TYPES OF ENTITIES
A key aspect to be considered when starting a new business is to consider and adopt a legal entity format would be best suited depending upon, amongst various other factors, the nature of the business. The entity options typically considered are as follows:
- Sole Proprietorship
- Partnership Firm
- Limited Liability Partnership
- One-person Company
- Private Limited Company
A Sole Proprietorship is typically considered in case there is just one owner and the proposed business would be run in a small scale. The advantage of a Sole Proprietorship is that it would require less paperwork and the process of setting it up is usually simple and quick. However, the crucial aspect to be considered is that the Sole Proprietorship would not be a separate legal entity and the liability of the owner would be unlimited putting at risk the personal assts of the owner in case of any liability.
A Partnership Firm is where there are two or more owners / partners and there is a formal agreement between them that is either registered under the Indian Partnership Act 1932 or is unregistered. While the partnership deed / agreement is not compulsorily registrable, depending upon the nature of busines proposed to be undertaken, it would be advisable to do so at the jurisdictional Registrar of Partnership Firms. One of the advantages of setting up a Partnership Firm is that it is easy to set up, however, the foremost disadvantage is that the liabilities of the partners would be unlimited and their personal assets would be at risk in relation to the liabilities of the Partnership Firm.
Limited Liability Partnership (LLP) is an option that provides the flexibility of a Partnership Firm as well as limits the liability to the agreed contribution of a partner to the LLP. Unlike the risk of unlimited liability extending to the personal assets in the case of a Partnership Firm, LLP ring fences a partner’s personal assets. Setting up an LLP would require executing a LLP agreement as per the LLP Act, 2008 and registration with the Registrar of Companies, Ministry of Company Affairs (RoC). Typically, professionals, micro and small businesses that are family owned or closely-held would prefer this type of entity option
One-person company (OPC) is an alternative to a Sole Proprietorship, where the liability is limited. An OPC must be registered with the RoC. A crucial aspect to be considered is that, in the event the paid-up share capital of an OPC exceeds INR50 lakhs or the average annual turnover of immediately preceeding three financial years exceeds INR2 crores, then the OPC must convert itself into a Private Limited Company.
A Private Limited Company is a preferred entity option for various reasons and particularly if the promoters propose to raise investments from investors. A Private Limited Company must be registered with the RoC and would be subject to various compliances under the Companies Act 2013. Although setting up a Private Limited Company may seem tedious comparatively, it has several advantages including separate identity, limited liability of shareholders, long and continuity of existence, tax efficiency and ease of raising investments.
Please note that the contents of this note are for general information purposes and not meant to be a substitute for obtaining legal advice. This note is only a brief introduction, which may not be up to date and we urge you to consult your lawyers for specific advice.