When setting up a company, it’s important to understand how different types of business structure work. Factors such as the business owners’ exposure to financial risk will require careful consideration when deciding which type of company structure is most suitable.
In this guide, we focus on limited liability structure. We explain the meaning of ‘limited liability’ and the pros and cons of this structure for the business owners.
Limited liability meaning
In business, limited liability is about reducing your personal exposure to any financial risk. If your business fails or, alternatively, if the business is sued, then the amount of money for which you are liable can be limited by the type of structure under which your business operates, where there are a number of different forms that this legal safety net can take.
The most popular form of limited liability, and also the most popular business structure in the UK, is the private limited company (Ltd). The term LLC (limited liability company), similar to a private limited company, is this model is typically adopted in the US and does not exist as a separate structure in the UK. The UK’s public limited company (Plc) is similar to a private limited company, although shares in a Plc are traded on the stock market and, as such, can be bought and sold by anyone. Usually a company will be a private limited company before it ever gets to be a public limited company, so you will already be familiar with limited liability meaning.
Once created, the private limited company becomes a distinct legal entity with business finances that are totally separate from that of the business owners. This means that, in the event of either liquidation or litigation, the most that you can be personally liable for as the business owner is the face value of your share in the business. In other words, any corporate loss will not exceed the amount invested. Any additional liability must be paid out of the company’s assets, where any private assets that you own will usually be safe. In this way, as a company owner, you will be protected from going personally bankrupt in the event that the business fails.
However, there are certain exceptions to this rule, when limited liability will not fully protect you. This includes where there is evidence of some form of fraudulent trading or misfeasance and if you have given a personal guarantee as a form of security on any loan, you must personally assume responsibility for paying back the money owed.
Limited liability partnerships
The same limited liability meaning also applies to limited liability partnerships (LLPs), another protected form of business structure in the UK, where the partners responsible for setting up and running their partnership will not be personally liable for any financial losses flowing from it.
An LLP is essentially a hybrid form of business entity, between an ordinary business partnership and a company. LLPs allow for a traditional partnership structure for two or more people but, rather than the partners being liable for each other’s actions, for example, if one partner is sued, the partners will only stand to lose what they invest.
It is not uncommon to start a partnership in the traditional way, but then later convert to an LLP once it grows beyond a certain number of partners, in this way reducing the risk to its members by making the partnership itself liable for any debts, liabilities or financial losses.
Advantages of the limited liability structure
The key benefit of the limited liability business structure, in the context of both limited companies and LLPs, is that the company or partnership has an entirely separate legal identity to its owners. As such, any debts, liabilities or losses belong to that corporate entity. In this way, the limited liability model provides a far greater degree of personal protection than any other type of business structure, limiting the liability of its members — in the event of insolvency or liquidation, or to settle any legal proceedings — to the amount of money invested and any personal guarantees given when raising loans.
In contrast, if you operate as a sole trader, where you own and run your business as a private individual, although this is arguably the easiest structure to set up and manage, you will ultimately be responsible for any liabilities and losses. This is because the law does not treat sole traders as a distinct legal entity separate to their business, but rather as one and the same, making the sole trader personally liable if their business gets into trouble. This means that you would need to discharge any debts directly out of your own pocket.
Equally, if you set up and run an ordinary partnership, without limiting the liability of the partners, each will be held personally liable for any debts, liabilities or financial losses, where the partnerships finances will not be treated separately from the partners own finances. The LLP will therefore provide you with a far greater degree of protection from financial risk than a traditional partnership, but still allow you the flexibility of organising your internal structure in the same way, with similar tax treatment. Under an LLP, each member will still pay tax on their share of the profits, as they would under an ordinary partnership, but they will not be personally liable for any monies the business cannot pay.
You can also set up a private unlimited company in the UK although, as the name suggests, there is no limit to the amount of money for which you will be personally liable. This type of corporate structure only tends to be used to keep information that could be valuable to competitors, such as turnover and the amounts paid in dividends, out of the public eye. This is because there are no disclosure requirements, where the accounts of an unlimited company do not generally need to be filed with Companies House. Still, unlimited companies are not common in the UK, where if the business becomes insolvent or is sued, then the owners would be fully liable for all debts or court-ordered damages to be paid.
Disadvantages of a limited liability structure
There are, however, various drawbacks when it comes to a limited liability structure.
Starting a company is the most complex type of business structure, regardless of whether you are going into business on your own or with others, with extensive filing and reporting requirements in relation to both Companies House and HM Revenue and Customs (HMRC). These requirements include registering the company’s name and address, submitting a confirmation statement and annual accounts, as well as filing a company tax return. This makes setting up and running a limited company far more costly and time-consuming than operating as either a sole trader or ordinary partnership. As a limited company, your annual accounts and financial reports will also be placed in the public domain.
Similarly, in the context of an LLP, as with a limited company, you will again be required to register the partnership with Companies House. Running an LLP also gives rise to its own filing and reporting obligations with both Companies House and HMRC. In short, the accounting responsibilities are far greater for an LLP than for a traditional-style partnership.
How to set up a private limited company
A private limited company is essentially a privately-managed business, typically owned by its shareholders and run by its directors. When setting up a company, you will need at least one director and one shareholder, although the same person can assume both of these roles.
A company can either be limited by shares or limited by guarantee, and while these different operating structures have some important distinctions — namely how money is extracted from the company, where companies limited by guarantee are typically non profit companies — when it comes to limited liability, they follow a similar premise. In simple terms, for a company limited by guarantee, rather than the liability of each member being limited to the amount unpaid on their shares, liability is limited to the amount each member agrees, or guarantees, to contribute to the company’s assets if the company is wound up. This is typically a nominal amount which is often set at just £1.
To register as a private limited company you will need to complete an online form, pay an application fee and be incorporated with Companies House. Incorporation is the process by which a business registers as a limited company. As part of your online application, you will need to provide a company name ending with Ltd, a registered office address, details of your proposed business activities and director(s), and any company secretary, if it has one.
You will also be required to file a Memorandum of Association, ie; a legal statement signed by the initial shareholders or guarantors agreeing to form the company, and Articles of Association, ie; a document which sets out the written rules about how the company is to be run, as agreed between the company directors and the shareholders or guarantors. Every company is required to have Articles of Association, which are legally binding on both the company and its members. The articles will help to ensure that the company’s business runs as efficiently and smoothly as possible, and will set out how decisions are taken.
Once your private limited company has been registered, you will be sent a certificate of incorporation. Importantly, in order to be afforded limited liability meaning, a company must be incorporated at Companies House and registered as a Ltd company.
How to set up a limited liability partnership
A limited liability partnership can be the perfect solution for some businesses, as this legal structure still protects the personal assets of the partners in the event of any financial ruin, but with less administrative burden when compared with running a limited company. Still, in the same way as a private limited company, an LLP must be incorporated.
You can incorporate an LLP to run a business with two or more members. You can have any number of ordinary members, where a member can be a person or a company, but you will need at least two ‘designated members’ at all times. The designated members will have more administrative responsibilities, for example, keeping partnership accounts.
As with a Ltd company, you will need to choose a partnership name ending with LLP, have a registered partnership address and register the LLP with Companies House. You will also need an LLP agreement stipulating how the partnership will be run, including how profits are shared, members responsibilities, who needs to agree decisions, and how members can join or leave. Once your LLP has been registered, you will again be sent a certificate of incorporation. As with a limited company, in order to be afforded limited liability, an LLP must be incorporated at Companies House and registered as a limited liability partnership.
Key considerations of limited liability
When it comes to deciding on how you want to run your business and the right structure to use, there are various different considerations to take into account. The business model that you ultimately choose will not only dictate the level of financial risk that you and any co-owners are willing to take, where this can potentially have significant implications for any personal liability should the business fail, it can also impact the following:
- the relevant authorities that you need to register your business with
- the records and accounts that you are required to keep
- the ways in which your business can raise money
- the ways in which management decisions are made about the business
- the amount and type of tax that you have to pay.
You must think carefully about which structure is best suited to your business needs, depending on factors such as the nature and size of your business, whether you intend to do business on your own or as a joint venture, and your future plans for it.
Setting up and running either a limited company or an LLP can be both costly and complex. From the outset, you will have to comply with strict registration requirements, with various other rules and responsibilities on an ongoing basis for the life of the business, and even after. However, if you are looking to limit any personal liability, you will need to understand these rules, and be prepared to take on these extra administrative responsibilities. Equally, if you are looking for scalability, you will also need to think about one of these more complex corporate structures so as to allow for business growth moving forward.
Securing expert advice as to the various legal, financial and practical implications of limited liability models, as well as unlimited business models, can be key to getting this right.
Limited liability FAQs
What it means to have limited liability?
Limited liability is all about reducing personal exposure to financial risk when running a business. If your business is insolvent, liquidated or sued, then the sum of money for which you are personally liable is limited by the business structure.
What is limited liability examples?
Limited liability models can be used in the context of both companies and business partnerships, where a private limited company is abbreviated to Ltd, and a limited liability partnership is abbreviated to LLP.
What is the difference between liability and limited liability?
In the context of running a business, limited liability separates and protects any personal assets, whereas liability, or unlimited liability, means that the business owners personally assume all liability for any financial failure of the business.
Is having limited liability a good thing?
Running a private limited company (Ltd) or limited liability partnership (LLP) can protect you from any personal liability should the business fall into debt or get sued, in this way reducing your personal exposure to any financial risk.
The matters contained in this article are intended to be for general information purposes only. This article does not constitute legal advice, nor is it a complete or authoritative statement of the law, and should not be treated as such. Whilst every effort is made to ensure that the information is correct, no warranty, express or implied, is given as to its accuracy and no liability is accepted for any error or omission. Before acting on any of the information contained herein, expert legal advice should be sought.