Selecting A Legal Entity For Your Startup

If you are planning to start a business in India, here are the choices of legal entity that you can opt for.

Business can be carried in various forms and structures in India. These structures include sole proprietorships, general partnerships, limited partnerships, limited companies, unlimited companies and one person companies. Typically, technology startups in India incorporate themselves either as companies limited by shares or as limited liability partnership or as general partnerships.

Indian companies are regulated, inter alia, by the Companies Act 2013 (2013 Act). Startups are usually incorporated either as a private company limited by shares or as a public company limited by shares. The preferred mode being private companies due to fewer compliances as compared to public companies.

A brief comparison of private and public companies limited by shares is set out below:

Limited liability partnership. An alternative option available to startups is to incorporate as a limited liability partnership (LLP). LLPs are regulated by the Limited Liability Partnership Act 2008 (LLP Act). An LLP is a body corporate and a legal entity distinct from its partners and has perpetual succession.

Any change in partners of an LLP does not affect its existence, rights or liabilities. An LLP is capable of entering into contracts and holding assets in its own name. Every LLP is required to be formed with at least two partners. The LLP Act, however, does not stipulate a maximum limit. A person can be admitted as a partner or cease to be a partner in accordance with the LLP agreement. The LLP Act also mandates that an LLP should have at least two individuals as designated partners, out of which at least one should be a resident of India. If the partners of an LLP are bodies corporate, they may nominate two individuals to act as designated partners of the LLP. The designated partners are: (a) responsible for undertaking all acts, matters and things which are required to be done by the LLP under the LLP Act; and (b) liable for all the penalties imposed on an LLP for contravention of the provisions of the LLP Act. All the partners act as agents of the LLP but not of the other partners. The mutual rights and duties of the partners of the LLP inter se and those of the LLP and its partners are governed by an agreement between the partners or between the LLP and the partners. The LLP Act provides flexibility in drawing the agreement as per the choice of the contracting parties so long as it does not violate the LLP Act or any other applicable law. If the partners do not have a specific LLP agreement, then the first schedule of the LLP Act will govern the mutual rights and duties of the partners and the LLP. The contribution of a partner to an LLP may be in the form of money, tangible or intangible property or by contracts for services performed or to be performed. The obligation of a partner to contribute money or property for an LLP will be as provided in the LLP agreement. In the absence of any provision to the contrary in the LLP agreement, all partners are entitled to share profits and losses of an LLP equally in the capital of such LLP.

Income tax on LLPs is between ~30.09% and ~34.61%. No further tax is required to be paid upon the distribution of profits to the partners (unlike in case of companies). Further, such profits do not attract tax in the hands of the partner (to the extent they have already been taxed LLP level).

Foreign direct investment (FDI) is permitted in LLPs; provided, however, the LLPs are operating in sectors/activities where 100 per cent FDI is allowed through the automatic route and where no FDI-related performance conditions have been prescribed.

LLPs are also not mandatorily required to get their accounts audited if they include in their statements of account and solvency, a statement by the partners acknowledging their responsibility for complying with the requirements of the LLP Act in relation to preparation of books of accounts.However, LLPs are subject to certain restrictions in relation to conduct of their operations. For example, they are not prescribed as ‘permitted borrowers’ for purposes of raising external commercial borrowings.

Choice of legal entity for starting up a business in India would depend on the short to medium to long term goals of such a business. Indian laws prescribe the type...

General partnership. Unlike an LLP, a general partnership is not a separate legal entity. Liability of the partners of a general partnership is unlimited irrespective of their capital contribution. It is not mandatory to register a general partnership with the Registrar of Partnerships. However, an unregistered partnership cannot sue or be sued in its own name. General partnerships are also not permitted to receive foreign investment. Income tax on general partnerships ranges between ~30.09 per cent and ~34.61 per cent.

Choice of legal entity for starting-up a business in India would depend on the short to medium to long term goals of such business. In some instances, Indian laws prescribe the type of entity for conducting specific activities (for example, insurance business). While a general partnership is the most non-complex form of business entity after sole-proprietorship, it exposes its partners to unlimited liability. In case of LLPs, liability of members/partners is limited, they require lesser compliances and they provide for greater flexibility (in terms of constitutional documents, etc.). However, LLPs may not be suited for raising foreign capital (depending on their activities), external debt or capital from public. Companies, on the other hand, have greater flexibility when it comes to raising capital or raising debt but they require more statutory compliances than LLPs. It is also important to note that the nature of a business can be changed from one form to another depending on the needs or stage of such business.

About the Authors:
Rishabh Bharadwaj is a Senior Associate and H Muralikrishnan is an Associate at Khaitan & Co. They are a part of the firm’s corporate practice, and specialise in advising domestic and international clients on various corporate and commercial related regulatory and legal issues.

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