Legal Structures

How do you choose the right legal structure for

your business?

Types of Legal Structures

Non-profit Organization

◦ Trust, Society

For profit enterprise

◦ Sole Proprietorship, Partnership, Limited

Liability Partnership, Private Limited

Company, Public Limited Company, Co-

operative

Non – Profit Organization

Trust

Public Trust◦ Created for charitable purpose

◦ Under the Public Charitable Trust Act

◦ Minimum two trustees

Private trust, created under and governed by the Indian Trusts Act of 1882, aims at managing assigned trust properties for private or religious purpose. It does not enjoy the privileges and tax benefits of a public trust

Society

Registered under Societies

Registration Act 1860

For literary, scientific or charitable

purpose

Minimum 7 people

Memorandum of Association

◦ Name

◦ Objectives

◦ Details of the members

For Profit Enterprise

Sole Proprietorship

One owner

Unlimited liability

No registration required

Pros

It is the cheapest and easiest form of business structure

Undivided profits belong to the sole proprietor

The owner can keep or reinvest the income as they wish

The owner is in complete control of the business

Provides a greater amount of flexibility in the business operations and decisions

This business is easy to set up and also easy to dissolve

There are less legal formalities

Cons

Unlimited liability

Responsible for all debts related to the business.

Hard to attract employees of higher quality, especially during the setting up stages of the business

Difficulty to raise funds from banks or investors

Funds are limited to only personal savings and loans or borrowings from family or friends

Because of the fact that it is difficult to raise capital, this business entity may have limited growth potential

After the death of the business owner, it could be tough for the business to survive as others may not want to take up unlimited liability for it

Partnership

Agreement between 2 or more people

Maximum of 20 partners (Banking –

10 partners)

Every partner shares responsibility

Owners are individually known as

‘Partner’ and collectively as ‘Firm’

“Relation between persons who have

agreed to share the profits of a

business carried on by all or any one

of them acting for all”

Examples

A & B are friends. They contribute equal amount of money to buy a plot of land to build their houses.

C puts in capital to start a business. D manages the business. C pays salary to D.

E starts a business. F buys goods from a factory as E’s agent and gives it to E.

G & H put equal money to start a business. G acting for himself and H gets goods from a factory while H acting for himself and G gets a loan for the business.

Partnership Deed

Name of the firm

Names of the partners

Location of the firm

The mission statement, or some statement that reflects the firm’s prerogative

Contribution by each partner in terms of capital

Share of the partners in profit and loss

Each partner’s responsibilities in regard to the firm

Debts incurred by the partners, with interest

The amount of drawings by each of the partners from the company, and the rate of interest established

Partnership

Introduction of a new partner◦ Consent of all partners

Retirement of a partner◦ Consent of all partners

◦ In accordance to the agreement

Dissolution of a firm◦ Death of a partner

◦ Bankruptcy of a partner

◦ End of period

◦ End of activity

Pros

Easy to establish and the work and responsibilities are shared

There is an increased possibility of raising funds, as capital can be pooled together

The partners have mutual support and motivation, which is especially important for new entrepreneurs

Easy to administer with profits and losses being shared by the partners depending on their business share

Filing income tax returns is easy since it is the partners and not the ‘partnership’ which is taxed

Cons

There may be conflicts arising out of shared decisions

Partnerships have a limited life and can end upon the withdrawal of partnership or by the death of one of the partners

There are also several restrictions on the transfer of rights and there is lack of unanimous authority

Unlimited liability incurred by the partners

Tax is charged individually so as the business earnings increase, so does the tax

Personal differences may crop up between the partners which may be detrimental to the business

Limited Liability Partnership

An alternative corporate business

vehicle 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.

Origin of LLP’s

USA – Early 1990’s

◦ Real Estate Crash of the 80’s

Reason – to shield innocent members

from the liability of a partnership

India – 2009

◦ Limited Liability Partnership Act, 2008

Features of a LLP

An LLP is a body corporate and legal entity separate from its partners. It has perpetual succession. No upper limit on the no. of members

The provisions of Indian Partnership Act, 1932 are not applicable to an LLP and it is regulated by the contractual agreement between the partners.

Use the words “Limited Liability Partnership” or its acronym “LLP” as the last words of its name.

It contains elements of both ‘a corporate structure’ as well as ‘a partnership firm structure’.

Features of LLP Two designated partners being

individuals, at least one of them being resident in India and all the partners shall be the agent of the LLP but not of other partners.

While the LLP will be a separate legal entity, liable to the full extent of its assets, the liability of the partners would be limited to their agreed contribution in the LLP.

No partner would be liable on account of the independent or un-authorized actions of other partners, thus allowing individual partners to be shielded from joint liability created by another partner’s wrongful business decisions or misconduct.

Features of LLP

An LLP shall be under obligation to maintain annual accounts reflecting true and fair view of its state of affairs.

Provisions have been made in the Bill for corporate actions like mergers, amalgamations etc.

LLP agreement is not mandatory but in the absence of LLP agreement, mutual rights and liabilities of partners shall be determined as provided under Schedule I to the LLP Act.

Advantages

Organized Business Model based on an agreement.

Limited liability

More flexibility & lower compliance requirement as compared to a company

Simple registration procedure, no requirement of minimum capital, no restrictions on maximum limit of partners.

No exposure to personal assets of the partners except in case of fraud.

Advantages

It is easy to become a partner or leave the LLP or otherwise.

Easy to transfer ownership

As a juristic legal person, an LLP can sue in its name and be sued by others. The partners are not liable to be sued for dues against the LLP.

No restriction on limit of the remuneration to be paid to the partners

Easy to convert existing ventures to LLP

Disadvantages of a LLP

Any act of the partner without the consent of other partners, can bind the LLP.

An LLP are not allowed to raise money from Public.

Because of the hybrid form of the business, it is required to comply with various rules & regulations and legal formalities.

Winding up of business is a tedious process

Creating a LLP

Need a minimum of 2 persons

Ltd. Co., Foreign co., a LLP, a non

resident and HUF Karta can be

partners

Incorporation Document

LLP Agreement

Registrar of companies

Steps to create a LLP

Deciding the Partners

Obtaining Director Identification No &

Digital Signature

Checking Name availability for LLP

Drafting LLP Agreement

Filing of incorporation documents

Certificate of Incorporation

Accounting Aspects

The Income of LLP will be charged to

tax in the hands of the LLP only and

not in the hands of individual partners

Remuneration to partners will be taxed

as “Income from Business &

Profession”

Share of profit in the hands of the

partner is exempt from tax u/s 10(2A).

The Income of an LLP is taxable

@30%

Subject to Minimum Tax

Private Limited Company

A private limited company is a

voluntary association of not less than

two and not more than fifty members,

whose liability is limited, the transfer of

whose shares is limited to its

members and who is not allowed to

invite the general public to subscribe

to its shares or debentures.

Features Independent Legal Existence Follows the Indian Companies Act, 1956

and now 2013 Less cumbersome to organize and

operate it as it has been exempted from many regulations and restrictions to which a public limited company is subjected to.

The liability of its members is limited The shares allotted to it's members are

also not freely transferable between them. These companies are not allowed to invite public to subscribe to its shares and debentures.

It enjoys continuity of existence i.e. it continues to exist even if all its members

Advantages

Continuity of existence

Limited liability

Less legal restrictions

Disadvantages

Shares are not freely transferable

Not allowed to invite public to

subscribe to its shares

Scope for promotional frauds

Undemocratic control

Starting a Pvt Ltd. Co

Min. 2 Directors & Min. 2

Shareholders

Min. Share Capital – 1 Lakh

Director Identification Number

Digital Signature o the Directors

Search for the company name (MCA

website)

Application for name availability

◦ Give 6 options priority wise

Contd..

Drafting Memorandum of Association

& Articles of Association

Submission / Filing at ROC

Payment of RoC Fees and Stamp

Duty

Verification by RoC

Issue of Certificate of Incorporation

Public Limited Company

A public limited company is a

voluntary association of members

which is incorporated and, therefore

has a separate legal existence and the

liability of whose members is limited.

Features

Separate legal existence

Strictly governed by the laws, rules and regulations of the Indian Cos. Act.

Min. 7 members, No limit on maximum members

Share Capital – Raising capital by sale o shares

Share Holders are known as members in the company

Shares are freely transferable

Features

Liability limited only up to the face

value of the shares held.

Ownership is separate from

management

Existence is not affected by the death,

retirement or insolvency of any of its

shareholders

Advantages

Continuity of existence

Larger amount of capital

Unity of direction

Efficient management

Limited liability

Disadvantages

Scope for promotional frauds

Undemocratic control

Scope for directors for personal profit

Subjected to strict regulations

Starting a Public Ltd. Co.

◦ A Public Limited Company, in addition to

the steps followed by a Private Limited

Company has to obtain a certificate of

Commencement of Business before they

can commence the business.

Co-Operative

A society whose objective is the

promotion of the interests of its

members.

Primary motive is service to the

members rather than making profits.

Features

It is a voluntary organisation as a member is free to leave the society and withdraw his capital at any time, after giving a notice.

The minimum number of members is 10, but there is no limit to the maximum number of members. However, the members must be residing or working in the same locality.

Registration of a co-operative enterprise is compulsory. A co-operative society may be registered with the Registrar of Co-operatives Societies.

Features

Separate Legal Entity

Follows Co-operative Societies Act, 1912 or State Acts

Submit annual reports and accounts to the Registrar of Societies.

Limited Liability

Shares are not transferrable but can be returned back to the co-operative

Continuity of existince

Advantages

Greater amount of capital

Reasonable price, good quality or

better service

Better conditions of service to

employees

Continuity of existence

Limited liability

Disadvantages

Inability to collect sufficient capital

Inability to provide efficient managerial

services

Organizational limitation