How to Choose the Best Legal Structure for Business

Choosing the best structure for business can be dicey and confusing. Various factors are needed to be kept in mind while choosing because each form of business has different way of registration, different tax compliance, different liability, jurisdiction, authority, management and number of members.

It also depends on what type of business you want to do, on what scale you want to do the business and whether you want to do it single-handedly or with two or more persons.

One has to thoroughly study the types of business structures you can implement for your business and the benefits you can derive from it.

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Types of business structure one can create:-

1. Sole Proprietorship
2. Partnership Firm
3. Non-Government Organisation
4. One Person Company
5. Private Limited Company
6. Public Limited Company
7. Limited Liability Partnership
8. Hindu Undivided Family

1. Sole Proprietorship – It is the oldest and the simplest form of business entity. This type of business entity is mainly suitable for small-scale business operators. Sole Proprietorship Company is owned and managed by the individual making him the sole authority to take all kind of decisions regarding the operations of the organization. Further, the taxation and accounting procedure in this form of company is much easier than other forms of companies. As a sole proprietor is not required to file a separate business tax return and all income generated from the business is reported on the personal tax form.

Advantages –

• No need to file financial statements to any authority.
• Ease of starting business.
• Can be started with less cost.
• Less legal compliances required.
• Only one person is required to start business.

Disadvantages –

• Unlimited liability of the proprietor.
• Less sources of funds available.
• Becomes difficult to be managed by single person when business grows at very fast pace.
• No perpetual succession.

Limits –

• Only 1 individual is holds the authority.
• Unlimited liability.
2. Partnership Firm – The partnership firm is an association of 2 or more persons who desire to come together and carry out a business. One of the advantages of partnership firm over sole proprietorship firm is the increase in the amount of capital investment. Further, more than one owner helps to increase the skills and improves the decision-making process. In addition to this, the risk of losses will be shared by all the members in this type of company. It is registered under The Partnership Act, 1932.

Advantages –

• Audit of the firm is not required.
• Less compliances required.
• Less costly to establish.
• Can be owned by two or more persons.

Disadvantages –

• Unlimited liability of partners.
• Less source of funds available.
• Disputable form of business.
• No transferability of shares.

Limits -

• Minimum 2 partners; maximum 50.
• Unlimited liability.
• No fixed minimum capital requirement.
3. Non-Government Organisation – The Non-profit Organisation is that Organisation which did not do their work for earning profit rather than its main objective is to do work to achieve a specific goal for the welfare of society or its members. These are founded by a group of people who come together for a common purpose, i.e. to provide service to members and people. These types of organisations run its operation mainly on the donations, entrance fee, subscription fee, or membership fee. Non-government organizations in India can be structured and incorporated as one of the following three forms: Trust registered under Indian Trust Act, 1882, Society registered under Societies Registration Act, 1860, Non-Profit Company registered under Section 8 of The Indian Companies Act, 2013.

Advantages –

• Distinct Legal Identity.
• Zero tax.
• No Minimum Capital demand.
• Name.
• CARO.
• Tax advantages.
• Credibility Exemption to the donor’s Membership.

Disadvantages –

• Use of Profits.
• No profit distribution.
• Remuneration Officer: Zero Benefits.
• .Objectives.
• Alteration in AOA not possible.
• Rules and Regulations.

Limits –

• No limit number of members.
4. One Person Company – The concept of One Person Company (OPC) was recently introduced to overcome the various disadvantages associated with sole proprietorship form of business. Just like sole proprietor company, one person company is also owned and managed by the single owner, giving him a full control over the company. However, unlike the sole proprietorship business entity, the liability of the owner is limited to his/her contributions to the business. Further, as the company formed is a separate legal entity from its members, the life of the company does not come to an end with the death of partners. It is registered under The Companies Act, 2013.

Advantages –

• Less compliances to be maintained.
• Status of separate legal entity.
• Perpetual existence.
• Great opportunity for small business to expand.
• Having contractual rights.

Disadvantages –

• It has to be converted into private limited company after some limits.
• A foreign national, minor or any corporate entity cannot participate in One Person Company.
• Cannot raise funds from public.
• Cannot run NBFC operations.
• Cannot turn into Section 8 companies.

Limits –

• Only 1 member
• Only 1 nominee
• At least 1 director; maximum 15
• PUSC Rs. 1 lakh ≤ Rs. 50 lakh
• Turnover ≤ Rs. 2 crore

Private Limited Company – This type of company is basically suitable for medium and large-scale business enterprises. It is a form of privately held business with minimum 2 and maximum 50 members. Some of the advantages of this form of company are that the liability of the members of this company is limited to their share. It also involves many legal and tax compliances. It is registered under The Companies Act, 2013.

• Preferred by banks, VCs and investors.
• Easy to allocate and redistribute shares to other directors/ people who have invested money in the company.
• Acts as separate legal entity which limits the liability.
• Offers the flexibility of a partnership firms and advantages of a Limited Company.
• Easy to register, manage and run.
• The company can be smoothly dissolved.
• Perpetual Succession.

Disadvantages –

• Registration process is slightly lengthy and expensive.
• Compliance formalities.
• Division of ownership.
• Restricts transferability of shares.
• Cannot bring public issue.

Limits –

• Minimum 2 shareholders; maximum 200.
• At least 2 directors; maximum 15
• PUSC at least Rs. 1 lakh

Public Limited Company – This type of company can be formed with at least 3 directors and 7 shareholders with a minimum paid up capital of Rs 5,00,000. One of the major benefits of the public limited company is that it can offer its share to the public at large and raise funds. Further, it gives better expansion opportunities to business entities as compared to private limited companies. Because this type of business has the scope of huge expansions, much compliance also comes along. It is registered under The Companies Act, 2013.

Advantages -

• Prestigious Business Profile.
• More confidence of general public in company.
• Promotion at larger scale.
• Professionally managed.
• Shared risk of business.
• Perpetual Succession.
• Can raise funds from public.

Disadvantages -

• High cost of starting the business.
• Non suitable for many types of business.
• Transparency of business which lacks secrecy.
• Higher degree of external controls.
• Needs experts to run the business
• Lots of compliances

Limits -

• Minimum 7 shareholders; maximum is unlimited.
• At least 3 directors; maximum 15
• PUSC at least Rs. 5 lakh

Limited Liability Partnership – This type of company was introduced in India through the Limited Liability Partnership Act 2008. One of the biggest advantages of LLP over the traditional form of partnership is the presence of limited liability. The LLP formed is considered to be a separate legal entity from its members which makes the liability of the members limited to their share. Moreover, the incorporation process and the compliance process are simpler for this form of company.

Advantages -

• Status of separate legal entity.
• Possesses contractual rights.
• Corporations can be owners in LLP.
• Limited liability of partners while enjoying features of company.
• Perpetual Succession.

Disadvantages –

• Transparency of business leads to lack of secrecy.
• LLP running with less than 2 members has to be dissolved.
• Rules for retaining profit in LLP are different from company’s rules.

Limits -

• Minimum 2 members; maximum unlimited.

Hindi Undivided Family – Hindu Undivided Family (HUF) is a family which consists of all persons lineally descended from a common ancestor and includes their wives and unmarried daughters. The senior-most member of the family is the “Karta” who is responsible of all the major decisions in the business. An HUF cannot be created under a contract; it is created automatically in a Hindu Family.
Jain and Sikh families even though are not governed by the Hindu Law, but they are treated as HUF under the Act.

Advantages –

• Tax benefits.
• Minor can be a member.
• It is recognized in whole India except Kerala.

Disadvantages -

• Dissolution on partition of family.
• All members have equal rights irrespective of anything.
• Any addition to family becomes a member.

Synopsis

Factors	Pvt. Ltd. Co.	Public Ltd Co.	OPC	LLP	Partnership	Sole Prop.
Ideal for	Startup and growing Companies	Large no. of professionals	Single promoters	Professionals	Small business & Home Business	Small Traders and Manufacturers
Requirements	2 Directors/ 2 Shareholders	3 Directors/ 7 Shareholders	1 Director/ 1 Shareholder	2 Partners	2 Partners	1 Proprietor
Initial Investment	Rs. 1 lakh	Rs. 5 lakh	Rs. 1 lakh	Not required	Not required	Not required
Tax benefits	Few benefits	Few benefits	Many benefits	Most efficient	Minimal	Minimal
Compliances	High	Very high	Moderate	Low	Minimal	Minimal
Limited liability protection	Yes	Yes	Yes	Yes	No	No
Time taken for registration	5-10 days	10-15 days	5-10 days	10-15 days	5-10 days	2-5 days