Picking the right limited liability structure for your business

If you’re thinking of structuring your business so that it enjoys the benefits of limited liability, you have a choice of three different options; a company limited by shares, a company limited by guarantee, or a limited liability partnership.

Emily Coltman FCA, chief accountant to award-winning online software provider FreeAgent, explores the difference between these three.

Company limited by shares

A company that’s limited by shares is owned by its shareholders, each of whom will own a certain number of shares in the company.

A private limited company (in other words, a company whose shares can’t be bought and sold on the open market) may only have one shareholder – one individual who owns all the shares and therefore owns the company in its entirety.

In the event of the company being wound up or liquidated, the shareholders only have to pay the value of their shares towards any payments to the company’s creditors – hence the term “limited liability”.

Note that in many small private companies, the shareholders of the company are also directors of the company, and if the directors have given personal guarantees to meet any of the company’s debts, or are found guilty of wrongdoing, then they can have to pay the company’s debts from their own money.

Companies pay corporation tax on any profits that the company makes. Any spare profit left over after the company has paid its corporation tax may be paid to the shareholders by way of a dividend.

Company limited by guarantee

A company that’s limited by guarantee does not issue shares and has no shareholders. Instead, a company that’s limited by guarantee will have members, who typically have overall control of the company – for example, the members can appoint and remove directors, and vote on matters concerning the company at the AGM and other meetings.

The company’s articles will give a figure for the limit of each member’s liability in the event of the company being wound up. This is usually £1 per member.

The directors of a company that’s limited by guarantee may be liable for the company’s debts in the same way as for a company that’s limited by shares.

Because a company that’s limited by guarantee has no shares, it cannot pay dividends. For that reason, charities, social enterprises, and not-for-profit organisations, that exist to benefit the community rather than make money for individuals, and that wish to benefit from limited liability, will usually incorporate as a company limited by guarantee, rather than as a company limited by shares.

If a company that’s limited by guarantee does make a profit, then it would be subject to corporation tax on those profits, unless the company has been recognised by HMRC as a charity.

Limited liability partnership (LLP)

A limited liability partnership (commonly referred to as an LLP) is a different type of limited liability structure, a hybrid of a partnership and a company limited by shares.

Instead of shareholders, an LLP has members, and instead of directors it has partners. The members will nearly always be the same individuals as the partners. A corporate body (such as a company) can also be a member and partner in an LLP.

An LLP must have at least two partners and members.

An LLP doesn’t pay tax on its own profits in its own right. Instead, the partners pay income tax and class 4 NIC on their share of the business’s profit, like a partnership where the liability is not limited. That means that if the LLP makes losses in its early years, these can potentially be used to claim back tax on the partners’ other income, for example if they also have jobs outside the partnership. The difference from the above is when the LLP is being wound up, in which case it becomes liable to corporation tax in its own right.

When you’re running a business for profit, you’re more likely to choose a company limited by shares or an LLP, as opposed to a company that’s limited by guarantee. If you’re running and owning the business on your own, then in order to set up an LLP you would also need to set up a company to be the second member of the LLP.

If you’re in any doubt as to which structure would suit your business better, talk to your accountant.

Emily Coltman FCA is chief accountant at FreeAgent, who make award-winning cloud accounting software for freelancers, micro-businesses and their accountants. Try it for free at www.freeagent.com