The term ‘Private Limited Company’ refers to a company that is owned by shareholders of company members with limited liability and more credibility. The MCA is an authority in India that is responsible for regulating Private Limited Companies. Third party investors looking to invest in potential enterprises can find a range of benefits by investing in a private limited company.
Private Limited Company is recognised as a notable business form that is widely used by aspiring entrepreneurs. Private Limited Company, being a government-authorised company, provides various advantages to those wishing to start a new business and also offers numerous options for third party investors to make a wise investment in a private limited company.
Benefits of Incorporating a Private Limited Company
1. 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 personal 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.
2. 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.
3. Debt Capacity
Private Limited Companies enjoy a more favourable 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.
4. 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 authorised 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.
5. 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 causing disruption to 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.
Factors to Consider by a Third Party Before Investing in a Private Limited Company
The following factors must be taken into consideration before making investment in a private limited company by a third-party investor:
1. Investment Objectives
Any investor considering investing in a Private Limited Company should have clear objectives behind their investment. These objectives generally include:
- Earning Returns: Investors seek returns on their investment, which can come in various forms, such as interest, dividends or appreciation of the principal amount.
- Safety and Security: Investors also prioritise the safety and security of their principal amount. They want assurance that their investment will be protected from potential risks.
- Liquidity: Easy liquidity is essential for investors, allowing them to convert their investments into cash whenever needed.
2. Returns from Investment
The potential returns from investing in a Private Limited Company depend on the company’s stage of development and the type of investment:
- Start-up Companies: 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.
- Established Companies: 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.
- Investment Types: 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.
3. Control and Safety
Investors should consider the level of control they desire over the company’s operations and the safety of their principal amount:
- Shares Investment: 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.
- Debentures or Loans: 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.
How Can a 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:
1. Debentures: A secure investment route in a Private Limited Company, providing a fixed return over time. Two types of debentures exist:
a) 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.
b) 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.
2. 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.
3. 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.
4. Other 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.
Final Thoughts
A Private Limited Company offers numerous advantages when incorporated, such as limited liability, access to funding through equity shares, greater borrowing capacity, enhanced credibility and ease of exit. These benefits make it an attractive option for entrepreneurs seeking a secure and flexible business structure. Third-party investors have various options like debentures, loans and holding shares to participate in the growth of a Private Limited Company.
However, careful consideration of investment objectives and risk tolerance is vital for investors. Ultimately, the Private Limited Company structure provides a dependable platform for both entrepreneurs and investors, ensuring growth and stability in the business landscape.
For more clarity on how a Third-Party Investor can invest in a Private Limited Company, connect with our experts at StartupFino.
