That’s the first question that comes to anyone’s mind who has validated a business idea or want to kickstart a new business- “Which entity should I choose for starting the business?”
That’s an important question because how you are going to answer this & what factors would you take into account to make the decision will determine whether the legal functioning of your business would be smooth or would it weigh down what could have been a promising business.
So, how exactly do we choose the correct business entity type? Is there any one correct single solution to this decision? The answer is, there can be multiple business type which might suit your business needs. More often than not, you won’t be able to filter it down. Having said that, if you consider all the factors which are important to your business acumen & approach, you will definitely come to a business entity type which would suit your business needs better than the others & that’s where the answer lies.
In this article, we are going to assist the readers interactively to analyze the factors in general, essentially helping them to make a better decision.
So, we start with listing down the most popular business entity types in India:
- Sole proprietorship
- Partnership firm
- Limited Liability Partnership (LLP)
- Company (Private Limited or Limited)
Next, we are listing down a comparative analysis of the above entity types on basis the important factors which one should consider for choosing the correct business type:
| Basis of comparison | Sole proprietorship | Partnership firm | Limited liability partnership | Private Limited Company |
| No. of members | Only one person can be owner | Min. 2 persons are required as partners. There could be max. 100 partners | Min. 2 persons are required as partners. There is no max. limit on the number of partners | Min. 2 persons are required. There could be max. 100 members |
| Addition of members | Not possible | Possible up to the max. limit. Partnership agreement needs to be revised | Possible up to the max. limit. Partnership agreement needs to be amended & registered | Possible up to the max. limit. New shares can be issued or existing shares can be transferred |
| Min. capital requirement | No min. capital requirement | No min. capital requirement | No min. capital requirement | No min. capital requirement |
| Liability | Unlimited liability of owner | Unlimited liability of Partners | Liability limited to the share in the firm | Liability limited to the share in the company |
| Separate legal entity | No Separate legal entity. Owner & business are considered same in the eyes of law | Partners & firm have a separate legal entity | Partners & firm have a separate legal entity | Owners & Company have a separate legal entity |
| Governing Act | There is no specific governing act for the sole proprietorship | Partnership firms are governed by Partnership Act 1932 | LLP firms are governed by LLP Act 2008 | Private Limited Companies are governed by Companies Act 2013 |
| Requirement of incorporation | Registration is not required | Registration is optional | Registration is mandatory | Registration is mandatory |
| Declaration of commencement | Not required | Not required | Not required | Required |
| Income tax impact | Sole proprietorship are taxed on slab applicable to Individuals | Taxed at 30% | Taxed at 30% | Taxed at 25% |
| Requirement of GST registration | Might be required as per GST Act | Might be required as per GST Act | Might be required as per GST Act | Might be required as per GST Act |
| Length of legal Compliance | Legal compliance is least relatively | Has more legal compliance requirement than proprietorship, but lesser than LLP & Companies | Requires lesser compliance than companies | Has the highest compliance requirements |
| TDS compliance | TDS compliance is required only by proprietorship those are liable for income tax audit | TDS compliance is required | TDS compliance is required | TDS compliance is required |
| Audit requirement | Liable for Income tax & GST audit, if turnover exceeds the specified limits | Liable for Income tax & GST audit, if turnover exceeds the specified limits | Apart from Income tax & GST audit, LLPs require audit under LLP Act, if turnover or contribution exceeds the specified limits | Apart from Income tax & GST audit, Companies require audit under Companies Act. |
| Exit | Closing a proprietorship is least complicated | Closing a partnership firm is easier than closing a LLP or company | Closing a LLP is easier than closing a company | Closing a company is relatively complicated |
The above table illustrates the most common & looked upon factors on a general basis. On a specific basis, one might need to consider other factors as well, which might be more important than any of the factors listed above
Now that we have listed the most common factors, we also need to understand that these factors might also imply some important results, which might be relevant for your business.
For instance, a company is required to do more compliance than all other business entity types, as a result of which, it also enjoys a better image of trust & status among various types of stakeholders in general. Thus, if a particular business requires to have a strong & trustworthy image owing to the nature of industry or the type of consumers it will cater to. In that case, choosing a company as the entity type might be a better option for you even though it has its own set of limitations as well.
So, in conclusion, in order to choose the right entity type of your business, one needs to do a thorough analysis of the requirements of the business and the problems it might face. Then, the next step would be to loot at the various factors of the business entity types and then mapping them to determine which entity has more pros than cons. Doing this activity, will surely put you in a better position to take a informed decision.
Disclaimer: The above post is only for the purpose of academic discussion and should not be construed as any legal opinion in any matter whatsoever.
The author is a CA in practice at Delhi and can be contacted at: E-mail: abhinandansethia90@gmail.com, Mobile: +91-9811741451