Entrepreneur’s Handbook: Exploring Legal Entities for Your Indian Startup

Do you want to run your startup but wondering which legal business entity to establish?

If yes, then we’ll get you covered. Choosing the correct legal business entity is vital to growing your business. Various factors need to be considered when selecting a legal business entity. These factors include registration, ownership structure, the liability of the owners, and control of the business, among other things. The right legal entity helps you differentiate from the other businesses. 

Let’s know what types of startups are there in India. 

Types of legal business entities in India

1. Sole Proprietorship

Sole Proprietorship is the simplest type of startup, where individuals operate and control their business under their own PAN. Also, they are solo decision-makers in the company. However, the disadvantage of Sole Proprietorship is that they must bear unlimited personal liability. Additionally, owners’ assets are at risk to cover business debts, due to which individuals face financial difficulties. 

The sole  Proprietorship business is most suited to individuals who need to control and operate their business themselves. It is an ideal startup business to choose to run a low-risk business. The business such as service provider and daily needs provider business. However, before selecting this legal entity, one must take care of their finances and assets as they are the business’s liability holders. 

Some of the Pros and cons of the Sole Proprietorship business are:

Pros of Sole Proprietorship

1. Minimum legal formalities
2. Filing an income tax return is hassle-free.
3. Easy to set up
4. The owner can control and make decision
5. Low cost of compliance

Cons of Sole Proprietorship

1. Unlimited liability on the owner
2. Difficult in getting the funds
3. Less credible
4. Personal assets at risk
5. No distinct legal identity
6. Limited growth potential

2. Partnership Firm

When two or more people come together for the business to earn a profit, it is known as a Partnership Firm. In this entity type, partners share resources, ownership, management, responsibilities, and risks. Also, all decisions are taken by partners together. The profit is shared according to the partnership deed.

To build the partnership firm, a written agreement is needed where detailed aspects of partners dealing in the firm are written on, such as their role and responsibilities, decision-making process, and profit sharing ratio. This agreement is known as a partnership deed & it plays an essential role in defining the terms of the partnership and ensures transparency in business operations. 

Partnership firms are well suited when small and medium businesses need to be established, and partners must share the risk and resources. This type of business is expected in the accounting, legal, healthcare, and consulting industries, where partners come together to share experiences and networks. However, unlike a sole proprietorship, it is a separate legal entity with unlimited liability for partners.

Pros of Partnership Firm

1. Financial contribution
2. Diverse expertise and skills
3. Low cost of compliance
4. Flexibility in management
5. Cost of Taxes gets divided

Cons of partnership firm

1. Partners shared unlimited liability
2. Personal assets of partners at risk
3. Challenging in raising funds
4. Conflict happens in partners as decisions are delayed
5. Transfer ownership is difficult
6. Lack of continued existence

3. Limited liability partnership or LLP

A limited liability partnership offers a hybrid structure where a combination of companies and traditional partners exists. It provides partnerships with limited liability protection and protects personal assets from business debts. Also, it provides flexibility in management and taxation. This type of legal entity is ideal for service-based businesses and professionals seeking limited personal liability without any complex legal requirements. 

Limited liability partnerships are formed with registration with the Registrar of Companies, where you need to submit incorporated documents and comply with statutory requirements. LLPs have a separate legal identity where LLP can enter into contracts, own assets, and sue in its name. In LLPs, partners are not personally liable for debts and risks, and here, there is a degree of financial security and risk mitigation. 

Pros of Limited liability partnerships

1. Limited liability of partners
2. Distinct legal identity
3. Flexible management
4. Separate authority to control management
5. Perpetual existence
6. Low cost of compliance as compared to companies

Cons of Limited Liability Partnerships

1. Access to capital is limited
2. Disclose public information
3. The cost of incorporating is significant
4. High-income tax
5. No option for equity investment
6. Hefty penalties for non-compliance

4. One-person companies

A one-person company is a startup for individuals who want to start their business with limited liability protection. In one-person companies, one individual controls their business and owns 100% of the business. One of the advantages of one-person companies is that personal assets from business debts and obligations are protected. This startup is suited for individuals who need a limited liability partnership. This type of business suits freelancers, solo entrepreneurs, and professionals in IT services, consulting, and creative industries. 

Pros of One-person companies

1. Limited liability for a sole owner
2. 100% share of profits
3. Perpetual succession
4. Distinct Legal Identity
5. Fund access is easy
6. Enhanced transparency and credibility in operations
7. Perpetual Succession through Nominee
8. Low Taxation Rates
9. Shareholders relieved from daily activity

Cons of One-person companies

1. The sole owner bears the financial burden
2. Disclosure of public financial information
3. High cost of compliance
4. Suitable for small business
5. Prohibited of foreign ownership

5. Private limited companies

The most popular choice for startups due to its separate legal entity status, limited liability protection, and scalability. It requires at least two directors and shareholders. Additionally, the liability of shareholders is restricted to their holding of shares, and shareholder personal assets are protected from debts and business liability. It is a well-suited business for entrepreneurs looking for limited liability partnership, credibility, and flexibility in management. 

Pros 

• Distinct Legal Identity
• Shared and Limited Liability for Shareholders 
• Perpetual Succession
• Fund each access
• High Growth Potential
• Enhanced Transparency and credibility  in Operations 
• Low Taxation Rates 
• Shareholders relieved from daily activity

Cons of private limited companies

• High Cost of Incorporation and Compliance 
• Disclosure of Public Financial Information
• Transfer of Shares is restricted
•  Prohibited to the Public the sale of shares
• Exhaustive Decision-Making Process

6. Public Limited companies

Public limited companies are a type of startup business where you can raise funds from the public through issues of shares in the stock exchange markets. In this business, shareholders hold shares, and directors manage the company appointed by shareholders. However, the liability of shareholders is limited to the shares they hold, and their personal assets are protected from business debts and obligations. The public limited company business is suited for entrepreneurs who want to raise funds from the public and enhance their credibility and visibility in the market. 

Pros 

• Legal Identity creates distinct 
• Shared and Limited Liability for Shareholders 
• Perpetual Succession
•  Public Transfer of Shares is free 
• High Growth Potential
• Low Taxation Rates 
• Shareholders are not Involved in daily management.

Cons

• High Cost of Incorporation and Compliance
• Stringent Regulatory Requirements from RBI & SEBI 
• Financial Information disclose publicly 
• Exhaustive Decision-Making Process

Conclusion 

When selecting the type of startup business in India to establish, look into factors of liability protection, regulation compliance and growth potential to achieve the business goals and reduce the risk of business. However, taking the expert helps to establish a solid business that will succeed in your startup business.