Limited company: definition of the legal structure

Would you like to start a company? Theoretically, there are many different legal forms to choose from. Liability, the required start-up capital, and formal aspects are important criteria that you should take into account when deciding on a specific legal form. Ltds are one of the most popular business types in the UK today! But what exactly is an Ltd, and what are the advantages and disadvantages? 

What is an Ltd?

A limited company is a business structure where members or shareholders have limited liability depending on how much they have invested in the company. You aren’t personally liable for the company if it goes bankrupt; you are only responsible for business debts up to the value of your investments. Finances are separate from personal ones, and you can keep any profits you make after paying tax.

It is relatively easy to form a limited company, but first you have to work out exactly which kind of structure you would like. There are several different types of limited company in the UK such as limited liability partnership (LLP), public limited company (PLC), company limited by guarantee, etc. When talking about limited companies, it is usually private limited companies (Ltd) that are being referred to, so we will focus on this type in the article.

Definition

A limited company is a popular small business structure that limits owner liability to their shares, limits the number of shareholders to 50, and restricts shareholders from trading shares publicly.

A limited company must be registered with Companies House, which is the UK’s registrar of companies. Each year, all registered limited companies must file annual financial statements to this registrar.

How much is the start-up capital?

When you start up a limited company, you have the choice of what you want to do with your start-up capital. There are two options: you can either loan it to the company or issue share capital to the value of the money you’re investing. Here’s an example:

Jane decides to found a company selling stationery, but before she can set it up, she first needs to buy stock of £20,000 as well as pay someone to manage her website for £5,000. Since Jane has decided to pay out of her own pocket, she can either loan £25,000 to the company, or the company can issue 25,000 £1 shares to her in exchange for her money.

Loaning the money

There might not be any tax advantages for choosing this option, but there is a cash-flow advantage. If you lend the company money, you will get it back once the business has enough profit to re-pay it.

Issuing shares

This is more of a long-term commitment to the company, since you won’t get your money back even when the company starts to make enough. You could have the company buy your shares off you, but this is not as easy as it sounds and a solicitor may have to get involved.

Who is liable for the company and its members?

Ownership of the company is divided into shares, which are distributed between the shareholders. Each shareholder can decide how many shares they want in the company. The more shares you have, the more liability you have. An example being: A company sells 100 shares for £1 and John buys 20 of these for £20. This means that John owns 20% of the company. The most John will have to contribute to company debts is £20 since that is the amount he has agreed to pay for the shares. He would only have to pay this money if the company were unable to pays its creditors.

This is one of the biggest advantages of forming your own company. The business is entirely separate from those in charge of it, so any debt or legal claims are associated with the company and not the individual people.

The hierarchy of a limited liability company

The hierarchical structure differs between limited companies, but here is what these companies generally look like:

Director

A limited company must have at least one director and there is no limit to the number of directors allowed. A director can be an individual or a corporate body and is responsible for managing and conducting the company’s daily operation as well as being up-to-date with the business’ financial situation. Directors don’t necessarily have to reside in the UK; they can be situated anywhere in the world. The Companies Act 2006 lists what is to be expected from a director, so make sure you adhere to these regulations.

Company secretary

A secretary isn’t mandatory, but if you do decide to have one, they could even be one of the directors. Just like a director, a secretary can be an individual or a corporate body, and reside anywhere in the world. The general tasks include taking care of administrative matters, maintaining books, registers, and accounts. The secretary must be up-to-date on any changes in company law so the director(s) can be advised and decide on a plan of action.

Shareholders

There is no restriction to the number of shareholders (also referred to as “members”) a company can have, but there must be at least one of them. Sole shareholders are allowed in private companies and don’t necessarily have to abide in the UK. There isn’t a usual share structure for a new company, it simply depends on what you want the ownership to look like. If your business is only owned by you, you simply have to have a single share issued in your name. If you plan to spread the shares, consider allotting around 100 of them to make it easier.

Taxing a limited company

By effectively planning and understanding your responsibilities as the business owner, you can keep on top of your taxes. The alternative is to end up with a sizeable fine by filing them incorrectly or not at all. It might be a good idea to hire an accountant to make filing taxes a lot easier and also to make sure you’re paying the right taxes for your company. Here are the main taxes that an Ltd should pay:

Corporation tax

Corporation tax must be paid on the profits that your company has earned. Every financial year, you’re required to fill out the CT600 form and every company (no matter the size) pays the same rate. The current corporation tax rate is 19% (as of 2018/19 tax year).

Value added tax (VAT)

A company only needs to pay VAT when its annual turnover is £85,000 or more (although those making less can decide to pay it if they want). What makes VAT different to other taxes is that it’s the company itself that collects the tax on behalf of HMRC, rather than the government taking it directly. The reason a company would choose to pay VAT when it doesn’t need to is because it allows you to deduct the cost of any VAT your business incurs via day-to-day expenses. You can opt for a flat rate across all turnover or work out the correct amount for each individual transaction since VAT is charged on practically all UK products.

National Insurance (NI)

NI contributions are made on the company employees’ salaries. The employer collects the amount and pays it to the HMRC either monthly or quarterly. Employees earning under £162 per week don’t have to pay any contributions, between £162 and £892 per week results in a 12% tax charge, and if you earn more than £892 per week, you will be charged another 2% tax on anything earned over £892.

Income tax

During the 2018/19 tax year, you can earn up to £11,850 before you have to start paying income tax. All employees and directors (getting paid) are required to pay income tax although the rates differ. You can be taxed 20%, 40%, or 45%.

Dividend tax

It’s compulsory to pay tax on any dividends you might have received during the tax year. A system of “tax credits” was previously used to incorporate the fact that corporation tax had already been paid. This changed as of April 2016 and now there are three different rates: 7.5%, 32.5%, and 38.1%.

Advantages and disadvantages of an Ltd

A limited company might be the least complex business structure and is extremely popular among businesses large and small, since it combines the potential to share in profits and at the same time restricts personal financial liability. Unfortunately, it doesn’t come without its drawbacks. We’ve compiled a list of the pros and cons of Ltds so you can decide whether this business structure is for you:

Advantages of an Ltd

  • Minimised personal liability: Shareholders are only liable for debt depending on the amount they invested.
  • Separate entity from owners: The company can continue to exist even if the owner dies or retires.
  • Tax advantages: Ltds are only taxed on their profits, meaning a lower tax rate.
  • Increased credibility: Partners and suppliers may favour your business over others since more commitment is shown.

Disadvantages of an Ltd

  • Too much distribution of power: Since shares can be bought by anyone, it distributes the power to more and more people, which could cause tension between directors and shareholders when important decisions are to be made.
  • Lots of paperwork: Laws regarding limited companies are strict and every detail needs to be documented otherwise this can have undesired results for the company.
  • Expensive: A lot of capital is involved when setting up and maintaining a limited company. Since the accounts are quite complicated, it makes sense to hire a professional, which doesn’t come cheap.
  • Transparency: Documents sent annually to the Registrar of Companies are available to the public.

Please note the legal disclaimer relating to this article.


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