This article is written by Muhammad Aslah pursuing Diploma in Business Laws for In-House Counsels from LawSikho. The article has been edited by Aatima Bhatia (Associate, LawSikho) and Dipshi Swara (Senior Associate, LawSikho).
Table of Contents
Introduction
People who are crazy enough to think that they can change the world are the ones who do. Have you ever heard of this famous quote by the pioneer of technology and the founder of Apple; Steve Jobs? If not, the statement is true in the real world. Entrepreneurs in this world create some magical things. Many of them have turned the impossible into possible. Success doesn’t come overnight. Like any entrepreneur, they also started creating or manufacturing with the available resources. It would be incorrect to say that these companies were MNCs from the beginning. We can take an example and prove it. Amazon initially started in a small room. Similarly, the founder of Adani Group only had Rs.100 to his name when the company was created. Hence, hard work and consistent preparation make an entrepreneur reach new heights.
A startup is a term used to describe a company started by an entrepreneur to execute a scalable business idea. For starting a business, many founders used the start-up model at their company’s initial stages of preparation. In India, we can see many startups coming into the picture. There are four categories of business structures. A business structure for an entrepreneur needs to be selected with utmost care or else it may lead to a disaster. One such example is the failure of Dhoodwala. Dhoodwala was a start-up that gave fresh bottles of milk to its customers via online bookings. Despite being able to raise funds through several investors, the start-up couldn’t last long. Hence, choosing the right business model is of immense importance for the startup. The author through this article talks about sole proprietorship and its usage as a business structure for various startups.
What is a sole proprietorship?
A sole proprietorship is one of the best kinds of start-ups in India. In a sole proprietorship, there exists only one owner. According to Investopedia, a sole proprietorship is an unincorporated business that has just one person who pays personal income tax on profits earned from the business. This type of business is most suited to newer startups due to limited legal compliances. It can help in reducing the extra financial requirements for the co-founders of a start-up. In a sole proprietorship, the income earned through businesses is paid as personal income. Thus, there is no requirement for a separate legal entity and income tax category. For example, if A and B start a small business selling natural tea, then their income from selling tea can be paid under personal income. Later on, if A and B expand their business structure into a large company, then it will be necessary to pay taxes as separate income. Hence, turning a startup into a sole proprietorship has its pros and cons.
Difference between a sole proprietorship and other business structures for startups
Setting up a business structure is the first step that the founders of a new idea decide upon. It commercializes its products or services. Commercialization of their products or services allows them to generate revenue and net profits. For any start-up, the first step is deciding on a business structure. The start-up needs to take this decision through meetings and discussions. Selecting a proper business structure is eminent for a startup. Any failure to do so shall result in failure. In India and globally, there are six main categories of business structures. A start-up can choose between any of the below mentioned through proper analysis and decision-making:
| FEATURES | SOLE PROPRIETORSHIP | ONE PERSON COMPANY | PARTNERSHIP | LIMITED LIABILITY PARTNERSHIP |
| Registration | No separate registration is required. | It is necessary to register under the Companies Act 2013. | It is not necessary to register the partnership firm but it is recommended to get registered as per the Indian Partnership Act 1932. | The registration is mandatory along with the LLP Agreement as per the Limited Liability Partnership Act 2008. |
| Status of legal entity | No separate legal entity as the proprietor and the entity are the same. | A separate legal entity is required as the shareholders, one person company are considered as different. | A firm is not a legal entity. Therefore, it has no legal identity distinct from the personalities of its constituent members. | The limited liability partnership has a separate legal entity. |
| Status of conducting the meetings | There is no need to conduct general meetings and board meetings. | One person company is exempted from conducting general and board meetings. | A partnership firm is required to conduct the board and annual general meetings. | The limited liability partnership firm is not exempted from conducting the board and annual general meetings. |
| Liability | Unlimited liability as the liability of the proprietor extends to his or her assets. | Limited liability to the extent of holding shares in the company. | The partners of a partnership firm have unlimited liability as any debts of the firm can be incurred from the personal assets of the partners. | The partners of a limited liability partnership firm have limited liability to the extent of holding shares in the firm or the company. |
| Conduct of Audits | An audit is needed to be conducted only if the turnover threshold exceeds Rs. 1 crore in a financial year as per the Income Tax Act 1961. | One person in the Company is required to conduct the audits and file the financial statements to the Ministry of Corporate Affairs. | The conduct of auditing in a partnership firm is not compulsory but recommended to do the same if the total turnover threshold exceeds Rs. 1 crore. | It is mandatory to conduct the process of audits in a limited liability partnership firm or a company under Rule 24 of LLP Rules, 2009. |
| Status of the succession of the business | There is no succession in a sole proprietorship as the business comes to an end with the death of the owner or owners. | The death of the shareholder does not at any cost impact the existence of the company. | For the succession process, an explicit mentioning in the partnership deed is required to admit one person as the successor of the dead or insolvent partner. | The limited liability partnership firm has a perpetual succession with the legal heirs admitting into the firm via death, exit or insolvency of a shareholder or partner. |
| Securing of finances | The securing of a fund or finance is based upon the track record of the proprietor. | The securing of a fund or finance is based upon the track record of the one-person company. | The securing of finances or a fund is based upon the financial health of the partnership firm. | The securing of the finances or a fund is based upon the financial health of the limited liability partnership or the company. |
| Status of debt or loan repayment | The sole proprietor is responsible for repaying the debts and loans secured through banks, non-banking financial corporations and so on. | The one person company is required to pay the loans and other debts and not the sole shareholder. | The repayment of loans and debts is needed to be repaid from the form failing to do so can be extended to pay from the personal assets of the partners. | The repayment of debt or loan must be paid by the limited liability partnership firm to the extent of loans or debts taken failing to do shall not exceed the personal assets of the shareholders. |
| Legal compliances | In a sole proprietorship, there are fewer legal compliances. | In a one-person company, the legal compliances are much more compared to a sole proprietorship. | The legal compliances are much more; such as conducting of meetings, tax payments and so on. | The legal compliances are much more such as mandatory audits, registration, income tax return filings and so on. |
How is a sole proprietorship business model beneficial for startups?
Selecting an appropriate business model for the start-up is quite risky. It takes time to think, rethink and arrive at a conclusion. Most of the startups in India and around the world had chosen the sole proprietorship model, initially, as a business structure. Some examples are Flipkart, Snapdeal, Coca-Cola, Apple, Hewlett-Packards, etc. They all started something small alone and made it grow into a giant company. The reasons why a sole proprietorship can be beneficial for a startup are as follows.
No registration is required
Registering a sole proprietorship firm is not necessary for India. It can be used as an added tool to test the services or products of a startup. Any person or a group of two persons can start a sole proprietorship within their comfort zones. Having a small office or room for a sole proprietorship is not mandatory. A start-up can start sole proprietorship by using their personal Permanent Account Number (PAN) and other personal details.
No additional operation costs
Operating a sole proprietorship firm is less expensive compared to other business structures. The co-founders of a start-up can start the business within their own homes. There is no separate legal entity in the business structure and this might mean that the owner faces unlimited liability but the operation costs are low. Moreover, it helps in saving some funds as a balance for other purposes of the startup.
No liability to others
A sole proprietorship is a business model in which there are no major liabilities. The nature of liability is unlimited owing to the absence of a separate legal entity. But that doesn’t mean that the start-up needs to bear the costs of others. It needs to only bear the costs incurred during the time of establishing the startup. Any liability that needs to be covered out of the sole proprietorship firm can be taken from the personal assets to the extent of the liability. Hence, mitigant liability costs are compared to other business models.
Secrecy
In a sole proprietorship company, the proprietor is in a position to keep his plans to himself as the entire management and control of the business is solely in his hands. This prevents the disclosure or leakage of any confidential information or ideas with respect to the business.
Conclusion
A startup is a method that can be used to convert new ideas into great ventures. The establishment of a company is not easy. It requires choosing a business model among the other business models. The business model of a sole proprietorship is one among them. It has its own added benefits as well as nuances. Therefore, start-up founders should choose their start-up model with care and caution to further reduce the risks for the start-up.
References
- https://www.legalraasta.com/blog/sole-proprietorship-registration/
- https://startuptrak.com/7-reasons-why-doodhwala-failed/
- https://www.passionateinmarketing.com/case-study-the-fall-of-doodhwala-explained/
- https://www.investopedia.com/terms/s/soleproprietorship.asp
- https://www.ahlawatassociates.com/blog/types-of-business-structures-in-india/
- https://www.startupindia.gov.in/content/sih/en/international/go-to-market-guide/types-of-businesses.html
- https://legex.in/blog/compliances-needed-by-a-general-partnership-firm
- https://businessdebtline.org/fact-sheet-library/business-partnerships-ew/
- https://www.mca.gov.in/MinistryV2/natureoflimitedliabilityparterneshipllp.html
- https://www.companysuggestion.com/limited-liability-partnership/
- https://www.indiafilings.com/learn/partnership-firm/
- https://www.indiafilings.com/learn/basics-of-a-company-board-meeting/
- https://www.wework.com/ideas/professional-development/management-leadership/advantages-of-sole-proprietorship
- https://www.myonlineca.in/name-proprietorship-companies/
- https://www.mca.gov.in/MinistryV2/disclosureauditandfilingrequirements.html#:~:text=The%20accounts%20of%20every%20LLP,to%20get%20its%20accounts%20audited
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