A private limited company's liability protection and ease of transferability appeal to most medium and large businesses. This article examines a few disadvantages associated with a private limited company, particularly for micro and small businesses.
A private limited company provides numerous benefits to medium and large businesses, such as liability protection and ease of share transferability. These companies, governed by the Companies Act 2013, have articles of association that restrict share transferability, distinguishing them from other types of public companies.
Given the expanding business landscape in the country, it becomes crucial to comprehend the various types of business entities in India. However, it’s worth noting that private limited companies may not be the most suitable choice for all businesses, especially micro and small enterprises. Explore the drawbacks of private limited companies in this article
Definition
Private limited companies, as per Section 2(68) of The Companies Act, 2013, are entities with limited liability. In contrast to public companies, they don’t freely transfer shares to the public. These companies retain all profits and liabilities, and stakeholders are not personally liable for the company’s debts.
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Types of Private Limited Companies
Private limited companies come in different types, including:
- Limited By Shares:
Private companies limited by shares restrict their capital by owing money to shareholders. The Memorandum of Association (MOA) limits shareholders’ liability to the number of their shares or the remaining unpaid amount. Shareholders are not liable to pay more than their share capital.
- Limited by Guarantee:
In a private limited company limited by guarantee, an individual shareholder’s liability is limited to the amount guaranteed in the Memorandum of Association. They can only be liable for the guaranteed amount, and this guarantee comes into play only if the company is permanently closed.
- Unlimited Companies:
Unlimited companies are distinct legal entities with no limitations on members’ liability. In such companies, members may be liable for the entire debts of the company, and their personal assets can be used to settle company debts.
Registration Process
Vakilsearch offers a streamlined registration process for your private limited company, completing the registration within just 7 days. The registration involves specific processes and costs that don’t apply to unregistered entities like proprietorships.
Upon successful registration, a private limited company gains extensive powers and rights, simplifying tasks such as opening a bank account or obtaining a payment gateway. In contrast, unregistered business entities like proprietorships and partnership firms face challenges in accessing these services post-registration.
Essential Documents Required for Setting up a Private Limited Company
To establish a private limited company, you will need the following essential documents:
- Memorandum of Association:
This document outlines the business’s purpose, nature, objectives, and capital clause. It establishes the company’s relationships with shareholders and defines its goals. It is also known as a company charter.
- Articles of Association:
The internal operating system of the company is detailed in this document. It explains the management process, duties and responsibilities of each member, dividend policy, shareholder meetings, and board appointments.
- Certificate of Incorporation:
Once all necessary documents are submitted for registration, the directors receive a certificate or license. In India, the Registrar of Companies (ROC) issues this document, serving as the primary authentication for the company.
- Other Documents:
Directors and shareholders need to provide identification proof (PAN card, Aadhaar card), address proof (ration card, voter ID), rental agreement, a No Objection Certificate (NOC) from the property owner, and a copy of the sale deed for owned property.
Disadvantages of Private Limited Company
Disadvantages of Private Limited Company
- Compliance Formalities:
After incorporation, a private limited company is obligated to adhere to various compliance requirements. This includes holding board meetings, conducting general meetings, auditing accounts, maintaining statutory registers, and filing an annual return with the Ministry of Corporate Affairs. Additionally, adherence to tax, labor laws, and corporate compliance formalities is essential for any business entity.
- Division of Ownership:
One notable drawback of private limited companies is the requirement for at least two directors and shareholders. This poses a challenge for sole entrepreneurs aiming to establish and operate a business independently, as a private limited company necessitates the involvement of two individuals for decision-making. Even if one shareholder holds a minimal share percentage, the company still requires two shareholders. To address this, the government introduced One Person Companies (OPC) for entrepreneurs, allowing them to operate alone. However, OPCs need to convert to private limited companies after reaching ₹2 crores in annual sales.
- Personal Liability:
While a company bears full responsibility for its debts with unlimited liability, its members are shielded from personal liability. However, there are instances where directors and members may be held personally liable, such as misrepresentation of the company’s name in a contract, fraudulent conduct during winding up, and other specific circumstances.
- Winding Up of Company:
Compared to winding up an unregistered partnership firm, the process of winding up a company can be intricate, time-consuming, and costly. Therefore, registering a company should be a serious commitment, undertaken when promoters are genuinely dedicated to utilizing it for business purposes.
Conclusion: Advantages of Private Limited Company
In India, company registration online is the most preferred method for establishing private limited companies, despite the disadvantages listed above. This is because, despite its drawbacks, it is considered worth the hassle. In fact, the benefits of incorporating and doing business as a private limited company should mandatorily be considered before choosing a business entity.
To know more about the right business entity structure for you, request a callback from the experts at Vakilsearch right away!
FAQs
What is a Private Limited Company?
A Private Limited Company is a type of business entity that is owned by a small group of individuals, with limited liability protection for its shareholders.
What are the main disadvantages of a Private Limited Company?
Some of the main disadvantages of a Private Limited Company include limited ownership, higher costs, and potential for less control compared to other business structures.
What is the difference between a Private Limited Company and a Sole Proprietorship?
A Private Limited Company offers limited liability protection for its shareholders, while a Sole Proprietorship does not, making it a more risky option for business owners.
What is the difference between a Private Limited Company and a Public Limited Company?
A Public Limited Company is owned by the public and must comply with more stringent regulations, while a Private Limited Company is owned by a small group of individuals and has fewer reporting requirements.
What are the ownership restrictions in a Private Limited Company?
Private Limited Companies have restrictions on the number of shareholders and the transfer of shares, which can limit the flexibility of the business structure.
What are the costs associated with a Private Limited Company?
Private Limited Companies have higher costs compared to other business structures due to the need for more formalities, such as holding annual general meetings and filing annual returns.
How does a Private Limited Company affect control?
A Private Limited Company may result in less control for the business owner, as decisions may need to be made through a board of directors or shareholders' meetings.
What are the tax implications of a Private Limited Company?
Private Limited Companies are subject to corporate tax, and shareholders may also be subject to personal tax on their dividends.
How does a Private Limited Company affect the ability to raise capital?
Private Limited Companies may have more difficulty raising capital compared to other business structures, as they are not publicly traded and have fewer shareholders.
What are some alternatives to a Private Limited Company?
Alternatives to a Private Limited Company include Sole Proprietorships, Partnerships, and Limited Liability Parternsips (LLPs), each with their own advantages and disadvantages.
