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Choose the right business model
The
right idea is only the birth of a business. Running it successfully will
depend on how you structure the company. Here are five business models and
what you should consider before choosing one.
1. Proprietorship
Ideally, you should opt for a proprietorship if you are
setting up a small business. Also, if you are not sure of how your venture
is likely to develop, you can start by setting up a proprietorship and
later, explore other business structures.
2. Partnership
You could opt for a partnership firm if yours is a
medium-sized business with limited capital, such as a small-scale industry
or retail trade. Partnership is a popular form of business among smaller
concerns too like transport or real estate agents. However, it is best
suited for professionals like chartered accountants or lawyers, who can
team up to offer their services.
3. Company
A company is not easy to form and run. So, opt for it
only if you need to issue stocks and obtain investment capital. You may
also form a company if you want to save tax. As a company is a separate
entity, you can split your income by keeping some profits in the
corporation every year and save tax accordingly. If, however, your only
motive to form a company is to limit your liability, you could explore the
option of limited liability partnership An LLP or limited liability
partnership is a hybrid of a company and a partnership.
4. Franchise
You can buy a franchise if you are
averse to risk and want handholding in the initial years in
the business. If you are someone who
doesn’t know much about running a business and wants
an expert to handle the legal, financial
and marketing matters, this is the best option for you.
5. Trust
A trust is best suited for family businesses, where you
want to create a structure that preserves assets for future generations.
You could also use a trust where you want to retain long-term control over
the management of the business.
FOR DETAILS READ THE FULL ARTICLE
There
are numerous people who want to explore their entrepreneurial side and have
a good idea of what they want to do, but are stumped as to where to start
and how to set up the venture.
Each type of business model
comes with its benefits and bugs, from the procedures and approvals
required to set up the venture to how its income will be taxed. “The kind
of set-up you choose will depend on a variety of factors, such as your
business, the amount of risk you can afford to take, legal provisions and
liabilities. Do your homework carefully before you choose a particular
organisation type,” advises Aakanksha Joshi, senior associate, Economic
Laws Practice.
This is why choosing the right type of business
set-up is the first crucial step of your entrepreneurship path. You need to
understand the key features of each type and analyse the advantages and
drawbacks so that it gives you a comprehensive idea of whether the business
model will serve your purpose.
To help you get started, here’s a ready reckoner
that lists the characteristics of the five most common organisational
set-ups.
Proprietorship
This is the simplest business type. As you don’t
need to fulfill any legal formalities, you can simply set up shop and start
a proprietorship on your own. You may need to acquire some
business-specific approvals, depending on the type of business, such as a
tax identification number (TIN) if you want to manufacture products or
become a dealer. However, these are fewer than what are needed if you start
a company.
PROS AND CONS
While a proprietorship gives you immense flexibility to carry out your
business the way you want to, it also brings with it huge responsibilities.
Firstly, you will be legally responsible for anything and everything.
Secondly, you will be personally responsible for any fraud or credit
default that may occur in the course of business. Besides, as a
proprietorship does not have a separate identity distinct from its owner,
you can be personally sued for matters that go wrong in the business.
Moreover, the risk levels are extremely high as you are solely running the
business, especially as in the case of credit default, unsatisfied
creditors can ask you to clear their debt by selling your personal
property. Apart from this, the income that you earn from your business will
be clubbed with your personal income, so your tax liability could be very
high. This is why a proprietorship is not a very tax-efficient business
set-up.
WHO SHOULD GO FOR IT?
Ideally, you should opt for a proprietorship if you are setting up a
small business. Also, if you are not sure of how your venture is likely to
develop, you can start by setting up a proprietorship and later, explore
other business structures. This is exactly what Mumbai-based Rakesh Nanda
did when he started his flex printing business in 2008. “Initially, I
wasn’t sure whether my business would take off, so a proprietorship seemed
ideal. However, after nearly five years in the business, I am now exploring
the option of setting up a private limited company,” says the 25 year old.
Partnership
In the degree of simplicity, this comes second. A
partnership is basically a relation between two or more people who come
together to run a business and share the profits earned. The organisation
so formed by the partners is known as a partnership firm. The legal
formalities to set it up are minimal. All you have to do is execute a
partnership deed that clearly spells out the rights and duties of all
partners as well as specifies the share of each partner in the profits. A
partnership deed can also list the terms and conditions under which the
partners will work, the amount of capital to be contributed by each
partner, how much they will earn from the business, and so on. You should make
sure that the deed is signed by all partners to avoid trouble in the
future. Though registration is not mandatory, it is highly recommended that
you register the firm.
There are some inherent features of this kind of
set-up. Firstly, a partnership firm is not a separate legal entity like a
company. In the eyes of the law, the firm and its partners are one and the
same. This leads to the principle of unlimited liability of the partners.
So, in case of credit default, creditors can proceed against the personal
property of partners as well, similar to what’s possible in the case of
proprietorship. Besides, if a partner wants to leave the firm and transfer
his interest to a third person, he will need to get the consent of all the
other partners to do so. A bigger problem is that a partnership firm will
automatically dissolve in case of lunacy, bankruptcy, retirement or death
of any partner. Despite this rigidity, the most positive aspect is that all
partners have a right to participate in all the activities of the business
and have the right to share in the management of the partnership firm. So,
any partner can inspect the account books at any time.
PROS AND CONS
A partnership firm is very easy to form, which is one of its biggest
plus points. Also, individual partners have greater access to capital and
resources. However, there are a few drawbacks that must be considered.
Firstly, there is a restriction on the number of partners. For instance, a
banking business cannot have more than 10 partners, while for most other
partnerships the maximum number is 20. Secondly, the absence of an absolute
authority can lead to slow decision-making and ultimately hamper the
business. Moreover, partners can lose their personal assets as well in case
of credit default due to the unlimited liability factor. To add to this,
each partner is also responsible for the actions of other partners, which
could prove to be a precarious situation. Since the death, insolvency or
lunacy of any partner would automatically dissolve the firm, it means that
such firms have a limited lifespan.
WHO SHOULD GO FOR IT?
You could opt for a partnership firm if yours is a medium-sized
business with limited capital, such as a small-scale industry or retail
trade. Partnership is a popular form of business among smaller concerns too
like transport or real estate agents. However, it is best suited for
professionals like chartered accountants or lawyers, who can team up to
offer their services.
Company
The term company is used very casually to refer to
any type of enterprise. However, a company is actually very well defined
and has to conform to various rules prescribed under The Companies Act,
1956. In simple terms, a company is an association of individuals who share
a common purpose and unite to achieve specific, declared goals. A company
can be formed by individuals or even a corporate body, also known as
promoters. There are several types of companies, such as private limited,
public, non-profit making, etc, from which you could choose the one that
suits you. Generally, most start-ups opt for a private limited company.
A private company is one that cannot invite
deposits from the public and the transferability of its shares is
restricted. Such a company is exempt from complying with certain provisions
of The Companies Act since public interest is negligible in its affairs. On
the other hand, a public company is one that has a minimum paid up capital
of 5 lakh. There is no restriction on the transferability of its shares;
anybody can buy the shares or debentures of a public company, which are
quoted on stock exchanges. The provisions of The Companies Act are fully
applicable on these companies.
Setting up a company is a complex process and
involves a lot of paperwork. To start with, you have to zero in on a name,
which isn’t easy as you have to first apply to the Registrar of Companies
of your state to check the availability of the name. After you receive
confirmation on the name, you have to start other paperwork. These include
assigning a Director Identification Number to each director and applying
for digital signatures for directors.
You also need to draft the memorandum of
association and articles of association that list the objectives of the
company. Since these documents state the fundamental provisions on which
the company is incorporated as well as the bylaws and regulations that
govern the management of the company, it is best that you get an expert to
help you draft them. You must register all documents pertaining to the formation
of the company and pay the registration fee, which depends on the capital
of the company. You can get the requisite information from the website of
the Ministry of Corporate Affairs (mca.gov.in).
After all the formalities are completed, the registrar
will issue a Certificate of Incorporation within seven days of receiving
the documents. In the case of a private limited company, you may commence
business from the date of incorporation. However, in case of a public
company, you will have to obtain a certificate of commencement of business.
Even after the company has been formed, there are many other formalities
that have to be followed, such as conducting board meetings and annual
general meetings.
PROS AND CONS
Despite the lengthy and time-consuming procedure for forming a company,
there are several advantages that this business set-up offers. Unlike other
models, a company is treated as a separate legal entity—distinct from its
shareholders, directors and managers—by the law. This special feature lends
the business structure its main characteristic of limited liability. So, if
there is a credit default, personal assets of directors and shareholders
remain protected. Also, this feature allows a company to sue other
entities. It were these features that prompted Aadil Muscatwala and Rishabh
Gupta to form a company when they established a chain of budget hotels
called Vedanta Wake Up! in 2011. “Besides, it is easier to attract
investors if you have a more structured organisation (that is, a company),”
says Mumbai-based Muscatwala. Also, a company is not affected by the death
of a shareholder or director and its shares can be easily transferred.
However, running a company can be a costly affair. Even winding it up is an
expensive process.
WHO SHOULD GO FOR IT?
A company is not easy to form and run. So, opt for it only if you need
to issue stocks and obtain investment capital. You may also form a company
if you want to save tax. As a company is a separate entity, you can split
your income by keeping some profits in the corporation every year and save
tax accordingly. If, however, your only motive to form a company is to
limit your liability, you could explore the option of limited liability
partnership An
LLP or limited liability partnership is a hybrid of a company and a
partnership. So, similar to a company set-up, partners have limited
liability as the firm is a legal entity separate from its partners and has
perpetual succession. Also, the process for incorporation of an LLP is
similar to that of a company. However, for taxation purposes, an LLP is
treated like a partnership firm.
Franchise
Buying
a franchise lets you be your own boss without the added worries regarding
ideation, brand building, infrastructure and legal problems. You don’t need
to start from scratch since the franchiser is an already established brand
that would allow you to sell its products and to operate under its brand
name. Of course, this also comes with stringent rules regarding how the
workplace will look, the products that will be used and the programme menu
that will be implemented. The business structure is such that there is
little scope for innovation as franchisers would like to maintain
consistency across all franchisees.
The greatest appeal of the franchise model, apart
from the immense support and established brand name, is that you can find a
business to suit all pockets, no matter which industry you want to set foot
in. Of course, the bigger the brand, the higher is the cost of buying the
franchise. So, a small street food kiosk could be owned for as little as 5
lakh, while you may have to invest 30 lakh for a large Chinese food joint.
This one-time investment is a collation of various charges, including the
setting up of infrastructure as well as hiring of employees and their
uniforms. It also includes a franchise fee and a refundable security
deposit. For instance, if you take a Cocoberry franchise, you will have to
invest 20-30 lakh, depending on the location. This includes a deposit for 5
lakh, while the royalty is in the range of 5-9% of your profit.
Apart from the basic investment, as a franchisee,
you will have to shell out a royalty, which typically ranges from 5-30%.
This can be paid quarterly, monthly, annually or only once. Royalty is an
important aspect of a franchise model as it has an impact on the profit you
earn. Another expenditure that you will have to bear on your own is the
rent. Given these expenses, it will take a while before you break even.
However, the good part is that break-even periods are usually established
or projected by the company, so you’ll have a reasonable idea about when
you could start pocketing your own salary.
PROS AND CONS
A franchisee gets the opportunity to benefit from the well-known brand
name and goodwill of the franchiser, which is a considerable advantage
considering that these are things that are very hard for a new business to
build from scratch. Besides, the franchisee also gets to benefit from tried
and proven business systems that the franchiser has established. If you
were to venture out on your own, it would take a considerable period of
time to build your own systems. “As I lacked the practical experience of
building a brand, the franchise model seemed the best possible option,”
says Mary. On the other hand, the model does not encourage thinking out of
the box. So, it could be a little frustrating for highly enterprising
people who want to try out innovations.
WHO SHOULD GO FOR IT?
You can buy a franchise if you are averse to risk and want handholding
in the initial years in the business. If you are someone who doesn’t know
much about running a business and wants an expert to handle the legal,
financial and marketing matters, this is the best option for you.
Trust
Generally a trust is associated with estate
planning or charity, but it can also be used as a business model. This is
how it usually works: A company is formed to carry on the business, and
then a trust is created as its majority shareholder. So, the trustees would
primarily be responsible for the management of assets and business for the
benefit of the company. Forming a trust is not a complicated process. All
you have to do is execute a trust deed that lists the terms and conditions
on which the trust would function. Besides, the trust deed also
incorporates the powers and duties of the trustees. In cases where the
trust is revocable, the trust deed should also specify how and when the
trust would be revoked.
“The main idea behind opting for a trust is
ring-fencing of assets and retaining control over the business,” says Richa
Karpe, director, investments, Altamount Capital. Your company may get into
trouble or there may be huge losses in your family business, but the assets
that you put into the trust will remain safe. This way at least a portion
of your wealth is secure. A trust also offers you tremendous control over
your assets as compared with a company. In a company set-up, promoters may
not be able to give detailed instruction to directors to act in a certain
manner, but this kind of mandate can be given to trustees. This feature is
especially useful for family and private businesses.
PROS AND CONS
While a trust allows you to retain control over your assets, choosing
the right trustees and beneficiaries can be a daunting task. “A wrong
trustee or beneficiary can defeat the very purpose of setting up the
trust,” says Karpe. Another disadvantage of using trusts is that you cannot
pull out an asset that you have put into a trust. Also, people who own
several companies that are listed on the stock exchanges need to be careful
as to how they use their trusts. Most ultra HNIs, who own such companies,
are advised to create a holding company. As they would also want to ensure
that their assets are secure for the generations to come, they can create a
family trust above the holding company to complete the succession planning.
The family trust will hold personal as well as holding company assets. This
structure can help a business family meet long-term succession, taxation
and personal objectives.
WHO SHOULD GO FOR IT?
A trust is best suited for family businesses, where you want to create
a structure that preserves assets for future generations. You could also
use a trust where you want to retain long-term control over the management
of the business.
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