How can a third party invest in a Private Limited Company?

A ‘Private Limited Company’ is owned either by non-governmental organizations or by a small number of shareholders/ company members. In India, the Ministry of Corporate Affairs is the governing body which regulates the Private Limited Company.

Due to the unique features like easy formation, the requirement of a minimum of only two members, limited liability etc., currently, the Private Limited Company is a hot favourite amongst upcoming entrepreneurs. 

However, the biggest downside of the private limited company is that it cannot offer its company stock/ shares to the general public on the stock exchange. Instead, private limited company’s stock is owned, offered and traded/ exchanged privately only. Due to the restriction on the general public to invest in a Private Limited Company, it is more preferable for an investor to invest in Public Company.

The present article helps the reader to understand the following – 

• Various points which one should keep in mind before investing in the Private Limited Company;
• Different ways which can be adopted to invest in the Private Limited Company.

Things to consider before investing in Private Limited Company

Any investor willing to invest funds generally has the following objective behind the investment:

1. Earning return (can be in any form like interest or dividend or principal appreciation etc.);
2. Safety as well as security of the principal amount;
3. Easy liquidity (i.e. easy conversion of investment into cash as and when required).

Based on the above investment objective, the investor should keep the following in mind before opting for investment in a Private Limited Company.

• Talking about returns from the investment in a Private Limited Company

If the investor is willing to invest in a start-up company, then, there is a probability of having low returns in the initial stage as compared to the investor planning to invest in an already established company.  

Investment through shares can result in higher returns. However, investment through debentures or loans results into average returns.

• Control over operations vis-à-vis safety of the principal amount

If the investor opts to invest in a Private Limited Company by purchasing shares in the company. Such investor shareholder can have voting power resulting in control over the operations of the company and decision making to some extent. However, investing in shares can yield higher returns, but the safety of the principal amount would be comparatively low.

Whereas, if the investor invests by acquiring debentures or in the form of loans and advance, the return would be average. At the same time, the safety of the principal amount would be higher.  

Hence depending upon the need/ requirement of the investor, the option can be selected.

Options for the third party to invest in a Private Limited Company

Holding shares in a Private Limited Company

As already mentioned above, a private limited company cannot invite the general public at large to subscribe to its shares. Due to the restriction, the private limited company can raise its capital only through private arrangements i.e. from its members, directors or their relatives. 

The person willing to invest in a private limited company needs to contact the promoters or directors of the company.

Debentures

Investment through debenture is considered as one of the safe routes to invest in the Private Limited Company. There are two types of debentures – convertible debentures and non-convertible debentures. 

The convertible debentures combine benefits of both equity and debt. Further, the investor is also bestowed with an option to convert the debt into equity. However, the return under convertible debentures would be average.

On the other hand, non-convertible debentures offer higher returns with no conversion option.

Investing in the form of Loan & Advances

The simplest way to invest in a Private Limited Company with average return and full security of principal amount would be investing in the form of loans and advances. The investor would be receiving regular returns in the form of interest. But there are certain restrictions on the persons from whom a private limited company can accept loans. A private limited company can accept loans only from:

1. Directors
2. Relatives of Directors
3. Members
4. Other Company

Other Miscellaneous options

In case the investor is not willing to go for any of the above available options, then, options like a venture capitalist, angel investors etc. are also available. The investors can invest in the Private Limited Company with such additional options also.