Setting up a business as a limited company is the second most popular way of setting up a business in the UK. In 2021, there were around 4.5 million private limited companies. There are both huge advantages and disadvantages of running a limited company, as well as, other structures such as sole traders (which is the most popular business structure, with their being 3.2 million in 2021). It’s important for any aspiring entrepreneurs to understand the range of benefits and pitfalls of different business structures to determine if they are the right fit for their business idea.
Here is all you need to know about what a limited company is, as well as, the advantages and disadvantages of a limited company compared to other structures.
What is a Limited Company?
A limited company is one of the three business structures used in the UK. The business structure allows an individual to create a business as a separate entity. It allows the owner to and any other shareholder to only risk their investment and keep their personal finances protected. Therefore, its popular way to set up a business as it offers protection should the business fail.
Any business debts will only have to be paid by the business, not the owner or the shareholders. Whereas a sole trader and the owner are seen as one entity in the eyes of the law, meaning that the owner is responsible for any business debts and failures.
What are the Advantages of a Limited Company?
There are some great benefits of setting up a limited company and here they are:
It’s well known that a limited company is more likely to be tax efficient compared to a sole trader, and that is one of the many reasons it’s a popular business model. A limited company director will usually take the maximum amount that is not being taxed in the tax year. For example, for the tax year 2021/22 this sum is £12,570. More on tax rates here. Then the remainder of the income is taken through dividends.
More detail on dividends can be found below:
- Dividends are great as you don’t have to pay NIC’s (National Insurance Contributions) on the dividedness.
- Dividends are also taxed on the lower rate of income tax than self-employment incomes. More on dividends here.
- Companies also have to pay the 19% corporation tax if your profit falls below £300,000. This will remain at 19% until the year 23/24 when it will change from 19% to 25%, find out more, here.
In comparison, Income tax for sole trader profits come to around 20-40%.
A limited company offers limited liability to the business owner. Whereas a sole trader is responsible and liable for all the business, a limited company owner/director has limited liability. This is one of the biggest reasons why entrepreneurs opt for this business structure. Having limited liability means that if a business incurs debts, your personal assets and finances will be protected in the eyes of the law.
For example, if your business is in severe debt, you will not have to use your personal assets to cover the business debt, although you may choose to.
In the eyes of the law, a limited company business is a separate entity to its owner. This is another great benefit of setting up a limited company, rather than a sole trader. A sole trader and its owner are seen as one entity. A limited company director has the protection, should the business fail. As the company is the separate entity, it can enter into contracts and is liable for all the business actions. A limited company director will have no attachment to the company’s actions apart from their share of the company.
When a business is set up as a sole trader, the business is not officially registered with the Companies House. This makes the process easier, however, anyone can use your name for their business and you will have no right to take action against this (unless you get it trademarked). When you register your business with the Companies House, you trademark your business name so no other business can use it. This makes your business individual and it can also help it to be found easily online.
Additionally, limited companies have more prestige when it comes to the business image. Limited companies also can come across bigger than they are, making them appear professional. It also means that a limited company is more likely to attract clients and investors than other business structures. It might even be easier for limited company directors to get funding such as loans from banks, as they are seen as a secure business.
As an owner of the limited company, the director can invest pre-tax sum into a company pension scheme. This means that the director can save money instead of taking money out and investing it in a personal pension scheme, which will be subjected to both business and personal tax.
Maximising Tax-Free Income
A limited company will allow you to maximise tax-free income, by having your husband/wife/partner and children shareholders. This will mean that each person can take the tax-free salary of £12,570 (as of the tax year 2021/22).
For example, if a husband and wife take salary up to the amount of the tax-free income, they can accumulate £25,140 all tax-free. This is a great benefit of having a limited company, working your way around tax and maximising your income.
What are the Disadvantages of a Limited Company?
With positives, there come some negatives. Here are the disadvantages of a limited company:
Complicated to Set-up
A sole trader it is pretty easy and straightforward as you only have to register with the HMRC. Whereas, setting up a limited company will mean registering with the Companies House. You will also have to pay a fee for setting up. You can also form a limited company through a formation company for a fee.
Limited company accounts can be complicated compared to other business structures. This will require the director to record information on the monthly basis. Some of the things that need to be covered are tax returns, business expenses and keeping the business accounts up to date. As the accounts for limited accounts are quite complex, it is essential that you hire help.
If you fail or make mistakes when filing tax returns and keeping a record of business accounts, you could face penalties from the HRMC. Here is all you need to know about limited company accounts.
It’s strongly advised that you hire an accountant for your limited company in order to deal with your taxes. Some of the tasks that an accountant can do for you include, filing your company tax returns, paying your corporation tax, as well as filing your VAT returns (if applicable).
This means that you will need to pay the accountancy fees, which can be quite steep. However, as a limited company, these costs are necessary to avoid paying penalties. To set up a limited company, you will need to complete the following documents to submit to Companies house: IN01 – your company details and Memorandum and Articles of association. More on setting up a limited company.
A limited company is likely to have shareholders, and those shareholders have a say in how the business is run. The way a sole trader is run as well as its general goals are all dictated by the owner. However, if a limited company has multiple shareholders then their opinions and views need to be taken into account. The bigger the share that other people, the less ownership you have. Therefore, be prepared to share some decisions with your shareholders/partners when running your limited company.
As a limited company owner, you have to register your house with the Companies House in the UK. This will mean that you provide information on company accounts, company records, company directors and company shareholders. The information you provide to the Companies House is then published and can be accessed by anyone. This reduces the level of privacy a business has. If you trade as a sole trader, your privacy remains.
More on limited company tax and limited company accountants.
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