What is a Limited Company?

When starting a business in the UK, one common structure to consider is a limited company. A limited company, commonly referred to as "Ltd," is a type of business entity recognized by law as a separate legal entity from its owners. Entrepreneurs and businesses often opt for this structure due to its unique set of advantages and legal protections.

But the first step is to understand what is a limited company, and whether setting up such a company can help you achieve your goals. This article will clearly explain the pro's and con's so you can make an educated decision.

By Chris Andreou
Last updated
February 2, 2024
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limited company definition, types, guide
limited company definition, types, guide

Limited Company Definition

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. It's a separate legal entity from its owner(s), known as shareholders, providing distinct advantages and legal protections. 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 you may use to run your business (the others being sole trader and umbrella companies).

How a Limited Company Works

Limited companies operate through a governance structure that includes directors, shareholders, and, in the case of larger companies, a board of directors. The company is legally responsible for its debts, and shareholders' liability is restricted to the amount unpaid on their shares. This structure not only attracts investors but also ensures a level of financial protection for the owners.

What does "Separate Legal Entity" Mean?

New company director signing limited company documents

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

Three hot air balloons showing three benefits

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 and two disadvantages of limited companies.

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

Disadvantages of 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:

Step 1: Choose a Unique Company Name

Select a name for your company that is distinct and not already in use. Check availability and ensure it complies with the regulations set by the Companies House.

Step 2: Register Your Company with Companies House

Submit the necessary paperwork to officially register your company with Companies House. This includes details about your company's structure and key personnel.

Step 3: Define Your Company's Rules with Articles of Association

Draft a document called the "articles of association" that outlines the internal rules and regulations of your company. This includes information about shareholders, directors, and decision-making processes.

Step 4: Appoint Shareholders and Directors

Identify and appoint individuals who will be shareholders and directors of the company. Shareholders own the company's shares, and directors manage its day-to-day operations.

Step 5: Submit Documents to Companies House

Provide the required documents, including the memorandum of association and any other relevant paperwork, to Companies House for official record-keeping.

Step 6: Obtain Necessary Licenses and Permits

Check and secure any licenses or permits required for your specific business activities. This step ensures compliance with industry regulations.

Step 7: Set Up Your Business Bank Account

Open a business bank account to separate your personal and business finances. This is essential for managing transactions and maintaining financial clarity.

A Final Word on Setting up a Limited Company UK

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.

opting for a limited company structure offers entrepreneurs a number of advantages, including limited liability, investor appeal, and tax benefits. However, navigating 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.

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