Entrepreneurs are often confused on selecting the best form of the legal entity for their Startup Ventures.
In this series, we will discuss in detail with the various forms of Structure with its benefits / limitations which will help Entrepreneurs in deciding for their startup legal form.
In India, Entrepreneurs can conduct business in various structures, of which we will discuss the most popular ones amongst entrepreneurs i.e. Proprietorship Firm.
In the subsequent Articles, we will cover each form of business which are Private Limited Company, Limited Liability Partnership
1. Sole Proprietorship Firm :
Sole Proprietorship firm is also referred as Proprietorship Firm. The proprietor is the Owner of the business. Sole Proprietorship firm are best suited for Sole Entrepreneurs / Single Owner Business, where the Individual Owner will act as a Sole Proprietor.
Naming of business : : Proprietorship firm can name their business without any restriction or naming guidelines as they wish to. Example of Proprietorship firm can be M/s. Laxmi Enterprises, M/s. Shree Agency, M/s. ABC Infotech etc. Thus the proprietor can select any name of their choice which they believe are best for their business.
Legal Registration of Proprietorship Firm: : Unlike Private Limited Companies and LLPs, Proprietorship firms are non-regulated form of business. i.e. They are not registered with any govt./ law for starting of business. Thus, there is no formal Legal Registration of Name of Proprietorship firm with Govt./ MCA etc.
Proprietorship can use PAN Number of its Proprietor for all legal licensing and regulatory filing purpose, since Proprietorship firm is not an artificial legal person in the eyes of the law. They are treated at Par as Individuals or HUF depend upon its proprietor status.
Ease of Doing Business under Proprietorship : They are the simplest form of business. One can start doing business almost immediately under proprietorship model which requires very less Business registration formality. Entrepreneur can decide the name of their proprietorship, Open Current Account with a Bank and obtain Statutory Registration such as Shop Act License, Udyam Registration and GST (if applicable) and start doing the business immediately.
Similarly, Proprietorship can also be closed easily without too much of documentation and regulatory reportings.
They are best suited for Sole Individual Entrepreneur with small to mid-size business and who is not looking for external Investor Funding / Stake dilutions.
Treatment under Income Tax Act: Proprietorship are assessed under PAN of their Proprietor. Hence, if Individual is a proprietor, the entire income from proprietorship business will be taxed and reported in the Income Tax Return of the Individual Proprietor only. Proprietorship Firms are tax friendly as well, as Individual can get the benefit of slab-wise taxation under income tax vs. Flat rate of Taxation under other business models.
Treatment under Goods and Service Tax Act (GST) : Proprietorship Firms can register under Goods and Service Tax Act with their Proprietor Name and Trade Name. PAN Number of Proprietor will be used for GST Registration.
Operating Compliance Cost for Proprietorship Firm : It is the cheapest form of structure since there are very limited compliances to be done by Proprietorship firm compared to other forms like Private Limited / LLPs.
Limitation of Proprietorship Firm : The Proprietorship Firm structure has following limitations:
a. No Legal Recognition : Since proprietorship firms are not regulated by any govt. authority, they are considered as non-regulated form of business. Since they are non-regulated, their business compliances like financials, reporting etc. are not governed by any Govt. Thus, they are considered as less reliable compared to other forms of Business Structures.
b. Unlimited Liability : It carries a risk of unlimited liability to the Proprietor, as the Owner and the Proprietorship firm are one and the same person and any breach of law or misconduct may held its proprietor personally liable in the eyes of the law.
c. External Funding from Investor/ Stake dilution is not possible under proprietorship. Since they are not a Private Limited Company which can give its Equity Ownership to external investors for Funding, the proprietorship firms wont be able to get External Funding from Investors. They rely heavily on Capital infused by Proprietor and Bank Borrowings.
d. Less Preferred over Corporate Form by Large Organisations : If your Vendors /Customers are large corporates, they would prefer to deal with regulated form of entities like Private Limited or LLP, instead of proprietorship, since compliances and recognition of regulated entities are better.
Is the Proprietorship firm is suitable for Startups : Well the answer is Yes. It is advisable to start business as Sole proprietor in the initial stage of business to firstly test the market and idea by the startups. Since startups are the high-risk ventures, the Entrepreneur will find Sole proprietorship as the most affordabl and easy to operate during the initial days of the business.
In future, if the business does well, the Entrepreneur can switch to the better regulated form of business as Private Limited or LLP as per their needs. However, if the business fails, then it would be easier for the Entrepreneur to wind up without much of a legal hassle and in affordable cost.
Conclusion : To Conclude, Sole proprietorship is the simplest form of business offers benefit of ease in incorporation, less operating compliance, tax friendly and cheaper mode of business and mostly suited for Single Owner Business. At the same time, it has its own limitation of less legal recognition, unfriendly structure for Funding and to scale big. In nutshell, Entrepreneur can weigh the pros and Cons and then select their choice of structure.
Disclaimer: The views expressed are strictly of the author. The contents of this article are solely for informational purpose. It does not constitute professional advice or recommendation of firm. Neither the author nor firm and its affiliates accepts any liabilities for any loss or damage of any kind arising out of any information in this article nor for any actions taken in reliance thereon.