In our back to basics series on different company vehicles, we’re exploring in detail the different legal entities your business can take, and the pros and cons of each. Here we’re delving into private companies limited by shares.
- What is a private company limited by shares?
- What are they used for?
- How do you form a private company limited by shares?
- What are the advantages and disadvantages of a private company limited by shares?
- How are private companies limited by shares managed?
- Model company formation documents for private companies limited by shares
- How many shares should your company have?
- How do you buy and sell shares in a private limited company?
- What are the rights of shareholders in a private limited company?
- Should your company be limited by shares or by guarantee?
- Differences between a partnership and a private limited company
- Section 60 exemption
- Can a private limited company issue shares to members of the public?
- Can a private limited company trade their shares on the stock exchange?
What is a private company limited by shares?
Many people, at some point in their lives, dream of owning their own business. Perhaps they’re tired of working the 9-to-5 and long for the independence that being their own boss could bring. Maybe they have a brilliant business idea and would like to chance to develop this further and possibly make their fortune. Or perhaps they’ve been working for a while as a freelancer or consultant, and would like a more formal or ‘professional’ front for their business activities.
Setting up a private company limited by shares is a way to create an organisation that is a legal person in its own right, able to enter contracts, own property and employ staff. A private share company offers its owners a degree of protection from personal liability and responsibility for any debts the company runs up in the course of its activities.
In the UK, most businesses are run as private limited companies, and the financial responsibility of the owners (shareholders) are limited to the value of the shares they own. The shares of private limited companies cannot be bought or sold by members of the general public.
Private companies limited by shares must be formally registered with Companies House, based in Cardiff. There must be at least one director from the outset. Their activities, and the way they are administered is governed by certain documents filed with Companies House, namely the company’s Memorandum and Articles of Association.
They must keep formal accounts, and these are open to inspection by members of the public, as are the records of who owns the shares, and the names and addresses of the directors.
What are they used for?
Private limited companies limited by shares are used as a tax-efficient way to run a business, to generate profits for shareholders, and to provide legal protection for their owners.
Most start-ups begin life as private share companies, and many freelancers and contractors set up private limited companies as a way to protect themselves from legal liability for claims against them, and financial exposure for losses.
They are also used to provide a more ‘professional’ front for business activities, and to define a ‘brand’ that will be owned by the company and create value for the owners.
How do you form a private company limited by shares?
A company comes into being when the Registrar of Companies of Companies House issues a certificate of incorporation. This is accomplished by filing the necessary documents with the Registrar and paying a fee.
The owners of a limited company can either register a company with documents that have been tailor-made for their needs, or they can buy a company ‘off the shelf’ that has been already set up but has not yet traded. They then register the changes they need (change in the identity of the shareholders and directors for example) with the Registrar.
The easiest way to form a private company limited by shares is to ask your lawyer, accountant, or a company formation agent to do this for you. They can also help you prepare the documents you need to tailor the company to your individual requirements.
You can also set up a company yourself online using the web service provided by Companies House. You will need to obtain a special code that you’ll use to authenticate documents and provide certain personal details such as your mother’s maiden name and passport number, you’ll also need to provide your address and phone number. Whichever route you choose, we’ve compiled a handy guide, The Honest Guide to What You Do And Don’t Actually Need A Solicitor For – Part 1: Setting Up A Business.
The documents needed to form a company are an application form, the memorandum of association (a brief form in a set format that contains details of the company’s ownership, the shares and a request to form a company), and the company’s articles of association that set out the rules by which the company will be run. These documents are known as the company’s ‘constitution’.
The law relating to companies prescribes different types of model articles for the various types of company, including private companies limited by shares. These will apply by default to your company unless you register a set of tailor-made articles.
The application to form a company at Companies House will need to include the following details:
- The proposed name of the company (this can’t be the same as any other company already on record)
- The type of company (limited by shares) and what business it will be engaged in
- The address of the registered office to which all correspondence will be sent
- The identity of the director(s) and any secretary, including names and addresses
- The number and value of the initial shares, and any share classes
- Other formal documents and declarations prescribed by the Registrar
What are the advantages and disadvantages of a private company limited by shares?
The main advantages of owning a private company limited by shares are:
- They are tax efficient, particularly compared to running a business as a sole trader. Companies pay corporation tax that is currently 19% (2018/19). If you own a limited company in which you also work as a director, you can take a limited salary on which you will pay income tax and national insurance, and take the rest of your earnings as a dividend on which no NI will be due.
- You can run your business entirely separately from your personal affairs. Third parties such as landlords, clients and suppliers will enter into contracts with the company rather than you personally. Your staff will be employed by the company.
- You won’t be able to be sued individually for any claims against the company, or be liable for financial losses, barring fraud.
- You will look more professional and established, particularly if you deal with larger businesses, and if you wish to bid for government work, being established as a company may be a requirement.
- It can be easier to get finance and loans if you are set up as a limited company.
- You can protect your company’s name, and the intellectual property created by your business will be owned by the company and reflected in the value of your shares.
- The company will, if it’s successful, be a valuable asset in its own right that you can sell. You can also sell your shares if you want to retire, do something different, and can pass shares to family members or others in your will.
- Setting up a limited company is relatively easy and cheap.
- You can provide a pension for yourself and your employees as a legitimate business expense.
Here are the disadvantages of a limited company:
- You will have to pay tax on the profits of the business (corporation tax).
- You will have certain routine administration, such as the preparation and filing of company accounts at Companies House, and an annual return of shareholders.
- Members of the public will be able to see your company’s accounts, as well as personal details of the shareholders and directors (unless you have elected to have your address kept private).
- You will have certain ongoing costs, such as accountancy and filing costs.
How are private companies limited by shares managed?
The directors are appointed by the shareholders, and in small companies and start-ups, these are often the same people. Sometimes there is only one shareholder and director, for example freelancers and consultants.
The shareholders don’t run the business, and their liability towards the debts of the business is limited to the ‘nominal’ value of their shares – the value given to the shares when the company was originally set up.
The nominal value of the shares is usually £1. This is different from the market value of the shares that will fluctuate depending on the underlying value of the company’s business and the assets it owns. The difference between the nominal and the market value of a share is known as the share ‘premium’.
The only decisions that shareholders make in the running of a business is the name of the company, the appointment and removal of directors, the directors’ powers and duties, and any changes to the company’s constitution. You can read more about shareholders here.
Model company formation documents for private companies limited by shares
If you are considering setting up your own company limited by shares, there are certain template or model documents that can help you. For example, here is a link to the model articles, and here is a link to the model memorandum.
How many shares should your company have?
Each share of a company limited by shares represents an individual slice of the company’s value. The minimum number of shares your company can have is one. Shareholders are also known as members of the company. There’s no limit on the number of shares you can issue, and you can issue more shares as the company grows, or if you want to create different types of shares or share ‘classes’.
Since owning shares also gives their owners the right to control the company, the percentage of shares owned by each shareholder is important. For example, a company with a single share is owned 100% by that shareholder. If two shares of equal value have been issued, and these are owned by different people, then each shareholder will control 50% of the company and so on.
Most companies are set up with ‘ordinary’ shares, with each share having an equal right to receive dividends and to vote. You can also choose to issue different classes of shares, with different rights to vote, different entitlements to receive a share of the profits, and different rights if the company is closed (wound up). You can read more about shares and share capital here.
How do you buy and sell shares in a private limited company?
Shares in a private limited company are not able to be sold to members of the public in a general sale. The only way you can sell them is privately, to friends or family or by word of mouth. It’s also possible that the articles will restrict your ability to sell shares, by requiring that these be offered to the other shareholders first.
If you are a start-up, or have received investment or finance to start your business, you may also have entered into a shareholders’ agreement with the other investors that may restrict your ability to sell your shares, as a means of locking you into the business in the early stages or as the company grows and becomes more valuable.
What are the rights of shareholders in a private limited company?
As we’ve seen, the rights of shareholders are described in the company’s articles and in any shareholders’ agreement. It’s also possible that the owners have created different classes of shares, with different rights, for example:
- The right to appoint directors
- The right to be consulted on, or to veto, certain decisions a company may make, for example to enter into loans or to dispose of assets
- The right to have a certain weighting applied to their shares in the event of a vote on key events
Certain shares may be non-voting, and the right to receive a dividend may be disallowed. This is common when companies set up share ownership schemes for their employees.
Minority shareholders (those holding a relatively small percentage of the shares) also have certain protections, for example, to call a general meeting, to prevent a meeting being held at short notice, or to prevent the passing of a special resolution at a general meeting of the company.
Should your company be limited by shares or by guarantee?
The financial liability of members of a private company limited by shares is the nominal value of the shares they own. However, companies can also be limited by guarantee; this means that instead of the owners’ liability being limited to the value of their shares, it’s limited by the guarantee given at the time of incorporation – that each member will pay a certain amount to the company when called upon to do so during a winding-up of the company – generally a nominal amount such as £1.
A company limited by guarantee is normally the appropriate format for a non-profitmaking company, an association or a club, where members want to be able to contract with third parties but seek the legal protection from liability that company ownership brings.
A company limited by guarantee is not an appropriate vehicle for a business, as any ‘profits’ (surplus of any income or value of the assets of the company over the company’s liabilities) cannot be distributed to its members by way of dividend.
Differences between a partnership and a private limited company
A legal partnership is very different from a company. Partners in a business are jointly responsible for the profits and losses of a business, and each partner pays their own taxes on their share of the income of the business.
The key differences between private limited companies and partnerships are that:
- Limited companies must be registered at Companies House, and its accounts are open to inspection by the public
- Partners are personally responsible for the liabilities of the business
- Partners do not pay National Insurance contributions on the profits of the business that they take out in earnings
Section 60 exemption
Most private limited companies are obliged to put ‘Limited’ or ‘Ltd’ at the end of the company name when they are registered at Companies House.
Some limited companies are exempt from this requirement (a section 60 exemption), provided they can show that they meet the following conditions:
- They are limited by guarantee and not by shares
- The objectives of the business must be the promotion or regulation of commerce, art, science, education, religion, charity or a profession
- Profits are applied to the promotion of the business
- No profits are returned to members
- If the business is wound up, all assets are returned to the members
Can a private limited company issue shares to members of the public?
No, shares in a private limited company can’t be sold to members of the public. The only type of share that can be freely traded are those in public limited companies (PLCs). PLCs are very similar to non-public companies, but they must meet certain minimum capital requirements, and have at least two directors and a company secretary with a professional qualification.
The main advantage of becoming a PLC is the ability to generate capital through the sale of shares. This type of company structure is most suitable for companies that have reached a certain level of maturity.
Can a private limited company trade their shares on the stock exchange?
No, a private limited company cannot trade their shares on the stock exchange.