How to choose the best business structure for your business?
In India we have basically three types of business structures namely Sole proprietorship, Partnership firms and Company (pvt or public), however a new hybrid form of partnership firm and company known as Limited liability (LLP) emerged a few years ago. Each structure has its own pros and cons and it depends upon the individual circumstances of each business owner as to which structure will best suit his business. These include the level of personal liability you are willing to take for business debts, your personal tax position, the level of administration you want to do and how you want your business to be perceived.
Ownership and control
The forms of Sole Proprietorship and partnership firms limit the number or type of people who can invest in your business. If you’re seeking a large number of investors or international investors, you may opt for LLP and Company.
If you desire to maintain a direct relationship between ownership and management of the business then limited liability partnerships (LLPs) are preferable over limited Company. However if the objective is to maintain complete authority, then sole proprietorship form of business is best suited.
Where is your company headed, and which type of legal structure allows for the growth you envision? Turn to your business plan to review your goals, and see which structure best aligns with those objectives. Your entity should support the possibility for growth and change, not hold it back from its potential.
When it comes to startup and operational complexity, nothing is more simple than a sole proprietorship. You simply register your name, start doing business, report the profits, and pay taxes on it as personal income. However, it can be difficult to procure outside funding. Partnerships, on the other hand, require a signed agreement to define the roles and percentages of profits. Corporations and LLCs have various reporting requirements with state governments and the federal government.
Registration and maintenance costs
The registration cost in most cases is very similar. However, Proprietorship firms are easy and inexpensive to form. As registration is a one-time cost, you should focus on maintenance cost. It majorly includes the cost of compliance. The compliance level in a company is the highest, followed by an LLP. Continuous and event-based compliance are provided under law. However, you might want to compromise on cost for the benefits offered by a specific structure.
When you are looking to minimize your personal liability you can generally rule out sole proprietorships and partnerships firms right away because there is lack of liability protection in these two forms. With these two forms, the business is not regarded as a separate legal entity from you, so your personal assets are part of the business. This means that if the business is sued for whatever reason, your personal assets are at stake. In a partnership form of business, even your personal assets are at stake for anything that your partner may do.
Companies and LLP are more credible structures. Professional certification and centralised registration offer them higher credibility. Further, the financial and other data are accessible to the public. Therefore, third parties could easily rely on such structures. But, a structure like a sole proprietorship has very little credibility of its own. Rather it is dependent on the owner’s credibility.
Continuity of existence
Businesses heavily depend on promoters. But, it affects the survival of the business. For new businesses, it may not be much important. However, it is surely important in long term, especially, for funding. Investment agencies prefer business continuity for a safer investment. It is best offered by Companies and LLPs. Businesses at the pilot stage can choose an informal structure that is easy to convert later.
There is a defined tax structure for each form. Some structures being separate legal entities are taxed directly. Such as Company and LLP. Partnership firm is also a different entity for tax purpose. All these forms attract 30% basic tax (except small company @25%). Income of a Proprietorship firm is taxed in a slab of 5 to 30% post basic exemption limit. You must understand the tax structure of any form to best business plan the tax liabilities.
Privacy of documents
Certain business structures require to make all documents part of the public record, accessible to all. While documents in the company are fully accessible to the public, LLP Agreement remains private. If you wish not to disclose the details of your business, choose the structure of your business carefully.
Types of business structures
The most common types of business entities include sole proprietorships, partnerships, limited liability companies, corporations and cooperatives. Here’s more about each type of legal structure.
1. Sole proprietorship:
This is the simplest form of business entity. With a sole proprietorship, one person is responsible for all a company’s profits and debts.
Proprietorship costs vary, depending on which market your business is part of. Generally, your early expenses will consist of state and federal fees, taxes, equipment needs, office space, banking fees, and any professional services your business decides to contract. Some examples of these businesses are freelance writers, tutors, bookkeepers, cleaning service providers and babysitters.
Here are some of the advantages of this business structure:
Easy setup. A sole proprietorship is the simplest legal structure to set up. If your business is owned by you and only you, this might be the best structure for your business. There is very little paperwork since you have no partners or executive boards to answer to.
Low cost – Costs vary depending on which state you live in, but, generally, the only fees associated with a proprietorship are license fees and business taxes.
Tax deduction – Since you and your business are a single entity, you may be eligible for certain business tax deductions, such as a health insurance deduction.
Easy exit – Forming the proprietorship is easy and so is exiting one. As a single owner, you can dissolve your business at any time with no formal paperwork required. For example, if you start a daycare center and wish to fold the business, you can simply refrain from operating the daycare and advertising your services.
This entity is owned by two or more individuals. There are two types: a general partnership, where all is shared equally; and a limited partnership, where only one partner has control of its operation while the other person (or persons) contributes to and receives part of the profits. Partnerships carry a dual status as a sole proprietorship or limited liability partnership (LLP), depending on the entity’s funding and liability structure.
The cost of a general partnership varies, but it is more expensive than a sole proprietorship, because you want an attorney to review your partnership agreement. The experience and location of the attorney can affect the price range. A general partnership must be a win-win for both sides for it to be successful.
3. Limited liability company
A limited liability company (LLC) is a hybrid structure that allows owners, partners or shareholders to limit their personal liabilities while enjoying the tax and flexibility benefits of a partnership. Under an LLC, members are shielded from personal liability for the debts of the business if it cannot be proven that they acted in an illegal, unethical or irresponsible manner in carrying out the activities of the business.
The law regards a corporation as an entity separate from its owners. It has its own legal rights, independent of its owners – it can sue, be sued, own and sell property, and sell the rights of ownership in the form of stocks. Corporation filing fees vary by state and fee category.
- Limited liability. Stockholders are not personally liable for claims against your corporation; they are only liable for their personal investments.
- Continuity. Corporations are not affected by death or the transferring of shares by its owners. Your business continues to operate indefinitely, which is preferred by investors, creditors and consumers.
- Capital. It’s much easier to raise large amounts of capital from multiple investors when your business is incorporated.
A cooperative (co-op) is owned by the same people it serves. Its offerings benefit the company’s members, also called user-owners, who vote on the organization’s mission and direction and share profits. Advantages that cooperatives offer include:
- Lower taxes. Like an LLC, a cooperative doesn’t tax its members on their income.
- Increased funding. Cooperatives may be eligible for federal grants that help them get started.
- Discounts and better service. Cooperatives can leverage their business size, thus obtaining discounts on products and services for their members.