Do you have a small business and are not sure whether setting up a company is right for you? What are some advantages of setting up a company rather than being a sole trader?
To help you answer that, let’s look at what a company is and how limited liability can benefit you.
A New Person: Jim
When you incorporate a company, you create a person. Let’s call it Jim. Jim can buy things. It can sell things. It can own things. It can do things. Jim doesn’t have a body or a mind, but, as far as the law is concerned, it is a person. This means that Jim is responsible for Jim’s debts and, for the most part, Jim’s actions. If you own Jim, this can benefit you.
Your Relationship to Jim
When you set up a company, you decide who will own it and in what proportion. If you are setting up a company for yourself and are the only person with a share in Jim, then you own 100% of Jim. You are Jim’s only shareholder (aka member/owner). Jim needs to act for your benefit.
Maybe you set up a company with other people, and there are five owners (aka shareholders/members). In this case, Jim needs to act for the benefit of all five of you.
If you set up a company for yourself, you may also be a director of Jim. All companies must have at least one director. As a director, there are restrictions on what you can and cannot do, and you must promote Jim’s success for the benefit of the members, whether that is just yourself or you and the other owners. Limited liability is not designed to benefit you, as a director. It is designed to benefit you, as an owner.
This article will look at the benefits of limited liability for you as an owner.
1. Limited Liability and What Is It?
Limited liability is a limit on the amount that you need to pay if your business fails. When you set up a company, you decide how much money you want to be responsible for. Many owners choose to have a £1 share capital. If the company fails, Jim would be insolvent and would have to close, but the owner is only on the hook for that £1. You do not have to pay Jim’s debts. Your liability is limited to the amount you invested or agreed to invest.
2. Insolvency
Thanks to the £1 limit on your liability (or however much you chose when you created Jim) if Jim goes insolvent, you do not risk bankruptcy. Your money (other than what you gave to Jim) is safe.
If you wish, you can set up another company, Jemma, and try again.
3. Profits
We have looked at what happens if the business tanks. If, on the other hand, the business booms and Jim makes £100,000,000, the profits can be paid to you in dividends. The directors decide when to do this, but remember, they run the company for your benefit.
While your liability is limited, your potential dividends are not. In other words, your risk is limited, but your potential reward is not.
4. Dividend Tax Rates
Rates of tax on dividends are generally lower than income from work. This means that you pay less tax in relation to owning a company than you would if you were working for yourself. The amount of tax you pay on dividends varies, and you can find out more information on the HMRC website here.
https://www.gov.uk/tax-on-dividends
5. Identity
Linked to credibility is the fact that a limited liability company is easy to identify. Clients may not all feel comfortable asking you, as a sole trader, to show them your address and identification. With a limited liability company, they can check this at Companies House. They can check that the company exists, how long it has existed for, where it is located, who owns it, who directs it and more. This can help clients trust you.
https://www.gov.uk/get-information-about-a-company
6. Credibility
For many people, limited liability companies, even though they have no body or mind, are considered more credible than, say, a sole trader. The mere existence of a limited liability structure gives the organisation an air of establishment.
Many people, for example, would feel more comfortable paying a deposit over the phone to Jim Limited, whom they have verified at Companies House, rather than to Jim the builder.
7. Finance
The structure of a limited liability company also makes it easier to get financing. The air of credibility surrounding Jim’s limited liability may make it seem safer to lend money to Jim than to you. Banks giving loans can also secure a loan against Jim. This is like a mortgage on Jim. In certain circumstances, Jim can issue shares, so other people (real or fictional) can give Jim money in exchange for a share of the future profits.
So, What’s Next?
Well, there’s more to having a company than being a shareholder. If you intend to run the company, you need to understand your obligations as a director and the company’s obligations. You can read more about that in my article, coming soon.
As far as being a shareholder, you will want to consider the costs of running a company, the limitations of limited liability and your risks when you invest in the company or provide guarantees on behalf of the company. You can read more about it in my article, How Limited Liability Is Not Limited.
Pingback: How Limited Liability is not Limited -