A Private Limited Company (Pvt. Ltd.) is a popular business structure in India, chosen by entrepreneurs for its ability to limit liability and facilitate easier management.   It features limited liability and is relatively easy to manage.  Main advantages include protection through limited liability, equity for raising capital, and the structured governance framework.

However, this business structure also comes with its own set of cons. Drawbacks of PVT ltd company also has to be considered before finally deciding upon private incorporation as the legal method by which one wants his entity to function. Here are some Disadvantages of starting a private limited company that should be accounted while serving  businesses for a long distance concerning performance and even overall chances for future success based purely on an unfavourable formation option for function 

Complex Formation Process

Establishing a Private Limited Company involves navigating a complex web of legal requirements and extensive documentation. It has a complex process:

1. The registration of the company is undertaken within the purview of the Companies Act 2013 that has its separate conditions for company formation 
2. This involves procurement of the Digital Signature Certificate along with a DIN for directors and acquiring Certificate of Incorporation along with the registration which includes the process of Goods and Service Tax is also applicable depending upon the cases. 
3. Even more, the private company documents like Memorandum of Association (MOA) and Articles of Association (AOA) have to be prepared and submitted to the Registrar of Companies (ROC). All of these processes together take a lot of time and are really very intimidating. Most budding entrepreneurs are discouraged by all the procedures.

• Registration Process in Detail

The process of registration for Private Limited Company involves several procedural steps. The explanation for each step is provided below.

1. DSC: Get a Digital Signature Certificate for all the proposed directors 
2. Apply for DIN: Obtain a Director Identification Number through the MCA portal 
3. Name Approval: Propose a unique company name and get it approved through the RUN service of the MCA portal 
4. MOA and AOA: Draft and sign the Memorandum of Association and Articles of Association.
5. File Registration Forms: Lodge all the necessary forms provided with the necessary documents attached and the appropriate fees for filing with the ROC
6. Obtain Certificate of Incorporation: When the name is approved, the Registrar will issue the Certificate of Incorporation. This is upon incorporation, when the company is technically said to come into being.

This whole process may take anything from a few days to several weeks, depending upon how efficiently it is documented and processed.

Cost: The professional charges plus government charges can be anywhere between several hundred to several thousand rupees.

Here’s a table comparing the formation process of a Private Limited Company with that of a Sole Proprietorship:

Aspect	Private Limited Company	Sole Proprietorship
Documentation Requirements	Extensive documentation, including MOA, AOA, and various government forms. Requires DSC and DIN for directors.	Minimal documentation, often just a business license and local registration.
Regulatory Compliance	Subject to rigorous compliance with the Companies Act, 2013, requiring regular filings and audits.	Less stringent regulations; compliance primarily involves local business regulations and tax requirements.
Time and Cost	Formation can take weeks, with costs potentially reaching several thousand rupees due to professional fees and government charges.	Quick setup, often completed in days, with significantly lower costs, making it a more accessible option.
Liability and Ownership Structure	Offers limited liability protection; personal assets of owners are protected from business debts. Allows multiple shareholders for capital raising.	No limited liability protection; the owner is personally liable for all business debts, exposing personal assets to risks.
Operational Complexity	More complex operational framework requiring adherence to formalities like annual general meetings and maintaining statutory records.	Straightforward operation with fewer formal requirements, allowing quick decision-making without board approvals.

This table provides a clear comparison of the two business structures, highlighting their key differences.

• Stringent Compliance Requirements

The stringent compliance requirements for Private Limited Companies in India demand rigorous adherence to legal regulations, including frequent filings and audits. This can create significant administrative burdens and detract from the company’s operational focus. Here is a detailed outline of the same: 

•  Annual Filings and Auditing

 Annual compliances are essential for corporate governance in India. Key requirements include:

1. INC-20A: Declaration for Commencement of Business
   Companies incorporated after November 2019 must secure a Commencement of Business Certificate within 180 days. Failing to do so incurs a fine of ₹50,000, with directors liable for ₹1,000 per day for non-compliance.
2. Appointment of Auditor and Filing E-form ADT-1
   The first auditor must be appointed within 30 days of incorporation and confirmed at the first Annual General Meeting (AGM). Form ADT-1 must be filed with the Registrar of Companies (ROC) within 15 days post-AGM.
3. Board Meetings
   The initial board meeting must occur within 30 days of incorporation, followed by at least four meetings annually, spaced no more than 120 days apart. Minutes of these meetings must be recorded and maintained.
4. Annual General Meeting (AGM)
   The first AGM should be held within nine months of the first financial year’s closure. Subsequent AGMs must occur within six months of the financial year’s end, ensuring no more than 15 months elapse between meetings. AGMs address financial statements, dividends, auditor appointments, and director remuneration.
5. Annual ROC Filings
   Companies must file annual accounts and returns, including:
   • AOC-4: Financial statements submitted within 30 days of the AGM.
   • MGT-7: Annual returns filed within 60 days of the AGM.
   • DIR-12: Changes in directorship reported within 30 days.
   • DIR-3 KYC: Directors must submit KYC details by September 30 annually, with a penalty of ₹5,000 for late filing.
   • DPT-3: Annual reporting of deposits by June 30.
6. Directors’ Report
   An abridged report summarising required information for small companies under Section 134 must be prepared and authorised by the shareholder or at least two directors.
7. Maintenance of Statutory Registers and Books of Accounts
   Companies must maintain and update statutory registers, board meeting minutes, financial statements, and ROC files regularly.

• Administrative Burden

The compliance requirements for Private Limited Companies in India impose a significant administrative burden on business owners. From the need to maintain extensive documentation to the obligation of filing multiple forms with the Registrar of Companies (ROC), the process demands considerable time and resources. Companies must appoint auditors, conduct regular board meetings, and prepare detailed financial statements—all of which require meticulous record-keeping and adherence to strict timelines. This complexity can overwhelm entrepreneurs, diverting their focus from core business activities and hindering growth.

• Comparison with Other Business Structures

When compared to partnerships and sole proprietorships, the compliance requirements for Private Limited Companies are markedly more rigorous:

1. Partnerships:
   • Compliance is generally less demanding, with fewer formalities and no requirement for regular audits. While partnerships must maintain accounting records, they are not obligated to file annual returns or undergo the same level of regulatory scrutiny as Pvt. Ltd. companies.
2. Sole Proprietorships:
   • The compliance burden is minimal, often requiring only basic registration and local licenses. Sole proprietors do not have to conduct annual audits, file statutory returns, or hold formal meetings, allowing for greater operational flexibility.

Restriction on Share Transfer

A private limited company must mandatorily include restrictions on the transfer of shares in its Articles of Association.  Share transfer restrictions in private limited companies are imposed by different companies to meet the requirements of the definition of a private limited company. The most common type of restriction imposed on the companies are by way of Right of Pre-Emption or Right of First Refusal.

• Legal Restraints by Companies Act, 2013

Share transfers are subject to legal restrictions imposed by the Companies Act, 2013, especially in the case of Private Limited Companies, which differs from publicly traded ones. Often, it requires that Articles of Association (AoA) carry clauses that do not permit shares to be transferred unless authorised by other shareholders for such sale or transfer. Ownership therefore remains with a controlled group, making it safe and secure from the current interests of those owning shares; however it makes share transfers complicated.

• Challenges on  Liquidity

Shareholding in a Private Limited Company is complicated in that trying to transfer ownership out will be seriously complicated due to the existence of such share transfer limitations. This would mean that every transfer has to be modified by existing shareholders, thus causing delay and uncertainty as regards finding potential buyers willing to go through the arduous approval process. Such lack of clear-cut exit strategies may make the shareholders feel stuck, especially when they want to liquidate their investment for personal or financial reasons.

• Effect on Liquidity

The given restriction in Private Limited Companies directly affects the share of liquidity that the shareholder undergoes. For instance, a seller who wishes to dispose of his or her equity holdings may face unhelpful shareholders, the duration taken to acquire may become too long, or any other related problem may have an effect on the sale. 

This is normally found when there is a downturn in performance; the no-access-to-cash issue further frustrates the shareholder apart from intensifying pressure that eventually leads to liquidity issues. 

Higher Tax Rates Compared to Other Structures

Understanding the tax implications of different business structures is crucial for entrepreneurs in India. Private Limited Companies often face a higher tax burden than alternative forms of business organisation, such as sole proprietorships, partnerships, and Limited Liability Partnerships (LLPs). This section explores the corporate tax rates, the impact of Minimum Alternate Tax (MAT), and a comparison of the tax obligations across various entities.

• Corporate Tax Rates

Private Limited Companies in India are subject to higher corporate tax rates compared to other business structures. While a Private Limited Company with an annual revenue below ₹400 crores pays a tax rate of 25%, those with revenues exceeding ₹400 crores face a tax rate of 30%. Additionally, existing companies can opt for the new tax regime with rates of 22% or 15% for new companies, which may further complicate tax planning.

• Minimum Alternate Tax (MAT) Impact

The Minimum Alternate Tax (MAT) significantly impacts the profitability of Private Limited Companies. MAT is levied at a rate of 15% on the book profits of companies that do not pay income tax due to exemptions or deductions. This tax can reduce the overall profitability of Pvt. Ltd. companies, forcing them to account for this additional liability and affecting their financial planning and resource allocation.

• Tax Comparison with Other Entities

When comparing the tax burden between Private Limited Companies and other business entities like sole proprietorships and partnerships, the differences are pronounced. Sole proprietorships are taxed at individual tax rates, which can be lower for many business owners, while partnerships enjoy similar taxation but without the complexities of MAT. 

In contrast, Limited Liability Partnerships (LLPs) face a fixed tax rate of 30% on total income, with an additional surcharge of 12% for incomes exceeding ₹1 crore. This comparison highlights the relatively heavier tax burden faced by Pvt. Ltd. companies, making it essential for business owners to carefully consider their structure in light of potential tax implications. 

Difficulty in Winding Up

 The winding up of a private limited company in India is a complex and multi-step process. The process can be arduous for the owner. It is therefore very important to understand this process for those who contemplate closing it down. Here is a detailed process: 

• Winding Up Process

Winding up a private limited company in India is very cumbersome, as it involves a lot of procedural formalities and requirements. Some of them are given below:

1. Board Resolution: A majority of the directors have to pass a resolution to initiate the process of winding up.
2. Special Resolution: At least three-fourth of the shareholders must agree to the decision to wind up the company.
3. Creditors’ Resolution: Creditors must pass a resolution to confirm that there are no outstanding debts the company owes them.
4. Statutory Declaration of Solvency: The company should issue a Statutory Declaration of Solvency; this is a declaration which proves the creditworthiness of the company, to be accepted by trade creditors
5. Liquidator: An appointed liquidator will prepare an account of the assets, liabilities, and overall position of the company.
6. Tribunal Order: The liquidator has to move the Tribunal for an order of dissolution, which has to be passed within 60 days.
7. ROC Filing: The liquidator is required to file a copy of final accounts and resolutions with the ROC and a copy of the final order.

Other factors that may make winding up take longer are the pending cases in the court and the time taken for the ROC to give documents. Normally, taking all things together, it takes six to eight months to close a private limited company.

• Time and Cost Factors

The winding up process is very time-consuming and involves high costs of legal fees, liquidator fees, and ROC compliance. These costs do tend to add up, thus making the entire process more cumbersome.

• Comparison to Other Structures

It is very much more cumbersome than winding up a simpler form of business, such as a sole proprietorship, in contrast. Sole proprietorships close with minimal forms to complete, which, again, permits a quicker, cheaper way out than in the legalistic procedures undergone by a private limited company. 

• Limited Capital Availability

Any business relies on capital, and the access to capital is what decides the growth and sustainability of a business. Indian private limited companies face heavy challenges to raise funds, which in turn limits their potential growth, reduces their capacity, and strengthens the competition they face.

• Limited Capital Mobilisation

Private limited companies can’t issue shares or raise their capital from the general public. The firms cannot sell shares for raising funds through the public market, therefore, their sources of financing are private and limited hence cannot have diversified sources of funding. There may then be funding issues concerning the private limited companies as that may not be possible enough to generate the kind of capital needed for further developments and innovations.

• Reliance on Private Capital End

Growth options for private limited companies are largely dependent on private investors or bank loans. Such dependency creates a limitation because funds from private investors are always negotiable and based on the individual’s personal relationships with the investor. Banks usually have stringent lending conditions, and thus companies may face difficulties in accessing the necessary finance, especially in the initial stages of development. This clearly indicates that the restrictions in raising capital by Pvt. Ltd. entities are a limitation to its growth path.

• Challenge to Large-Scale Funding

Accessing large-scale funding by private limited firms is challenging compared to public limited companies. Public companies can seek capital markets and attract institutional investors. This provides public companies with significant financial sources. Private limited companies cannot access such avenues, hence finding it challenging to get the huge funding needed to finance large projects or other rapid growth initiatives. This complicates pvt ltd  company investment further because they cannot access public capital to expand further.

Loss of Privacy 

Private limited companies have some trade-offs especially regarding maintaining private details of the company, most of which are financial and related to shareholder information. Even though registration is one of the positive effects of a company, some significant implications fall in the aspect of confidentiality.

• Public Disclosure of Information

In case of private limited companies, statements of finance and those related to shareholders have to provide for public disclosures in terms of the compliance obligations. Being the result of public disclosure through Pvt. Ltd., even sensitive data like yearly reports, balance sheets, or data about the director have easy access by the general public. The open stance by Pvt. Ltd. sends shivers down the spine of businesspersons in facing this transparent approach and keeping financial doors open to notice from the public.

• Increased Transparency but Reduced Confidentiality

While such compliance audits and filings increase the accountability and transparency of companies, it sacrifices the confidential nature of companies’ private affairs. As stakeholders are expecting increased openness in operations, increased internal affairs confidentiality of a company may have a way to expose private operational strategies that are detrimental to their security and financial weaknesses that place these companies in a less secure competitive environment. Hence business owners are not feeling assured to share particular strategic decisions and financial data.

• Comparison with Sole Proprietorships or Partnerships

Private limited companies are compared to other forms of business structures, like sole proprietorships and partnerships. In general, these structures ensure a higher level of confidentiality. These entities do not have the same stringent public disclosure requirements as private limited companies, which means that the business owners can keep their financial matters private. Therefore, privacy in private limited companies can be a significant concern for entrepreneurs who value discretion over public accountability.

• Dilution of Control

As the private limited company expands and requires external investments, control may be largely diluted. Although raising money is necessary for expansion, it dilutes control in a private limited company.

• Issuing More Shares

When shares are issued by the private limited company for the invitation of more investors, a decline in the percentage shareholding of original owners occurs. Shareholding dilutes the influence of the owner in important decisions that run within the business. Hence, the balance of authority would change in the entire firm. Rights and privilege may be bestowed on them with the loss of rights in authority of the original founder of the firm. Hence, the same will result in a complete direction towards the business.

• Shareholders’ Agreement and Voting Power

Shareholders’ agreement explains the procedures followed in making decisions of an entity. In private limited entities, more commonly, agreements provide voting powers and how decision-making processes can be made to add further complexity through governance mechanisms. For instance, in case of many external investors owning shares, they may vote to outmanoeuvre the founders on major issues which can change the strategic direction of the firm. Such changes in the decision-making in private firms can lead to frustration and disagreements among the shareholders due to differences in priorities among them.

• Potential Conflicts Among Shareholders

With the sharing of control by multiple stakeholders, there is a potential conflict. The shareholders are diverse, and therefore, some have varying expectations and goals. Expectations over where the company is headed or management decisions may lead to disputes over profit distribution among the different shareholders. The strained relationships among the shareholders are likely to result in failure to collaborate properly and, therefore, affect the performance of the company. Balancing the interest of different parties calls for careful management with proper communication to ensure harmony in the company and attainment of common goals.

Conclusion

Private limited companies offer various advantages, including limited liability and enhanced credibility. However, they also come with notable disadvantages such as stringent compliance requirements, restricted capital raising, loss of privacy, and dilution of control. It is essential to thoroughly evaluate the private limited company pros and cons before deciding on this business structure.

Entrepreneurs should carefully consider whether a Pvt. Ltd. company is right for you?. Factors such as the need for capital, privacy concerns, and governance dynamics play a crucial role in this decision-making process. By weighing the benefits against the drawbacks, business owners can determine if choosing a private limited company in India is the right path for their entrepreneurial journey. Ultimately, making an informed choice will help ensure that the selected structure supports long-term success and growth. At Vakilsearch, we understand that navigating legal and compliance requirements can be overwhelming for business owners.

FAQs on Disadvantages of Private Limited Companies in India

How do compliance requirements impact business operations?

Compliance requirements can impose a significant administrative burden, diverting resources and attention from core business activities and increasing operational costs.

Are tax rates for private limited companies higher than for other structures?

Yes, private limited companies often face higher tax rates compared to sole proprietorships and partnerships, including corporate tax and Minimum Alternate Tax (MAT).

Can shareholders easily exit a private limited company?

No, exiting a private limited company can be difficult due to restrictions on share transfers and the need for approval from other shareholders.

Why is winding up a private limited company so challenging?

Winding up involves complex legal and regulatory processes, which can be time-consuming and costly, often requiring the approval of multiple stakeholders and compliance with various laws.

How does limited capital availability affect growth potential?

Limited capital availability restricts the ability to invest in expansion, research, and development, hindering the company's growth potential and competitiveness in the market.