The Advantages of Incorporation
29th August 2018
Are you considering incorporating your business but unsure if it will be a worthwhile? Here are the key advantages which incorporation can bring to your business.
Unlimited personal liability –v- Limited Liability
The core advantage of incorporating is to limit your liability. A company has a separate legal personality. As a sole trader, the individual and the business are one and the same. If the business were to encounter financial difficulties, the individual would be liable for the debts, business or trading losses personally and on an unlimited basis. If the business were to be incorporated as a private company limited by shares, the liability of the shareholders would be limited to the extent of their shareholding and no more; the directors of the company would not have any personal liability for the company’s debts, business or trading losses (other than in exceptional cases which would generally involve some ‘misbehaviour’ on the part of the director). Your personal assets can therefore be ringfenced from the business and, if the business becomes insolvent, it doesn’t mean that you also become insolvent.
Access to Finance/Capital
A limited company structure is a far more attractive vehicle as an opportunity for investors. An investor is more likely to be willing to invest knowing that its liability is limited to its shareholding and reduces the investment risk. An investor can also take a defined and clear stake through a specific shareholding which is much harder to achieve if not incorporated. Limited companies are also arguably more attractive for banks and lenders. This is partly due to the fact that these institutions have become accustomed to dealing with limited companies as a matter of course and tend to prefer dealing with incorporated bodies over sole traders and family business partnerships, the latter being generally seen as more unstable.
Companies are also attractive to lenders because they have the option to take security (a floating charge) over the entire assets of the company. It is worth noting that the benefit of limited liability does come with a caveat - many institutional lenders will, as a condition of making a facility available, also seek a personal guarantee from the majority shareholders or director(s) in a start up or new business scenario. This enables lenders to pursue the guarantor as an individual if the company cannot repay its debts. As a general rule, directors and shareholders of limited companies should avoid giving personal guarantees to banks etc. in order to maintain the ringfencing of the business from the personal (although that’s sometimes easier said than done).
If your business requires immediate capital from third party investors or lenders, the decision to incorporate is an important consideration for those looking to expand but lacking the resources to do so.
Potential Cost Savings
The initial legal and accountancy costs are frequently treated as a barrier to incorporation. Setting up a company is much quicker and easier than ever before – you can incorporate a company online for just £12. The only other statutory running cost is the fee of £13 for submitting a Confirmation Statement. The simplicity of online WebFiling with Companies House means that compliance with the reporting requirements can be dealt with quickly and inexpensively. The initial cost involved in setting up a company can often be offset by the potential tax savings, but this depends on a number of factors (net profit, number of employees, existing business structure etc.) and specialised tax planning is required to fully realise this benefit.
The limited company structure makes it much easier to pass on the business to future generations. If a shareholder wants to retire, sell on his shareholding or dies it is much simpler to transfer ownership (shares from A to B). Even where there is a change in the ownership (shareholders) of the company, limited companies are optimised for ensuring continuity of management, contractual relationships etc. Employees of the company can also be given shares so that they have a stake in the business. For sole traders and family businesses run as partnerships, in the absence of formal arrangements in place, there can be problems ensuring the continuity of business after a death – particularly if bank accounts are frozen and there are employees waiting to be paid.
The peace of mind that comes with limited liability is in of itself a justification to incorporate your business. The benefits of incorporation will usually outweigh the disadvantages.
The information contained in this newsletter is for general guidance only and represents our understanding of relevant law and practice as at August 2018. Wright, Johnston & Mackenzie LLP cannot be held responsible for any action taken or not taken in reliance upon the contents. Specific advice should be taken on any individual matter. Transmissions to or from our email system and calls to or from our offices may be monitored and/or recorded for regulatory purposes. Authorised and regulated by the Financial Conduct Authority. Registered office: 302 St Vincent Street, Glasgow, G2 5RZ. A limited liability partnership registered in Scotland, number SO 300336.