What is a Limited Company?

Limited companies provide numerous benefits, from tax savings to limiting your liability.

But the first step is to understand what a limited company is exactly, 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.

In a nutshell, a limited company is a private company that's a separate legal entity from its owner(s). 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).

In this article, we walk you through:

• What a "separate legal entity" means
• The different types of Limited Companies
• The pros and cons of setting up a Limited Company
• How to start a Limited Company

1. They are a Separate Legal Entity

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 company 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.

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.

Here in the UK, there are three types of limited companies:

• Private and limited by shares (or private companies limited by shares)
• Private and limited by guarantee (or private companies limited by guarantee)
• Public limited company (or public limited companies)

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

2. Company Structure: Private and 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 incorporating 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 director - that will do the trick. 

3. Company Structure: Private and Limited 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 income, assets, 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.

4. Company Structure: 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 market exchanges 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.

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.

5. Advantage: Owners aren't (fully) liable

One of the biggest advantages of a limited company is 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.

6. Advantage: Tax savings

On top of that, setting up a limited company allows you to save on taxes (and who doesn't like saving on taxes)?

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.

7. Advantage: Professional image

Finally, using 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.

8. Disadvantage: Additional filing and reporting requirements

A limited company is subject to additional filing 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.  

9. Disadvantage: Reduced privacy

Another disadvantage of setting up a limited company is that your company information will be disclosed on public record. This means anyone will be able to look up details of your directors and owners. 

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.