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Tax & complianceRunning Your Brand as a Proprietorship, Partnership or LLP? How to Convert to a Private Limited Company Before You Raise, Without Losing Tax Neutrality or DPIIT Eligibility
By the Alphamark Venture Partners teamPublished 22 October 20264 min read
Investors need a private limited company. Converting a proprietorship, firm or LLP is routine, but the 50% for five years tax condition, DPIIT's reconstruction rule and marketplace migration catch founders mid-round.
The short answer
Institutional investors invest through CCPS, ESOPs and shareholder agreements, which need a private limited company. A partnership firm or LLP can register as a company under Section 366 of the Companies Act; a proprietorship cannot convert directly, so a new company takes over the business. Both routes can be tax-neutral, but only if all assets and liabilities move to the company, the owners receive nothing but shares, and the original owners keep at least 50% of the voting power for five years. Fundraising within those five years can breach that condition and make the exempted gain taxable in the company's hands. Plan the conversion three to six months before the raise, keep the transfer values clean, and structure investor voting so the five-year condition holds.
Who this is for: Founders of consumer brands and service businesses running as proprietorships, partnership firms or LLPs who plan to raise equity in the next 12 months, and founders who converted in the last five years and are now raising.
Summary: what most founders miss
- Investors need a private limited company: CCPS, ESOPs and standard SHA rights do not work in a proprietorship, and LLPs cannot issue shares or ESOPs.
- Firms and LLPs can register as a company under Section 366. A proprietorship needs a new company to take over its business.
- Tax neutrality needs all assets and liabilities to move, no consideration other than shares, and the original owners to keep at least 50% of voting power for five years.
- Raising within those five years can breach the 50% condition and make the exempted gain taxable in the company's hands. Structure investor voting with that in mind.
- DPIIT does not treat an entity formed by splitting up or reconstruction of an existing business as a startup. Check how your route will be read before relying on startup benefits.
A surprising number of profitable Indian consumer brands, especially those that grew on Amazon and in modern trade, still run as a proprietorship or a family partnership. It works until the first investor asks for the cap table. The conversion itself is routine. What goes wrong is the timing, a tax condition most founders have never read, and the operational migration of GST, marketplace accounts and trademarks while a round is closing.
Why investors will not invest in a proprietorship, firm or LLP
| Need | Proprietorship | Partnership firm | LLP | Private limited company |
|---|---|---|---|---|
| Issue shares or CCPS to an investor | No | No | No (capital contribution only) | Yes |
| ESOPs for the team | No | No | No | Yes |
| Liquidation preference, anti-dilution, standard SHA rights | No | Partly, by contract | Partly, by contract | Yes |
| Foreign investment | No | No | Only in fully automatic-route sectors without conditions | Yes, subject to sector rules |
| Owner's liability | Unlimited | Unlimited | Limited | Limited |
Swipe the table sideways to see all columns.
FDI into LLPs is permitted under the automatic route only in sectors where 100% FDI is allowed without performance-linked conditions. Practitioner summary; check your sector.
The three conversion routes, and the tax condition attached to each
| From | Legal route | Conditions for tax neutrality | Typical time |
|---|---|---|---|
| Proprietorship | Incorporate a new company; it takes over the whole business under a business transfer agreement, paying in shares | All assets and liabilities pass to the company; proprietor gets only shares; proprietor holds at least 50% of voting power for five years | 4 to 8 weeks, plus registrations |
| Partnership firm | Register the firm as a company under Section 366 | All assets and liabilities pass; partners get shares in proportion to capital accounts and nothing else; partners together hold at least 50% of voting power for five years | 6 to 10 weeks |
| LLP | Register the LLP as a company under Section 366 | Same as a firm, since an LLP is a firm for income tax | 6 to 10 weeks |
Swipe the table sideways to see all columns.
Companies Act 2013, Chapter XXI (Section 366). Tax-neutral conditions from Section 47(xiii) and 47(xiv) of the Income-tax Act 1961, carried into the Income-tax Act 2025 under new numbering; an LLP is treated as a firm for income tax. If a condition is later breached, the exempted gain becomes taxable in the successor company's hands in the year of breach. Confirm current section references with your CA.
How to raise without breaching the 50% condition
- Know what counts as voting power. The test is voting power, not economic ownership. Under the Companies Act, preference shareholders vote only on matters affecting their class, unless the articles give them more. Many VC-style articles give CCPS as-if-converted voting; if yours do, those votes may count against the founders.
- Use CCPS that convert after the window. Investors can hold CCPS with their governance protections delivered as contractual consent rights in the SHA rather than as general voting, and a mandatory conversion date after the five-year window.
- Keep the transfer values clean. If the business moved at book value and no large goodwill was booked, the gain at stake may be small. A founder who booked crores of goodwill to strengthen the balance sheet has created a bigger exposure.
- Quantify it and disclose it. Investors' lawyers will find it. A one-page note with the conversion date, the gain exempted and the voting math through year five turns a diligence surprise into a known item.
DPIIT recognition: the reconstruction rule
DPIIT's February 2026 notification (G.S.R. 108(E)) raised the turnover limit to ₹200 Cr and kept the age limit at ten years, but it also kept the rule that an entity formed by splitting up or reconstruction of an existing business is not a startup. A new company taking over a five-year-old proprietorship can be read as exactly that. If DPIIT recognition matters to you, for the tax holiday, ESOP tax deferral for employees or scheme eligibility, get a view on how your route will be read before you choose it. See why few startups get the Section 80-IAC (now Section 140) tax holiday.
The operational migration consumer brands underestimate
| Item | What to do | Why investors care |
|---|---|---|
| Trademark | Assign the mark from the founder to the company and record it with the Trade Marks Registry | A brand owned personally by the founder is the first red flag in consumer diligence |
| GST | New GSTIN for the company in every state; move input tax credit with ITC-02 | Clean GST returns in the company's name from day one |
| Marketplace and quick commerce accounts | Seller accounts are tied to PAN and GSTIN; plan the entity change or a new account with the platform, keeping the old one live until the new one is verified | Revenue continuity; listings and reviews follow the product listing, and brand registry follows the trademark owner, so assign the trademark first |
| Licences | FSSAI, BIS, legal metrology, drug or cosmetic licences and IEC in the company's name | An unlicensed entity selling regulated products is a closing condition, not a footnote |
| Contracts | Novate distributor, retail, warehousing, co-manufacturer and platform agreements | Revenue under contracts with the old entity is hard to diligence |
| People | Move employees with continuity of service; transfer PF and ESI | Avoids gratuity and continuity disputes later |
| Track record | Prepare brand-level financials for the pre-company years | Investors price on history; a proprietor's ITR mixes personal and business income |
Practitioner checklist for consumer brands. GST registration is PAN-based, so the company needs its own GSTIN in each state; transfer of a business as a going concern is exempt from GST, and unused input tax credit can be moved with Form GST ITC-02.
If an SME IPO is a possible path, conversion timing matters there too. Current SEBI rules need one full financial year as a company after conversion from a proprietorship, partnership or LLP; SEBI's October 2026 consultation paper proposes four completed quarters plus an audited annual statement, and counting the predecessor's track record. See SME IPO or venture capital?.
Case study
The conversion that nearly added a ₹50 lakh tax bill to a Series A
Skincare brand, ₹24 Cr revenue, converted from a proprietorship to a private limited company in April 2024
Situation
At conversion the founder held 100% and booked ₹4 Cr of brand goodwill on the transfer. She then transferred 25% to a co-founder in 2024 and raised a seed round for 15% in 2025, taking her own stake to about 64%.
What was missed
The 2026 Series A term sheet, for 20% plus a 5% ESOP top-up, with as-if-converted voting on the CCPS, would have taken her voting power to about 48% in year three. That would have made the ₹4 Cr gain exempted at conversion taxable in the company's hands: about ₹50 lakh at 12.5%, before surcharge and cess.
What changed
The Series A investors agreed to hold CCPS whose voting was limited to matters affecting their class, with their protections as contractual consent rights in the SHA, and a mandatory conversion date after April 2029. Unexercised ESOP options carry no votes, so the pool top-up did not count either, and the founder's voting power stayed at about 64% through the five-year window.
Outcome
The round closed on schedule with the exposure documented and avoided. Economic ownership was unchanged; only the voting mechanics moved.
The lesson
If you converted in the last five years, model founder voting power through year five before you sign a term sheet. The fix is easy at term sheet stage and expensive after closing.
Illustrative case. ₹4 Cr × 12.5% = ₹50 lakh, before surcharge and cess. Whether a co-founder's holding counts toward the 50% depends on the route and on who held the business before conversion; take advice on your facts.
Related: Why good brands fail due diligence and 11 tax and compliance traps in 2026. Converting before a raise? Send us your structure.
Sources
- Income Tax Department: Section 47 of the Income-tax Act 1961 (clauses xiii and xiv)
- WIRC of ICAI: Conversion of firm or LLP into company, process and tax conditions
- Startup India: DPIIT recognition criteria under G.S.R. 108(E)
- Fox Mandal: DPIIT notifies revised startup framework (February 2026)
- Khanal Group: SEBI SME IPO consultation paper of 14 October 2026, track record after conversion
Questions founders ask us
Can a proprietorship raise investment from angels or VCs?
Not as equity. A proprietorship has no shares to issue, so investors cannot hold CCPS, ESOPs or standard shareholder rights. The business needs to move into a private limited company before an equity round.
Can an LLP raise venture capital?
Rarely. An LLP takes capital contributions, not shares, cannot issue ESOPs, and can take foreign investment only in sectors with 100% automatic-route FDI and no performance-linked conditions. Most investors will ask the LLP to register as a company under Section 366 first.
How do I convert a proprietorship into a private limited company without paying capital gains tax?
Incorporate a company that takes over the whole business, with all assets and liabilities, in exchange only for shares, and keep at least 50% of the company's voting power for five years. If those conditions hold, the transfer is not treated as a taxable transfer.
What happens if my shareholding falls below 50% within five years of conversion?
The capital gain that was exempt at conversion becomes taxable in the company's hands in the year the condition is breached. It is a voting power test, so how investors' CCPS vote matters.
Will converting my business affect DPIIT startup recognition?
It can. DPIIT's 2026 notification excludes entities formed by splitting up or reconstruction of an existing business. A new company that takes over an existing proprietorship may be read that way, so check before relying on startup benefits.
How long does conversion take before I can raise?
Six to ten weeks for incorporation, the business transfer and core registrations, plus four to eight weeks for marketplace and licence migration that can run in parallel. Start three to six months before you plan to raise.
About the author
Written by the Alphamark Venture Partners team, a fundraising advisory firm helping founders raise seed, angel and pre-Series A rounds, with a focus on consumer, consumer tech and consumer AI. Rules, figures and benchmarks are checked against the sources listed and are current as of the date shown. This is general information, not legal, tax or investment advice.
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