How to Choose the Correct Form of Entity for Your Startup?

In India, various opportunities are provided to the entrepreneurs to start up their own business and contribute towards the growth of the economy. Where the new entrepreneurs have to focus on a lot of things and make plans to start up a company, the first step that involves is how to choose the correct form of entity for your startup?

Starting up a business involves legal documentation and registration, obtaining various licenses, capital investment and so on. This article will help to understand how to choose the correct form of entity depending upon various factors and considerations.

Types of Business Entities

1. Sole Proprietorship Firm (SPF)

A sole proprietorship firm is owned by a single person and has no separate legal distinction from that of the owner. It does not require any formal government approval or registration to start a sole proprietorship business. A sole proprietorship firm is a much common form of entity and simpler to start as only one proprietor is required to start a business and less expenses are needed as compared to the other entities.

The Advantages of a Sole Proprietorship firm are: –

1. Only one person is required to start this type of entity
2. Only basic documents required for registration such as GST registration certificate or MSME.
3. Less taxation as compared to other types of entities. Taxation in a proprietorship firm is according to the individual’s taxation rules. Taxation is paid in the name of the proprietor itself. Business income is also taxed at personal tax rates.  

The Disadvantages of a Sole Proprietorship firm are: –

1. Cannot add investors or partners
2. All the liabilities will be of the sole proprietor and the sole proprietor will be liable for all the debts and obligations of the business.
3. Since the assets used in the business are not separate from the assets of the owner, it may be difficult to sell the business as a whole after the death of the sole proprietor.
4. The firm name cannot be protected

2. Partnership Firm (PF)

It is governed under the Partnership Act, 1932^[1]. Two or more people are required to start up this type of firm.  It is considered to be the best start-up entity when proprietors are willing to raise funds from the investors. All the partners share liabilities and profits equally in this type of entity.

There are two types of entities under this type: general partnership and the other is a limited partnership.

What is a General Partnership? (GP)

After a sole proprietorship firm, the easiest entity to form is the general partnership. No formal written agreement is required to form a general partnership; however, the partners should form a written document specifying their rights and duties under it. When two or more people enter into this type of entity and agree to share profit and losses even though no written agreement is formed, it will still be treated as a general partnership. Under the general partnership, each partner has a right to take decision relating to the working and management of the firm.

All the partners share legal and financial liabilities and profits equally. And the partners are personally responsible for the debts. Since the partner’s liability is unlimited, in any loss occurred by the act of one partner the personal assets of the partners will be taken away to pay back the debts and claims of the creditors.

What is a Limited Liability Partnership? (LLP)

A Limited Liability Partnership firm is a type of entity which is reserved for licensed professionals like attorneys, accountants, medical professionals and architects. The liability of all the partners is limited under the LLP. The partner under the LLP is not liable for any debt, losses, obligations etc resulting from the wrongful acts, negligence or malpractice by another partner except of their own. 

The Advantages of Partnership Firm are: –

1. Easy formation as no legal formalities are required.
2. It helps to facilitate loan under a partnership firm .
3. Partnership business is flexible and changes can be easily introduced whenever necessary.
4. Risk does not fall on one partner and is shared equally by all.
5. It is easy to dissolve a partnership firm as no legal proceeding as required and can be dissolved with the consent of all the partners by making an agreement.
6. Liability is limited under LP and LLP to the partners.

The Disadvantages of Partnership Firm are: –

1. Liability of every partner is unlimited as to the debts in the business.
2. Limited Capital as the entity is established and managed by the restricted maximum number of partners.
3. Uncertain existence as the partners can dissolve the firm anytime by making an agreement between them.
4. Lack of public confidence as there is no governmental supervision over the operations of the business and publishing account is also not necessary.
5. Difficulty to transfer shares as it cannot be done without the consent of all the other partners.
6. Lack of prompt decision as it requires to be discussed and approved by all the partners.

3. Public Limited Company (PLC)

A Public limited company is a voluntary association of two or more members that are incorporated and the members have a separate legal existence from the PLC. The liability of the members is limited under this type of company.

PLC is listed on the Stock exchange board of India where the stocks and shares are traded publically. The formation and winding up of a public limited company is strictly governed by the rules, regulations and laws.  The company is formed with a minimum of seven members but there is not limit as to the maximum number of members. The shares of the company can also be transferred without the consent of the other shareholders or notice to the company.

The Advantages of Public Limited Company are: –

1. Board of Directors lead the company
2. Partners have limited liability in the company
3. Shares can be easily transferred without the consent of other shareholders or notice to the company
4. Capital Investment is generally large in this type of Company
5. The complete financial statement is required to be published as it is strictly regulated by-laws and rules.

The Disadvantages of Public Limited Company are: –

1. Requires high cost in the formation
2. Slow decisions are made due to taking consent with all the partners in any activity
3. No limit to how many shares one can buy since the company is public and anyone can buy up shares
4. Lack of control by the founders of the company since it is public

4. Private Limited Company (Pvt. Ltd. co)

It is a type of company which consists of minimum two members to start up the business. The funds cannot be raised from the public under this entity. It cannot issue shares publicly. The liability of the partners is limited. The shares can be easily transferred to the other person and issue debentures to the public and receive funds as well.

The Advantages of Private Limited Company are: –

1. Limited liability to the partners or investors
2. Shares can be transferred to the other person
3. Can receive funds from the public and issue debentures

The Disadvantages of Private Limited Company are: –

1. The cost of formation is high
2. Cannot dissolve easily
3. More compliance as compared to other types of entities

5. One Person Company (OPC)

Only one person is the proprietor of this company. It is similar to a private limited company. The owner has a limited liability under this type of entity.

The Advantages of Once person Company are: –

1. Limited liability in the Business
2. No requirement of any other partner for registration
3. Full control over the operations in the entity

The Disadvantages of One Person Company are: –

1. Cannot add partners in future
2. Costly for formation as compared to Pvt ltd company
3. Equal annual maintenance to Pvt ltd company

Conclusion

An entrepreneur must focus upon various factors such as liability, taxes, complexity, control, capital investment before starting up a business. How to choose the correct form of entity is an important question. The objective of the owner should ultimately be to generate profits in the company. The type of entity that will suit the best must be planned properly by looking upon various factors and creating strategies for it.

Also, Read: Things to Remember before starting a food business in India