Raising Funds in Private Limited Company – Know the mandates!

The organisational structure of Private Limited Company is highly preferred by the start ups these days considering the ease in raising funds through shares allotment at premium pricing. Most of the venture funds and other investors have a strong preference for this formation type because of limited liability, transparency in accounts mandated by law, amongst other benefits.

However, there are some inherent restrictions and prohibitions laid down under Company Law on Private Limited Company by way of including the same in the definition of Private Company.

Before private limited company registration, it is important to know some features which include the meaning given by law along with what is known in general parlance. Definition of Private Limited Company is provided under Section 2(68) of Indian Companies Act, 2013, explanation of which can be given below:

A Private Limited Company shall include following clauses in its Articles of Associations:

1. Restriction on transferability of its share;
2. Limitation on number of members to Two Hundred (except in case of One Person Company);
3. Prohibition on any invitation to the public to subscribe for any securities of the company.

These three clauses mentioned above are the significant part of Private Company, which differentiates Private Company from the Public Company. In case, any of these clauses are removed from the AoA, the company automatically loses its status and shall be converted into Public Limited Company, which in turn results in revocation of various exemptions and privileges given to Private Limited Company.

Let us discuss in detail the meaning and impact of the clauses added in the AoA.

 Restriction of Transfer of Shares

 A Private Company is owned by the number of members closely related to each other or diverse people. In the practical scenario, a private company is registered with a view to carry on business owned by few of related personal and small group of people. Law requires this characteristic of the Private Limited Company to remain unaffected by any outsider thus there is the restriction on transfer of shares by the member of the company to any other person. This helps to indemnify any dilution of shares or control of the Private Company from the hands of existing promoters/members.

First, the person willing to transfer the share shall offer it to the existing members only, if existing members are not ready to accept the shares, only then shares can be offered to the outsiders. The transfer of same shall be considered and adopted in the meeting of Board of Directors of the company. The Board of Directors have power to refuse the transfer in good faith by considering the best for the company. The Rule of Preference to the existing members is called Rule of Pre-Emption.

 Limitation on number of Members

The minimum number of members is 2 and the ceiling limit is set up to 200 members. In the case of One Person Company, i.e. OPC, the number of member is one only hence the same is an exception to said clause.

The following shareholders will not be considered for the purpose of calculation of number of members for ceiling limit laid down in the definition:

• Shareholder being in employment of the company; and
• The personnel who have been shareholders while being in employment of company and have been holding share even after the cessation of employment from the company.

Furthermore, where one or more person hold the share(s) jointly, are considered as single member for this purpose of calculation of number of members in Private Company.

Prohibition on issue of securities to Public

Unlike a public company, the Private Company is prohibited to invite public for subscription of securities. Public Companies can raise capital by way of Public Issue by issuing the Prospectus. Here, a Private Company is prohibited i.e. banned to issue any such kind of documents which invites public to subscribe securities. By way of addition of this clause, the private company is not able raise capital from public.

Earlier, the definition also required the minimum paid-up capital in Private Company to be Rs. 100,000/-, requirement of which has been removed by way of amendment in the Companies Act. However, while registration of Private Limited Company, the minimum authorised capital shall be Rs 100,000/-.

The promoters of company are at very responsible role and should deliver the services by keeping in mind all the necessary rules and regulations related to company while registration as well as operations with a vision to remain in the market for long term. After reaching at the stage of sustainability, the Private Company can be registered as Public company by way of conversion, in case of any future requirement.