What is a Limited Company?

What is a Limited Company?

A limited company, commonly referred to as an "Ltd" or "Limited," is a type of business structure in which the company's liability is limited to its assets. This means that the company's finances are separate from the personal finances of its shareholders. It's a separate legal entity from its owner(s), known as shareholders, providing distinct advantages and legal protections. If the company faces financial difficulties or legal issues, the personal assets of the shareholders are protected; they are only liable up to the amount they have invested in the company. Limited companies can either be private or public, each with its own set of regulations and disclosure requirements.

For freelancers and contractors, a limited company is one of the three main business structures that they may use to run the business (the others being sole trader and umbrella companies).

How a Limited Company Works

Understanding how a limited company operates is essential for business owners and potential investors. This section provides a detailed look at the mechanics of a limited company, from its organizational structure to its financial operations and regulatory compliance.

Organisational Structure

1. Shareholders

Shareholders are the owners of the company. Each shareholder owns a portion of the company, represented by their shareholding. Shareholders' liability is limited to the amount they invested in the company.

2. Directors

Directors are appointed to manage the company’s day-to-day operations and make strategic decisions. They have a fiduciary duty to act in the best interest of the company and its shareholders. A limited company must have at least one director, who can also be a shareholder.

3. Company Secretary

While not mandatory for private limited companies, a company secretary can be appointed to assist with compliance and administrative tasks. For public limited companies, having a company secretary is a legal requirement.

Financial Operations

1. Capital and Shares

A limited company raises capital by issuing shares. These shares represent ownership in the company and can be issued to raise funds for business activities. The number and value of shares are defined in the company's statement of capital.

2. Profit Distribution

Profits made by the company can be distributed to shareholders in the form of dividends. The amount of dividend each shareholder receives is proportionate to their shareholding in the company. Dividends are paid out of the company's post-tax profits.

3. Company Accounts

Limited companies are required to keep accurate and up-to-date financial records. These records include details of all income, expenses, assets, and liabilities. Annual financial statements must be prepared, including a balance sheet and profit and loss account.

Regulatory Compliance

1. Registration with Companies House

Every limited company in the UK must be registered with Companies House. This involves submitting an application form, along with the company's memorandum and articles of association, and paying the registration fee.

2. Annual Filing Requirements

Limited companies must file annual accounts and a confirmation statement with Companies House. The confirmation statement provides an overview of the company’s information at a particular date, including the details of directors, shareholders, PSCs and registered office address.

3. Tax Obligations

Limited companies are subject to Corporation Tax on their profits. They must register for Corporation Tax and file an annual Corporation Tax return with HRC. Additionally, companies may need to register for VAT if their taxable turnover exceeds the VAT threshold £90,000 (VAT threshold 2024), and for PAYE if they have employees.

Operation and Decision-Making

1. Board Meetings

The directors hold board meetings to discuss and make decisions on significant matters affecting the company. Minutes of these meetings must be recorded and kept as part of the company’s records.

2. Shareholders’ Meetings

Annual General Meetings (AGMs) are held to allow shareholders to receive information about the company’s performance and to vote on key issues. For private limited companies, AGMs are not mandatory unless stipulated in the articles of association.

3. Resolutions

Decisions made by shareholders can be formalized through resolutions. There are two types of resolutions: ordinary resolutions, which require a simple majority, and special resolutions, which require at least 75% of the votes.

Legal Obligations

1. Director’s Duties

Directors have a legal duty to act within their powers, promote the success of the company, exercise independent judgment, and avoid conflicts of interest. They must also ensure the company complies with its legal obligations, including filing requirements and maintaining accurate records.

2. Statutory Records

Limited companies must maintain statutory records, including a register of shareholders, a register of directors, and records of resolutions and meetings. These records must be available for inspection by shareholders and regulatory authorities.

3. Employment Law

If the company has employees, it must comply with employment law, including providing written terms of employment, paying at least the minimum wage, and ensuring a safe working environment. Companies must also manage payroll and deductions, such as National Insurance and income tax.

Closing a Limited Company

Closing a limited company can be done voluntarily or through compulsory measures:

1. Voluntary Strike Off

A company can apply to be struck off the Companies House register if it has not traded or sold any stock in the last three months. The process involves filing a DS01 form and informing all interested parties.

2. Insolvency

If a company cannot pay its debts, it may need to go through an insolvency process. This can involve liquidation, administration, or a company voluntary arrangement (CVA), depending on the circumstances.

What does "Separate Legal Entity" Mean?

Limited companies or private limited companies are companies that have been incorporated at Companies House as a separate legal entity. Incorporating your company at Companies House requires you to choose an original business name, which has certain limitations. Basically, what this means is that the company exists and operates independently to the owners of the business, and it can enter into contracts under its own name. Thus, there is an important legal distinction.

How Does this Benefit the Owner of the Company?

Well, companies that are separate legal entities are protected by limited liability, meaning that the owners are only liable for the business debts up to their original investment in the business. The company's rights and liabilities are separate from those of its owners, offering a layer of protection to shareholders' personal assets. At the time of financial difficulties or legal disputes, the liability of shareholders is typically limited to the amount they have invested in the company.

In other words: if you have been incorporated at Companies House and invested £10,000 from your finances to start your company, and you later on accumulate £50,000 worth of debt that are you unable to repay, you'll only be liable to pay £10,000 worth of that debt - assuming you've set up a Limited Company.

On the other hand, if you're a sole trader and not incorporated at Companies House, your business operations are linked to you as an individual. If you overrun with debt or legal woes as a sole trader, there is no escaping those liabilities, you'll personally be on the hook for every penny.

At the end of the day, limited liability provides huge protection for business owners, particularly when legal action is taken against their company. The same applies in cases of insolvency where business owners aren't able to pay off their debts.

Types of Limited Companies

Here in the United Kingdom, there are 4 types of limited companies:

1. Private and limited by shares (or private companies limited by shares)
2. Private and limited by guarantee (or private companies limited by guarantee)
3. Public limited company (or public limited companies)
4. Limited Liability Partnership

In this section, we'll discuss each type of Limited Company, including private limited companies, explain their legal distinction, and how they work.

1. Private Limited by Shares

These are by far the most common limited company, and they're an excellent choice for freelancers and contractors who want to start companies.

"Limited by shares" means that the private limited company is divided into shares, which are distributed amongst shareholders with the same monetary value attached to each share (anyone can buy shares). These companies must have at least one shareholder, but there's no upper limit or maximum number of shareholders.

Here's an example: if you're a freelancer setting up your own business, you own 100% of the company, and you'll be liable for whatever amount you've invested in the case of insolvency. If you're setting up an agency with a friend, and each of you put £5,000 into the business, you'll each be personally liable for £5,000.

When setting up a private company that's limited by shares and while incorporation of it at Companies House, shareholders have to appoint directors to manage the day-to-day business activities on their behalf. Assuming you're just a one-man show at this point, just appoint yourself as a company director - that will do the trick.

2. Private Limited by Guarantee

This setup is most commonly used by non-profits who reinvest their profits back into the organisation, and it involves guarantors instead of shareholders.

Like private companies that are limited by shares, private companies that are limited by guarantee (also referred to as guarantee companies) are seen as separate legal entities that are responsible for their own assets, income, debts and limited liabilities.

That said, since this type of company does not issue any shares, there are no shareholders in the picture. Instead, companies that are limited by guarantee are owned by individuals who are called guarantors.

Now, you might be wondering, how does limited liability work in this case?

Here, a guarantor's personal liability isn't limited to their original investment. Instead, it's limited to a fixed amount of money called a "guarantee". If your guarantee is £8,000, for instance, then that's what you'll pay in the case of insolvency.

Like shareholders, guarantors are required to appoint directors to manage the day-to-day affairs of the company. Again, it's possible (and common) for guarantors to appoint themselves as directors at Companies House, so you don't have to scratch your head over finding someone to be your director.

3. Public Limited Company

When a private company limited by shares grows large enough, the company's owners or shareholders might choose to take the company "public" in an Initial Public Offering (IPO). When this happens, the company will be classed as a Public Limited Company instead of a private limited company.

These companies' shares are available for trading on stock exchange such as the FTSE 500 or the Nasdaq. This means that the company's shareholders are able to sell their shares to the public.

Generally speaking, Public Limited Companies are more complex to run compared to Private Companies.

For one thing, Public Companies are required to have at least two directors and hold annual general meetings (AGMs). On top of that, it's also mandatory for Public Limited Companies to publish information about its financial health so that shareholders and potential shareholders have clarity about the value of their stock.

4. Limited Liability Partnership

A Limited Liability Partnership (LLP) is a unique business structure that combines the advantages of both a partnership and a limited liability company. It offers flexibility, legal protection, and tax benefits to its members. An LLP has a separate legal existence from its partners, providing personal asset protection. The primary advantage of an LLP is limited liability, as partners are not personally liable for the debts of the business. LLPs also offer flexibility in internal governance, tax benefits as profits are distributed to partners, enhanced professional reputation, and continuity even with changes in partners.

Limited Company Advantages

There are three major advantages of a limited company.

In this section, we'll walk you through these benefits and drawbacks, so you can decide if a limited company is a good fit for you.

1. Limited Liability: Owners aren't (fully) liable

One of the biggest advantages of a limited company is limited liability protection which means that the owners or shareholders aren't fully liable if someone takes legal action against the company (or if the company becomes insolvent).

Think of it this way: if you're a sole trader, and someone sues you for hundreds of thousands of pounds and you lose the case, this could very well bankrupt you which will have devastating consequences on your personal life.

If you own a limited company, on the other hand, you'll only have to pay the amount you've invested. It can be the difference between losing everything and losing a manageable amount of money.

2. Tax Benefits

On top of that, and who doesn't like saving on taxes? Limited companies can enjoy various tax benefits, including enhanced tax efficiency.

More specifically: where sole traders pay 20% to 45% income tax on all taxable earnings, owners of limited companies pay a flat rate of 19% corporation tax on their profits. And this 19% can be lowered substantially through dividends and expenses. If you are a self-employed sole trader, you will also need to pay capital gains tax.

If you are self-employed and your profits are more than £12,570 a year, you will usually need to pay Class 2 and Class 4 National Insurance rates. If you're the director of a limited company, your National Insurance contributions (typically Class 1) are paid through your PAYE payroll.

Use our online calculator if you would like to see an example of the income tax and corporation tax savings of using a limited company over sole traders.

3. Professional Image

With a limited company structure increases the legitimacy of your business, and provides you with a more professional image to external customers and suppliers.

On a related note, clients who are looking to work with you on a long-term basis can hire your business instead of you, making it a much simpler transaction for them.

4. Access to Funding and Investment

Limited companies have a more established and credible reputation, making them attractive to potential investors and lenders. They can issue shares and raise capital through equity financing, enabling them to finance business expansion, research and development, or new ventures. Additionally, limited companies can access various financing options such as bank loans, lines of credit, and venture capital. The ability to secure external funding and investment not only provides the necessary financial resources but also enhances the company's credibility and growth potential. This increased access to funding and investment gives limited companies a competitive edge and opens doors to new opportunities for business growth and success.

Limited Company Disadvantages

While setting up a private limited company comes with numerous advantages, it is essential to consider the potential disadvantages as well. Understanding limited company disadvantages can help you make a well-informed decision about whether this business structure is the right fit for your venture. Here are some of the key challenges associated with running a private limited company.

1. Complex Administration and Compliance

A limited company is subject to additional filing, paperwork and reporting requirements.

Amongst other things, you (or your accountant) will have to keep accounting records about:

• All money received and spent by the company
• Details of assets owned by the company
• Debts the company owes or is owed
• Stock the company owns at the end of the financial year
• The stock takings you used to work out the stock figure
• All goods bought and sold
• Who you bought and sold them to and from (unless you run a retail business)

Most owners choose to outsource these to an accountant, although you're welcome to tackle these yourself if you have a knack for accounting.

2. Disclosure of Information

Another disadvantage of setting up a limited company is that your company information will be disclosed on public record. This means general public can look up details of your directors and owners. Such transparency can expose sensitive business information, including financial performance, director details, and shareholdings, which may potentially affect the company's reputation and market perception and those seeking privacy or competitive advantage.

3. Higher Costs and Financial Obligations

Limited companies often face higher costs and financial obligations compared to sole traders or partnerships. Setting up a limited company involves registration fees, legal fees, and ongoing expenses such as fees for hiring an accountant for managing tax and financial matters. Additionally, limited companies are subject to corporation tax, employer's National Insurance contributions, and other financial obligations that can increase the overall financial burden.

How to Set up a Limited Company?

Setting up a limited company involves a series of straightforward steps and considerations, but with the right guidance, it can be a smooth process. From choosing the right type of company to registering with Companies House, each step is crucial for a successful setup.

• Step 1: Decide Type of Limited Company
• Step 2: Choose a Unique Company Name
• Step 3: Appoint Shareholders and Directors
• Step 4: Prepare the Required Documents
• Step 5: Register Your Company with Companies House
• Step 6: Obtain Necessary Licenses and Permits
• Step 7: Set Up Your Business Bank Account

Tax Obligations of a Limited Company

Operating a limited company in the UK comes with various tax obligations that must be fulfilled to ensure compliance with HMRC. These obligations can be complex, but they are crucial for the smooth operation and legal standing of the company.

1. Corporation Tax

Registration

After incorporating a limited company, you must register it for Corporation Tax within three months of starting business operations. This can be done online through the HMRC website.

Tax Rate

Limited companies are required to pay Corporation Tax on their profits. As of the current tax year, the Corporation Tax rate is 25%. However, companies with profits up to £50,000 may qualify for a lower rate of 19% (small profits rate).

Filing Requirements

Companies must file a Corporation Tax return (CT600) annually. The return includes details of the company’s income, expenses, and profits. The deadline for filing is 12 months after the end of the company’s accounting period, but any tax owed must be paid within 9 months and 1 day after the end of the accounting period.

2. Value Added Tax (VAT)

VAT Registration Threshold

A limited company must register for VAT if its taxable turnover exceeds the VAT threshold, which is £90,000 (as of the 2024/25 tax year). Voluntary registration is also an option if the company’s turnover is below the threshold, which can be beneficial for claiming back VAT on business expenses.

VAT Returns

Once registered, the company must charge VAT on its sales and submit regular VAT returns, usually every quarter. These returns include the VAT charged on sales (output tax) and the VAT paid on purchases (input tax). The company must pay HMRC the difference between the output tax and the input tax.

3. Pay As You Earn (PAYE) and National Insurance Contributions (NICs)

Employer Registration

If a limited company employs staff, including directors, it must register as an employer with HMRC for PAYE. This system is used to collect Income Tax and National Insurance contributions from employees’ wages.

PAYE and NICs

The company must deduct Income Tax and employee National Insurance contributions from employees’ salaries and pay them to HMRC. Additionally, the company must pay employer’s National Insurance contributions. These payments are usually made monthly or quarterly, depending on the size of the PAYE bill.

Real Time Information (RTI)

Under the RTI system, the company must submit payroll information to HMRC every time employees are paid. This ensures that tax and NICs are calculated and reported in real time.

4. Dividend Tax

Dividend Payments

When a limited company distributes profits to its shareholders in the form of dividends, the shareholders must pay tax on dividends. The company must keep accurate records of all dividend payments, including the amounts and the dates they were paid.

Dividend Tax Rates

Shareholders are entitled to a dividend allowance, which is a tax-free amount they can receive each year. For the 2024/25 tax year, the dividend allowance is £500. Dividends exceeding this allowance are taxed at different rates, depending on the shareholder's income tax band:

• Basic rate taxpayers: 8.75%
• Higher rate taxpayers: 33.75%
• Additional rate taxpayers: 39.35%

5. Other Taxes

Capital Gains Tax (CGT)

If the company sells an asset and makes a profit, it may need to pay capital gains tax. This is calculated as the difference between the sale price and the asset’s cost, minus any allowable expenses.

Stamp Duty

If the company buys property or shares, it may need to pay Stamp Duty or Stamp Duty Land Tax. The amount payable depends on the value of the transaction and the type of property or shares acquired.

Research and Development (R&D) Tax Relief

Companies engaging in qualifying R&D activities can claim R&D tax relief, which can reduce their Corporation Tax bill or result in a payable tax credit. This relief is designed to encourage innovation and technological advancements.

How GoForma Can Help?

If you're going into business on your own, it's important to cover all your bases and make sure you're protected under all circumstances. That's where limited companies come in.

While there are some disadvantages associated with Limited Companies, these are far outweighed by the benefits, and for most business owners, it still pays to set up a private limited company (as opposed to simply working as sole traders).

At the end of the day, starting a business is a huge step. That's why setting up a limited company is important—it allows you to be confident that you won't be left floundering in the event that things go south, and lets you benefit from potentially large income and corporation tax savings (as well as capital gains tax savings) at the same time.

Understanding the complexities of setting up and managing a limited company requires expertise. To ensure compliance with regulations, optimize tax efficiency, and make informed financial decisions, it is advisable to hire specialized limited company accountants. These professionals bring a wealth of knowledge and experience, ensuring that your limited company thrives in the competitive business landscape while safeguarding your financial interests.

Frequently Asked Questions about a Limited Company

Can I be the sole director and shareholder of a limited company?

‍Yes, you can be the sole director and shareholder of a limited company. This provides you with control over decision-making and ownership rights.

Can I convert my existing business into a limited company?

‍Yes, you can convert your existing business into a limited company. This process typically involves incorporating your business with Companies House and transferring its assets, liabilities, and operations to the newly formed limited company.

Why is it better to be a limited company?

‍Operating as a limited company offers several advantages compared to other business structures such as limited liability protection, tax efficiency, enhanced professional image, and access to funding and investment opportunities.

Is a Ltd a small business?

‍Yes, a Ltd (Limited Company) can be a small business as the term refers to the legal structure rather than the size of the business.