In this blog post, Aakriti Sood, a student at Bharatiya Vidyapeeth Deemed University, Pune and pursuing a Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, describes the process of converting a sole proprietorship into a company.

Business in general means providing services in exchange for money and it includes commercial, professional and industrial activities. When it comes to beginning one’s business, the initial and primary thought which comes to an entrepreneur mind is what kind of business he would like to be in? Many before starting of their business do not think and lack strategies. There is less guidance provided when it comes to the start of their business. The framework for this consists of three step strategies:

• Entrepreneur current goals.
• Evaluate the strategies for attaining those goals.
• Assess the capacity to execute these strategies.

Before launching their businesses, entrepreneurs must plan so as to execute them. A vague goal leads them nowhere whereas an identified goal is more specific and independent one, which further can provide them with quick profits and long-term sustainability. One has to see all the criteria’s like resources, profitability, durability, sustainability, growth rate and tolerance for risk before starting of their business, as formulating a sound strategy is necessary.

When it comes to a legal structure of business, one can choose from four different types of business according to their needs¾Self-proprietorship, Partnership, Limited Liability Partnerships or Companies.

What is Sole Proprietorship?

In India, a majority of businesses begin as a sole proprietorship. Sole means “single” and Proprietorship means “ownership of a business or property”. It is considered to be one of that simplest and straightforward form of business structure because of its single or one owner trade characteristic. The first and foremost question arises in a person mind is whether sole proprietorship applies to the person who owns the business or whether the business is owned by a single person. Thus, in this type of structure, the business does not have a separate existence from the owner. When a person enters into business as a sole proprietor, he possesses all the responsibilities with regards to its business, and for that matter, he enjoys a complete and exclusive right, which is only available to him. The responsibility carried by him must be both, i.e., legal and financial in nature. Apart from that as a sole trader he is also under some obligations. Therefore, with all these responsibilities and obligations he solely enjoys entire profit incurred from the business but with all such benefits he may also be held personally liable for any business expenses.

Formation of a Sole Proprietorship

Formation of a sole proprietorship is easy because of its very nature that it is the oldest form of business structure and so it does not involve any formal creation. Thus it comes with the very basic legal formalities and requires less paperwork. Therefore, one can form it by simply filing with the local office available in that particular city. The fees that have to be paid for license and permits are minimal. Above all, it does not require any registration as a corporation or as any other form of business. A sole proprietorship can either be on owners name or any fictitious name, but fictitious names may vary by state, as it is just a trade name. Thus it does not require setting up any separate trade name.

For instance, a catering sole proprietorship business named as Prem Kumar caters where owner name is Prem Kumar, and he hires an employee to offer services in parties, marriage functions, etc. Here, in this case, the trade name and owner name are both the same. A bakery or restaurants are other examples of a sole proprietorship business.

As a sole owner, he owns all the assets of the business. Similarly, he is also entitled to all the profits incurred from that business. But with all these benefits he also bears the risks associated with it such as the taxes or in terms of investment of funds made by him. The principle behind it is that the law does not differentiate between the owner and the business in sole proprietorship and the owner is personally liable for all debts, business losses and unlimited liabilities due to which it is said to be the riskiest business out of all.

Setting Up of a Sole Proprietorship

A sole proprietorship is the least expensive to set up. Professionals and consultants consider taking this option for a start-up as a way to test their business before expanding and taking it to the next level. The one who wants to take control of all the management and make all the decisions then this type of business structure is best suitable to them. It spares them from all those headaches of taking approval from other members. Hence this does not fall under any scrutiny by any other members.

The decision-making and response are certainly quicker in this case as it solely depends on upon a single owner so instead of waiting for others approval one can have a faster and flexible management. There is no need to submit a lot of documentation in government offices; all one needs is to have its business registered at the local business office. For instance, an indigenous craftsman can also be a sole proprietor. The product that he sells requires intricate work and unique craftsmanship that is not possible to be duplicated by machines. Hence the manufacturing of such goods are not possible at a mass level and as a safer option as a craftsman is a sole proprietorship which is cost effective and requires less formal procedural work.

Tax Procedure in a Sole Proprietorship

Since this type of business structure has no separate entity like partnership or company thus the tax procedure is simple as compared to others. The business and its owner are considered to be a single entity so; only one income tax return is required to be filed. Whatever income is earned by the business is equivalent to the income earned by the owner. Therefore the concept of double taxation does not lie here. Even the recordkeeping is simple and straightforward because the owner does not require an accountant for any formal financial statements.

Once the owner decides to dissolve this type of business, then he may do so by paying off all his business debts and closing all accounts related to the same. Before that, a notification is required to be sent to the tax authorities in regards to tax informing about the dissolution of the business. It is easy and simple because it does not undergo lengthy and formal procedures.

As a sole owner, one does not have any protection from liabilities since the legal and financial responsibilities as well as obligations related to paying off business debts lies with him due to its single entity character and thus if one fails to pay off those numerous debts incurred from business losses, unlimited liability arises. A creditor then may go after his personal assets and properties. So a risk of losing is always associated with this type of business, and the owner is personally liable for it.

Building a Sustainable Business

To build a sustainable business, which can benefit in the long run then it must not be limited to just one owner like in case of sole proprietorship where the owner has a limited scope, and he becomes solely liable for all the business debts and losses whereas in the event of company, being an artificial person and having a distinct identity from its shareholders and incorporators is treated as a separate legal entity. This significant feature protects its members and makes them liable only to a certain extent. Thus the avoidance of the personal liability becomes its key benefit, and the extent of their liability in a company is only till their investment and shareholdings, rest the company is liable for its own acts.

When one starts with his business as a sole proprietor, another uncertainty in regards to business life remains with it. One of the issues lies with the continuity in such type of business is when the owner and the business are considered to be one single entity then what if the owner becomes incapable in decision-making or if he’s unable to manage his business or a condition like death or retirement of an owner takes place then it will automatically say to be a cessation of business and its operation. Thus it shows that the existence of sole proprietorship as a business is a fragile one and hence the continuity remains uncertain. A company on the other side, have an unlimited life which is based on the idea of “Perpetual Succession”. It is well said that an incorporated company never dies. It means that the membership of a company may keep changing, but it does not affect its continuity. Members may come, and members may go, but the company can go forever. Thus continuity of a business is not a concern in regards to a company where it has a foreseeable future.

Because of the rigid and formal procedures followed by the companies, does a sole proprietorship is less business like is another question which arises in one’s mind. Even though a sole proprietorship is the most traditional form of business where one can simply begin his business as a sole trader and without any multiple investors and has the most simplified approach still it appears to public as an informal type of business, and a comparison arises in regards to a company or a corporation. Well in the case of a company, it follows their own strict formal procedures and has more explicit strategies to work upon. There is less scope available to practice corrupt activities, as it is in the series of scrutiny. It is the law, which regulates the companies under The Companies Act, 2013.

Funding by banks and other financial institutions and granting financial aids to a sole proprietorship is not cakewalk. There are limited funds available in this business, and there are no investors except the owner who is also personally liable for every act done by him or on behalf of his business. Multiple investors are one of the key features available to a company, which makes it more reliable and preferred business structure out of all. Funding becomes more sceptical because there is a limited scope of reimbursement and thus it makes sole proprietorship a less attractive prospectus for investors and lenders. Even the working capital is limited to the funds of the owner, and other funds can only be obtained through loans. A limitation is always there in terms of a sole proprietorship business structure whereas in the case of a company if they require funds for their expansion, they may issue equity in forms of the share of stocks. Bank loans are too easily provided as compared to the sole proprietorship business.

Even though the decision-making is faster and there are no delay issues which would arise out of sole proprietorship business as it is considered as one of the most flexible management type of business structure where decision depends merely on one single person, i.e., the owner but it comes with its own price. Poor decision-making is a heavy burden to bear, and one poor decision can lead to a failure of the business. The risk of failure is always attached to it so a specific team pours the views become limited whereas in a case of other business like companies, the decision-making is strong because of varieties of ideas. Phenomena of “Red-Tapism” exist only in companies and it means the practice of requiring excessive paperwork and TDS procedures before action can be considered complete. The line of command in a sole proprietorship is vertical, i.e., there is a single line of a command, which exist between the sole proprietor and the employees. However, the structure of a company can be described as a web of the line of commands at various levels, which may lead to a delay in decision-making. The importance of unity of command is realised when a decision needs to be fast because of the competition existing in the market. The strategies made by companies are better because they have a bold vision to attract people and resources and give a profitable result.