Company Law

Advantages of an LLP structure over a Private Limited Company

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This blog post is written by Mr. Gagan Kelhanka, a law graduate from at KC Law College and worked as in-house counsel at Xoxoday. He pursued Companies Act, 2013 & SEBI Law Course from Bettering Results (BR). 

OVERVIEW 

One of the most commonly and reasonably expected dilemmas of any new budding entrepreneur intending to start up a business venture in India is often the choice of form of entity structure that best suits their individual needs. Due to the plethora of alternatives available under the Indian legal regime, it can unsurprisingly be a daunting and thoughtfully challenging task, but equally important nonetheless. This particular decision has a significant impact on the profitability and sustainability of a business, in terms of different material aspects such as liability, control, cost, risk, etc. Therefore, it is absolutely vital that this decision be made diligently after taking all relevant considerations into account. 

This article is intended to provide the readers with some clarity on two of the most popular business structures found in the country for more than a decade now, i.e., Limited Liability Partnerships (“LLP”) and Private Limited Companies (“PLC”), and why the former is usually a better option than the latter. 

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WHAT ARE THESE STRUCTURES? 

LLPs 

A LLP is a relatively new and unique form of business entity structure that combines the flexibility of a traditional partnership firm and the core benefits of a PLC, thus making it an attractive and popular choice among willing entrepreneurs for a considerable period of time now. Its inception dates back to 2008 with the passing of the Limited Liability Partnership Act (“LLP Act”) which was brought into force by the legislature to be the governing statute for LLPs. A LLP firm is registered by the Ministry of Corporate Affairs (“MCA”) as per the provisions of LLP Act. 

The basic features of a LLP are as following: 

➢ A minimum of two partners are required for the formation of a LLP. There is no such limit for the maximum number of partners. 

➢ There is no minimum amount of capital requirement for the creation of a LLP. This implies partners enjoy the flexibility of determining how much capital they are willing to infuse in the business and also that they can contribute in terms other than money such as manpower, fixed assets, technical knowhow, goodwill, etc. 

➢ As the name suggests, the liability of the partners in a LLP is limited to the extent of their contributions to the firm, which means that they are not liable beyond that in the event of losses or repayment of debts and their personal assets or property are safe from attachment in such a case. 

➢ Unlike a traditional partnership, the partners in a LLP enjoy immunity from any responsibility in relation to acts done by their fellow partners. They can be held accountable only for their own individual conduct.

➢ There is no distinction between the ownership and management in the LLP structure. This is to say that partners are owners themselves who manage the affairs of the business. An LLP also has designated partners who are responsible for managing its affairs; there may be sleeping partners as well. 

➢ The functioning of LLPs is governed as per the LLP Agreement, which needs to be filed with the MCA within 30 days of their incorporation. 

➢ The name of a LLP should contain ‘LLP’ mandatorily. 

➢ It is a suitable form of structure for small-to-medium sized businesses which do not require significant funding from external sources. 

 

PLCs 

A PLC is a form of business entity that is privately formed and held by its members/promoters that come together in furtherance of shared commercial aspirations. It varies from a public limited company as it is not permitted to invite subscription to its securities by the general public. Registration of a PLC is carried out by the Registrar of Companies (“RoC”), the statutory authority acting for the MCA, as per the provisions of the Companies Act, 2013 (“CA 2013”) along with ‘Companies (Incorporation) Rules, 2014’. 

The basic features of a PLC are as following: 

➢ A minimum of two members are requisite in order to incorporate a PLC who need to subscribe to the Memorandum of Association (“MoA”) to be filed with the Registrar of Companies. The membership can be extended to a maximum cap of 200 members. 

➢ Similar to the membership needs, at least two directors are required for the formation of a PLC whereas the maximum threshold is 15. Directors are vested with managerial powers who are responsible for the day-to-day affairs and functioning of the company. 

➢ There is no amount fixed as the minimum capital requirement for the registration of a PLC. 

➢ The liability of members in a PLC is limited to the extent of their shareholding if the company is limited by shares or to the extent of the guarantee provided by them if the company is limited by guarantee. 

➢ The internal management of a PLC is conducted as per its Articles of Association (“AoA”), which serves as the constitutional document of the company and lays the groundwork for material procedures and policies to be in place. AoA needs to be filed with the MoA and any other required documents at the time of incorporation. 

➢ The name of a PLC should contain ‘Private Limited’ mandatorily. 

➢ This form of business entity structure is ideal for ventures that are intended to operate on a relatively larger scale, expecting a sizable turnover and have a requirement of significant funding from external routes such as private equity, venture capital, angel investors, etc.

BENEFITS OF LLP STRUCTURE OVER PLC 

  1. Registration and Management – It is considerably easier and cheaper to start as well as run a LLP business as compared to its PLC counterpart, as the mandatory requirements and costs involved are significantly lesser in quantum in case of a LLP. This makes choosing a LLP entity over a PLC one highly advantageous for the willing entrepreneurs, as they are able to save precious money at the nascent stages of their venture which can be utilised for key growth objectives in the future. In addition, they do not need to worry too much about the hassles of constant regulatory compliances, preserving valuable time and energy that can be invested in more essentially integral aspects driving business growth and expansion.
  2. Control – Another important merit of a LLP over a PLC is the control factor. Within a PLC setup, there is a much greater need of heavy funding from external sources such as private equity & venture capital firms, angel investors, etc., and control is often diluted to the hands of these resultantly mighty stakeholders, as they seek sizable chunks of shareholding in the company to protect their interests. This can end up with them having an influential say in the decision making process of the business, thus making life hard and unfair for the laborious founders who, in most cases, put in years of hard work, struggle as well as planning in order to convert an idea into a worthy profit making business venture. This misfortune is entirely impossible altogether in a LLP, where the founders are the very people who manage the complete functioning and decision making of the business, as partners in the firm. They are in full and sole control.
  3. Taxation – The taxation structure applicable in the case of a LLP is also simpler and more economic as compared to a PLC, resulting in further savings. PLCs need to first and foremost pay tax on its income at the rate of 25%, its obligations increase by another 7% as surcharge once the income exceeds INR 1 Crore and then 12% once it exceeds INR 10 Crores added to other taxes such as a Dividend Distribution Tax, Education Cess, Wealth Tax and a Minimum Alternate Tax (“MAT”), upon fulfilment of requisite criteria. Whereas a LLP is treated at par with a traditional partnership firm when it comes to the taxation aspect and majorly is required to pay only a fixed amount of 30% out of its taxable income, with the benefit of deductions in the form of remuneration, salary, bonus, commission or interest payable to its partners. It may be subject to a MAT which is lesser than normal obligations and is only applicable in the alternate scenario and a surcharge of 12% if the taxable income inclusive of capital gains exceeds INR 1 Crore, which is not very common.
  4. Compliances – LLPs enjoy greater leeway when it comes to statutory compliances than PLCs. For instance, a LLP is only required to get their accounts audited if its annual turnover exceeds INR 40 Lakhs or its capital contribution exceeds INR 25 Lakhs in any financial year, whereas a PLC needs to get the statutory audit done irrespective of its turnover. PLCs are also mandated to hold at least four board meetings and a general meeting of members every financial year, whereas no such obligations are imposed on partners of a LLP.

CONCLUSIVE REMARKS 

Although no structure out of the two is a “one-size fits all” and the choice of any one depends entirely upon the needs of any particular case, a LLP is certainly likelier to be considered as the wiser alternative as it combines the benefits of a traditional partnership firm and a PLC in such a manner that is most ideal for the majority of entrepreneurs, as it facilitates preservation of invaluable time, money, energy and resources that can be pivotal to the long-term survival and growth of any business. In consideration of all relevant factors, the author strongly opines in favour of LLP and advocates for its election over a PLC structure to any willing entrepreneur intending to start a small-to-medium sized business with minimum regulatory burdens, considerable saving of material resources and maximum growth within a relatively shorter span of time.

Company Law in a Nutshell

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Company Law in India

Company law is a compendium of legislative measures, rules, and regulations that govern the formation, structure, management, operation, administration, and compliance of companies. The Companies Act, 2013 (the “Act”), – which replaced the erstwhile Companies Act, 1956 – along with circulars, orders, rules, amendments, forms, and notifications together encompass the company law in India. 

 

Company – Meaning, Nature, Characteristics

A company is a separate legal entity or legal person (a.k.a. Artificial Legal Person) that has its own corporate personality independent from that of its members. It is legally competent like a natural person to own property, incur debts, borrow money, have a bank account, have transferable shares, employ people in its name, enter into contracts, sue, or be sued independently. However, in certain cases, the courts may examine a company from beyond the purview of its corporate personality and begin to look at the members or managers directly, termed as the ‘lifting of the corporate veil’.

 

Company v/s Partnership Firms and Limited Liability Partnership

Partnership firms are often confused to have similar characteristics as a company. However, unlike a company’s distinction from its members as a legal person, a partner is an agent of the partnership firm whose liability is unlimited and the partner cannot independently dispose of the property or contract with the firm or transfer their shares without the other partner’s consent. Furthermore, the process of dissolution, accounting, and auditing of a partnership firm differs from that of a company.

 

On the other hand, a limited liability partnership is a blend of both, a company and a partnership firm. It is a separate legal entity like a company but functions in consonance with the contractual agreement between the partners with flexible compliance and governance like a partnership firm. 

Kinds of companies

Companies in India are incorporated when a certain number of persons sign a memorandum for any lawful purpose, with or without limited liability, and contractually agree to comply with the requirements of the Act. These companies can be divided into various kinds on the basis of the following categories:

  1. Based on incorporation: Statutory Company, Registered Company
  2. Based on members: Private, Public, One Person Company
  3. Based on liability: Limited by shares, Limited by guarantee, Unlimited
  4. Based on control: Associate or Joint Venture Company, Holding and Subsidiary Company

A company can further be classified into Foreign Company, Government Company, and Section 8 Company.

Incorporation of a Company

The formation and incorporation of a company begin with the registration of at least one suitable name, in order of preference, with a maximum of six other options, followed by the filing of documents like a declaration of compliance, notice of situation of the registered office, and particulars of the director(s), etc. post the name approval. A company’s incorporation is incomplete without drafting and stamping the Memorandum and Article of the Company. These two documents are vetted by the Registrar of Companies (the “RoC”) having jurisdiction over the proposed registered office of the company. RoC further issues a certificate of incorporation, and a Corporate Identity Number, post which the companies are required to maintain copies of all documents and information.

Some of the significant company documents and records that have been detailed in the Act are Memorandum of Association, Articles of Association, Prospectus, Share Certificate, Share Warrant, and Statutory Registers.

Directors and Key managerial personnel

A company’s values and standards are maintained through strategic planning, performance reviews, and robust financial, human resource, and risk management. It requires entrepreneurial leadership demonstrated by the Board of Directors. The constitution of the Board, its powers, restrictions, and appointment of directors are elaborated in the Act. The Act also mandates appointment of Key Managerial Personnel (the “KMP”) by certain classes of companies, as the collective in charge of its operations, and decision-making. Section 2(51) of the Act defines KMP of a company to include the Chief executive officer, manager or managing director, Company Secretary, Whole-time director, Chief financial officer, and such other officers, designated by the Board as KMP but are not more than one level below the directors in whole-time employment or as may be prescribed.

 

Corporate Finances

Corporate finances are the funds or capital that play a great role in the establishment of the company, operating business activities, decision-making, and long-term planning for the company’s future. The issuance of rights shares, employee stock options, preferential allotments, buy-back of shares, and shares with differing voting rights are only a few of the ways to generate capital. It entails a number of approvals, disclosures, filings, and record-keeping requirements that must be met in accordance with Chapter IV of the Act read with the Companies (Share Capital and Debentures) Rules, 2014. 

Company Administration and Corporate Governance

The Act with the Companies Rules provides a robust framework for corporate governance and administration, thus, including, but not limited to, the independent directors’ qualifications and responsibilities, mandatory appointment of a female director, and creation of specific committees such as the CSR Committee, the Audit Committee, the Nomination and Remuneration Committee, and the Stakeholders Relationship Committee. The provisions further dilate the scope, conduct, and essentials of board meetings, General Meetings, and Shareholder Meetings for the efficient functioning of the companies.

Accounts, Financial Statements & Audits

All kinds of companies are mandated to maintain a “Book of Accounts” which forms the basis of the financial statements of the company for annual return filing.  It inter alia includes records maintained in respect of the company’s business transactions, trade of goods and services, and assets and liabilities. The achievement of a company’s business goals, accurate financial reporting on its operations, preventing fraud and asset theft, and lowering its cost of capital ultimately depend on maintaining an efficient system of internal controls. 

Corporate Social Responsibility

India became the first country in the world to have statutorily mandated Corporate Social Responsibility (“CSR”) for certain companies with the enactment of the Act. It strengthens India’s corporate philanthropy by mandating social welfare for companies, whether private limited or public limited, to spend at least 2% of the average net profits made during the 3 immediately preceding financial years, within the defined activities and parameters. Section 135 of the Act read with the CSR Rules sets out a logical framework for the companies to comply with for the formation of the CSR committee, their roles and objects, and the parameters to be adopted for compliance.

Company Processes

A company in its lifetime undergoes various changes and processes. It may experience a compromise demanding vigorous dispute resolution through a compromise plan, arrangement of the rights and obligations of the company’s shareholders, restructuring the capital structure by transfer of assets, amalgamation through mergers and acquisitions, and finally, the winding up of a company, either voluntary or mandatory, to terminate the existence of the company and asset management. All corporate law issues arising during the lifetime of a company are adjudicated by quasi-judicial bodies like National Company Law Tribunal, National Company Law Appellate Tribunal, and other Appellate Tribunals and Special Courts in India.

 

Did you know that the first provision for registration of joint stock companies in India was made in 1850, based on the English Joint Stock Companies Act 1844? It is intriguing to see how far the company laws in India have come since then!!