Choosing the Right Legal Structure: Sole Proprietorship, Partnership, LLP, or Company

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If you have decided to start a business, it is normal and very common to get confused about choosing the right legal business structure for your new startup/ business as you get to hear various types of business structures. The correct legal framework for your business is an important choice that will always have a good impact in the future. You must understand your business operations, tax requirements, and liability protection impact on the legal structure you choose. 

The common are Private Limited Company Registration, OPC Registration, Public Company Registration, LLP Registration, Proprietorship Firm Registration, and Partnership Firm Registration. Also, knowing the benefits, drawbacks, and legal requirements related to each structure enables you to make an educated choice that supports the expansion goals of your business and conforms with applicable regulations. The legal structure that is selected affects several factors, including personal liability, necessary paperwork, organizational goals, and capital availability. 

Making informed decisions can help you with the opportunity to raise funds and attract employees through ESOP (Private Limited), Less Compliance Cost (Limited Liability Partnership), Making it Big with an IPO (Public Company), Going Solo (One Person Company), Starting Small (Proprietorship), Doing business with someone with no MCA Compliance (Partnership Firm) and some other aspects like money on taxes etc. At Compliance Calendar LLP, we make it easy for you to choose the right legal business structure with our business registration advisors. For your ease, we have written this article to help you choose the right legal structure if you are just starting. At the end of this article you will understand the basics and should you wish to connect, feel free to reach out to us.

Contents

  • Importance of Business Structure
  • Types of Legal Structures
  • Sole Proprietorship
  • Partnership Firm
  • Limited Liability Partnership
  • Private Limited Company
  • Public Limited Company
  • Important Factors
  • Concluding Note
Importance of Business Structure:

  • Taxation- Every legal structure has different tax brackets. Proprietorship firm classifies their firm revenue as personal income. A partnership firm has a 30% slab while companies have a 25% tax rate and may go up to 30% with an increase in turnover. Your decision about your structure has a big influence on your tax burden because firms, companies and LLPs are taxed at different rates.

  • Compliance- Depending on the type of business structure, various compliances get triggered and they are specific to each legal structure. For example, if you are starting with a Private Limited Company, a Statutory Audit by CA is applicable even if you do not have any business. In the case of LLP, Audit is not applicable up to 25 Lakhs of Capital Contribution and 40 Lakhs of Turnover. Also, in terms of compliance, private companies have to adhere to more compliance and thus become costlier. 

  • Management- A board of directors is required for a company. In the case of OPC, minimum of 1 director is required. In the case of LLP, 2 Designated Partners are required. In a public limited company, you need to have a minimum of 3 directors.

  • Funding- Additionally, your structure may prevent you from obtaining money in some ways. Sole proprietorships, for instance, are typically unable to provide stocks. Companies are the primary holders of such privilege.

Types of Legal Structures:

Sole Proprietorship Registration

 

A sole proprietorship is a basic type of business entity. It gives one person complete control over all obligations and earnings. Although it gives total power, it does not safeguard assets, which might cause problems if the firm grows. The first expenses include taxes, office space, equipment rentals, state, and professional services. Notably, well-known businesses with development potential were once sole proprietorships, such as eBay, JCPenney, Walmart, and Marriott Hotels and as they scaled, they went to register companies. One Person Company Registration is the recommended option if you want to go solo.

 

Advantages:

  • Simplicity- There aren't many legal requirements or papers needed to set up a sole proprietorship, and it can be done for a reasonable price.

  • Total Control- As the only proprietor, you have total authority over all business decisions, operations, and earnings.

  • Benefits to Taxation- By reporting business income and expenses on their tax returns, sole proprietors avoid the complications associated with separate employment taxes.

Partnership Firm Registration

 

Partnership firms are started by two or more individuals. Partners share profits, losses, and decision-making, with liability extending to both partners. One can choose to register a Registered Partnership Firm with Locan Sub-Registrar or may execute a Partnership Agreement on the Stamp Paper (Non-Judicial) on the stamp duty subject to state. Successful partnerships include Warner Bros., Hewlett-Packard, Microsoft, Apple, Ben & Jerry’s, and Twitter. Larry Page and Sergey Brin's Google partnership, originating at Stanford University, exemplifies partnership success, with a combined ownership net worth of nearly $226.4 billion.

 

Advantages:

  • Shared Responsibilities: By combining their networks, resources, and experience, partners may make decisions together and utilize complementary skill sets.

  • Ease of Formation: It requires less documentation requirements to create a general partnership compared to other business models.

Limited Liability Partnership (LLP) Registration

Unlike a partnership, an LLP offers personal liability protection and flexibility to maek changes in the partners online on the MCA Portal. Unless negligence can be shown, members are protected from personal liability for corporate liability. Every state has different stamp duty on the LLP Agreement and it differs in how much it costs to incorporate an LLP. LLPs can have several members, and the distribution of earnings and losses might be lopsided. The LLP structure is a popular option among firms of all sizes and industries since it offers liability protection and has lesser compliance requirements. Big 4 Firms like KPMG, EY, Deloitte, PWC are registered as LLP in India. In the USA, it is related to LLC which we call as LLP in India and suitable for those who do not wish to raise funds.

 

Advantages:

  • No Minimum Capital Requirement: There is no minimum financial commitment needed to launch an LLP.

  • Suitability: Compared to a private limited company, forming an LLP is a simpler process with fewer legal requirements.

  • There is no cap on the number of entrepreneurs: This type of legal structure allows for two or more partners.

  • Reduced Registration Fee: Compared to a private limited company or public limited business, there are fewer registration fees.

  • Less Compliance: Only the Annual Return Statement (Form 11) and the Statement of Accounts (Form 8) are required to be submitted by LLPs as far as MCA compliance is concerned. The compliance requirements are lower compared to private limited companies.

  • Simple Exit: LLP can be filed for Fast Track Closure on FTE by filing Form 24 if there is no business operation even after 1 year of incorporation or 1 year has passed since there is no business activity.

Private Limited Company Registration

A private company is defined under section 2(68) of the Companies Act 2013. It is "a company having the minimum paid-up share capital as prescribed and in its terms."

 (i) limits the ability to swap its stock

(ii) restricts the number of its members to 200. 

(iii) forbids inviting members of the public to subscribe to any of the securities of the company.

Advantages:

  • Independent Legal Entity: A private limited company is an independent legal entity. An entity is anything that is recognized by law. Moreover, the business may file lawsuits under its name and may likewise be sued itself.

  • Borrowing capacity: A private limited company can borrow more money than an LLP. This is due to its greater choices for taking on debt. There is always the possibility of issuing convertible debentures. It is in addition to regular debentures also. Private limited companies are more widely accepted by banks and other financial institutions than partnership firms.

  • Simple Exit: Sometimes, a private limited company is sold or transferred, in whole or in part, to another person or organization. In these scenarios, there is no impact on the ongoing operations.

  • The ability to sue and be sued: To sue is to bring legal action against someone. In the same way that an individual can file a lawsuit against another in that person's name, a distinct legal entity, can file a lawsuit under its name.

  • Continuous Existence: The resignation or death of a member/ director has no impact on the company's ability to continue operating.

Public Limited Company

A public company is defined as "a company which is not a private company" under Section 2(71) of the Companies Act. A public limited company must be created with a minimum paid-up capital and at least seven (seven) members. The company may list on a stock exchange, at which point its shares are exchanged publicly. Compared to a Private Limited Company, this kind of formation is subject to stricter legal constraints.

 

Advantages:

  • Limited responsibility: A shareholder's responsibility is capped to the amount of their interest. The company does not have any shareholders; hence it may be sued.

  • Number of Members: Seven shareholders are required at a minimum, but the number of members can be as high as the share capital that the company can hold.

  • Continuous existence: The passing of a shareholder or member has no bearing on the public limited company's lifespan.

  • Massive Capital: By offering bonds and debentures to the public, public limited companies can now have a greater capacity to raise capital through the stock market.

Note: If you want to start an NGO, you can choose to have a Trust Registration, Society Registration or Section 8 Company Registration.

Important Factors to be kept in Mind before choosing a Business Structure:

  • Adaptability- What direction is your business going, and what kind of legal structure will enable the expansion you hope to achieve? Consult with Compliance Calendar LLP to define your strategy to evaluate your objectives and choose which structure best fits them. Your organization should encourage development and change rather than prevent it from reaching its full potential.

  • Intricacy- A sole proprietorship is a simple business structure in terms of starting and operating difficulty. Get Trademark Registration for your Brand Name/ Logo, get your business going, declare the profits, and pay personal income taxes on them. However, obtaining outside finance may not always be easy. In contrast, a formal agreement outlining the responsibilities and profit-sharing percentages is necessary for partnerships. 

  • Liability- Since a company is considered to be an independent legal body, it is subject to the least level of personal culpability. This implies that although creditors and clients may file a lawsuit against the company, they will not be able to seize any of the executives' or shareholders' private property. According to the terms of a partnership agreement, partners in a partnership share liability and may be jointly and severally liable.

  • Control- A sole proprietorship or One Person Company can be the best option if you desire complete or main control over the company and all of its operations. Such control may also be discussed and agreed to in a partnership agreement if you are forming a Partnership Firm or LLP.

  • Investment of capital- You could be better off forming a company if you need to get outside investment from a bank, venture capitalist, or investor. Compared to sole proprietorships, companies have easier difficulty collecting outside investment.

  • Taxes- A sole proprietorship owner is subject to the same taxation as a single proprietor. All profits are taxed as personal income at the end of the year. Partners in a partnership may additionally deduct their income from their portion of the earnings. Your accountant may recommend that initial payments be made quarterly or bi-annually. This is to minimize the impact on your tax returns. Each year, the company files its tax returns and pays taxes on the profits. However, it is after deducting salaries and other expenses. You will pay your taxes on your return, including Social Security and Medicare taxes.

Concluding Note

Choosing a business structure is an important choice that affects many characteristics of your company/firm, such as liability, taxation, and business flexibility. Each legal entity has its advantages and disadvantages, including partnerships, limited liability partnerships, sole proprietorships, and public limited companies. It is important to consider aspects such as financial needs and future growth potential. Understanding the complexity involved in each structure can be made easier by seeking the advice of legal and financial specialists. Compliance Calendar LLP can help you pick the appropriate business structure that will support your goals, promote long-term success, ensure regulatory compliance, and provide a strong basis for your commercial ventures. In case of any query regarding choosing the Right Legal Structure: Sole Proprietorship Registration, OPC Registration, Partnership Firm Registration, LLP Registration, or Company Registration, feel free to connect with our Incorporation Team at info@ccoffice.in or Phone/WhatsApp at 9988424211.

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