Designing a building requires a solid foundation and pillar structure as they significantly impact the building’s various aspects. Similarly, starting a business involves getting several elements right, such as the business idea, entity type, market, etc. New business owners may feel uncertain about choosing the right entity type. This blog discusses the different entity types to consider when starting a business.
There are multiple forms of entities that one may consider: Sole Proprietorships, unincorporated Partnership, Limited Liability Partnership, One Person Company and Private/Public Companies. Many important components play a role in deciding the type of entity that best suits the nature of your business. These include:
- Personal liability;
- Tax implications;
- Cost of formation and maintenance;
- Flexibility;
- Complexity of compliance;
- Financing for the business;
It is recommended to analyze these components carefully to ensure a successful start. Taking the time to do so can help avoid any potential issues down the line.
So, what are the common types of entities found in India?
1. Unincorporated entities:
Sole proprietorships and unincorporated partnerships are entities where the business is owned by the proprietors/partners and there is no separate legal status. The proprietor’s/partner’s liability is unlimited and they cannot distance themselves from the business.
Suitable for: Small businesses, family concerns.
Not suitable in any of the following situations: Operations at scale, external financing required, external investors required.
Operations must be simple, with limited chance of third party liabilities of any kind. Cost of setting up and maintaining an entity is more important than capital requirements and potential liability risks for owners.
Examples: Trading concerns, Asset ownership.
2. Incorporated entities:
Limited Liability Partnership (LLP), One-Person Company (OPC), Private/Public Limited Companies are entities with separate legal status, providing limited liability to their owners/shareholders. This means that the liabilities of the business are met through its resources, without any charge on personal assets. While OPCs have limited liability like other companies, they cannot attract investors. In the following sections, we will discuss the features, advantages, and disadvantages of LLPs and companies.
| Particulars | Limited Liability Partnership | Private Limited Company | Public Limited Company |
| Limited liability (subject to exceptions such as fraud) | Yes | Yes | Yes |
| Tax Rates | Higher than companies | Lower than LLP and same as public company. | Lower than LLP and same as private company. |
| Distribution of profits | Simple | Subject to rules relating to dividend distribution. | Subject to rules relating to dividend distribution. |
| Dividend related taxes | Not applicable | Applicable | Applicable |
| Capitalisation and Fund raising | Possible but for simple structures. | Complex structures possible. | Complex structures possible. |
| Listing of equity interests | Not possible | Not possible | Possible |
| Total number of owners |
Minimum 2 Maximum 200 |
Minimum 2 Maximum 200 |
Minimum 7 Maximum – Unlimited |
| Corporate Compliance | Simplest | Moderate | Unless listed, marginally more complex than private companies. |
| Conversion to other structures | Possible | Possible | Possible |
| Other Issues | Disputes amongst partners can affect any change in structure significantly. All partners need to sign off on a variety of items. | Board and shareholder majorities can take many decisions. | Board and shareholder majorities can take many decisions. |
| Examples (suitable for) |
Asset ownership businesses. Businesses (small and large) where external equity financing is not required. For instance, entities wholly owned by corporate entities including owned by overseas enterprises. Lifestyle businesses where profits are generated and expected to be distributed to owners. |
Startups that seek to scale. Large number of investors expected. Dividends are not a significant aspect value creation for owners. |
Business where equity interests are proposed to be listed. |
Please note that, there are exceptions to these principles that are not discussed in this writing. Further, tax Rules are to be ascertained. Conversion from public to private and private to public is not subject to any taxation on account of the conversion
In recent years, the Government of India has introduced multiple schemes to create a coherent environment for startups to grow. These schemes allow startups to enjoy tax benefits, create networks, register themselves under the patent/trademark/environmental and labour laws. However, these perks are available only for entities registered as private limited companies.
Make sure that you carefully analyze the pros and cons that each entity type carries with it as it plays a role in customer engagement and also adds to the success of your startup.
With the above information, we hope you start your business in the right cast. Or reach out to us at sales@rulezero.com for a one to one discussion.
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