Conversion Of Sole Proprietorship to Company

Introduction

A Company tends to hold more freedom and opportunities taken into consideration the legal setting and the economic settings as the entity will now enjoy a separate legal entity, giving perpetual succession and also limited liability to its owners and investors. But there will be dilution in the ownership and loss of independence with respect to decision making along with profit-sharing with the investors. So, prior to making a decision with regard to converting sole proprietorship, the owner should make proper understanding and considerations regarding both such that they land into making the proper and apt decision.

Necessities for Conversion

For ensuring the conversion of the Sole Proprietorship into a company there are certain points that should be taken care of by the Sole Proprietor and the company. These points have been enlisted below:

1. There should be mutual agreement reached between Sole Proprietorship to Company. For this, there should be a takeover agreement or sale agreement entered into between these two parties.
2. The Memorandum of Association (MOA) of the company should carry the object as, “The takeover of a Sole Proprietorship Concern.”
3. All the assets and liabilities of the Sole Proprietorship should be transferred to the Company.
4. The Sole Proprietor should hold not less than 50% of the shares of the company and the allied voting power and this should be held for a minimum period of 5 years or more.
5. The proprietor should only be earning benefits in a direct or indirect format to the extent of shares held by him in the company.
6. There should be a minimum of 2 directors and 2 members in the Private Limited Company.

The potential challenges may arise during the conversion process

Converting a sole proprietorship to a company may present some challenges or roadblocks that need to be addressed. One such challenge is the transfer of assets and liabilities from the sole proprietorship to the company, which may involve legal and regulatory compliance. Another challenge is the potential resistance from employees, customers, or suppliers who may be accustomed to dealing with the sole proprietor. Additionally, the conversion may require changes to the business structure, management, and decision-making processes, which may take time and resources to implement.

Procedure for Conversion of Sole Proprietorship into Company

The following enumerated steps are to be followed by the Sole Proprietor who would want to convert the Sole Proprietorship Concern into a Company:

1. The slump sale formalities should be completed by the Sole Proprietor. Slump Sale is nothing but the transfer of one or more undertakings for a lump sum consideration.
2. All the directors on the Board of the new company should be having Digital Signature Certificates (DSC) and Director Identification Number (DIN).
3. The Sole Proprietor should then file an application for the availability of name.
4. Now the Articles of Association (AOA) and Memorandum of Association (MOA) should be prepared for specifying the rules and objects of the company newly formed.
5. The application should now be submitted with the MCA (Ministry of Corporate Affairs) for the incorporation of the company along with the submission of all relevant documents for effecting the same.
6. The receipt of the Certificate of Incorporation would be the next step.
7. The company will be allotted with the PAN and TAN along with the incorporation certificate and can also modify the bank and other basic details in accordance with the Company Name and other particulars.

Documents to be Furnished for Effecting the Conversion of Sole Proprietorship to Company

1. Identity proof of all directors, say a copy of PAN Card.
2. Address proof of directors, say copy of Voter ID or Aadhaar Card.
3. Passport size photographs of the Directors.
4. If the business place is owned by the company, then the documents pertaining to such ownership.
5. If the business place is rented then the rental agreement of the same.
6. NOC or No Objection Certificate or Letter obtained from the landlord.
7. Copy of utility bills like water or electricity bills.

The Advantages and Disadvantages of Converting from a Sole Proprietorship to a Company

Advantages:

1. Limited liability: When a sole proprietorship is converted into a company, the liability of the shareholders is limited to the amount of capital they have invested in the company. This means that in case of any debts or liabilities, the personal assets of the shareholders will not be at risk.
2. Separate legal entity: A company is a separate legal entity, distinct from its shareholders. This means that it can enter into contracts, own assets, and sue or be sued in its own name, without affecting the personal assets of the shareholders.
3. Easier access to funding: As a separate legal entity, a company can raise funds easily through equity or debt financing. This is not possible for a sole proprietorship, where the owner has to rely on personal savings or borrowings.
4. Better governance: A company is governed by a board of directors, who are elected by the shareholders. This provides better corporate governance and transparency in decision-making, compared to a sole proprietorship where the owner makes all the decisions.

Disadvantages:

1. Higher compliance costs: A company has to comply with various legal and regulatory requirements, such as filing annual returns, maintaining statutory records, and conducting regular board meetings. This results in higher compliance costs compared to a sole proprietorship.
2. Complexity: A company is more complex in terms of its structure and governance, compared to a sole proprietorship. This can make it difficult to manage and may require the services of professionals such as lawyers and accountants.
3. Loss of control: When a sole proprietorship is converted into a company, the owner may lose some control over the business, as the board of directors and shareholders have a say in decision-making.
4. Tax implications: The conversion of a sole proprietorship to a company may have tax implications, such as capital gains tax on the transfer of assets and the applicability of corporate tax rates.

The Tax Implications of the Conversion

When converting a sole proprietorship to a private company, there are several tax implications that need to be considered. The conversion may trigger capital gains tax on the transfer of assets from the sole proprietorship to the company. Additionally, the company will be subject to corporate tax rates, which may be higher than the personal income tax rates applicable to a sole proprietorship.

Requirements for Forming a Private Limited Company

1. Capital: There is not minimum paid up capital requirement for forming a Private Limited Company. However, in case of conversion of sole proprietorship into Company, the amount of capital shall be decided upon based on the value of the assets that are to be taken over by the company on its incorporation.
2. Shareholders: A Private Limited Company should be having a minimum of 2 directors and 2 members. And here one major point to be noted is that the Sole Proprietor should be one of the directors and members of the company.
3. Directors: For forming a company a minimum of 2 directors are mandatory and out of which one should be the Sole Proprietor himself, while the other one can be anyone.
4. DIN: All the directors as such should have obtained DIN i.e., Director Identification Number prior to being appointed as the Director of the company.

The differences in management and decision-making between a sole proprietorship and a company

The conversion of a sole proprietorship to a company involves a shift in management and decision-making. In a sole proprietorship, the owner has complete control over the business and makes all decisions. In contrast, a company is governed by a board of directors elected by the shareholders, who are responsible for making strategic decisions and overseeing the management of the company. This means that the owner may have to cede some control over the business and work collaboratively with other stakeholders in the company. Additionally, the decision-making process in a company may be more formalized and structured compared to a sole proprietorship, which may require the adoption of new policies and procedures. It is important to be prepared for these changes and ensure that the management and decision-making structures are aligned with the goals and objectives of the business.

Conclusion

Hence, we can conclude that despite having many benefits by converting to a Private Limited Company, there are also certain problems which might be faced by the Sole Proprietor. Amongst this one major point is the dilution in the ownership of the entity and also sharing of profits. So, any Sole Proprietor should first consider these points before converting their Sole Proprietorship Concern into a Company.

So as the final point lets discuss the pros and cons which are held by Private Limited Company and Sole Proprietorship Concern in a table:

FAQs on Converting Sole Proprietorship to Company