How to choose the right legal entity for your startup?

If anything is just as important as that unique business idea you may have for a startup, it is the legal structure of the business. Beyond the initial seed idea, running a successful business enterprise requires planning in various areas of business. Opting for the right legal structure is one of the essentials that underlines the fact that you are focusing on the fundamentals to make your business a success in the long run.

Many entrepreneurs find it difficult to choose the appropriate legal entity for their business. We provide some pointers for choosing the right legal entity for your startup.

Business registrations in India are broadly classified under five distinct types as outlined below.

1: Sole Proprietorship Company

A sole proprietorship firm is a one person company, which is ideally suited for solo business operations. All expenses and income generated by such business firms are included in the personal income tax return of the business owner or proprietor.

Advantages and disadvantages

• A sole proprietorship is a one person business entity requiring less documentation, with considerable ease of account opening.
• It is not possible to add investors or partner under such an entity.
• Taxation is based on the individual owner’s IT slab.

2: Partnership Firm

A partnership firm is similar in structure to a sole proprietorship but requires two or more people for registration. A partnership firm is ideally suited for startups having a co-founder on board, with a company registration deed highlighting all business and financial details of the proposed business.

Advantages and disadvantages

• A partnership form is easy to create, with just a registration deed and PAN cards of all partners as required documentation.
• It is optional to get a partnership firm registered with the Registrar of Firms.
• VCs and investors do not generally prefer such an entity as the personal liabilities for such firms are those of the partners.

3: Limited Liability Partnership Firm (LLP)

Limited Liability Partnerships offer partners limited liability in the business. LLPs are suited for startups or business entities just starting out on their entrepreneurial journey not sure of how much they are likely to grow in the first few years.

Advantages and disadvantages

• LLPs offer Limited liability in the business and cost less compared to a private limited company.
• ESOPs are not available in the LLP.

4: Private Limited Company (PLC)

A private limited company is the most popular and preferred legal entity for businesses. Private limited firms are preferred when VCs or investors plan to invest in the business as shares can be issued to investors easily.

Advantages and disadvantages

• Private limited firms come with a higher cost of formation and have more yearly compliances compared to other business entities.
• Private limited companies provide ESOP Options, offering shares to employees.
• Such firms are investment ready for VCs and another source of investment or funding.

5: One Person Company (OPC)

A One Person Company offers all advantages of a private limited company but requires only a single individual to register the company. For individuals seeking 100% control of their business, a One Person Company is the preferred legal entity for operating business.

Advantages and disadvantages

• OPCs have a higher cost of formation compared to private limited company.
• OPCs offer limited liability and 100% equity control in the business.
• OPCs cannot add any partners at any time in the future.

Choosing the right legal entity for startups should be a priority. To make best use of various regulatory and tax implications, seeking advice of a legal expert can also go a long way in ensuring your startup adopts the right legal entity.