Article by Drishti Saigal.
When you’re starting out with a business, there’s tons of ways you can go about it.
You can start your business as a sole-proprietorship, a partnership, a Limited Liability Partnership or you can even start a private company.
Now, of these types of legal business structures, two are very popular – an LLP and a Private Company.
In this article, we are going to compare the two business structures and show for you, which one is better for your business.
If you start out with a partnership, you can limit your liability towards third-parties by forming an LLP. An LLP is governed under the provisions of the Limited Liability Partnership Act, 2008.
A private company also is a business structure, which limits the liabilities of its owners. It is a very lean method of doing business like that of the LLP.
Plus, with several recent amendments to the Companies Act, 2013, there is even a special class of private companies called One Person Companies, which can be formed even by one member.
What is a Limited Liability Partnership?
It is viewed as an alternative corporate business vehicle that provides the benefits that a company with limited liability has, but it allows its members the flexibility of organizing their internal structure as a partnership based on a mutually arrived agreement.
It would enable you i.e. entrepreneurs, professionals and enterprises providing services etc. to form commercially efficient vehicles suited to your requirements.
Nature of Limited Liability Partnerships
- Limited liability partnership is a corporate body, which is formed and incorporated under the Limited Liability Partnership Act, 2008.
- It has a separate legal entity from its partners, as provided under Section 3(1) and has perpetual succession as provided under Section 3(2) of the statute.
- Any change in the constitution of the partners of such a partnership shall not affect the existence, rights or liabilities of the limited liability partnership.
- You require two or more partners to form an LLP and any individual or a body corporate can be a partner in an LLP.
For an individual to be a partner as provided under section 5, he/she should not be-
- Found to be of unsound mind by a court of competent jurisdiction and the finding is in force, or –
- An undischarged insolvent, or –
- A person who has applied to be adjudicated as insolvent and the application is pending.
The mutual rights and duties of the partners in an LLP and those of the LLP and its partners shall be governed by an agreement between partners or between the LLP and the partners subject to the provisions of the statute.
However, in the absence of any such agreement, the mutual rights and duties shall be governed by the provisions of the Act and the LLP Rules, 2009.
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The liability of a partner in an LLP is limited to one’s contribution or stake in the LLP.
The benefit of an LLP is that of severable liability. You as a partner would not be liable on the account of the independent or unauthorized actions of other partners or their misconduct.
However, the liabilities of the LLP and partners who are found to have acted with the intent to defraud creditors or acted for any fraudulent purpose shall be unlimited for all or any of the debts or other liabilities of the LLP.
Every LLP shall have at least 2 designated partners of whom at least one shall be a resident of India.
An LLP can have a common seal, if it so decides.
Every LLP is required to submit income tax returns and annual filings with the Registrar of Companies. Registration of an LLP is mandatory as per the provisions of the LLP Act, 2008.
LLP Agreement and Incorporation document are principal documents of the LLP. An agreement of a partner with a LLP is a proof of a partnership.
LLPs have to affix ‘LLP’ or Limited Liability Partnership after its name. LLPs will be treated as Partnership firms for the purpose of Income Tax.
What is a Private Company?
A private company is the most popular legal structure for businesses and startups. It is a favourable option for anyone who is looking to build a scalable business.
According to section 2(68) of the Companies Act 2013, private company means a company which has a minimum paid up share capital of rupees one lakh or such a higher amount as may be prescribed by law.
Section 2(68) also requires that the company through its articles of association—
- restricts the right of shareholders to transfer its shares;
- except in case of One Person Company, limits the number of its members to two hundred:
Features of a Private Company
- A private company has a separate legal identity so it is responsible to its debtors and creditors for the management of its assets and liabilities etc.
- Company has a perpetual succession. It means that once a company is incorporated, then the life of the company does not depend upon that of its member.
- Minimum number of members required to form a private company is 2 and this cannot exceed 200. However, One Person Company is a special type of private company wherein only one member can form a company. The capital contribution and the number of members among which the capital is divided should be provided for in the memorandum of association of the company.
- You need to have at least two directors and the maximum can depend upon the Articles of association of company in a private company.
- In case of a private Company whose shares can be issued only among its members, shares are not freely transferable i.e, you cannot transfer shares freely as per your wish, unlike public companies.
- The quorum for the meeting of a private company is 2.
- At the end of the name of the company the words “Private Ltd” must be used.
- Books of Accounts are preserved for the period of 8 years in a Private Ltd Company.
- You need a certification of incorporation for the formation of a Private Ltd company.
- You need to hold statutory meetings and file a statutory Report in the case of a Private Limited company.
Now, that I have gone through the basics of both these types of business structures, I’ll analyse these two forms of businesses as against each other.
Pros and Cons of Conducting Business as a Limited Liability Partnership
Let’s Start with the Pros of a Limited Liability Partnership-
- Owing to the flexibility in its structure and operation, LLP would be a suitable vehicle for small enterprises and for investment by venture capitalists.
- You as a partner would not be liable on the account of the independent or unauthorized actions of other partners or their misconduct.
- Any change in the partners of a limited liability partnership shall not affect the existence, rights or liabilities of the limited liability partnership.
- There is no limit on maximum number of partners.
- Indians as well as foreigners can be partners in any LLP.
- Partners are not liable to outsiders for debts and obligations of a LLP.
- A Limited Liability Partnership gives the dual advantage of both a company and a Partnership firm into a single form of organization .
- The personal assets of the partners are safe because the liability of the LLP is limited to the assets of the LLP.
- The LLP has no minimum capital requirements, thus it is substantially better for individuals with nil / very low capital who want to start a business as against the mandatory requirement of a cost of set up of a Private Limited Company.
- No audit is required in Limited Liability Partnership unlike mandatory audits in case of a Private Limited Company. However, LLP’s accounts are required to be audited only if it has a turnover greater than Rs 40 Lakhs or capital contribution of over Rs. 25 Lakhs.
- Dividend Distribution Tax and tax surcharge are not applicable unlike that of a Private Limited Company.
- LLP is not liable for paying Deemed Dividend Taxes (DDT).
- Interest from loans to partners is also not taxable.
- Registration of an LLP is easier and the cost to register it is very less as compared to other forms of company registrations.
- LLP has lesser government intervention, restrictions and compliances imposed by the government.
- The FDI guidelines have been liberalized to a much larger extent for LLPs.
Cons of a Limited Liability Partnership
- It can be more difficult to gain funding for an LLP and to raise capital in contrast to how private companies can raise capital by issuing and selling new shares. As such, most LLPs are bootstrapped.
- You can not leave an LLP dormant as it becomes liable to be de-registered by the Ministry of Corporate Affairs.
- There is no legal requirement to have a Partnership Agreement, which could lead to issues in governing internal relationships. This is why there needs to be a proper contract outlaying rights and duties of each other.
- There are no provisions relating to oppression and mismanagement in the LLP Act.
- Private Equity funds and venture capitalists are unlikely to invest, as it would require them to become partners.
Sectors in Which an LLP is More Favourable
LLP is more favourable for small businesses and start-ups offering professional services and consultancy because of its flexible structure and tax benefits i.e., having to provide for less paid-up capital, easy transferability of ownership, limited liability etc.
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It is also favourable for Medium scale enterprises, Professional firms such as medical professional services, legal firms etc., venture businesses, family operated businesses, Information technology firms, Service Industry and for businesses where investors can play a role as a silent partner.
Pros and Cons of a Private Limited Company
Pros of a Private Limited Company
- The liability of the shareholders of a private limited company is limited up to the extent of the contribution made by the shareholders.
- Registration of a private company helps entrepreneurs to raise funds through equity and expansion. This also limits its liability and capital is raised at the same time. Banks supplying capital for working capital and managing business finances, usually prefer this business structure more.
- A company has a perpetual succession. It means that once a company is incorporated, then the life of the company does not depend upon that of its member.
- This form of doing business is more trustworthy as the details of such a company can be confirmed with the Ministry of Corporate Affairs, which have to be provided during the Incorporation of a Company, as the registration of the company is done in India with the ROC (Registrar of Companies).
- It is not necessary to have received subscriptions before allotment of a share is initiated in a private limited company.
- Directors are permanent in case of a private company and the requirement of retirement by rotation does not apply in case of a private company.
- Section 184 of Companies Act does not apply to a Private Company because in case of a Private company, an interested Director cannot be excluded from participating in voting to the subject matter of his own interest.
- The directors of a private limited company can borrow loans from a private company (although this is not recommended as a practice).
- The restrictions on the remuneration of directors are far less.
- Start-ups and high-growth businesses pick this type of a company because it allows them to offer employee stock options to attract top talent.
- These entities hold Board meetings and file annual returns with the Ministry of Corporate Affairs (MCA) so they tend to be viewed with more credibility than a LLP or General Partnership.
- A private limited company has more options for taking debts than LLPs. Not only are the Bank loans easy to obtain but also the options of issuing debentures and convertible debentures are available to it.
- A private company can sue and it can also be sued, as it is a distinct entity in the eyes of law.
- Private limited companies are more allowed to take in FDI more liberally through the automatic route.
Cons of a Private Limited Company
- Dividend Distribution Tax (DDT) and Minimum Alternate Tax applies to a private company.
- It is a relatively expensive option with registration costs varying, depending upon the number of Directors, members, authorized share capital and Professional fees. Professional fees may depend upon the complexity of the task. Here’s how you can frame a power of attorney, if you want to hire a lawyer to do it for you.
- You must submit annual accounts and annual returns. Otherwise, you will incur a penalty or your company name can be struck off the Register of Companies.
- Cost of hiring an accountant and key managerial personnel can hurt startups.
- The financial and managerial resources of a Private Company are comparatively limited.
- A shareholder cannot leave a Private Limited Company easily as there are restrictions on the transfer of shares in a private company.
- The minority members may suffer at the cost of members having majority shares although there are safeguards to prevent such occurrences.
- A shareholder cannot know the real value of his investment in a private company as the shares of a private company are not listed on any stock exchange and are not easily transferrable.
Sectors with More Private Companies
A private company is more favorable for small businesses and startups who want to grow quickly and be able to make changes at a rapid pace. Tech startups, manufacturing businesses often prefer to incorporate themselves as a private limited company.
It is favourable for mostly all the sectors including business, financial services, marketing, taxation, infrastructure, transport, manufacturing, agriculture, telecommunication, Information technology etc., provided you are not selling consultancy or professional services.
Wrapping up the Comparison between a Limited Liability Partnership and a Private Company
Thus, to conclude I would like to say that a Private Limited Company and an LLP (Limited liability partnership) serve different functions.
Private companies serves best for enterprises that are in manufacturing as they require a lot of start-up capital or service sectors that sell software or have a business model or revenue model that of a software as a service.
Comparatively Limited Liability Partnerships are best for businesses that sell professional services as their business is very much dependent on the professional skill and experience of their partners.
It is also not entirely uncommon for Start-up Founders to first register as an LLP and then convert it to a private limited company immediately before funding is raised.
That’s all. If you have any questions, leave it down in the comments. And if you liked the article, do give it a share.
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Author Bio: Drishti Saigal hails from a legal background having a Bachelor of Laws degree from Svkm’s Jitendra Chauhan College, Mumbai. Connect with her on LinkedIn.