10 advantages of setting up a limited company

There are currently over 5 million limited companies incorporated in the UK. Incorporation is often preferred to a sole trader or general partnership structure for one or more of the following reasons:

A limited company has its own legal identity. So third parties contract with the company and not the individual directors or shareholders. Unlike a sole trader, multiple people can take an ownership stake in a company by the allotment of shares.

A company can survive the death of the owners and directors. It’s possible for the directors and shareholders involved with the company to change over time.

A company’s existence will only cease if it is formally dissolved, liquidated or ended by other order of the courts or Registrar of Companies. Amongst other benefits, this can provide more perceived security for employees than other business structures.

The shareholders of a company have a capped liability for the debts, losses or legal claims of the business.  Their liability is limited to the amount paid for their shares plus, if they have any, the unpaid amount on any nil or partly paid shares.

This contrasts with the situation for partnerships and sole traders, where there is potentially unlimited personal liability. Your personal assets, such as your private residence and savings, could be at risk to settle debts of the business.

A limited company can therefore allow you to take a calculated business risk without the prospect of losing everything. Limited liability is always valuable, but particularly so when you are providing high value supplies or undertaking services that could lead to liability claims.

The one major exception is in cases of fraud, where the personal liability of directors is unlimited.

The formation of a private limited company can suggest that the business has permanence and is committed to effective and responsible management. It gives both suppliers and customers a sense of confidence.

Many companies, particularly larger organisations, will not deal with a business that’s not a limited company. Forming a company can therefore open up new business opportunities that wouldn’t otherwise be available. Often, the extra accounting and reporting requirements that apply for limited companies are worth it in terms of extra opportunities.

Sole traders and partnerships will not necessarily have a unique name, whereas there can only ever be one active UK company with any particular name. Once you’ve registered a company with Companies House, your new company name is protected and no-one can use the same name or even a name that’s too similar.

Sole traders and partners in a partnership pay in the region of 20% to 45% income tax while companies pay corporation tax, typically at 19%. As long as corporation tax rates are lower than income tax rates the advantage will often be with a limited company.

As well as salary payments to employees, a company can also pay dividends to its shareholders. A shareholder director will therefore often choose to receive the most tax efficient mix of salary and dividends. Provided a minimum level of salary is taken, the director retains entitlement to certain State benefits without any employee or employer National Insurance Contributions being payable. The balance of remuneration is sometimes taken as dividends, which may suffer less tax than salary and which are not themselves subject to National Insurance Contributions. Dividends would, however, be liable to corporation tax within the company.

In another article, we explore the taxation of dividend payments.

Companies generally also have a more benign set of rules around allowable expenses and reliefs. There is a range of allowances and tax-deductible costs that can be offset against a company’s profits. Surplus profits can also be retained within a company to fund costs and invest in growth and development.

It’s also possible effectively to defer income to a later tax year. This might be advantageous when the withdrawal of further income this year would take you into a higher tax bracket.

You should always take professional tax or financial advice in the light of your specific circumstances, and this area is no exception. No advice is offered here.

Rather than an employee director funding pensions out of taxed income, the company can make pension contributions. A company will often be able to make a higher tax relievable pension contribution than an individual. Contributions will usually also be a tax deductible expense for the company. It should therefore gain corporation tax relief against the value of the contribution.

There are no National Insurance Contributions for an employer or employee on pension contributions and contributions are generally not taxable for the employee.

Again, you should consult a professional adviser if you need advice in this area.

Whereas sole traders and partnerships generally have to raise new capital from their own resources, companies are able to raise capital at any time by issuing new shares.  New shares can be offered to existing shareholders or new investors, although only public limited companies can offer shares to the public.

The creation of one or more new share classes can be used to offer flexibility. You can thereby tailor rights to vote and therefore control the company, receive dividends and extract capital if the company is wound up. While the company may be established so new shareholders can easily be introduced, it is also possible to include pre-emption rights to protect the interests of existing shareholders.

There are tax-advantaged schemes such as Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) that are specifically targeted towards companies raising capital via share issue. Some grant funding may also only be available to businesses set up as companies.

If the company is going to borrow money from a bank it may be possible to secure a lower interest rate than for a sole trader. It may also be possible to obtain a loan without the need for the directors to give a personal guarantee. In contrast, sole traders will likely face the prospect of a charge on their private residence.

A company does not have to trade to exist.  It can be dormant, which means it has made no ‘significant accounting transactions’ during its financial year.  This can be useful if you have an idea and a name for a business but not yet the time or capital to develop it.

You’ll need to register the name and maintain the necessary formalities to keep the company on the register. However, these requirements are somewhat easier to meet than those for other companies.

Registering a business as a limited company can aid the possibility of selling it in the future, which can be difficult to achieve with other business structures. The original owner may be able to achieve a completely clean break and receive some financial benefit to help fund their future lifestyle – or the start of another business!

Entrepreneurs’ relief against capital gains tax may also be available on the sale of the business.

Even if the aim is not financial benefit, a limited company structure makes it comparatively straightforward to draw up succession plans and pass on the business to the next generation.

Lastly, the decision on whether or not to incorporate a company can simply come down to personal preference.  If you are familiar and comfortable with running a company then incorporating a new company will seem entirely natural and probably is a preferred course of action.

In many circumstances, running your business as a limited company can offer a strong base on which to expand and develop. However, other business structures, such operating as a sole trader, may be most appropriate in some scenarios. Many large and successful businesses have been grown from small limited companies, sometimes bringing great financial rewards – as well a lot of enjoyment – to those who’ve put in so much work to nurture them.

If you decide a limited company is right for your new business, check out how Inform Direct can help you start your limited company the easy way.

A previous version of this article was published on 7 August 2013.