Many people starting their business for the first time are always in a dilemma on what option to choose to start their business in India – Proprietorship, partnership, Private Limited, Limited Liability Partnership or One-Person Company (OPC). I will share my views on these based on close experience of starting and running these forms of entities.
The factors that you should consider while choosing these options are:
- Number of people managing the business
- Number of investors in the business
- Starting procedure
- Income tax calculation
- Statutory compliance & Auditor fee
- Book of accounts
- Exit strategy (very important)
- Asset allocation
- Proprietorship – If you are a single individual who wants to start his own business, consultancy, freelancing, then this is the most simplest form of starting a business and easiest to maintain. You start a proprietorship simply by opening a current account in the bank. You don’t need a separate PAN card and basically the business entity – proprietorship – is the same as you. Since it doesn’t need a separate PAN, accounting is easier and you can choose to not maintain book of accounts while filing returns, which means that annual returns of you and the business entity could be calculated based on a small percentage of annual income. This option is given in India as lot of small shop owners don’t maintain a book of records, but I have seen many small industrial setups too choosing this option. It also has the least statutory compliance. And if you ever you want to exit the business, you only need to close the bank account. But the liability is also maximum in this type, which means, if ever you owe money to your lenders or employees or government and you are not able to pay them, then your personal assets can also get involved to recover the dues. So choose this type depending on the risk taking ability of your business. If you are opening a consultancy or freelancing, you could start a proprietorship. But if you are starting a factory, you probably should think more about this option. Also, in case your death occurs, the business ceases to exist and all assets (including bank accounts) are now in the hands of your legal heirs.
- Partnership – This option can be used for 2 or more person wanting to start a business. Personally, I wouldn’t recommend this option to anyone, especially with the LLP option now available in India. Partnership means unlimited liability for the partners. Partnership works if you are a group of lawyers, advocates, accountants or doctors coming together to provide a consultancy service. Or it might work if you are a husband-wife couple in the business. Otherwise it is a risky option. I will give some of my reasons for this. First, to start a partnership you need to register a deed of partnership with a the Registrar of Firms. The deed of partnership can contain any clauses that you wish to enlist. It doesn’t cost much to register this deed. Then you need a separate PAN Card for the firm. Then you open a bank account. You then maintain a book of accounts for the firm. But here is when things go different – while calculation income tax, the income tax slabs available to companies and individuals are not applicable to partnership firms. Partnership firms have to pay a flat tax rate of 30% and the remuneration provided to partners, which forms the major part of expenses in PnL, has some restrictions. Also, presumptive taxation is allowed here as available in Proprietorship. Partnership firm is like proprietorship when it comes to liabilities, all partners are liable to pay the dues personally. Basically partnership firm is not a separate legal entity in the eyes of the law. The firm is the partners, whereas in Private Limited, the company is a separate legal entity. The only advantage of starting a partnership firm is that you can exit it easily, or stop the firm easily. Any partner can one day decide that the firm should shut down and the firm might cease to exist, depending on the Deed of partnership registered.
- Private Limited – This is the third and most popular option today and the government is trying hard to make the process easier. I have been running a private limited for quite sometime and now when my friends and acquaintances ask me about it, I advise them not to go for this. The major reason for that is the exit option. It is extremely hard and next to impossible to shut down a private limited company. Say you are two friends who want to start a startup and are excited to do business and if everything goes right, you will make millions. But if anything goes wrong and you want to shut down or quit, you can’t. It means you will have to keep the company alive, pay your CA some amount every year just to file NIL returns annually and observe the statutory compliance. Indian government has recently brought the Bankruptcy law but things will be clear only after 3-4 years. Another negative aspect of Pvt Ltd is the increasing number of statutory compliance. Just in past 2 years, 2 compulsory forms have to be filed through digital signature by the directors, failing which the company will be rendered inactive or default. You need to understand that private limited was made to protect the rights of the investors. In Pvt Ltd, you have a separate legal entity, each director has to obtain a DIN, the liability is not unlimited like partnership, so directors are not liable personally in case there are any dues to vendors, government, employees. Investors get shares and if the company does bad, the share money is lost. Hence the laws governing private limited are very stringent even now to protect money of all the people who come in contact with the business. But there are advantages too – income tax calculation is simple, separate tax slabs for companies, director salary is treated just like any other employee salary for the purpose of tax calculation, the procedure to start a pvt ltd has come down considerably from past decade, even if one director exits or passes away, the company continues to stay, assets belong to company and not to individuals as in case of proprietorship and partnership. I would recommend this option if you have other investors, apart from friends & family, in your business. This option is similar to the Inc. option in USA.
- One Person Company – This is the most recent option available in India and is basically a private limited but with only one person. Private Limited required atleast 2 people and this option – OPC – allows a single individual to start a company too. As of now (2020) I would prefer to go for proprietorship than a OPC, because the rules are not yet clear in all departments – Income tax, State departments etc. I am not yet sure what the exit options are to close the One Person Company.
- Limited Liability Partnership – LLP – This option was made available since 2012 and I hope the rules and laws regarding LLP are now clear. As it says, it is a limited liability which makes it the best option to start small venture. You get the benefits of a partnership firm and also have limited liability like Pvt Ltd. This option is similar to the LLC available in USA. Partners still need to get a DIN and get their firm registered with the Registrar. But presumptive taxation is not allowed in LLP. Since it’s been 8 years, it remains to be seen how many businesses have opted to close down the LLP and what the experience has been so far.
Overall, I would suggest to keep things simple when starting a business. Always have a goal in mind and be optimistic about your path, but also think of exit options if things don’t go well. You can choose any option first while starting a business and then after 2-3 years you could shift or convert to another type when situation changes. CAs and CS will do that for you. For example, you are an individual who wants to do consulting, then start a proprietorship now and then later go for the OPC if you think you need more investors for your business. If tomorrow you want to bring additional working partners then stop your proprietorship, start a partnership or LLP. Or if you are a group of friends who want to try a startup, then make a LLP now and then go for private limited later only when you need funding from investors. Knowing what works for you is also a part of the business journey.