Overview
A business enterprise can be owned and organized in various types of business structures in India. Each legal form of business has its own merits and demerits. The ultimate choice of business entity types depends upon the balancing of the advantages and disadvantages of the various legal form of business. The right choice of type of business structure is very crucial because it determines the power, control, risk and responsibility of the entrepreneur as well as the division of profits and losses. Being a long-term commitment, the choice of the legal form of business should be made after considerable thought and deliberation. The selection of a suitable legal structure for a business organization is an important entrepreneurial decision because it influences the success and growth of a business – e.g., it determines the division or distribution of profits, the risk associated with business, and so on.
Once a type of business structure is chosen, it is very difficult to switch over to another legal form of business because it needs the winding up, or dissolution of the existing organization which may be treated as a case which is raised by oneself to face with the complex issues and procedures which ultimately results into the waste of time, effort and money.
Further, the closure of the business will entail the loss of business opportunity, capital and employment. The volume of risks and liabilities as well as the willingness of the owners to bear them is also an important consideration in choosing the right business entity types.
Types of Business Organisations
The choice of a business entity will depend on the object, nature and size of the business of such entity which will be varied from case-to-case basis and will also depend upon the will of the business entity owners which they want to accomplish. The main type of business structures in India is Sole Proprietorship, Partnership, Hindu Undivided Family (HUF) Business, Limited Liability Partnership (LLP), Co-operative Societies, Branch Offices and Companies which may be any kind of company including One Person Companies (OPC), a private company, public company, Guarantee company, subsidiary company, statutory company, an insurance company or unlimited company. Further, company formed under section 8 of the Companies Act, 2013 or under section 25 of the earlier Companies Act of 1956 is a non-profit business entity. There can also be Association of Persons (AOP) and Body of Individuals (BOI), corporation, Co-operative Society, Trust etc.
Sole Proprietorship
A sole proprietorship is a type of business structure, wherein one person owns all the assets of the business, and no legal formalities are required to create a sole proprietorship. The owner reports income/loss from this business along with his personal income tax return.
Partnership Firm
Partnership firms are a type of business structure are created by drafting a partnership deed among the partners. Partnership firms in India are, governed by the Indian Partnership Act of 1932.
Section 464 of the Companies Act, 2013 empowers the Central Government to prescribe a maximum number of partners in a firm but the number of partners so prescribed cannot be more than 100.
The Central Government has prescribed a maximum number of partners in a firm to be 50 vide Rule 10 of the Companies (Miscellaneous) Rules,2014. Thus, in effect, a partnership firm cannot have more than 50 members”.
Hindu Undivided Family (HUF)
A Hindu family can come together and form a type of business structure called HUF. HUF is taxed separately from its members. HUF has its own PAN and files tax returns independent of its members.
Limited Liability Partnership (LLP)
Limited Liability Partnership is a legal structure of the business that provides the benefits of limited liability of a company but allows its members the flexibility of organizing their internal management on the basis of a mutually-arrived agreement, as is the case in a partnership firm.
Co-operative Society
A cooperative organization is an association of persons, usually of limited means, who have voluntarily joined together to achieve a common economic end through the formation of a democratically controlled organization.
Section 8 company
Section 8 company is established for promoting commerce, art, science, sports, education, research, social welfare, religion, charity, protection of the environment or any such other object’, provided the profits, if any, or other income is applied for promoting only the objects of the company and no dividend is paid to its members. Section 8 Companies are registered under the Companies Act, 2013.
One Person company
An OPC is the legal structure of a company with only 1 person as a member Shareholder can make only 1 nominee, he shall become a shareholder in case of death/incapacity of the original stakeholder.
Private company
A private company is the legal structure of a company which has the following characteristics:
(i) Shareholders’ right to transfer shares is restricted
(ii) Minimum number of 2 members in the company
(iii) Number of shareholders is limited to 200
(iv) An invitation to the public to subscribe to any shares or debentures or any type of security is prohibited.
Public company
A public company is the legal structure of a company which has the following characteristics
(i) Shareholders’ right to transfer shares; is not restricted
(ii) Minimum 7 members
(iii) An invitation to the public to subscribe to any shares or debentures or any type of security is permitted.
Producer company
According to Section 378A of the Companies Act, 2013, Producer company means a
body corporate having objects or activities specified in section 378B of the Companies Act, -2013 and registered as a Producer company under the Companies Act, 2013 or under the Companies Act, 1956.
The Companies Amendment Act, 2020 has introduced a separate Chapter (Section 378A to 378ZU) relating to Producer Companies under the Companies Act, 2013.[Amendment effective from 11th February 2021]
Nidhi Companies
A Nidhi company is the legal structure of a company in the Indian non-banking finance sector, recognized under section 406 of the Companies Act, 2013 their core business is borrowing and lending money between their members. They are also known as Permanent Funds, Benefit Funds, Mutual Benefit Funds and Mutual Benefit Companies. These companies are regulated under the Nidhi Rules, 2014 issued by the Ministry of Corporate affairs.
Foreign company
As per section 2(42) of the Companies Act, 2013 the “foreign company” means any
company or body corporate incorporated outside India which,-
(i) has a place of business in India whether by itself or through an agent, physically or through electronic mode; and
(ii) conducts any business activity in India in any other manner.
Non-Banking Financial company
A Non-Banking Financial company (NBFC) is the legal structure of a company registered under the Companies Act, 1956 / 2013 engaged in the business of loans and advances, acquisition of shares/ stocks/bonds/debentures/securities issued by Government or local authority or other marketable securities of a like nature, leasing, hire-purchase, insurance business, chit business but does not include any institution whose principal business is that of agriculture activity, industrial activity, purchase or sale of any goods (other than securities) or providing any services and sale/purchase/construction of the immovable property.
A non-banking institution which is a company and has the principal business of receiving deposits under any scheme or arrangement in one lump sum or in instalments by way of contributions or in any other manner is also a non-banking financial company.
Listed company
“Listed company” means a legal structure of a company which has any of its securities listed on any recognised stock exchange;
“Provided that such class of companies, which have listed or intend to list such class of securities, as may be prescribed in consultation with the Securities and Exchange Board, shall not be considered as listed companies.”
As per Rule 2A of the Companies (Specification of definitions details) Rules, 2014 Companies are not to be considered as listed companies–
For the purposes of the proviso to clause (52) of section 2 of the Companies Act, 2013, the following classes of companies shall not be considered as listed companies, namely:-
a) Public companies which have not listed their equity shares on a recognized stock exchange but have listed their –
(i) non-convertible debt securities issued on a private placement basis in terms of SEBI (Issue and Listing of Debt Securities) Regulations, 2008; or
(ii) non-convertible redeemable preference shares issued on a private placement basis in terms of SEBI (Issue and Listing of Non-Convertible Redeemable Preference Shares) Regulations, 2013; or
(iii) both categories of (i) and (ii) above.
b) Private companies which have listed their non-convertible debt securities on a private placement basis on a recognized stock exchange in terms of SEBI (Issue and Listing of Debt Securities) Regulations, 2008;
c) Public companies which have not listed their equity shares on a recognized stock exchange but whose equity shares are listed on a stock exchange in a jurisdiction as specified in Section 23(3) of the Companies Act, 2013.
Government company
As per section 2(45) of the Companies Act, 2013 the Government company” is the legal structure of a company in which not less than fifty-one per cent of the paid-up share capital is held by the Central Government, or by any State Government or Governments, or partly by the Central Government and partly by one or more State Governments, and includes a company which is a subsidiary company of such a Government company;
Explanation.- For the purposes of this clause, the “paid-up share capital” shall be construed as “total voting power”, where shares with differential voting right.
Other Forms of Companies
Holding and Subsidiary company
As per section 2(46) of the Companies Act, 2013, the “holding company”, in relation to one or more other companies, means a company of which such companies are subsidiary companies and the expression “company” includes any body corporate.
As per section 2(87) of the Companies Act, 2013 “subsidiary company” or “subsidiary”, in relation to any other company (that is to say the holding company), means a company in which the holding company –
(i) controls the composition of the Board of Directors; or
(ii) exercises or controls more than one-half of the total voting power either at its own or together with one or more of its subsidiary companies:
Provided that such class or classes of holding companies as may be prescribed shall not have layers of subsidiaries beyond such numbers as may be prescribed.
Explanation. – For the purposes of this clause, –
(i) a company shall be deemed to be a subsidiary company of the holding company even if the control referred to in sub-clause (i) or sub-clause (ii) is of another subsidiary company of the holding company;
(ii) the composition of a company’s Board of Directors shall be deemed to be controlled by another company if that other company by exercise of some power exercisable by it at its discretion can appoint or remove all or a majority of the directors;
(iii) the expression “company” includes any body corporate;
(iv) “layer” in relation to a holding company means its subsidiary or subsidiaries.
As per section 2(11) of the Companies Act, 2013, the “body corporate” or “corporation” includes a company incorporated outside India, but does not include –
(i) a co-operative society registered under any law relating to co-operative societies; and
(ii) any other body corporate (not being a company as defined in this Act), which the Central Government may, by notification, specify on this behalf
Associate Companies/ Joint Venture company
As per section 2(6) of the Companies Act, 2013 the “associate company”, in relation to another company, means a legal structure of a company in which that other company has a significant influence, but which is not a subsidiary company of the company having such influence and includes a joint venture company.
Explanation. – For the purpose of this clause, –
(i) the expression “significant influence” means control of at least twenty per cent. of total voting power, or control of or participation in business decisions under an agreement;
(ii) the expression “joint venture” means a joint arrangement whereby the parties that have joint control of the arrangement have rights to the net assets of the arrangement.
Investment company
The term “investment company” is the legal structure of a company that includes a company whose principal business is the acquisition of shares, debentures or other securities and a company will be deemed to be principally engaged in the business of acquisition of shares, debentures or other securities if its assets in the form of investment in shares, debentures or other securities constitute not less than fifty per cent. of its total assets, or if its income derived from investment business constitutes not less than fifty per cent. as a proportion of its gross income.
Dormant company
It is covered under Section 455 of the Companies Act. 2013 and includes a company which is formed and registered under the Act for a future project or to hold an asset or intellectual property and which has not been carrying on any business or operation, or has not made any significant accounting transaction during the last two financial years, or has not filed financial statements and annual returns during the last two financial years.
Small company
The MCA for the Ease of Doing Business has revised the definition of Small companies by increasing their threshold limits for paid-up capital from “not exceeding Rs. 50 Lakhs” to “not exceeding Rs. 2 Crore” and turnover from “not exceeding Rs. 2 Crore” to “not exceeding Rs. 20 Crore”.
Thus, the definition of the small company under Section 2(85) read with Rule 2(1)(t) of the Companies (Specification of definitions Details) Rules, 2014 with effect from 1 April 2021 is hereunder:
“Small company” means a legal structure of a company, other than a public company, —
(i) paid-up share capital of which does not exceed two crores rupees or a such higher amount as may be prescribed which shall not be more than ten crore rupees; and
(ii) turnover of which as per profit and loss account for the immediately preceding financial year does not exceed twenty crore rupees or a such higher amount as may be prescribed which shall not be more than one hundred crore rupees:
Provided that nothing in this clause shall apply to—
(A) a holding company or a subsidiary company;
(B) a company registered under Section 8; or
(C) a company or body corporate governed by any particular Act.
Factors for consideration before choosing a suitable type of business structure
Nature of Business Activity
In small trading businesses, professions, and rendering of personal services, a sole proprietorship is predominant.
The partnership is suitable in all those cases where sole proprietorship is suitable, provided the business is to be carried on a slightly bigger scale with help of one or more partners (owner).
Similarly, the business lines such as carrying on large chain stores, multiple shops, super-bazaars, engineering industrial activities with high capital and working capital requirements and software industrial activities are generally in the form of companies.
Where the persons intending to start a business and wish to launch a legal form of business organization clothed with a legal entity and in corporate form with a feature of having their sole ownership and control thereon, they may decide to form a One-Person company (OPC).
An alternative type of business structure where two or more persons are involved in starting a legal structure of the business organization is the Limited Liability Partnership (‘LLP’) under the Limited Liability Partnership Act, of 2008.
Scale of Operations
If the scale of operations of business activities is small, a sole proprietorship or a One Person company (OPC) business entity type is suitable; If the scale of operations is modest – neither too small nor too large – partnership or limited liability partnership (LLP) is preferable; whereas, in case of the large scale of operations, the company form is advantageous.
Capital Requirements
Enterprises requiring heavy investment should be organized as companies. Depending on the capital required, they can be set up as public companies and, in some cases, maybe in the form of listed companies by raising money from the public and being listed on the stock exchanges.
Enterprises requiring small investments can be best organized as sole proprietorships or even as Partnerships.
Managerial Ability
It is difficult for a sole proprietor to have expertise in all functional areas of business.
In other forms of organizations like partnerships and companies, there is a division of work among the partners which allows the partners to specialize in specific areas, leading to better outputs and decision-making.
Degree of control and Management
In sole proprietorship and OPC: ownership, management, and control are completely fused.
In partnership: management and control of the business are jointly shared by the partners.
In a company: however, there is a divergence between ownership and management, the management and control of the company business is entrusted to the Board, who are generally the elected representatives of shareholders.
Degree of Risk and Liability
The sole proprietor is personally liable for all the debts of the business to the extent of his entire property. Likewise, in partnership, partners are individually and jointly responsible for the liabilities of the partnership firm.
Companies and LLPs have a real advantage, as far as the risk is concerned, over the other legal form of business organization. Creditors can force payment of their claims only to the limit of the company’s and LLPs’ assets.
Stability of Business
The stability of the business is another factor that governs the choice of type of business structure. Sole proprietorships are not stable, although no time limit is placed on them by law.
Partnerships are also unstable since they are terminated by the death, insolvency, insanity, retirement, admission, expulsion or withdrawal of/ by one of the partners.
Companies and LLPs have the most business stability due to their feature or perpetuity being an artificial or legal person.
Flexibility of Administration
The internal functioning of a sole proprietary business, for instance, is very simple, and therefore, any change in its administration can be affected with the least inconvenience and loss. To the large extent, the case is the same in a partnership business also.
While, in the case of a company, the administration is not that flexible because its activities are conducted on a large scale and are quite rigidly structured.
Division of Profit
An entrepreneur desiring to pocket all the profits of the business will naturally prefer sole proprietorship of course, in a sole proprietorship, the personal liability is also unlimited.
But, if he is willing to share the profits, a partnership form of organization would be preferred. In a company form of organization, however, the profits (whenever the Board of Directors decides) are distributed among shareholders in proportion to their shareholding, but the liability of the shareholders is limited.
Costs, Procedure and Government Regulation
Sole proprietorships are the easiest and cheapest to get started. There is no one specific government regulation. but is guided by various state and central laws to give valid proof of existence e.g. – The shops and Establishment Act.
Partnerships are also quite simple to be initiated. Even a written document is not always necessarily a prerequisite since an oral agreement can be equally effective. However, in actual practice, a written partnership deed is usually entered into.
The legal structure of a company form of business organization is more complicated to form. It can be created by law, dissolved by law, and operated under the express provisions of the law.
Tax Implication
In smaller entities, such as sole proprietorships or partnerships, the tax liability is dependent on the extent of profits.
In the case of companies or LLPs, the liability of shareholders is limited to the value of the shares they have purchased. In the case of companies or LLPs, tax liability could be higher.
Geographical Mobility
If a concern deals with a local market, a seasonal product or perishable goods, or is meant to cater to a specific city or locality, then sole proprietorship or partnership business entity types may be suitable. If it is proposed to market the product or service all over India (which may also entail providing customer support services), a company form of organization may be preferred.
Transferability of Ownership
A sole proprietorship, being a one-person entity does not lend itself to transferability of ownership as the owner himself enjoys the profits and suffers the losses in his business. A partnership form of organization is one where two or more partners share the profits and/or losses in the agreed proportion.
In the company form of organization, transfer of ownership is possible by transfer of shareholding by any person or group of persons in favour of another person or group of persons.