Wednesday, October 3, 2007

When is a sole proprietorship appropriate in India ?

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When you are toying with your first business idea, the initial costs and procedural encumbrances associated with company formation in India may deter you. While a company (private or public limited) structure offers its directors and promoters a certain amount of security should things turn sour with the business, a sole proprietorship format can work just fine under the right conditions.

In India, the majority of businesses are sole proprietorships. Obviously, we are mainly talking about small, one man or family businesses. A sole proprietorship, by definition, has a single owner, who has total control over the business. In the eyes of the law, the proprietor and the proprietorship are one and the same.

What this means is that the proprietor is entitled to all the profits of the proprietorship business. On the flip side, he or she is totally personally liable for any loss, debt or liabilities of any other kind. Should the business go bankrupt, the proprietor’s personal assets could be at risk.

That being said, this business structure offers several advantages, simplicity and ease of operation being the foremost.

There are hardly any formalities to starting a sole proprietorship. There is no need for registration with the Registrar of Companies, and therefore, no requirement of filing a Balance Sheet with them each year. Neither is there a need for elaborate accounting and auditing
It costs next to nothing to set one up. Since the proprietor’s personal finances are the principal source of funding, this is a pretty big plus point. It can be set up very quickly, as opposed to establishing even a simple private limited company that can take a few weeks. And best of all, the proprietor is assured of total control over the business and complete confidentiality.

A sole proprietorship makes good sense if the business has these characteristics:
  • Is small in scale
  • Is relatively risk free – for example a small business which does not intend to tak on major liabilities
  • Is not geographically diversified
  • Is heavily dependent on one individual.

Importantly, there are certain precautions that the proprietor can take to protect his or her financial position:

  • Make sure your personal financial assets are protected through legal structures, should your business run into trouble. Your chartered accountant should be able to advise you on this matter
  • Insure fixed assets, equipment etc. that may have been purchased for the business.
    Take adequate life / health / accident insurance cover for the proprietor.

So, if you think that you can manage the risks quite comfortably, you can choose to start the business as a proprietorship concern. But sooner or later, you will have to switch to a more complex structure when your capital and human resource/expertise requirements expand. Last but not least, a company structure ensures business continuity, whereas a proprietorship ceases when the proprietor is no more.

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