A Private Limited Company is a company owned by shareholders or members with limited liability and higher credibility. In India, the MCA (The Ministry of Corporate Affairs is an Indian government ministry primarily concerned with the administration of the Companies Act 2013, the Companies Act 1956, the Limited Liability Partnership Act, 2008, and the Insolvency and Bankruptcy Code, 2016) regulates these types of companies.
If you are interested in investing in a potential enterprise, investing in a private limited company can provide you with a range of benefits. This type of company is a popular business form for aspiring entrepreneurs because it offers various advantages.
Benefits of a Private Limited Company
Some Benefits of a Private Limited Company are:
- Limited Liability: One of the key advantages of incorporating a Private Limited Company is limited liability. In structures like general partnerships, all partners are personally liable for the debts incurred by the business. If the partnership faces financial difficulties and cannot repay its debts, the partners are at risk of losing their assets to settle the obligations. However, in a Private Limited Company, only the amount invested in starting the business is at risk. The personal assets of directors and shareholders are protected from any business-related risks, providing a shield against potential financial liabilities.
- Access to Funding: Private Limited Companies have a distinct advantage in terms of accessing funding. These entities can easily accommodate equity funding by issuing shares to investors. Additionally, the limited liability feature makes Private Limited Companies an attractive option for venture capitalists and private equity funds. Investors prefer Private Limited Companies over other business structures like Limited Liability Partnerships (LLPs) since becoming a shareholder in a Private Limited Company requires less involvement compared to becoming a business partner in an LLP. This ability to raise funds through equity shares enables Private Limited Companies to attract investments and hire top talent that might have been otherwise challenging for the business.
- Debt Capacity: Private Limited Companies enjoy a more favorable borrowing capacity compared to other business structures like One Person Companies (OPCs) and LLPs. These companies have better access to bank loans, making it easier for them to secure financial support when needed. Moreover, Private Limited Companies can explore additional borrowing options by issuing debentures and convertible debentures. This flexibility in debt financing provides Private Limited Companies with greater financial flexibility.
- Greater Credibility: Incorporating as a Private Limited Company enhances the business’s credibility. The company is required to disclose extensive information about its structure, operations, and finances to the Registrar of Companies, which becomes public knowledge. This transparency allows vendors, lenders, employees, and the public to access important details such as authorized capital, names of directors, registered office, etc. The established transparency and accountability elevate the company’s credibility in the eyes of stakeholders. This level of disclosure sets Private Limited Companies apart from other entities like partnerships and proprietorships, which lack the same obligation to provide such comprehensive information.
- Easy Exit: Another advantage of incorporating a Private Limited Company is the ease of exit for shareholders. Private Limited Companies can be sold or transferred partially or wholly to another individual or entity without disrupting the current business operations. This flexibility in ownership transfer allows shareholders to exit the company when desired, making it an attractive option for investors who seek liquidity and an efficient exit strategy.
Important Factors a 3rd Party Investor should Consider Investing in a Private Limited Company
There are some factors a third-party investor must consider before investing in a Private Limited Company.
- Investment Objectives
Any investor considering investing in a Private Limited Company should have clear objectives behind their investment. They must seek returns on their investments, which can come in various forms, such as interest, dividends, or appreciation of the principal amount.
Investors also prioritize the safety and security of their principal amount. They want assurance that their investment will be protected from potential risks. Easy liquidity is essential for investors, allowing them to convert their investments into cash whenever needed.
- Returns from Investment
Investing in a start-up company may result in low returns in the initial stages. Start-ups often face higher risks and success may take time. However, if the start-up becomes successful, the returns could be substantial in the long run.
Investing in an already-established Private Limited Company may offer more stable returns. Established companies generally have a proven track record and may provide better predictability in terms of returns.
The type of investment also impacts the returns. Investment through shares can lead to higher returns, especially if the company performs well and its share value appreciates. On the other hand, investment through debentures or loans typically results in more moderate returns.
- Control and Safety
Purchasing shares in a Private Limited Company grants the investor shareholder voting power and some level of control over company operations. However, this can come with higher risk, as share values may fluctuate and the safety of the principal amount is relatively lower. Investing through debentures or providing loans to the company offers more security for the principal amount. Debenture holders and lenders have priority in repayment during bankruptcy or liquidation. However, the returns from such investments are normally more moderate.
Third-Party Invest in a Private Limited Company
Raising capital for Private Limited Companies is limited since shares cannot be sold to the general public. Instead, investments from company members, family, and friends fuel their business operations. As a third-party investor seeking to invest in a Private Limited Company, there are three primary investment options:
- Debentures: A secure investment route in a Private Limited Company, providing a fixed return over time. Two types of debentures exist:
- Convertible Debentures: Holders can convert debt into equity shares later, though offering average returns. However, the advantage lies in potential appreciation if the company’s performance improves.
- Non-Convertible Debentures: These debentures cannot be transformed into equity shares, but they generally yield higher returns. Investors seeking steady income may prefer non-convertible debentures.
- Investing in Loans and Advances: A straightforward method of investing in a Private Limited Company involves loans and advances. Investors benefit from regular interest payments, ensuring a stable income stream. Moreover, the principal amount remains fully secure. However, certain restrictions govern the sources from which a Private Limited Company can accept loans. Typically, loans are acceptable from relatives of directors, other companies, members and directors of the company.
- Holding Shares: Though Private Limited Companies cannot publicly sell shares, they raise capital through private connections. For investors interested in holding shares, direct communication with promoters, directors or members of the company is essential. These shares are not publicly traded, necessitating discussions regarding investment terms directly with the company’s executives.
- Some Miscellaneous Options: If the above options do not align with your investment preferences, alternative possibilities exist, such as collaborating with venture capitalists, angel investors and similar entities. These additional avenues offer potential for investment in Private Limited Companies. However, it remains important for investors to carefully assess the terms, risks and potential returns associated with these options.
FAQs
- Can a third party invest in a Pvt Ltd Company?
Yes, it is possible for a third party to invest in a private limited company. There are several ways in which private limited companies can raise funds from third-party investors, including private placements, venture capital investments, angel investors, or crowdfunding platforms.
- What are the typical methods for a third party to invest in a Pvt Ltd company?
A third party can invest in a private limited company through equity investments, where the investor purchases shares or ownership stakes in the company, or through debt financing, where the third party provides loans or convertible debt to the company.
- Are there any legal requirements or regulations that govern third-party investment in private limited companies?
Yes, there are legal requirements and regulations that govern third-party investment in private limited companies. These may include compliance with securities laws, shareholder agreements, disclosure requirements, and other regulatory frameworks that protect the interests of investors and ensure transparency in the investment process. The specific requirements may vary depending on the jurisdiction.
- What factors should a third party consider before investing in a Pvt Ltd company?
Before investing in a private limited company, third parties should consider several factors, including the company’s business model, financial performance, growth potential, management team, market conditions, competitive landscape, and exit strategies. Conducting thorough due diligence and seeking professional advice can help mitigate risks and make informed investment decisions.
- How does a third party typically exit their investment in a Pvt Ltd company?
Third-party investors in private limited companies can exit their investments in various ways, such as selling their shares to other investors, through mergers and acquisitions, or by the company going public through an initial public offering (IPO). The exit strategy often depends on factors such as the company’s growth trajectory, market conditions, and investor preferences.