PRIVATE LIMITED COMPANY OR LIMITED LIABILITY PARTNERSHIP: WHICH ONE SHOULD YOU CHOOSE FOR YOUR STARTUP?
Till very recently, a Private Limited Company (PLC) was the format of choice for an entrepreneur for starting a venture. PLCs have enjoyed independent legal existence and have limited shareholder liability — both these features have made it an attractive format over proprietorships and partnerships. A recent introduction, the Limited Liability Partnership (LLP) also offers these benefits. So which of these entities are better suited for housing your business?
Here are the 10 important factors that help you decide.
THE DECISIVE FACTORS
#1. LEGAL COMPLIANCE
PLCs are more expensive to set up as compared to LLP. Also, in the routine course of business, PLCs are required to file a variety of documents with the Ministry of Corporate Affairs (MCA) every year (a fee is required to be paid for each filing). LLPs are required to make only 2 filings per year after incorporation. This makes compliance of PLCs a more complex and costly affair.
Advantage: LLP
#2. FINANCIAL COMPLIANCE
PLCs are required to have their annual accounts audited and filed with the Ministry of Corporate Affairs every year. In case of a LLP, if its annual turnover is less than Rs. 40 lac and its capital contribution is less than Rs. 25 lac, the LLP need not have its accounts audited.
Advantage: LLP
#3. BUSINESS LIABILITY
A PLC can act only as per the instructions of the Board of Directors. The Board comprises Directors who are elected by the majority of shareholders. In the case of a PLC, therefore, the acts of an individual shareholder cannot make the company financially liable, since a shareholder does not necessarily have management powers. However, in the case of an LLP, a partner is both an owner of the LLP and its manager. Further, each partner of the LLP is an agent of the LLP, though not of the other partners. This means that the lawful dealings of a partner — even without the consent of the other partner(s) — are binding on the LLP; in case of a dispute arising from such a dealing, the counterparty can stake claim against the assets of the LLP (but not against the personal assets of the other partners).
Advantage: PLC
#4. CHANGES TO OWNERSHIP STRUCTURE
Addition: It is relatively simpler for a PLC to raise capital by issue of shares. Due to the separation of ownership (shareholders) and management (directors), a PLC can raise capital without the worry of interference in the administration of its business affairs by the new owners. In contrast, raising fresh capital for an LLP involves inviting a partner who may bind the company by his actions (see the point on Business Liability above). Also, introducing a partner may require formalities such as redrafting of the Partnership Agreement with terms applicable to the new partners and signatures of all the existing partners.
Removal: A PLC cannot involuntarily expel a shareholder for any reason other than a default in the payment of sums of money towards the purchase of its shares. A shareholder of a PLC holding fully-paid up shares would continue to remain so for such time as he pleases. In contrast, the Partnership Agreement of an LLP may specify the conditions under which the partners may expel one of themselves from the partnership.
Transfer: Theoretically, ownership of both PLCs and LLPs can be transferred. However, in practice, shares of a PLC are far more easily transferable than a partner’s stake in an LLP. The transfer of shares of a PLC is regulated by the Articles of Association of the PLC and is required to be approved by the Board of Directors of the PLC. The transfer of a partner’s interest is regulated by the partnership agreement; in some cases, this may require re-writing the partnership agreement.
Death: In case of death of a shareholder, the shares pass on to his legal heirs. In the event of the death of a partner of an LLP, the LLP will continue with the other partners. The heirs of the deceased will get the share of profits of the deceased from the LLP. They, however, do not automatically become partners of the LLP unless the partnership agreement so provides.
For these purposes, in case a client is looking to review the capital structure of his venture in the foreseeable future by means of Foreign Investments (FDI), Employee Stock Options (ESOP), capital raising or venture capital funding, we recommend a PLC form of business over an LLP form.
Advantage: PLC
#5. REMUNERATION TO DIRECTORS / PARTNERS
There are no restrictions or maximum limit on the remuneration that may be paid by a PLC to its Directors. In case of LLPs, however, the maximum amount that may be paid as remuneration by an LLP to its partners is prescribed under Section 40(b) of the Income Tax Act, 1961. This Section permits remuneration to be paid only to a working partner. The maximum compensation payable to the partners under this Section is: (A) higher of (i) Rs. 1,50,000 and (ii) 90% of the book profits for the first Rs. 3,00,000 of the book profits plus (B) 60% of the book profits of the LLP over Rs. 3,00,000. To illustrate, if the book profits of the LLP are Rs. 5,00,000, the remuneration permitted to partners will be (A) (90% of Rs. 3,00,000) + (B) (60% of Rs. 2,00,000) = Rs. 3,90,000.
Advantage: PLC
#6. LOAN TO DIRECTORS / PARTNERS
A loan made by a PLC to its Director is treated as a deemed dividend under Section 2(22)(e) of the Income Tax Act, 1961. Also, loans to directors are required to comply with stringent provisions under Section Section 185 of the Companies Act, 2013. This Section also prescribes very severe penalties for making a loan to a Director without fulfilling its provisions (fine ranges from Rs. 5 lacs to Rs. 25 lacs on both the PLC as well as the borrowing Director). There is no restriction on an LLP making a loan to a partner.
Advantage: LLP
#7. LIMITED LIABILITY
While both the structures limit the liability of their owners in the general course, there is an important aspect concerning LLPs. The liability of a partner who is held under the law to have committed a fraud or wilful misconduct is unlimited against liability arising from such fraud or misconduct. In contrast, as a shareholder is not involved in the management of affairs of a PLC, his liability is always limited to the extent of amounts of money paid by him for the shares held by him (and sums of money payable in case such shares are not fully paid up).
Advantage: PLC
#8. PENALTIES FOR DELAYS IN COMPLIANCE
LLPS are subject to a higher penalty for non-compliance than are PLCs. A penalty of a flat fee of Rs. 100 per day is charged for non-filing of documents by an LLP, with no limit on liability. If unnoticed, this seemingly paltry fine can balloon into a large amount. It is necessary that partners of an LLP are aware of the compliances required to be met by their venture and that they ensure that the LLP files the prescribed documents with the government well within time.
Advantage: PLC
#9. TAXATION
In the evaluation of taxability, an LLP is beneficial compared to a PLC. Under the present tax regime (AY 2015–16), the rate of tax applicable to PLC and LLP is 30.90%. However, in case the taxable income of a PLC exceeds Rs. 1 crore, the rate of tax is 32.445%. Further, in the case of a PLC, declaration of dividend attracts Dividend Distribution Tax of 16.2225%. Both dividend and profits from LLP are tax-free in the hands of a shareholder and a partner respectively. Effectively, for every Rs. 100 of profit that the business makes, the eventual amount received by the owners post-tax is Rs. 57.89 in case of a shareholder of a PLC and Rs. 69.10 in case of a partner of an LLP.
Advantage: LLP
#10. PERCEPTION
PLCs are perceived to be more stable, transparent and creditworthy, in part due to the numerous filings that they are required to make with the government. LLP as an Indian entity is quite a recent invention and are still to have set legal procedures and precedents. This perception may matter in matters such as business transactions, raising loans, seeking capital and proposing business associations and joint ventures.
Advantage: PLC
MAKING THE DECISION: PLC OR LLP?
Knowing what you now do, how do you decide between a PLC and an LLP? Here is a rule of thumb: Most of the businesses which involve stable capital structures and are led personally by their promoters are formed as LLPs (think architect firms, chartered account firms, legal firms, etc.) On the other hand, if a business is expected to generate Intellectual Property or it depends on professionals rather than promoters to create value or is process driven rather than people driven, a PLC is generally preferred; examples being IT and ITES firms, manufacturing units, and retail outlets.
For your specific case, answers to the following questions may help you choose the most-suited format.
A. Are the costs of setting up and running your venture a significant factor in deciding between a PLC and an LLP?
If your answer is “Yes”: LLP
If your answer is “No”: PLC
Reason: Costs of setting up and running an LLP are lower than in the case of a PLC. However, be mindful of the penalties for delay in compliances by an LLP!
B. Do you plan to add on new partners in your venture in the next few years?
If your answer is “Yes”: PLC
If your answer is “No”: LLP
Reason: Procedural ease.
C. If the answer to the question above is “yes”, then will your existing partner(s) be comfortable with induction of the new partner(s)?
If your answer is “Yes”: LLP
If your answer is “No”: PLC
Reason: In most cases, Partnership Agreements require unanimous consent for the introduction of a partner. A partner has the authority to bind the LLP by his actions. While one partner may favour the introduction of a new partner, the other(s) may not be as enthusiastic because of this factor. This situation may result in a deadlock.
D. Do you wish to have an Employee Stock Option Plan in your venture?
If your answer is “Yes”: PLC
If your answer is “No”: LLP
Reason: Procedural ease in strutting the ESOP policy and issue of shares on vesting. Also, in the case of PLC, your employees will eventually become your co-shareholders (who have no management rights) and not your partners (who have the authority to bind your LLP).
E. Are you looking at raising external funds (loans or equity) for your venture in the next few years?
If your answer is “Yes”: PLC
If your answer is “No”: LLP
Reason: Procedural ease, perception, and higher credibility.
F. Do you wish to draw remuneration from the venture?
If your answer is “Yes”: PLC
If your answer is “No”: LLP
Reason: There is no maximum ceiling on remuneration to Directors, but Directors cannot take a loan from the PLC. There is a maximum amount fixed for remuneration to partners; however, the partners can take a loan from the LLP.
