Private and Public Companies in India: A comparative analysis

Transcription

1 Private and Public Companies in India: A comparative analysis Private and Public Companies in India: A comparative analysis BY Aishwarya Padmanabhan* Cite as: (2011) PL January S-9 Introduction The aim of this paper is to discuss in detail the fundamental differences between private and public companies in India under the Companies Act, It also looks into those ambiguous areas under the Indian company law where the distinction between the two gets blurred. A â œcompanyâ is an artificial person created by the process of law and hence, can only be destroyed by the process of law. A company is a legal person. It means that the company can sue and be sued â œin its own nameâ, the emphasis being on the words â œin its own nameâ.1 A company can hold property, acquire, sell, lease, mortgage, gift or otherwise transfer a property in its own name, in other words, a company as such can be a transferor or a transferee of a property. A company is a separate legal entity distinct from its members. It means the assets of the company are not the assets of the members. Conversely, the assets of the members are not the assets of the company2. Further, since the company is created by the process of law, it can be killed only by the process of law. Until a company is dissolved, it continues to be a legal person (perpetual succession). The Companies Act, 1956 provides for a variety of companies that may be promoted and registered under the Act. The two common types of companies which may be registered under the Act are3: - Private companies - Public companies Companies deemed to be public limited company A private company will be treated as a deemed public limited company in any of the following circumstances: - Where at least 25% of the paid-up share capital of a private company is held by one or more bodies corporate, the private company shall automatically become a public company on and from the date on which the aforesaid percentage is so held. - Where the annual average turnover of the private company during the period of three consecutive financial years is not less than `25 crores, the private company shall be, irrespective of its paid-up share capital, become a deemed public company. - Where not less than 25% of the paid-up capital of a public limited company is held by the private company, then the private company shall become a public company on and from the date on which the aforesaid percentage is so held. 4 - Where a private company accepts deposits after the invitation is made by advertisement or renews deposits from the public (other than from its members or directors or their relatives), such company shall become a public company on and from the date such acceptance or renewal is first made.5 Further, companies may be incorporated either as limited liability companies or as unlimited liability companies. Limited and unlimited companies Companies may be limited or unlimited companies. A company may be limited by shares or limited by guarantee. a. Company limited by shares â In this case, the liability of members is limited to the amount of uncalled share capital. No member of a company limited by shares can be called upon to pay more than the face value of shares or so much of it as is remaining unpaid. The members have no liability in case of fully paid-up shares.6 b. Company limited by guarantee â A company limited by guarantee is a registered company having the liability of its members limited by its memorandum of association to such amount as the members may respectively thereby undertake to pay if necessary on liquidation of the company. The liability of the members to pay the guaranteed amount arises only when the company has gone into liquidation and not when it is a going concern. A guarantee company may be a company with share capital or without share capital. Unlimited company â The liability of members of an unlimited company is unlimited. Therefore their liability is similar to that of the liability of the partners of a partnership firm. Section 25, Companies Act â Under the Companies Act, 1956, the name of a public limited company must end with the word â œlimitedâ and the name of a private limited company must end with the word â œprivate Limitedâ. However, un Section 25, the Central Government may allow companies to remove the word â œlimited/private Limitedâ from the name if the following conditions are satisfied: - The company is formed for promoting commerce, science, art, religion, charity or other socially useful objects. - The company does not intend to pay dividend to its members but apply its profits and other income in promotion of its

2 objects.7 Private company Private company means a company which by its articles of association 88: - Restricts the right of members to transfer its shares. - Limits the number of its members to fifty. In determining this number of 50, employee-members and ex-employee members are not to be considered. - Prohibits an invitation to the public to subscribe to any shares in or the debentures of the company. If a private company contravenes any of the aforesaid three provisions, it ceases to be private company and loses all the exemptions and privileges which a private company is entitled. Following are some of the privileges and exemptions of a private limited company: - Minimum number of members are two (seven in case of public companies). - Prohibition of allotment of shares or debentures in certain cases unless statement in lieu of prospectus has been delivered to the Registrar of Companies does not apply. - Restriction contained in Section 81 related to the rights issues of share capital does not apply. A special resolution to issue shares to non-members is not required in case of a private company.9 - Restriction contained in Section 149 on commencement of business by a company does not apply. A private company does not need a separate certificate of commencement of business.10 - Provisions of Section 165 relating to statutory meeting and submission of statutory report do not apply.11 - One (if seven or fewer members are present) or two members (if more than seven members are present) present in person at a meeting of the company can demand a poll. - In case of a private company which is not a subsidiary of a public limited company or in the case of a private company of which the entire paid-up share capital is held by one or more body corporate incorporated outside India, no person other than the member of the company concerned shall be entitled to inspect or obtain the copies of profit and loss account of that company. - Minimum number of directors is only two (three in case of a public company).12 The Company Law Board on being satisfied that the infringement of the aforesaid 3 conditions was accidental or due to inadvertence or that on other grounds, it was just and equitable to grant relief, may grant relief to the company from the consequences of such infringement. The infringement of the last 3 conditions does not automatically convert a private company into a public company. It continues to remain a private company; it merely ceases to be entitled to the privileges and exemptions available to a private company.13 Further companies may also be classified as statutory companies; registered companies; existing companies; associations not for profit; government companies; foreign companies; holding and subsidiary companies and investment companies.14 For the purpose of this project, there would be an understanding of the various fundamental differences that exist between a public and a private company. Public and private company: Differences The main differences between public and private companies relate to the provisions of the Companies Act that are not applicable to private companies. These include: - Provisions as to the type of share capital, further issue of share capital, voting rights, issue of shares with disproportionate rights, etc. - Provisions restricting the company from giving financial assistance to subscribe to its own shares. - Provisions restricting the amount of managerial remuneration paid and certain other provisions relating to managerial personnel. - Provisions restricting the powers of the Board of Directors. - Provisions restricting loans to directors. - Private companies are deemed to be converted into public companies in the following circumstances: - When not less than 25% of the paid-up capital of the company is held by one or more corporate bodies. - When the company holds 25% of the paid-up share capital of a public company. - When the average annual turnover of the company exceeds `100 million. - When the company accepts deposits from the public.15 - On becoming a deemed public company, many provisions of the Companies Act, 1956 in respect of which the company had exemption as a private company would become applicable. 16 Private companies are formed between 2 to 50 members and it prohibits invitation to public for capital issues. Many provisions of the Companies Act are not applicable. Also, there is a restriction on transfer of shares and the taxation rates are higher. Shares of the public limited companies on the other hand, are normally freely transferable. Minimum seven members are required to form the company. The taxation rates are normally lower and there is a wider coverage of the Companies Act.17 Establishing new ventures â Company formation â Public and private company Incorporating a company Approval of

3 name The first step in the formation of a company is the approval of the name by the Registrar of Companies (ROC) in the State/Union Territory in which the company will maintain its registered office. This approval is provided subject to certain conditions: for instance, there should not be an existing company by the same name. Further, the last words in the name are required to be â œprivate Limitedâ in the case of a private company and â œlimitedâ in the case of a public company.18 Memorandum and articles of association The memorandum of association and articles of association are the most important documents to be submitted to the ROC for the purpose of incorporation of a company. The memorandum of association is a document that sets out the constitution of the company. It contains, amongst others, the objects and the scope of activity of the company and also defines the relationship of the company with the outside world.19 The articles of association contain the rules and regulations of the company for the management of its internal affairs. While the memorandum specifies the objects and purposes for which the company has been formed, the articles lay down the rules and regulations for achieving those objects and purposes.20 The ROC will give the certificate of incorporation after the required documents are presented along with the requisite registration fee, which is scaled according to the share capital of the company, as stated in its memorandum. A private company can commence business on receipt of its certificate of incorporation. A public company has the option of inviting the public for subscription to its share capital. Accordingly, the company has to issue a prospectus, which provides information about the company to potential investors. The Companies Act specifies the information to be contained in the prospectus. The prospectus has to be filed with the ROC before it can be issued to the public. In case the company decides not to approach the public for the necessary capital and obtains it privately, it can file a â œstatement in Lieu of Prospectusâ with the ROC.21 On fulfilment of these requirements, the ROC issues a certificate of commencement of business to the public company. The company can commence business immediately after it receives this certificate. Winding up The Companies Act lays down the provisions and the procedures for winding-up operations leading to the dissolution of the company. Winding up may be either through court or voluntarily by the members of the company.22 Before a company can initiate such proceedings under the Companies Act, it must seek clearance from the Government for closure of the unit and displacement of labour under the Industrial Disputes Act.23 A sick or a potentially sick company that has been referred to the Board of Financial and Industrial Reconstruction may be wound up pursuant to an order passed by the Board. If a company wishes to close down a manufacturing unit without dissolving itself, it requires clearance from the Government under the Industrial Disputes Act. For final settlement to members of the Company Board, prior permission of RBI is required24. This permission is to be taken once the final amount for payment has been ascertained. Valuation of Private v. Public Firms There are a number of factors that are considered differently in the valuation of privately held versus public companies â even those that are in the same industryâ making a direct comparison for valuation purposes difficult. Following is a list of some of the issues that may result in differences between the valuations of public and private firms: 1. Market liquidity â A lack of market liquidity is usually the biggest factor contributing to a discount in the value of companies. With public companies, we can, if we choose, switch our investment to the stock of a different public company on a daily (if not more frequent) basis. The stock of privately held firms, however, is more difficult to sell quickly, making the value drop accordingly Profit measurement â While private companies seek mostly to minimise taxes, public companies seek to maximise earnings for shareholder reporting purposes. Therefore, the profitability of a private firm may require restatement in order for it to be directly comparable to that of a public firm. In addition, public company multiples are generally calculated from net income (after taxes), while private company multiples are often based on pre-tax (and many times, pre-debt) income. This discrepancy can result in an inaccurate formula for the valuation of a private company Capitalisation/capital structure â Public companies within a specific industry generally maintain capital structures (debt/equity mixes) that are fairly similar. That means the relative price/earnings ratios (where earnings include the servicing of debt) are usually comparable. Private companies within the same industry, however, can vary widely in capital structure. The valuation of a privately held business is therefore frequently based on â œenterprise value,â or the predebt value of a business rather than the value of the stock of the business, like public companies.27 This is another reason why private company multiples are generally based on pre-tax profits and may not be directly comparable to the price/earnings ratio of public firms Risk profile â Public companies usually provide an assurance of continuing operations above that of smaller, privately held firms. Downturns in the economy or a change in the environment (such as an increase in competition or regulatory changes) often have a greater impact on private firms than public firms in terms of performance and market

4 positioning. That higher risk may result in a discount in value for private firms. 5. Differences in operations â It is often difficult to find a public company operating in the same niche as a private firm. Public companies typically have operations spanning a broader range of products and services than do private companies. In addition, even if the products and services are the same, the revenue mix is often different Operational control â Although private companies are more likely to receive valuation discounts than public companies, there is at least one area where they may receive a value premium. While the sale of a private company usually results in the purchase of the controlling interest in the business, ownership of public company stock generally consists of a minority share ownership which may be construed to be less valuable than a controlling-interest position. Distinction between a public company and a private company a public company and a private company : Following are the main points of difference between - Minimum paid-up capital â A company to be incorporated as a private company must have a minimum paid-up capital of `1,00,000, whereas a public company must have a minimum paid-up capital of `5,00, Minimum number of members â Minimum number of members required to form a private company is 2, whereas a public company requires at least 7 members.31 - Maximum number of members â Maximum number of members in a private company is restricted to 50; there is no restriction of maximum number of members in a public company. - Transferability of shares â There is complete restriction on the transferability of the shares of a private company through its articles of association, whereas there is no restriction on the transferability of the shares of a public company. - Issue of prospectus â A private company is prohibited from inviting the public for subscription of its shares i.e. a private company cannot issue prospectus, whereas a public company is free to invite public for subscription i.e. a public company can issue a prospectus.32 - Number of directors â A private company may have two directors to manage the affairs of the company, whereas a public company must have at least three directors. - Consent of the directors â There is no need to give the consent by the directors of a private company, whereas the directors of a public company must have filed with the Registrar consent to act as director of the company.33 - Qualification shares â The directors of a private company need not sign an undertaking to acquire the qualification shares, whereas the directors of a public company are required to sign an undertaking to acquire the qualification shares of the public company. - Commencement of business â A private company can commence its business immediately after its incorporation, whereas a private company cannot start its business until a certificate to commencement of business is issued to it. - Shares warrants â A private company cannot issue share warrants against its fully paid shares, whereas a private company can issue share warrants against its fully paid-up shares.34 - Further issue of shares â A private company need not offer the further issue of shares to its existing shareholders, whereas a public company has to offer the further issue of shares to its existing shareholders as right shares. Further issue of shares can only be offer to the general public with the approval of the existing shareholders in the general meeting of the shareholders only. - Statutory meeting â A private company has no obligation to call the statutory meeting of the members, whereas a public company must call its statutory meeting and file statutory report with the Registrar of Companies.35 - Quorum â The quorum in the case of a private company is two members present personally, whereas in the case of a public company five members must be present personally to constitute quorum. However, the articles of association may provide for the number of members to be more than required under the Act. - Managerial remuneration â Total managerial remuneration in the case of a public company cannot exceed 11% of the net profits, and in case of inadequate profits a maximum of `87,500 can be paid. However, these restrictions do not apply on a private company.36 - Special privileges â A private company enjoys some special privileges, which are not available to a public company. Conclusion The Companies Act provides for a variety of companies that may be promoted and registered under the Act. However, two basic types of companies which may be registered under the Act are â œprivateâ and â œpublicâ compa As it can be seen, there are multifarious differences between a private company and a public company. These are important to understand in order to appreciate the functioning of these entities in the corporate world. However, there are certain grey areas in the realm of private and public company where the distinction between the two gets blurred. Section 43 A of the Companies Act A deemed public company under Section 43-A is not a public company for all purposes. The articles of a Section 43-A company may continue to include provisions relating to restriction on transfer of shares, limitation on the number of its members to 50, and prohibition for invitation to the public to subscribe for its shares, which are typical characteristics of a private company. Therefore, the expression, â œpublic companyâ in Section 3(1)(iv) cannot be equated with a â œprivate companyâ which has become a public company by virtue of Section 43-A.37 The number of members of a public company cannot fall below seven without attracting the serious consequences provided for by Section 45 (personal liability of members for the companyâ s debts) and Section 433(d) (winding up in case

5 the number falls below seven). A Section 43-A company can still maintain its separate corporate identity qua debts even if the number of its members is reduced below seven and is also not liable to be wound up for that reason. A Section 43- A company cannot be incorporated and registered as such under the Act. It is registered as a private company and becomes, by operation of law, a public company. Thus, it can be seen that there are certain nebulous areas of company law that make it difficult to distinguish the differences clearly between a private and public company. However, on the face of it, there are several differences between a private and public company. *BA, LLB (Hons.) 4th year student, WB National University of Judicial Sciences (WB NUJS), Kolkata, [ aishwarya_p@hotmail.com, aishwarya.padmanabhan4@gmail.com]. - Geoffrey Morse, Charlesworth and Morse on Company Law, (16th Edn., Sweet & Maxwell, London 1999). - Denis Keenan, Smith and Keenanâ s Company Law (12th Edn., Pearson Education, London 2002). - See the Companies Act, Avtar Singh, Company Law (12th Edn., Eastern Book Company, Lucknow 1999). - See Companies Act, 1956, S K.S. Anantharaman, Lectures on Company Law and Competition Act (Including Secretarial Practice) (9th Edn., Wadhwa Publishers, Nagpur 2005). - See the Companies Act, 1956, S See the Companies Act, 1956, S. 165, supra, n Supra, n Supra, n M.C. Bhandari, Guide to Memorandum, Articles and Incorporation of Companies (4th Edn., Wadhwa Publishers, Nagpur 2005). - Supra, n Supra, n Supra, n Derek French, Mayson, French & Ryan on Company Law, (25th Edn., OUP, London 2008). - Supra, n Supra, n Supra, n Supra, n Supra, n See Companies Act, 1956, S. 43-A.