How to choose the business structure while starting a new business?

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Founders often find it difficult to choose the right business structure out of the many available. Each such structure has its own distinctive set of features. Therefore, the best option is to talk to your legal consultant or consult business professional services.

This article will cover 3 major business structures adopted by startups across India.

1. Company: Companies are registered under the Companies Act as a body corporate. There are chiefly 3 types of companies:

  • Private Company
  • One Person Company (OPC)
  • Public Company

2. Sole Proprietorship: One of the simplest of all business structures is a sole proprietorship. Going by its name, it is a single-owner business structure. But do note that it is an informal structure and does not stand as a legal entity.

3. Partnership: When a group of people puts in efforts to drive a profit-based business then they are required to register a partnership business. Partnership business has two types of possible registration;

  • Limited Liability Partnership (LLP)
  • General Partnership Firm

Note that LLP acts as the body corporate out of the two, meaning, it is recognized as a business entity in the eyes of law.

Consider Growth Plan

Your business will have a growth plan in place depending on how you plan to scale it. Now blend in the size and structure of the business with your growth plan to determine the right kind of business structure. For instance, those who want to simply function on their own can go with sole proprietorship but if want to add someone as a partner in future can go ahead with general partnership now itself than to register a sole proprietorship firm.

Understand that a lot depends on the business structure so you need to choose it wisely. It is the business structure that helps to determine your tax slabs, personal assets’ protection and even the way you control the business.

So when you have to choose the business structure for your startup, consider these key points before you take the next step.

Know your investment requirements

There are many funding options available to the founders where internal funding and bank borrowings are the most common ones. You need to know the fact that lending agencies and banks prefer structured entities like LLP and Private Limited Company to provide funding. Whereas in other structures, owners can add partners to bring in more capital to manage the fund flow from a certain extent from such internal sources.

Now, if you consider your business is about to experience a higher growth rate and need more funding then is best to opt for a private limited company registration. This makes raising money from Angel investors, VCs and other agencies easy. For instance, if you register an OPC and look out for funding then it is nearly impossible to do so as OPC creates a limited membership.

Take Risk Assessment

The type of business structure and the activities it undertakes defines the risk associated with the business. I have often seen owners going choosing the structure that protects their personal assets. Such structures are private limited company and LLP. In such situations, a higher level of risk associated in business may jeopardize owners’ personal properties as well.

Having a body corporate like LLP and private limited company protect the assets of owners in case of business bankruptcy or liquidation. So best is to gauge the business risk while starting up and choose the business structure wisely based on such evaluation.

Consider Taxation Involved

Taxation takes the centre stage once the business starts bringing in the revenue. Any income that a business generates is taxed and the business structure defines the amount of taxability. Minimizing the tax amount will leave behind a larger chunk of revenue when planned well. For example, the sole proprietorship business has a tax slab of 5% to 30% once the business income crosses the exemption limit. But all the other business structure has a flat fee rate which means that even a single rupee is taxed at 30% except registered SMEs who pays 25% of tax.

It is important to know LLP and partnership are treated as equal by the Tax authorities for tax purpose. But the provision of Dividend Distribution Tax (DDT) prompts the business promoters to go with the LLP instead of Company registration. Any income that is distributed by the company attracts DDT at a gross rate of 15%.

Consider the Maintenance Cost

Start with comparing the maintenance cost associated with a particular business structure. For example, establishing a sole proprietorship is easiest of all with the nominal cost associated with registration. While LLP and Company registration does not involve a relatively higher cost of registration but also requires maintenance in terms of staying compliant.

Staying compliant is important for the smooth running of the business, especially this is true for LLP and Private Company with the latter having the highest compliance requirement. For example, LLP registration requires your business to file LLP annual return to operate without any hassles. But if you are looking for an easy structure which is convenient for a small business then choose sole proprietorship. To dig deeper into each of the business structure for making the right decision will require you to know the cost involved in maintaining the business. It is best to consult business professionals to get the exact idea and take the right decision.

Determine Control over business

The greater the number of people involved, the lesser you will be in control. To put up the business structure to it, a sole proprietorship will have the most control over the business whereas the ownership is divided into other business structures.

It all boils down to how much control you want over your business and whether or not the control is an important factor to decide business structure. If you want to keep yourself away from the business a lot and let people take calls and be responsible then consider taking passive ownership.

You can also be a sleeping partner in a partnership firm or hold a membership in a private company. Understand that a private company will have different norms for those who have ownership as against those who have the management.

Conclusion

Follow the key points mentioned above to decide the right business structure for your business. There are times when you get confused with deciding the right business structure in India especially if the structure is not permanent.

You may register a One Person Company today and then go on register Partnership firm at a later stage. Again, you can convert a partnership firm to an LLP at a later stage. All these can get quite overwhelming if you do not have any consulting legal partner to help you make an ideal choice.

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