How to open a company ? What are the types of companies which can be opened in India ?

Understanding Partnership Businesses

When one is starting a business, one may form a sole proprietorship when the business is small. The problem with this kind of business is that it cannot grow beyond a certain limit. This is because a sole proprietorship will not be readily sponsored by banks other sources of finance.

Also the amount of money that the sole proprietor can contribute to the business “alone” is not very high. Besides this, the sole proprietor has to take wise decisions in running the business. If he is unable to do so, the business will not be very successful and will not grow.

A sole proprietor might be an expert at marketing or might be technically strong. But it is not likely that he will be strong in all the fields that are important for making wise and successful business decisions.

For all the above reasons, one may choose to form a partnership firm right from the start or later change their firm to a partnership firm. So, one may start a partnership firm with the objective of pulling in people so that more capital is generated or making specifically skilled people partners so that wise business decisions may be made.

Before a partnership is formed, a “partnership deed” should be prepared. This partnership deed may be oral or in writing. However it is wise to make sure that the partnership deed is in writing so that future conflicts may be resolved. More about the partnership deed shall be explained ahead.

To understand all the characteristics of a partnership consider the following:

Two or more members:

At least two members are required to start a partnership business. But the number of members should not exceed 10 in case of “banking business” and 20 in case of “other business”. If the number of members exceeds this maximum limit, then that business is not called as a partnership business legally. (All the rules stated in this complete article are for a business in India)

Partnership agreement:

Whenever you think of starting a partnership business, there must be an agreement between all the partners. 

This agreement must contain-

The amount of initial capital contributed by each partner

Profit or loss sharing ratio for each partner

Salary or commission payable to the partners, if any

Duration of business, if any

Name and address of the partners and the firm

Duties and powers of each partner;

Nature and place of business; and

Any other terms and conditions to run the business

The partnership deed is usually not very hard to prepare through a trusted local lawyer.

Lawful business:

The partners should always carry on any kind of lawful business. To start a business in smuggling, black marketing, etc., is not termed as a partnership business in the eye of the law. Again, doing social work is not termed as a partnership business.

Competence of partners:

Since individuals join hands to become partners, it is necessary that they must be “competent” to enter into a partnership. Thus, minors, lunatics and insolvent people are not eligible to become partners. However, a minor can be admitted to the benefits of partnership i.e., he can have a share in the profits only.

Sharing of profits:

The main objective of every partnership firm is to make and share the profits of the business. In the absence of any “agreement” for profit sharing, it should be shared “equally” among the partners. Suppose, there are two partners in the business and they earn a profit of Rs.20,000. They may share the profits equally i.e., Rs.10,000 each or in any other agreed proportion, say one forth and three fourth i.e. Rs.5,000/- and Rs.15,000/-

Unlimited liability:

Just like a sole proprietorship, the liability of partners in a parnership is also unlimited. This means, if the assets of the firm are insufficient to meet the liabilities, the personal properties of the partners, if any, can be utilized to meet the business liabilities. Suppose, the firm has to make payment of Rs.25,000/- to the suppliers for some goods. The partners are able to arrange for only Rs.19,000/- from the business. The balance amount, of Rs.6,000/- will have to be arranged from the personal properties and assets of the partners.

Voluntary registration:

It is not compulsory that you register your partnership firm. However, if you don’t get your firm registered, you will be deprived of certain legal benefits, therefore it is desirable to register. The effects of non-registration are:

Your firm cannot take any action in a court of law against any other parties for settlement of claims.

In case there is any dispute among partners, it is not possible to settle the disputes through a court of law.

Note: Registration is voluntary in most states. However it would be best to check up the rules of your state to be sure. In states like Maharashtra, registration is almost compulsory.

No separate legal existence:

Just like sole proprietorships, partnership firms also have no separate legal existence from its owners. The partnership firm is just a name for the business as a whole. If somone sues the firm, it is as good as someone sueing all the partners.

Restriction on transfer of interest:

No partner can sell or transfer his share or part or parnership of the firm to any one without the consent of the other partners. For example, A, B, and C are three partners.If “A” wants to sell his share to “D” as his health problems prevent him from working, he can not do so until B and C both agree.

Continuity of business:

A partnership firm comes to an end at death, lunacy or bankruptcy of any partner. Even otherwise, it can stop it’s business at the will of the partners. At any time, they may take a decision to end their partnership.

Understanding joint stock companies (Private & Public Limited)

In a partnership, there can be a maximum of 20 people. Because of this limit, the amount of capital that can be generated is limited. Also, because of the unlimited liability of partnerships, the partners may be discouraged from taking huge risks and further expanding their business. To overcome these problems a public or a private company may be formed.

Private and public companies are much better investments because of “Limited liability”. This means that if an investor has invested Rs.1000/- in a particular company, and the company goes bankrupt, the investor only looses the money he has invested. To pay of the debt, the investors property, bank accounts etc. are "not" used.

Because of this limited liability, many investors are interested in investing in these private or public companies. Hence, a large capital can be generated and a huge business can be run.

The major disadvantage of Private and Public companies, is that they have a costly and elaborate process of setting up. They are also closely regulated by the government.

So what are Public or Private companies?

These companies are also know as “joint stock companies”. The companies in India are governed by the Indian Companies Act, 1956. The Act defines a company as an artificial person created by law, having a separate legal entity, with perpetual succession and a common seal.

What this means is that, the company “is different” from the investors. The investors put in money and capital is raised. But the company is treated as a virtual person. The company is treated as a person who is different from it’s investors. The company has an identity of it’s own. If some one sues the company, he does not sue the investors, he sues the virtual person that is the company.

To understand the concept of joint stock (private and public limited) companies, consider the following characteristics:

Legal formation:

No single individual or a group of individuals can start a business and call it a joint stock company. A joint stock company can come into existence only when it has been registered after completion of all the legal formalities required by the Indian Companies Act, 1956.

Artificial person:

Just like an individual takes birth, grows, enters into relationships and dies, a joint stock company takes birth, grows, enters into relationships and dies. However, it is called an artificial person as it’s birth, existence and death are regulated by law.

Separate legal entity:

Being an artificial person, a joint stock company has its own separate existence independent of it’s investors. This means that a joint stock company can own property, enter into contracts and conduct any lawful business in it’s “own” name. It can sue and can be sued by others in the court of law. The shareholders are “not” the owners of the property owned by the company. Also, the shareholders cannot be held responsible for any of the acts of the company.

Common seal:

A joint stock company has a “seal”, which is used while dealing with others or entering into contracts with outsiders. It is called a common seal as it can be used by any officer at any level of the organization working on behalf of the company. Any document, on which the company's seal is put and is duly signed by any official of the company, becomes binding on the company.

For example, a purchase manager may enter into a contract for buying raw materials from a supplier. Once the contract paper is sealed and signed by the purchase manager, it becomes valid. The purchase manager may leave the company or may be removed from his job or may have taken a wrong decision, yet, the contract is valid till a new contract is made or the existing contract expires.

Perpetual existence:

A joint stock company continues to exist as long as it fulfills the requirements of law. It is not affected by the death, lunacy, insolvency or retirement of any of it’s investors. For example, in case of a private limited company having four members, if all of them die in an accident, the company will “not” be closed. It will continue to exist. The shares of the company will be transferred to the legal heirs of the members.

Limited liability:

In a joint stock company, the liability of a member is limited to the amount he has invested. While repaying debts, for example, if a person has invested only Rs.10,000 then only this amount that he has invested can be used for the payment of debts. That is, even if there is liquidation of the company, the personal property of the investor can not be used to pay the debts and he will lose his investment worth Rs.10,000.

Democratic management:

Joint stock companies have democratic management and control. Since in joint stock companies there are thousands and thousands of investors, all of them cannot participate in the affairs of management of the company. Normally, the investors elect representatives from among themselves known as ‘Directors’ to manage the affairs of the company.

The above description must have given you an idea about public and private limited companies in general. There are some special characteristics of Public and Private limited companies that must be understood. There are given below.

Special characteristics of Private Limited Companies

These companies can be formed by at least two individuals having minimum paid-up capital of not less than Rupees 1 lakh.

As per the Companies Act, 1956 the total membership of these companies cannot exceed 50.

The shares allotted to it’s members are also not freely transferable between them.

These companies are not allowed to raise money from the public through open invitation.

They are required to use “Private Limited” after their names.

The examples of such companies are Combined Marketing Services Private Limited, Indian Publishers and 

Distributors Private Limited etc.

Special characteristics of Public Limited Companies

A minimum of seven members are required to form a public limited company.

It must have minimum paid-up capital of Rs 5 lakhs.

There is no restriction on maximum number of members.

The shares allotted to the members are freely transferable.

These companies can raise funds from general public through open invitations by selling its shares or 

accepting fixed deposits.

These companies are required to write either ‘public limited’ or ‘limited’ after their names.

Examples of such companies are Hyundai Motors India Limited, Jhandu Pharmaceuticals Limited etc.

Understanding Sole Proprietorships

A sole proprietorship is the most common type of business. There are sole proprietorships everywhere. Small grocery stores, STD booths are mostly proprietorship businesses.

A “Sole Proprietorship” business means that there is only ONE owner. There may be employees or helpers hired under the owner, but there is only one “head” who administers and runs the show.

The definition of a Sole Proprietorship is: A business enterprise exclusively owned, managed and controlled by a single person with all authority, responsibility and risk.

The basic advantage of a sole proprietorship is that since you are the only owner, you are free to run the business just the way you want to run it. Also, in a sole proprietorship you get to keep all the profits.

The biggest disadvantage is that there is “unlimited liability” on the “Sole Owner”.

What is the meaning of unlimited liability?

In the case of “Sole Proprietorship”, the Govt. does not see any difference between the firm and the individual. If you are a plumber named Raju Sharma and you start a plumbing service firm called “Flush” which is a sole proprietorship, the government does not differentiate between “Flush” and “Raju Sharma”

This means that if someone sues “Flush” and “Flush” owes that person a huge sum of money, it is as good as Raju Sharma owes that person a huge sum of money. Raju Sharma's bank accounts, property and even his house may be used to settle the claim.

This is the biggest disadvantage of sole proprietorships. Because of this reason, sole proprietorships are generally started if the business is small and there is “not much risk involved”.

If the concept of unlimited liability is not clear, dont worry. It shall be cleared when you consider the other kinds of business.

To properly understand the nature of a sole proprietorship, here are a few characteristics of a sole proprietorship explained in detail:

Single Ownership:

A single individual owns the sole proprietorship! That individual owns all the assets and properties of the business. He alone bears all the risk of the business.

  

No sharing of profit & loss:

The entire profit out of the sole proprietor ship business goes to the sole proprietor. If there is any loss, it is also borne by the sole proprietor alone. Nobody else shares any of the profit and loss of the business.

Low capital:

The capital required by a sole proprietorship is totally arranged by the sole proprietor. He raises the capital either from his personal resources or by borrowing from friends, relatives, banks or financial institutions. Since there is only one person raising capital, very low capital can be raised.

One-man control:

The controlling power in a sole proprietorship business always remains with the owner alone. The owner or proprietor alone takes all the decisions to run the business. He may take decisions though a consultant or some advice, but the final decisions are always in his hand.

Unlimited Liability:

The liability of the sole proprietor is unlimited. This implies that, in case of loss the business assets along with the personal properties of the proprietor shall be used to pay the business liabilities.

Almost no legal formalities:

The formation and operation of a sole proprietorship requires almost no legal formalities. However, the owner may be required to obtain a license from the local administration or from the health department of the government, whatever is necessary depending on the nature of the business.

How to Incorporate?

What is Incorporation?

When starting a company, once the company idea is decided, and the company is about to start business, the first thing that needs to be done is, the company has to be registered. After the company is registered with the Govt., then it can start business. The process of registering a company is known as incorporation.

Most of the people reading this article are entrepreneurs. They have decided to start their own business. If you are one of them, we strongly suggest that you read the “How to start a company?” article. That article covers all the basics you need to consider and know before you think about starting the business.

“This” article talks about how you should go about the process of turning your business idea into a registered business. It talks about the various kinds of options available and gives you the information that you will require while making these choices.

If you are starting a business, there are different kinds of legal structures among which you can choose your business to be.

These are:

A Sole Proprietorship

A Partnership Firm

A Private & Public Limited Company

You could move directly to the kind of legal structure you are interested in if you know what you want. If you are not sure, we suggest you read though all the structures. This will give you a much better idea about what choices you have.

Note: Even though, forming sole proprietorship and partnership firms are not technically referred to as incorporation, we have explained them too in this article for the benefit of everybody.