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Private Ltd, Partnership or Proprietorship: What should you choose?

Private Ltd, Partnership or Proprietorship: What should you choose?
rohit
Rohit22 December 2023

Selecting the right business structure is important as it can significantly affect various aspects, such as tax obligations, legal liabilities, and growth opportunities. Moreover, altering the structure down the line can prove to be a time-consuming and costly endeavor. 

Therefore, it becomes crucial to carefully consider and choose a suitable legal framework from the outset.

In India, the most common business structures are:

  • Private Limited Company
  • Limited Liability Partnership Firm
  • Partnership Firm
  • Proprietorship

In the financial year 2021-22, as many as 1.67 lakh new companies registered with the Ministry of Corporate Affairs, bringing the total to 14,13,249 registered private companies and 2,52,460 limited liability partnerships, while more than 60% of all registered businesses are sole proprietorships

Six Factors to Consider When Choosing a Business Structure

Six Factors to Consider When Choosing a Business Structure

1. Size and nature of the business

If you want to start a business, you can look towards starting a private limited company. Private limited companies can have a minimum of 2 and a maximum of 200 members. This structure suits medium to large-sized businesses requiring significant investment, infrastructure, and compliance requirements. 

Partnerships involve a minimum of two and a maximum of 20 partners, making it suitable for small to medium-sized businesses that require less investment, have lower compliance requirements, and are easier to set up. Some examples are Maruti Suzuki, Mahindra and Mahindra and Hindustan Petroleum. 

A single individual owns proprietorships, making them suitable for small businesses requiring minimal investment, low compliance requirements, and easy to manage. 

2. Liability Protection

Liabilities include all the business's financial obligations, such as debt, which they are legally liable to repay. However, some business structures differentiate between the enterprise and the owner to protect the owners from being personally liable to compensate liabilities. 

You can start a private limited company if you want to have limited liability to the extent of the share capital ie your contribution to the company. Your personal assets will be safe. 

However, in the case of general partnerships, you and your partners will be jointly liable for the business’s debts and obligations. That means, your personal assets will be at risk. If you do not want unlimited liability but want to create a partnership firm, you can start a limited partnership (LLP). LLPs have at least one general partner with unlimited liability and one or more limited partners whose liability is limited to the extent of their contribution. 

Here, starting a proprietorship may not be the right decision as the sole owner has unlimited liability and is personally liable to repay all the financial obligations. 

3. Tax Implications 

Every business is legally liable to pay tax on the profits. However, as taxes reduce the overall profits, you should choose among the three based on their tax implications.  For example, if you do not want to start a business liable to pay high taxes, you can pass on starting private limited companies and partnerships as they must pay taxes on the profits at a flat 30% rate, plus surcharge and cess as applicable.

In the case of proprietorships, the sole owner personally receives the profits. Hence it is taxed per personal income tax laws as per the applicable tax slab. Sole proprietorships involve paying fewer taxes and prove an ideal choice if reducing tax liability is a vital business factor. 

4. Cost and complexity of setup and maintenance

All entrepreneurs want to start a business that does not include higher costs and complex processes. If you have high capital and the efforts to start a big business, you can choose private limited companies as the business structure. Private limited companies require a minimum share capital of Rs. 1,00,000. They also require a higher initial investment for legal fees, registration fees, and other compliance requirements. The complexity of setup and maintenance is also higher than other business structures. 

However, if you want a business structure which is relatively affordable and easier to set up, a partnership firm will be an apt business structure as the minimum capital required is Rs 50,000. It requires minimal legal formalities, and the cost of maintaining a partnership is also lower than a private limited company, as it has fewer compliance requirements.

The best business structure for the lowest cost and complexity is a sole proprietorship, which does not require extensive registration or legal formalities. Many proprietors don’t even register the company, running it in their name with their personal bank accounts. 

5. Ownership and Control

Some entrepreneurs want total control over all business affairs, while some seek the expertise and skills of others to make mutual decisions. If you are the former, you can choose sole proprietorship as the business structure. The sole owner of the proprietorship has complete control over the management and the profits, as it is not a separate legal entity.

However, if you are the former, you can create a partnership firm, as all the partners have ownership and control based on the profit-sharing ratio determined at the time of incorporation. In the case of private limited companies, the shareholders have ownership, but the board of directors controls the entity. Hence, the decision-making is collective and requires mutual agreement on implementing business ideas. 

6. Funding

Funding is an important aspect of the success of a business, allowing entrepreneurs to ensure constant cash flow into the business. Private companies are the ideal business structure to create a business that can raise funds as needed. Private limited companies are popular when choosing a business structure, as they can issue equity shares to investors. Private limited companies can raise funds through venture capital, private equity, angel investors, and even an initial public offering (IPO) if they meet specific criteria. It becomes easy to issue new shares, buy back old ones, or sell or buy them.

Partnerships can only raise funds through the personal resources of the partners, whereas proprietors leverage personal resources or borrow funds from banks and other financial institutions. Both business structures can not issue equity shares to investors or borrow funds by pledging their assets as collateral. If they want to change the partnership structure or add investors, they must dissolve the current partnership and create a new one.

Pvt Ltd: Private Limited Companies

Registered under the Companies Act 2013 with the Ministry of Corporate Affairs are legal business entities held privately by various shareholders. 

Private limited companies in India need approval by the Registrar of the Company concerning their name and can have a minimum of two and a maximum of 200 members/directors. Shareholders have limited liability that extends only to their share capital. Foreigners can invest in private limited companies under the automatic route, and owners can transfer ownership through share transfer.

Pvt Ltd: Private Limited Companies

Advantages of Pvt Ltd

  • Private Limited companies offer limited liability to shareholders, protecting their personal assets in case of losses or legal issues. 

  • They can issue shares to investors, making raising capital for business operations or expansion easier. 

  • Pvt Ltd companies are eligible for various tax benefits offered by the Indian government on R&D expenses, depreciation, and other business expenses.

Disadvantages of Pvt Ltd 

  • The cost of setting up and maintaining private limited companies is higher, and the process is time-consuming. 

  • Private limited companies are subject to various compliance requirements under the Companies Act 2013, such as maintaining statutory registers, filing annual returns, and holding annual general meetings. 

  • Since the board of directors control the company, shareholders have limited control over the business operations. 

Examples of businesses suitable for Pvt Ltd

The business structure of a private limited company is suitable for businesses that require high investment and are large to medium size. This can include capital-intensive manufacturing, IT, real estate, retail and large-scale service enterprises. 

Questions to ask yourself before you choose Pvt Ltd

Ponder upon the following questions before choosing the private limited structuring.

  • Do you have the high initial capital required to set up a Pvt Ltd company?

  • Do you have at least one other person to tick off the minimum member requirement? (Now, you can also create an OPC - a one-person company, which doesn’t need another director)

  • Do you want the size of the business to be comparatively bigger than a small business? 

  • Are you ready to spend considerable time fulfilling the business's legal and compliance-related obligations? 

Compliance and Role of CAs and Lawyers in Pvt Ltd Companies

Compliance is critical to running a private limited company in India. Seek the advice and guidance of qualified professionals, such as Chartered Accountants (CAs), Company Secretaries (CS) and lawyers, to ensure effective compliance with all legal and regulatory requirements. 

Such professionals help with–

  • The company’s incorporation and registration

  • Preparing necessary documents for complying with the rules of the Companies Act, taxation and accounting

  • Risk management

Government Schemes

The Indian government has established numerous schemes to support private limited companies such as:

  • A Scheme for Promotion of Innovation, Rural Industries and Entrepreneurship (ASPIRE)

  • Support for International Patent Protection in Electronics & Information Technology (SIP-EIT)

  • Credit Guarantee Scheme for Startups (CGSS)

  • Pradhan Mantri Mudra Yojana
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