Understanding different business structures w.r.t capital
Published On: Jul 22, 2019 • Last Updated: Oct 14, 2023 • 4.7 min read •
While deciding the correct business structure, many factors play a role. For example, the question of major importance is wrt capital. This includes any present and future fundraising rounds. You must be wondering how the question of raising funds in the future is important when the business isn’t even formed. However, there are certain business structures that have limitations on the modes of raising funds wrt capital of the business.
The need for raising funds with growth of a business is inevitable. Funds can be raised in two ways, internally and externally. Different types of business structures have ideal ways of raising funds, such as private equity, debt funding, loans, angel investments, venture capitals, etc.
This article covers a list of business structures and their suitability features wrt capital fund raising.
Pvt. Ltd. companies allow fundraising by issuance of equity shares. As a result of which, all companies are owned by its shareholders. Further, upon incorporation wrt capital, companies are allowed to raise funds from investors. These investors are a part of the shareholding of the company, but the company will be managed by its board.
Wrt capital, a company can raise funds in the following ways:
Right issue wrt capital means the circumstance when a company raises funds from its existing shareholders. This is one of the internal modes of fundraising in a pvt ltd company.
Private Placement of shares
When a company issues shares to a selected small group of persons, it is ‘private placement of shares’. The procedure of issuing shares by private placement must be in accordance with the provisions of the companies act. The only condition is that the maximum number of 200 members should not be crossed.
Employee Stock Option Plan
The concept of turning employees into part owners of the company is ‘ESOP’. ESOP helps in retaining good employees, and growing the business because of their active efforts. ESOP wrt capital structure is gaining a lot of popularity amongst startups. Startups especially appreciate this concept as they need talent but are low on funds and can hire talent through ESOPs!
Debt Funding wrt Capital in Companies
Apart from the above given fund raising options, a company can raise funds by way of deposits, debentures, bonds, loans and advances, etc. Raising debt, however, depends on the limits set and a company cannot raise more debt than its prescribed limit.
A partnership firm is an easy and informal form of business. The formation of a partnership firm is easy due to its minimum compliance requirements. All partners bring in certain capital while forming the business. Once the partnership firm begins its functioning, funds wrt capital can be raised in the following ways:
Additional funds from existing partners;
Raise Capital by adding a new partner; and
Loans from external parties such as banks, financial institutions, etc. wrt capital.
Amongst the informal business structures, such as sole proprietorship, partnership firms are more beneficial. Considering the fact that they delude credibility and access to more resources.
Limited Liability Partnership is a hybrid business model. It has the best of both worlds through the following characteristics:
Limited liability of partners;
Separate legal entity;
Cost -effectiveness; and
Public Accessibility of data.
Keeping all these features in mind, an LLP registration provides benefits of both, partnership firm and private limited companies. However, wrt capital fundraising, the LLPs are treated somewhat similarly to partnership firms. There is no concept of equity in LLPs. Hence, all funding options available to a partnership firm are applicable to a limited liability partnership wrt capital.
However, LLPs being a formal business structure increases the credibility of partners as compared to a partnership firm.
Proprietorship Firms and Raising Funds!
Proprietorship business is a sole firm, which is formed, owned and managed by one person single handedly. The proprietor is liable personally for all decisions of the firm wrt capital, funding, management, growth etc. The following modes of raising capital are available in proprietorship firms:
Self investment by the proprietor; and
Loans from banks, financial institutions, creditors, friends, relatives, etc.
As you can see, proprietorship firms are the least suitable business structure wrt capital fundraising. The best ones are private limited companies, for a scalable business. However, proprietorship firms are the best business model when the owner wants to run a small business.
Comparative Analysis of business structures wrt Capital
Limited Liability Partnership
Private Limited Company
Raising of funds through promoters
Raising of funds through adding partner/member
Raising funds through equities
Raising funds through debts
All forms of business structures are allowed to raise funds by way of debts. However, only companies in India are allowed to raise funds by way of equity. Hence, a company and then an LLP, are the best business structures for raising funds externally. Before choosing the correct business structure, you need to be aware of the financial projections, need wrt capital, estimated size of business, nature of business, etc. Connect with Legalwiz.in experts to understand the best suitable business for you!
Shivani is a Company Secretary at Legalwiz.in with an endowment towards content writing. She has proficiency in the stream of Company Law and IPR. In addition to that she holds degree of bachelors of Law and Masters of commerce.