PRIVATE LIMITED COMPANY OR LLP (LIMITED LIABILITY PARTNERSHIP): WHICH ONE SHOULD YOU CHOOSE FOR YOUR START UP?

PRIVATE LIMITED COMPANY OR LLP (LIMITED LIABILITY PARTNERSHIP): WHICH ONE SHOULD YOU CHOOSE FOR YOUR START UP?

Pradeep Dubbula

Adv. Pradeep Dubbula

Partner
LawLeo.com
Fort , Mumbai

Posted on: 23rd Dec, 2015

Till very recently, a Private Limited Company (PLC) was the format of choice for a start-up entrepreneur. 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) format too offers these benefits. So which of these entities are better suited for housing your business? We list down the 10 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 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 case of a 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 separation of ownership (shareholders) and management (directors), a PLC can raise capital without the worry of interference in administration of its business affairs by the new owners. In contrast, raising fresh capital for a LLP involves inducting 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 payment of moneys towards issue of 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 a 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 a LLP. Transfer of shares of a PLC are regulated by the Articles of Association of the PLC and is required to be approved by the Board of Directors of the PLC. Transfer of a partner’s interest are 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 a 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 a 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 a 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 a 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 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 management of affairs of a PLC, his liability is always limited to the extent of moneys paid by him for the shares held by him (and moneys 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 a LLP, with no limit on liability. If unnoticed, this seemingly paltry fine can balloon into a large amount. It is necessary that partners of a LLP are aware about 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 evaluation of taxability, a 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 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 partner of a LLP.

Advantage: LLP

 

#10. PERCEPTION

PLCs are perceived to be more stable, transparent and credit worthy, in part due to the numerous filings that they are required to make with the government. LLPs as an Indian entity are 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 a LLP? Here is a rule of thumb: Most of businesses which involve stable capital structures and are led personally by their promoters are formed as LLPs (think architech firms, chartered account firms, legal firms, etc.) On the other hand, if a business is expected to generate Intellectual Property or it depend on professionals rather than promoters to create value or is process driven rather than people driven, a PLC is generally prefered; 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 a LLP?

If your answer is “Yes”: LLP

If your answer is “No”: PLC

Reason: Costs of setting up and running a LLP are lower than in case of a PLC. However, be mindful of the penalties for delay in compliances by a 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 introduction of a partner. A partner has the authority to bind the LLP by his actions. While one partner may favour 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 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.

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Vey helpful article, thanks pradeep. October 24, 2016, 11:33 am

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