Types of Enterprises in India: Sole Proprietorship, Partnership, Limited Liability Partnership

In this post I’m going to talk about the different types of enterprises in India, and also about the difference between an “enterprise” and an “establishment”. These concepts are necessary for grasping the data collected in the Economic Census and various NSS surveys (we’ll talk about these in future posts), which is then used to make NAS estimates. 

Enterprise Vs. Establishment

What is an Enterprise? 

An institutional unit in its capacity as a producer of goods and services is known as an enterprise. An enterprise is an economic transactor with autonomy in respect of financial and investment decision-making, as well as authority and responsibility for allocating resources for production of goods and services. It may be engaged in one or more economic activities at one or more locations. An enterprise may be a sole legal unit. (from the 5th Economic Census)

What is an Establishment?

The establishment is defined as an enterprise or part of an enterprise that is situated in a single location in which one or predominantly one kind of economic activity is carried out. It is an economic unit under a single legal entity. (from the 5th Economic Census)

Examples please!

Let’s use examples to better understand the difference between an enterprise and an establishment. The State Bank of India (with all its branches spread all over the country) for example, is a single enterprise unit. Its individual branches are establishments. The “Big Chill Cafe” chain of restaurants is an enterprise. The Big Chill Café at Khan Market is an establishment. The small mom and pop store in your neighbourhood (the only one that the owners have) is an establishment as well as an enterprise. Most small businesses in India have just one location, so the establishment = the enterprise in their case. The distinction between establishment and enterprise becomes important for larger, multi-location, multi-activity businesses. 

Why the distinction matters

The reason that this distinction is important to us is because when the Economic Census is conducted in India, it counts establishments. When NSS surveys are conducted, they usually sample enterprises. Sometimes these terms are used interchangeably, and sometimes they’re not. We’ll talk more about this later, but for now, suffice it to say, one must be aware of the distinction. 

Different types of Enterprises in India

1. Sole proprietorship

“Sole Proprietorship” is an enterprise that is owned by a single person and is not registered as a Corporation, Partnership or Limited Liability Partnership (LLP) (Partnerships and LLPs have at least 2 owners). There is no legal distinction between the owner (proprietor) and the business in the case of a Sole Proprietorship. The owner receives all business profits and has “unlimited liability” for all business debts, claims, losses etc. This means that his personal assets can be attached to meet business claims. 

Easiest type of Enterprise to start in India

A Sole Proprietorship is the easiest type of enterprise to start in India. The PAN (Permanent Account Number) of the owner serves as the PAN for the Sole Proprietorship; no separate PAN is needed. No “blanket” registration with the government is needed, so to speak, the way it is for a Company for instance (needs to be registered under the Companies Act, 2013). Registrations with the government are done only on a requirement basis. For example, if a proprietor is involved in selling goods and VAT is applicable on the sale of those goods, he has to obtain a VAT registration. This has to be done by all type of businesses in India that sells goods. Similarly, if the proprietor is involved in selling a service and service tax is applicable (independent lawyers don’t have to pay service tax for instance), then registration with the service tax department is needed. 

When is Sole Proprietorship a good structure for an Enterprise?
Sole proprietorship is a good form of enterprise when the associated business is small. It is the easiest to start, has the lowest compliance and capital requirements and the owner has full control.

Examples please!

Examples of Sole Proprietorships include: 1) a lawyer, accountant, financial consultant, wedding planner, photographer, plumber etc. who works alone and owns his own service business 2) any of the above who is the sole owner of his service business and employs others as well 3) The sole owner of a small manufacturing business that provides employment to others as well. 

Disadvantages of a Sole Proprietorship

A Sole Proprietorship’s key disadvantage is its small business size. Due to this reason, 1) it is hard for a proprietor to access capital (banks are more cautious to lend), talent and expertise 2) a proprietorship is more risky/less stable that a larger, better-funded enterprise 3) the business is hard to scale/grow. 

2. Partnership

Under the Indian Partnership Act, 1932, a "Partnership” is defined “an agreement between two or more persons who have agreed to share profits of the business carried on by all or any one of them acting upon all." Here are some of the key characteristics of a Partnership enterprise (as laid down by the Indian Partnership Act, 1932 that governs all Partnerships in India). 

• Needs at least 2 members: At least two members (or Partners) are needed to start a Partnership enterprise. For a partnership enterprise involved in the banking business, the number of members should not be >10; for other businesses, the number of members cannot be >20. 

•  Requires a Partnership Agreement, written or oral: A written Partnership Agreement, also called “Partnership Deed”, is preferable so that any disputes arising between partners may be more easily resolved in the future. A Partnership Deed usually includes names of partners of the firm along with their addresses, capital contributions of partners, profit sharing ratios for each partner, duties and rights of partners, salaries/ commissions to be paid to partners, duration of partnership, procedures to be employed while addressing disputes between partners etc. 

• Unlimited liability of partners: This means that partners are personally liable to meet claims made on the Partnership. Their personal assets can be attached to meet such claims/liabilities. 

• Profit sharing: Profits of a Partnership are shared between partners based on the rules laid down in the Partnership Agreement. In case there is no formal agreement on profit sharing, the profits are usually shared equally amongst partners. 

• Not compulsory to register Partnership: It is not compulsory to register your Partnership enterprise under the Indian Partnership Act, 1932. That said, it is recommended to register anyway because in the absence of registration, a Partnership enterprise cannot take a 3rd party to court for breach of any contract. Also partners cannot sue each other or the Partnership enterprise for breach of contract. 

Note: A partnership firm has its own PAN number, even though the partners have unlimited liability. 

When is Partnership a good structure for an Enterprise?

I mentioned the key disadvantages of a sole proprietorship above – limited access to funds and talent, more risk/ less stability, hard to grow the business etc. A Partnership structure helps overcome some of these disadvantages. 1) Due to the larger number of owners/ partners (2-20), the access to capital is higher. Not only do the partners contribute capital themselves, banks are more willing to lend. 2) The partners bring with them their own expertise and years of experience, which helps in better management of the enterprise. 3) It is less risky than a sole proprietorship, since the risks/ losses are shared, just as are the profits. 4) While there is a partnership deed (in most cases) that lays down rules for the functioning of a partnership, it is still a fairly flexible form of enterprise (much more than a corporation). Decisions can be taken rather quickly if the partners agree. 5) It is easy to form; registration is not compulsory. 

An important point to remember is that Partnerships are ideal for a business with a high-small (my word invention) to medium type of capital requirement. If the capital needed is small, a Sole Proprietorship would be ideal – why would the proprietor want to share profits with a partner? If the capital requirement is large, a Corporation would be preferred since it would have greater access to funds given its ability to sell stock, as opposed to a Partnership which cannot do so (would have to bank on loans, turn to partners).

Businesses where certain types of expertise are required are also well suited for the partnership structure, law firms being the poster-child in this regard. A majority of law firms are operated as partnerships as opposed to corporations. 

Examples please!

Examples of Partnerships include: a small store owned and run by 2 partners, a manufacturing partnership business owned by 2 or more partners, a law business that is a partnership between 10 lawyers, a financial consultancy firm which is a partnership between 2 former employees of a big bank etc. (just off the top of my head). 

Disadvantages of a Partnership

These include 1) disputes between partners which can hold back growth/expansion 2) unlimited liability of partners 2) uncertainty about life of the partnership in case of death / exit of partner(s).

3. Limited Liability Partnership (LLP)

The Limited Liability Partnership (LLP) was introduced in India only after The Limited Liability Partnership Act, 2008 came into effect in 2009. 

Need for LLP structure?

A Partnership in India cannot have more than 20 members and all members have unlimited liability for the Partnership’s debts and losses. 

This means that even if new members with capital and expertise are available, Partnerships that have 20 members already, cannot bring them on. Also, the existing partners are always cautious about expansion/ growth, since they are personally liable incase of any missteps. There is an increasing trend of litigation in India citing negligence by professionals. Such suits are especially challenging for partners (in professional Partnerships) since their personal assets can be attached. Together, these factors severely limit the growth of Partnership enterprises in India. 

With the LLP, these deterrents are addressed. The LLP is a hybrid structure that combines the limited liability benefit of a Company with the flexibility of internal organization of a Partnership (i.e. flexibility to draft mutually acceptable rules of operation in Partnership agreement). 

Key Characteristics of an LLP

• Legal entity separate from Partners; Perpetual Succession: An LLP is a body corporate formed and incorporated under the Limited Liability Partnership Act, 2008 and a legal entity separate from its partners. Remember, a Partnership does not have a legal entity separate from its partners. Also, unlike a Partnership, an LLC has “Perpetual Succession” which means that any change in Partners (death, exit, retirement) will not affect the existence, rights or liabilities of the LLP. 

• Limited liability of Partners: The liability of the partners in an LLC is limited to their agreed contribution in the LLP. No partner would be liable on account of the independent or unauthorized actions of other partners or their misconduct. However, the liabilities of the LLP and its partners who are found to have acted with intent to defraud creditors or for any fraudulent purpose shall be unlimited for all or any of the debts or other liabilities of the LLP. 

• Minimum 2 partners; at least 2 individuals as “Designated partners”; no upper limit on total number of partners: An LLP should have at least two partners (can be individuals or body corporates) and at least two individuals as “Designated Partners”, of whom at least one should be resident in India. Designated partners are responsible for compliance with the provisions of the LLP Act, 2008. There is no upper limit on total number of partners. 

• An LLP Agreement is recommended, but not mandatory: The drafting of an LLP Agreement defining the rights and duties of the Partners is recommended, but not compulsory. In the absence of such an agreement, the rights & duties as prescribed under Schedule I of the LLP Act, 2008 will be applicable. 

• Compulsory to register LLP with ROC (Registrar of Companies)

When is LLP a good structure for an Enterprise?

The LLP structure is available to all manufacturing, service/professional and trading enterprises that fulfill the requirements of the LLP Act, 2008. Small and Medium Size Enterprises (SMEs) can especially benefit from the LLP structure. Most SMEs in India are Sole Proprietorships (close to 95%), only ~2% are Partnerships. With the LLP structure, SMEs can get better access to credit (no limit on partners, banks also more willing to lend) as compared to the Sole Proprietorship and Partnership structures, while also maintaining relatively high flexibility and low compliance cost (vs. a Corporate structure). 

LLP is also a good structure for professional firms of lawyers, Chartered Accountants, financial consultants etc. It also provides an alternative structure for entrepreneurs looking for flexible / low compliance structures. 

OK.... the blog police called again! This post is much longer than I intended. That said, I daresay it provides a good comparative view of different enterprise structures in India. I still have to cover the “Company” which I will take up in my next post.