A private limited company is the best option for entrepreneurs seeking to grow, enhance their credibility, and improve the financial stability of their business. Unlike a proprietorship, a private limited company protects the personal assets of the owner from the business’s obligations. A private limited company, as opposed to a sole proprietorship, which relies entirely on individual resources, can also attract investors, raise capital, and establish an organised management system. In India, private limited companies are governed by the Companies Act, 2013, and the Income Tax Act, 1961. A private limited company is the go-to option for business owners seeking long-term growth, as it offers tax advantages, facilitates the easier acquisition of bank loans, and has a more substantial market presence. A business can enhance stability, investor trust, and operational scalability by converting from a sole proprietorship to a Private Limited Company.
In this guide, we will explore what a Private Limited Company is, the reasons for converting a sole proprietorship into one, its benefits, the required documents, and the detailed conversion process.
What is a Private Limited Company?
A Private Limited Company is a business entity held by private stakeholders registered under the Companies Act, 2013. It restricts the ability to transfer its shares and the liability of the owner only to the extent of the capital contributed to the company. \
- A private limited company can have a minimum of two shareholders and a maximum of 200 shareholders.
- The transfer of shares is restricted in a private limited company, i.e., shares cannot be freely transferred to the public or external parties.
- A private limited company cannot invite the public to subscribe to its shares or debentures.
Why Convert from a Sole Proprietorship to a Private Limited Company?
- Risk Reduction: In a sole proprietorship, the proprietor of the business is personally liable for business debts, while the Private Limited Company limits the liability of the owner.
- Better Funding Options: A Private Limited Company can raise capital more quickly through equity or institutional funding.
- Legal Recognition: A Private Limited Company is a separate legal entity, as compared to a sole proprietorship.
- Expansion Opportunities: A Private Limited Company can scale operations, expand across regions, and enter into contracts more effectively.
- Improved Business Image: Clients, vendors, and investors prefer dealing with a company rather than an individual.
- Tax Efficiency: Companies benefit from lower corporate tax rates and various exemptions.
- Continuity & Succession Planning: Unlike sole proprietorships, a Private Limited Company does not dissolve with the exit of the owner, such as death or insolvency.
- Attracting Skilled Workforce: A company structure is more formal than a sole proprietorship and allows for better hiring of talent.
- Better Market Positioning: A Private Limited Company has better recognition in the eyes of the law and the general public as compared to a sole proprietorship.
Benefits of a Private Limited Company
The Private Limited Company has many benefits, and some of the benefits are listed below:
- Limited Liability Protection: The personal assets of shareholders are separated and protected from the company’s debts and liabilities.
- Separate Legal Entity: A Private Limited Company is a distinct, separate entity in the eyes of law. Its existence is independent of its owners.
- Perpetual Existence: A Private Limited Company continues even if the owners change or die.
- Easier Fundraising: Banks and investors prefer lending to a structured company than a sole proprietor.
- Tax Benefits: Private Limited Companies enjoy lower tax rates and exemptions than sole proprietors.
- Enhanced Credibility: A registered company holds more trust in the market and holds a separate brand identity.
- Better Business Opportunities: Investors and large corporations prefer dealing with structured and registered companies over sole proprietorships.
- Structured Management: A Private Limited Company has defined roles for directors and shareholders to ensure better governance.
- Employee Benefits: A Company offers benefits, such as ESOPs and other incentives, to its employees.
Documents Required for Conversion
The following documents are needed to convert a Sole Proprietorship into a Private Limited Company:
- Personal Identification Documents
- PAN Card of the proprietor and directors.
- Aadhar Card of the proprietor and directors for identity verification.
- Address Proof
- Electricity bill, rent agreement, lease agreement, or property documents as proof of business location. You can also attach utility bills, such as electricity bills, but they should not be older than two months.
- Financial Documents
- Bank statements of the past six (6) months of the sole proprietorship and the newly formed company.
- Business Formation Documents
- Memorandum of Association (MoA): It defines the company’s objectives and purpose.
- Articles of Association (AoA): These documents outline the company’s rules, operational structure, and internal management.
- Certificate of Incorporation: It is issued by the Registrar of Companies (ROC) upon successful completion of the registration process.
- Shareholder Agreement: The agreement specifies the ownership structure and voting rights in the Company.
- Compliance & Legal Documents
- Director Identification Number (DIN) of all directors.
- Digital Signature Certificate (DSC) for electronic document submission.
- GST registration (if applicable).
- Transfer Deed for moving assets and liabilities from the proprietorship to the new company.
Step-by-Step Process for Conversion
Step 1: Obtain DSC and DIN
- The first step is to apply for a Digital Signature Certificate (DSC) for all directors of the Company.
- Obtain a Director Identification Number (DIN) from the Ministry of Corporate Affairs (MCA).
Step 2: Draft MoA and AoA
Prepare the Memorandum of Association (MoA) and Articles of Association (AoA), which define the company’s objectives, management rules, and operational guidelines.
Step 3: Name Approval
Apply for company name approval with the MCA via the RUN (Reserve Unique Name) service. You can propose two names for the company, and the names shall be reserved for 15 days.
Step 4: File Incorporation Documents
Submit Form SPICe+ (Simplified Proforma for Incorporating Company Electronically) to the ROC via the MCA portal.
Upon approval, obtain the Certificate of Incorporation from the ROC.
Step 5: Transfer Assets & Liabilities
Legally transfer all assets, liabilities, bank accounts, and contracts from the proprietorship to the new company. Draft a Transfer Deed to document all the transfers.
Step 6: Tax & Compliance Formalities
- Update the PAN (Permanent Account Number) and TAN (Tax Account Number) for the new entity.
- Modify GST registration if applicable.
Step 7: Open a Business Bank Account
- Open a corporate bank account in the name of the newly formed Private Limited Company.
Step 8: Obtain Necessary Licenses & Approvals
- Depending on the industry, apply for sector-specific licenses, permits, or approvals as required by the relevant authorities.
