Whenever a person wants to start a business or venture, then a big question after deciding the nature of business and capital investment is that what should be the form of business. Whether to do alone by going for sole proprietorship business or to start partnership firm with someone. And further, if it is partnership then he should go by forming a partnership firm or to go for a new format i.e. Limited Liability Partnership. There is also an option to make the private limited company or Public limited company.
This is an effortful decision which everyone has to take and select the business form. Without this decision, he cannot move ahead. This decision of selection should be a well informed decision after detailed input, analysis, consulting and through a brain storming process. Otherwise this question will always trouble the person that whether he has taken the right decision or not at every stage of business, this question will knock the mind hence he should be knowing all the aspects of business formats very well and after considering all the positives, negatives and limitations of all the aspects to take the right decision. Let us understand with the meaning first.
Types of Business Forms and Basic Definitions:
1. Sole Proprietorship (Individual): It is a one-man organization where a single individual owns, manages and controls the business. This is owned and run by one person along and in which there is no distinction between the owner and the business entity. Single owner is sole responsible for risk and reward of the business.
2. Partnership Firm: It is an arrangement where 2 or more than two persons (known as partners) agree to cooperate to advance their mutual interest for starting a business venture with interest to share the risk and rewards, contribution of capital and effort of different partners, having same and different partnership ratio in pursuance of partnership deed. The partners in partnership firm may be individuals, organisations and other combinations.
3. Limited Liability Partnership (LLP): In this form, partners have the limited liability subject to maximum of capital contribution and partners are not responsible or liable for the misconduct or negligence of other partners. Virtually a LLP is the improved version of partnership firm and having the limited liability like the company and feature of the partnership firm.
4. Company: A company is incorporated under the Companies Act, 2013 or under any other previous company law. A company is a separate legal entity made up of an association of people for carrying on a commercial object. The member of the company has the limited liability clause and has the perpetual existence.
So to choose among the Sole Proprietorship, Partnership Firm, LLP or the Company, one need to know the characteristics of each business form, fair comparison and the need of his own business which he wants to start. We have tried to give a critical analysis of each aspect of the various business formats which may enable him to take the right decision for his venture. On the other hand, he should also consider his own facts like, type of business, size of business, scalability, investment needed, creation of goodwill, involvement of outsiders equity, bank funding, usage of credit, budget of initial cost of start of business, need to create / acquire the trademark/ patents, business dynamism, geographical size of business, trade secrets, willing to share profit, control and/or ownership, possession of special skills, business continuity plan, future financial needs, probability of future liability (expected or unexpected) etc. Please understand that no single form of ownership will give you everything you desire. You’ll have to make some trade-offs for final decision because each option has both advantages and disadvantages, you have to decide which one offers the features that are most important to you.
- Existing Law: Sole Proprietorship is not covered under any specific business laws and hence other commercial laws eg. Income Tax, GST, Trademark etc will be applicable. The Partnership firm is covered under the Indian Partnership Act, 1932. Limited liability partnerships (LLP) are covered by the Limited Liability Partnership Act, 2008. Now the companies are incorporated under The Companies Act, 2013.
- Registration: Registration of sole proprietorship is not mandatory, it is optional on whether a person intends to register his sole proprietorship or not. He may get registered under GST, MSME Registration or under the Shops & Establishment Act. Partnership Firm registration is optional however if registered then it will be entitled some benefits. Registration with registrar of LLP is required in case of LLP under the LLP Act, 2008 MCA 21 portal, however it is covered under the Companies Act 2013. A company is required to be registered with Registrar of Companies (ROC). The company registration process and the LLP registration process are very similar with some differences in the document and form being filed for incorporation.
- Name of the Entity: Sole proprietorship and partnership firm can choose any name as per their choice. There is no need of suffix etc. In case of Limited Liability Partnership, the words “LLP” has to be added at the end of name and Pvt. Limited / Limited to be added in case of Company. The approval of ROC is mandatory for LLP and Company.
- Separate Legal Entity: Sole Proprietorship is not a separate legal entity. Partnership firm is also not a separate legal entity from its partner. LLP is a separate legal entity under the LLP act 2008. Company is also separate legal entity under the Companies Act, 2013.
- Flexibility in Operation: Sole proprietorship business may have the flexibility in operation but has limited resources such as money, man, skills etc. The proprietor can make any change he wants without much hassle. A sole proprietorship is the most flexible as long as the business remains small. The Partnership Firm is also simple forms of business which does not require stringent procedure to be followed and avails the flexibility in administration to the Partners. The working in Partnership Firm shall be with mutual consent of Partners to the business. So this is easy but sometimes creates rigidity when the consent is not there and create lot of problems.
The LLP provides the benefits of limited liability with the flexibility of a partnership firm which is regulated by a partnership deed executed between the partners. LLP has a perpetual succession and it can hold property own name. LLP is useful for small and medium enterprises. In case of Company, Companies Act require a formal board structure and decision making at validity constituted meeting, passing of resolutions and maintenance of minutes of the meeting and other statutory records.
- Perpetual Succession: Sole Proprietorship & partnership firm does not have perpetual succession. The LLP and Company has perpetual succession and designated partners & members may come and go.
- Ownership of Assets: In sole proprietorship, all of the business assets are owned by the owner personally. In case of a partnership firm, the partners have joint ownership of all the assets belonging to the partnership firm as per the capital structure ratio as well as the capital contribution or anything special in the content of partnership deed regards though the prima facie the assets are owned by the firm. In case of LLP and Company, these entities have the ownership of assets.
- Number of Partners/Members: In Sole Proprietorship there is only one owner i.e. individual, self. In case of partnership firm it can have Minimum 2 and maximum not more than 100 partners. LLP can have minimum 2 partners and there is no limitation of maximum number of partners. In case of a company, it is determined by its shareholding pattern. A Private Limited Company can have 2 to 200 shareholders. And in case of Public Company can have minimum 7 shareholders and there is no limitation of maximum number of shareholders.
- Rights And Duties of Partners: In sole proprietorship, the owner has full responsibility for managing the business and receives all the profits and is responsible for all losses. In partnership firm, the rights and duties are governed by partnership deed as well as Indian Partnership Act. The rights and duties of partners are governed by LLP agreement in case of LLP. The rights and duties are of the directors are governed by AOA and resolution passed by the shareholders or directors.
- Transfer of Rights: Sole Proprietor can transfer its business by selling its tangible and intangible assets. It is not transferable in case of partnership firm, however if the partnership deed provides it can act accordingly. In LLP, regulations relating to transfer are governed by the LLP agreement. In case of company, ownership is easily transferable.
- Director Identification Number (DIN): In case of the sole proprietorship & partnership firm, DIN is not required. In case of LLP, each of the designated partner is required to have DPIN before being appointed as designated partner of LLP. In case of company, each director is required to have DIN before being appointed as director of any company.
- Digital Signature: A person who is running sole proprietorship business is liable for tax audit as per income tax act, 1961, so for filing of ITR there should be a digital signature in his personal name or in the name of business he is running. Similarly, a partner is also required to obtain digital signature in partnership firm for income tax purposes. As e-forms are filed electronically, at least one designated partner and one director should have digital signature in case of LLP & Company.
- Admission As Partner/Member: There is no provision of adding any person as a partner /member in sole proprietorship. A person can be admitted as a partner as per the partnership agreement in partnership firm. A person can be admitted as a partner as per the LLP agreement. A person can become member by buying shares of a company.
- Cessation As Partner/ Member: There is no provision as such of cessation in sole proprietorship. A person can cease to be a partner as per the partnership deed in case of partnership firm. A person can cease to be a designated partner as per the LLP agreement or in absence of the same by giving 30 days prior notice to the LLP. A member/shareholder can cease to be a member by selling his shares in case of a company.
- Audit of Accounts: There is no obligation for a sole proprietor & Partnership Firm under any law to get their accounts audited except in case where the turnover of a proprietary business in any financial year exceeds as per the limits of tax audits under the income tax act, 1961. All LLP having turnover less then Rs.40 lakhs or Rs.25 lakhs contribution in any financial year are required to get their accounts audited annually. All the companies are required to get their accounts audited annually as per the provisions of the Companies Act, 2013.
- Maintenance Of Statutory Records: In case of sole proprietorship & Partnership Firms the person is required to maintain records as per tax laws. In case of LLP & Company, it is required to maintain the books of accounts statutory registers, minutes and to keep them for 8 years as the case may be.
- Statutory Meetings: There is no provision as such of meeting in sole proprietorship & partnership firm. Though there is no provision of holding of any meeting in firm and LLp but informal meetings takes place to reach on the various business decision. In case of company Directors are required to conduct board meetings and general meetings at an appropriate time.
- Charter Documents: Self declaration is the Charter of sole proprietorship. The partnership deed is a charter of the firm which denotes its scope of operation and rights and duties of the partners, The LLP agreement is a charter of the LLP. Which denotes its scope of operation and rights and duties of the designated partners. Memorandum and Articles of association is the Charter of the company that defines its scope of operations.
- Dividend Distribution: In case of sole proprietorship, since the person has all the profits in his hand, so there is no question of dividend distribution. In case of partnership firm, the profit shall be distributed as per the partnership deed and also the income received as profit in partnership is exempt from income tax. In case of LLP, dividend shall be distributed similar to the partnership firm. In case of Company, the company can distribute dividend as per the consent from the board of directors, however before paying the dividend the company has to pay corporate dividend tax (CDT) as per rate applicable from time to time.
- Tax Liability: The sole proprietorship is liable to pay tax at flat rate as per Income Tax Act, 1961 for individual after deduction and rebate. In Partnership firm the tax rate is 30% and surcharge as applicable as per the Income Tax Act, 1961. In case of LLP the tax rate is 30% and surcharge as applicable as per Income Tax Act, 1961. In case of domestic company if gross turnover is upto 250 crores then the tax rate is 25% and when the gross turnover is more then 250 crores then the tax rate is 30% & in case of foreign company tax rate is flat 40% and surcharge are applicable as per the Income Tax Act,1961.
- Dissolution: The sole proprietorship business can be dissolved by the person itself. The Partnership Firm can be dissolved by partnership deed, mutual consent, insolvency, certain contingencies and by the court order. The LLP can be dissolved voluntary or by order of National company law tribunal (NCLT). The company can be dissolved voluntary or by order of National company law tribunal (NCLT).