One of the first steps in your startup journey is to choose the type of legal entity for your business. You have several options when it comes to choosing the best legal entity for your startup. Over the last decade, I have dealt with several legal entity types by operating businesses in India, United States, and making global sales. In this article I will try to leave the legal jargons aside and help you decide on the best legal entity for your startup.
Let’s say you’re just starting out from the idea phase of your startup journey. Instead of approaching the problem from the type of entity, we will try to approach from the individual’s requirements. There are only two key things to consider:
- Number of Founders
- Bootstrapping or Raising Investments
Considering the above factors we will try to choose a legal entity with least legal complexities, least compliance requirement and off-course optimise for tax savings. This is being shared just from experience and should not be considered as a tax or legal advice.
Best Legal Entity for Single Founder Startup
So, you’re a single person working on a startup idea. The best thing to do in such cases is to choose your “individual” as a legal entity. This is most commonly called as “Sole Proprietorship“
Did you know it is very much legal to do business in your own name? You can even raise invoice in your own name like I do. You don’t have to do any registrations(off course you will need tax ID) and simply receive the money in your personal bank account. If there is any tax deductions at source it will happen to your individual tax ID like PAN in India.
If you are a blogger or freelancer on online marketplaces you can do the same and you don’t even have to raise invoices. You can use third party services like Payoneer to receive money from international clients. Payoneer has an offering name “Global Payment Service” which enables you to receive payments from companies worldwide – as if you have a local bank account in those countries. Clients can also pay you through check or credit card. Payoneer fees are lowest in the industry and money will hit your Indian Bank account in INR.
Now lets say you don’t want to use your individual name but have a business/brand name. As a sole “Sole Proprietorship,” you can keep any name for your business. Literally you can register a sole proprietorship even with the name “Amazon Inc” in India and there is no system to allot name or check the names registered by others. Of course, I suggest not to do that as there will be trademark registrations etc. However you can use “Inc” in the name(as India uses Pvt Ltd for private companies) i.e you can register “SomeName Inc” as your company name as sole proprietorship. Since we now live in a global world, you have added brand value using Inc.
Bank Account with Brand Name for Sole Proprietorship
Government regulations to open a bank account for a sole proprietorship are pretty simple. You need the following documents:
- Copy PAN CARD (also acts as proof of identity)
- Address Proof (Individuals Driving License, Passport etc)
- One government document/certificate in the company/brand name
The easiest government certificate to get is MSME Certificate at https://udyamregistration.gov.in . It is completely online and you can get it in few minutes. The system takes whatever you enter(based on self declaration without any verification) and generates certificate.
Next easiest certificate to get is professional tax registration, as they also don’t ask much documents to register. You might have to visit the professional tax office and complexities of getting on may vary from state to state.
In case the bank asks for additional documents (better stay away from such banks) you can also provide a certificate from a Chartered Accountant.
Let’s take a real world example. Shruti is a blogger who runs artsycraftsymom.com. Most of her revenue comes from advertisements and sponsored content. She wrote sponsored content for brands like Snapdeal, Nestle etc. These companies needed her to have a registered company. So I recommended Shruti to register for Udyog Aadhaar(now called Udham) and “ArtsyCraftyMom Inc” has a registration certificate in few minutes. She also opened business/current bank account with just this document and her individual PAN card. Its really that simple!
Tax Benefits for Sole Proprietorship
In most countries Sole Proprietorship is taxed as Individual tax rates. India has one of the lowest tax rate for Sole Proprietorship with a special scheme under Section 44AD also known as presumptive taxation. A person adopting the presumptive taxation scheme can declare income at 6% of turnover without maintaining any books of account and audit. Free free to schedule a call with me to learn more about this.
Best Legal Entity for Multi-Founder Startup
If you have multiple founders and do not plan to raise outside funding or provide equity to others, registering a “Partnership Firm” is the easiest legal entity for your startup. All founders are known as partners and are jointly responsible for the management and administration of the firm.
To form a partnership firm in India, a minimum of two individuals are required. These individuals must enter into a partnership agreement, which lays down the terms and conditions of the partnership, including the profit and loss sharing ratio, the responsibilities of each partner, and the method of resolving disputes. The partnership agreement must be signed by all partners and must be registered with the Registrar of Firms in the state where the firm is located. The partnership firm must also obtain a Permanent Account Number (PAN). It is optional to obtain GST registration, if your turnover is less than Rs.20 lakhs for services or less than Rs.40 lakhs for products.
One of the key advantages of a partnership firm is that it is relatively easy and inexpensive to set up. Additionally, it offers flexibility in terms of management and decision-making. It is also easy to wind-down if things don’t go as planned. However, it is important to note that all partners are jointly liable for the debts and liabilities of the firm. In the US, you could also setup a LLC which will shield against any liability as well. LLP’s of Single Person companies have also same compliance burden as Private Limited company, so I would personally not recommend them.
It is a myth that partnerships firms can’t be large. For example India’s largest stock trading platform Zerodha started as a partnership firm in 2010. It only converted into a Private Limited company is 2018 for regulatory reasons. That’s a 8 long year of simple operations with 1000’s of crores of business!
Now, if you are multiple founders and want to raise money for equity, you will have to incorporate a Private Limited company or a C-Corp in the US. It is a separate legal entity from its owners, meaning that it can enter into contracts, borrow money, and sue or be sued in its own name. Setting up a private limited company in India is a relatively straightforward process, but it does require some time and effort.
The first step in setting up a private limited company in India is to choose a name for the company. The name must be unique and not already in use by another company. It is recommended to check availability of the name on the Ministry of Corporate Affairs website. Once a suitable name is chosen, the next step is to obtain a digital signature certificate (DSC) and a director identification number (DIN) for the proposed directors of the company. These can be obtained through the Ministry of Corporate Affairs website.
The next step is to draft the Memorandum of Association (MOA) and the Articles of Association (AOA) of the company. These documents set out the company’s objectives, share capital, and other important information about the company. It is important to hire a legal professional to ensure that these documents are properly drafted and comply with all legal requirements.
Once the MOA and AOA have been drafted, the company can file its incorporation documents with the Registrar of Companies (ROC). This can be done online through the Ministry of Corporate Affairs website. The ROC will review the documents and, if everything is in order, will issue a certificate of incorporation.
After the company has been incorporated, it must obtain a PAN (permanent account number) and a TAN (tax deduction and collection account number) from the Income Tax Department. The company must also register for GST (goods and services tax) with the Central Board of Indirect Taxes and Customs.
Once all of these steps have been completed, the company is officially incorporated and can begin conducting business activities. However, it is important to note that there are ongoing compliance requirements that the company must meet, such as filing annual returns and holding annual general meetings.
It is important to note that there are various other compliances that need to be taken care of post registration of the private limited company, such as filing of Annual Return, holding of Annual General Meeting, maintenance of statutory records, filing of financial statements and other mandatory filings as per Companies Act, 2013. It is advisable to take professional help to ensure compliance with all the laws and regulations.
Alternately if you are selling online globally, you can consider setting up C-Corp in US. I will do a separate blog post about US incorporation in the future.
In conclusion, choosing the best legal entity for your startup is an important decision that will have long-term implications for your business. The most common legal entities for startups are sole proprietorships, partnerships and corporations. Each type of entity has its own advantages and disadvantages, and the best choice for your startup will depend on your specific business needs and goals.
Sole proprietorships are the simplest and most common type of legal entity for small businesses. They offer complete control and flexibility but also come with unlimited personal liability. Partnerships, on the other hand, offer shared ownership and management, but also shared personal liability.
Private Limited corporations, on the other hand, offer limited personal liability and the ability to raise capital through the sale of stock, but also come with complex tax and compliance requirements.
Ultimately, the best legal entity for your startup will depend on your specific business needs and goals. It is important to consult with a legal professional and consider all the pros and cons of each type of entity before making a decision. You could also schedule a non-legal, one-on-one call with me. With the right legal entity, your startup can focus on growing and achieving success.