20 March 2023
When starting up, founders have to have a strategy in place in relation to a number of things, with one of them necessarily involving the figuring out of a mode of incorporation, i.e. the vehicle through which the founders aim to do business. Two vehicles between which the decisions of founders tend to oscillate are the Limited Liability Partnerships (“LLP’s”) and Private Limited Companies (“Companies” and distinguished from “Public Limited Companies” or “Limited Companies”)
This article aims to make you aware of the varied features of both the structures and guide you in the selection of a suitable one. The write-up does not provide a straight forward solution as to what is the ‘correct’ structure but aims to put forth various perspectives that should be analyzed while making this decision.
When is the right time to make the choice between LLP & Company?
As soon as you have validated your business idea!
Once validated, you should decide the legal structure of your business.
Comparison Chart: LLP vs. Company
The following table briefly compares the characteristics of the two business vehicles and helps you make a decision based on what factors are most crucial for your business:
|Applicable Law||Limited Liability Partnership Act, 2008 (“LLP Act”)||Companies Act, 2013 (the “Act”)|
|Charter Documents||LLP agreement||Memorandum and Articles of Association and certificate of incorporation.|
|Number of Partners/Members||Minimum – 2 Maximum – No limit||Minimum – 2 Maximum – 200|
|Liability of Partners / Member||Limited - indicating partners will not be personally liable for any debts of the LLP||Limited - indicating members will not be personally liable for any debts of the company|
|Legal Entity||Yes, can sue or be sued in the name of LLP||Yes, can sue or be sued in the name of the Company|
|Need to Appoint a key managerial person/Company Secretary||No||No, unless applicable|
|Board Meetings||Depends on the procedure prescribed in the LLP agreement||Mandatory, at least four (4) in every year|
|Shareholders Meeting||Not applicable||Mandatory|
|Preparation of Minute Book||Depends on the procedure prescribed in the LLP Agreement||Mandatory|
|Maintenance of Statutory Registers||LLP is not required to maintain any Registers, Records and Minutes unless specifically mandated by LLP Agreement. The partners are at liberty to decide the requirements.||A Company is required to maintain various Registers, Records and to Minutes of Board Meetings and General Meetings from time to time irrespective of doing business.|
|Conversion||Can be converted into a Company||Can be converted into LLP or any other class of Companies subject to certain restrictions as per the Act.|
|Directorship / Partnership||Foreign national can be a partner in the LLP subject to FEMA Regulations||Foreign national can be a Director in the Company.|
|Audit||LLP is required to get their accounts audited only if their annual turnover exceeds INR 40 Lakhs or capital contribution exceeds INR 25 Lakh||All Companies are required to get their accounts audited annually.|
|Withdrawal of capital||Partners can withdraw capital subject to LLP agreement. It is also possible for a partner to reduce contribution liability after giving notice to creditors.||Once paid up, capital cannot be withdrawn by shareholders without the approval of the court. Companies can buy back the shares subject to provisions of the Companies Act or transfer shares to others.|
|Management||LLP is managed by partners as per LLP agreement. Partners can delegate management power to a management team or single partner||Management of Company is vested with Board of Directors elected by shareholders|
|Taxability of Dividend in the hands of partner / shareholder||Profit distributed by an LLP is completely exempted in the hands of a partner.||Dividend from a Company up to INR 10 Lakhs is exempted in the hands of a shareholder. Dividend in excess of ₹10 Lakhs shall be taxable at 10% in the case of a resident individual/Firm.|
|Employee Stock Options Plans for attracting Employees||Not Applicable||Companies can issue Employee Stock Options Plans.|
|Funding||LLP cannot raise equity funding, as there is no concept of shareholding in an LLP. Investors would have to be provided an interest in the LLP, often through becoming partners in the LLP Agreement.||Private companies are preferred for external funding since shares can be issued against funds received (explained in detail below)|
|Listing||An LLP cannot ‘go’ public, in the sense that it cannot be listed on a stock exchange, which many investors view as a mode to exit from their interest in the entity.||Private companies can list their shares on the stock exchange and convert into a public limited company subject to provisions of Companies Act & SEBI Regulations|
Investors are usually more willing to invest in a business vehicle set up as a Company, since through certain arrangements (between the investors, founders and companies) the investors are able to gain the right to ‘control’ their investment. Investors are provided shares in the Company for their investment. To protect their investment, Indian laws allow freedom to the Company to structure share issue and allotment to investors in a manner that is mutually beneficial to both. The investors gain important rights such as the right to vote on certain business decisions, appoint their nominee directors on the board of the Company, gain access to sensitive financials and financial information of the Company.
Shares are of two types; equity and preference. Equity shareholding (if) provided to investors gives them a percentage share in the equity of the Company. The more the share, the more control investors as equity shareholders will have.
However, if the investment by the investors provides them a lion’s share in the equity of the Company, the founders who started the business may not have any interest in running the business itself, as their proportional ownership of the shares is not as high as it was before the investment was made. E.g.: An investor may invest INR ‘x’ in the equity share capital of the Company, taking the equity ownership of the founders down from 90% to 50%. To counter such situations, Companies are allowed to issue preference share capital to investors. Investors may still invest the same amount, however, the founders do not lose their stake in the equity of the company post investment. Preference shares can be issued in a manner that allows the investors to either be paid; i) dividends before equity shareholders; ii) interest payments; iii) right to convert to equity at a future date at a pre-determined value and other such superior rights in a Company.
Business: Product or Service?
An equally important consideration to keep in mind is the business itself. Businesses are of primarily two types: those that offer products or provide services.
Products mostly adhere to a standard that is common for all, i.e. for those that sell it and for those that buy it (think of wallets – to keep your money in, uber – a product to hail rides, Zomato – a product providing restaurant listing services). Its easier to scale production with an increase in availability of resources. In such cases, a private limited company could be a better option.
Services, on the other hand, are a customized offering to the customers/market of a startup, and are dependent on the manual labour and inputs of a professional (think a marketing, advertising, legal or finance firm). Services mostly depend on professionals and need to be customized progressively more when offering the services to a larger market, i.e. scalability is a challenge. LLP structures are more suited in such cases.
Therefore, you’d have to know the nature of your business, which if considered in the manner just stated, is an easier choice to make – and helps deciding whether to choose either a Company, or an LLP as the preferred business vehicle.
SaaS is an interesting category, which would depend on how customized or standardized the software itself needs to be. Moreover, at Treelife we have observed that often a SaaS could start out as a service, but as the business itself matures/grows, it could take on the nature of a product. For example, a startup could enter into agreements which allow their offering to be tailored to a specific need, but later on could diversify the same offering for a larger market.
We hope that this analysis into the nature of the business, funding preferences and the comparative features of the two structures, mentioned above, would help you in deciding between setting up a private limited company or LLP!
This article has been prepared for general guidance and information on the subject matter and does not constitute professional advice. The matters described herein are general in nature and you should not act upon the information contained in this note without obtaining specific professional advice. No representation or warranty (express or implied) is given as to the accuracy or completeness of the information contained in this note. The author of the article and Treelife Consulting accept no liability, and disclaim all responsibility, for the consequences of you or anyone else acting, or refraining to act, in reliance on the information contained in this publication or for any decision based on it. Without prior permission of the author / Treelife, this note may not be quoted in whole or in part or otherwise referred to any person or in any documents.
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