Choosing a Constitution Before the First Term Loan
Three cousins in Nashik - Anita, Ramesh and Farid - plan a chilli-and-turmeric grinding unit. Project cost is ₹35 lakh: Ramesh will transfer his 1,200 sq ft shed (valued ₹12 lakh) to the business, Anita contributes ₹10 lakh from savings, Farid ₹5 lakh, and ₹8 lakh is to be borrowed. A fourth person, Nikhil, will put in ₹8 lakh for a 10% stake, but he refuses to sign any partnership deed or take management duties, and wants to be able to sell his stake after three years. Farid also wants a defined exit after three years because he plans to migrate. The bank's term-loan desk has asked for a registered constitution and audited accounts, and the cousins worry about annual compliance cost on a first-year turnover of about ₹60 lakh. Ramesh insists the shed must stay "in the family" and can never be sold to an outsider.
1. Compare a partnership firm, an LLP and a private limited company on liability, compliance cost, ability to admit Nikhil, and exit, and recommend one with reasons.
Read the worked answer
Screen the options against the three non-negotiables first:
- Partnership firm (Indian Partnership Act, 1932): unlimited joint and several liability - Ramesh loses the shed if the unit is sued. No separate legal personality, no share issuance, so Nikhil cannot be given a 10% equity stake that is freely transferable. Cheapest to run (no statutory audit), but it fails both the liability test and the investor test.
- LLP (LLP Act, 2008): limited liability, separate entity, no audit unless turnover exceeds ₹40 lakh or contribution exceeds ₹25 lakh. But Nikhil would have to be a partner, with implied rights to inspect accounts and participate in management - exactly what he has refused. Transferring a partner's interest needs every partner's consent, which makes Farid's clean three-year exit messy.
- Private limited company: separate legal entity, liability capped at unpaid share capital, shares transferable under the Articles, and a new investor can be admitted as a shareholder without management rights. Mandatory statutory audit plus AOC-4/MGT-7 filing, DIN and DSC costs are usually ₹30,000–₹50,000 a year - under 1% of projected turnover, and the price of getting the ₹8 lakh and bank finance.
Recommendation: private limited company. Nikhil gets shares, not a partnership interest; Farid's exit is a share transfer at a valuer's price; Ramesh's exposure is limited to his shareholding. Protect Ramesh with a shareholders' agreement and Articles clauses: right of first refusal, a lock-in on Nikhil's shares, and a buy-back/put option for Farid at fair value.
2. How should Ramesh's shed be brought into the business while satisfying his "never to outsiders" condition, and what does each route do to the funding plan?
Read the worked answer
Two lawful routes, with very different funding consequences:
- Sale/transfer as capital contribution. A registered valuer fixes fair value (₹12 lakh); Ramesh takes shares in lieu. Stamp duty and registration fee under Maharashtra law apply on the conveyance, and Ramesh may have capital gains (indexation if held long-term). Once sold, the shed is the company's asset - mortgageable to the bank, but in insolvency it goes to creditors before shareholders. "Family" control is preserved only contractually (right of first refusal, family trustee shareholding), not by ownership.
- Registered lease at market rent. Ownership stays with Ramesh, the unit gets a deductible rent expense (taxable in Ramesh's hands under house property, with the 30% standard deduction). No conveyance stamp duty, no capital gains. But the bank then has no immovable collateral and may demand a personal guarantee or a third-party mortgage.
The funding trap: the ₹35 lakh project is built on ₹12 lakh of shed equity. If he leases instead, the company's own contribution falls to ₹15 lakh and the ₹8 lakh loan only funds ₹23 lakh - the project is short by ₹12 lakh. So the lease route quietly forces either a much larger loan (harder to get without collateral) or a smaller plant.
Practical answer: transfer the shed to the company at a documented valuation, take shares, and sign a shareholders' agreement with a first-refusal clause plus a family trust as shareholder. That satisfies the bank, keeps control contractual, and preserves the debt-equity structure the projection assumes.
3. Set out the registration sequence from name approval to first GST return, and flag the two steps most often skipped by first-time promoters.
Read the worked answer
Sequence:
- Name reservation - SPICe+ Part A with two proposed names (include the activity word, e.g. "Spices"), checking that the name is not identical or too nearly resembling an existing company/LLP.
- Incorporation - SPICe+ Part B: MOA (objects: grinding, packing, trading), AOA with the transfer restrictions, registered office proof (the shed's title/lease plus utility bill), DIN/DSC for all three directors, and the subscribers' sheets.
- Statutory registrations bundled with incorporation - PAN, TAN, EPFO, ESIC and the professional tax employer registration (PTEC) through the same form; open the current account only after the certificate of incorporation and PAN.
- Udyam registration - free, Aadhaar/PAN-based, gives the enterprise its micro/small status for the MSMED Act 45-day payment right and scheme eligibility.
- GST registration - needed before the first taxable supply; note the ₹40 lakh goods threshold in Maharashtra, but compulsory registration applies to inter-state supply regardless of turnover. Composition scheme is not suitable here because it blocks input credit on the ₹9–12 lakh of plant.
- Others - FSSAI (spice packing), factory licence if the worker count crosses 10 with power, MPCB consent, fire NOC, trade licence, and the shed's mutation/mortgage entry with the bank.
Most-skipped steps: (a) filing the commencement-of-business declaration (INC-20A) after the subscription money is actually credited - banks hold disbursement until it is filed; (b) the first auditor's appointment in ADT-1 within 30 days of incorporation. Both are trivial to file and expensive to miss.