There comes a point in every successful sole trader business where the notion of making the switch to a private limited company is mentioned more and more – especially in cases where more than one person is putting their money on the line for the company. But why make the change, and what are the advantages/disadvantages of making the switch?
In this article, Real Business will outline these very questions, including a breakdown of what a private limited company is, why it’s so beneficial, and the precise moment in a sole trader business’ lifespan that they should consider making the switch.
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Listing Private Limited Company Advantages
When you make the switch from a sole trader to a private limited company, you become a private company that’s owned by a group of shareholders, rather than being owned by one or more individuals in a sole trader structure.
Said private company gets access to the following benefits as a result.
Limited Liability Protection
A private limited company has a separate legal identity from its owners, freeing them from being personally liable. Personal liability means someone is legally responsible for decisions and consequences of an action taken, and in the context of a private limited company, this revolves majorly around financial obligations.
This lessens the risk for the shareholders. For example, in the case of debts, the private limited company being a separate legal entity means that the company itself takes on the debt, not the company director or any shareholders. So, in the event of a downturn or other similar financial issues, the personal assets of the owners are never at risk.
Separate Legal Entity
A private limited company is a separate legal entity from the owners. This means that not only are debts tacked onto the company, but the company can also enter contracts, accrue debts and be sued with no harm coming to the owners at all.
Tax Benefits
A sole trader may get to keep all of their business profits, but they also have to pay income tax. Income tax rates can go as high as 45% (once you earn over £125,140 annually), which means nearly half of profits are taxed.
This isn’t the case with a private limited company. A private limited company pay corporation tax, and corporation tax rates range between 19% (£0 – £50,000) to 25% (£250,000 and up).
After corporation tax, a limited company can lessen national insurance contributions by structuring their income through salaries and dividends. This can not only help you pay less, but ensures a clearer business structure that’s obvious to all.
Overall, the low corporation tax and ability to increase tax efficiency through income structuring is a huge part of what makes a private limited company so popular. The tax laws surrounding these companies are put in place to encourage business activity.
Continuity Of Existence
Even if all the shareholders and the company director were to leave the company, or pass away, the private limited company itself would continue to exist. This allows the company to grow independent of original owners, and continue generating revenue.
Greater Credibility
In general, private limited companies are viewed as more credible and trustworthy than sole traders and other types of legal business entities. PLCs are subject to more stringent legal and financial requirements, such as audits.
Due to frequent audits, annual filings, and regulation compliance, it’s easier for private limited companies to attract investment, win contracts, and build strong marketplace reputations, making them competitive, successful and highly trusted.
This trust goes a long way. As a private limited company, you have access to a wider range of funding options compared to sole traders, such as:
- Venture capital – Private limited companies can attract venture capital investment, which can provide a significant injection of funds to support business growth.
- Crowdfunding – Limited companies can use crowdfunding platforms to raise funds from a large number of people, typically in exchange for equity or rewards.
- Bank loans – Private limited companies can access bank loans, which can provide a stable source of funding for business growth.
- Angel investors – Limited companies can attract angel investors, who are high-net-worth individuals who invest in businesses in exchange for equity.
- Government grants – Private limited companies may be eligible for government grants, which can provide funding for specific business activities or projects.
Listing Private Limited Company Disadvantages
Complex Setup And Management
PLCs can be more complex and time-consuming than other types of business:
- Registration – As with all businesses and companies, you must apply with companies house.
- Documentation – You need to draft legal documents, such as the memorandum and articles of association.
- Issuing shares – Share issuance and shareholder agreements add complexity.
- Compliance obligations – You will be bound by regulations that you must adhere to, including annual accounts, tax filings and record-keeping. All can be costly and time-consuming.
- Auditing – Some private companies may require audits relating to size and turnover.
- Corporate governance – The company director must meet statutory duties and ensure proper corporate governance.
Limited Control
Since private limited companies are owned by shareholders, it can be difficult to manage the company on a day-to-day basis; decision-making is divided between multiple shareholders so the first and final say doesn’t simply rest with you.
Shareholders may have different goals and priorities for the company. This could end up requiring occasional meetings to get approval at best, or conflicts and disagreements about the direction of the company at worst.
Limited Flexibility
Private limited companies might find it hard to adapt to changing market conditions due to limited flexibility. PLCs are subject to more stringent rules and regulations than other types of business placing limits on adaptability.
For example, private limited companies may have limits on the number of shareholders, restrictions on transferring shares, and requirements for holding annual meetings that prevent the PLC from pursuing opportunities.
Costly Compliance
As mentioned, private limited companies are subject to more stringent rules and regulations including legal and industry requirements. While this ensures the company can operate legally within its given industry, it can be costly for owners. Companies must conduct annual audits, file reports, and lots more.
Public Scrutiny
As a private limited company, you are required to file certain documents with Companies House, which are publicly available. This includes:
- Annual accounts – Private limited companies must file annual accounts with Companies House, which provides a snapshot of the company’s financial position.
- Confirmation statement – Limited companies must file a confirmation statement with Companies House, which confirms the company’s details and provides information on its shareholders and directors.
- Director and shareholder information – Private limited companies must provide information on their directors and shareholders, including their names, addresses, and dates of birth.
While this level of public scrutiny is a disadvantage, it can also be a boon. It simply means that a private limited company is held to a standard that the public can scrutinise, so you should ensure that everything submitted is accurate.
How To Set Up A Private Limited Company
If you have evaluated the pros and cons of private limited companies and have now decided that this business structure is right for your business, here is a run-through of how to set one up:
- Choosing a company name – Picking your company name is an important first step. The name must be unique, meaning no two companies can have the exact same name.
- Appointing directors and shareholders – You will need to appoint at least one company director and one shareholder to operate a limited company.
- Registering the company – With the directors, shareholders and business name in place, you can now register your company with Companies House. This involves filling out basic contact information online and paying a small registration fee.
- Drafting legal documents – The company’s articles of association and memorandum of association are important regulatory documents required for all limited companies. They outline the purpose, rules, and regulations for the business around the following areas:
- Issuing shares: How and when shares are issued to shareholders, how much they total and who owns what percentage. The allotment of shares needs to be registered with Companies House.
- Registering for taxes: Register your company for taxes, such as Corporation Tax, Value Added Tax (VAT), and PAYE (Pay As You Earn) for employees.
- Setting up company bank accounts: A dedicated business bank account is required for all limited companies. This keeps personal and business finances separate.
- Registering for other permits and licences: Depending on the nature of your business, you might need to register for permits and licences, such as food sale licences or trading permits.
- Complying with ongoing regulatory requirements: Ensure ongoing compliance with regulatory requirements, such as filing annual accounts and annual confirmation statements with Companies House.
Following the steps above will get you started on the journey of owning a private limited company. Whilst not exhaustive, as every business is different, it provides a useful starting point.
Conclusion
Private limited companies are a great choice for business owners looking to distance themselves from being personally liable for the financial and legal side of the business, whilst also getting access to massive tax benefits. The tradeoff is a loss of control.
Establishing a business entity as a private limited company is a bright idea for the right business–but it’s not right for everyone. Business owners must consider the pros and cons carefully, and make decisions with expert advice. For the most part, small business owners are highly rewarded with low levels of income tax, and it’s only as that income tax rises that they begin to find limitations in an expansion that they consider a private limited company.
