The nitty gritties of a Private Limited Company

In India, most of the startups and tech companies are registered as Private Limited Companies. The terms related to a company are mostly defined under Companies Act. While most of the terms sound very technical, they are very easy if you comprehend them. Let us look at some of such terms that we come across especially during M&As and Fund Raise : 

1.     Shareholders: The actual owners of the company. 
Shareholders might not be involved in the daily activities of the company, nor are they expected to be involved in running the business. Shareholders in turn appoint the Board of directors to run the business for them. In early stages, usually the founders are both shareholders and directors.      

2.   Authorized Share Capital: It is the maximum amount of capital that the company can raise at any given point of time. Authorized share capital is primarily classified into equity shares and preference shares.The board of directors, with the approval of the shareholders, can increase the authorized share capital as and when required.     

3.   Paid-up Capital: The current share capital of the company. Paid-up capital reflects the actual amount paid up by the shareholders of the company. This is the face value of the shares issued by the company.

4.   Board of Directors: Board of directors are the personnel involved in managing the operational activities of the company. They run the business of the company on behalf of the shareholders.
They are entitled to take decisions on almost every aspect of the day-to-day business of the company except for certain key matters as specified in the Act, for which approval of Shareholders is also required.

5.   Financial Statements: Includes the Balance Sheet, Profit and Loss Statement, Notes to Accounts, Cash Flow Statement (if applicable), Explanatory note, statement of changes in equity (if applicable), of the company, prepared in accordance with the accounting standards as prescribed in the Companies Act 2013.  

6. Equity Shares: All the share capital other than preference share capital.

7.     Preference Shares:  Issued share capital of the company which carries or would carry a preferential right with respect to payment of dividend and liquidation preference (in case of winding up). Investors generally prefer preference shares over equity shares due to this very “preference”.

8.   Convertible Note and Compulsorily Convertible Debentures are some of the other instruments used for fund raise. They are classified as debt in nature and are convertible to equity. However, convertible notes may be repaid depending on the terms of the agreement. The primary advantage is that for these instruments, the valuation is mostly dependent on the next round of funding. For a seed stage startup where it is difficult to arrive at a fixed valuation, these instruments are beneficial to both the investor and the company.

9.     Pre-money Valuation: Current valuation of the company, i.e., valuation of the company right before raising the investment.        

10.  Post-money Valuation: Valuation of the company immediately after raising the investment. (it would be the pre-money valuation plus the investment amount of the round of funding).       

11.  Limited Company: The liability of the shareholders of the company is limited to the extent of their capital contribution in the company. The company has a separate legal existence from the shareholders.

12.  Profit sharing: Unlike a partnership firm, the shareholders are not allowed to withdraw cash from the company. If there is surplus profit and after complying with the procedures as mentioned in the Act, the company may declare dividends out of the profits.  Such dividends are already subject to the corporate tax. Dividends are further taxable in the hands of the shareholders, depending on their taxable income slab.