Welcome to the idea of starting your own organization!
- One of the first and most important decisions a business owner makes is selecting
the organizational form under which he or she will operate. The following are
some common organizational types (also called “legal structures”):
o Individual / Sole Proprietorship
o Partnership
Partnership Firm
Limited Liability Partnership (LLP)
o Company
One Person Company (OPC)
Private Limited Company
Public Limited Company
Charitable Purpose Company (Section 8 Company)
o Co-operative Society
o Charitable / Religious Society
o Trust
o Hindu Undivided Family (HUF)
o Office of Foreign Entity - It is important to have reasonable knowledge and expertise to transform an
interest or hobby into a commercial enterprise or charitable organization. Perform
an honest and accurate appraisal of one’s skills, background, and entrepreneurial
abilities before launching a business, as it can prevent disappointment and failure
later on. - Everyone’s tolerance for risk is different. Some people enjoy the rush of skydiving
and rollercoasters, while others prefer to stick to the carousel or keep their feet on
the ground. In business, one’s degree of risk tolerance should be compatible with
the form of ownership being considered. For example, a forty-five-year-old
entrepreneur, with dependents, might seek to protect his/her accumulated assets
(real estate, savings, retirement corpus, etc.) and therefore select a legal structure
that carries less personal financial risk. Every prospective business owner must
gauge what he or she is willing to risk losing and choose a form of business
accordingly. - Selecting the right business organization is an essential part of starting a new
business. Each option has distinct qualities, as well as pros and cons, that the
business owner needs to consider before making a commitment. Choosing the
right type of organization for a new business comes down to a little research and
an understanding of the responsibilities involved with each structure. Here are
some of the criteria you may evaluate in order to make a calculated and right
decision:
o Scale & Capital: If you are going to run the business/organization without
much support from others or would require a few team members for non-
material functions with limited (manageable with own or bank financing)
capital requirement (small business), you may consider sole proprietorship
form. If the scale is a little larger and also require functional expertise from
others but all in a close circle, may consider creating a partnership firm as you
may require other functional/technical expert(s) to co-own the business (skin-
in-the-game). If the scale is expected to be large with several owners and
intends to deal with medium and large corporates, it is better to incorporate a
company as it is the most acceptable form in the large business dealings. In
case the organization need significant capital from several sources and
multiple security category, it is advisable to incorporate a company.
o Purpose / Objective: A not-for-profit organization (NGO) usually gets
registered either as a Trust or Charitable / Religious Society or charitable
purpose company (incorporated under Section 8 of the Companies Act, 2013).
There are tax exemptions and compliance relaxations for these organizations,
subject to certain conditions to be fulfilled. Sometimes, society is also created
for the social cause, for example, a resident welfare association in a gated
community apartment.
o Cost & Time to start: A sole proprietorship has the least initial amount of
paperwork, cost, and can start the business, almost, immediately since you
and your business are the same legal entity. A general partnership firm
requires initial partnership documents, start-up costs are generally low and
also require limited ongoing paperwork. As the forms of business ownership
become more complex, the cost associated with establishing the business also
increases. A limited liability partnership or company requires initial
paperwork, approvals with the state/registrar of companies and hence, may
require sometime before a business can be started. You can get more details
of the incorporation requirements in the next section of this website.
o Liability: Make an assessment of the liability you want for the business. A sole
proprietor and general partner are personally and financially responsible for
the business. If the business fails, the sole proprietor or general partner’s
personal assets can be tapped to pay off business debts. Other business
structures, namely, Limited Liability Partnership and Company, create
distance between the business owner or owners, and their personal assets by
making the business a unique legal entity with liability limited to their capital
contribution in the business (called as Corporate Veil).
o Tax considerations: Tax structure also plays an important role in choosing an
organization type. For example, a Hindu Undivided Family (HUF) type of
organization is chosen mainly to take advantage of a separate legal entity
from individual family members and it is also taxed separately (under
separate tax slabs) as per the Income Tax Act. A sole proprietor files all
business information on his personal taxes, because the business is not
registered as a separate legal entity. At the same time, sole proprietors are
also taxed only once, rather than twice i.e. once for personal, once for the
business. Similarly, business owners in a partnership or an LLC do not have to
file separate business taxes, although in these two cases the business is
recognized separately from its owners–limited personal liability in case of
business failure. A company is an entirely separate entity and the owners
(shareholders) must file separate tax returns. This means that company
owners are essentially taxed twice, once at the personal level and once at the
business level. The applicable tax rate may also influence the decision of
choosing an organization type. Recent changes in the income tax rates, at the
highest income slab i.e. more than Rs 15 Lakh, made the company an
attractive choice (applicable tax rate reduced for the companies), provided
there is no immediate objective of dividend payment.
o Compliance & Recordkeeping: Recordkeeping and compliances are an
essential part of running any business, but the types of records and
compliances that you keep and maintain for the business will depend on its
structure. In the case of a company, the requirements of compliances and
recordkeeping would be much more as compared to sole proprietorship or
partnership. You can get more details of the compliance requirements in the
next section of this website.
o Control: One of the primary reasons people give for wanting to start their
own business is the desire to be independent and “be your own boss”.
Different organization/legal structures provide the owner with more or less
control and authority. There are trade-offs in each case because with
autonomy and control come responsibility. For instance, if you’re the sole
proprietor of a business with no employees, as a one-person show, you retain
all the control, but you also have all the work and responsibility. Other forms
of business, such as partnerships, may mean relinquishing some control, but,
in return, the responsibility (and liability) may be spread among several
principals. In the case of a company, the control is, generally, exercised by the
Board of Directors appointed by owners/shareholders. The Board of Directors
shall be guided by the statutory provisions and charter documents of the
company (mainly Memorandum and Articles of Association of the company).
o Profit or Loss sharing: Decide on the number of owners who will share the
profit or loss. A sole proprietorship allows for one official owner only, and all
the other business structures allow for multiple partners who share the profit
or loss. While the sole proprietorship can limit the difficulties that may arise
when multiple people own a single business, partners provide for expanded
initial contribution to the business and shared liability for its operation.
o Exit considerations: Finally, business owners need to consider if they want
their business to outlive them or carry on after they leave. If an owner is
looking to start a business that can be passed on to his or her children or
other family members, then the legal structure of the business is extremely
important. Certain organizational types “die” with the owner, so it’s crucial
for the owner to decide how and whether a business will persist and/or be
sold to new ownership. Many of these issues require owners to look far into
the future of their business and imagine all of the “what if’s” associated with
being self-employed. Although it is possible to change legal structure once the
business is established, the more complex the business operations are the
more complex the change will be. In some cases, the complexity of the
situation can prevent the owner from making the change that’s desired.
Considering as many of these factors as possible from the outset can save
countless hours and great expense down the road. For a sole proprietorship
or general partnership, transferring the business is difficult or impossible.
Company form of a business assures the easiest way for transfer and exit.
After making the assessment, as mentioned above, you may be able to firm-up your
decision regarding the type of organization you want to create and proceed for the
incorporation / registration of your organization.