Category Archives: Start Ups

How to set up a legal structure of your Start Up?

UnknownAre you a budding entrepreneur with/ an idea which can take you places! So, if you have a business idea and you are about to take a plunge to start your own business but don’t know how to go about forming your company legal set up, here is a guide to understand about available options in India for registering your company or a firm. Let’s understand in detail about how to go about registering your billion dollar idea:-

In India, you can start your business by choosing any of the available legal structure as follows:

  1. Sole Proprietorship
  2. Partnership Firm
  3. One Person Company
  4. Limited Liability Partnership (LLP)
  5. Company (Private Limited or Public Limited).

Let’s understand in detail:-

Sole Proprietorship: 

This is the easiest and the simplest form of business entity to establish in India because there is no specific requirement for its registration. When you are all alone i.e. starting your business on your own, the business will be in your individual name and you will be called its Sole Proprietor. Though you can get a Trade Name for your business like ABC Consulting/XYZ Interiors Solutions/ABC Boutique/Studio etc. but the business and the ownership is not separate from each other and you i.e. the sole owner command the complete control over all the aspects of the business. You however need to apply for a Shop and Establishment License to run your business and this is the only legal formality which is applicable to get a legal status as a sole proprietorship firm. This Shop Act license requirement also depends and varies from State to State in India. The cost for getting this license is very minimal and ranges between Rs. 1500 to 3500/- only; overall cost to start a proprietorship will be less than Rs. five thousand. The next step is to open a bank account (current) in your name or a trade name which you want and you are all set to run your business.

Apart from that you do not need to enroll specifically with any other government organization for registering yourself as a sole proprietor. However if your business or profession requires you to charge and pay Service Tax or VAT or any other legal duty and taxes or it requires you to get a specific license for e.g. Food license to run a restaurant or a café/chains then that needs to be applied separately. But these legal duties and licenses are applicable based on the nature of your business or profession and needs to be applied for irrespective of you being a sole proprietorship or running a Private limited company. So Shop Act license is the only thing which gives certain legal status to your business/profession and another important thing you need to do is to protect your trade name and intellectual properties. Apply for a Trade Mark, Copyright or even file for a Patent wherever applicable to protect your idea/business process from getting copied by others. The only challenge a Proprietor has is the unlimited business liability which means if you have taken any loans or having outstanding liabilities and you default on the payments then your personal assets can be attached to recover the money by your creditors.

Partnership Firm

If you have another co founder or a partner in the proposed business or a profession then you want to protect each other’s interest in terms of the amount of money, time and ideas you are bringing on the table then you can look forward to form a Partnership Firm. When two or more people come together to share the profits and losses of a business without any formal entity, they are said to be running a general Partnership firm, it can have a maximum no. of 20 partners. This will help you put down all your internal arrangement on paper and gives a legal status and helps to resolve any issues later on as everything had already been documented in terms of who commands what share of firm’s assets/profits, capital contribution, profit & loss sharing ratio or salary to partners etc.

For forming a partnership firm you need to buy a stamp paper (based on capital introduced) and make a legal contract, the same can be registered with the registrar of office or you even run your partnership business without registering it. Though in that case it may not command a legal status but in any case it does not prevent its partners from suing each other in a court of law. You can again name the business i.e. Trade Name and start a business, the cost to form a simple unregistered partnership firm will again be less than Rs. five thousand except legal stamp duty which again is caped at Rs. five thousand on a higher side. Here also your personal assets can be attached in case your partnership firm defaults on the payments to creditors or bank etc.

One Person Company

During the makeover of Companies Act, the newly enacted companies act has introduced a new form of entity that is called One Person Company i.e. OPC. This is relatively a new concept in India but a very prevalent concept in the other parts of the world like US, Singapore, China etc. The very reason to introduce this concept is that is to mitigate the risk involved in running a business wherein the owner i.e. a sole proprietor as seen in my last article is solely responsible to make good all the losses his or her business had made. OPC gives a legal status of a company which is run by one person only and he or she being the shareholder as well as a director. The process of setting up OPC is same as private limited company and the name will carry a suffix OPC similar to “pvt ltd.”

The biggest advantage of a company is that it has a separate legal identity than of its owner and in case the company is involved in a legal controversy then its owner cannot be sued in his personal capacity for any payments defaults. But setting up OPC requires lot of paper work as compared to its raw version ie sole proprietorship and another disadvantage is that it is taxed at 30% flat. I will write a detailed article on OPC in upcoming articles.

 

Limited Liability Partnership (LLP)

To mitigate the drawback of partnership firm i.e. unlimited liability of its partners, a new form of partnership had been recognized by an Act of the Parliament which is similar to Partnership but with a difference of protection of limited liability of its partners. The liability of each partner is limited to the extent of their investment in the firm and it commands a legal status. I would say this is an upgraded version of a simple partnership firm and a lower version of a private limited company, it lies in between. This needs to be registered with the registrar of companies and cost including stamp duty etc. will range from Rs. ten thousand to Rs. 15000, this is relatively a new concept in India and need to be used carefully as it comes with certain legal obligations which you have to mandatorily follow like filing regular form 8 and 11 irrespective of whether you are making profits or not and any defaults will run in to per day fine. Apart from that this is more suited for a business wherein third party liabilities are more or a franchise kind of a business where you would like to protect your personal liability getting attached in case of any business payments defaults or losses.

The only challenge is that if you are bullish on your business and sure that you can scale it up and you can build a brand similar to a great successful start ups to a hugely successful start ups like flipkart, zomato or Red Bus then you definitely need outside funding/investors to pump money to manage and scale it up and these venture capitalists or different group of investors do not prefer investing in LLPs. Mostly they ask you to have a private limited company. So be clear about your long term plan before you decide to go with LLP looking all the parameters as mentioned above.

Private Limited Company

It is a form of company registered under Companies Act with limited members between 2 to 200 and starts with a minimum capital of Rs 100,000/-. It is also a separate legal entity & liability of the shareholders is limited to their share capital or agreed amount. For carrying out the business, directors are appointed by the Shareholders and legal compliances in case of a Private Limited Company are much more as compared to a Partnership firm or an LLP. These are mostly held by family, friends and relatives and now a days investors because private companies can issue stock, however these shares does not trade on any stock exchange and it cannot issue any public offering, IPOs.

It also has limited liability for its shareholders which mean that if the personal assets of shareholders will not be attached in case of defaults in payments. The biggest advantage is that a private limited company gives a very strong legal identity to the entity of any organization and it has the best scope for expansion because it is easy to raise capital from investors. The only issue is that it has lot of legal obligations to be complied round the year like getting the books audited even though the company does not earn or filing regular ROC forms or regular minutes of meetings or resolution for every other thing or annual general meeting etc. This is suited for a mature business or in case a startup which is promising and need funds to expand or mange operations, either case private limited will only serves the purpose. The cost to register a private limited company ranges from Rs. 20000 to 25000 and it also has a high cost of maintaining its legal obligations round the year and the most importantly if you decide to close it down, then that would be a herculean task in itself, so choose carefully.

Public Limited Company

It is similar to a private limited company with a benefit of having an unlimited no. of shareholders with a minimum of 7 members to start with. Establishing a public limited company is advised only after achieving a scale in a business as it has lot more compliance to be fulfilled than the other entities. It can be either listed in a stock exchange or not. This is suited purely when the funds needed are of huge amount and has achieved a very high maturity in terms of operations. Opening or closing a public limited company takes a lot of time and cost and managing its day to day legal obligations again calls for a high maintenance. It is a ultimate destination for any entrepreneur to start his or her company and take it to a level wherein it can be made in to a public limited company.

Conclusion:

As we have seen various options for giving a legal status to your business or a startup and if you are one of those budding entrepreneur looking forward to set up his or her business and still confused about how to go about registering the company then I would strongly suggest you to start small and take baby steps and never register your entity without knowing about what you are getting in to. This is because choosing a legal entity can have far more implication than you might have thought more especially in terms of

  1. Scaling up
  2. Funding, Investors
  3. Exit option
  4. Introduction of new co-founders
  5. Legal compliances
  6. Others

Keep the above factors in mind and if you are alone and in the very initial stage of your business, start with a sole proprietorship to keep your time and monetary cost at a very low level and as you progress gradually and you need of getting more people in the form of partners/founders or investors then you can go to the next level and form a partnership or a private limited company suiting to your long term goals with respect to your company.

Be careful while fixing the nuts and bolts in setting up the legal structure of your company as it has far more implications as mentioned above, so be smart and start smart.