When you are starting a new enterprise you often wonder – should I start as a sole proprietor, or as a partnership, or a private limited company…You are dazzled at the array are you not?
And what does that do to your personal finance?
If you are starting a big manufacturing company, you will of course be a public limited company. However if you are starting a mutual fund distribution business, a RIA set up, a brokerage business, you have a choice from the ‘sole-prop’ to partnership, Llp, and a limited company.
Your choice of structure will decide how you will take money from the business. If you are a sole proprietor you may or may not draw any fixed salary. You will only withdraw money for your expenses. This does not matter as long as you are the only person who is owning the business.
The minute you have a partner, BOTH of you need to be compensated on the basis of time spent (effort put in). Remember this means that the balance sheet can be shared in a different ratio than the Profit and Loss account. Imagine if there is a business where I am holding 99% of the shares and take on a young partner, I will have to pay him or her a salary which is much higher than what I get paid. Sensible, is it not.
So knowing how much money to take from the business and build your own private corpus is very important too. Also remember that if you have started as a sole prop you can make it into a partnership, you can go from a partnership to a limited company. It is not easy, but it is not impossible to shut down a company. Don’t think that the formation is cast in stone. It is not.
Cash accrual, removal, taxation – all these decide on which form to use. So see if you can create more entities – paying a salary to your wife and children is not a sensible decision. However, when you form a limited company getting expenses like depreciation on all assets, travelling and entertainment expenses, hiring more people, recruiting, becomes easier. You need to note that the administrative work might be more – and you may have to comply with more laws.
Do a SWOT analysis of all the factors before you decide on which form your business will take.
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