For a startup, one of the most important decisions in beginning is to decide whether to incorporate itself as Limited liability Partnership (LLP) or a Private limited Company (Company). This decision is important by virtue of the fact that it will have bearing upon ownership, management, taxation & business debt questions. Before going into the question of which is best choice for startup, we need to understand first their salient features respectively.
A private limited company (or a Company) is an association of not less than two members having limited liability to the extent of their contribution with the restriction on free transfer of their shares between them. The maximum number of members prescribed is 200 only. A company is registered under Companies Act, 2013.
On the other hand, in India, there was need to provide a business form that would combine the feature of flexibility of partnership and advantages of company at a low compliance cost. So, Limited liability partnership or commonly known as LLP was introduced & is treated like any other partnership firm. It is an amalgamation of a company and a partnership which incorporates the features of both i.e. the flexibility of operations in partnership and benefits of a company.
So, it is a business form which combines the benefits of a company and allows its members to organize their management operations on the basis of mutually arrived agreement as in the case of partnership firm. A LLP is governed by Limited Liability Partnership Act, 2008. From the above, following features of LLP can be chalk out:
• Perpetual Succession i.e. the legal status of LLP is not affected by non-existence or any change in partners.
• It can also enter into contracts & own property in its own name.
• Separate legal entity i.e. like company, partners & LLP are distinct persons and the liability of partners are limited to their contributions.
Now, there are similarities between both business formats as well which includes one, that both are required to be registered with Ministry of Corporate Affairs (MCA). Two, that the minimum number of persons required for incorporation is 2. Three, the requirement of maintaining annual accounts and fulfillment of annual compliances with MCA.
Now, following facts should be kept in mind while deciding the choice of business form for startup:
The Objective plays an important role that if startups see large scale of operations in long term, it may happen that they need to infuse more stakeholders, investors, professionals. So, the law and structure of a company makes it easier. Also, venture capitalists prefer Company over LLP as it provides easier investment opportunities and the capital can be raised in easier ways in contrast to LLP.
However, LLP is suitable in cases where the startup intends to run as a small scale concern over a particular area.
Another advantage of company can be noted that as compared to LLP is that company enjoys confidence and credibility of investors, banks etc. due to their strict compliances under Income tax, Company Law and other laws in force.
Firstly, the cost of incorporating a LLP is less than a company. Secondly, in terms of procedural requirements, LLP again requires less legal compliances, for instance, after incorporation LLP Agreement can be filed within 30 days from the date of its registration in Form 3.
Given the lesser compliances in case of LLP, cost is further lowered whereas in case of a company it has to comply with more MCA regulations and hence higher cost than LLP.
Another important incorporation aspect is that in case of LLP, only the minimum number of partners i.e. 2 is prescribed. Unlike company, for LLP there is no limitation on maximum number of partners, whereas for Company the restriction of not more than 200 members is prescribed.
As per Company law, all the companies are required to undergo compulsory audit of their accounts irrespective of their share capital. But for LLP there is no such mandatory compliance. However, as per LLP Act, it is required to get its accounts audited only when the Contribution of LLP is Rs. 25 Lacs or more or the annual turnover is Rs. 40 Lacs or more in a financial year. LLP Act further provides that if the partners of LLP decides not to the get the accounts audited then LLP shall include in the statement of Account and Solvency a statement by the partners to the effect that the partner acknowledges the responsibility of complying with the requirements of the Act and rules with respect to preparation of accounts and a certificate in the Form 8. However, no such relaxation is provided to companies.
The Compliance burden on LLP is less than company as LLP is only required to file an annual return in Form 11 and a statement of Accounts and Solvency in Form 8.
As per Company Law, a company is bound to conduct Quarterly board meetings, statutory meetings etc. whereas there is no such mandatory requirement of holding meetings in law. On the contrary, partners can mutually decide in partnership deed, the frequency of their meetings and decide the issues to be discussed in those meetings.
Profits of both LLP & Companies are taxed @ of 30% plus Surcharge and Cess applicable. Since, for income tax purposes, an LLP is treated at par with partnership, profits are taxed to LLP separately and not to partners. Thus, dividend distribution tax is not payable. Also, deemed dividend provisions under income tax law are not applicable to LLP.
In LLP, partners can directly manage the business whereas in case of companies there is no direct relationship between ownership and management meaning thereby that the shareholders appoint board of directors to run the affairs of company.
So, where the startup is intended to be managed by few partners making similar contribution and the objective is to have direct control over affairs, LLP is suitable option.
To conclude, it may be said that with lower compliances and lesser costs, LLP is a preferred route in the beginning of a business and later on with the changing requirements of business it can be converted into a company. However, there is no thumb rule that for startups only LLP or any other form of business is suitable. But the same is to be determined specifically on case to case basis by keeping in mind the factors like objective of founder, capital requirements, desired control over business etc.