Advantages and Disadvantages of a Limited Company
When starting a small business, one of the first things to be decided is the legal structure you will have. It can either be a sole trader, limited company or a partnership.
We have come up with 5 advantages and disadvantages of a Limited Company so that you can make up your mind.
The most popular legal structure in the UK is a sole trader, with approximately 3.5 million sole proprietorships in 2020. Sole traders account for 59% of small businesses in the UK.
There were also 2 million limited companies registered at Companies House, making it the second most popular legal structure. That is what we are looking at here; what are the implications of choosing the Limited Company.
Let’s start with some positivity.
Limited Company Advantages
1. A Better Impression to Clients
Rightly or wrong first impressions count, and if you are set up as a limited company, it can reassure your potential customers. Even though it might still be one person essentially doing all the work, a limited company projects the image of a larger entity. This can be useful if you want to work with larger businesses, and in fact, some may not even deal with you unless you are limited.
2. More Tax Efficient
Once you reach a certain threshold of profits, it is more tax-efficient to be a limited company as you don’t pay income tax on your earnings like a sole trader; you pay corporation tax on the business’ profits and dividend tax. On lower profits, it is not an advantage, so be sure to check the relevant amounts for your situation. An accountant can advise you in this area, but if you are making over 50k a year, it is worth looking into due to the 40% tax bracket thresholds.
As a company director, you will be employed by the company and pay tax through the payroll. You will still have to complete a self-assessment tax return.
3. Can Raise Capital from Lenders
As a limited company, you can apply for loans etc. and apply for certain funding for startups that a sole trader may not be eligible for. As a start-up you can apply for grants, startups have a complete list.
4. Limited Liability
Hence the name, this means if your business fails, they won’t be coming for you and your personal assets, like your house. The company will be a separate legal entity itself and treated as such. This is pretty important if you are dealing in large amounts of money and therefore risk. You must open a business bank account.
You don’t want your family home to be on the line if you invest in and grow a business that doesn’t make it.
5. If you have a Board of Directors, so other People can help with Decisions
You are not alone! Being a sole trader can be a lonely business, but when you set up a Limited company, you have to have at least one director and at least one member, they can be the same person, so you can do it by yourself, but you also might have other directors. Then you don’t have to do it all by yourself. Not only will you have people to discuss ideas with but also share the burden of responsibility.
Limited Company Disadvantages
1. Can’t Sell Shares
A private limited company compared with a public company is at the disadvantage that you cannot sell shares in your business at any point. This is obviously a way that public companies raise capital. And we have all heard of companies ‘going public’. You do have shares, though, and you can be the sole shareholder or have them divided between others of your choosing, as long as there is a clear record.
2. Must Abide by Companies Act
There are some strict rules and expectations set out in law that you must adhere to, such as having at least one director and filing annual accounts and other record-keeping, as detailed below.
3. You Can’t just Take all the Profits
The money is the company’s, not yours. You can pay yourself a wage; many people choose for tax reasons to make this a small amount., You can then pay yourself extra amounts called dividends. But it all needs to be accounted for, and the money is your business, not yours. This is the main difference in many ways, especially if you go from being a sole trader to a limited company.
4. Decisions may take Longer
If there ARE more people involved and multiple directors, it may take longer to make decisions, which can cause friction or barriers to running the business. Whereas if it’s just you then you only have yourself to answer to.
5. More Complex Administration and Accounting
The accounting must be done correctly and the administration is a little more involved as you have legal requirements to keep records of the directors, shareholders and company secretary (if there is one), any loans, detailed accounting records, annual tax records filed and many other things that are specified in the legislation and can be found on the HMRC website. You can be fined £3000 if you don’t keep up with all of these requirements!
Accountancy fees are higher for a limited company and it is better to use an accountant to submit the annual accounts and corporation tax return to Companies House.
So, there you have it, 5 advantages and disadvantages of a limited company to think about. But please make the decision that is right for you. And remember, if you start out as a sole trader, it is relatively easy to change the business structure over to a limited company; you just need to register it.