December 5, 2021

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Advantages of incorporation of a company over partnership firm

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This article is written by Hritika Jannawar, pursuing Diploma in General Corporate Practice: Transactions, Governance and Disputes from Lawsikho. The article has been edited by Tanmaya Sharma (Associate, LawSikho) and Smriti Katiyar (Associate, LawSikho).

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To start any business is considered a mammoth of a task, but if a person is determined and certain in what fashion he wants his business to function in, half the battle is already won. Every entrepreneur has different needs in their endeavours. Some are more comfortable with mere Partnership while others want security and move ahead to adopt the Company model as the form for their business. While Company is considered the most favourable, still at the end of the day, it differs from entrepreneur to entrepreneur. This article at first discusses the nature of Partnership and Company and then dives into the Company’s advantages over Partnership.

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It is a Business carried out by two or more persons and agreed to share profits. Owners of Partnership firms are individually known as Partners and collectively as a firm. In India, it is not mandatory to register a partnership firm. However, it is deemed beneficial to register the firm under the ‘Partnership Act, 1932‘ to avail the legal benefits. Meaning if a Partnership firm is not registered, it cannot file a suit against a Third Party and a third party can file a suit against the firm, and the firm cannot claim Set-off against the third party. The Partnership deed is what governs the business and relationship between the Partners. The Profits by Partners are shared in the proportion of ratios agreed amongst them, and if not directed by any ratios, they share profits in equal proportions. This type of business structure in India is not recognized as a separate legal entity, and hence the Partner’s liability in Partnership firms is unlimited. 

Limited Liability Partnership is a Hybrid version of business Form. It consists of the characteristic nature of the traditional type of Partnership Firm as well as a Company. As a Company, the LLP is a Body Corporate forming a separate legal entity from its Partners, thereby limiting the liability of Partners. Like Partnership firms, the whole of the business is handled by the Partners directly and not corporate shareholders. An agreement between them governs the relationship of the partners. However, unlike Partnership Firm one Partner here is not responsible for the misconduct and negligence of the other Partner. The Minimum requirement of Partners herein is two, out of which one should be an Indian resident and no limit on the maximum number. It needs a Compulsory audit only if the contribution to LLP exceeds 25 Lakh or annual turnover exceeds 40o Lakh. The only disadvantage of LLP is that it is still considered less credible in India due to its close resemblance to Partnership Firm.

Company is a ‘Legal Corporation’ under whose name the business is carried out. It is a separate legal entity. To incorporate a company in India means to constitute a legal Corporation in India that strictly adheres to the provisions of the ‘The Companies Act, 2013‘. People who initiate the Company Set up are known as Promoters. As per the requirements of the promoters, they choose which type of Company they want to incorporate under the Act. Private Limited Company, Limited Company, unlimited Company, One Person Company, and Section 8 Company are the types of the Companies under the Act.

Other people involved in the business of the Company are the Directors (who manage the business of the Company) and the shareholders (who own stake in the Company)

Private Limited Company

Minimum 2 to a maximum of 200 members are required to constitute this type of Company. Shares of this type of Company cannot be traded publicly.

Company Limited by Shares – means a Company having a liability of its members limited by a Memorandum to the amount unpaid on the shares respectively held by them.

Company Limited by Guarantee – means a company has the liability of its members limited by Memorandum to the extent of such amount as agreed by the member to contribute at the time of winding up of the Company.

Unlimited Company –means a company does not have any limit on the liability of its members.

One Person Company

It is the new form of Company introduced with the advent of the Companies Act, 2013. In this form of Company, only a single person can form a Company as opposed to the incorporation of a Private Company or Partnership. Hence, it is favourable for entrepreneurs who want solely to control their business and not succumb to the risks of Sole Proprietorship. It forms a separate legal entity offering its members’ limited liability and continuity of business.

Limited Company

It requires a minimum of three directors and seven members are required to incorporate this type of Company. There is no limit on the maximum number of members here. This type of Company has more stringent compliance provided under the Act and other allied laws to follow when compared to Private Limited Companies. The Shares of this Company can be listed and traded on the stock exchanges freely, when listed it has to conform to the rules of SEBI (Securities and Exchange Board of India).

This type of Company is established for the promotion of objects such as commerce, Art, charity, Protection of the environment, etc. the profits out of this venture are applied for the promotion of these objects and intend to prohibit dividends to its members.

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Funding

For any business venture, the cornerstone of its building is funding. Acquiring funds for a company is more convenient as compared to a Partnership firm or LLP as they are seen to be less credible in India because they are seen as the extensions of their Partners only. Therefore, the Partnership firms are put under much scrutiny when accessing funds.

Companies as a Business form has two types of funding they could acquire

A) Equity and B) Debt (loans from Banks, other Creditors etc.).

When we consider equity, privately formed companies are again restricted to private members but could easily later transform into public Companies and get listed on the stock exchange to tap the market for public funding. IPOs, OFS, etc do it. It is where the Company offers the public number of shares in return for Money. Public Companies can also issue debentures both secured and unsecured to raise funds.

Partnership Firm, firstly, cannot access public capital and is considered less credible when accessing loans, making it a less favourable business vehicle.

Separate legal entity

A company is a separate legal entity as compared to a Partnership firm. Although LLP shares this quality with companies it still fails to meet the other advantages of the Companies as a Business form.

Owing to the fact that it forms a separate legal entity, it could buy, sell and own property. The Company can also be sued and sued in its name. This attribute of separate legal status has been also extended to One Person Company to support the entrepreneurs who can and want to single-handedly manage the business with the securities that Companies enjoy in the new Companies Act, 2013, which the Sole Proprietorship form of business lacked.

  1. Limited Liability – In a Company as a business form is chosen, it effectively limits the liability of the member to its contribution (their investment in shares of the Company), as a company itself is a registered entity and forms a different juristic person. If a member purchases 5 shares worth Rs. 500 each, then his maximum liability shall be INR 2500. Now there is a perk for a member in the case of closely held companies i.e. in a Private Company if a member cannot discharge his liability in a situation he can always settle his dues at the time of winding up of the Company. While under Partnership, all the Partners are jointly and severally liable for every act done in the name of the firm, which leads to unlimited liability which is kind of a risk entailing position.
  2. Perpetual Succession – In a Company even if the shareholder dies or is removed from the Company, the Company continues to exist. Changes in the management do not affect the identity of the Company. A company continues to exist until it is wound up, struck off or dissolved per applicable law. In the case of a Partnership Firm, unless the Partnership deed showcases any contrary intention, the firm is dissolved automatically on the death or insolvency of a Partner.
  3. Transferability of Shares – Shares are like movable property. They provide security of liquidity to its holders. They can be sold in exchange for money. The only difference is that it can be easily transferable in a Public Limited Company. While it is restricted to an extent it is not entirely impossible in Private limited Companies, as it is a closely held company, the introduction of new authority in management due to the owing number of percentage is thwarted at times. 
  4. Expertise – In the backdrop of Company set up the management and ownership are two different concepts unlike in Partnership. Hence, the promoters or shareholders are open to hiring experts in the field to manage the aspects of business and drastically increase efficiency.

Every Business form has its own pros and cons; it is ultimately upon the entrepreneur to decide in which case the pros outweigh the cons for his business. The One Person Company is also an attractive prospect for an entrepreneur to keep the reins in his hand while enjoying the securities of the Company. There are few misconceptions about Company incorporation meaning limited personal liability of shareholder means whatever a shareholder does his personal assets won’t be touched, so this is a wrong notion, for instance, if he signs his own name for authorizing a company transaction or guarantees a loan in his name or commits fraud, he shall be personally liable. It is also considered incorporating and then running Company requires insurmountable paperwork. However, to an extent, it is true if directly compared to a Partnership whose greatest advantage is the ease of formation. Still, like it was mentioned earlier, the pros of Company formation are more than the cons. The procedure is also streamlined hence can be completed correctly and quickly. Also, both Companies and Partnership firms are taxed at 30%, in fact for certain Companies having turnover below the prescribed limit are taxed at a lower rate. Moreover, there is no limit for minimum turnover to incorporate the business as a Company. Perusing the aforementioned comparison it is possible to incline towards the prospect of incorporating a Company.

  1. https://cleartax.in/s/company-incorporation-advantages last seen on 29/10/2021.
  2. https://uk.practicallaw.thomsonreuters.com/w-006-4210?transitionType=Default&contextData=(sc. Default)&firstPage=true

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