This article is written by Prateek Singh from Institute of Law, Nirma University, Ahmedabad.
In this article, the author explains the difference between a Private Limited Company and a Partnership by analysing their advantages and disadvantages and the way they are formed.
In a marketplace where people come out to start a business venture to boost their chances of survival, they find new ways to invest money and make their fortune out of it. Being part of a Private Limited Company or a Partnership Firm are just two of the many options available in the market. It is the different types of business structures that we will be discussing in this article and whose needs do they suit better is what we will find out. Further in this article we shall go through the definitions of the two names mentioned above, the difference between the two, laws they are regulated under and their advantages and disadvantages.
Private Limited Company
A Private Limited Company is a privately held small business entity which limits the owner’s liability to their shares, it also restricts the number of shareholders to 50 and does not allow to trade the shares publically. It is a business entity held by a small group of people who has to go through a registration process under the Companies Act of 2013 in order to get itself recognised.
The factor to define ownership in a Private Limited Company is the share capital, the ratio of ownership is determined by the shares held by the owners in the company. This structure attracts the investors more than anything else because this allows them to claim ownership in the company and at the same time their liability is limited to the shares that they hold.
A Partnership is a business arrangement consisting of two or more members and they all come together to share the profits and the losses of the business equally among themselves, this is one of the major differentiating factors between a Partnership and a Private Limited Company.
People who can form these partnerships can be from various sectors and sections of the society, they can be governments, businesses, private individuals, non-profit organisations etc. and what they want to achieve from their partnership setup will also vary according to their objectives.
There are 3 major categories of partnership:
- General Partnership– A general partnership is a business arrangement by which two or more individuals agree to share in all assets, profits, and financial and legal liabilities of a jointly-owned business. In a General Partnership setup, all the legal and financial liability as well as the profits are shared equally by all the parties.
- Limited Partnership- In a Limited Partnership setup, there are two basic requirements, one that there has to be at least one partner who will bear the total personal liability for the partnership’s debts and there has to be one partner who will only bear the liability of the amount invested. This partner is also called the silent partner. The silent partner will not be a part of the management or day to day operation of the partnership.
- Limited Liability Partnership- Limited Liability Partnerships are a very commonly practised structure for the professionals, mainly for the likes of lawyers and accountants. In this structure, as the name suggests, the liabilities are limited to the partners for themselves and that helps in saving one’s own assets in cases when one of the partners is being sued for a crime, for example- malpractice. Under no circumstances will the assets of an innocent partner be at risk even if the other partners are being charged legally. This helps in retaining personal properties and hence is favoured by the professionals.
The three above mentioned forms are the major forms of partnership in practice, however, there is one another by the name Limited Liability Limited Partnership, which consists of one or more General Partners and one or more Limited Partners, the partnership is managed by the general partners whereas the limited partners are involved financially but are excluded from the management. This form of partnership is recognised under United States Commercial Law.
The first major difference between a Partnership and a Private Limited company is the identity of the two. A partnership does not have an identity of its own, it comes into existence when two or more people join to start a partnership. A company on the other hand is a separate legal entity of its own, it is treated as a person in the eyes of law.
Registration is not compulsory in case of a partnership but registering a Private Limited Company is necessary. The name should not be identical or similar to that of any other firm doing the same business. One other provision is that the name of the firm should not carry the tags such as emperor, crown, empire etc which shows an approval of the government.
There are 4 steps to register a Private Limited Company:
- Procure a digital signature certificate by filing an e-form on the website of the Ministry of Corporate Affairs.
- Obtain the Director Identification Number which is allotted by the Ministry of Corporate Affairs which stays valid for a lifetime unless it is withdrawn or surrendered.
- Reserving a name that has a distinct identity and the certificate of incorporation.
The governing acts for the Private Limited Companies can be classified into two parts, one where there are general laws which apply on all companies and then there are industry-specific laws which apply on the companies based on their area of operations.
General laws that apply to all the companies:
- Income Tax Act, 1961,
- Payment of Gratuity Act, 1972,
- Central Sales Tax Act, 1956,
- Employees State Insurance Act, 1948,
- The Maternity Benefit Act, 1961,
- The Finance Act, 2004,
- Wealth Tax Act, 1957,
- Employees Provident Fund and Miscellaneous Provisions Act, 1952,
- Environment Laws,
- Labour Laws and Provisions.
To become a member of a Partnership, anyone who is willing has to be of the age of majority, should be of sound mind, should be of a sound state of mind and should not be disqualified by law to enter into a contract.
People who can be a member of a partnership are:
- An Individual who is qualified by law to become a partner can be a member of the Partnership firm in the capacity as an individual as well as in the capacity of a representative of a Hindu Undivided family.
- A Karta of a Hindu Undivided Family can be a member of a Partnership firm considering that he contributes his personal skill and labour.
- A firm, since it is not recognised by law as a person or an individual entity, it can not be a part of a Partnership firm but a partner of that firm can become a part of another partnership in his individual capacity, where he can share profit with others.
- A Company can be a part of a Partnership firm since it is identified and acknowledged by law as an individual person/entity.
- Trustees of private religious trusts are seen as juristic persons and hence they are eligible to become a partner in a Partnership firm as well.
There are two ways to become a part of a company, by becoming a member or by becoming a shareholder. A member in a company is someone who has his name in the ‘Register of Members’, this means that the person has willingly become a member of the company and is someone who holds some share of the company.
Some differences between a member and a shareholder in a company:
- Unlike the member, a shareholder does not have his name enlisted into the ‘Register of Members’,
- A member is defined under Section 2(55) of Companies Act, 2013 but the shareholder is not listed in the Companies Act,
- After signing the Memorandum of Association with the company anyone can become a member but in order to be a shareholder he needs to be allotted shares.
The membership of the company can end in various ways, like by transfer of membership, transmission of membership, surrender of membership, forfeiture of membership or by share buy back.
Key differences between a Partnership and Private Limited Company
- Regulation: A partnership firm is regulated by the Registrar of Firms of the State Government whereas the Registrar of Companies of Central Government regulates the Private Limited Companies.
- Name: It is necessary for the Company to add Pvt. Ltd. at the end of its name but this does not apply to the Partnership Firm.
- Capital Requirement: Rupees 1 Lakh is the minimum capital requirement for the Private Limited Company whereas there is no such minimum requirement clause in cases of Partnership Firm.
- Dissolving: In order to dissolve a Private Limited Company there are legal formalities to be done but that is not the case with partnership firms.
Advantages and disadvantages of Private Limited Company
Advantages of a Private Limited Company
- Separate Legal Entity: This makes the company a legal person and by that you can avail its benefits like owning property in the name of the company or can even incur debts. The shareholders or debtors of the company will have no liability to the creditors for those debts.
- Sue and be Sued: Because the company is a separate legal entity, it has the ability to sue and be sued in its own name. This helps in keeping away the names of members of the company out and the Company fights on its own name.
- Limited Liability: The liability of the members of a company is limited to the number of shares that they hold. This helps release the additional burden of carrying the responsibility of all on your own.
Disadvantages of a Private Limited Company
- Restricted Shareholders: In a Private Limited Company setup, the number of investors can not exceed 50 people. So the chances of further growth or expansion cancels out.
- Registration Process: The process of registering the Company takes around 10-20 days in total in order to file up all the necessary documents. This makes it a hectic and burdening work.
- Division of Ownership: in a Company, there have to be at least two directors and two shareholders, so you have to make every decision with the consent of two individuals and even if the other shareholders holds a negligible amount of shares, there is still a need to have two shareholders.
Advantages and disadvantages of Partnership
Advantages of Partnership
- Easy to Form: Since there is no requirement of registration, this makes it easier to open a Partnership Firm just with the consent and willingness of two or more people. This makes the beginning a smoother process.
- Better Management: The partners take interest in day to day business of the Partnership Firm and that helps in a better management of the firm.
- Sharing of Risk: In a Partnership Firm, every partner bears the same amount of risk as it is one of the core principles of formation of the firm, this cuts the load off of other partners’ heads.
Disadvantages of Partnership
- Not Being a Legal Entity: A Partnership Firm is not a legal entity, unlike the Company, it does not have a life of its own. When the partners’ separate, it dies.
- Uncertainty of Future: The future of a Partnership Firm is very uncertain, it dies if any of the partners’ dies or declares insolvency and the induction of a new partner is only going to be possible when all the remaining partners agree to it.
- Conflicting Nature: In a setup where there are several people working and they all have the same level of authority, conflicts occur. This hinders with the day to day business of the firm or with the direction in which the firm was supposed to be headed.
We have seen how the two forms of businesses function, what all it takes to register them and make them functioning and after analysing the advantages and disadvantages of both of them it is safe to say that there are different needs, different expected outcomes and different approaches to the both forms of businesses. Both of them have their own sets of ups and downs and it is really a matter of interest for the investor as to where he would want to put his money.
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