Startups are just business plants; they sprout from a tiny seed and make its way through all odds to survive in a mighty business environment. Every seed sown by an entrepreneur is always with a view to see the seed flourish into a unicorn.
A startup journey is never about how small you started, a start is itself a pre-emptive evidence that you have already climbed half the ladder. Undoubtedly the second half of the scalable growth journey is very daunting, but you can surely achieve it if you know when to pivot.
Startups usually prefer to start with a primitive and an easy to form, business model of a Sole-proprietorship. But as the roots of the business spreads, it’s time to restructure the business model by incorporating a Private Limited Company.
Let’s understand the transition from a proprietorship into a private limited institution.
# Rational Behind Choosing A Private Limited Company
Sole Proprietorship model only extends help in the initial setup, with an easy formation and minimal paperwork. As the business flourishes, more rooms are required to expand and to overcome teething obstacles. Therefore it is inevitable to transform into a Private Limited Company and take advantage of its benefits.
Some benefits of incorporating a Private Limited are:
- Control Tax Pay-outs
With the increase in the revenues, it is advisable that entrepreneurs bifurcate their personal accounts from their business. Depending on the tax slabs, it might reduce the tax filings and can enjoy corporate tax benefits.
- Enhances Goodwill of your Startup
Since the records of a private limited company are maintained with the ministry of corporate affairs, it provides an authentic source of legal existence over proprietorship. Also, no two Private limited companies have the same name thereby it gives a unique brand name to the business.
- Attracts Funding
The conversion opens many financing avenues. The funds can now be infused into the business by adding more directors, leveraging shares, or by pitching to angel investors in return for a share in the company.
- Business Expansion
On conversion, an entrepreneur can hire more directors and expand the outlook of the business. They get greater public visibility and acceptance.
The conversion process is easy and cost-effective. Entrepreneurs are exempted from paying any stamp duty or any capital gain tax on any assets or property transferred for conversion from a sole proprietorship to a private limited company.
# The Conversion Of Proprietorship into a Company
The Conversion process involves following points:
- Incorporation of a Private limited company
You are required to incorporate a new private limited company. This can be done in just four simple steps:
- Select a Suitable Name
- Apply for DSC
- File incorporation documents on MCA portal
- Get Certificate of Incorporation, PAN and TAN, and DIN.
- Insertion of a Clause in MOA
At the time of incorporation, it is necessary to mention “to takeover of a sole proprietorship concern” as one of its objectives in the Memorandum of Association. Nowadays we have eMOA so the process of insertion of the clause is easy.
- Agreement of Takeover
An agreement needs to be drafted on behalf of the company to takeover all the assets and liabilities of the Sole Proprietorship. The same shall be executed on a Stamp paper expressly specifying the details of assets and liabilities along with the consideration in its exchange.
- Avoid Capital Gain Tax
According to the Income Tax Act,1961 capital gain on such transfers can be exempted if the following conditions are met:
- All assets and liabilities are transferred
- The shareholding/voting rights of the proprietor will not fall below 50% for the next 5 years
- The proprietor will get shares only in exchange for net assets of the business.
In case of any breach, the capital gain tax will be applicable on any profits or transfer of assets.
- Termination of Sole Proprietorship
You can now close down the sole proprietorship. The bank account needs to be shut down and a separate corporate account is required for the new company incorporated. All other registrations need to be surrendered and reapplied as a Private limited.
Moreover, any pending contracts, agreements or lease needs to be re-signed under the new company.
Many businesses, which starts off as a sole proprietorship fear to end up small, without being able to pivot out of their comfort zone.
Well, if you are stuck in that phase, it is the right time to transit. The Government of India has recently waived off all charges for incorporating a private limited company in India.
It is important to remember, as Mark Twain quoted, “ It’s not the size of the dog in the fight, It’s the size of the fight in the dog.” What matters.