What is a private limited company?

Setting up a private limited company is a popular way to start running a business.

Learn what's involved in forming a limited company, how it operates and the rules it must follow to help you decide if it's right for your business.

Many start up businesses choose to operate as a private limited company.

Unlike working as a sole trader or being in a partnership a limited company is a legal entity in its own right.

It has a different structure and more complex requirements such as different tax and legal obligations.

The biggest different between going it alone as a sole trader and forming a limited company is that a limited company has special status in the eyes of the law.

Part of a limited company's definition is that it is incorporated - formally set up and registered with Companies House - and it issues shares to its shareholders.

Limited companies can be private or public.

Unlike a publicly limited company, where shares are traded on the stock exchange, a private limited company does not publicly trade shares and is limited to a maximum of 50 shareholders.

An example of a private limited company is often a local retailer, such as a shop or restaurant, that does not have a national presence.

An example of a publicly limited company is a large corporation such as chain of retailers or restaurants with shares that anyone can buy and sell.

Most private limited companies are small as there is no minimum capital requirement to incorporate a limited company aside from the issuing of at least one share.

Initial share capital is commonly around £100 and accounts filed with Companies House are usually modified accounts.

What is the definition of a limited company?

A private limited company is the most common form of UK company incorporation.

It is set up directly by registering the company with Companies House.

It operates as a distinct legal entity to its directors and shareholders - the company is an 'individual' in its own right.

This means that all the business assets, liabilities and profits belong to the company itself and the shareholders are not wholly responsible for debts incurred by the company.

Being a director of a private limited company is different to being self-employed or operating as a sole trader.

A director of a private limited company is considered an employee of the company and, in the event of a legal dispute or problems with debt, it is the private limited company itself that is sued or pursued rather than the directors.

This means if the company fails the director's personal assets such as family home or savings are not at risk - unlike a sole trader, who is held personally accountable for any unpaid debts or legal bills arising from a dispute or insolvency.

The shareholder's liability is limited to the shares they hold in the business - hence the 'limited' part of the business structure name.

There are lots of characteristics of a private limited company that cover issues such as borrowing money, paying pensions, reporting business accounts, selling the business or raising capital, and how you pay yourself.

Who can set up a private limited company?

The owners of private limited companies are known as shareholders and each holds a certain number of shares in the business.

This means you can set up a limited company yourself - you'd own 100% of all the shares - or with others, dividing the available shares between the shareholders.

To become a shareholder you must purchase one or more shares issued by the company and these are issued when you form the company with each share representing an equal percentage of the business.

Additional shares can be created and issued after the business is incorporated and the more shares you hold, the larger the percentage of the business you own.

Who runs limited companies?

Directors - known as company officers - manage limited companies and they can be shareholders as well.

A private limited company must have at least one director and most company owners are directors - meaning you can own and manage a limited company yourself or with others.

What are the advantages of a private limited company?

While setting up a limited company and operating it can be a time-consuming task with lots of requirements there are some clear advantages to setting up a private limited company.

• Limited liability - as company owners are not legally obliged to pay outstanding company debts beyond the value of the shares they hold it protects the personal assets (such as a home or savings) of the company owners should a business fail.
• Professional status - a limited company is typically seen as a more professional operation than an unincorporated sole trader. This is due to the transparent nature of the business accounts which, along with the details of the directors and persons of significant influence, need to be made public. Other companies are more likely to trust limited companies.
• Tax efficient income - a private limited company can be a tax efficient way to pay yourself, within legal limitations. Directors and company owners can pay themselves via a PAYE salary and then top this up with shareholder dividends after paying corporation tax. As corporation tax has been paid on profits any dividends paid are not subject to NICs.
• Protect your business name - when you incorporate your company its name is protected and other businesses cannot use the name or one that is similar when trading.
• Raising capital - you can raise additional capital by selling shares in your limited company to help invest and grow your business. The good news is that investors are also protected from the company failing and their risk is limited to the value of the shares they hold.
• Doing business with other companies - simply put most larger businesses will not work with unincorporated businesses such as sole traders so you may need to operate as a limited company to provide goods and services to other companies.

What are the disadvantages of a private limited company?

Setting up and running a private limited company is no small undertaking and while there are many benefits it's worth noting the potential downsides to setting up a limited company.

• Legal requirements - there are lots of requirements such as completing annual accounts and returns to Companies House, delivering a corporation tax return to HMRC, setting up and running PAYE and payroll, and producing quarterly VAT returns for HMRC. Miss a deadline or a payment on money you owe to HMRC and the company could face a hefty fine.
• Getting paid - unlike a sole trader who can take cash out of a business without restriction, removing money from a private limited company is more complicated. As an owner or director the business has to legally transfer money to you in the form of a salary or dividend payment which means you can't just use the company as a personal income source. You will need to register for PAYE with HMRC even to pay yourself as a director and run a monthly payroll to draw a salary.
• Setting up and closure - setting up a private limited company is straightforward but you'll need to register with Companies House and inform HMRC as well as pay annual fees. If you decide to close a limited company you'll have to apply to dissolve the business which can take three months.

Tax, profit and loss for a private limited company

A private limited company must register with HMRC and pay corporation tax on any profits it makes within its financial year - and corporation tax is in addition to any income tax and National Insurance contributions (NICs) employees and directors must pay.

A private limited company can also pay dividends to shareholders and these are subject to income tax, though exempt from NICs.

Payments to employees have to be made via PAYE and the company must as pay NICs to HMRC as part of an employee's salary.

Employee salaries are classified as a business expense however and can be offset against profits along with all other expenses.

This means that a private limited company can pay staff, incur costs and purchase services from suppliers and still claim these as expenses to offset tax payable on the income the company generates.

The company's profit is then subject to corporation tax at the current rate of 20%.

Pensions, borrowing and accounts

Unlike a sole trader, limited companies have differences when it comes to pensions too.

Employee pensions can be more generous in terms of benefits and limits - whereas a sole trader can only have a personal pension.

However, a limited company has to consider pension arrangements for all employees.

Directors can also borrow from a limited company but be aware that there is a tax charge of 32.5% for loans that are not repaid within nine months of the year end.

Finally, accounts must be prepared annually for a limited company and filed with HMRC and Companies House, and accounts must meet accounting standards.