Choosing a form of business organisation: the considerations

The forms available

A person starting a business must decide its legal form of ownership. The main forms in India are the sole proprietorship, the partnership firm, the limited liability partnership (LLP), the Hindu Undivided Family business, the company (private, public or one person company) and the cooperative society. Each differs in who owns it, who bears the risk, how it is controlled and what the law requires. No form is best in all cases; the right choice depends on the following considerations.

Considerations in choosing a form

1. Nature of the business. A small shop or a professional service can be run as a proprietorship; a business needing heavy plant, many employees or public trust (large manufacturing, for instance) is generally best run as a company.
2. Scale of operations and capital required. One person's savings limit a proprietorship; partners pool more capital; a company can raise large sums from many shareholders and lenders.
3. Liability of the owners. Proprietors and partners of an ordinary firm have unlimited personal liability. Shareholders, and partners of an LLP, risk only what they have agreed to contribute. Where the risk is high, limited liability is preferred.
4. Control and management. A proprietor keeps full control; partners share it; in a company, ownership and management are separated and control rests with the board. Owners who want direct control choose a simpler form.
5. Ease and cost of formation. A proprietorship needs almost no formalities; a partnership needs an agreement; forming a company is a legal process that takes time and money, and an LLP too comes into existence only when the Registrar registers its incorporation document.
6. Continuity and stability. A proprietorship or partnership can end with the death, insolvency or exit of an owner, whereas a company has a separate legal existence and perpetual succession.
7. Flexibility of operations. Smaller forms can change their line of business or methods quickly; companies are bound by their documents and by law.
8. Transfer of ownership. Shares in a public company can be transferred easily; a partner's share cannot be transferred without the others' consent.
9. Secrecy. A company's affairs are less private, because the law requires it to disclose a good deal of information; a sole trader or a partnership firm is not required to publish its accounts.
10. Taxation and legal compliance. Tax rates, the treatment of profits paid to owners, and the annual compliance burden differ by form and affect the net return.
11. Ability to attract skills. A partnership or company can bring in people with different expertise.

Matching the form to the business

Example. Two friends plan a design studio needing little capital but exposed to client claims: an LLP gives them shared control with limited liability at modest cost. A young founder planning a technology product that will need outside investors would choose a private company, because investors can be issued shares. A retired teacher opening a stationery shop would choose a sole proprietorship for its simplicity and secrecy.

Conclusion

The choice of form balances capital needs, risk, control, cost and continuity. A sound choice at the start should also allow for growth: many businesses begin as proprietorships or firms and convert into LLPs or companies as they expand.