You have mustered all the courage to start your own business. And now, a hundred decisions await your approval stamp. One of the most important decisions is organising your venture around a legal framework. One of the most preliminary decisions relate to
Business Entities for Start-ups
You have mustered all the courage to start your own business. And now, a hundred decisions await your approval stamp. One of the most important decisions is organising your venture around a legal framework. One of the most preliminary decisions relate to your business structure. In India, popular models an entrepreneur can chose from are proprietorship, partnership, a private limited company or a limited liability company. Exploring the merits and demerits of each can help you make the right choice.
What You Should Consider
Nature of business
The most important consideration should be the nature of your business. For entrepreneurs offering professional services like doctors or lawyers, the proprietary form is the most suitable one. Other businesses that require pooling of skills and funds, a partnership firm is more feasible. Whereas for manufacturing businesses which are generally large in size, the public or private set up is generally opted for.
Scale of operations
The volume and scale of your business is a key consideration. Consider if your business is large, medium or small in terms of scale of operations and also the size of the market, whether it is local, national or international. For large scale organisations catering to national and international markets, a public company set up or private company set up is best suited. Small and medium scale firms are generally set up as partnerships and sole proprietorships.
Degree of Control
For an entrepreneur who wants to control his business directly, sole proprietorship is the best option. But an entrepreneur who can be comfortable with separate ownership and management, a company set up will be desirable.
Sole proprietorships are most suited for businesses requiring limited investments for establishment and operation of the business. However, when a business requires funds to be pooled in by different heads, then a partnership or private limited company is more favourable.
Risk appetite is an important consideration. An entrepreneur who is comfortable with bearing all the risks associated with the business would fit in the proprietor model. On the other hand, if one wants risk sharing between all stakeholders, a partnership or a private limited company will be the best bet.
Feasible structures for start-ups
This is the most common type of start-up entity in India. The entrepreneur is the sole owner of the business, who fund as well as operates the business. It is the simplest form of business entity, which can be easily set up with minimum formalities. No rules about records are required to be kept, no requirement of having your accounts audited and no requirement of filing financial information to the registrar of companies. In other words, there is no legal distinction between you and your business.
In a partnership, you partner with other individuals to own and run the business. By partnering with other individuals, you get access to a bigger pool of capital, skills and other resources to fund and run your business. All partners contribute capital equally, share profits and losses equally and have an equal say in business decisions.
Limited Liability Company
This type of business entity is most common and preferred type for a start-up. A limited liability company is a separate legal entity from its founders, shareholders and managers. The liability of the shareholders is limited to the paid-unpaid capital that is issued as part of the company. Thus, in case of bankruptcy, personal assets of the founders/managers are not affected. A limited liability company needs to keep record of accounts, audit their records and file an annual report on return with the registrar of companies.
Private Limited Company
A private limited company is a preferred choice for those who want the advantages of limited liability but at the same time desire to keep control over the business within a limited circle and maintain privacy of their business. A private company can be formed by more than two and less than 50 members. Members are not liable for losses incurred due to decisions or actions of other members.
There is scope for frauds in a private company