Choosing the Right Business Structure for Your Startup
You're reading Entrepreneur India, an international franchise of Entrepreneur Media.
It is common for the business owner to go through dilemma over choosing the right business structure. A business structure comes with many legal implications that follow. In India, there are 3 main business structures to start a profit-based business.
Sole Proprietorship: Sole proprietorship is the easiest of all business structures, owned by an individual. It is not a legal entity and is merely an informal structure.
Partnership: Partnership is a profit-based business formed by a group of persons. It can either be a general or a limited partnership, based on registration. Known as LLP, Limited Partnership is registered under LLP Act as a body corporate.
Company: It is a body corporate registered under the Companies Act. Private Company, One Person Company (OPC) and Public Company are the types of Company. One Person Company is owned by a single member.
The right structure depends on the type and size of your business and the growth you plan for. Generally, a sole member would prefer a proprietorship firm or an OPC. However, to avail benefits of other structure, few counts on family members or friends to fulfil the structural requirements.
The business structure determines the tax implications, control over business, and protection to personal assets. Thus, you should rest on an informed choice.
Consider these 5 key factors as you move to choose the right business structure.
The Risk Associated With Business:
The level of risk is directly associated with the type of business and activities. When associated with a higher level of risk, the owners are likely to follow the structures that protect their personal properties and assets. This is best protected by the body corporate such as LLP and Private Limited Company or even an OPC. Having a separate identity, a body corporate protects its owners’ personal assets even in case of liquidation. This leads Company for prominent choice among startups.
Investment need is a subjective one. Internal funding is possible in all structures besides external borrowings from the banks. Banks and lending agencies are more inclined towards the structured entities. The owners also add partners for its capital. It is possible to manage the inflow of funds to a certain extent from such resources.
But, a business with higher growth rate finds it difficult to feed its large funding requirements with such limited resources. If you plan to raise funds from VCs or angel investors, company form is best is the best to go with. But, OPC is unfit to this list because of its limited membership.
Registration and Maintenance Cost:
Among all, sole proprietorship firm is the easiest to establish with minimal setup requirements and nominal cost. Companies and LLPs are comparatively costly to start with. It is recommended to focus on the maintenance cost of business since the business registration cost isn’t a costly affair anymore.
Also, it is a one-time cost. The maintenance cost includes the regulatory and other compliance. The compliance level in a corporate structure is the highest with Pvt. Ltd. Company topping the list. The sole proprietorship tops the convenient list. Compliance varies based on structure and activity. It is best to consult the professionals to get the exact idea.
For any business, the tax is a prominent consideration. Any business income would attract the tax. However, owners seek to minimize the taxability at the best. The Income under sole proprietorship is taxed as per given the slab of 5per cent-30per cent post basic exemption limit. However, there is a flat tax rate in all the other structure. Even a penny earned is taxed at the rate of 30per cent, except specified small companies (prescribed rate, 25per cent).
Tax authorities consider Partnership and LLP same for tax purpose. The Dividend Distribution Tax (DDT) directs the promoters to choose an LLP instead of a company. DDT is a tax on income distribution by company applicable with a gross rate of 15per cent.
Control Over Business:
A Sole Proprietor will have an undivided control over the owned business. In other structure, the control and ownership are divided amongst multiple owners. Many would choose to have direct control over the business, while others distance themselves. For the latter category of persons, here is way out - consider passive ownership. They can be sleeping partners in the firm or hold only membership in the company. In a Company, management and ownership are in different hands. Although the same person can be both – a director and a shareholder; the structure still holds the benefit of separation, whenever required.
These are major deciding factors for the right structure. But, make the note that your structure is not permanent. The business needs keep changing and it necessitates the structure to change. Don’t find yourself alone to make this decision; expert advice eases your task.