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Private Limited Companies

Updated on November 27, 2015

What is private limited company?

A private limited company is a type of company which is an association of individuals that come together to contribute money towards the starting of a business entity and who have limited liability.

One of the biggest traits of the private limited company is its ability to raise capital through the sales of shares to people. The number of shareholders in a private limited company normally doesn’t exceed a total of 50. The opposite of a private limited company is a public limited company. Private limited companies are not allowed to sell shares on the stock market; they sell shares privately. But public limited companies can sell shares to the public through the stock market.

Features of a private limited company

The most common features of this type of company are:

  1. It has a legal entity. This means that the law recognizes such a company as an entity which is separate from the individuals that own the company. A limited company can therefore sue and be sued. For example, if someone or an organization sues a limited liability company for something they have done wrong, since the company has a legal entity and is separated from the individuals that own it, only the company is sued and not the individuals that own it.
  2. Private limited companies raise capital for the businesses through the sales of shares to people they know such as friends and families. Anybody who buys a share in a limited company basically owns part of the company. Such a person is called a shareholder. The shareholders are the owners of a company.
  3. It enjoys limited liability. All private limited companies will always enjoy limited liability. What limited liability basically means is that the liability of each individual that owns the company is limited only to the amount of money he or she has contributed to the business. This means that in the event that the company becomes indebted, the personal assets of the owners of the company cannot be sold to pay what the company owes.
  4. The shareholders of the company meet once a year at a meeting called an Annual General Meeting (AGM) in order to discuss all pertinent affairs that pertain to the running of the company. They also discuss how profit will be shared. At the AGM, they also debate and vote on important matters.
  5. The management and control of the company is done by the board of directors. The members of the board of directors are appointed by the shareholders of the company at their Annual General Meetings (AGM).
  6. The number of shareholders of a private limited company cannot exceed a certain number. This number is normally 50.

Sources of funds for private limited companies

There are so many ways private limited companies can raise funds for the growth of their businesses. The most common sources of funds for these companies include the following:

  1. Selling of shares: All private limited companies raise funds for their businesses through sales of shares. When anybody buys a share in the company, he or she becomes a shareholder of the company and therefore owns part of the company.
  2. Re-investing the company’s profit back into the business: Another common source of funds for a private limited company is by reinvesting the profits made into the business in order to expand it. Before the profits are reinvested into the business, the shareholders come together and agree that their profits should be reinvested instead of being shared.
  3. Borrowing from banks: Private limited companies can also raise funds for the growth of their businesses is by securing loans from banks and other financial institutions. It is not difficult for these companies to raise loans from banks since they have the necessary collaterals that the banks need before giving out loans. Also, their strong business plans easily make the banks lend money to them.

Advantages of private limited companies

There are so many advantages of the private limited company, which is why this type of business organization is very common all over the world. Here are some of the common advantages of these companies:

  1. The risk involved in running these companies is limited because shareholders have limited liability. This means that in the unfortunate event where the company suddenly goes bankrupt and is in debt, the shareholders of the company will lose only the capital they contributed and nothing else. The limited liability these companies enjoy save shareholders from losing their savings and even their possessions to pay the huge debts of the company. It is because of this that many people are not afraid to invest their money into buying shares of a company. Had there been no limited liability, not too many people would be willing to buy the shares of a company because it would be a very risky venture.
  2. Shareholders don’t need to worry about how to go about managing the company since the board of directors is there to handle that for them. This makes shareholders free to go about doing their other businesses without worrying about running the company.
  3. As a result of the fact that these companies are able to raise large capitals (remember capital is contributed by a large number of people), the scope of their business activities is also very large. They therefore benefit from economies of scale (the larger the scale of production of a business, the more profitable it is for the business to operate, and vice versa).
  4. The sheer sizes of these companies help in reducing the unemployment problems in the country since they are capable of giving employment to a large number of people. This eventually helps to grow the economy of the country they find themselves in.
  5. All private limited companies also enjoy being separate legal entities. In this case, the law considers the owners of such companies totally separate from their companies. This therefore means that if the company is involved in any irregularities or if the company owes money, the shareholders cannot be taken to court or be held responsible since they have a separate legal identity. Rather it is the company that will be sued or held responsible and face any consequences that follow.
  6. The company is able to enjoy a continued existence. Unlike a business such as a sole proprietorship or the partnership, the private limited company has a very long life span. Such a business can last for so many decades even after the death of its original founders. The reason why this is so is because of the fact that the shareholders are numerous and new shareholders keep joining the business from time to time. So the death of or withdrawal of any shareholder doesn’t really affect the existence of the company that much.

Disadvantages of private limited companies

Now that we have taken a look at the advantages that the private limited company has to offer, let us turn our attention to the disadvantages of such a company. Below are some of the most common disadvantages of a private limited company:

  1. In many parts of the world, forming this type of company can be very difficult and frustrating mainly because of the extremely complex and demanding legal requirements. This is the reason why joint stock companies are said to be the most difficult type of business organization to form.
  2. There is a lack of privacy with this type of business organization since it is required by law that the company disclose information about itself to the general public in the form of publishing its annual account.
  3. The owners of the company have a limited control over their own company. This happens as a result of the fact that ownership and management are not the same. While the company is owned by the shareholders, management of the company is in the hands of the board of directors who control how the business is run and the policies that are made.
  4. The company is controlled by directors who may not have as much interest in the company as the owners. It is obvious that no one will have more interest in the success of a business than the owner himself. As a result of the little interest directors may have, they can easily become ineffective and make decisions that can cause the shareholders to lose money. The directors wouldn’t care since they stand to lose nothing.
  5. Another major disadvantage associated with a private limited company is the fact that the profits the company makes are taxed twice. How does this happen? Since these companies are separate legal entities, they pay corporate taxes on their net profit. After these taxes have been deducted, the remaining money is then shared among the shareholders in the form of dividends. Shareholders are then taxed again on their dividend income.
  6. Although these companies can raise finance for expansion, sometimes they face money problems in their attempts to expand their businesses beyond a certain size. This happens as a result of the fact that private limited companies are not allowed to sell shares to the general public over the stock exchange and the number of shareholders of the company cannot exceed a certain number (usually 50). This often results in such companies unable to get enough money to grow or expand their business activities. This is the reason why most private limited companies are normally small-sized companies and end up remaining like that for a very long period. But this isn’t the case for public limited companies which can sell shares through a stock market to as many members of the public as possible.

Summary

  • A private limited company has limited liability
  • The company has one or more people who own the business
  • The owners of a private limited company are called shareholders
  • Shareholders receive profits from the company
  • Shares of the company are sold privately
  • The shareholders of the private limited company cannot be sued
  • Directors are appointed to run the company not the shareholders
  • A private limited company has to publish its annual accounts

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