Companies Act, 2013|
|Name||No guidelines||No guidelines.||Name to prefix with “LLP” Limited Liability Partnership”||Name of a public company to end with the word “limited” and a private company with the words “private limited”|
|Formation||Created by owner||Created by Contract||Created by Law||Created by Law|
|Formalities of Incorporation||NA||In case of registration, Partnership Deed along with form / affidavit required to be filled with Registrar of firms along with requisite filing fee||Various e-forms and the LLP Agreement are filed with the Registrar of LLP along with the prescribed Fee.||Various e-forms along the Memorandum & Articles of Association are filled with Registrar of Companies with prescribed fees|
|Capital contribution||Not specified||Not specified||Not specified||Private company should have a minimum paid up capital of Rs. 1 lakh and Rs.5 lakhs for a public company|
|Annual Return||Not taxed as a different legal entity||No return is required to be filed with Registrar of Firms||Annual Return has to be filed with ROC within sixty days of the closure of the financial year.||Every company having a share capital shall within [sixty] days from the day on which each of the annual general meetings is held, prepare and file with the Registrar|
|Audit||Proprietor to have tax audit of their a/c as per the provision of Income Tax Act||Partnership firms are only required to have tax audit of their accounts as per the provisions of the Income Tax Act ( Limit- 60 Lakhs for business and 40 lakhs foe profession)||All LLP except for those having turnover less than Rs.40 Lakhs or Rs.25 Lakhs contribution in any financial year are required to get their accounts audited annually as per the provisions of LLP Act 2008.||Companies are required to get their accounts audited annually as per the provisions of the Companies Act, 1956,irrespective of share capital and turnover|
|Dissolution||Settling a/c, liabilities, credits, cancelling registration||By agreement of the partners, insolvency or by Court Order||Less procedural compared to company. Voluntary or by Order of National Company Law Tribunal||Very procedural. Voluntary or by Order of National Company Law Tribunal|
|Suitability||Suitable for new start up, individual venture to start with lesser capital requirement and taxations||More suitable for small businesses like retail ,wholesale trade or small manufacturing units, legal firms ,etc.||
More suitable for professionals like CAs, CSs, advocates etc. and service sector.
|More suitable for businesses, trade, manufactures, large industrial establishments etc.|
Do’s & Don’ts
- Understand the tax and personal liability consequences of a business entity prior decision making
- Develop a business plan aligning with the option you have in choosing a business form.
- Carefully meet the state requirements if your business entity is required to file documents with the state.
- Don’t start working on your business prior to deciding its structure.
- Don’t accept that the business structure you pick is approved to work together in different states also. LLP and limited companies need to enroll in the states where they will operate their business.
- Don’t hurry. Choosing the right business structure can be complicated but worth for the long term smooth running of your business.
The structure you choose should be determined by what it is you want to accomplish through your venture as the quick financing prerequisite. Make sure to think about the more long term prerequisites and how these might be antagonistically affected by choosing a structure to meet the short term. This is imperative to get it right from the starting point, else it may be both intricate and expensive to transform from some legal structure to another later.