Introduction - entrepreneurs that have never set up a company before, need to be aware of the practical and legal implications of doing so. The following article outlines the general principles, practicalities of setting up a limited liability company. In particular, it describes Directors duties, what is means to be Director, the associated company paperwork and the legal principles surrounding incorporating a ltd business. As the law changes over time, this page should be seen as out of date and merely a helpful guide to the legal issues to consider. The following article is not comprehensive and does not purport to legal advice relating to any particular circumstances. Always seek qualified UK legal advice regarding specific issues….
What is a limited liability company? - a limited company exists as a separate legal entity in that it's financial assets and liabilities are entirely separate from those of its shareholder owners. With the exception of a personal guarantee, shareholders are not liable for business debt of the company. It the company fails and can no longer trade, shareholders may lose their investment. Conversely, the profits and cash surpluses of the company, are the property of the company and not the director or shareholder. Profits are provided to shareholders in form of dividends. Directors of the company are also employees of the company and are liable to pay any relevant income tax and national insurance accordingly. All UK limited liability companies are registered at companies house in Wales. Each company must have at least one Director and one company secretary. The role of the company secretary is to maintain the registered office, a range company meetings, document and take minutes of meetings, submit more appropriate annual returns to Companies House. There are millions of small limited companies set up in the UK across all types of industries and trades. Each limited company must have a registered office in England or Walesand must issue nominal share capital of £10,000 made up of 10,000 shares at one pound each.
The Main Methods of Starting a Business - there are for legal methods of starting a new business in the UK. They are as follows:-
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Sole Trader - this legal status is for the one man band, entrepreneurial, risk-taking type of individual. Being a sole trader means taking huge risks with personal investment and reaping all the rewards if it succeeds.. There are limited government benefits for sole traders related such as less statutory sick. With Sole Trader status, the business and the individual are basically the same thing. Any business debt may also be recovered from the sole trader individuals personal assets. Sole traders are typically self-starters who are not afraid to learn new skills.
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Partnership – a partnership involves at least two people who are carrying on a business enterprise together. The workload for managing the business is usually split between the individual partners. All partners are liable for debts incurred by the business, which means that a mistake or misjudgement by one partner, can ruin the others. They are typically used in professional type businesses such as the legal and accountancy professions.
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Limited liability Partnership (LLP) - this is a mixture between a partnership and a limited company. It exists where there are two or more people who wish to organise their own internal company structure on the traditional lines of a partnership, while enjoying the protection of limited liability.' and LLP means that the time is individual debts are limited to those of the company. However, where professional partnerships are created, negligence and fraud are still risks that must be indemnified with insurance and are not linked with the company, but instead with the individuals concerned.
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Limited Liability Company (Ltd) - a company that is a limited company means that the shareholders of the company are not personally liable for any of the companies business debts, beyond the value of the shares of each shareholder. In principle, this means that if the company goes into insolvency and personal assets of the owners are normally completely safe and protected. The exceptions to this principle related to fraudulent activity on a half of a director or where a director has broken company laws. A Director and a Shareholder have separate roles. Typically, directors of small firms are also shareholders. To raise business finance, Directors of small businesses typically have to give personal guarantees to underwrite and guarantee any business loans obtained form their bank. If the business fails and enters into administration or liquidation, to repay these loans, the Directors home or other personal assets may be seized to repay the debt. So in practice, a Directors liability is not always limited. A limited company is a separate legal entity from its owners and its shareholders. The company must pay corporation tax from company profits. The companies shareholders may receive a dividend and will subsequently have to pay own income tax on the dividend received.
History of Limited Liability - a legal process has evolved over hundreds of years to assist and promote enterprise and facilitate entrepreneurial risk taking.The biggest advantage which has continued since its original conception has been that the owners personal liability is separate from the debts of the company. The origins of the principal were established during the industrial revolution with the Limited Liability Act of 1855. This established the principle of limited liability for companies with more than 25 shareholders. This number was subsequently reduced in the Companies Act 1856. By 1989, the EU enacted the Twelfth Council Company Law Directive which required member states to provide a legal structure for any individual wishing to trade on a limited liability basis. Critics of the current form of legal liability points towards endless business failures were unsecured creditors have been left with nothing at the expense of securing preferential creditors.
Directors Salary versus Dividend? - over the last 15 years governments have changed the rules regarding the tax issues surrounding limited company and their owner Directors. During the 1980s, tax allowances were created to stimulate incorporation of new businesses so that entrepreneurs could benefit from a lower overall tax threshold and, hopefully stimulate wealth in the economy. Since then, the political priority has been to increases Corporate Tax's, lower or scrap tax allowances, in order to minimise perceived tax avoidance by Director owners. As a result, there has been a re-balancing of the tax system so create a so called "level playing field", where small business owner Directors and full time employees have the same opportunities and pay similar overall taxes.
Dividends are not subject to PAYE or employers and employees National Insurance. In addition, dividends can only be paid from 'distributable profits available to the purpose', which basically means that the company have cash in the bank and is expected to make a profit at the end of the fiscal year. Any interim dividend is payable to shareholder director owners must be from the surplus and must not push the company's accounts into a declared loss-making position at the end of the year. With this in mind, there is no doubt that an individual who runs a limited company has more flexibility to declare a lower income and therefore benefit from a lower tax band....
For instance, higher rate taxpayers can choose to leave profits within the limited company at the end of a fiscal year, thereby avoiding paying higher income-tax. This has drawbacks in that the company will pay a higher corporation tax bill, even though the individual shareholders income taxes may be lower. The overall balance between the two is the measure Directors use to find the most tax efficient means of drawing an income from the business, bearing in mind their individuals needs and circumstances and the tax system of the day. Using a limited company in this way has proved politically contentious and has been acted upon by the Inland Revenue. The introduction of the IR35 by the Inland Revenue is an attempt to crack down on individuals who are avoiding income tax, by providing solely dedicated personal services to one company, via a limited company, instead of as an employee of that company.
Small Company Borrowing - Directors of limited companies can apply for a business loan from a bank on behalf of the limited company. The business debt comes from the bank account of a limited company, not the shareholders or Directors. Although the Director controls the company bank account, it is not their money, it is owned by the business, along with all other assets and liabilities. The Director is not personally liable for repaying the business loan (unless they have signed some form of personal guarantee).
Directors Duties - There are implications regarding becoming a company director. It is important that any individual when deciding whether or not to become a Director, understands what these legal responsibilities and duties are. Each limited company must have a director and a secretary. In other words, are no one-man band limited companies. In practice, company secretaries are often of the accountants employed by the small firm, (and who have little day to day responsibility for controlling the company). Directors main responsibilities and duties these mainly come under the Companies Act 1985 are summarised as follows....
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Duty to exercise reasonable care, skill and diligence (174) - This duty aims to assess and compare how a diligent and experienced person in the same role would have been expected to behave in the same circumstances. failure to exercise this duty could result in the accompanying paying damages via a court case;
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Duty to promote the success of the company (172) - Under this duty a director must act in good faith to promote the best interests for the company as a whole, as opposed to acting for a minority interest. The director must consider a number of factors when making decisions including its employees, suppliers, community and the environment, the reputation and contact of the company in the long term. In effect, it concentrates the mind of the director to assess the impact of their decisions within a limited company in the wider business and social context;
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Duty to act within powers (171) - Every director must act within the constitution and any resolutions that the company has set out in the articles of association;
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Duty to exercise independent judgement (173) -In delicate and complicated situations, all directors are expected to take proper advice and to remain impartial in their decision-making processes. By obtaining third-party or outside advice directors must show they have exercised good judgement based on an independent source;
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Duty to avoid conflicts of interest (175) - Each director must avoid situations where there is a conflict of interest between themselves and the company. For instance, a conflict will would occur in situations where a director's spouse, family members or associated business connections may benefit from actions implemented via the company.
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Duty not to accept benefits from third parties (176) - Any benefits must be declared an authorised by the company shareholders. The aim of the duty is to stop underhand or secretive financial gain by an individual director, purely because they hold that position within the company.
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Duty to declare any Director interest in a proposed transaction (177) - Directors must disclose the nature of any proposed transaction before it occurs to the company, in situations where a conflict of interest is likely to rise.
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Company Accounts and Statutory Forms - Directors must ensure that proper accounting records bookkeeping matters are implemented, that the accounts of the company are prepared according to statutory guidelines and that these accounts are presented to the company shareholders, no later than 10 months after the end of the last financial year. In addition, the following forms need to be posted to companies house:-
Form 363 Annual Returns - This a simple summary of the company information including details of any directors, shareholders, share capital allocations, the secretary.
Form 225 Change of Accounting Dates - Each company has a specific end of year accounting date which dictates when annual accounts for the company must be submitted. It is not necessarily the 31st of December, it could be any convenient date or a date when the company was formed.
Form 287 Change of Registered Office - to ensure that official correspondence, VAT and tax notices are sent to the correct address, this form allows a director to change its registered office location, if appropriate.
Form 288 Change of Directors or Secretary - there are three version... 288(a) is for the appointment of an officer. 288(b) is for an officer ceasing to act. Form 288(c) is for changes in personal details such as address.
Directors Drawbacks - being a company director means that the individual has specific responsibilities and legal duties as described above. Failure to understand or be ignorant of these duties is no excuse and the penalties for breaking these laws could be a fine or even imprisonment. In addition, directors are vulnerable to the shareholders of the company who may have voting rights to remove them. In addition, they may not exceed any powers listed in the Articles of Association. If a board of directors exists, then there must be a collective agreement and all decisions must be recorded in writing. If a Director has any knowledge of a fellow Directors failings, they are obliged to report this to the Board in the best interests of the company. Limited liability only extends to directors where no statutory responsibilities have been the broken. In a statutory duty has been broken, a director may be personally liable for any loss or criminal offence associated with the breach. In addition, most sole Director/ sole shareholder owners of small businesses who have provided personal guarantees to a bank in exchange for a business loan, are personally liable for the company's debts, if the company cannot afford to repay them. This typically means that their home or personal assets are at risk. If a Director fails in their duties they may be struck off the Company Register. Their name will be added to the publicly available companies house register of 'Disqualified Directors'. This will have implications for future personal borrowing as it affects the credit history report of the individual concerned. Lastly, all registered limited liability companies accounts and details of shareholdings are filed at companies house for the general public to view. This means that a company director has less personal privacy than a full-time PAYE employee.
Starting a Limited Liability Company - practically speaking, the process is a relatively cheap and straightforward one. The main steps are as follows:-
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Name the Company - the first step is to find a suitable name for the new company. The company name must have the word 'limited' at the end of it. The name cannot be a duplicate of the existing limited company, or the offensive or misleading of respects to its activities. It must also not be associated with government or local authority or royalty or use sensitive or common brand related words. A simple search facility is available at the companies house website. In addition, not using an existing company name, it also makes sense to search the trademarks index via the company's house website. Lastly a business website is vital in today's online world to communicate and all deliver a successful business model. By using the whois database it is possible to check domain names that have been purchased and or hosted.
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Incorporation - the next step is doing by a ready-made company or incorporate a new one. Most accountants can set up a company for you by using an 'off the shelf company'. This is one in which he is usually dormant and has already been incorporated and can simply be renamed with new directors and shareholders. Off the shelf companies can also be purchased from company formation agents ,that usually offer prospective directors standard packs of articles and other regulatory paperwork. The entire process can be completed within days. Alternatively, to incorporate a brand new company is a relatively straightforward exercise by using the Registrar of Companies same day service. If any new corporation is selected the next step is to prepare and submit the documents to the Registrar of Companies....
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Preparation of Statutory Documents - it is strongly advisable to employ the services of a solicitor or a regulated accountancy firm, in order to prepare all of these documents and submit the relevant documents to companies house accordingly. Each newly incorporated limited liability company must produce and submit:-
Memorandum of Association - this states that at least one subscriber has agreed to take at least one share in the new company and this undertaking has been witnessed. It will outline the authorised share capital and the names of the shareholders.
Articles of Association - this dictates the regulations and rules regarding the internal running of the company. it must also be signed by the subscribers to the memorandum and witnessed.
Form 10 - this form provides the details of the directors and company secretary and the address of the registered office. The registered office may be different from the trading address and is the address where all formal companies house letters and correspondence will be sent. Typically, for small firms the registered company address is also the address of the company secretary, company formation agent or accountant of the company.
Form 12 - this form confirms that the proper procedure has been followed by the directors in the formation of the company.
The registrar of companies will then post a certificate of incorporation to the registered company address, confirming that the new private limited company has the authority to begin trading once it has become incorporated.