Company Formation & Legal Structure

23 Jan 2013

company-formation-services-250x250Prior to launching a businesses, selecting its legal structure is important.  In addition to the amount of regulatory paperwork needed,  personal liability regarding investments into the business, and taxes to be paid should also be factored in the decision process. Also, if you are looking for funding, understanding the type of entity that financers are typically comfortable working with, should play an important role in  selecting a legal framework for the business. In this article we discuss the more popular legal structures prevalent in India and the USA. 

 


 

India

The following is a guide to the different types of business entities that are prevalent in India.

  • Sole Proprietorship
  • Partnership firm
  • Limited Liability Partnership
  • Private Limited Company
  • Public Limited Company

 

Sole Proprietorship

Sole proprietorships are the most common and simplest form of business organization. Sole proprietorships are owned by one person who is generally also responsible for the business’s day-to-day operational activities. Sole proprietors own all assets and profits of the business and also assume complete responsibility for business’ liabilities and debts.

Partnership

A partnership is an association of two or more people formed for the purpose of carrying on a business. Partnerships are governed by the Partnership Act. Partnership firm is formed by an agreement between two or more people to own and run the business. This arrangement enables enterprising individuals to pool their resources to establish and expand a business. Collectively the individual partners become a firm. In general, each partner contributes to all aspects of the business including money, property, and labor or skill. In return, each partner shares in the profits and losses of the business. Unlike an incorporated company, a partnership does not have a "legal entity" of its own. Therefore the Partners are liable for any debts of the business.

Limited Liability Partnership

Limited Liability partnership provides all the benefits of an incorporated company as well as the flexibility of a partnership. In an LLP, all partners have limited liability, similar to that of the shareholders of a limited company, and are relieved from the liability for the acts of other partners. Unlike the shareholder of a company, the partners have the right to manage the business directly. An LLP also limits the personal liability of a partner for the errors, omissions, incompetence, or negligence of the LLP’s employees or other agents.

Private Limited Company

A private limited company must be appropriately incorporated with the Registrar of Companies (ROC) and has a separate legal identity. The governing provisions for a Private Limited Company are contained in The Companies Act, 1956. A Private Limited Company must have a minimum of two and a maximum of 50 members as its shareholders. It must have minimum of two directors and maximum of 12 directors. The minimum paid up capital at the time of incorporation of a Private Limited Company is INR 100,000. It can be increased any time, by payment of additional stamp duty and registration fees.

The liabilities of the shareholders are limited to the shares subscribed by them. Although the liabilities of the shareholders are limited, at times, the liability of a Director/Manager can be unlimited. A Private Company is prohibited from inviting the public to subscribe for any shares or debentures of the company. It is also prohibited from inviting or accepting deposits from persons other than its members, directors or their relatives. The shares can be transferred only among its members and it involves some restrictions.

Public Limited Company

A Public Limited Company is a Company limited by shares in which there is no restriction on the maximum number of shareholders, transfer of shares and acceptance of public deposits. A company is a legally independent body therefore is perpetual irrespective of death, retirement or insolvency of any of its shareholders. The shareholders do not have a right in managing the activities of the company there is a clear separation of management and ownership and the company’s Board of Directors are vested with the decision making power as per the rule of majority. The minimum paid-up capital for a public limited company is INR 500,000. A Public Limited Company must have a minimum of seven shareholders and have a minimum of three directors and maximum of 12 directors.

The liability of each shareholder is limited to the extent of the unpaid amount of the shares’ face value and the premium thereon in respect of the shares held by him. However, the liability of a Director / Manager of such a Company can at times be unlimited. The shares of a company are freely transferable and that too without the prior consent of other shareholders or without subsequent notice to the company.

There are some strict compliance requirements for a Public Limited Company as mentioned below:

  • It must have at least three Directors
  • A prospectus or a statement in lieu of prospectus has to be filed with the Registrar of Companies before allotment of shares.
  • It has to obtain Certificate of Commencement of Business from the Registrar of Companies before it can commence business on incorporation.
  • It has to hold a statutory meeting of members and file a Statutory Report with the Registrar of Companies.


USA

Sole Proprietorship

Sole proprietorships are the most common - and simplest - form of business organization. A sole proprietorship is an unincorporated business organization that's owned and operated by an individual. They own all assets and profits of the business and also assume complete responsibility for business’ liabilities and debts.  Sole proprietors do not run their operations through separate legal entities (such as corporations). They can sell goods or services; they can also be self-employed freelancers, independent contractors (ICs) and consultants who provide their services to other businesses.

Partnerships

When two or more people decide to join together to carry on a trade or business, their relationship is considered to be a partnership. Partnerships are governed by the Partnership Act (1890). In general, each partner contributes to all aspects of the business including money, property, and labor or skill. In return, each partner shares in the profits and losses of the business. The operation of a partnership is usually governed by a "Partnership Agreement". Entrepreneurs planning to form a business partnership should consider having a written partnership agreement, also known as the articles of partnership. Under the Uniform Partnership Act, a partnership agreement may be written, oral or implied.

The specific terms of this agreement are determined by the partners themselves, covering issues such as:

  • Profit-sharing - normally, partners share equally in the profits;
  • Entitlement to receive salaries and other benefits in kind (e.g. cars, health insurance)
  • Interest on capital (the amount invested in the partnership)
  • Arrangements for the introduction of new partners
  • Arrangements for retiring partners
  • What happens when the partnership is dissolved

Partner liability can take several forms. General Partners (the usual situation) are fully liable for business debts. Limited Partners are limited to the amount of investment they have made in the Partnership. Nominal Partners also sometimes exist. These are people who allow their names to be used for the benefit of the partnership, usually for remuneration, but they do not get a share of the partnership profits.

Limited Liability Partnership

Limited Liability Partnership (LLP): LLP, like an LLC, places a limitation on liability for claims against those involved in the partnership. LLPs also limit the liability that any one partner may have for actions conducted by other partners. This type of business structure is particularly popular for professional enterprises, such as law and accounting firms, which may be held liable for those they advise or represent in some cases. Furthermore, the members of an LLP are not required to pay self-employment taxes.

C and S Corporation

A corporation is an independent legal entity owned by shareholders. This means that the corporation itself, not the shareholders that own it, is held legally liable for the actions and debts incurred by the business.

An S Corporation or S Corp is a special type of corporation created through an IRS tax election. An eligible domestic corporation can avoid double taxation (once to the corporation and again to the shareholders) by electing to be treated as an S corporation.

A C corporation is a legal entity that exists separately from its owners and is taxed as a separate entity. As a result, C corporations are subject to double taxation: the corporation pays income tax on its profits, but the shareholders must also report their dividends on their personal income-tax returns.

Limited Liability Companies

As the name suggests, in this form of business your liability is limited to the amount you contribute by way of share capital. A Limited Liability Company is a separate legal entity, distinct from both its shareholders, directors and managers. The liability of the shareholders is limited to the amount paid or unpaid on issued share capital.

However, many restrictions are put on the company. It must maintain certain books of accounts. Appoint an auditor and file an annual return with the registrar of companies which includes the accounts as well as details of directors and mortgages.


Comparison of Legal Structures

Type of Company

Type of Business

Advantages

Limitations

Sole Proprietorship

Freelancers, Small Traders, Craftsmen, Home based businesses

Few Legal Formalities, Low investment

No legal identity of the business, Unlimited liability of the proprietor

Partnership

Team of people rendering professional services like lawyers, chartered accountants, consultants

Few legal formalities, Low costs, Pooling of resources in form of capital or skill sets

Dependency on partners, Unlimited liability of partners

Limited Liability Partnership/Companies

Team of people rendering professional services like lawyers, chartered accountants, consultants

Liability of owners is limited, Separate legal entity

Business is dependent on partners, Business has to be run by partners

Private Limited Company

Closely held businesses,

Separate legal identity, confidentiality

Restriction on transfer of shares and raising of capital

Public Limited Company/Corporations

Large Businesses with huge capital requirements

Perpetual existence, Legally independent, Shares freely transferable

No confidentiality, Strict regulatory requirements, Initial costs are high

Last modified on Wednesday, 23 January 2013 23:56
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