Sole proprietorship, LLP to private limited company; business structures for startups explained

When you start a business, it’s important to decide on the right legal structure because it can be crucial for your company’s long-term growth, compliance burden, taxation, control over the organisation, and personal liability. To ease the dilemma of picking an appropriate business structure for startups, the Department for Promotion of Industry and Internal Trade (DPIIT) lists five options, along with the respective features of each.

Sole proprietorship

The business is owned and managed by a single person, who has complete control over it. Since it does not require a separate registration, it’s one of the easiest businesses to set up. All you need is government registration relevant to the business. For instance, if you are selling goods online, a proprietor would only need sales tax registration. You also don’t need to file separate taxes for the business as the personal income tax filing will be sufficient.

However, since there is no difference between the business and the proprietor, all business debts are the personal responsibility of the owner, which can lead to unlimited liability, especially if business loans have been taken.

One-person company

The one-person company arrangement is an improvement over sole proprietorship since it allows one person to own and manage a company without making it his personal liability. This means that the promoter’s personal assets are legally protected from settling the company’s debts. The person and company are treated as separate legal entities.

The founder needs to appoint a nominee during registration so that the latter can take over the business in case of the founder’s death or incapacity. The OPC cannot raise equity funding or offer employee stock options. It also requires high compliance, and will have to conduct a statutory audit, submit income tax returns, and comply with the requirements of the Ministry of Corporate Affairs.

General partnership

In this type of business structure, two or more individuals manage and operate a business as per the terms and objectives of a partnership deed. Like sole proprietorship, the partners have unlimited liability, which means they are personally liable for business debts.

Since registration is optional, and it requires low cost and minimal compliance, this business is easy to set up, especially if you are not planning to take any loans. It’s extremely suitable for very small businesses. If you choose not to register your partnership firm, all you need to get started is a partnership deed.

Limited liability partnership

This is better than general partnership since it “limits the liabilities of its partners to their contributions to the business, and offers each partner protection from negligence, misdeeds or incompetence of the other partners”, as per the DPIIT. There is no limit to the number of partners who can set up an LLP. It’s also much cheaper than setting up a private limited company and has fewer compliance costs, combining the benefits of general partnership and private limited company. This also offers some tax advantages.

Private limited company

This business structure is good for fastgrowing companies that require equity funding. It also limits the liabilities of its shareholders to the amount that they invest in starting the business, and enables them to offer employee stock options to attract talent.

A private limited company is more expensive to set up and also incurs compliance costs. Among other compliance requirements, the company needs to include a statutory audit, annual filings with the registrar of companies, annual submission of income tax returns, quarterly board meetings, filing of minutes of these meetings, and file annual returns with the Ministry of Corporate Affairs.