The word incorporation in common parlance means” the process of constituting a company, city or other organisation as a legal corporation”. Incorporating a company in India involves complying with the rules provided in the Companies Act 2013. Although ensuring legal compliance involves a great deal of effort, the advantages of incorporating a company are far more.
1. Helps to generate capital
Capital is the money needed to produce goods and services. A company has two forms of obtaining capital: equity, which means raising funds through the public and debt referring to bank loans or other forms of credit. When a company is incorporated, it is considered more reliable; hence it shall be easy to obtain capital.
The SEBI and other allied laws require the incorporation of the company to allow sourcing funds in the form of equity. Moreover, if the funds are raised from the public instead of a private group, the company must satisfy the conditions for a public company and be listed on a recognised stock exchange. Hence, it promotes the easy way for capital formation and pooling.
2. Separate entity
A company is a separate legal entity to the following stakeholders:
- Promoters: People who initiated the company setup
- Directors: People who control the company and manage its business
- Shareholders: People who own the company
The hallmarks of this concept are:
- The company can buy, sell and own property
- The company can sue and be sued in its name
In the recent past, the Companies Act 2013 has permitted setting up of a new class of companies which is known as a one person company. This structure has provided the ‘separate entity’ benefit to an individual which was not available under the erstwhile sole proprietorship form of business. Due to this change, the sole proprietor also enjoys limited liability.
3. Limited liability
Members are legally bound to pay only to the extent of their undischarged liability. In case of a company limited by shares, it is limited to the amount unpaid on their shares. While in a company limited by guarantee the liability shall be only the amount the members have agreed to guarantee. For example, a person has purchased 10 shares of Rs 100 each. His maximum liability shall be INR 1000 only. Now, as seen mostly in case of closely-held companies (private companies), a member could not have discharged his liability. In such a case, he will be asked to settle his dues at the time of winding up of the company. This is an incentive to the members since their liability is capped unlike a sole proprietorship or a partnership.
4. Transferability of shares
Shares are considered at par with a movable property and hence transferable easily from one person to another. This aspect provides liquidity to the shareholders. Members are in a position to encash the shares at any time as they will. In a public limited company, the shares can be transferred freely. Whereas, in a private limited company, the share transfer is not frequent due to it being closely-held, but is not prohibited.
5. The double E’s – Expertise and Efficiency
Since the management and ownership are distinct, experts in the field can be appointed for each function in the company. This leads to improved accountability. The availability of resources makes it conducive to offer good salary packages and attract the best talent available in the market.
What are the Misconceptions Around Company Incorporation?
1. Incorporation means no personal liability
Although there exists the separate legal entity concept, it does not absolve the owners from liability completely. For instance, the owner may have authorised a transaction for the company by signing in his own name, or guarantees a loan in his name or commits fraud. In such cases, he shall be personally liable.
2. Insurmountable paperwork for compliance
Too often, people fear the load of filing and paperwork that comes along with the incorporation of a company. But the process of incorporation has been streamlined, and with guidance from the right experts, the work can be completed quickly and correctly.
3. Companies are taxed at a higher rate
A common misconception that lies in the minds of the people is that if the business is set up in any other form like a Partnership or LLP, it will reduce the tax liability. This isn’t the case because whether it is a Partnership or a company, they are all taxed at the rate of 30%. In fact, for certain companies having turnover below a prescribed limit need to pay income tax at a lower rate.
4. Exorbitant costs
A few years ago the cost of incorporation was high, while today it is not so. With the advent of the competitive environment, the cost charged by professionals has considerably reduced. The various online registration services make it hassle-free and affordable for the customers. The Income Tax Act 1961 also provides an advantage of amortising the pre-incorporation expenses by allowing a deduction of an amount that is equal to one-fifth of the expense for each of the five successive previous years.
5. Minimum turnover criterion
A company is just like any other form of business organization which can be started from zero and there is no criterion for a minimum turnover to incorporate the business as a company.
Currently, the buzz word is entrepreneurship, and an entrepreneur needs to factor in the various advantages and risks involved while choosing the form of business. An appropriate business form goes a long way in deciding the future of the company. Incorporating business as a company provides security and enjoys far more credibility than other business forms.