When you start a business, you need to choose the legal status of your business, You have to decide if you are going to run it as a Sole Trader, a Partnership, or a Limited Company. The key decision criterion is about personal financial liability, although there are other implications to consider. This section highlights the advantages and disadvantages of being a limited company and outlines the legal responsibilities.
2. What is a Limited Company
The amount of tax and National Insurance you pay, the records and accounts you keep, the way you take profit out of the business and the way you make decisions about running the business are key implications you need to consider.
As a sole trader or partnership, you are personally liable for all the debts of the business. This means that if the business fails, you may risk personal bankruptcy if the business debt is considerable and you are unable to pay it. Setting up a limited company offers protection against this.
You may decide to set up your business as a limited company from the outset, or you may choose to change the legal status of your business as it grows and is more established.
A limited company is a separate legal entity and as such, is responsible in its own right for everything it does. The company’s finances are separate from the personal finances of the owners.
This guarantees more protection for the owners and other shareholders who are not liable for the company’s debts.
A limited company must be registered with Companies House - follow the links to Starting a New Company.
3. Advantages of a limited company
There are a number of benefits associated with becoming a limited company.
- As has already been explained, the number one benefit is the financial security that comes with being a limited company. As long as the business is operated legally and within the terms of the Companies Act, the personal assets of both shareholders and directors of a limited company are not at risk should the company go out of business. Shareholders and directors are liable only to the level of their own investment and no more.
- There are tax and National Insurance advantages. For example, up to a certain value a company’s profits are tax free – refer to HM Revenue and Customs for the current values and information. Company profits can be distributed as dividends to shareholders and, currently, National Insurance is not applicable to dividend payments, effectively reducing your tax liability further. There are also potential tax advantages for those wishing to keep their money in the business or within a pension scheme.
Please note: this is an illustration of potential tax and NI advantages only. For detailed and up-to-date information and to find out about your personal circumstances, speak to your accountant or financial adviser.
- There is often a sense of confidence amongst both suppliers and customers if you operate as a limited company, and this increases the credibility of the business. Be aware that there are some larger organisations that prefer not to deal with businesses that are not limited.
- The costs associated with managing and operating a limited company, particularly accounting fees and taxes, are not significantly greater than non-limited businesses. In fact, changes in legislation over the last few years have meant much lower costs in these respects.
Always take advice from your accountant regarding the costs for your business.
- The formation of a limited company is one way to protect a business name. No 2 limited companies can have the same name, so there is no chance of confusion between different businesses. Also, your company name can be protected indefinitely, even if your company remains inactive for a lengthy period of time.
- As a limited company, it can be easier to secure funding, particularly through banks or shareholders.
- If the business is sold, it is easier to transfer to a new owner through the process of selling shares.
4. Disadvantages of a limited company
Whilst there are considerable advantages to becoming a limited company, there are also some disadvantages.
- There is a cost associated with forming a limited company. Whilst this is not onerous, it is something you must consider.
- There are more complex and restrictive rules regarding the accounts and bookkeeping for a limited company. For example, the company must produce annual accounts including a balance sheet and other financial statements. If you choose to do this yourself, there is a time implication. Alternatively if you hire someone or ask your accountant to do it for you, there is a cost implication.
- Accounts have to be filed at Companies House every year and these will be on public record. This means that others, including competitors, can see an abridged version of your accounts.
You also have to file accounts, company tax and corporation tax calculations with HM Revenue and Customs every year. Your accountant can help with this, but this will incur a cost.
Be aware of the strict filing times for both Companies House and HM Revenue and Customs and the potential of financial and other penalties if you do not file on time.
There are legal obligations for directors of limited companies as set out in the Companies Act.
The profits are the property of the company and do not belong to the shareholders (owners). This means, as the owner, you cannot take money out of the business when you feel like it - there are restrictions and tax consequences.
As a shareholder, the company can pay you a dividend, as long as it has enough profit – remember, the profit must be shared between all the shareholders, which may dilute the amount you receive.
As a director (employee) you can be paid a salary. The company can also pay you back business expenses if you have spent your own money, but be aware of the tax implications in this area.
As you can see, the benefits heavily outweigh the drawbacks of being a limited company. However, make sure you consider your situation fully before deciding whether it is the best decision for you.
It is always advisable to seek professional advice when deciding the legal status of your business.
5. Who owns a limited company?
The ownership of a limited company is divided into equal parts called shares. Shareholders, also known as members, are the people or organisations that own one or more of these shares.
Because limited companies have their own legal identity, the owners are not personally liable for the business’ debts. The shareholders have limited liability – limited to the value of the number of shares they own.
Unlike a sole trader or a partnership, the owners of a limited company are not necessarily involved in running the business. This is the job of the Board of Directors. The owner can, however, be one of the directors of the company. Directors are also known as officers of the business.
Shareholders own (and fund) the company.
Directors manage the business and are responsible to the shareholders.
Very often, the shareholders and directors are the same individuals. For example, if you start a business on your own and then become a limited company, you may own 100% of the shares and also run and manage the business on a day-to-day basis.
Alternatively, as the owner of the business, you may have someone else to run and manage it for you and you may (or may not) give or sell them shares in the business.
Even if the shareholders and directors are the same individuals, remember shareholders and directors have 2 different legal identities each with their own rights and obligations. You may be one person but with 2 roles.
6. Limited Companies’ legal responsibilities
A limited company has a number of legal responsibilities:
- The company must be registered at Companies House.
- Annual accounts must be filed at Companies House.
- An Annual Return must be submitted to Companies House.
- The company must maintain Statutory Registers which record the names and addresses of the officers and shareholders of the company.
- The company must inform HM Revenue and Customs of profits and taxable income for the company on a Company Tax Return and must meet all its tax obligations (Corporation Tax, Self-Assessment, NI and PAYE, and VAT).
- The company’s full name must be displayed at the registered office and on cheques, and all company letterheads must show the registered office address (and business address, if this is different) and the company registration number.
Next: Director's duties and responsibilities