Disadvantages of Private Limited Company

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:

1. 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.

2. 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.

3. 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:

1. 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.

2. 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.

3. 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.

4. 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

1. 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.

2. 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.

3. 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.

4. 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, private limited companies are the most preferred type of legal entity 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

Other Related Topics:

• Characteristics of Private Limited Company
• How to Get Private Limited Company Incorporation?