Advantages and disadvantages of a limited company
Limited companies are the second most popular business model, after sole traders. Many new and established sole traders or businesses may ponder the advantages and disadvantages of a limited company, or whether they should seek an alternate employment status.
There are numerous benefits to the limited company structure, which can benefit small and large companies alike. However, these must be carefully considered against the downsides to choose the structure that best suits your business.
What is a limited company?
In this context, ‘limited’ is a shorthand for ‘limited liability’. As the name implies, the personal assets of owners or shareholders are protected from the debts and liabilities of the limited company that they are invested in.
In the eyes of the law, a limited company is its own entity and is itself responsible for any debts it may accumulate. This allows entrepreneurs and shareholders to separate their own assets from their company, eliminating the threat to their personal wealth if the company is rendered bankrupt. This protection extends to litigation and lawsuits that may be brought against your business.
Types of limited company
Limited companies can be public or private and can change between the two under certain circumstances.
Public limited companies (PLCs) are businesses where shares totalling at least £50,000 have been issued to more than one shareholder. The shares of PLCs can be freely traded from one shareholder to another, and they don’t need to be listed on any stock exchange to be considered ‘public’. These companies are known as unlisted public companies and account for most small businesses that aren’t seeking public investors.
Private limited companies are owned entirely by one shareholder, and no shares are available for public trading. Almost all limited companies will begin as private endeavours, before ‘going public’ on a stock exchange if and when they’re ready.
Likewise, a public company can become private if all shares are purchased by a single shareholder, typically another company. This process is termed as a ‘buyout’ or ‘acquisition’.
This may seem like a distant prospect for many new entrepreneurs, but keep in mind that sole traders cannot issue shares of any kind - no matter how large their business may grow, which can make it difficult to attract investors.
The advantages and disadvantages of a limited company
A clear benefit to operating as a limited company is liability protection. No one wants to plan for failure, but sole traders facing significant debt or litigation risk losing all their personal assets, as there is no legal distinction between you and your business. Personal bankruptcy is significantly more damaging than business bankruptcy, as shareholders are only held accountable for the nominal value of their shares when it comes to repaying creditors.
It looks good
The veneer of professionality and legitimacy afforded by a branded company is no secret, but this perception is not entirely superficial.
Limited companies are monitored and held to a much higher standard than sole traders, and their accounts and other important corporate information are made publicly available. This increased transparency serves to greatly increase the trust that clients, customers, and investors will have in you and your business.
Registering a limited company will also ensure a distinct and protected name for your business, which is a key first step in building your brand.
Tax efficiency and planning
At certain profit levels, transitioning your business to a limited company is a no-brainer. Limited companies will pay between 19% and 21% in corporation tax on their profits. Sole traders are taxed entirely through income tax, which begins at 20% and reaches 45% in the highest bracket.
Further benefits include the ability to defer pay, split personal income, claim tax-deductible business mileage, set up a pre-tax company pension, and reinvest your income back into your own business, tax free. If used to their fullest, these methods of avoidance could save a large amount of your income from HMRC.
The downside of all this is, of course, the significantly increased complexity for your business finances. When combined with the strict responsibilities and regulations placed upon limited companies, many entrepreneurs choose to outsource their finances to a specialist self-employment accountancy firm. While this is another outgoing for your business, it can often be an expense that pays for itself.
As a limited company, you will also have to pay yourself an income before you can legally spend any money outside of your business. By being a director, employee, and shareholder simultaneously, you can be paid through a combination of salary and dividends - aiming to pay the minimum amount of tax on each income stream.
Likewise, if your business finds success, limited companies gain the option to sell either shares or the company outright. Successful startups, especially within the technology sector, can be sold for vast quantities of money. If your business has good scalability prospects, it is quite likely to be more valuable in the hands of a larger, more established company, who can take your business much further than you could alone.
There are many advantages and disadvantages of a limited company. Have a read of our extensive guides covering all you need to know about setting up a limited company, including how to register with Companies House, and how to transition out of an umbrella company.