Category: Company Law

Many of you who are presently reading this post may have already stumbled upon your big idea. The innovation must be flowing into your brains like a new river from the glacier and looking out for the right spot for carving out its streams. If you are one of those and have found your determination to start a firm for your own then this is the most important question you want to answer before you start venturing on your entrepreneurial path. What kind of business firm is right for you? Let us try to find answer to this question.

First it would be convenient to know the different kind of business firms allowed in India. Once we have this fact with us it would be worthwhile to analyse the advantages and disadvantages of different business forms  and then their suitability for each kind of business requirement.

The business forms are basically categorized into 3 types.

1. Proprietorship firm
2. Partnership firm
3. Company form

There are also other forms like

1. Limited Liability Company (LLP)
2. Hindu Undivided Family Business (HUF)
3. Banking and Non Banking Financial Institutions
4. Firms specified in section 8 of the Company Act, 2013 eg. NGO
5. Cooperative Society
6. Nidhi Company,
7. Others

This is not an exhaustive list but unless you are opting for specific types of business it would be sufficient to know about the basic forms. Let us discuss this in details.

1. Proprietorship : In this kind of firm, the business is owned and managed by a single person who is known as proprietor. The proprietor owns all the assets of the firm and utilizes it to run the business. All the liabilities of the firm are also in the name of the proprietor. If the firm defaults on any payment or debts the proprietor is personally responsible to make good of it. On the other hand the profit accumulated from the business is solely for the proprietor.

2. Partnership firm : Sometimes it is not possible for a single person to own and run a business- maybe because more capital is required and two or more persons have agreed to pool their resources, or the expertise of a single person is insufficient for the business requirement. In such a situation two or more persons forms a partnership and starts the partnership firm. The liabilities and assets of the firm are jointly owned by all the partners.

3. Company

   : This is specialized form of business where a separate artificial person is created by registration under the Company Act, 2013 or any other Acts. All the assets and liabilities are owned by this artificial legal entity and this entity runs the business. Confused ! How can a artificial person run a business? After all a real person can have the brains to run the show. The artificial person is controlled by a group of person know as Board of Directors (BOD) and all the decisions of the firm are taken at the board meeting by the BOD. These decisions are taken in the name of the company. Now the next question that may be popping in you head is what is the advantage of doing so much of work. We will be discussing this in awhile in the coming sections and you are recommended to note down this query somewhere for a while before you find a definitive answer.

Let us discuss the advantages of the above 3 forms in specific situation before we move to other forms of business.

1. Capital Requirement: Capital requirement is one of the important factor for consideration. A proprietor firm has all the capital that a single person called proprietor can accumulate for the business. Two or more partners can acquire somewhat greater amount  of capital as compared to a proprietor concern. However a company kind of firm has a potential of acquiring a much greater amount of capital. The main reason is a company complies by most of the legal requirement and instills more confidence in the investors and banks. Further a public company can get itself listed on the stock exchange and draw capital from the market. Let us take an example of a small shop where capital requirement is relatively less. A single person can draw sufficient capital out of its own assets to run such an establishment. However a iron and steel plant requires a lot of funds. Such a kind of fund can be drawn from the market. So proprietor concern is suitable for the former and company form is suitable for the late                                                                                                            r.

2. Scalability : It is quite difficult for a proprietor to run a large scale of business operation due to the limited capability of a single human. It requires more expertise and management effort. So a company form is more appropriate.

3. Control : Now as we have observed that in a proprietorship concern a single person owns all the assets of the firm to run the business. The entire operation is managed by him and he decides the method of distribution of profit. Moreover all the employees are controlled by the proprietor to achieve the organisational objective. So the control in this kind is maximum. The control decreases as more partners comes in and begin to take decision for the firm. In the company as all the decisions are taken by the Board of Directors and the owners may have little say in the day to day affairs of the company the control is less.

4. Perpetual succession: The life of a proprietorship / partnership firm is dependent of the life of the proprietor / partners. The death of the proprietor or the partner can bring an end to the life of the firm  However the company thrives even after the death of members/ owners. This can be understood from a different point of view. A real person could die and if the identity of the firm is not distinct from the identity of the real person, the life of the firm too ends. On the other hand an artificial person is like immortal and the death of members merely shift the control of the firm to different hands. However the firm keeps its existence intact which is the case of a company form of business.

5. Distribution of profit: Again in the proprietor firm the owner can keep all the profit accumulated from his business to himself. On the other hand in the profit in company could be distributed through a set rule.

6. Specialization : Now some business requires specialization and it may not be humanly possible for a single person to look into all the specialization required at that moment. So bringing more partners may be a relief. Taking the business into company form may even make a greater difference as such kind of business not only have as well formed management to take care of different aspects of business but could also attract better talent.

We have already discussed different forms of business along with their suitability in different conditions. Now it would be worthwhile to know about some other business forms.

1. Limited Liability Partnership : This kind of firm can be formed by registration of business under the Limited Liability Partnership Act ,2008. Now this is  a new innovation for business where the benefit of a partnership firm and company form of business is combined. Here a group of partners can form a business firm having a separate legal entity form the owners. Here the partners can own and run the business while the advantage of perpetuity could be attained. The control and distribution of profit is determined by the partnership deed. The advantage of this kind of firm is that the number of legal compliance required is a lot less compared to the Company formed under the Company Act, 2013. However it suffers from disadvantages like external commercial borrowing is not allowed, winding of LLP is comparatively difficult, etc.

2. Hindu Undivided Company : This is a patriarchal form of family business. In this the membership in acquired by birth in the family owning the business. All the business decisions are taken by Karta who is usually the eldest male member of the family. The Karta has the right to incur debt or loan on the assets of the business. This kind of business does not require any registration and is governed by the Hindu Succession Act ,1956.

3. Not for Profit Organisation : This is a not for profit organisation. That means that you cannot carry the profit arising from the business with you. This kind of Company is formed under Section 8 of the Company Act, 2013.

4. Cooperative firms : The objective of a cooperative firm is some kind of benefit for only the members of the cooperative. The members comes together to form the organisation for mutual benefit. For an example a farming cooperative provides technical , market related and financial assistance for all the members of the cooperative.

5. Financial Institutions : The financial institution can be bank or Non Banking Financial Institutions mainly established for providing financial benefits like loans, insurance , deposit facility , etc. RBI or specific regulatory bodies like IRDA, etc governs such kind of institutions.

There may be other kind of firms like Nidhi Companies, Chit funds , etc. However as we have covered the major forms and other kindly are not as relevant for the present discussion we may summarize.

It is absolutely important to analyse and decide the form of business you want to open before starting up as conversion of forms for a business is difficult and tedious process. You don’t want to incur unnecessary cost for your hasty decision.