Business Entity Types in India
The following is a guide to the different business entity types in India that are allowed, providing an overview of each type and their advantages and drawbacks. India is one of the fastest growing economies of the world. In line with the globalization and liberalization trends it has been facilitating the growth of enterprise and entrepreneurship by instituting several reforms and adapting a pro-enterprise approach. It has readily embraced new and evolving corporate vehicles, such as Limited Liability Partnership, while retaining certain vehicles that are inherent to its heritage. The scope of the guide is limited to commercial businesses and does not include vehicles covering non-commercial activities.
Indian legal framework allows for several business entity types in India:
- One Person Company
- Partnership firm
- Limited Liability Partnership
- Private Limited Company
- Public Limited Company
In addition to the above legal entities, the following types of entities are available for foreign investors/foreign companies doing business in India:
- Wholly owned Subsidiary Company
- Joint Venture Company
- Liaison Office/Representative Office
- Project Office
- Branch Office
Other forms of business entities which are beyond the realms of this guide are
- Joint Hindu Family Business
It is an archaic form of business entity and also the easiest form to set up and most common entity in India. This does not even require a formal registration with the Registrar of Companies (ROC) however trade related licenses that are mandatory have to be obtained. The businesses usually involve less risk, small market, small capital and in turn have limited growth potential. It is the preferred type of entity among freelancers, small traders, people who ply their skills and craftsmanship such as tailors, bakers, etc.
Relatively, there is less compliance burden on the owner and as a sole owner can exercise complete authority and control. It provides complete confidentiality. The business owner and the business are one and the same; there is no legal distinction between the two. This is a major drawback, as there is no protection for the personal assets of the proprietor, in case of payment defaults, creditors can make claims against the personal assets of the owner. This form of entity is less attractive to investors or financial institution as it has no long term vision or transferability or transparency. It is very difficult to raise capital hence this entity will have limited growth potential.
One Person Company
This is a completely new structure of business. It is a hybrid between sole proprietorship and private limited company. One person company can be formed with just one member. It means that the requirement of minimum two shareholders for a private limited company has been dispensed with. One Person Company can be formed only by “naturally born” Indian “residents” and “citizens”. This form of business provides the benefits of limited liability, better structure, legal protection, access to credit institutions and banks, etc. to start-ups & small-scale businesses.
Partnership firm is formed by an agreement between two or more people to own and run the business. This arrangement enables enterprising individuals to pool their resources to establish and expand a business. Collectively the individual partners become a firm. This type of entity is suitable for team of people rendering professional services such as lawyers, charted accountants, management consultancies, doctors etc. This is also an ideal setup for small scale companies which require pooling of capital and management expertise for running the business.
The law relating to a partnership firm is contained in the Indian Partnership Act, 1932. It does not require compulsory registration of firms. It is optional for partners to register the firm and there are no penalties for non-registration. A partner of an unregistered firm cannot file a suit in any court against the firm or other partners for the enforcement of any right conferred by a contract or the Partnership Act. Likewise the unregistered firm cannot seek legal action in the court of law against any third party howsoever it does not limit a third party from suing the firm. In order to avail legal privileges a partnership firm must be registered with the Registrar of Firms. It is not necessary to register at the time of formation. A firm may be registered at any time by filing an application with the local Registrar of Firms.
Partnership Firms in India can have a minimum of two partners and a maximum of 20 partners, notably the banking businesses are allowed a maximum of 10 partners only. Like proprietorship the firm also does not have a separate identity, the partners and the firm is one and the same. In the event of the assets and property of the firm is insufficient to meet the debts of the firm, the creditors can recover their loans from the personal property of the individual partners.
There are restrictions on transfer of rights; no partner can transfer his individual rights to another third party without the unanimous consent of all the partners. The firm must be dissolved on the retirement, lunacy, bankruptcy, or death of any partner.
All partners have a right in management of the activities of the business and the extent of the rights of each partner may be clearly determined in an agreement. Usually the rights, liabilities and duties of the partners are laid out in an agreement in a professionally administered partnership firm. When the written agreement is duly stamped and registered, it is known as “Partnership Deed”. If the deed does not enlist the rights, duties and liabilities the provisions of The Indian Partnership Act, 1932 will apply.
Generally a partnership deed contains the following particulars:-
- Name of the firm
- Nature of the business to be carried out
- Names of the partners
- The town and the place where business will be carried on
- The amount of capital to be contributed by each partner
- Loans and advances by partners and the interest payable on them
- The amount of drawings by each partner and the rate of interest allowed thereon
- Duties and powers of each partner
- Any other terms and conditions to run the business
Other than the ease of formation and ease of pooling capital and expertise, partnership firm has several drawbacks such as, unlimited liability, limited lifespan, and restrictions on transfer of rights, lack of unanimous authority, and more importantly liability for the acts of other partners.
Limited Liability Partnership (LLP)
It was introduced in India through Limited Liability Partnership Act, 2008. Limited Liability partnership provides all the benefits of an incorporated company as well as the flexibility of a partnership. In an LLP, all partners have limited liability, similar to that of the shareholders of a limited company, and are relieved from the liability for the acts of other partners. Unlike the shareholder of a company, the partners have the right to manage the business directly. An LLP also limits the personal liability of a partner for the errors, omissions, incompetence, or negligence of the LLP’s employees or other agents.
Unlike a partnership firm there is no restriction on the number of partners. Any two or more persons, associated for carrying on a lawful business with a view to profit, may by subscribing their names to an incorporation document and filing the same with the Registrar, may form a Limited Liability Partnership. At least one of the partners should be an Indian resident.
It has a unique legal identity and is separate from the partners. It also has perpetual succession. The liability of the partners is limited to their agreed contribution in the LLP. However the liabilities of the LLP and partners, who are found to have acted with intent to defraud creditors or for any fraudulent purpose, shall be unlimited for all or any of the debts or other liabilities of the LLP.
There is no minimum capital requirement. The mutual rights and duties of partners of an LLP inter se and those of the LLP and its partners shall be governed by an agreement between partners or between the LLP and the partners subject to the provisions of the LLP Act 2008. The LLP is required to maintain proper accounts. Annual statement of accounts and solvency shall be filed by every LLP with the Registrar.
The relative ease of setting up an LLP, limited liability, perpetuality and minimal compliance requirement and cost makes it increasingly popular among small businesses involving professionals. Moreover this type of entity is also internationally recognized and a relative newcomer in many of the forward looking business jurisdictions which are keen on encouraging enterprise growth. This international recognition also adds to the merits of this type of business entity.
Private Limited Company
The governing provisions for a Private Limited Company are contained in The Companies Act, 1956. A private limited company must be appropriately incorporated with the Registrar of Companies (ROC). India being a vast country with several provinces, ROCs are located across the states and Union Territories. A company incorporated in any state of India can do business all over India.
The minimum paid up capital at the time of incorporation of a Private Limited Company is INR 100,000. It can be increased any time, by payment of additional stamp duty and registration fees. A Private Limited Company must have a minimum of two and a maximum of 50 members as its shareholders. It must have minimum of two directors and maximum of 12 directors. Where the paid-up capital is equal to or exceeds INR 50 million a company secretary must be appointed. The shareholders and directors need not be locals.
The liabilities of the share holders are limited to the shares subscribed by them. A Private Company is prohibited from inviting the public to subscribe for any shares or debentures of the company. It is also prohibited from inviting or accepting deposits from persons other than its members, directors or their relatives. The shares can be transferred only among its members and it involves some restrictions.
A Private Limited Company has a separate legal identity. It is perpetual. Although the liabilities of the shareholders are limited, at times, the liability of a Director/Manager can be unlimited. Under the Companies Act several regulatory exemptions are granted to a Private Limited Company, such as exemption from filing prospectus with the Registrar, exemption from obtaining Certificate for Commencement of business, exemption from holding statutory meeting and statutory report, etc. Similarly the directors of a private limited company do not face restrictions as those of the Public Limited Company.
A Private Limited Company is easy to set up and there are relatively less compliance requirements than a public limited company, however there are some limitations such as restrictions on share transfer. Notably the limited liability clause is undermined by the bankers and financial institutions, which are increasingly resorting to personal guarantee from directors of Private Limited Company. Nevertheless, it is an ideal vehicle where the shares of the company will be closely held and where there is no requirement for more capital to be raised through public issue.
Public Limited Company
The regulatory provisions for this type of entity are contained in The Companies Act, 1956. A Public Limited Company must be registered with ROC.
A Public Limited Company is a Company limited by shares in which there is no restriction on the maximum number of shareholders, transfer of shares and acceptance of public deposits. The minimum paid-up capital for a public limited company is INR 500,000. A Public Limited Company must have a minimum of seven shareholders and have a minimum of three directors and maximum of 12 directors. Where the paid-up capital is equal to or exceeds INR 50 million, a company secretary must be appointed.
The liability of each shareholder is limited to the extent of the unpaid amount of the shares’ face value and the premium thereon in respect of the shares held by him. However, the liability of a Director / Manager of such a Company can at times be unlimited. The shares of a company are freely transferable and that too without the prior consent of other shareholders or without subsequent notice to the company.
A company is a legally independent body therefore is perpetual irrespective of death, retirement or insolvency of any of its shareholders. The shareholders do not have a right in managing the activities of the company there is a clear separation of management and ownership and the company’s Board of Directors are vested with the decision making power as per the rule of majority.
There are some strict compliance requirements for Public Limited Company
- It must have at least three Directors
- A prospectus or a statement in lieu of prospectus has to be filed with the Registrar of Companies before allotment of shares.
- It has to obtain Certificate of Commencement of Business from the Registrar of Companies before it can commence business on incorporation.
- It has to hold a statutory meeting of members and file a Statutory Report with the Registrar of Companies.
It must be noted that the financial status of the company is public and requires public disclosure of its operational outcomes hence there is no confidentiality. The regulatory regime is very strict for Public Limited Companies and resultant compliance cost is also high. But it is suitable for large scale businesses that require huge capital and allied resources. The ease of raising capital by issuing shares or through loans and ability to attract high quality talents to manage the company affairs, democratic management etc., make it an ideal format for large scale businesses.