Starting a business in India requires one to choose a type of business entity. In India one can choose from five different types of legal entities to conduct business. These include Sole Proprietorship, Partnership Firm, Limited Liability Partnership, Private Limited Company and Public Limited Company. The choice of the business entity is dependent on various factors such as taxation, owner liability, compliance burden, investment and funding and exit strategy.
Lets look at each of these entities
This is the most easy business entity to establish in India. It doesn’t need its own Permanent Account Number (PAN) and the PAN of the owner (Proprietor) acts as the PAN for the Sole Proprietorship firm. Registrations with various government departments are required only on a need basis. For example, if the business provides services and service tax is applicable, then registration with the service tax department is required. Same is true for other indirect taxes like VAT, Excise etc. It is not possible to transfer the ownership of a Sole Proprietorship from one person to another. Assets of such firm may be sold from one person to another. Proprietors of such firms have unlimited business liability. This means that owners personal assets can be attached to meet business liability claims.
A partnership firm in India is governed by The Partnership Act, 1932. Two or more people can form a Partnership subject to maximum of 20 partners. A partnership deed is prepared that details the amount of capital each partner will contribute to the partnership. It also details how much profit/loss each partner will share. Working partners of the partnership are also allowed to draw a salary in accordance with The Indian Partnership Act. A partnership is also allowed to purchase assets in its name. However the owner of such assets are the partners of the firm. A partnership may/may not be dissolved in case of death of a partner. The partnership doesn’t really have its own legal standing although a separate Permanent Account Number (PAN) is allotted to the partnership. Partners of the firm have unlimited business liabilities which means their personal assets can be attached to meet business liability claims of the partnership firm. Also losses incurred due to act of one partner is liable for payment from every partner of the partnership firm.
A partnership firm may or may not be registered with Registrar of Firms (ROF). Registration provides some legal protection to partners in case they have differences between them. Until a partnership deed is registered with the ROF, it may not be treated as legal document. However, this does not prevent either the Partnership firm from suing someone or someone suing the partnership firm in a court of law.
Limited Liability Partnership
Limited Liability Partnership (LLP) firm is a new form of business entity established by an Act of the Parliament. LLP allows members to retain flexibility of ownership (similar to Partnership Firm) but provides a liability protection. The maximum liability of each partner in an LLP is limited to the extent of his/her investment in the firm. An LLP has its owner Permanent Account Number (PAN) and legal status. LLP also provides protection to partners for illegal or unauthorized actions taken by other partners of the LLP. A Private or Public Limited Company as well as Partnership Firms are allowed to be converted into an Limited Liability Partnership.
Private Limited Company
A Private Limited Company in India is similar to a C-Corporation in the US. Private Limited Company allows owners to subscribe to its shares by paying a share capital fees. On subscribing to shares, the owners/members become shareholders on the company. A Private Limited Company is a separate legal entity both in terms of taxation as well as liability. The personal liability of the shareholders is limited to their share capital. A private limited company can be formed by registering the company name with appropriate Registrar of Companies (ROC). Draft of Memorandum of Association and Article of Association are prepared and signed by the promoters (initial shareholders) of the company. A Private Limited Company can have between 2 to 50 members with minimum share capital of Rs 1,00,000 (one lac). To look after the day to day activities of the company, Directors are appointed by the Shareholders. Minimum two Directors must be appointed to look after the daily affairs of the company. A Private Limited Company has more compliance burden when compared to a Partnership and LLP. For example, the Board of Directors must meet every quarter and at least one annual general meeting of Shareholders and Directors must be called. Accounts of the company must be prepared in accordance with Income Tax Act as well as Companies Act. Also Companies are taxed twice if profits are to be distributed to Shareholders. Closing a Private Limited Company is a tedious process and requires many months.
One the positive side, Shareholders of a Private Limited Company can change without affecting the operational or legal standing of the company. Generally Venture Capital investors prefer to invest in businesses that are Private Limited Company since it allows great degree of separation between ownership and operations. It also allows investors to exit the company by selling shares without being liable for company affairs.
Public Limited Company
Public Limited Company is similar to Private Limited Company with the difference being that number of shareholders of a Public Limited Company can be unlimited with a minimum seven members. It is generally very difficult to establish a public limited company. A Public Limited Company can be either listed in a stock exchange or remain unlisted. A Listed Public Limited Company allows shareholders of the company to trade its shares freely on the stock exchange. A Public Limited Company requires more public disclosures and compliance from the government as well as market regular SEBI (Securities and Exchange Board of India) including appointment of independent directors on the board, public disclosure of books of accounts, cap of salaries of Directors and CEO. Like a Private Limited Company, a Public Limited Company is also an independent legal person, its existence is not affected by the death, retirement or insolvency of any of its shareholders.