There’s a constant flow of new start-ups setting up in Bangalore every month and one of the first things that every startup founder has to decide is what kind of structure should they register under. The decision to opt for a Private Limited Company, Limited Liability Partnership or a Sole Proprietorship is not one that can be taken lightly. It determines tax considerations, exposure to personal liability, external funding options and how much ongoing compliance the founder will have to deal with. We’ve pulled out the nitty-gritty details to help you decide which path is right for you as a new entrepreneur.
Sole Proprietorship: Simplicity with Personal Risk
A Sole Proprietorship is the easiest entity to establish, with little formalities in registering and the owner controlling the entire business. If you are a freelancer, consultant, or a very small local company without extensive external contacts, this convenience is definitely attractive because you do not have to keep a separate legal company or entity going, nor conduct board meetings, and there is comparatively less annual compliance.
There is the major disadvantage of personal liability. Because the business is not a separate legal entity from the owner, debts, legal claims and liabilities of the business will be transferred directly to the proprietor’s personal assets. This exposure is a very real issue when the business expands, goes for larger contracts, or starts to have clients that demand more liability coverage. Also, a sole proprietorship is not ideal for attracting outside capital because investors typically want a structure that will provide clean ownership of equity, which is not available in a sole proprietorship.
Limited Liability Partnership: A Middle Ground
The LLP will allow a professional services firm or small consulting practice to enjoy the benefits of limited liability without the complexity of the company compliance regime, and could also be a suitable option for businesses with many partners who are not planning to seek institutional funding in the near future. Partners in an LLP are safeguarded from personal liability beyond their agreed contribution, a significant improvement upon a proprietorship arrangement, and the profits can be shared as per the LLP agreement as opposed to a fixed percentage in the shareholding.
Unlike that of a private limited company, few mandatory filings are required for LP and the compliance requirements are also lighter, as there is no requirement for statutory audit if the turnover or contribution falls below certain thresholds. But in terms of raising capital, LLPs have definite restrictions. They can’t sell equity shares and most VC or angel investors are designed to invest in companies not in LLPs because the way ownership and exit work in an LLP and how the VC or angel investors structure themselves doesn’t fit together the best. For founders looking to build a smaller more sustainable business, LLPs may be an easy structure, but for founders expecting a growth model driven by external funds, they tend to quickly outgrow the LLP structure.
Private Limited Company: The Standard for Growth-Oriented Startups
The Private Limited Company continues to be the preferred option for founders, especially those who intend to raise capital or scale up their business, or even eventually have institutional investors. It provides limited liability, separate legal entity and a well-known process for issuing shares, attracting investors and setting up employee stock options, all of which will benefit a startup in a growth phase.
The investor ecosystem in Bangalore is largely around the Private Limited structure including the angel networks, VC firms and the accelerator programs, and most of the funding term sheets require this structure as a pre-condition before starting any investor discussion. The compliance requirements are heavier in turn, such as board meeting requirements, requirement for annual filings with the Registrar of Companies and even the statutory audit despite lack of turnover, but for a business that is looking to scale up, this compliance is usually considered worth the flexibility and credibility the structure affords.
Practical Considerations Specific to Bangalore
There are some points to consider while founding a company in Bangalore. Many start-ups are registered from COWs and to get a No Objection Certificate from the COWs provider along with the rent or license agreement from the COWs provider is required to register a company or LLP from COW Address otherwise will delay the registration of the company or LLP or in the case of later on registration of GST.
With the startup base being composed largely of professionals and technologists, a lot of founders are simultaneously dealing with issues like registering the startup, employee stock options and preemptive fundraising discussions etc., which can be more easily structured correctly from the start under a Private Limited Company than a LLP.
Making the Right Choice
A final decision will be made by the Founder according to his idea about the business. If you are a consultant or freelancer with relatively small, stable earnings and no intention of outside financing you may be able to achieve success in a Sole Proprietorship. This can be a good choice for a small group developing a multi-partner services enterprise where there is no short-term funding plan. Most founders who intend to raise capital for their scalable product or service should start with the Private Limited Company structure from the outset as it is possible to change later, though sometimes it can become cumbersome, time consuming and expensive.
In Bangalore, where the founders are finding themselves in this dilemma, seeking professional advice early eases the strain and expense of a company restructuring later in growth. Anagha Consulting helps the founders to register, set up a company and structuring that’s aligned with their growth plans and future business goals.