The Different Ways to Form a Company and Their Pros & Cons

StartupThis column is by Mayank Goel, Co-founder and COO, Registrationwala

When you decide to start your own business, you need to determine what type of business structure best suits your needs. There are 3 ways to form a company and start a business:

1. Sole Proprietorship

William R. Basset opines that “The one-man control is the best in the world if that man is big enough to manage everything”.

The most common and simplest form of business is a sole proprietorship. With this type of business organization, all profits are yours to keep. Because you are personally liable, a creditor can make a claim against your personal assets as well as your business assets in order to satisfy any debts. In a proprietorship, the enterprise is owned and controlled by one person. This form is the most popular form in India due to the distinct advantages it offers.

Advantages-
  • A sole proprietor has complete control and decision-making power over the business.
  • There are no legal formalities in forming or dissolving the business.
  • It’s easy to change your legal structure later if circumstances change.
  • Minimal working capital required for start-up.
  • Some tax advantages if your business is not doing well (for example, deducting your losses from your personal income, and a lower tax bracket when profits are low)
  • Owner keeps all the profits.

But because the owner and the business are legally viewed as the same entity, forming a business as a sole proprietor carries with it certain financial risks and limitations.

Disadvantages-
  • The sole proprietor of the business can be held personally liable for the debts and obligations of the business. Additionally, this risk extends to any liabilities incurred as a result of acts committed by employees of the company.
  • Can be difficult to raise capital on your own.
  • The business does not continue if the owner becomes deceased or incapacitated, since they are treated as one and the same.  
  • Sole Proprietors are taxed as a single person.
  • Sole Proprietorships Have Fewer Ways to Raise Money.

2. Partnership

L. Hanson are opines that, “a partnership is a form of business organisation in which two or more persons up to a maximum of twenty join together to undertake some form of business activity”.

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The Indian Partnership Act, 1932, Section 4, defined partnership as “the relation between persons who have agreed to share the profits of business carried on by all or any of them acting for all”. A partnership is a form of business organization in which owners have unlimited personal liability for the actions of the business. Partnerships are the simplest and most common form of business arrangements besides sole proprietorships.  The owners of a partnership have invested their own funds and time in the business, and share proportionally in any profits earned by it. Minimum 2 and maximum 20 members are required and in case of banking minimum 2 and maximum 10 members are required.

Advantages-
  • This type of business of organization can be formed easily without any complex legal formalities. Two or more persons can start the business at any time. Its registration is also very easy.
  • The main advantage is that partners have greater borrowing capacity.  With many partners, a business has a much richer source of capital than would be the case for a sole proprietorship.
  • In partnership every partner bears the risks individually as it is easier compared to sole proprietorship.
  • It does not pay income taxes. Instead, the various partners report their share of the partnership’s profit on their their personal income tax returns.
Disadvantages-
  • Ordinary Partnerships are subject to unlimited liability, which means that each of the partners shares the liability and financial risks of the business, which can be off putting for some people.
  • Due to the restriction on the maximum number of members, a limited amount of capital can be raised.
  • Partners share the profits equally. This can lead to inconsistency where one or more partners aren’t putting a fair share of effort into the running or management of the business, but still reaping the rewards.
  • Absent an agreement to the contrary, the default rule in partnerships is that one person’s stake cannot be transferred to another without prior consent from all of the remaining partners.
  • A partnership firm does not have a legal status like a Joint Stock Company.

3. Private Limited Company

A private limited company is a limited company incorporated under the Companies Act 2013 .

Minimum requirements for the Private Limited Company:

  • Minimum 2 Directors [As per Section 149 (3) of the Companies Act, 2013 (implemented with effect from 01.04.2014), every company shall have at least one director on its board of directors, who has stayed in India for a total period of not less than one hundred and eighty two (182) days in the previous calendar year.]
  • Minimum 2 Shareholders.
  • The directors and shareholders can be the same person.
  • Minimum Share Capital shall be Rs.100,000 (INR One Lac).

It is a type of company that offers limited liability, or legal protection for its shareholders but that places certain restrictions on its ownership. These restrictions are defined in the company’s bylaws or regulations and are meant to prevent any hostile takeover attempt.

The major ownership restrictions are:

  • Shareholders cannot sell or transfer their shares without offering them first to other shareholders for purchase.
  • Shareholders cannot offer their shares to the general public over a stock exchange.
  • The number of shareholders cannot exceed a fixed figure.
Advantages-
  • Continuity of existence: business not affected by the status of the owner.
  • A private limited company represents a clever means of attracting investment capital to start the business with.
  • Scope of expansion is higher because easy to raise capital from financial institutions and the advantage of limited liability.
  • In a private limited company, shareholders accept that their money is tied up in the business for the long term.
Disadvantages-
  • The shares in a private limited company cannot be sold or transferred to anyone else without the agreement of other shareholders.
  • Not allowed to invite public to subscribe to its shares.

About the Author:

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Mayank Goel is the co-founder and COO of Registrationwala. He is a commerce graduate from Delhi university and an IPR expert. He is known to advise his clients across different sectors including, consumer products retail, manufacturing, infrastructure, and automobile, on indirect tax implications and FEMA matters.

Disclaimer: This column is powered by Registrationwala

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  • Bikram

    You missed out LLP, this seems to be gaining popularity.