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Strategic advantages of a company for business owners

Why choose a company as your business vehicle? Strategic considerations and comparison with other business structures

As the first step in learning about the new Companies Act, you should learn about the commercial relevance of a company as opposed to other business vehicles, and the criteria used for identifying an optimal business.

Imagine a businessman plans to start a new business – which business entity should he choose? Should it be a proprietorship, partnership, a company or the newly popular LLP? Often, younger professionals cite generic and vague reasons such as ‘limited liability’ or ‘freedom and flexibility’ to prefer one vehicle over another, and there is lack of consistency in the argument provided.

Businessmen often struggle to understand the real benefits of one business structure over another due to lack of adequate insights and professional expertise available on the subject. For example, if selecting a vehicle with limited liability is the objective, then which vehicle is preferable – an LLP or a company? Both fulfil the criterion of offering limited liability for their owners. If freedom and flexibility is the goal, should one opt for LLP or a partnership? In this context, what is the use of a company at all, if it offers less flexibility?

Some advanced questions also arise, such as -

Should you choose a private company or a public company for a new business?
What is the relevance of the newly introduced One Person Company (OPC) in the Companies Act 2013 from a business structuring perspective? How does an OPC compare with a sole proprietorship?

In a practical scenario, in what way does the Companies Act provide relaxations to small companies? Does that make small companies operationally as flexible as LLPs and partnerships?
Selecting a business structure is the first challenge faced by any new business. The most successful business consultants and professionals, however, command great respect due to their insights on these areas.

In this context, what are the advantages of incorporating a company, as compared to any other business vehicle? Interestingly, there are limited factors which need to be assessed to determine a suitable business structure, which are discussed in this chapter. On some fronts, incorporation of a company has distinct advantages over other business structures, which professionals must be aware of, in order to provide suitable guidance. At the end of this chapter, you will also get access to downloadable charts which explain the differences between the entities and technical points. This chapter contains practical concepts but does not cover specific sections of the new Companies Act, which are discussed in more detail in later chapters.


Learning objectives

In this chapter you will learn the following:

  1. Criteria relevant for selection of a suitable business structure from a practical and business perspective
  2. Differences between a company and other business structures such as LLP or a partnership
  3. Situations when other business structures are preferable
  4. Strategic advantages and motivations behind selection of a company
  5. Should you choose a private company or a public company for a new business?
  6. Relevance of One Person Company (OPC) and comparison with sole proprietorships
  7. Relaxations to small companies - does that make small companies operationally as flexible as LLPs and partnerships?

Let’s start. As anyone who has a basic background in commerce would know that there are broadly four types of legal structures that can be chosen when one wishes to start their business - self proprietorships, partnerships, limited liability partnerships or companies. We are not discussing Hindu Undivided Families (HUFs) here.

How should you select an optimal business structure?
This section explains criteria that must be considered before for selecting a suitable business structure for any business. As you will realize, all the criteria relate to the business and commercial goals of the business owner – you must have clarity on this before you advise on a business structure. After reading it, you should be able to identify in which situations a company is preferable, and when it is not.

Liability of owners
Are owners personally liable for the debts and obligations of the business? This is a major concern, especially for businesses with a high volume of investment and loans. Personal assets of the owners, that is partners (in the case of afirm) or the proprietor can be annexed to fulfil the obligations of the business. LLPs and companies are the only two vehicles which ensure limited liability for their owners.

For small businesses with no debt or little external investment (say, from venture capitalists) and financial commitments to third parties, this is may not be a major consideration, until the business assumes a certain scale of operation.

How an entity is taxed is extremely important as it directly impacts the post-tax retained earnings of the business, which can be used for its various activities or distributed to its owners. On this front, income of thesole proprietorship is added to its owner’s personal income and the personal income tax slab is applied to it. The highest rate of tax is applicable only to that portion of the income which crosses a specific threshold (currently, the highest rate is 30 percent, applicable when income exceeds INR 10 lakhs). Partnerships, LLPs and companies are taxed at the same flat rate of 30 percent of their entire income. On this front, the sole proprietorship is preferable.

Apart from income taxwhich is paid on the profits of the business, any taxes applicable to profits distributed to owners (i.e. on dividends or similar payouts) must also be included in this evaluation. In this regard, distribution of profits in a company attracts dividend distribution tax (DDT) of around 17 percent approximately on the profit that is paid out, which reduces the actual income received by shareholders. Once again, a company does not have the advantage on this front.

If limited liability and lower tax rates are to be both achieved together (in the best possible manner), an LLP is a suitable choice.

Incorporation process, documentation and regulatory framework
The length and cost of the incorporation process is sometimes important while deciding a business structure.
  • Sole proprietorships – no incorporation is required as a sole proprietorship is not considered to be different from its owner. Hence no separate documentation is executed. A sole proprietorship is immediately active and running (subject to obtaining any business licenses).
  • Partnerships – A stamped partnership deed which is subsequently registered with the Registrar of Partnerships is important for ensuring enforceability.No incorporation process is required to be followed.
  • LLPs - A detailed incorporation and filing process must be followed which includes execution of a stamped LLP Agreement. This process is more expensive compared to the above options.
  • Companies – A detailed incorporation and filing process must be followed, at the end of which a stamped memorandum and articles of association need to be filed with the Registrar of Companies. This process is more expensive compared to the above options.
Analysis and inferences:
As seen above, sole proprietorships require no additional documentation or incorporation. Both LLP and private limited company are incorporated under Registrar of Companies and both the entities protect the partners/ members from the legal risk stemming from the activities of LLP or company.

While commencement of a partnership business involves less steps as compared to incorporation of an LLP or company, practical benefits of lower costs or quicker registration process are difficult to realize as the process is not electronic and registrars (for partnerships) in different regions are governed by state-level rules which are not uniform across different states.
Government cost of incorporation of an LLP is cheaper as compared to a company – however, both can be achieved in as little as INR 10,000 – 15,000 (or lesser in exceptional cases).

Business Licences
Irrespective of the way a business is structured, licences must be obtained depending on the nature of the activity –for example, if an office is set up, a Shops and Establishment registration must be obtained. Similarly, if a factory is set up, a Factories Act registration is necessary. It does not matter whether the business is a partnership or a company.

However, in certain sectors the business must mandatorily be structured in a certain way, depending on applicable sectoral regulations. For example, a bank must necessarily be structured as a company due to banking laws and regulations passed by the sectoral regulator RBI. On the other hand, legal advisors are structured as proprietorships, partnerships or LLPs, but never as companies, due to regulatory restrictions.

Ease of raising investment and obtaining loans

Foreign investment and foreign loans: Companies have much better access to foreign investment and foreign loan markets as compared to LLPs. LLPs require regulatory approvals under the Foreign Exchange Management Act (FEMA) to receive foreign investment, although however most sectors are open to foreign investment under the automatic route if the investment is made into a company. Partnerships and proprietorships are prohibited from raising foreign investment under the Foreign Direct Investment regulations of the Reserve Bank of India.

LLPs, partnerships and proprietorships are prohibited from accessing foreign loans (which are significantly cheaper compared to domestic loans) under the External Commercial Borrowings regulations of the Reserve Bank of India.


Domestic investment and loansLegal and contractual mechanisms for investing in a company are time-tested and determinate. Angel investors, venture capitalists or private equity investors in the domestic market will all prefer to invest in a company. They are not comfortable investing in LLPs – they do not want to be partners in the business, and moreover, how the legal document and regulations will govern the investor’s relationship is very unpredictable and uncertain, as LLPs are a new vehicle.VCs insist that the startups they will consider for investment should be in the form of private company or that a private company should be formed to take their investment and henceforth business should be done in name of the company. Even internationally, LLPs have been used for professional firms, not for starting venture-capital funded rapidly scalable businesses. VCs are risk averse and generally have proven to be slow adopters despite significant benefits of the LLP form in case of many business models as far as India is concerned.

This is surprising given that several VC funds were quick in forming LLPs instead of private trusts in order to administer and manage their funds. If you are planning to raise venture capital in the near future, private limited company is the way to go. Of course, you can convert your business into a private limited company later on in case you start out through another structure.
Let’s understand which vehicle has better access to loans and debt finance. In a real-world scenario, loans from banks or financial institutions are easiest to obtain for companies, but LLPs, partnerships and proprietorships can also obtain them, depending on their line of business, net worth, security provided for the loan and other financial credentials.

Related party dealings and director loans

Related party transactions: Personal relationships and family networks of the promoters or directors can be key sources of business for the company. Such transactions are termed related party transactions and require additional steps to be taken, if the business is structured as a company, as opposed to an LLP or partnership. These are discussed in more detail later in the course.

Director loans: Transactions between the founders and the business are very common, especially during the early stages of a business. For example, when the business faces a cash crunch, a founder may provide a loan to help the business through. Similarly, when the business is cash-positive, a founder may need to draw money out from the business for his or her own needs (founders and promoters often take little or no salaries in the initial stages of a business), which is usually structured as a loan.

Here’s the interesting bit - loans to founders can be more expensive in case of companies than LLPs. Do you know why? If the business is profitable, this loan can be treated as dividend payout under tax law, if the business is structured as a company, but not as an LLP.

Annual and periodic compliance requirements
The yearly cost of compliance in case of private company can be substantial. Under the Companies Act, 2013 and rules, a limited liability company is required to prepare and file financial statements (such as balance sheet, profit and loss account), hold meetings, prepare directors’ report, arrange for mandatory audit, maintain specific registers, appoint auditors, but annual compliance in case of LLP is much simpler- a statement of accounts and solvency along with an annual report is only required to be filed, and meetings can be held in a very flexible manner. Event-based filings are minimal for LLPs –in contrast, companies need to file various kinds of resolutions on key events pertaining to the business. See below for more details.

Practically, the effort and cost of compliance in case of LLPs is a fraction of what is required in case of a private limited company. On the volume of compliance required, see here.
For more details, refer:
  • Annual compliance by companies and list of registers to be maintained by companies (Download the chapter on annual compliance by companies here)
  • E-filing process to be made to the Ministry of Corporate Affairs (access here)
  • Section 34and 35, Limited Liability Partnerships Act, 2008 (access here)
  • Limited Liability Partnerships Rules, 2009 (access here)
Ability to incentivise employees
Building a team that is driven to work hard in the long-term is a key motivation of any businessman. Interestingly, selection of a suitable business structure can facilitate the realization of this initiative. Do you know how?

Let’s start from the basics – did you know that Google’s chefs became millionaires when the company went public and listed on US stock exchanges? Do you know how they became so rich? It is because they held Employee Stock Options (ESOPs), which became very valuable by the time the company listed. This concept has worked well in India in the IT sector and is being adopted by startups. For example, in 2001, over one lakh Infosys shares issued pursuant to an ESOP scheme started in 1994 became freely tradable and were worth almost INR 50 crores for 1500 employees (within a span of 7 years) – both Infosys and Wipro re-introduced ESOPs in 2010 to reduce employee attrition rates.

Employee stock option plans and their relationship with the Companies Act is discussed in more detail later on, but for now, it is important to understand that they are very easy to create for companies, but extremely difficult to implementfor LLPs and partnerships. As an exception, note that some professional services firms (e.g. law firms) have created equity-based incentivization structures to provide financial incentives to partners, but these work when the number of partners is very small and are not tradable in the same way as the shares of a company. You can read more about such structures here and here.
ESOPs are discussed in more details in the Module - Owner's and managerial remuneration.

When should a business be conducted through a company?
Let’s assume that the business owner wants to use a vehicle that separates his personal assets from those of the business. In that case, if the business can generate sufficient revenues from operations, if it does not need to depend on external investment or raise foreign loans (which are obtained at a cheaper rate) an LLP is preferable. It will help in reducing the impact of taxes, minimize compliance requirements and ensure maximum operational flexibility.
If the plan is to raise venture capital, approach foreign investors or raise cheaper loans by approaching foreign banks (which is the case for companies which intend to rapidly scale up their operations), structuring a business as a company is preferable.

Of course, the requirements of a business can change as it grows and is influenced by market developments. Under these circumstances various options are possible for selecting a different entity, the most important being conversion. Read the chapter on Conversion of a business into a company for further details.

Relevance of One Person Company and comparison with sole proprietorships (advanced reading)
A one person company and sole proprietorships are useful for single founder businesses, which are often usually short-term phenomena. Many expanding businesses which assume a certain scale require co-founders, additional promoters or involve sharing equity with employees. However, from a business structuring perspective, how do OPCs compare with sole proprietorships? 
Unlike a sole proprietorship, an OPC has a separate legal status– this helps in separating the personal assets of the founder from those of the business.
However, an OPC has some disadvantages compared to a proprietorship: 

a.  An OPC is taxed at the corporate income tax rate, which is 30 percent plus surcharge. In case of sole proprietorship the proprietor will have to pay income tax as per the personal income tax slab rates. A 30 percent income tax rate only applies to the income which crosses INR 10 lakhs. Income below INR 10 lakhs is taxed at lower rates. This can cause significant savings for a proprietor.

 For example, income of INR 300,000 will be taxed at INR 90,000 if corporate income tax rate is applied. However, if the personal income tax slab is INR 2,00,000 and the tax rate between income of INR 2,00,000 to 5,00,000 is 10 percent (the tax rate escalates progressively), tax of INR 10,000 will only be payable (i.e. 10 percent of (INR 3,00,000 – INR 2,00,000), which is a significant saving.


b. Apart from conducting meetings, remaining compliance requirements and filings (such as conducting audit or filing a form for creation of charge, if secured loan is taken) are applicable to an OPC, which makes running day to day operations more expensive and time-consuming, as compared to a sole-proprietorship. Let’s take the example of an audit to explain this further - an OPC will be required to conduct an audit in all cases under the Companies Act, whereas a sole proprietorship will only be required to conduct an audit under the Income Tax Act if turnover in a particular year exceeds INR 1 crore (or in case of a professional, if total revenues exceed INR 25 lakhs).
Small companies and comparison with LLPs and partnerships (advanced reading)

Companies Act provides certain relaxations to small companies, that is, companies which have share capital of less than INR 50 lakhs or less than INR 2 crorerevenues. Does that make them more appealing and bring them closer to LLPs or partnerships? For a small business, how does taking advantage of the ‘small company’ relaxations compare with conducting business as a Limited Liability Partnership?
For this, we need to first consider the benefits available to ‘small companies’:
  • They hold upto two board meetings only, instead of four board meetings per year. However, notice how LLPs and partnerships have more flexibility with respect to how frequently they hold meetings, how they conduct meetings and keep records, as per the LLP agreement.
  • They are not required to mandatorily rotate auditors after certain time period (but they are required to conduct audit nevertheless). Notice how LLPs and partnerships are only required to conduct audit if their turnover crosses the following amount:
Audit under LLP Act: Rs.25 lakhs or if annual turnover is above Rs. 40 lakhs.
Audit under Income Tax Act: if turnover in a particular year exceeds INR 1 crore (or in case of a professional,if total revenues exceed INR 25 lakhs).
As seen above, a ‘small company’ does not offer the flexibility that is possible for an LLP or company. In that event, when should ‘small company’relaxations be used?
Legally, a ‘small company’ is exactly the same vehicle as a company, with relaxations pertaining to compliance. Availing of ‘small company’ relaxations can avoid hassles pertaining to the conversion process later on. If a business is expected to scale rapidly, it makes sense to incorporate as a company (and benefit from relaxations available to ‘small companies’) rather than incorporating as an LLP and subsequently converting to a company.

Public company vs. private company – which is better for business
What are the differences between private and public companies? How do private companies compare with public companies? When should a business be structured as a private company and under which circumstances is a public company preferable?
In this discussion, we keep the focus on key differences between private and public companies.
  • Ability to raise access public funds–A private company cannot have more than 200 members, and it cannot raise funds, whether equity or debt, from the public, either in India or abroad. It cannot accept public deposits either.
The ability to raise funds from the public is a significant advantage for mature companies, as it enables them to obtain large quantities of finance cheaply and scale up operations. This optionis only available to public companies. You will notice that the eventual goal of a new business which raises venture capital or private equity is to
‘go public’ and list shares on a stock exchange, which denotes that it has achieved certain scale and market validation for its business model (apart from offering investors opportunities to make windfall gains).
Raising capital Indian or offshore public markets is discussed later in this course.
  • Restrictions on transferability of shares – Shares of a public company are freely transferable and a public company is not allowed to impose restrictions on their transfer. Private equity investors and venture capitalists, who invest large amounts of capital in companies, impose various kinds of restrictions on share transfers as a matter of practice, to ensure that they are given preference when promoters are considering options to raise finance.The end goal of the investors is to recoup their investment and make some return on it. This frequently causedlegal disputes and litigation when private equity investors invested in unlisted public companies or in listed companies, because their agreements with the promoters and the companies contained these restrictions.
The Companies Act 2013 has modified provisions now – although it states that public company shares are freely transferable, it allows shareholders to impose restrictions on transfer of their shares through private contracts.
Certain other differences also exist:
  • A public company can only commence business after receiving a certificate of commencement of business, and not just after the certificate of incorporation, as is the case for a private company.
  • A public company is required to convene a statutory general meeting at the time of commencement of business, a requirement which is not applicable to private companies.
There were differences in how certain activities could be undertaken by a private or a public company under the old Companies Act, 1956 but are no longer applicable under the new Companies Act 2013:
  • Preferential allotments – Issuance of shares to a new set of shareholders is called ‘preferential allotment’ - under the old Companies Act, a preferential allotment could be undertaken by a public company only after a special resolution of shareholders. In a private company, by default the board of directors had the power to issue shares to any person (so long as the articles of association did not prohibit this).
Under the new Companies Act 2013, preferential allotments by private companies also require a special resolution of shareholders (along with certain under compliances, discussed in the Chapter - Security issuance and corporate compliances - Private placements and issuance of debentures in the Module Corporate finance and Companies Act, 2013)
  • Loans to directors –The provision related to advancing of loans to directors or any person related to the director now applies to private companies as well. Loans cannot to be advanced to the directors or persons related to the director.
  • Related party transactions - The list of restricted contracts has been expanded by the 2013 Act – the list is wide enough to cover almost any kind of commercial arrangement. However, the rule related to obtaining Central government’s approval for related party transactions has been done away with under the 2013 Act and replaced with the requirement of passing a board resolution. A special provision has been enacted which outlines the harsher penal consequences of contravention of the requirements of the Companies Act. Earlier, it was merely punishable as per the general provisions under the 1956 Act which did not impose harsh financial liability on the director to reimburse and criminal liability. 
Structuring a business as a partnership is tax efficient and relatively more flexible, but it is a more risky option, due tothe risk of personal liability of promoters.
While an LLP is preferable on this front,there are several constraints on expansion of the business for both partnerships and LLPs, such as the difficulty of raising capital from large investors and inability to access cheap foreign loans.Thus, the utility of an LLP is primarily with respect to certain kinds of businesses or a business in its initial phases.
A Limited Liability Partnership is subjected just to income tax (or minimum alternate tax, if applicable). A company on the other hand is liable to pay income tax (or minimum alternate tax, if applicable) and dividend distribution tax. The profits shared by partners of an LLP and dividend earned by shareholders are not taxable any further when it reaches the hands of recipients. Due to increased tax implications and excessive record keeping, filing and compliance requirements, it may not be the best idea to structure every business as a company from the beginning.
Depending on what are the goals, a new business could be initially commenced as a proprietorship, partnership or LLP, and subsequently convertedinto a company if the primary business objective is to raise a lot of finance, scale operations and provide equity-based incentives to employees (apart from just cash-based remuneration such as bonuses).
A risk relating back to the time when the business was a partnership can arise even after conversion. What does this mean? If the promoters of a business are sued in personal capacity for the debts of a partnership firm (which was later converted to a company after the obligation was incurred), the promoters will continue to be personally liable, since it is a prior debt.

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