You can form a limited company in a matter of hours without running into legal obstacles. But understanding whether you need one or not takes much more deliberation.
In this guide, we’ll explore what it means to form a limited company, explore the key differences with similar business structures, and compare its advantages.
The Essence of a Limited Company
The simplest way to describe a limited company is an organization that lets you set up a business that is responsible for its own finances, liabilities, and debts. The distinction establishes legal protection for owners and shareholders, who are no longer under obligation to cover the company’s debts from their personal finances.
This also means that directors and shareholders cannot just take money out of the company whenever they feel like it. The money the company earns belongs to it, not to the individuals. Moreover, the company is required to file accounts and a confirmation statement every year with Companies House. This documentation is available for public viewing.
Any profit the business generates will be jointly shared by the owners of the company, after its taxes have been paid. Due to its tax advantages and a host of other features, most small and medium-sized businesses prefer to operate as a limited company.
A Historical Background of Private Limited Companies
The modern form of limited liability companies underwent countless transformations over several centuries. The earliest notion of limited liability was the commenda, a system developed in 11th Century Italy, where a ‘passive partner’ provided investment money in a merchant vessel to a ‘managing partner’ who invested no capital.
After completion of the voyage, the partners would split up the profits under an agreed-upon rule. This arrangement allowed the passive partner to limit their liability of the investment, while the manager assumed all the risks associated with the vessel. Soon, more investors began to realize the benefits of pairing limited liability with their investments.
Another close proximity to limited liability companies are joint stock companies. They were first observed in the 1600s when the British Crown began granting groups of private investors permission to undertake certain ventures. These investors took the form of joint-stock companies that allowed them to aggregate labor and capital for the purpose of undertaking tasks that were deemed too large for a single person. Investors would pool their capital into a single joint-stock company, from which profits would be distributed based on capital invested. One famous example of a Joint Stock Company is the East India Company.
It should be noted that judicial authorities showed little interest on the subject of shareholder liability before the 19th century. Mostly because there wasn’t enough public interest in the idea of limited liability – probably because investors had greater appetites for risk back then and were more optimistic about their ventures. In his classic 1938 examination of 18th century company developments, Armand DuBois found the Warmley Company’s proprietors’ attempts to obtain incorporation as the earliest recognition of limited liability.
Main Features of a Limited Company
Fast forward into the 21st century, and limited companies are the default choice of business structure for entrepreneurs. According to Companies House, there are over 4 million incorporated companies in the UK. Here are a few key features of limited companies.
Protection through Limited Liability
The biggest advantage of limited companies is that directors and shareholders have limited liability for its debts. So if the company goes belly up, directors and shareholders won’t be personally responsible for its financial losses. There is one exception to the rule. If the company’s creditors lose money due to fraudulent activity, the director could end up losing their limited liability protections.
By contrast, sole traders get no protection from financial claims if the business runs into trouble.
Tax Benefits
Owners of a limited company are entitled to tax benefits without having to pay employee NICs. They can do this by drawing the bulk of their income from dividends while taking out a small salary only. Dividends are subject to less tax than salary, whereas a sole trader has to pay NICs on their entire income.
To sum up, limited companies can provide higher take-home pay to directors. It is worth pointing out that the tax treatment of dividends has undergone a few changes over the years, resulting in higher tax rates on dividends.
Easy to Form
Many people assume that forming a limited company is difficult due to bureaucratic obstacles and several months of hard work. The truth is that it is easy to incorporate online in less than 24 hours (and sometimes in as little as 6 hours) without any hectic legal work or obstacles. It’s that easy.
Easier Access to Finances
Shareholders and directors have an easier time accessing the funds of a limited company, compared to sole traders. This is because their finances are separate from those of a limited company. More importantly, Limited Companies can raise investments by issuing new shares to investors and shareholders. On the other hand, sole traders will have to raise capital from their personal assets. If they are strapped for cash, they really won’t have many choices of raising capital.
Securing a Trading Name
Once you incorporate a company with Companies House, the company name is legally protected. Only one such company is allowed to operate in the UK under the same name.
Gain Credibility
Many vendors, clients, and traders have more confidence in a limited company. Some clients – particularly large corporates – prefer to work exclusively with limited companies and may even refuse to deal with unincorporated companies. So working as a limited company can expand your business opportunities that may not be available otherwise.
Tax Responsibilities for Limited Companies
Limited Companies are required to register for VAT if their turnover £90,000 or more (2019/2020 tax year). Limited companies must also:
- Send an annual return to Companies House (also known as a confirmation statement)
- Provide HMRC with an annual Company Tax Return (for UK residents)
- Maintain the company’s annual accounts, also known as statutory accounts at the end of the financial year (for UK residents)
UK Resident directors are required to do the following:
- Complete an annual self-assessment tax return
- Pay tax and national insurance through the PayE system (if they are receiving a salary form the
company)
Ready to Incorporate?
If these features have piqued your interest and you are ready to start a limited company, you can do so in a matter of hours with Smart Formations . Don’t know which business structure is right for you? Get in touch with our support team to make the right choice based on your unique needs.