Choosing The Right Business Structure - Partnership, LLP Or Company
- LAWfield Associates
- Aug 3, 2020
- 6 min read
A Business may be understood as an enterprise or an organisation directed in providing services to its customers and earning profit in its return, although the object of a business goes beyond profit making. Businesses vary in size, as measured by the capital invested, employees appointed or by the volume of sales etc. Based on these factors business organisations can be classified into:
Partnership Firm
Limited Liability Partnerships
Company
Co-Operatives
HUFs
Societies, and more.
One of the most common problems that an entrepreneur or start-up faces while entering the industry, is with the choice of business organization. With so many to choose from, it becomes really difficult to select an ideal one. This article aims at clearing up the basic features of three most popular and beneficial business structures in present day market - a company, a Limited Liability Partnership, and a Partnership Firm.
Need For Selecting Proper Business Structure
It is very crucial for a start-up to choose a proper business structure that will suit it the best and help in the long run. Any one of the forms may be adopted for establishing a business, but generally one type is more suitable for a particular business than the other. Before selecting the form of organisations, an entrepreneur should keep in mind and consider the subsequent factors. The choice of the form of business largely depends on these traits:
Nature of the business
Adequacy of capital
Objective of the Organisation
Legal Requirements
Scale of Operations
Risk Tolerance
Apart from the aforementioned factors, an enterprise should have a rational and a logical ‘Vision and Mission Statement’. A Vision Statement expresses the future position of the company whereas a Mission Statement lays down the purposes, goals and its approach to reach its objectives. Not only that, an enterprise must reflect on the internal and the external environment of an organisation. An organisation has complete power and authority in the internal environment, but has no control on the external environment. Thus, the internal environment has to adapt to the changing external environment. The internal environment comprises of human resources, financial factors, physical assets and facilities. Usually, a business has command over these factors and can alter these factors according to the need of the enterprise. On the other hand, the external environment includes the customers, suppliers, employees, technological advancement, economic conditions, political and legal aspects, socio-cultural demographics. These factors exist outside the organisation but have major influence over its growth and survival. An intense analysis of the strengths and weaknesses of the internal and external factors helps the organisation to strategize and execute its plans. An entrepreneur must consider all the factors before choosing the appropriate business organisation.
Partnership
The Indian Partnership Act,1932 defines partnership as:
“the relation between persons who have agreed to share the profits of a business carried on by all or any one of them acting for all.”
As stated by Haney, “Partnership is the relation between persons competing to make contract who agree to carry on a lawful business in common with a view of private gain.”
In this kind of business, minimum two persons are required who are tied together either by a written, verbal or an implied contract.
Advantages Of Partnership Firm
Easy Formation - It can be easily organized. No complex legal formalities are involved.
Voluntary Registration - Registration of a partnership firm is not mandatory. Although, registration of firm is desirable so that it can avail the benefits of a registered firm.
Profit Incentive - The profit from the business is shared as per the agreement. So, greater the profit of the business, greater will be the share of the partners.
Maintenance of Secrecy - The firm does not have to publish the account sheets. So, in this manner they can maintain secrecy.
Improvement in the spirit of Co-operation - The business runs on the spirit of co-operation and mutual trust. It helps them in increasing the spirit of togetherness.
Ease of Dissolution - A partnership firm can be easily dissolved as per the agreement or by mutual consent of the partners.
Disadvantages Of Partnership Firm
Unlimited liability - In a partnership form of business, the partners are personally and jointly liable for all the debts and obligations of the firm.
Uncertain Existence - The duration and the span of a partnership firm is always uncertain. It may be dissolved due to death, retirement or disputes among the partners.
Disputes among partners - There may be unnecessary friction and disputes among the partners which could hamper the working of the organisation.
Lack of Public Support – A partnership form of business does not always enjoy public support and confidence due to lack of transparency, publicity and regulations.
A partnership firm is most suitable for ‘small businesses such as retail and wholesale trade, professional services, medium sized mercantile houses and small manufacturing units’[1]. Generally, small organization start as a partnership business and afterwards when it becomes economically stable and financially attractive for the investors, it converts into a company.
Company
A Company is governed by The Companies Act, 2013. This Act defines a company as an artificial person created by law having perpetual existence and a common seal. A company is of two types:
Private Company - A Private Company has limit on maximum to 200 members. It restricts the right to transfer its shares and forbids any invitation to the public to subscribe for any of the company’s security.
Public Company - A public company does not have any restriction like a private company. It requires a minimum of 7 members. The shares of such company can be traded in the stock market.
Advantages Of Company
Greater life-span - The life of a company compared to a partnership firm is much greater. In fact, a company, once incorporated, has a permanent existence. It is not affected by the death, insolvency, disability or disputes among the shareholders.
Limited Liability - The liability of the shareholders extent to the amount of money invested.
Huge Capital Investment - A Company attracts huge amount of capital from its investors which help in greater production and cost reduction of goods.
Large Scale Production - Due to higher investments and availability of large capital, the company benefits from large scale production.
Management Functions - The management activities are divided, which aids in greater efficiency and effectiveness of the employees.
Disadvantages Of A Company
Complex Formation Procedure - The formation of a company is a complex procedure. Detailed legal formalities need to be fulfilled for the establishment of a company.
Separation of Authority and Ownership - The shareholders are not allowed to take part in the day to day functioning of the business. The Directors with the managers look after the operations of the company.
Detailed Compliance Procedure - A company has to publish the account sheets, assets and liabilities, and various other compliance reports at the end of each financial year. While this is beneficial in avoiding any secrecy in the functioning of the company, but at the same time it can give the competitors full knowledge about the weaknesses of the company. It also makes a company administration difficult and complex.
Double Taxation - A company pays tax on its earnings and even the shareholders pay tax on the receipt of the dividend. This amounts to taxing the earnings twice.
A company is suitable where the volume of business is large, area of operation is extensive, the risk factor involved is heavy and there is a need for huge financial resources accompanied by manpower.
Limited Liability Partnerships
Limited Liability Partnership is controlled by the Limited Liability Partnership Act, 2008. It incorporates the advantages of both the company and a partnership firm in a single form of organisation. In this type of organisation, all partners have limited form of liability and is not responsible for another partner’s wrongdoing. In an LLP, partners are administered by the LLP agreement but in the absence of an agreement it is subject to the provisions provided in Schedule 1 of the Limited Liability Partnership Act,2008.
Advantages Of Limited Liability Partnership
Separate Legal Entity - LLP is a separate legal entity having perpetual existence separate from its partners. This ensures limitation of liabilities for the partners.
Easy to establish - There is flexibility in establishment without complex legal and procedural requirements. Moreover, formation cost is also lesser compared to a company.
Maximum Members - There is no limit as to the maximum number of members are concerned.
Disadvantages Of Limited Liability Partnership
Raising of Funds - LLP cannot raise funds from the public. With regard to investment from private sources, the procedure is difficult and may affect the business of the LLP, as investors are inducted as partners in the LLP.
No separation of management powers - In LLP, every member takes part in the operations of the business. Thus, there is no separation of management from the owners.
Conclusion
Thus, a business enterprise can be categorized in different forms. Each of these forms has its own pros and cons. Eventually, it depends upon balancing the merits and demerits of the several forms of business. Selecting the right form of business is very critical. An entrepreneur must take into consideration all the factors affecting the business for the growth and stability of the business. The decision should be made by the entrepreneur after considerable thought and deliberation.
[1] https://careerdioxide.com/entrepreneurship/kb/choose-a-business-structure.jsp
This article has been authored by Ms. Abheri Roy, a student of the Department of Law, University of Calcutta.
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