8 Disadvantages of a Private Limited Company

What is a Private Limited Company?

A Private Limited Company is a legal business entity formed by a group of individuals or shareholders. It offers limited liability protection to its owners and restricts the transferability of shares to a predetermined group. This structure is often preferred for its benefits but is not without its drawbacks.

What are the Limited Company Disadvantages?

Entrepreneurs have several business structures to choose from when starting a business, including sole proprietorships, partnerships, and private limited companies. Each structure has advantages and disadvantages; choosing the right one is crucial to the business's success.

In the UK, private limited companies are a popular business structure for entrepreneurs and small business owners. This model offers several advantages, including limited liability protection, tax benefits, and raising capital through issuing shares. However, there are also drawbacks to operating as a limited company, and it's important to understand them before making a decision.

8 Disadvantages of a Private Limited Company

1. Administrative Burden

2. Financial Transparency and Public Disclosure

3. Costs and Financial Obligations

4. Restrictions on Company Activities

5. Limited Stock Exchange Access

6. Legal and Regulatory Requirements

7. Personal Guarantees and Liability

8. Perception and Credibility

1. Administrative Burden

When you decide to set up a limited company in the UK, you must be prepared for a significant administrative burden. This burden comes from both the initial formation process and the ongoing compliance requirements.

1.1. Complex Formation Process

‍
The first step in forming a limited company involves navigating through a complex process filled with detailed paperwork and legal formalities. Here’s what you need to know:

Detailed Paperwork and Legal Formalities:

Administrative burden refers to the extensive paperwork, record-keeping, and compliance requirements that come with operating this type of business structure. These companies are expected to keep detailed records of their business, including regular financial reporting, tax filings, maintaining shareholder records, taking minutes during meetings and making notes of any decisions made by directors or other senior staff. Failing to keep up with these administrative requirements can result in legal penalties.

Registration with Companies House

One of the main cons of running a private limited company is the requirement to be incorporated with Companies House. Companies House is the official government body responsible for maintaining a register of incorporated businesses in the UK. While the registration process itself is straightforward and this is also an advantage in legal protection, it imposes certain obligations and drawbacks on Private Limited Companies.

Firstly, company registration or incorporation is not free, and there is a fee involved. Additionally, once you’ve registered with Companies House, the company information such as its registered address, directors, shareholders, and annual financial statements is disclosed publicly. This information becomes publicly available and can be accessed by anyone, including competitors and potential business partners. This lack of privacy may be a significant drawback for some business owners.

There's a way of getting around this. When you sign up for our accountancy package, you’ll be able to use our virtual office as your registered office/ business address, thereby keeping your residential address off the public record. Your name and company accounts will still be visible on the public records, but other personal information will remain private.

Setting up a limited company is slightly more complicated than setting up as a sole trader.

You'll have to:

• Register the company through Companies House, and provide them with all the information they need
• Come up with a suitable company name. The name must not be in use presently elsewhere
• Pay an administrative fee. The standard fee for online registration is £50, while postal registration costs £71

These are all relatively small tasks (it’ll only take you a few hours), so it’s not a huge drawback by any means - but the process is decidedly more time-consuming than registering as self-employed.

1.2. Ongoing Compliance Requirements

Once your limited company is up and running, the administrative responsibilities don’t end. Maintaining a limited company involves ongoing compliance with various legal requirements. Here are the key areas you need to manage:

Annual Filings and Updates to Companies House:

• Confirmation Statement: Every year, your company must submit a confirmation statement to Companies House. This document confirms that the information Companies House holds about your company is correct. The filing fee is £34 if done online or £62 if done by post.
• Changes in Company Details: If there are any changes to your company’s details, such as changes in directors, registered office address, or share structure, you must notify Companies House promptly.

Statutory Accounts and Corporation Tax Returns:

• Annual Accounts: Each year, you need to prepare and file annual accounts. These accounts give a detailed picture of your company’s financial health and include a balance sheet, a profit and loss account, and notes about the accounts.
• Corporation Tax Return: You must also file a corporation tax return with HMRC. This involves calculating your company’s taxable profits and the amount of corporation tax you owe.

Record-Keeping and Documentation:

• Financial Records: Your company must keep detailed records of all financial transactions. This includes records of sales and purchases, all money spent and received, and the company’s assets and liabilities.
• Personnel Records: You also need to maintain up-to-date records of directors, shareholders, and company secretaries. This includes keeping track of their personal details and any changes in their roles or shareholdings.
• Meeting Minutes: Documenting the minutes of all meetings, especially board meetings and annual general meetings (AGMs), is another essential task. These minutes serve as an official record of the decisions made and actions taken during the meetings.

2. Financial Transparency and Public Disclosure

When you operate a limited company in the UK, financial transparency and public disclosure become crucial aspects of your business. These requirements are designed to promote accountability and trust but can also present challenges.

2.1. Public Access to Financial Information

One of the primary requirements for limited companies in the UK is to submit financial data to the public records. This involves making detailed financial information about your company available to the public, including your competitors.

Availability of Financial Data to the Public and Competitors:

• Public Records: Once you submit annual accounts, your company’s accounts become public records. Anyone can access these documents online through Companies House. This means that your financial performance, including profits, losses, assets, and liabilities, is available for scrutiny by anyone interested.
• Competitors' Insight: This level of transparency can be a double-edged sword. On one hand, it promotes trust and confidence among investors, creditors, and customers. On the other hand, it also gives your competitors insight into your business’s financial health and strategies. They can analyze your strengths and weaknesses, potentially using this information to their advantage.

2.2. Disclosure of Directors' Information

In addition to financial transparency, limited companies must also disclose detailed information about their directors. This includes making certain personal details publicly accessible, which can raise privacy concerns for directors and shareholders.

Public Listing of Directors' Personal Details:

• Director Information Requirements: When you register your company and during annual filings, you must provide personal details of all directors. This includes their full names, dates of birth (only the month and year are shown publicly), residential addresses (a service address can be used for public records), and any other directorships held in the past five years.
• Public Access: This information is then made publicly available through Companies House. Anyone, including competitors, potential clients, and the general public, can access these details.

Potential Privacy Concerns for Directors and Shareholders:

• Privacy Issues: The public availability of personal information can pose significant privacy concerns. Directors may feel uneasy knowing that their details are easily accessible, potentially exposing them to unwanted attention or even identity theft.
• Safety Risks: For some directors, particularly those with high-profile roles or those operating in contentious industries, public disclosure of their residential addresses can present safety risks. While using a virtual address can mitigate this risk, it does not entirely eliminate concerns about personal privacy.
• Impact on Recruitment: These privacy concerns can also impact the willingness of individuals to serve as directors. Talented professionals may be deterred from taking up directorship roles due to the public nature of the information disclosure requirements.

3. Costs and Financial Obligations

Running a limited company comes with various costs and financial obligations that can impact your business. These costs start from the moment you decide to form the company and continue throughout its operation. Additionally, understanding the taxation requirements is crucial to managing your company’s finances effectively. Let's dive into these aspects in detail.

3.1. Formation and Running Costs

Setting up and maintaining a limited company involves several costs, both one-time and ongoing. Here's what you need to consider:

Initial Registration Fees:

• Registration with Companies House: To form a limited company, you must register with Companies House. This involves a fee, which is £50 if you register online and £71 if you register by post. While this fee may seem modest, it’s just the beginning of your financial commitments.

Ongoing Costs:

• Accounting Fees: One of the significant ongoing costs is hiring an accountant. Limited companies must maintain detailed financial records and prepare statutory accounts, which often require professional help. Accountants’ fees can vary but typically range from a few hundred to several thousand pounds per year, depending on the size and complexity of your business.
• Legal Fees: Legal advice is another cost you need to consider. You might need legal services for drafting contracts, handling disputes, and ensuring compliance with various regulations. Legal fees can also add up, especially if your business faces legal challenges.
• Compliance Costs: Keeping your company compliant with all regulatory requirements involves several expenses. This includes filing the annual confirmation statement with Companies House, which costs £34 if done online and £62 by post. Additionally, there are costs associated with preparing and submitting annual accounts and tax returns. Failure to comply with these requirements can result in fines and penalties, adding to your financial burden.

These ongoing costs can add up quickly, making it essential to budget for them from the start. While some of these tasks can be handled internally, many businesses find it more efficient and less risky to hire professionals, which increases the overall costs.

3.2. Taxation

Taxation is a critical aspect of running a limited company. Understanding your tax obligations helps you manage your finances better and avoid potential penalties. Here are the key points to consider:

Corporation Tax Obligations:

• Corporation Tax: Limited companies must pay corporation tax on their profits. The current corporation tax rate in the UK is 25%. You must calculate your company’s profits, file a corporation tax return, and pay the tax due within nine months and one day after your accounting period ends. Failure to pay on time can result in interest charges and penalties.

Taxation of Dividends and Directors' Salaries:

• Dividends: When your company makes a profit, you can distribute it to shareholders as dividends. However, dividends are subject to taxation. The first £500 of dividends each year is tax-free, but anything above this amount is taxed at different rates depending on your total income. Basic rate taxpayers pay 8.75%, higher rate taxpayers pay 33.75%, and additional rate taxpayers pay 39.35% on dividends.
• Directors' Salaries: Directors, who are often shareholders, typically take money out of the limited company in the form of salary and dividends. Salaries are subject to income tax and National Insurance contributions. To optimize tax efficiency, many directors take a low salary and higher dividends, but it’s essential to balance this approach carefully to comply with tax laws and maintain personal financial stability.

Double Taxation Potential for Shareholders:

• Double Taxation: One of the challenges of running a limited company is the potential for double taxation. This occurs because the company pays corporation tax on its profits, and when these profits are distributed as dividends, shareholders must pay income tax on them. Effectively, the same money is taxed twice, which can reduce the overall amount of profit available to shareholders.

4. Restrictions on Company Activities

Operating a limited company involves certain restrictions on how the company can conduct its activities. These restrictions are primarily aimed at ensuring proper governance and protecting the interests of shareholders and other stakeholders. These shareholders have direct input into how the business is operated, and the more shares they own, the more input they have. However, they can also limit the flexibility of decision-making and lead to potential conflicts.

While shared ownership can offer benefits such as pooling resources and expertise, it also comes with certain drawbacks.

4.1. Limited Flexibility in Decision-Making

Running a limited company requires adherence to formal decision-making processes, which can limit the flexibility and speed of making decisions. Here’s how these processes work:

1. Decision-Making Challenges: With shared ownership, decision-making can become complex and time-consuming. Disagreements and differing opinions among shareholders may arise, leading to delays in crucial decision-making processes. Unresolved conflicts can hinder the company's ability to respond quickly to market changes or take advantage of emerging opportunities.
2. Lack of Control: In a Private Limited Company, no single shareholder may have complete control over the business. The decision-making power is often distributed based on the percentage of shares held by each shareholder. This can lead to a dilution of control and potentially result in conflicts or power struggles among shareholders.
3. Potential for Disagreements: Shared ownership increases the likelihood of conflicts and disagreements among shareholders. Differences in goals, visions, or management styles can create friction, making it challenging to achieve consensus on important matters. Resolving disputes may require negotiation, mediation, or legal intervention, adding further complexities and costs.
4. Compromised Decision Autonomy: Shareholders in a Private Limited Company may need to make compromises and align their interests to make collective decisions. This can limit the autonomy of individual shareholders and their ability to pursue their own strategic objectives.
5. Transferability Limitations: Private Limited Companies often impose restrictions on the transferability of shares. Shareholders may face limitations or require the approval of other shareholders before selling or transferring their shares. This can restrict liquidity and make it challenging for shareholders to exit the company or realize their investment.

4.2. Shareholder Agreements and Disputes

Shareholder agreements and the potential for disputes are another significant aspect of running a limited company. Here’s what you need to know:

Potential Conflicts Between Shareholders:

• Diverse Interests: Shareholders may have different interests and priorities. For instance, some may be focused on short-term profits, while others might prioritize long-term growth. These differing perspectives can lead to conflicts when making decisions about the company’s growth and strategy.
• Voting Rights: Shareholders typically have voting rights proportional to their shareholding. This can sometimes result in larger shareholders having more control over decisions, which might not sit well with minority shareholders.

Complexity in Resolving Internal Disputes:

• Shareholder Agreements: To manage potential conflicts, many companies create shareholder agreements. These agreements set out the rights and obligations of shareholders, as well as procedures for resolving disputes. While these agreements can help prevent conflicts, drafting them can be complex and time-consuming.
• Dispute Resolution: Despite having agreements in place, disputes can still arise. Resolving these disputes can be challenging and often requires mediation, arbitration, or legal action. These processes can be lengthy and costly, diverting time and resources away from the company’s operations.
• Impact on Company Operations: Ongoing disputes can affect the company’s morale and productivity. They can also damage the company’s reputation if they become public, potentially affecting relationships with customers, suppliers, and other stakeholders.

5. Limited Stock Exchange Access

Unlike publicly traded companies, Private Limited Companies have limitations when it comes to listing their shares on stock exchanges.

1. Restricted Access to Capital Markets: Private limited companies have the maximum number of shareholders, which limits their ability to offer shares to the public or trade them on stock exchanges, limiting their ability to attract a wide range of investors and raise substantial capital. This restricted access to stock exchange markets can make it challenging for private limited companies to raise capital compared to other business models.  
2. Limited Liquidity for Shareholders: Shareholders in a Private Limited Company often face limited liquidity options. Selling or transferring shares can be more challenging compared to publicly traded companies. There may be restrictions on the transferability of shares, requiring the approval of other shareholders or compliance with specific procedures.
3. Limited Valuation and Marketability: Private Limited Company shares lack the regular valuation and marketability associated with publicly traded stocks. The absence of a public market for the company's shares can make it challenging to determine their fair value and negotiate transactions. This can impact the company's ability to use its shares as currency for acquisitions or attracting key talent through stock-based compensation.
4. Reduced Visibility and Brand Recognition: Publicly traded companies often enjoy higher visibility and brand recognition due to their listing on stock exchanges. Private Limited Companies, on the other hand, may have limited exposure to potential customers, partners, and stakeholders. This can impact the company's ability to build a strong brand presence and compete effectively in the market.

6. Legal and Regulatory Requirements

Private limited companies have to comply with a set of rules and regulations to operate. These obligations ensure that companies operate transparently and fairly, protecting the interests of shareholders, employees, and the public. Understanding these requirements is crucial for company directors, as non-compliance can lead to significant consequences.

6.1. Director's Legal Duties

Directors of a limited company have specific legal duties designed to ensure they act in the best interests of the company and its stakeholders. Here’s a closer look at what these duties include:

Fiduciary Duties and Potential Liabilities:

• Duty to Act Within Powers: Directors must act according to the company's constitution and only use their powers for their intended purposes.
• Duty to Promote the Success of the Company: Directors are required to act in a way that they consider, in good faith, would be most likely to promote the success of the company for the benefit of its shareholders as a whole. This includes considering the long-term consequences of their decisions, the interests of employees, the need to foster business relationships, and the impact of the company's operations on the community and the environment.
• Duty to Exercise Independent Judgment: Directors must make their own decisions independently, without undue influence from others.
• Duty to Exercise Reasonable Care, Skill, and Diligence: Directors should perform their roles with the same level of care, skill, and diligence that could be expected from someone with their knowledge and experience.
• Duty to Avoid Conflicts of Interest: Directors must avoid situations where their personal interests conflict with those of the company. If a conflict arises, they must disclose it to the board and manage it appropriately.
• Duty Not to Accept Benefits from Third Parties: Directors should not accept benefits (such as gifts or bribes) from third parties that could cause a conflict of interest.
• Duty to Declare Interest in Proposed Transactions or Arrangements: If a director has any personal interest in a proposed transaction or arrangement, they must declare it to the board before the company enters into the transaction.

6.2. Penalties for Non-Compliance

In addition to fulfilling their legal duties, directors must ensure the company complies with various regulatory requirements. Failure to do so can result in significant penalties.

Fines and Penalties for Late Filings:

• Annual Accounts: Companies must file their annual accounts with Companies House within nine months of their financial year-end. Missing this deadline results in an automatic fine. The fine starts at £150 for being up to one month late and can increase to £1,500 if more than six months late.
• Confirmation Statement: This document, which confirms that the information Companies House holds about the company is correct, must be filed annually. The deadline for filing is usually within 14 days of the anniversary of the company’s incorporation or the date of the last confirmation statement. Failure to file on time can result in fines and the company being struck off the register.

Legal Repercussions of Failing to Meet Regulatory Standards:

• Striking Off: If a company fails to meet its filing requirements or becomes dormant, Companies House can strike it off the register. This means the company ceases to exist legally, and its assets become the property of the Crown.
• Investigations and Audits: Regulatory bodies such as HMRC can investigate companies that fail to meet regulatory standards. These investigations can be time-consuming, costly, and damaging to the company’s reputation.
• Prosecution: In cases of serious non-compliance, directors and the company can face prosecution. This could result in substantial fines, restrictions on the company’s ability to trade, or even imprisonment for those responsible.

7. Personal Guarantees and Liability

Although limited liability is a significant advantage of a private limited company, there are situations where personal guarantees and liabilities can come into play.

7.1. Limited Liability Misconception

One of the key benefits of a limited company is the protection it offers its owners through limited liability. However, this protection is not absolute, and there are scenarios where directors and shareholders may still face personal financial risks.

1. Personal Guarantees: Financial institutions and lenders may require personal guarantees from shareholders, especially when providing loans or credit facilities to the company. Personal guarantees make shareholders individually liable for repayment in the event the company fails to meet its financial obligations.
2. Failure to Meet Legal Obligations: If a Private Limited Company fails to fulfill its legal obligations, such as filing annual returns, paying taxes, or complying with regulatory requirements, shareholders may face personal liability. Regulatory authorities or creditors can hold shareholders responsible for the company's non-compliance and seek to recover debts or penalties from their personal assets.
3. Improper Capitalization: Insufficient capitalization or commingling personal and business funds can expose shareholders to personal financial liability. If the company faces financial difficulties or bankruptcy, creditors may argue that the shareholders did not maintain proper separation between personal and company finances, making them personally liable for the company's debts.
4. Start-Up Phase: New businesses, in particular, may find it challenging to secure funding without personal guarantees. Lenders view start-ups as high-risk and therefore seek additional security by holding directors personally accountable.

Directors' Personal Liability in Cases of Wrongful Trading or Fraud:

• Wrongful Trading: Directors have a legal duty to ensure the company does not trade if they know it is insolvent. If they continue to trade while knowing the company cannot avoid insolvency, they may be accused of wrongful trading. In such cases, a court can hold directors personally liable for the company’s debts.
• Fraud: If directors engage in fraudulent activities, such as falsifying accounts, misleading creditors, or using company assets for personal gain, they can face severe personal liability. Fraudulent behavior can lead to criminal charges, substantial fines, and even imprisonment. Directors found guilty of fraud can also be disqualified from serving as directors in the future.

7.2. Impact on Personal Credit

Taking on personal guarantees and the potential for personal liability can significantly impact a director’s personal finances and creditworthiness.

Personal Financial Implications for Directors:

• Risk to Personal Assets: When directors provide personal guarantees, their personal assets, such as homes, savings, and investments, are at risk if the company fails to meet its obligations. This risk can create substantial personal financial stress, especially if the company faces financial difficulties.
• Financial Planning: Directors must carefully consider the implications of personal guarantees on their financial planning. They need to ensure they have sufficient personal assets to cover potential liabilities and may need to adjust their personal financial strategies accordingly.

Challenges in Obtaining Personal Loans or Mortgages:

• Credit Score Impact: Personal guarantees and liabilities can affect a director’s credit score. If the company defaults on a loan or other financial obligations, the director’s personal credit score can suffer. This can make it more difficult to obtain personal loans, credit cards, or mortgages in the future.
• Lender Scrutiny: Lenders scrutinize the financial commitments of individuals when assessing applications for personal loans or mortgages. Directors with significant personal guarantees or a history of financial issues related to their company may face higher interest rates, more stringent lending conditions, or even outright rejection of their applications.
• Stress and Uncertainty: The potential impact on personal credit and finances can create stress and uncertainty for directors. This added pressure can affect their decision-making and overall well-being, both personally and professionally.

8. Perception and Credibility

The perception and credibility of a business play a crucial role in its success. For limited companies in the UK, certain factors can influence how they are perceived by others, including business relationships and the company’s lifespan.

8.1. Impact on Business Relationships

The way a limited company is perceived can significantly affect its business relationships. Despite the advantages of operating as a limited company, there can be challenges in how the business is viewed by others, particularly larger corporations.

Perception of Being a Small Business Despite Limited Company Status:

• Size and Scale: Many limited companies are small or medium-sized enterprises (SMEs). While the limited company structure offers credibility and a professional image, it does not automatically make a company appear large or well-established. Potential partners, clients, and investors may still view a limited company as a small business, especially if it lacks a substantial track record or visible market presence.
• Market Positioning: Building a reputation and demonstrating reliability takes time. New or small limited companies often need to work harder to prove their worth and establish themselves as serious players in their industry. This perception can be a barrier when trying to compete with larger, more established companies.

Challenges in Establishing Trust with Larger Corporations:

• Due Diligence: Larger corporations often conduct extensive due diligence before entering into partnerships or contracts with smaller companies. They look for evidence of stability, financial health, and operational capacity. Limited companies may need to provide detailed financial reports, references, and proof of past performance to build trust.
• Negotiating Power: Smaller limited companies typically have less negotiating power compared to larger corporations. This can result in less favorable terms in contracts and agreements. For instance, larger companies might insist on longer payment terms or more stringent service level agreements.
• Reputation Management: Any negative perception or doubt about a limited company’s capabilities can impact its reputation. Building and maintaining a positive reputation requires consistent performance, quality service, and proactive communication with stakeholders.

8.2. Limited Lifespan

The concept of a company’s lifespan is crucial for business continuity and legacy planning. Unlike sole proprietorships, a limited company has its own legal identity, which influences its potential lifespan and the process of dissolution.

Company Dissolution Process:

• Voluntary Dissolution: If the directors and shareholders decide to close the company, they can apply for voluntary dissolution. This involves filing a form (DS01) with Companies House and informing all interested parties, including creditors. The process typically takes around three months, during which time the company’s name will be published in the Gazette to notify any potential objections.
• Compulsory Dissolution: A company can also be dissolved compulsorily by Companies House if it fails to meet statutory obligations, such as filing annual accounts and confirmation statements. This process can be faster and less controlled, often resulting in the company’s assets being forfeited to the Crown.

Implications for Continuity and Legacy Planning:

• Continuity of Operations: Limited companies can theoretically continue to exist indefinitely, as their legal identity is separate from their owners. This allows for continuity of operations even if the original founders or directors retire, sell their shares, or pass away.
• Legacy Planning: For business owners looking to create a lasting legacy, the limited company structure offers advantages in terms of continuity and transferability. Shares can be passed on to heirs, sold to new owners, or transferred to existing management. However, effective legacy planning requires careful consideration of tax implications, legal requirements, and the interests of all stakeholders.
• Impact of Dissolution: When a limited company is dissolved, it ceases to exist, and its assets are distributed according to legal and contractual obligations. This can have significant implications for employees, customers, suppliers, and other stakeholders. Ensuring that dissolution is managed responsibly and transparently is crucial to minimize negative impacts and uphold the company’s reputation.

‍

Handling the complexities of a private limited company in the UK requires careful consideration of both its advantages and disadvantages. While the disadvantages exist, it's essential to note that the choice of business structure depends on various factors. Seeking advice from limited company accountants can be helpful in understanding these challenges. They not only ensure that you meet all compliance requirements and handle the necessary paperwork but also help optimize your financial strategies. From managing tax obligations to offering insights for better financial decision-making, these professionals bring expertise to the table. They can help you understand the full scope of running a limited company, ensuring you make an informed choice that aligns with your business strategy.

‍