In this blog post, Naman Maheshwari, a Taxation Expert at C.P.Laddha & Co. and a student pursuing his Diploma in Entrepreneurship Administration and Business Laws from NUJS, Kolkata, provides an overview of business structures suitable for a venture funded software business.
“Great advice once I heard was to structure your business so you respect your customers, because they will bring out the best in you and you will feel better yourself.” – Christopher Davis
Introduction
Business can be any work or process which is started by a person or jointly by a group of two or more persons with a common objective to earn money in exchange of goods or services or both. So a business can be anything or work which is done on a regular basis with an aim to accomplish goals by a person or group of two or more persons who own it and control it with the help of several others. But running a business in the correct manner is not that simple. Acquiring future growth, achievements, success, etc., is not that simple.
Every good business needs proper business structuring. When starting a business, one needs to choose the best feasible business structure through which business could exist successfully for a longer period in the corporate world.
A Business structure is just like a legal skeleton to prop up the business in existing corporate world. It is important for every growing company. Remember the chosen business structure will have both legal and tax implications. The number of business structures, we hear in our daily life are as follows:
- Sole Proprietorship
- Partnership
- One Person Company
- Limited Liability Partnership (LLP)/LLC
- Non-Profit Company
- Trust
- Joint Venture
- Association
Types of
The four types of Business Structures found in India are:
Sole Proprietorship: This is the most common type of business structure. This type of structure runs on the principle of One Person One Owner. No second person exists in such a type of business structures. A person starts business, invests, works, and earns. 
Partnership: Two or more than two persons start a business in the form of a partnership. The best part of this form of structure is that the profit and losses are borne the partners’ individual tax returns on the basis of their sharing ratios, so the burden of paying taxes do not fall on the company.
One person Company: This is a mixed form of Sole Proprietorship and a company form of business with concessional and relaxed, or nominal requirements. This was introduced under the Companies Act, 2013.
LLP/LLC (Limited Liability Partnership/Limited Liability Company): These are two hybrid kinds of business structures. LLP is a mixed form of Partnership and Limited Liability.
What Is Venture Funding?
Venture funding is a type of funding or equity which is very much different from a loan. In such a type of private equity, financing is provided to early-stage growing firms or businesses that have high potentials in reference to many factors like the number of employees, revenue or future stability and growth.
It is different from other funding because, in this type of funding, venture capitalists are more interested in buying stakes rather than just providing finance on some loan basis. They buy a fixed percentage of stakes in the business they are investing.
Which Business Structure Is More Suitable For Venture Funded Software Business?
Some factors which are noticeable for choosing a business structure include:
- Legal liability
- Tax implications
- Cost formation and ongoing administration
- Flexibility
- Future needs
So, if we take each and every factor, then the partnership is the best suitable business structure for a venture funded business structure. Under a partnership form of company, liability is divided between the numbers of available partners. This is not present in sole proprietorship which provides more flexibility and which also divides profit and losses of businesses in income tax returns of the number of partners rather than taking it whole as a gain of business which helps in showing lesser gains. The partnership provides more flexibility rather than other structures. Hence, a venture funded Software business will have potential future growth if the product research is done in a good area. However, this structure is suitable only in India. Concerns arise when this is shifted to an international level.
Two major business structures that come to mind when we think of one for a software business are LLC/LLP and C-corp. Since, we are looking at a venture-funded software business, C-corp. would definitely be the most suitable business structure.
C-corp. provides the company with a clean capital business structure that a venture capitalist would generally look for before investing. The C-corp. is an equity based capital structure, with the initial equity being owned by the founders, i.e., founder’s shares. At the time of incorporation, the share price is very nominal (e.g. – Rs. 0.0001 per share). Therefore, now the founders/owners of the company have ownership of the company in the form of shareholding. If the founders feel, they can give stock options to their employees and management, too.
Now to the outside investor this capital structure looks clean for investment. Firstly, there are a manageable number of shareholders. Second, the stock option plan gives key employees the incentive to continue working with the business and build on their shareholder value. Finally, there are no obstacles when the company issues shares to new investors in exchange for capital investment.
The only disadvantage of a C-corp. compared to an LLC/LLP is, in a C-corp. we are taxed twice. Taxed on the company’s net profits and taxed on our personal income. Whereas in an LLC/LLP, the net profits the company makes is seen as personal income. Thus, the company gets taxed only once. An alternative to overcome this issue is S-Corp. It has a capital structure similar to that of a C-corp. and tax benefits similar to that of an LLC/LLP.
The issue with S-corp. is that number of shareholders is limited. Transforming the company’s business structure from an S-corp. to a C-corp. can be an expensive affair. Therefore, I believe C-corp. is the most suitable business structure for a venture funded software business.
