India: Startup Style – What Legal Format Fits You Best?

Last Updated: 22 January 2018
Article by Asit Mehta

Everything about a startup is exciting – except the paperwork.

There are no two ways about it – no one enjoys the documentation involved in starting their own business. From shareholders' DSC and DINs to business PAN, TAN, GST, IEC, PTR, the list of abbreviations is long and tiresome. Yet as all entrepreneurs know, these are essential – without compliance, there is no business.

Over the years we have seen startups come to us earlier and earlier in the process, to discuss their options. One reason is the wide availability of information on the internet. The other is that entrepreneurs have become savvier. They now know the dangers of missing a step in the startup documents and compliance process.

Usually the very first question we ask entrepreneurs is "What sort of entity do you want?" Many think a private limited company is the only legal format for a startup. We discuss below how this is the most common myth, and how others may suit your startup much better.

Sole proprietorship

This is as simple a concept as possible – you and the firm are a single entity for all practical purposes. You may brand it what you like, of course. But to your vendors or employees or even the tax office, there is no distinction. Just as the lone entrepreneur is going out of style, so is the sole proprietorship.

Partnership firm

This applies when you have at least 2 business partners. A partnership firm in India allows you to have up to 100 partners (if you're feeling adventurous). The compliance requirements are low and while the firm is a distinct entity from the partners, each partner's liability is unlimited. Naturally this is not an attractive proposition, but for a long time this was the only option available to any startup that wanted a low compliance burden.

Limited liability partnership (LLP)

Recently introduced in India, a LLP is a partnership but with limited liability and certain differences in regulation. While a partnership reports to the Registrar of Firms, the LLP reports to the Registrar of Companies. The compliance burden is higher than that of a partnership firm but lower than that of a private limited company. The LLP format is gaining popularity in the startup world and for good reason.

Private limited company

A private limited company is the best understood structure because it has limited liability and has equity (rather than partnership interests). However it brings the largest compliance burden (short of a listed company) in terms of effort and cost, with a certain number of minimum filings each year with the Registrar of Companies (accounts, annual general meetings, Board meetings, auditor appointment, etc.)

Often a startup structures itself as a private limited company early on, only to realise that even the bare minimum compliance costs are eating into early years' profits.

A new option: One Person Company

Another recently introduced concept is a One Person Company (OPC). This is a private limited company (with equity and limited liability) with a single shareholder (a private limited company requires two shareholders at least). While there are certain restrictions on the OPC, this is nevertheless a good option for sole entrepreneurs looking to create a larger entity than a proprietorship.

In summary

What we present above are just the broad options. What's important to know is that there are also subjective factors which could impact your decision significantly.

For example, what are your long-term plans for the business? How many people are involved in the business and how do you see their contribution shaping up in the future? Is there a promise of sweat equity or ESOPs? Will your customers perceive a certain structure negatively? If, 3 years from incorporation, you want to transition to a different structure, how easy or difficult will it be?

Answering these questions (and many more) for startups forms a part of our work at AMA. We believe in taking the compliance burden off startups so that they can focus on what's important – their business.

To read more on this topic from Asit Mehta & Associates, please click here

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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